I’ve been reluctant to post this entry, mostly because I don’t know if I can write it and have it make any sense.

It involves an analysis of the subprime mortgage loan crisis written by Bill Gross, Managing Director of PIMCO Bonds, a mega-bond fund company. He’s written some good stuff in the past, and I trust his judgment, implicitly.

Here’s what he says:

The problem with housing, however, is not the frequently heralded increase in subprime delinquencies or defaults …

… [F]oreclosure losses as a percentage of existing loans will be small and the majority of homeowners have substantial amounts of equity in their homes …

The problem will be the tightening of credit by lenders.

Lender fears of potential new regulations can do nothing but begin to restrict additional lending at the margin, as will headlines heralding alleged predatory lending practices in recent years.

This will lead to a build-up in inventory across parts of the country, because there will be less people able to borrow money, but more people listing their homes for sale to escape foreclosure.

Which will threaten the nation’s economy.

One of two things will need to happen, then.

According to Bill Gross, home prices or mortgage rates (or a combination of the two) need to decline in order to revert back to affordability levels in 2003, a year which might have been the last to be described as a “normal� year for home price appreciation.

Wanna guess which is more likely to happen?

[W]hile the Fed may be willing to allow U.S. homeowners to suffer a little pain as indeed they have in recent quarters, a double-digit decline would risk consequences that few central banks would be willing to underwrite.

So a forecast of home prices almost implicitly carries with it a forecast for interest rates. To prevent a double-digit decline in prices, PIMCO’s statistical chart suggests that mortgage rates must decline a minimum of 60 basis points and the sooner the better.

A 60 basis points drop would be .6%, meaning today’s average fixed-rate mortgage loan rate of 6.23% would drop to 5.63%.

And, if it did this, what does it mean for buyers? (My analysis, from here on out, not Gross’s.)

That they’d be able to buy a home for cheaper than they’ve been able to, for the past two-three years.

But, here’s the kicker.

If The Fed does this, lowers interest rates, then sellers won’t have to lower their prices.

Now, I assume (doesn’t everyone) that sales prices will still decrease (on a national average, at least), but if this scenario unfolds, it’s going to be crazy.

Basically, anyone who bought in the past, anytime, anywhere, will have been able to lock-in their profit. Even better, those who bought more than three-four years ago will be able to enjoy the price appreciation everyone else did, just by waiting out the market.

Because, when people think about economics, they think simple supply and demand – number of homes vs. number of buyers.

But when you think of US economics, you have to include the government in the equation, meaning, the cost of money.

And if The Fed makes money cheap (as it has done in the past), it’s going to save a lot of homeowners a lot of heartbreak.

For better or worse.

*** Disclaimer: The Fed doesn’t set mortgage loan rates, of course. They only set short-term rates. Bill Gross’s conclusions assume that by lowering short-term rates, long-term rates would follow, ensuite. Not a guarantee.

More: Grim Reality – Investment Outlook – By William H Gross, PIMCO Bonds