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El-Erian: States Battle Spending Issues Better Than Federal Government

Friday, 10 Jun 2011 01:42 PM

States are righting their fiscal ships better than the federal government, says Mohamed El-Erian, co-head of Pimco, the world's largest bond fund.

While some defaults may occur at the municipal level, as star analyst Meredith Whitney has predicted, general obligation bonds probably won't go that route.

"It is very unlikely that you are going to see a G.O. default. You will see further down the capital structure municipalities default but it is very unlikely that you are going to see a G.O. default," El-Erian tells CNBC.

"In fact we are seeing the states adjust much more quickly than the federal level in terms of trying to get their arms around both revenue and spending."

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Mohamed El-Erian
(Associated Press)
Liabilities are an issue at the state and local levels, just like they are at the federal levels.

Many states are wrapping up fiscal-year 2011 and as they approach fiscal 2012, they must balance their budgets, a tough task in a still weak economy.

"When you suddenly have a debt overhang, contracts are going to get changed. That's the reality of a debt overhang," El-Erian says.

"Suddenly promises you have made in the past cannot be met. Most of these contracts are going to be rewritten in an orderly fashion and the key thing for investors is to recognize which contracts are going to be rewritten in which way."

The U.S. will likely avoid a double-dipping back into a recession, El-Erian says, although debt issues must be addressed..

While the debate rages on here about whether Congress should lift the $14.3 trillion debt ceiling, foreign investors are wondering why such a debate is taking place in the first place and are worried over the health of the U.S. debt they hold.

"They are looking at the federal level and are asking how long is it until we get our act together and the longer it takes, the riskier it is in terms of expecting them to continue to buy our bonds."

Foreign bondholders aren't the only ones concerned with U.S. debt.
Ratings agencies are, too.

Fitch Ratings says it could downgrade U.S. debt if lawmakers don't raise the debt ceiling in August.

"Default by the world's largest borrower and issuer of the pre-eminent reserve currency would be extraordinary and threaten the still fragile financial stability in the U.S. and the world as a whole, especially against the backdrop of the European sovereign debt crisis," says David Riley, head of Sovereign Ratings at Fitch, in a statement.

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States are righting their fiscal ships better than the federal government, says Mohamed El-Erian, co-head of Pimco, the world's largest bond fund. While some defaults may occur at the municipal level, as star analyst Meredith Whitney has predicted, general obligation bonds...
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Friday, 10 Jun 2011 01:42 PM
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