You can't bail out everyone, Bill Gross tells Obama

Bill Gross, the founder of the world's largest bond manager, Pimco, thinks the new US administration should focus on supporting asset prices, not just on one off bail-outs.

In Gross' latest investment outlook, published on the Pimco website on Thursday morning, he says that it is the so-called 'shadow banking' system (a phrase coined by Gross himself) which needs reinvigorating if asset prices are to ever recover and if the current 'mini-depression' is to be brought to an end. This shadow banking system to which Gross refers incorporates SIVs, hedge funds, CDOs and the massively levered mortgage and investment banks. He thinks it was this shadow system which fuelled asset appreciation in all investment markets in recent years and in turn spurred real economic growth and employment to unsustainable levels.

'With US housing prices as its trigger, the delevering process....headed over the cliff in mid-year 2007, dragging down almost all asset prices except government bonds,' he says. 'The real economy followed shortly thereafter, not just in the US, but globally, proving that linkages work on the “down” as well as the upside. To Pimco, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices. If that can be done, the real economy will level out as well.'

Gross has played an important role in the US government's strategy for stimulating the country's economy. Indeed, his company runs the Commercial Paper Funding Facility (CPFF), set up so the government can underpin the commercial paper market used by many major corporations to fund their day-to-day operations. He thinks that this CPFF and the Federal Reserve’s purchase program for agency-backed mortgage loans, which he also assists in, have been 'the major policy successes to date – not because of our involvement – but because they have supported and increased asset prices.'

'Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama’s targeted three million new jobs will have a fighting chance of being achieved,' Gross says.

His advice to the administration of Barack Obama is as follows:

'You can’t bail out everyone, yet economic recovery is not possible unless certain critical asset sectors are not only reliquefied, but rejuvenated in price. The prior administration’s focus on the banks has been critical but unidimensional. The shadow banking system with its leverage and financial innovation, powered a near 25-year global economic expansion, but it is the delevering of those hidden quasi-banks that is now threatening its petrification.

'Policymakers should not focus entirely on one-off bailouts of large real estate developers, municipalities, or even credit card issuers like they have with Citi, BofA, and AIG. Rather, they should recognize that supporting critical asset prices such as municipal bonds, CMBS, and even investment grade corporate bonds is a necessary step towards eventual economic revival.'

He thinks capitalism is hugely dependent on credit. While credit is now coming from within the banking system, it has shown to not be so easy to get the 'shadow' banking system to start lending again.

'That (shadow bank) lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist. The original focus of the TARP was on asset prices, but the prior Administration quickly lost its way or perhaps its nerve,' he says.

To avoid the 'deflationary precipice,' it is key that asset prices are supported, according to Gross. His full investment outlook can be found here.