LQD: Roubini predicts the worst financial crisis

RGE Monitor MEDIA ALERT: Nouriel Roubini predicts the worst financial crisis since the Great Depression and the worst U.S. Recession in the last few decades.

New York, July 15, 2008- In a series of recent writings on the RGE Monitor Nouriel Roubini - Chairman of RGE Monitor and Professor of Economics at the NYU Stern School of Business - has argued that the U.S. is experiencing its worst financial crisis since the Great Depression and will undergo its worst recession in the last few decades. His analysis leads to the following conclusions:

* Hundreds of small banks with massive exposure to real estate (the average small bank has 67% of its assets in real estate) will go bust

* Dozens of large regional/national banks (a' la IndyMac) are also bankrupt given their extreme exposure to real estate and will also go bust

* Some major money center banks are also semi-insolvent and while they are deemed too big to fail their rescue with FDIC money will be extremely costly.

* In a few years time there will be no major independent broker dealers as their business model (securitization, slice & dice and transfer of toxic credit risk and piling fees upon fees rather than earning income from holding credit risk) is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure (i.e. the four remaining U.S. big brokers dealers will either go bust or will have to be merged with traditional commercial banks). Firms that borrow liquid and short, highly leverage themselves and lend in longer term and illiquid ways (i.e. most of the shadow banking system) cannot survive without formal deposit insurance and formal permanent lender of last resort support from the central bank.

* The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient to cover the hole from the biggest banking crisis since the Great Depression

* Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

* This financial crisis will imply credit losses of at least $1 trillion and more likely $2 trillion.

* This is not just a subprime mortgage crisis; this is the crisis of an entire subprime financial system: losses are spreading from subprime to near prime and prime mortgages; to commercial real estate; to unsecured consumer credit (credit cards, student loans, auto loans); to leveraged loans that financed reckless debt-laden LBOs; to muni bonds that will go bust as hundred of municipalities will go bust; to industrial and commercial loans; to corporate bonds whose default rate will jump from close to 0% to over 10%; to CDSs where $62 trillion of nominal protection sits on top an outstanding stock of only $6 trillion of bonds and where counterparty risk - and the collapse of many counterparties - will lead to a systemic collapse of this market.

* This will be the most severe U.S. recession in decades with the U.S. consumer being on the ropes and faltering big time as soon as the temporary effect of the tax rebates will fade out by mid-summer (July). This U.S. consumer is shopped out, saving less, debt burdened and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation and rising oil and energy prices. This will be a long, ugly and nasty U-shaped recession lasting 12 to 18 months, not the mild 6 month V-shaped recession that the delusional consensus expects.

* Equity prices in the US and abroad will go much deeper in bear territory. In a typical US recession equity prices fall by an average of 28% relative to the peak. But this is not a typical US recession; it is rather a severe one associated with a severe financial crisis. Thus, equity prices will fall by about 40% relative to their peak. So, we are only barely mid-way in the meltdown of stock markets.

* The rest of the world will not decouple from the US recession and from the US financial meltdown; it will re-couple big time. Already 12 major economies are on the way to a recessionary hard landing; while the rest of the world will experience a severe growth slowdown only one step removed from a global recession. Given this sharp global economic slowdown oil, energy and commodity prices will fall 20 to 30% from their recent bubbly peaks.

* The current U.S recession and sharp global economic slowdown is combining the worst of the oil shocks of the 1970s with the worst of the asset/credit bust shocks (and ensuing credit crunch and investment busts) of 1990-91 and 2001: like in 1973 and 1979 we are facing a stagflationary shock to oil, energy and other commodity prices that by itself may tip many oil importing countries into a sharp slowdown or an outright recession. Also, like 1990-91 and 2001 we are now facing another asset bubble and credit bubble gone bust big time: the housing and overall household credit boom of the last seven years has now gone bust in the same way as the 1980s housing bubble and 1990s tech bubble went bust in 1990 and in 2000 triggering recessions. And a similar housing/asset/credit bubble is going bust in other countries - U.K., Spain, Ireland, Italy, Portugal, etc. - leading to a risk of a hard landing in these economies.

