There's a good chance you've never heard of him before, but this week you've probably seen Bill Gross on cable TV opining on the current financial crisis gripping Wall Street. Gross may not have the celebrity profile of the Oracle of Omaha, but he is to bond investors what Warren Buffett is to stock pickers: the guy you want to hear from more than anyone else, especially when everything debt-related in the world seems to be falling apart. That's because Gross's firm, Newport Beach, Calif.-based PIMCO, manages more than $800 billion in assets, including the world's largest bond fund, the $134 million Total Return Fund.
Gross and his colleagues at PIMCO were among the first to swear off the subprime mortgage debt that kicked off the current market chaos; in a particularly colorful investment outlook he sent out in June of 2007, he wrote that that the credit-rating agencies had been wooed by the "six-inch hooker heels" and "tramp stamp" of mortgage-backed securities and the collateralized debt obligations built on top of them.
But while Gross has one of the best track records in the business, even he has not been able to escape the recent wrath of Wall Street. PIMCO happened to be among the biggest holders of bonds at Lehman Brothers, the investment bank that declared bankruptcy on Monday after the federal government rebuffed the notion of a bailout and fellow financial institutions balked at stepping in without a government guarantee. And in the hysteria that has continued to sweep through market ever since, Gross's marquee Total Return has been battered along with the rest on Tuesday losing 1.4%, the fund's worst performance in three years.
It is one of the clearest examples yet of how even the smartest guys in the room didn't anticipate the level of tumult currently rippling from firm to firm, with AIG (another big PIMCO holding) essentially being taken over by Washington right now.
Gross, who likes to compare the financial sector of late to a game of Old Maid hide your bad loans in your hand and hope no one notices says that now the game has taken on a different air. "We're still playing Old Maid," he says, "but increasingly the market is reaching across the table and pulling the player's hand down to see whether or not the Old Maid is there."
As recently as a week and a half ago, Gross was riding high, having netted some $1.7 billion from investments in Fannie Mae and Freddie Mac after the federal government took over the two mortgage-finance companies, rewarding holders of Fannie and Freddie debt, while leaving the stockholders out to dry. Never shy about sharing his opinions, or sharing them colorfully, Gross had been clamoring for a bailout. The bailout with Lehman, though, didn't come, leaving Gross's funds with 35 cents on the dollar. Gross says that the impact of Lehman was moderated by other positions the firm holds in Treasuries and Eurodollars and that at the end of Monday, the day Lehman declared bankruptcy and the Dow dropped 504 points, his marquee Total Return Fund had actually finished up.
That doesn't mean investing in Lehman wasn't a mistake. Gross says that it was "we're not perfect, we buy things prematurely in some cases" but explains his logic this way: With so many bad assets floating around finance firms, his strategy had been to only invest in "high-quality institutions under the umbrella of regulatory protection." In other words, in companies that were, as we now say with a smirk, "too big to fail." Companies that, because of their interconnectedness with the rest of the market, the federal government would never let go belly up. On his original list Gross had five deposit-taking banks (Bank of America, JP Morgan, Wells Fargo, Citigroup and Wachovia) and five investment banks (Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs). The problem was that he got the size of the umbrella wrong. "I think it's fair to say over the past week the umbrella shrunk," he says.
But it was still big enough to include AIG. Late on Tuesday evening, in a dramatic last-ditch effort to keep the insurance megalith from collapsing, the federal government announced that it would take over AIG, lending up to $85 billion. The crisis was averted, at least for the moment. But if this week has taught us anything, it's that the next big thing is probably just around the corner. On Thursday, Morgan Stanley was on the brink of being the next firm swallowed up by Wachovia but the story will surely continue to go on.
And so Gross will keep getting up at 3:30 a.m., instead of his usual 5 a.m., to get to the office long before the markets open back East. He'll skip his afternoon workout and yoga session, and go one more weekend without playing golf (it's been six months). And whenever he can, he'll go on TV to keep promoting the idea that the federal government needs to get involved.
When asked how this period stacks up to what he's seen over the course of his 37 years at PIMCO, a firm he founded after honing his betting prowess in Las Vegas, Gross rattles through a greatest-hits list of financial crises: 1987, Asia, Long-Term Capital Management. But then he says there's been nothing like this, "a secular de-leveraging unwind that in effect moves the financial system in an entirely different direction and therefore precipitates this tsunami-like volatility that we're experiencing." Nothing like this, he repeats. "It's exhausting, but it's fun to be on the field."