GROSSLY MISTAKEN

This week I have a real treat for you. It’s a special guest editorial from free-lance financial journalist and Human Events magazine contributor Jim Woods. Jim is one of the finest writers I know. His grasp of the financial markets and his ability to convey what often is very complex information to a wide audience of non-experts is truly remarkable.

In this op-ed, Jim echoes many of my thoughts on the housing crisis and the dangers of government intervention in the subprime mess and in the economy at large. I hope you enjoy reading his philosophical perspective on this issue as much as I did.

By Jim Woods

"The ultimate solution, it seems to me, must not emanate from the bowels of Fed headquarters on Constitution Avenue, but from the West Wing of 1600 Pennsylvania Avenue. Fiscal, not monetary policy should be the preferred remedy, one scaling Rooseveltian proportions…"

—Bill Gross, Managing Director, PIMCO

For a free market, small "l" libertarian like me, nothing is scarier than the invocation of FDR when discussing a solution to the current housing crisis. Of course, I have come to expect such drivel from politicos, as their first solution to any market predicament is to stomp in with the giant boot of big government.

What I did not expect, however, is the wanton cry for government assistance from one of the premier bond mutual fund managers in the country. Bill Gross, managing director of the PIMCO bond funds, has long been regarded as one of the smartest guys in the room when it comes to fixed income investments. He’s a fixture on CNBC, and is nearly always brought in for his insights on the Fed and what is happening in the Treasury markets.

In his September Investment Outlook commentary, Gross writes about the subprime mortgage mess and the current housing crises. He likens the situation to the puzzle game, "Where’s Waldo?" Waldo, according to Gross, is "the bad loans and defaulting subprime paper of the U.S. mortgage market." His argument, in essence, is that nobody really knows where these subprime loan baskets are hidden, and as such they have the potential to rear their ugly heads and cause more damage where nobody suspects they would.

On this point, I think many observers, including myself, would agree with Gross. There are a lot of subprime mortgage derivatives owned by many banks and hedge funds around the globe. And, the uncertainty as to who owns what and how much makes for a volatile cocktail ready to intoxicate financial markets worldwide.

Now if Gross would have stopped here with his analysis, confining his comments to the more esoteric subprime mortgage loan derivative dangers, I wouldn’t have a bone to pick with him. Unfortunately, the PIMCO manager went on to address the issue of what to do about the housing market at large.

After the tacit acknowledgement that "…a certain dose of market discipline in the form of lower prices might be healthy… ," Gross goes on to argue that the resultant impact of a projected two million-plus mortgage loan defaults on housing prices will likely be close to a 10% decline. That, says Gross, is "… an asset deflation in the U.S. never seen since the Great Depression."

There’s the invocation of the Great Depression, and of course as Gross sees it, the only solution to the likes of the Great Depression is another New Deal government solution designed to "save" America from the looming housing crisis.

"If we can bail out Chrysler, why can’t we support the American homeowner?" asks Gross. He goes on to say that, "The time has come to acknowledge that there are precedents aplenty in the long and even recent history of American policy making. This rescue, which admittedly might bail out speculators who deserve much worse, would support millions of hard-working Americans whose recent hours have become ones of frantic desperation."

Now leaving aside the notion that the Great Depression was the result of bad government policies and that the New Deal actually prevented the economy from recovering faster than it otherwise would have without government intervention, I am going to concentrate on another aspect of this Bill’s grossly mistaken argument.*

The real issue here, as I see it, is the fact that those "hard-working Americans whose recent hours have become ones of frantic desperation" have only themselves to blame for their current situation.

Many Americans, having witnessed the sharp rise in home values in recent years, decided to gamble. They took out risky adjustable rate mortgage loans they really couldn’t afford in the hope that their home’s value would continue appreciating and that they would be able to refinance at a lower interest rate when the time came.

This was a risky proposition that worked out quite well for some homeowners. For others, it has turned into a financial nightmare, as their inability to pay their mortgage has forced them into foreclosure.

Such is the gamble that is life.

Sometimes calculated risks succeed, other times they fail. Ask any entrepreneur and he or she will tell you that risk taking is the essence of success. In fact, you cannot have the prospect of success without the prospect of failure.

This fact of life seems to be lost on those, such as Bill Gross, who seem to think that it is the government’s job to help homeowners live a risk-free life. This nanny-state mentality, however well-intentioned, is the exact opposite of what is required to remedy the excesses baked into the housing market.

The real solution, as Gross himself acknowledged, is to let the air seep out of the housing bubble and to let home prices come back down to rational levels again. It’s only by allowing the market’s pricing mechanism to work that we can ever hope to avoid and/or correct speculative market bubbles in the future.

Getting the government involved in bailing out homeowners will only reinforce the notion that no matter how risky the investment, you can always count on Uncle Sam to dig you out of your hole.

Let’s hope this grossly mistaken cry for a risk-free society falls on deaf ears.

*For those of you interested in a complete discussion on the Great Depression and its real cause, i.e., bad government policies, I suggest you read America’s Great Depression by Austrian economist Murray N. Rothbard. This brilliant analysis of one of the seminal events of the 20th century is a must read for anyone with even a passing interest in the subject.