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El-Erian: Worst Behind Us, but Risks Remain

Monday, 19 May 2008 05:04 PM

Mohamed El-Erian, the former manager of Harvard University’s huge endowment and now co-CEO of bond giant Pacific Investment Management, is cautiously optimistic about the economy.

Big risks lie ahead for the general economy, he tells BusinessWeek, but the worst of the Wall Street turmoil "is behind us,” he says.

"We’re three-quarters through a major dislocation that has repriced the U.S. financial system. The risk going forward is less about Wall Street and more about the small and midsize banks,” El-Erian says.

That’s because small banks are "heavily tied” to commercial real estate and to consumers.

El-Erian warns, too, that "an added shock” is coming from employment, an important indicator to watch for the next six months.

"If too many people lose their jobs, income and consumption will be thrown off balance,” he says.

El-Erian is less optimistic about housing. Home prices, he warns, still haven’t hit bottom.

"I don’t think we will see the bottom anytime soon,” he says.

As for the turmoil already past, El-Erian sees the pain as part of a much larger picture that policymakers and investors don’t yet understand.

"The global system is attempting to accommodate the breakout phase in the growth and wealth dynamics of a number of countries. The system is also trying to absorb the financial innovation inherent in the proliferation of structured products.

"Too many participants in the global system embarked on this journey with blunt instruments, inadequate monitoring, and risk management system as well as a backward-looking mindset,” El-Erian says.

The result of their behavior, he says "is an inevitable series of market accidents and policy mistakes.”

There is good news though, he says. "The financial problem is now finally morphing into something recognizable,” El-Erian says.

So what’s anchoring the markets now?

"We’re seeing a much-needed recapitalization,” says El-Erian.

"Over the past decade, you’ve seen the balance sheet of the emerging markets get recapitalized. Then it was the turn of the U.S. corporate and industrial sector on the back of Enron and WorldCom.

"Today we’re seeing the recapitalization of the U.S. financial system,” he says.

"A massive amount of capital has been issued in the past two weeks, some in the form of preferred stock. Once we get through [this period], we’ll all look back and realize that it’s positive,” El-Erian says.

An advocate for taking the long-term view, El-Erian advises investment managers against taking on new risk just yet. Some investment gurus say they’re flocking to financial sector stocks, which were been beaten down in recent months.

El-Erian is more selective there.

"We’re focusing on senior parts of the capital structure with very high-quality bonds, including the financial sector as it goes through this healthy recapitalization,” he says.

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Mohamed El-Erian, the former manager of Harvard University’s huge endowment and now co-CEO of bond giant Pacific Investment Management, is cautiously optimistic about the economy.Big risks lie ahead for the general economy, he tells BusinessWeek, but the worst of the Wall...
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2008-04-19
Monday, 19 May 2008 05:04 PM
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