Viewpoints

May 2010

This article was originally published in The Wall Street Journal on May 22, 2010.

Return of the Nervous Weekend

By Mohamed El-Erian

With global financial markets volatile once again, we’re back to what I call the
“weekend policy watches.” For many years, weekend policy watches were confined to
struggling developing countries. But beginning in 2008, the phenomenon burst onto the
American scene as government officials scrambled to contain the financial meltdown.
It’s hard to forget those “Sunday night specials” – long hours spent anxiously waiting to
hear from Washington on topics like Bear Stearns, Fannie and Freddie and Lehman
Brothers.

Now, it’s Europe’s turn. The focus these weekends is on Berlin, Brussels and Frankfurt,
with observers wondering how policymakers will react to the generalized disruptions in
global markets, and particularly to the mounting pressures facing the European banking
system.

It is absolutely critical to understand how we end up in the midst of these unsettling

weekends. It’s a failure of both crisis prevention and crisis management. It happens
because structural problems like excessive budget deficits are allowed to fester.
Policymakers quickly fall behind in terms of their understanding and ability to respond.
And the crisis morphs into a highly disruptive, multidimensional affair.

This is the case in Europe today. What started as a Greek debt problem, mistakenly
viewed by too many as containable, has gone regional and now global. The already
difficult debt challenge has now assumed complex economic and technical dimensions.

The immediate consequence of Greek contagion is heightened market volatility, violent,

across-the-board sell-offs in equities and other risky assets, a drying up of market
liquidity and cascading blockages in the plumbing of the global financial system. All of
this will have a negative impact on the real economy through tighter credit, lower
consumption, postponed investment and higher unemployment.

In assessing Europe’s various responses – and there are still many to come – we need
to keep three key questions in mind at all times:

First, is the Greek problem being treated for what it is (namely, a solvency problem) as
opposed to what people wish it to be (a liquidity problem)?

Second, are appropriate circuit breakers being put in place to limit the collateral
damage for European growth and the global economy more broadly?

And finally, how much have we done to prevent violent market sell-offs that aren’t
driven by economic fundamentals but are motivated by investor overleverage and
market illiquidity?

1
Viewpoints
May 2010

I fear that markets may not get sufficiently reassuring answers anytime soon to these
questions.

There is still a deep hesitancy among European policymakers to acknowledge that the
approach to rescuing Greece is incomplete. But few outside observers are fooled by a
strategy that results in a further increase of the country’s already excessive debt-to-
GDP ratio, relies too heavily on a blunt and draconian fiscal policy instrument and
sustains a debt overhang that will deter new investments and amplify an already painful
drop in GDP.

The emphasis on circuit breakers is there, but badly targeted. Rather than focus on a
defensible and sustainable fire break, too much effort and money are being deployed to
defend the indefensible, like Greek over-indebtedness. This also muddies the political
narrative.

The unwinding of unstable investor positions is still in its early stages. Having over-
romanced the cyclical bounce, some investors are now scrambling to reposition their
overextended portfolios now that structural problems are undeniable. The resulting
unwinding of overleveraged trades will inevitably disrupt a very wide range of other
assets as the good gets contaminated by the bad.

The bottom line is simple yet consequential: The disruption in financial markets is not a
garden-variety market fluctuation. Instead, it’s an overdue recognition that the global
economy faces an uncertain future that involves slower growth and greater government
regulation.

Structural problems require structural solutions. The question is whether those at the
weekend discussions will acknowledge this, or remain hostage to hope for an
immaculate recovery.

About the author:

Dr. El-Erian is CEO and co-CIO of PIMCO and is based in the Newport Beach office. He re-
joined PIMCO at the end of 2007 after serving for two years as president and CEO of Harvard
Management Company, the entity that manages Harvard’s endowment and related accounts. Dr.
El-Erian also served as a member of the faculty of Harvard Business School. He first joined
PIMCO in 1999 and was a senior member of PIMCO’s portfolio management and investment
strategy group. Before coming to PIMCO, Dr. El-Erian was a managing director at Salomon
Smith Barney/Citigroup in London and before that, he spent 15 years at the International
Monetary Fund in Washington, D.C. Dr. El-Erian has published widely on international economic
and finance topics. His book, When Markets Collide, was a New York Times and Wall Street
Journal bestseller, won the Financial Times/Goldman Sachs 2008 Business Book of the Year
and was named a book of the year by The Economist. Dr. El-Erian has served on several boards
and committees, including the U.S. Treasury Borrowing Advisory Committee, the International
Center for Research on Women, and the IMF’s Committee of Eminent Persons. He is currently a
board member of the NBER and the Peterson Institute for International Economics. He holds a
master’s degree and doctorate in economics from Oxford University and received his
undergraduate degree from Cambridge University.

2
Viewpoints
May 2010

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are
subject to change without notice. This material has been distributed for informational purposes only and
should not be considered as investment advice or a recommendation of any particular security, strategy or
investment product. Information contained herein has been obtained from sources believed to be reliable, but
not guaranteed. This material was reprinted with permission of The Wall Street Journal. Date of original
publication May 22, 2010.