* But over time inflation will be the last problem that the Fed will have to face as a severe US recession and global slowdown will lead to a sharp reduction in inflationary pressures in the U.S.: slack in goods markets with demand falling below supply will reduce pricing power of firms; slack in labor markets with unemployment rising will reduce wage pressures and labor costs pressures; a fall in commodity prices of the order of 20-30% will further reduce inflationary pressure. The Fed will have to cut the Fed Funds rate much more - as severe downside risks to growth and to financial stability will dominate any short-term upward inflationary pressures. Leaving aside the risk of a collapse of the US dollar given this easier monetary policy the Fed Funds rate may end up being closer to 0% than 1% by the end of this financial disaster and severe recession cycle.

* The Bretton Woods 2 regime of fixed exchange rates to the US dollar and/or heavily managed exchange will unravel - as the first Bretton Woods regimes did in the early 1970s - as US twin deficits, recession, financial crisis and rising commodity and goods inflation in emerging market economies will destroy the basis for it existence.

Thus, the scenario of 12 steps to a financial disaster that I outlined in my February 2008 paper is unfolding as predicted. If anything financial conditions are now much worse than they were at the previous peak of this financial crisis, i.e. in mid-march of 200

Yeah, I hate to go to these arcane sources, but I could not find the article on Roubini's "RGE Monitor" website. Maybe it is members only, I don't know.

I know the articles conclusion is inflammatory, calling for the worst recession since the Great Depression. It is not my aim to stir that pot. I am hoping that people will just read and absorb all of the financial reasons he gives to support his conclusion. I'm just trying to convey the extent of the futures losses and logjams in the financials and the economy.

Please try to keep an open mind despite the extreme conclusion the author is lead to by the data. I just want you to know the data and think for yourself what could come from it.

I know... I'm just a RAY of SUNSHINE!

With the democrat controlled Congress obstructing the drive for energy independence, of course we are doomed! That is precisely what the democrap party wants, our economic failure to empower their complete takeover of this nation. [If you doubt they would have such notions in their dark hearts, look at how they have supported, defended and funded the abortion holocaust as a means to empower their political party!]

BUT, if leadership would make the case for a 'moonshot' style drive for energy independence, the development of our resources --including of course the brilliant American citizen lead technology to exploit-- would drop price for oil immediately and become the means to end out debtor status and make us not only independent but the provider for the rest of the world seeking answers!

Mergers and acquisitions causing job losses, tight credit further limiting opportunities, free trade vs. fair trade shifting jobs to other countries, and outsourcing all look like things that could create a populist wave that the Democrats will try to ride to the White House.

I think voters care more about what is happening here in the U.S. than they do what is happening in Iraq.

Well, of course. We all know that the houses we live in are worthless, that land is free, that the current infrastructure of the country has no value whatsoever — so of course everything everybody owns is actually worthless.

On the other hand, I don’t I’ll mourn the death of the broker-dealers who did little more than interject themselves in the middle of the process and siphon off quick bucks while leaving others holding the bag.

I am just about as bearish as Roubini. But IMO it is important to not allow yourself to get too bearish, both as a matter of psychological survival and financial survival. That is sometimes difficult for me, as I tend to be pessimistic. Roubini has a pretty good understanding and I respect his views. I DO expect the US to enter a classically-defined recession, and I expect it to last 12-18 months. Historically it "rhymes" to have a first-year recession upon election of a new prez.

But there is also a possibility that it could get significantly worse, for all the reasons Roubini cites. There are a lot of negative factors in this particular perfect storm, and what I find MOST troubling is: it is not at all clear to me whether our leadership is looking to rip off or outright destroy the last bits of flesh of this country or to actually perform some constructive, corrective action.

Maybe we have to hit a hard bottom, "AA style" before this country can get on its feet again. If that's the case, then we do. Maybe this generation needs to have its "generational challenge" to separate the prevailing brain dead jerkball culture we have going.

I can't say. It's easy to get overwhelmed, we have some very serious stuff going on.

This administration is not "fighting" inflation. This administration carefully constructed the inflation, probably as a means to finance the profligate spending and the war. See Bush's original announcement that he was "devaluing" the dollar to teach those inscrutable folks in Asia a lesson.

