When Bill Gross speaks, listen up....

PIMCO (I call them PIMPCO - cuz I am stupid like that) recently released its investment outlook and it doesn't look good.

The Backdrop:
-We are still in a de-leveraging process
-Debt and credit are the "mother's milk" of capitalism. Without them we can still transact but not as efficiently; hence Central Banks do their best to supply us with just enough milk to maintain economic progress, but no so much that we ignite rampant inflation (too much money chasing too few goods)
-Sometimes the "milk" is bad and we have de-stabilization in the markets (aka we wait for milk but nothing comes out)

Given that, I now give you Mr. Gross:

"The housing bubble was well inflated by low interest rates, easy, and in some cases fraudulent credit, a lack of federal and state regulation, and a gullible public who read the history books for the past half century and knew full well that home prices never, ever go down. Not much of an enigma there. No riddle to be solved it would seem. It was simply a fairy tale too good to be true."

-This is the Nasdaq bubble placed in the hands of more "citizen" investors (the people that make up 70% of our GDP growth)

Housing can morph a froglike economy into something resembling Godzilla. That is because it is the most levered asset class and the one held by more “investor” citizens than any other. U.S. homes are market valued at over 20 trillion dollars with nearly half of the value supported by mortgage finance of one sort or another.

-Mr. Gross notes that now the economy is coming down from its "Godzilla-like high" and is now reverting the mean as 25 million homes purchased after 2004 could become "upsidedown" (I personally don't think its that high)

-Either way, however, the losses from the impending defaults and walk-aways (why would you keep paying if your house isn't worth as much as your loan?) could reach as high as $1 trillion dollars (that's a lot of chedda)

The “upsidedownness” in many cases results in foreclosures, or outright abandonment and most certainly serves as an example of what not to do for millions of twenty-somethings or new citizens choosing between homeownership and renting. The dominoes fall month-by-month, forcing prices ever lower as shown in Chart 1 provided by Case-Shiller. An asset deflation in turn becomes a debt deflation, as subprimes, alt-As, and finally prime mortgages surrender to the seemingly inevitable tide. PIMCO estimates a total of 5 trillion dollars of mortgage loans are in risky asset categories and that nearly 1 trillion dollars of cumulative losses will finally mark the gravestone of this housing bubble. The problem with writing off 1 trillion dollars from the finance industry’s cumulative balance sheet is that if not matched by capital raising, it necessitates a sale of assets, a reduction in lending or both that in turn begins to affect economic growth, creating what Mohamed El-Erian fears as a “negative feedback loop.”

-Another problem with losing a trillion dollars is that the banks believe they won't have to "mark to market" because...

GaveKal’s Anatole Kaletsky points out that “the whole point of a bank is to exchange short-term, liquid liabilities for long-term illiquid assets whose value is hard to gauge.

-However the problem with that theory (while correct in 99% of cases with banks) is that it doesn't work in this housing market given the enormous surplus of inventory and no amount of intervention/bailouts can re-inflate this housing market, so the banks will have to eventually "bite the bullet" on loan losses.

Make no mistake, the current conundrum that must be solved is: how to make the price of 120 million U.S. barns stop going down in price and then to make them go up again.

-Gross also notes that although the Fed has made capital abundant, mortgage rates have actually risen considerably, which shows that Banks and the broader market do not want to lend for homes as they are crappy investments.

Up until this point, the joint efforts of the Fed and the Treasury have been directed towards maintaining the stability of our major financial institutions, recapitalizing their balance sheets in “current form,” and lowering the cost of mortgage credit. All are crucial to any solution, but it is this third and last point where markets have failed to cooperate. With Fed Funds having been lowered from 5¼% to 2%, it would have been logical to assume that the price of mortgage credit would go down as well and that the price of homes would at least slow their current descent. Not so.

-When the cost of credit goes up (as often happens with de-levergaing processes) the discount rate rate goes up and present value of assets (stocks, bonds, homes, etc.) goes down. Conclusion: More pain ahead.