2008 August 19 Tuesday
Nouriel Roubini Expects Deep Recession
NYU economist Nouriel Roubini called our economic crisis but few believed him.
On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.
They didn't believe him. Some economists today even argue that Roubini has been incorrectly pessimistic in the past and now finally a downturn comes along that lets him be right by accident.
The audience seemed skeptical, even dismissive.
Roubini came to his predictions about the US economy by studying economic crises in other countries which were running large trade deficits.
The ’90s were an eventful time for an international economist like Roubini. Throughout the decade, one emerging economy after another was beset by crisis, beginning with Mexico’s in 1994. Panics swept Asia, including Thailand, Indonesia and Korea, in 1997 and 1998. The economies of Brazil and Russia imploded in 1998. Argentina’s followed in 2000. Roubini began studying these countries and soon identified what he saw as their common weaknesses. On the eve of the crises that befell them, he noticed, most had huge current-account deficits (meaning, basically, that they spent far more than they made), and they typically financed these deficits by borrowing from abroad in ways that exposed them to the national equivalent of bank runs. Most of these countries also had poorly regulated banking systems plagued by excessive borrowing and reckless lending. Corporate governance was often weak, with cronyism in abundance.
Roubini expects the current recession to deepen into the worst downturn since the Great Depression. Though he's not expecting a full-fledged depression. He expects we'll hit bottom in 2009. But the recovery will be slow. He expects lot of bank failures and credit problems that extend far beyond mortgages.
I do not see a bottom at least until the US trade deficit vanishes. The US has a lot of bad trends working against it including a disastrous demographic trend.
The recovery will be aborted if world oil production stays on a plateau. If oil production starts declining the downturn will deepen.
The FIRE (financial service, insurance, real estate) economy will go though the same downturn as technology and semiconductors did in the first half of this decade. This is entirely predictable and is certainly not the end of the world. Bubbles always result in corrections.
But the previous high-tech bubble was concentrated in Silicon Valley and related regions, with only a small percentage of the U.S. population employed in these areas. But in the case of the FIRE bubble you mention above, probably a larger percentage of the U.S. population will suffer, as far as unemployment is concerned, i.e. this time the correction will hurt more people.
The New York economy is toast. I believe that few realized how reckless and doomed to failure was the basic strategy of Wall Street firms: leverage yourself 30 to 1 and if there is a catastrophe - which is inevitable when the entire industry is leveraged to such an extreme - then call on the TAXPAYER to clean up the mess and bail out the instigators. Private "profits", socialized loss. Talk about welfare queens.
During the past 5-10 years there were no real, authentic profits made on Wall Street. Reported profits were an illusion. It was a Ponzi scheme. When you enter into contracts that play out over the course of 5+ years but you book profits today, that is a SCAM. Normal people can go to jail for such matters.
How can Wall Street firms dare even consider to go on with business as usual? Well, they will try. They own Senator Christopher Dodd and have deep hooks into Clinton and Schumer, among others. But somebody will make this the issue and the days of easy profits are over. Wall Street cannot make the profits they have grown accustomed to without the leverage.
So high tax, high welfare New York will suffer grievously, as it should. New York politicians crow often about how much money New York sends down to Washington in the firm of taxes and how little New York gets back. Well, look how New York makes its money. Nothing to brag about, is it. This time the entire country has a legitimate grievance against what was spawned by New York. A smart politician in the heartland should pick up on this. It will be good to see New York squirm.
Any thing bad for Manhattan is good for America.
"Reported profits were an illusion. It was a Ponzi scheme. When you enter into contracts that play out over the course of 5+ years but you book profits today, that is a SCAM. Normal people can go to jail for such matters."
The Wall Street firms should have paid bonuses which matched the time frame of the deals or trades which contributed to those bonuses. That is, if an trader books a trade with a five year time frame, then make the bonus pay out over five years. If an investment banker securitizes a product with a seven year time frame, make the bonus pay out over seven years. Payment of the bonuses should be conditional on the deal or trade performing as expected. The unpaid bonuses also serve as a cash buffer against bank runs.
"New York politicians crow often about how much money New York sends down to Washington in the firm of taxes and how little New York gets back. Well, look how New York makes its money. Nothing to brag about, is it."
My thinking on this is New York makes its money by getting Washington to impose rules and regulations on the rest of us. One example would be how the states tried to crack down on aggressive mortgage lending, but were overruled by the federal government. Other examples include requiring SEC regulation for issuing stock, requiring CFTC regulation for futures trading, not allowing student loans to be discharged in bankruptcy, and other rules relating to credit. These laws create a concentration of wealth which makes credit booms and busts more volatile. It is an abuse of the commerce clause of the Constitution.