"Devaluation" is inflation, just a less loaded word. That "devaluation" is ongoing with two upticks in the rate in the last 6 years. Real inflation right now is very high and at Carter levels. The official numbers are less onerous because periodically those who report the official rate remove the the most rapidly rising prices from the "basket" of prices used to compute the official rate. The proffered rate is not the inflation rate. It does not measure the actual inflation rate but measures, instead, the rate of increase of a few selected prices. Other prices, like oil, are not included because there are other reasons that can be cited for oil's rise.

If there were not inflation, the drastic rise in oil MUST cause a FALL in the average level of all other prices. That is manifestly not the case. The main clue that inflation is Policy is the nonpublication of the M3 measurement of money. That ceased to be published when it began to be obvious that the money numbers therein showed higher inflation rates than advertised by the government.

"In a typical US recession equity prices fall by an average of 28% relative to the peak. But this is not a typical US recession; it is rather a severe one associated with a severe financial crisis. Thus, equity prices will fall by about 40% relative to their peak. So, we are only barely mid-way in the meltdown of stock markets. "

Lots of generalities in the article.

Brinker has touted total market mutuals for ever. I don't listen much to him anymore. Has anyone heard him give a sell sign yet?

It is important to be equity specific, IMO.

Anyone heard from "professional" lately.

I can agree with the 28% pullback. When did Roubini write this, after the US market was already down 20% across the board?

Emphasis has been on financials and real estate for more than a year now. Don't invest in them. Don't put new money in equities. Sell financial mutuals or any that have more than 10% in financials.

IMO - The U.S. economy will not see a recession this year. More like 3% GDP growth.

yitbos

The February 2008 paper he speaks of with its eight steps appears to be the one at: http://www.house.gov/apps/list/hearing/financialsvcs_dem/roubini022608.pdf.

It is entitled:

The Current U.S. Recession and the Risks of a Systemic Financial Crisis

by

Nouriel Roubini

Professor of Economics at the Stern School of Business,

New York University

and

Chairman of RGE Monitor

(www.rgemonitor.com)

Written Testimony for

the House of Representatives’ Financial Services Committee

Hearing on February 26th, 2008

Inflation is the result of how we are paying for the war. We aren’t paying additional taxes to cover the expense, we are borrowing. Congress is authorizing increases in the national debt, which increases the money supply. And that’s inflationary.

If we don’t curtail government spending and reduce the trade deficit the dollar will continue to fall.

"We aren’t paying additional taxes to cover the expense, we are borrowing."

The U.S.A. economy has been growing nicely for more than 6 years now. GW's tax cuts have added immensly to the federal coffers. U.S. deficit spending is down vis a vis total spending for several years.

yitbos

Lots of generalities in the article.

Ah - yeah - it's a one page summary of what Roubini has written about in considerable detail earlier and elsewhere. So ... does it being a summary make it wrong?

Brinker has touted total market mutuals for ever.

What does Bob Brinker have to do with this?

It is important to be equity specific, IMO.

If you're saying that other economic, financial, or market analyses are wrong, because they are not equity specific, I disagree.

Emphasis has been on financials and real estate for more than a year now. Don't invest in them.

Roubini is stating that the bear market is widening, past just financials and real estate. He spells out why. His reasoning seems solid.

IMO - The U.S. economy will not see a recession this year. More like 3% GDP growth.

Have you been listening to Brinker too much ;)?

IMO, you're wrong. We shall see.

Yep.

If we can get Greenspan to keep knitting booties, and if Benranke would just shut the hell up.

Then there’s (maybe) the debt thing (which nobody wanted to hear in January of this year).

SO yes. The problem CAN be fixed (it won’t take Houdini to do it either).

But that’s ONLY if.

What I find most troubling also, is what is the basis for the decisions made by our "leadership". Is it ineptitude (bad enough) or is there some real malevalence at work ?

Will the Democrats really lead us over the edge out of spite, or are they just stupid?

Inflation is not the result of paying for the war. It is the method by which we are paying for the war. It is the government welshing on its debts by paying back dollar denominated debt in smaller dollars, smaller value. All governments indulge from time to time. It has ended some governments. Think of Weimar Germany.

What percentage of homes are owned outright? Where will the taxes come from for the towns and municipalities come from to pay the future obligations?

It's easy to call the equity in a home wealth - it's another thing to feed your family with it.

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