Noriel Roubini - One Of The World's Foremost Economists - NYU

[MetalMeister]

Avery important read!!!

Radical Policy Steps Necessary to Avoid a Systemic Meltdown: Interview with the Council on Foreign Relations

Nouriel Roubini | Oct 7, 2008

Here is below the text of an interview with the Council on Foreign Relations; the interview took place on Sunday October 5th but the message and policy recommendations that I proposed to prevent a systemic financial and corporate sector meltdown are still very relevant as the Fed and other central banks are still fiddling while Rome is burning. As discussed in this Global EconoMonitor forum Friday and yesterday Monday radical policy action is urgently necessary to avoid a systemic meltdown and a severe economic depression. The global economy is now already in a recession (as GDP is now contracting in all advanced economies and sharply slowing down in emerging market economies). We need now to take steps avoid a global depression.

9.30am Update: The Fed just announced a plan to start buying commercial paper (both asset backed and unsecured) from financial institutions and corporations. This action follows closely one of the radical policy options that I recommended last week: "Direct lending to the business sector from the Fed via extension of the PDCF and TSLF to the non financial corporate sector. This could include Fed purchases of commercial paper from corporations and other forms of financing of the short term liabilities of the Administration to small businesses secured in appropriate ways. Given the collapse of the corporate CP market and the banking system reluctance to provide loans to the corporate sector (credits lines are being shut down) the only alternative to the Fed becoming directly the biggest emergency bank for the corporate sector would be to force the banking system to maintain its exposure to the corporate sector, possibly in exchange for further Fed provision of liquidity to the banking system. The former option may be better than the latter to deal with the looming illiquidity of the corporate sector. " The action also allows the Fed to provide liquidity to non-bank financial instiutions that issues commercial paper; thus the PDCF has now been also extended well beyond non- bank primary dealers to other non-bank financial institutions that qualify for the new facility. This step also goes in the direction that I recommended last week: "Extension of the emergency liquidity support of the Fed (both TSLF and PDCF) to a broader range of institutions in the shadow banking system, especially those directly providing credit to the corporate sector. The TSLF and PDCF are already available to some non banks (the broker dealers that are primary dealers of the Fed). But two of such broker dealers are gone (Bear and Lehman) and the other three are under stress. Goldman Sachs, Morgan Stanley, the other primary dealers and the banks that have access to the TSLF and PDCF (and discount window) have massively used these facilities in the last few weeks; but they are hoarding such liquidity and not relending it to other banks, to the thousands of the other members of the shadow banking system and to the corporate sector as they need such liquidity and don’t trust any counterparty. Thus the transmission mechanism of credit policy (the non-traditional Fed liquidity lines) is completely shut down now. Thus, on an emergency basis the TSLF and PDCF need to be extended to other non-bank financial institutions, especially those directly providing credit to the corporate sector such as non-bank finance companies and leasing companies."

What still remains to be done - as i suggested last week - is a temporary blanket guarantee of all (insured and uninsured deposits) followed by a radical triage between insolvent banks that need to be shut down rapidly and solvent banks that need to be rescued. While Congress may resist legislation to pass such massive extension of deposit insurance the FDIC can rely on its "systemic risk exception" to provide guarantees to uninsured deposits. This "systemic risk exception" was already used - for the very first time in its historyy - by the FDIC to do the Citi-Wachovia. And yesterday the President's Working Group on Financial Markets made a statement that leaves open the option that "the FDIC will will use its authority and its resources, on an open or closed-bank basis, to protect depositors, guarantee liabilities, facilitate orderly wind downs, mergers, or adopt other stabilizing measures." I.e. both closed banks and still open banks may receive a guarantee of uninsured deposits. It is thus important that the FDIC uses such authority to stop a run on the uninsured deposits of the banking system. Whether the FDIC can use its "systemic risk exception" authority to provide a blanket guarantee of all uninsured deposits or whether the authority allows only to guarantee uninsured deposits on a case-by-case bank-by-bank basis is not clear. But certainly the authority could be used for large and systemically important banks that are at a risk of a run.

Steps to Halt the Slide

Interviewee:

Nouriel Roubini, Chairman, RGE Monitor, Professor of Economics, New York University

Interviewer:

Lee Hudson Teslik, Associate Editor, CFR.org

October 6, 2008

Nouriel Roubini, a professor of economics at New York University and the founder of the financial analysis firm RGE Monitor, has made his name by correctly predicting financial problems. Dubbed"Dr. Doom" by the New York Times Magazine, Roubini correctly warned of the impending housing market bust back in 2006, and, last February, of a rising probability of "catastrophic" financial system failure. At the time, he says, people called him a "lunatic," but his predictions have proven prescient.

