Did Pimco's Exec Pump and Dump Ginnie Maes? Not Likely

If you watch CNBC all day like we do, you may have caught a tense little segment on Tuesday's "Power Lunch," in which Bill Griffeth confronted Bill Gross about his appearance on the show two Fridays before.

Gross, managing director at Pimco, is the bond market's Peter Lynch. He manages the world's largest bond mutual fund and has one of the best long-term performance records. On his Sept. 15 "Power Lunch" appearance, he reiterated an opinion he'd been voicing for months: That Ginnie Mae mortgage pass-throughs (explained below) are going to outperform other kinds of bonds in the months ahead.

A little over a week later, BondWeek, a newsletter published by Institutional Investor, ran a story based on anonymous sources saying that on the same day Gross appeared on TV, Pimco had sold $2 billion of the securities he was recommending. The story didn't say it knew at what hour the alleged sale took place, but it did say the securities were being offered for sale before, during and after Gross's TV appearance.

Gross appeared on "Power Lunch" again on Tuesday, not to deny that Pimco had bought or sold Ginnie Mae mortgage pass-throughs that TV Friday, but to reject the story's implication: That the shop was guilty of pumping and dumping its position.

The episode affords an opportunity to explain a few things about the bond market. Specifically, how aspects of the story that went unreported -- arcane but crucial details about how the mortgage-backed securities market works -- make it seem unlikely that there was any wrongdoing involved.

Still, it seems pretty clear that Pimco didn't do enough to avoid the appearance of impropriety, and it will probably take pains to avoid this kind of embarrassment in the future. (I tried to get in touch with Gross, but his spokesman didn't return my call.)

As an aside, these are bonds we're talking about. Because they're a relatively low-risk investment, their prices never move that much to begin with. But if anyone can move the bond market, Gross can. The bond market listens to what he says because Pimco is such a large chunk of the market that his strategies push the market around. In January, for example, Pimco loaded up on long-maturity Treasuries, making a big bet that the Treasury yield curve would invert as long-maturity issues outperformed short-maturity ones. The yield curve did invert, but it inverted in part because Pimco was buying long-dated Treasuries in such large volume.

Gross's high regard for Ginnie Mae pass-throughs had been common knowledge in the bond market for months, however. Gross publishes a piece of commentary on Pimco's Web site every month, and he anointed Ginnie Mae pass-throughs as his new favorite bond investment back in May. (Fixed-Income Forum followed up with a series of articles on May 26, June 2 and June 9.) So he wasn't saying anything new on Sept. 15.

Bond Pump-And-Dumps Unlikely

There are at least a couple of reasons why the kind of pump-and-dump maneuver that works in the stock market probably wouldn't have worked in this case, or in the bond market generally.

One difference between stocks and bonds, as far as the potential for market-manipulation goes, is volume in individual issues. The bonds in question, Ginnie Mae Series I pass-throughs, are one of the most common varieties of mortgage-backed securities. At last reckoning there were $430 billion of them outstanding. While some 15% have been turned into derivatives that trade separately, even the residual $370 billion is more than the market value of all but two U.S. companies, General Electric and Cisco. Bill Gross may be influential, but this isn't a penny stock.

Incidentally, if Pimco had in fact sold $2 billion of Ginnie Mae Series I pass-throughs, that probably wouldn't have represented anything close to its total position. The $35 billion (PTTRX Quote)Total Return fund Gross runs, which is only the largest of several he manages, had $7.7 billion of them at the time of its latest filing on March 31 -- two months before he went public with his affection for the bonds. He may have added even more.

The second point concerns the institutional nature of the mortgage-backed securities, or MBS, market. To manipulate a market, you need gullible investors with the ability to pull the trigger immediately. The MBS market has few, if any. As my previous columns have explained in greater detail, MBS are among the most complicated bond investments to value, and they are denominated in units of $25,000. As a result, the MBS market is nearly the sole province of professionals. And nonprofessionals who invest in mortgage-backed securities aren't doing it through an online broker. It's still largely an over-the-counter market where you need a telephone and a broker to buy or sell. That remains true of the bond markets generally.

Complicated Ginnie Mae Transactions

Finally, it makes perfect sense that Pimco would have been involved in Ginnie Mae Series I transactions on Sept. 15, because of the way the securities are traded. Gross said on TV, and repeated to Bloomberg News, that the only Ginnie Mae transactions Pimco was involved in on that day were so-called rolls, in which it bought and sold securities simultaneously.

How's that? Most trading of MBS takes place in the "to-be-announced," or "roll" market. Securities are sold on a forward basis. Rather than holding the physical securities, investors instead agree to take delivery of them the following month at an agreed-upon price. This has two purposes: It enables mortgage bankers to extend mortgage loans that won't close for at least a month, and it saves MBS investors from having to account for the physical securities, which are an accounting nightmare. Investors obtain at least the same return from the arrangement that they would from holding the physical securities because they agree to pay a price that is lower than the securities' current market value.

Investors agree to take delivery of the MBS on the settlement date for that particular security. Where transactions involving stocks and other types of bonds settle within three days of the trade date, MBS transactions settle only once a month, according to a schedule set by the Bond Market Association, because settling a MBS trade is much more complicated.

As the settlement date for the security approaches, MBS investors decide whether they want to take delivery of the physical securities, close out their position, or roll their position into the next month. Rolling, the most popular option, entails simultaneously closing out the agreement to take delivery of the securities on the approaching settlement date and entering into a new agreement to take delivery of them on the subsequent settlement date. (It's comparable to what happens in the futures markets as expiration approaches.)

The heaviest roll activity takes place during the five business days leading up to the settlement date, which is different for different types of MBS. The settlement date for the securities in question here was Sept. 19, two business days after Gross's Sept. 15 appearance on CNBC.

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