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Pimco's Gross: Watch out below
The huge jump in debt is really troubling the country's most watched bond investor.
February 3, 2004: 2:45 PM EST
By Justin Lahart, CNN/Money senior writer

NEW YORK (CNN/Money) - Hearing Pimco's Bill Gross preach doom and gloom for the U.S. economy doesn't raise eyebrows anymore. Perhaps only Morgan Stanley economist Steve Roach seems more of a worrywart.

But in his latest note Gross takes an unexpected twist on who may be to blame for America's eventual financial downfall: Pimco itself.

The common trope on the U.S. economy is that over the past two decades it has gone from manufacturing-based to services-based. Gross thinks, however, that the economy has undergone a second transformation and that it is now finance-based -- both profits and employment are now chiefly a function of how much debt is getting generated and what that debt costs.

Homeowners, Gross writes, are no longer content to take on a 30-year mortgage and watch their home equity grow as they pay it down; instead they go the refi route to tap into the equity they've generated.

Meantime, whereas General Electric generated 92 percent of its profits from manufacturing back in 1980, now nearly half of its earnings come from its financial subsidiaries. Gross doesn't point it out, but a similar trend can be found at other companies -- 68 percent of General Motors' earnings in 2003 came from its finance arm, GMAC.

Coincident with the shift to a finance-based economy, total credit market debt as a portion of gross domestic product has more-than doubled since 1980, reaching 299 percent. Only the early years of the Great Depression offer anything similar.

How can this have happened? Much of it is due to outfits like Pimco which, with $350 billion in assets, is the nations biggest fixed-income manager.

"Who makes it possible to refi all those mortgages by holding $100 billion of them in PIMCO portfolios?" wrote Gross. "0% car loans? Who makes it possible by snapping up asset-backed securities at LIBOR plus yields? GE's swaps? PIMCO's got the same side of the trade."

It's a situation, Gross worries, that cannot persist. Debt levels cannot go up forever. Eventually fixed income investors -- maybe Pimco, maybe Asian central banks, maybe leveraged hedge-fund players -- are going to remember that what they are doing at root is lending money, and that the ultimate point of lending is to get back the cash you've handed over, plus interest.

When that happens, thinks Gross, there's going to be a recession unlike any we've seen since at least the early 1980s, back when United States had a manufacturing-based economy.

So what's Gross' game? Remember that his interest lies with the Pimco portfolio -- it's safest to assume that whenever he talks he's talking his book. And yet the scenario he's talking about, where lenders decide that enough is enough, would be the financial equivalent of the Triangle Shirt Factory fire for credit market participants, Pimco included.

Maybe more than anything, Gross is trying to keep his disaster scenario from occurring -- particularly since it's a disaster that Pimco would likely be at least partly blame for.

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Bid and Ask
Bill Gross
Written by: Justin Lahart

The growing budget deficit is a gnawing worry for many bond market participants, who worry that it will bring with it a crush of government debt. Washington is just now working over the 2005 budget, and Gross' latest may be a thinly veiled threat, or plea, to Congress to be fiscally conservative.

There's a message there for Alan Greenspan, too. The surge in debt and debt spending couldn't have happened if the Fed hadn't been busy trimming short-term rates to the point where they are now below the rate of inflation. Eventually the Fed will have to hike, and when it does, writes Gross, the economy will slow and may even falter.

Engineering a rate rise that doesn't buffet the economy badly will be a tricky business, but, following Gross' thinking, continuing to put off raising rates could be even more dangerous because it facilitates the piling up of debt to unsustainable levels.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.