In an interview with CFR.org, Roubini says the $700 billion financial bailout package passed by the U.S. Congress last week is unlikely to end the present crisis of confidence in financial markets. The plan, he says, does not get at the "much more urgent problem" of a "generalized run on the short-term liabilities both of the banks, of the non-bank shadow system, and now of the corporate sector." Roubini encourages a multi-pronged policy approach to the crisis, including: 1) coordinated interest rate cuts by all major world economies; 2) a move by the U.S. Federal Reserve to guarantee that it will provide liquidity in the event of any major bank run; 3) increased Fed action to provide short-term liquidity to non-bank actors that lend to corporations; and, if that doesn't work, 4) a willingness to make short-term loans directly to corporations. Roubini adds that despite having predicted much of the present crisis, he has been surprised at the speed at which it has unfolded.

Despite the so-called bailout plan passing the House of Representatives on Friday, there are obviously still some major strains to global financial markets, and it now appears as if commercial paper markets could be seizing up as well. How much of a help was the bailout plan, and where do you think things stand now?

The bill, first of all, in many dimensions is flawed. But leaving aside the flaws of the bill, there is a much more urgent problem that we're facing right now. It is one of a generalized run on the short-term liabilities both of the banks, of the non-bank shadow system, and now of the corporate sector. In the case of the banks, there is the beginning of a silent run on the uninsured debts of the banking systems, which are still over $2 trillion despite the increased deposit insurance. Many institutions in the non-bank shadow financial system are also finding that they cannot roll over their debts. There is a situation of generalized panic and lack of trust in counterparties. And worst of all, at this point, the commercial paper [short-term debt issued by large banks and corporations] to the corporate sector, and other types of funding to the corporate sector, is frozen right now. That can tip a corporation into a situation of defaults. They might not be able to pay interest on maturing debts, they might not be able to roll over maturing debts, and they might not be able to finance their working capital. So we're seeing a generalized liquidity run, and it's something that this bill cannot directly address. It's something that needs to be addressed with different sorts of tools.

What sorts of tools do you recommend? I see you've called for major coordinated interest-rate cuts, on the order of one hundred points across the board, in all major world economies.

That's only part of the solution. It has to do with coordinated rate cuts, but it's not obvious [even after the cuts] that liquidity is going to flow to those who need it. We need to do something slightly more radical than just an interest rate cut. Most likely the Fed will have either to guarantee all deposits on a temporary basis, since that's the only way you can essentially stop a run. But since that requires legislation and it's not obvious that Congress will pass a temporary blanket guarantee, the Fed has to stand ready to provide the liquidity to any bank that needs liquidity. So if there is a run on any bank, the Fed has to increase the money supply by as much as is needed to essentially prevent that particular institution from collapsing. That's the first thing.

The second thing is that the Fed is already, through its own emergency authority, allowed to provide liquidity to non-bank primary dealers that are systemically important. But the money the Fed is giving to the banks and to the primary dealers is not being re-lent to the other financial institutions in the shadow banking system. So the transmission of monetary policy is locked. Fixing that might require the Fed to start extending the PDCF [Primary Dealer Credit Facility], that is the facility that provides liquidity to non-banks, also to other financial institutions like finance companies, leasing companies, and you name it, in a way to provide liquidity to those financial institutions that directly lend to the corporate sector.

And if all that doesn't work, the Fed might be forced to directly liquefy the corporate sector by using its emergency powers to directly lend to the corporate sector, essentially buying commercial paper, providing cash.

Those are all three radical actions, but some combination of all three at this point is necessary. The problem is that once the bill was passed, the stock market reacted negatively both to the passage of the bill in the Senate--on Thursday, equities fell by 4 percent--then on Friday, after the House voted, the Dow fell almost 400 points. So the stock market is not reacting positively, and for the last couple weeks, interbank markets and commercial paper and other kinds of short-term lending in the financial system and the corporate system have come to a freeze. And this particular legislation doesn't have any role in essentially restoring the confidence and the liquidity in interbank and short-term credit markets. And in the short run, in the next few weeks, that's what you need to do. Because that legislation, even if implemented properly, is going to take a few months--if you don't reliquefy the banking system, the shadow banks, and the corporate sector, you'll have a financial meltdown in a matter of two or three weeks. That's much more urgent than anything else.

