Wall Street Whispers: Is Bill Gross Full of Baloney?

Bill Gross has used the press to threaten his abandonment of the mortgage market if policy doesn't go his way. There's a chance he's bluffing.
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NEW YORK (

TheStreet

) - Is Bill Gross full of baloney?

It's starting to seem that way.

Gross, a high-profile market sage who manages the world's biggest bond fund, made some provocative comments that stand to severely impact the $10 trillion mortgage-backed securities (MBS) market. Apparently, if the government stops standing behind MBS, Gross will stop buying them for his $234 billion PIMCO Total Return Fund.

"Without a government guarantee, as a private investor, I'd require borrowers to put at least 30% down, and most first-time homebuyers can't afford that," Gross told the

Financial Times

.

His comments come days ahead of the Obama administration's first step in a serious examination of what ought to be done to repair the nation's busted housing-finance system. As a result, one could be forgiven for thinking Gross is speaking from his bully pulpit, rather than from his heart.

President Obama taking on a huge task. At the moment, the housing system is structured such that mortgage lenders operate in an "originate to sell" model. They retain relatively little exposure to the loans they originate. The debt is mostly securitized, chopped up and passed along to the bond market.

A proposal in the financial-reform bill that will force banks to retain just 5% of the mortgages they shove off to investors received a significant amount of pushback and stands to freeze up lending even more. Major lenders like

Bank of America

(BAC) - Get Report

,

Wells Fargo

(WFC) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

and

Citigroup

(C) - Get Report

have already stopped originating mortgages that aren't backed by the federal government. That's because investors like Gross won't touch the other stuff today.

Therein lies the main problem with the housing-finance system: Taxpayers are left holding the bag when the system goes bust, while investors like Gross are relying upon a government guarantee to boost their bottom lines.

So far this year, PIMCO Total Return has delivered nearly an 8% return for investors - far better performance than many asset managers wading through the broader stock and bond markets. Over the past year, it has delivered a 12.6% return and over the past 10 years, it's delivered 7.4%, on an annualized basis.

PIMCO Total Return investors can thank taxpayers for most of those gains.

Allianz

(AZ)

, the German insurance giant which owns PIMCO, says 63% of the fund's total assets are stocked in "government-related" securities -- those bonds issued by the Treasury Department or backed by the

Federal Deposit Insurance Corp.

, as well as derivatives of those bonds. But truly, the amount backed by taxpayers is more like 82%.

That's because Gross' fund has another 3% in municipal bonds and 16% in "mortgage" assets, which is to say mortgage-backed securities that come with a GSE wrap from Fannie, Freddie, Ginnie or the FHLBs.

If Gross is being honest about his intentions in regards to MBS, and if the Obama administration does decide to do away with those guarantees - both big "ifs" - that would mean Gross' fund would have to get rid of $37 billion worth of assets pretty quickly.

Whispers about a scribbled note on a page of the reform bill regarding Fannie and Freddie sent bank stocks into a tailspin in moments' time. Completely removing government support from the mortgage market would cause a serious decline in the value of Gross' mortgage-related assets in a short amount of time.

Before issuing his veiled threat via the

FT

interview, Gross had spoken with another publication, saying he had moved more assets into Treasury bills because of deflation.

According to him, "deflation isn't just a topic of intellectual curiosity; it's happening."

That's a funny statement because, according to government statistics, it's questionable at best whether deflation is about to be happening.

The last time prices moved more than half a percentage point over a month's time, on a seasonally adjusted basis, was June 2009, when they rose 0.7%. On an annualized basis, prices have been going up steadily for the past eight months. Taking volatile commodity prices out of the mix paints an even more inflationary picture.

In any event, whether Gross is correct about deflation or not, he certainly helped his position by broadcasting it in the press. As a respected authority in regards to mortgage bonds, he will also be a featured panelist at the Treasury Department's event concerning the future of housing finance.

People listen to Gross, they want to know what he thinks, and they want to follow his lead in making investment decisions. But if the financial-reform bill showed anything, it's that power brokers and lobbyists aren't setting the agenda in Washington the way they once did -- even if they still set the agenda in the market and in the press.

President Obama is finally starting to address a serious issue that has been ignored for far too long. It didn't make it into the Dodd-Frank reform bill, barely got a nod from regulators and didn't have a strong presence in Washington dialogue until recently. And the ultimate outcome will have enormous consequences on Wall Street, Main Street and Capitol Hill.

A few ideas have been circulated to fix the housing system's busted foundation. The anti-Obama camp of hard-core conservatives supports a free-market approach. Under their notions of reform, the government guarantee goes out the window, with GSEs' existing debt wound down over a period of time.

Perhaps unsurprisingly, industry groups

really

dislike this approach, preferring to maintain the status quo. The most significant change they have proposed to the system is making sure the government guarantee on Fannie-Freddie debt is explicit - as it is with Ginnie and the FHLBs - rather than implicit, as it has been nominally since their inception.

Considering the political reality, Americans' fondness of homeownership and the sheer enormity of a task like wiping out the housing-finance system and starting from scratch, there will probably be some middle-of-the-road solution.

Whatever the outcome, another large buyer of Fannie-Freddie securities

recently pointed out that there's little chance private investors will abandon the mortgage-backed securities market completely. There will be some initial tremors from any major policy change, but eventually they will fade.

"I don't know what the answer is to GSE reform; what's your policy objective?" asked Jay Diamond, managing director of

Annaly Capital Management

(NLY) - Get Report

at a panel discussion on GSEs. Diamond later added: "The market will adapt to any change."

Even if the government does something drastic like removing its direct financial support of the housing system, Gross' threat appears to be empty. There's only so much yield one can derive from a portfolio of T-bills.

-- Written by Lauren Tara LaCapra in New York

.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.