U.S. Must Buy Assets to Prevent `Tsunami,' Gross Says

By Jody Shenn

Sept. 4 (Bloomberg) -- The U.S. government needs to start buying assets to stem a burgeoning ``financial tsunami,'' according to Bill Gross, manager of the world's biggest bond fund.

A process of delevering, where banks are shrinking and cutting off lending, is sapping demand for bonds, real estate, stocks and commodities, driving down assets of even ``impeccable quality,'' Gross said.

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross of Newport Beach, California-based Pacific Investment Management Co. said in commentary posted on the firm's Web site today. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

The government needs to replace private investors who either don't have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are now reluctant to fund financial firms after losing money on more than $400 billion in capital raisings, Gross said. Banks and brokerages are retreating after more than $500 billion in writedowns and credit losses since the credit seizure began last year.

Treasury should support not only mortgage finance providers Fannie Mae and Freddie Mac, but also ``Mom and Pop on Main Street U.S.A.,'' through subsidized home loans guaranteed by the Federal Housing Administration and other government institutions, Gross said. A new version of the Resolution Trust Corp., which bought assets from failing institutions during the savings-and-loan crisis of the 1980s, may also work, he said.

`New Balance Sheets'

As Fannie and Freddie, banks, securities firms and hedge funds shrink, yields on all debt assets will rise compared with benchmark rates and volatility will increase, Gross said. Delevering ends once sellers have depleted their assets and sufficient capital has been raised, Gross said. Unless ``new balance sheets'' emerge, prices of almost all assets will drop, he said.

``There is an increasing reluctance on the part of the private market to risk any more of its own capital,'' Gross said. ``Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning.''

Home prices have fallen 10 percent year over year, a decline not seen since the Great Depression, Gross said. That drop translates to an even bigger decline in overall wealth as margin calls lead to distressed sales, he said.

`Rare Diamonds'

Fannie and Freddie 30-year fixed-rate mortgage bond yields, which influence the rates on most new home loans, have probably risen 75 basis points because of the waning demand, Gross said. A basis point is 0.01 percentage point.

About 61 percent of the holdings of Gross's Pimco Total Return Fund were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or U.S. agency Ginnie Mae, according to data on Pimco's Web site.

The fund returned 9.8 percent in the past 12 months, beating 97 percent of its peers in the government and corporate bond fund category as of Sept. 3, according to Bloomberg data. The returns are 5.76 percent annually over five years. Pimco, a unit of Munich-based Allianz SE, has $830 billion of assets under management.

``In a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand,'' Gross said.

To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net