If we do start to see spillover into the corporate sector, where would you see that starting? Are there specific firms or specific industries that you think are most susceptible?

Now the situation is that even triple-A corporations [corporations with AAA credit ratings, the highest level] cannot roll over [defer payment on] commercial paper at any maturity past overnight. So we're already seeing a situation in which essentially commercial paper is frozen, and even corporations that are going to the banks now to try to draw down on their credit lines are finding that they are being refinanced at much higher rates. So it's becoming very expensive, and it's really squeezing the corporate sector. Unless the government steps in and directly provides liquidity to the corporate sector, I think we'll be in big trouble.

You have said that Goldman Sachs and Morgan Stanley converting themselves to bank holding companies was a "cosmetic" move and that they should be looking to merge at this point to avoid a run on their overnight liabilities. How big of a risk do you see at this point of a run?

They wanted to convert themselves as banks to have a stable base of insured deposits in the same way that brokerages in JP Morgan and Citi[group] have it, and the same way that Merrill [Lynch], being a part of Bank of America, will have it. You're not going to see Goldman Sachs or Morgan Stanley branches on the corner anytime soon. And even acquiring other banks over time, as a way to acquire deposits, is going to take a lot of time. Ninety percent of their borrowing is still overnight; they're leveraged thirty times, and they lend in ways that are illiquid and longer term. So there is a serious risk. Morgan Stanley, over the last ten days, has lost a good third of their hedge-fund clients. So the foundations of what they do are being undermined. Of course the Fed is providing both institutions with mass amounts of liquidity to try to compensate for whatever lack of finances they have, but how much? $100 billion? $200 billion? At some point there has to be a limit. So I think both institutions would be well-advised to do what Merrill did, as a way to avoid ending up like Lehman [Brothers, which collapsed]. Just do whatever to avoid ending up like Lehman is the basic thing, and just converting yourself to bank holding companies is not enough at this point. You really have to merge.

Obviously in many ways this is metastasized into a global crisis, but how evenly spread is the crisis across the globe? We've been seeing some pretty ugly news out of Europe. Which parts of the world are most vulnerable, and which are best buffered?

Certainly European banks are very vulnerable, for a variety of reasons. They bought a lot of the securitized debt, there is a bursting of housing bubbles in the UK, Ireland, Spain, even in Italy, Portugal, and France. There is the beginning of a recession in the Eurozone. The liquidity credit crunch in the United States is negatively affecting liquidity conditions in Europe. Plus European banks are exposed to Eastern Europe, Scandinavian banks are exposed to Iceland, Lithuania, Latvia, and Estonia-which are on their way to a hard landing. German and Austrian banks are exposed to countries in southern Europe like Hungary, the Czech Republic, Romania, Bulgaria, and Turkey-and they all look shaky. On top of all that the Fed at least has been cutting the Fed funds rate aggressively, while the ECB [European Central Bank] was first on hold and then they hiked from 4 [percent] to 4.25. They're going to cut them soon enough, but it's too little, too late. So the Eurozone and the rest of Europe is already in a recession, and it's getting worse, and now it's hit by a liquidity and credit crunch. And there is a crisis of confidence in European banks since several of them now from Germany, to the UK, to Iceland, to other parts of Europe, are now in trouble and need to be rescued. So the European banking crisis is getting severe.

Asia is less affected in terms of banks, even if you've had a couple of problems with banks in Hong Kong and there has been some nervousness there. The impact has been more on the stock market. The real economy is about to start to slow down, and hit Asian financial institutions.

Back in February, you predicted, or at least predicted the possibility, of much of what has happened. What about the way it has actually unfolded has surprised you the most?

I predicted most of these things happening, but what has surprised me the most is the speed at which things have happened. In February, back before Bear Stearns, I wrote this piece in which I said there are a couple major broker-dealers that could go belly-up and that in a couple years there won't be any major independent broker-dealers left, because I knew that their business model at this point was fundamentally flawed. But I said two years. Instead it took literally seven months, for first Bear Stearns to go, then Lehman, then Merrill merged with Bank of America, and now Morgan Stanley and Goldman Sachs have been forced to convert to bank holding companies. At that point people thought I was a lunatic to say two years, but it took seven months. In the last months we've had an acceleration of the collapse of the financial system. We had to go to a $700 billion package, but even that has not restored calm in the stock market, and it has not restored any calm in money markets or credit markets. The last few weeks since the proposal passed, interbank spreads have widened, TED spreads [the spread between interest rates on interbank loans and those on U.S. Treasury bills] have widened, credit spreads have widened, CDS [credit default swaps, essentially a kind of insurance on credit products] spreads have widened, and now there is even a run on commercial paper for corporations. So everything has gotten much worse. There is a generalized loss of confidence like we've never seen before. That was something that even somebody as bearish as myself wouldn't have thought would happen so quickly.

