Fed's Tools Won't Fix Housing Crisis: Pimco's El-Erian

Bond fund leader Pimco's Mohamed El-Erian on Wednesday said the Federal Reserve does not have the tools to deal with the U.S. housing crisis and rapidly rising consumer prices, leaving it to lawmakers to avert a severe recession.

The co-head of the world's largest bond fund company said U.S. policy makers "do not have good policy tools to deal with the destabilizing combination of asset price deflation, and goods inflation." El-Erian also added that the Fed is "particularly challenged" on account of its dual mandate that calls for maintaining solid employment and low inflation.

"This comes at a time when regulators are trying to play catch up with a financial system that has morphed into something that does not fit neatly into existing frameworks and mindsets," El-Erian wrote to clients after Pimco's quarterly economic forum at its Newport Beach, California headquarters.

"The longer the delay out of Washington D.C., in implementing fiscal measures to stabilize the housing sector, the greater the risk that the higher collateral damage on Main Street will induce a politically-driven regulatory over-reaction with unpredictable economic outcomes," he added.

El-Erian, who helps oversee $750 billion in assets, also said the Fed's move to let securities firm borrow directly through its discount window will likely evolve into a permanent facility.

Investment banks, forced to unwind years of huge leverage, will seek ways to secure a deposit base that can reduce their cost of funding, including through merger and acquisition, El-Erian added.

"This process of deleveraging and, if done properly, de-risking will have a number of implications for investors," El-Erian said. "And by creating an initial vacuum in the more highly leveraged space vacated by investment banks, it will entice new entrants, some of which will come from the current generation of private equity and hedge funds."

Pimco's forum included its economic consultant former Fed chairman Alan Greenspan as a participant.