Pimco’s Gross: Taxpayers can gain from $700 billion rescue

September 24th, 2008, 3:10 pm · 27 Comments · posted by Mathew Padilla

Don’t call it a bailout.

Bill Gross, the investment wiz of Newport Beach-based bond king Pimco, said the government is poised to make an “investment” in troubled assets. It’s not a bailout, he said. In fact, if Uncle Sam plays its cards right, taxpayers could actually profit, Gross says.

His outlook is a stark contrast to critics who decry Treasury Secretary Henry Paulson’s rescue plan as a big waste of taxpayer funds. Paulson wants the government to spend up to $700 billion on the most toxic mortgages and related assets on the books of banks.

Paulson, joined by Federal Reserve Chief Ben Bernanke, says buying the assets will shore up the books of banks, and they can then go out and make more loans.

His plan is being hotly debated in Congress, but some action is expected by next week.

In an interview with Mortgage Insider, Gross explained why he believes the plan is necessary and misunderstood.

Q. What would happen if Congress didn’t pass the $700 billion plan? Why should most citizens care?

A. “Because it will affect their jobs,” Gross said. “It will affect unemployment. It will affect the state of the economy. Asset prices are deflating rapidly. Banks are unwilling to make loans. That means payrolls may even be suspended as the ability to lend money is curtailed. It really snowballs pretty quickly when you study the dynamics of asset liquidation and debt deflations, such as the 1930s in the United States and Japan’s example of the 1990s.”

Gross said he estimates that all of the assets of the United States, meaning real estate, stocks and bonds, have lost about 12% in value over the past 12 months, dropping to $90 trillion.

“Other than the Depression, that number is unheard of. We have wealth destruction as prices go down. …The leverage society is now deleveraging, and it’s not pretty.”

Q. You have said this is not a bailout of Wall Street. If it’s not a bailout, what is it?

A. “It’s an investment, and that’s the way Bernanke and Paulson put it,” Gross said. “It depends on the prices that are paid for these mortgage pools.”

Gross says that if the plan is approved by Congress, everything will depend on what the government pays for the mortgages and related assets. For example, if a homeowner owes $100,000 on a mortgage, and the government pays the bank $100,000 for it, that would be a bailout of the bank. But if the government pays less than $100,000 for the same loan, the bank loses money and taxpayers could see a profit on their investment.

Q. But how can the government make money if Bernanke is saying the government will pay above market prices for the assets in order to recapitalize the banks?

A. “He is right,” Gross said. “There is this delicate balance.”

Gross said the government must find the right price between the market value of the assets they are buying and the value they have on paper at the banks holding them.

As an example, Gross said Pimco recently paid 65 cents on the dollar for a pool of mortgage-related assets. He said distressed loans and securities can trade anywhere from 20 cents on the dollar to 80 cents on the dollar, but 65 cents is a good benchmark.

Pimco expects to earn a double-digit return on its money for the 65 cents on the dollar it paid. The trick for the government is to find the right price between 65 cents and 100 cents on the dollars. The closer it gets to 100 cents on the dollar, the better banks will like the deal. But the closer it stays to 65 cents, the better for taxpayers. Gross said government must be careful and find the best compromise price, which means taxpayers will not lose money and may earn a profit.

Gross said 65 cents on the dollar assumes as many as 30 percent of the loans being purchased will end in foreclosure, and for every home that ends in foreclosure the investor gets as little as 40 cents on the dollar.

“It’s certainly possible if done right for the Treasury to make money for the tax payer,” Gross said.

Q. Would PIMCO benefit from the $700 billion plan?

A. “If they select us as an adviser we would work for no fee,” Gross said. “You can make your own assumption. We would work for free.”

Q. But what about the government’s takeover of major loan buyers Fannie Mae and Freddie Mac earlier this month? I understand Pimco’s funds own mortgage-backed securities and their prices jumped after the takeover. Your response?

A. Gross said the prices of Pimco’s mortgage securities did increase a little, but they were always good investments.

“They were agency guaranteed, tantamount to Treasury (bonds),” Gross said. “We are not talking about subprime. They were always AAA investments.”

Gross added he has long advocated for the government to buy up distressed loans and change the terms to help homeowners avoid foreclosure. He supports the Democrats calling for that to be included in the plan.

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