[punter]

My pal Peter Grandich also said " I can't have imagined this happening". We'll create a new game, I'll call it ' Stump the Pro's' , no one knows whats going on. Therein lies the rub. As I said earlier I think we'll have to see the body puking blood snd sctuslly die before it's understood that the bottom has been reached. I will wait until I can actually smel the corpse before I come back. I suspect it will get even uglier. As pissed off as I am for not being 100% out of the market, I didn't imagine we were at this point either. Fortunatley I did go 30+% into cash last 4th Q and have some staying/recovery powder left in the horn. But the carnage is not sweet.

I am at a point where I'm saying 'all bets are off' . I would not like to see the DOW proxy fall below 7000 because if it does there will be hell to pay all the way down to ZERO. We will be in uncharted waters. Nothing after 5000 is impossible.

[MetalMeister]

I don't know how we can NOT fall below DOW 5000.

How can all these derivatives unwind without the market crashing below that level?  So much of so many companies have hedged bets in those areas.

[MetalMeister]

Governments got religion after peering into the systemic meltdown abyss: aggressive and comprehensive policy action is now likely but significant downside risks to markets will remain

Nouriel Roubini  | Oct 13, 2008

I spent the weekend in Washington attending the IMF annual meetings and giving a series of talks in a variety of public and private fora (IADB talk, C-Span interview, Euro 50 Group meeting, IMF panel, etc.). After last week crash in stock markets and financial markets (and it was indeed a crash as during the week equity prices fell as much as the two day crash of 1929) policy makers finally realized the risk of a systemic financial meltdown, they peered into the systemic collapse abyss a few steps in front of them and finally got religion and started announcing radical policy actions (the G7 statement, the EU leaders agreement to bailout European banks, the British plan to rescue – and partially nationalize - its banks, the European countries plans along the same lines, and the Treasury plan to ditch the initial TARP that was aimed only buying toxic assets in favor of plan to recapitalize – i.e. partially nationalize – US banks and broker dealers. While many details of these plans are fuzzy and there will be some national variants the contour of the approach are similar and close to the recommendations that I made in this forum. Here are the main policy actions that will be undertaken:

- Preventing systemically important banks and broker dealers from going bust (i.e. the U.S. made a mistake letting Lehman fail; so Morgan Stanley and other systemically important financial institutions will be rescued) (“Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure” as in the G7 statement )

- Recapitalization of banks and broker dealers via public injections of capital via preferred shares (i.e. partial nationalization of financial institutions as it is already occurring in the UK, Belgium, Netherlands, Germany, Iceland and, soon enough the U.S.) matched by private equity injections (“Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”)

- Temporary guarantee of bank liabilities: certainly all deposits, possibly interbank lines along the lines of the British approach, likely other new debts incurred by the banking system (“Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits”)

- Unlimited provision of liquidity to the banking system and to some parts of the shadow banking system to restore interbank lending and lending to the real economy (“Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”)

- Provision of credit to the corporate sector via purchases of commercial paper (certainly in the US, possibly in Europe)

- Purchase of toxic assets to restore liquidity in the mortgage backed securities market (U.S.) (“Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.”)

- Implicit triage between distressed that are solvent given liquidity support and capital injection and non-systemically important and insolvent banks that will need to be closed down/merged/resolved/etc.

- Use of the IMF and other international financial institutions to provide lending to many emerging market economies – and some advanced ones such as Iceland - that are now at risk of a severe financial crisis.

- Use of any other tools that is available and necessary to avoid a systemic meltdown (including implicitly more monetary policy easing as well as possibly fiscal policy stimulus “We will use macroeconomic policy tools as necessary and appropriate.”).

At this stage central banks that are usually supposed to be the "lenders of last resort" need to become the "lenders of first and only resort" as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. Only over time private lending will recover.

