Pimco's Bill Gross thinks he may be part of a big problem for the U.S. economy.
February 3, 2004: 8:46 AM 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 by far.
"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.
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