Mohamed El-Erian warns of 'collateral damage' from the JPMorgan-First Republic deal, and points to 4 unintended consequences

Mohamed El Erian.

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• Mohamed El-Erian said JPMorgan's takeover of First Republic could lead to "potential collateral damage".
• It's another case of US government institutions settling for a "second best" solution, he wrote in a Bloomberg op-ed.
• El-Erian warned of four unintended consequences from the deal including "a more concentrated banking system" and the risk of deeper credit crunch. 

Top economist Mohamed El-Erian warned of further "potential collateral damages" from the failure of First Republic Bank and its subsequent takeover by JPMorgan.

The Wall Street giant agreed on Monday to acquire First Republic, which was shut down by after facing a spiraling deposit run in recent weeks, paying $10.6 billion to the Federal Deposit Insurance Corp. (FDIC) in a deal arranged by regulators.

"The solution that emerged early Monday morning  deals with the immediate threat of a disorderly failure of First Republic and, therefore, does not fuel the already uncomfortable risk of possible additional disruptions to other regional and community banks. Yet the potential collateral damage and the unintended consequences are far from immaterial," El-Erian wrote in an op-ed for Bloomberg on Monday.

The deal is another case of US government institutions settling for a "second best" option, showing how regulators and policymakers have failed time and again to achieve the best possible solution to economic and financial challenges, he added.

The economist has repeatedly criticized the Federal Reserve for dismissing inflation as transitory a couple of years ago, only to end up scrambling to contain the problem later by unleashing the most aggressive monetary-tightening campaign since the 1980s.

The chief economic adviser at Allianz warned of four notable unintended consequences for the US financial system, that could emerge from the final outcome of the First Republic narrative.

1. "First, the US now has a more concentrated banking system, with what was once viewed not so long ago as "too big to fail"/"too big to manage" banks becoming larger," he wrote. Such institutions are so large and crucial to the financial system that their fall would have disastrous impacts on the economy. 
2. "Second, there is even greater doubt about the nature of the de facto deposit insurance system in place."
3. "Third, the compositional risk within the banking system of less credit extending into the economy will continue, potentially aggravating the headwinds to high and inclusive growth."
4. "Finally, the total cost of First Republic's resolution remains to be assessed, including how the burden be shared among the public and private sectors and, with that, the extent of the "bailout" for the 11 banks that had large deposits with First Republic." 

The world's largest economy continues to face the consequences of the "easy money" regime that was in place for too long as well as "the subsequent mishandling of the rate hiking cycle and lapses in supervision and regulation," according to El-Erian.

"With that comes the ever-present risk of collateral damage and unintended consequences given that first best policy responses are no longer available," he wrote in the op-ed.

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