July 18 (Bloomberg) -- Prices of debt issued by mortgage- finance companies Fannie Mae and Freddie Mac don't reflect their true value, said Mohamed El-Erian, the co-chief investment officer of Pacific Investment Management Co.

``If you look at the bonds, if you look at the preferreds, you're seeing prices that are not linked to the underlying value,'' El-Erian said in a Bloomberg Television interview. ``When the tide goes out all the boats go down. The senior parts of the capital structures in many industries are being valued at levels that don't make sense at this point.''

Mortgage securities made up 61 percent of Pimco's $128.8 billion Total Return Fund as of June 30, up from 53 percent a year earlier, according to the Newport Beach, California-based firm's Web site. The fund is run by Pimco's co-chief investment officer Bill Gross.

Five-year bonds sold by Fannie Mae yield 0.87 percentage point more than U.S. Treasuries of similar maturity, almost double the average over the past 10 years, according to data compiled by Bloomberg. Freddie Mac debt pays a spread of 0.85 percentage point.

El-Erian, an emerging-markets specialist who was speaking about his book, `When Markets Collide: Investment Strategies for the Age of Global Economic Change,'' advised buying assets that provide protection from inflation and can withstand financial- market turmoil. Investors should look abroad for value, he said. Pimco manages the world's largest inflation-protected bond fund.

Housing Deflation

``Be global,'' he said. ``Don't be a victim of this home bias that is our natural tendency.''

Consumer spending will slow as long as housing prices sink, El-Erian said.

``As long as the price deflation in the housing stock continues, it will drag down the consumer who is already facing challenges'' because of surging energy costs, stricter credit standards and rising unemployment, he said.

Credit-market losses among banks and securities firms has led to a process of deleveraging and prompted selling of assets regardless of their value, El-Erian said.

``What we've seen is the process of sale, selling the good, the bad, and the ugly, not because of value but because of financing issues,'' he said.

El-Erian, 49, returned to Pimco in December after running Harvard University's endowment, the world's largest higher- education fund, for about two years. He guided the school's fund to a 23 percent gain in the fiscal year ended June 2007, adding $5.7 billion in value.

Before joining Harvard, El-Erian was a managing director at Pimco from 1999 to 2006 and oversaw the Pimco Emerging Markets Bond Fund. In addition to sharing investment-decision making duties with Gross, El-Erian is also co-chief executive officer with Bill Thompson.

Pimco, a unit of Munich-based Allianz SE, has about $800 billion of assets under management.

To contact the reporter on this story: Pimm Fox in New York at pfox11@bloomberg.net; Sandra Hernandez in New York at shernandez4@bloomberg.net.

Last Updated: July 18, 2008 17:34 EDT