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How Pimco Is Holding American Homeowners Hostage

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As overlord of the fixed-income finance market, it generates billions annually in effort-free profits. Now it wants to make things worse.

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When these kinds of outcomes are the fruit of Mr. Market at work, they are, of course, unobjectionable. But when they're gifts of the state, trouble eventually comes, and now it has with a vengeance.

At the end of the day there are upward of 15-20 million American households that can't afford their current mortgages or will be strongly disinclined to service them once housing prices take their next -- and unpreventable -- leg down. But Pimco's gold-coast socialism is exactly the wrong answer. Rather than having their mortgages modified or forgiven, these households should be foreclosed upon, and the sooner the better. In that event, there's absolutely no danger that impacted families will go without shelter. The supply of rental units is swelling by the day and rental rates will come down further as speculators buy up REO and recycle back to the rental market.

Stated differently, pulling the plug on HIDC will rescue millions of households from mortgage-payment slavery and put them into a buyer's market for rented-housing services -- a social welfare gain under present circumstances. To be sure, they'll loose their credit and probably their credit cards in the process. But the days of living off the housing ATM and bank-issued plastic are over for the American people anyway. Creating an honest financial environment where households are required to rebuild their balance sheets and consume within their means isn't a disservice or injustice to anyone.

Likewise, millions of additional families that can, in fact, service their mortgages or that own their homes debt-free will face a further shrinkage of their paper wealth. The $16.5 trillion of household real estate value reported by the Fed in its Flow of Funds for the first quarter of this year was already down about 30% from the 2006 peak, and could readily decline by another 20%. But would the implied $3 trillion loss of paper wealth be avoidable in any event?

The fact is, there are about 78 million baby boomers inexorably heading for their next to final final berth in a nursing home. Given the shambles of the American economy, who is going to buy their over-valued castles anyway? Certainly it won't be their downwardly mobile children. So why not purge this phony wealth now and let boomers began to plan for their golden years based on reality, not illusions.

Additionally, the great wave of foreclosures that would result from pulling the plug on HIDC will cause the enablers of the housing debt boom to suffer huge losses on the outstanding mortgage paper. Admittedly, much of that loss will accrue to the $5 trillion or so of mortgages guaranteed by Freddie/Fannie/FHA. But the taxpayers are on the hook for those losses already, and crystallizing huge write-downs now would actually have a very salutary effect. The voters would get in unmistakable terms a reckoning of the massive harm inflicted on them by the congressional housing princes such as Barney Frank and Chris Dodd and their crony capitalist paymasters. Hopefully, the result would be a thorough-going purge of the political system, too.

As to the enablers in the world of fixed-income managers, they'd get their just desserts as well. They'd be forced to absorb hundreds of billions in write-downs on impacted private-label residential and commercial mortgages -- perhaps sharpening their eye for credit risk in the future. But more importantly, pulling the plug on HIDC would eliminate in its entirely any new issues of federally guaranteed housing paper and the no-brainer spreads that the likes of Pimco have harvested from it for decades. Indeed, in a HIDC-free world, the great fixed-income fund managers would be transformed from parasitic enablers of financial bubbles to old-fashioned credit risk managers -- surely a gain to society, if not to their bonus accounts.

Finally, flushing out underwater mortgages and faux homeowners will create the greatest renter's market of all time, permitting lower-income households to rent shelter services at better prices than they've ever been afforded. Indeed, propping up HIDC actually works against the economically disadvantaged because the whole purpose is to keep housing asset values artificially high and foreclosed properties off the rental market.

To be sure, it could be accurately observed that there are millions of lower-income households that can't afford adequate housing services even at these prospective bargain-basement rents. But Milton Friedman pointed out long ago in one of the instances where he was dead-right that this is a problem of too little cash income, not of insufficient housing. And he proposed to address the social problem of inadequate cash income for housing, food, clothing, and all the other necessities of life, with a mechanism to efficiently supply disadvantaged families with additional cash -- the negative income tax ("NIT").

Needless to say, the crony capitalists of America have never been interested in the negative income tax because it would produce only social justice, not artificial economic windfalls to privileged suppliers of subsidized goods and services. Having loudly professed his heartfelt concern for the plight of the less advantaged, perhaps now would be a good time for Bill Gross to swap out his Fannie for a NIT.

No positions in stocks mentioned.

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