While most of the economic and financial damage is already done and the global economy will not be able to avoid a painful recession, financial and banking crisis (i.e. the V-shaped short and shallow 6-month recession is now out of the window and we will experience a severe and more protracted 18 to 24 months U-shaped recession) the rapid and consistent implementation of these and other action will prevent the US, European and global economies from experiencing a systemic financial meltdown and entering in a more severe L-shaped decade long stagnation like the one experienced by Japan after the bursting of its real estate and equity bubble.

Are we close to the bottom of this financial crisis? Today stock markets – and other financial markets - will rally on the news that terrified policy makers peering into the abyss got religion and started to do in a consistent way what is necessary but financial markets will remain volatile with significant downside risks over the next few weeks as:

- details of these plans are still very fuzzy and ambiguous and with uncertain effects on various assets classes (common shares, preferred shares, unsecured debt of financial institutions, etc.);

- macro news will surprise on the downside as the economies sharply weaken and contract while fiscal policy stimulus is lagging;

- earnings news for financial and non financial firms will surprise on the downside;

- the damage done to confidence and to levered investment is already severe and the process of deleveraging of the shadow financial system will continue;

- major sources of future stress in the financial system remain; these include the risk of a CDS market blowout, the collapse of hundreds of hedge funds, the rising troubles of many insurance companies, the risk that other systemically important financial institutions are insolvent and in need of expensive rescue programs, the risk that some significant emerging market economies and some advanced ones too (Iceland) will experience a severe financial crisis, the ongoing process of deleveraging in illiquid financial markets that will continue the vicious circle of falling asset prices, margin calls, further deleveraging and further sales in illiquid markets that continues the cascading fall in asset prices, further downside risks to housing and to home prices.

More aggressive and consistent and rapid implementation of the policy plans will increase the likelihood that risky asset prices will bottom out sooner rather than later and then start recovering. A key policy tool – that is currently missing in the G7 and EU plans is to use fiscal policy to boost aggregate demand. Indeed, given the current collapse of private aggregate demand (consumption is falling, residential investment is falling, non-residential investment in structures is falling, capex spending by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate) it is urgent to provide a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than spending and investing it is necessary now to boost directly public consumption of goods and services via a massive spending program (a $300 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be sharply increased together with a targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and growing budget deficits; but $300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets. Is such fiscal stimulus plan is not rapidly implemented any improvement in the financial conditions of financial institution that the rescue plans will provide will be undermined – in a matter of six months – with an even sharper drop of aggregate demand that will make an already severe recession even more severe. So a fiscal stimulus plan is essential to restore – on a sustained basis – the viability and solvency of many impaired financial institutions. If Main Street goes bust in the next six months rescuing in the short run Wall Street will still lead Wall Street to go bust again as the real economy implodes further.

Moreover, the US government will need to implement a clear plan to reduce the face value of mortgages for distressed home owners and avoid a tsunami of foreclosures (as in the Great Depression HOLC and in my HOME proposal). Households in the US have too much debt (subprime, near prime, prime mortgages, home equity loans, credit cards, auto loans and student loans) while their assets (values of their homes and stocks) are plunging leading to a sharp fall in their net worth. And households are getting buried under this mountain of mounting debt and rising debt servicing burdens. Thus, a fraction of the household sector – as well as a fraction of the financial sector and a fraction of the corporate sector and of the local government sector – is insolvent and needs debt relief. When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction. The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession - with a sharp fall now in real consumption spending – now worsening. The fiscal actions taken so far (income relief to households via tax rebates) do not resolve the fundamental debt problem because you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). During the Great Depression the Home Owners’ Loan Corporation was created to buy mortgages from bank at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing their homes and ending up in foreclosure. The HOLC bought mortgages for two year and managed such assets for 18 years at a relatively low fiscal cost (as the assets were bought at a discount and reducing the face value of the mortgages allowed home owners to avoid defaulting on the refinanced mortgages). A new HOLC will be the macro equivalent of creating a large “bad bank” where the bad assets of financial institutions are taken off their balance sheets and restructured/reduced.

A large fiscal stimulus plan and a plan to reduce the debt overhang of distressed home owners will also ease the political economy of the financial bailout: as the debate in Congress showed the US public is mad about a system where gains and profits are privatized while losses are socialized, a welfare system for the rich, the well connected and Wall Street. Bernanke and Paulson and the US administration did a lousy job in explaining why partially bailing Wall Street is necessary to avoid severe collateral damage to Main Street in the form of a most severe recession and a risk of an even more severe economic stagnation. At least the redesign of the TARP into a program that will recapitalize banks with public capital (and thus provide the US government and the taxpayer with some upside potential) makes this bailout more socially fair and acceptable.

