Mohammed El-Erian: We Have Not Reached Escape Velocity

The US Financial system has not fully emerged from the financial crisis, Mohammed El-Erian told an audience of nearly 1,000 advisors on Sunday night. His remarks kicked off this year’s Schwab Impact conference in San Diego.

El-Erian, the CEO and co-CIO of the global manager PIMCO, called the crisis a “sequential contamination of balance sheets” that initially hit the sub-prime and housing markets.  In 2007 the contamination spread to the financial services industry, and a year later it hit the global economy.  Now public finance balance sheets are strained, creating a new level of concern for policy makers.

Full emergence from the crisis is analogous to a rocket reaching its escape velocity – and the US economy isn’t there yet.  It won’t be, El-Erian said, until balance sheets are no longer contaminated.

Speaking with El-Erian was Larry Fink, the CEO of Blackrock, who generally agreed with El-Erian’s forecasts, and specifically seconded El-Erian’s assertion that the “New Normal” for the US will be slower economic growth.

Together, El-Erian and Fink addressed a number of issues related to the financial crisis, which I summarize below.

Are we safe yet?

In the narrowest sense, the US financial system is safe, in that El-Erian no longer believes a repeat of the cataclysmic events of last September and October are possible. 

In a broader sense, however, the global economy still faces many risks.  We are still dealing with the solvency of large institutions and have “inadvertently accelerated redesign of the global economy.” What’s more, we are doing so in the context of a “shrinking pie” – the global economy is contracting.  The government’s new ownership stakes in numerous companies has fundamentally changed it’s role – once a referee, it’s now a player.

Fink agreed that we are much safer than we were, but he did not say with any conviction that we are safe.  Prior to the crisis, the source of the market’s strength was a “myth” based on leverage, excess capital, and excess production capacity in industries such as automobile manufacturing. “We have a stronger system today than we did three years ago,” he said, but many of those fundamental problems remain unresolved.