When we hear of Pimco, Bill Gross and Mohamed El-Erian are normally its most public personalities, but Douglas Hodge, chief opearations officer of the bond management company, is another master inside the company, based in Newport Beach, California. Since he joined Pimco, back in 1989, Hodge has led the comany's business in the Asia-Pacific region, aside from participating in Pimco´s Executive Board. From his office, Hodge responded to some questions raised by elEconomista.
How new regulation is affecting your business in the US.
I think you have to start with what was the catalyst to change the regulations - what motivated the enactment of the Dodd-Frank legislation. And what could be the potential impacts on our industry and on PIMCO. The motivations, I think, are fairly simple, and in many respects noble. During the run-up to the crisis, we saw the privatization of profits, and then in the middle of the crisis, in order to protect the global financial system and ultimately the global economy, governments were compelled to socialize the losses. In other words, a very small group benefited from the upside while society at large ended up having to absorb and pay for the downside. The losses were largely in the banking system; although, you could expand that more broadly and say the losses were on the balance sheets of some of the largest financial institutions in the world. It wasn´t just about banks, but it was the largest financial institutions in the world that had exposed their balance sheets to these out-sized risks.
In addressing these significant challenges, governments had to infuse large sums of capital. So, the regulations that have been put in place in the wake of the crisis are largely centered around the safety and soundness of balance sheets, primarily of the banking system, but now also being applied to institutions which are non-banks. What is important is a firm like PIMCO is in the investment management industry; we are not a bank; we don?t have a balance sheet in the traditional sense. We help manage the balance sheets of others, of our clients who allocate a portion of the asset side of their balance sheet for us to invest on their behalf. The financial regulations, the market regulations have been oriented around transparency, fairness and disclosure. Not about safety and soundness of balance sheets.
Now that we are seeing low yield returns, where do your clients look at?
This is interesting because we would suggest that we´re perhaps now in the third phase of the financial crisis. The first phase was the Lehman induced crisis phase, in 2008. The second phase was the massive government response. Not just in the United States, but across all the developed markets. Now, we´re in the third phase where some of the elements that led to the crisis really haven´t been fully addressed are being revealed once again. The debt burdens of the private sector have now shifted to stresses on the sovereign balance sheets. Now, we´re talking about the balance sheet of Greece or the balance sheet of Italy. This contamination which you could argue began with the US homeowner, morphed into a contamination of the balance sheets of the private financial system and now is on the balance sheets of the public system. And that makes this a particularly dangerous phase of the crisis.
Under the current political environment, do you see any significant changes ahead for the industry?
This is a very uncertain period. The political environment in Washington is very difficult to read, but it still comes back to this phenomenon where we privatized the profits and socialized the losses and neither the Republicans nor the Democrats want to expose the government to that kind of risk again. While they may share a common objective, there is no consensus about how to achieve it. Though, let´s be clear, this is not easy. The complexity and the interconnectedness of the global financial system call for structural reforms that are global in nature. To date, we have seen different approaches taken by regulators around the world. The process of financial reform remains a work in process. In the United States, we´ll have to see how this process works out after the upcoming US presidential and Congressional elections.
If PIMCO´s business continues to grow and gets bigger, would you see any split up from Allianz anytime in the future?
No. Our relationship with our parent has three elements. They are an owner, they are a client because we invest on their behalf a large portion of the insurance assets and they are a business partner. As an owner and as a client, there´s no change and it´s been a very constructive relationship for the past 11 years. The third part as a business partner, that is the part we are redefining. Earlier this year we redefined in the United States and now we are redefining it in Europe and Asia. And this is really all about bringing PIMCO and its thought leadership and its products more directly to individual investors in the United States and now in Europe.
Taking in consideration Europe´s current crisis, how would you define the state of financial industry nowadays?
We´re in a period of great uncertainty. There´s regulatory uncertainty, there is market uncertainty, and we´re seeing both of those in this calendar year, 2011. So how you manage a business, how you plan ahead in a world where it?s never easy to look forward and try to predict what´s going to come over the horizon even more challenging today than it ever has been because there´s not only market risk, but there´s also regulatory risk.
The other part is what we´ve observed, and I´d say PIMCO has been one of the fortunate beneficiaries is it has become increasingly what I would characterize as a winner-take-all market in the investment management industry. The large firms who are successful; who can deliver value to their clients seem to win. The firms that are smaller niche players who have a special unique service or product, there´s room for them, but those that are in the middle are really challenged. These are the same dynamics of any industry that´s undergoing stress where you see consolidation. The firms that are in the middle of the market are under the most stress. At PIMCO, while we have offer a number of the niche products in some of our alternative strategies, we are in fact one of the larger players, in terms of our investment platform, our resources and our global footprint. That financial strength, that brand strength, our broad array of products and solutions, positions us very well for this kind of environment. We can be resilient in the face of great uncertainty whereas other firms are more challenged to do that.
People are not happy with what?s going on. Are we going to see an increase in that social instability?
There are multiple social contracts, for example, there´s a financial contract, but there´s a social contract that when you buy a home, you will pay back the loan. There´s a contract that when you´re employed, when you have a job, your employer will continue to employ you and not potentially lay you off for reasons you cannot control. All of those contracts are now being tested. The underlying theme of all of that stress is coming from these huge amounts of debt. Whether you´re an individual, a company, or a country, if you have large amounts of debt on your balance sheet, it limits your degrees of flexibility and being able to respond to the changing environment. That´s what we´re seeing play out over and over and over again.
All of these contracts are being examined and tested. It´s not clear whether they will continue to hold or not. But it creates these diverse views and certainly w are seeing this with the Occupy Wall Street movement, for example. Or what´s going on in Europe. You have seen the ongoing protests in Greece. Part of this is a reaction to moving from what we would characterize as an age of entitlement that was created as a result of significant profligate spending and overly expansive lending, to an age of austerity. That´s never going to be easy. There are parts of the population which are impacted greater than others.
