Bill Gross, the chief investment officer of the world’s largest bond fund, said the Fed “cannot afford to let homes go down by 10 to 15 percent”, so it will inevitably cut rates. Gross expects the Fed Funds rate to fall to 3.5%. He estimates the total cost “of subprimes and Alt-As and basically garbage loans” at $1 trillion. Gross has been calling on the Fed to act to save housing for months, but apparently his bailout scenario doesn’t even incorporate such economic indicators as the dollar exchange rates and inflation. He warns that $250 billion in non-prime loans are about to default and those could hurt banking giants like Merrill Lynch and Citigroup. Hey, in fact that’s already happening.
According to Gross, reducing the Fed Funds rate to 3.5% will result in 30-year fixed mortgage rates dropping to 5.0-5.5%, which will magically solve all the problems in financial markets. A simple solution, isn’t it? What’s the Fed waiting for? His monthly market commentary gives a nice analysis of the economic situation at the moment, but I don’t think a drastic rate cut is a solution. When the Fed cut rates in September, mortgage interest actually increased instead of dropping. Perhaps a drastic cut will actually lower the 30-year mortgage rates, but it may also wreak havoc in other sectors of the financial market and it will most probably result in monster inflation. Gas at $5/gallon, anyone? Blame financial innovation, not interest rates.
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