But the current collapse of private aggregate demand makes it fair, necessary and efficient to directly help Main Street with a direct fiscal stimulus program and with a plan to reduce the debt burden of distressed home owners. Those two additional policy actions are necessary and fundamental – together with the rescue and recapitalization of financial institutions – to minimize the damage to the real economy and to the financial system.

Post-Scriptum: Many many congrats to Paul Krugman for his very well deserved Nobel Prize in economics. While the prize was awarded to Paul for his contributions to trade theory his work in international macro/finance (currency and financial crises, currency target zones, reserve currencies, pass-through of exchange rates to import prices, contractionary effects of devaluations, sovereign debt crises, etc.) is as important and seminal. And his economic commentary is as incisive and deep as his more analytical research work.

[MetalMeister]

Good interview with Roubini on Charlie Rose.

"We're already in a recession.  Hundreds of banks are going to go belly up."

[MetalMeister]

I forgot to put up the link in that last post!!!

Can't believe I have not been called on the carpet for this...

Are you guys sleeping today???   


http://www.charlierose.com/shows/2008/10/14/3/a-conversation-with-nouriel-roubini

[MetalMeister]

Roubini sees Rally's End and Long Recession


http://www.youtube.com/watch?v=Vs8ry31BLLM

[MetalMeister]

Interesting on Russia vulnerabilities.


Russia's CDS Spreads Spike: How Much Is Russia's Default Risk Rising?

    * The cost of insuring Russian bonds against bankruptcy (spreads of Credit default swaps on Russia's debt ) rocketed to 1,123 bps, higher than Iceland's debt before it sought a rescue from the International Monetary Fund (Telegraph) Although other emerging markets including Baltic countries, Turkey and CEE countries have higher external financing needs and run current account deficits, the reduction in Russia's reserves, the prospect of current account and fiscal deficits, the implicit and explicit state assumption of significant corporate debt as the oil price slumps point to further risk.

    * Russian sovereign bonds were already trading at higher risk than other EM sovereign bonds even before S&P lowered its credit ratings outlook to negative from stable citing the worsening outlook for public finance in light of lower oil prices and increasing government support of the banking sector
    * Russia still looks stronger than some of its peers despite vulnerabilities (Uralsib) -  strengthening capital outflows as deposits are converted into dollars which may prompt restrictions on fx  transactions. Several other commodity export-led economies could face similar worries, yet they have not been downgraded  - the difference may be due to perception of higher political risk and government-led consolidation in Russia

    * The Russian banks’ dependence on wholesale and external funding is key to the economy’s vulnerability, which can be expected to mount if commodity prices fall further (Citi) Although the CBR's reserves far exceed Russia's short-term debt, they barely cover Russia's total external debt. Intervention to stabilize the rouble is depleting reserves rapidly (though the dollar rally also reduces the value of EUR and GBP holdings). Russia has to roll over $40b in debt this quarter and $150b in the next year. and the Government has promised over $200 billion in short and long-term capital to ease liquidity crunch and substitute for external finance

    * Russia may run a current account deficit with oil in the $60-70 a barrel range given the ramp up in imports and reduction in oil inflows - capital flows have already reversed and Russian investors flight to USD has pressured the rouble.

    * Weafer: An oil price in the $60’s/bbl should still mean a defendable ruble, but there will be a lot more pressure at $60/bbl, or lower. A combination of falling oil and a weakening currency will increase downward pressure on equity and bond markets. The correlation between the price of oil and the RTS was not very tight as oil was rising but it has increased on the downward trajectory.

    * Lacking a developed domestic bond market, the only way for oligarchs to raise money at present is by selling their equity, contributing to massive equity selloffs. Russia's unique fragility is that over $1 trillion of debt needs to financed from a domestic capital pool of $600bn (Bond)

    * Now that Russia's own sovereign debt is in question, and many other emerging markets are turning to the IMF to stabilize their balance of payments, markets no longer believe Russia is strong enough to guarantee the estimated $530bn of foreign debts accumulated by its companies during the break-neck expansion of the oil boom. (Redeker, via telegraph)

[Bottomfeeder]

A friend of mine just sent me this Roubini article:  Lengthy, but also gives good answers to inflation/deflation argument, and as a result answers to commodities questions:

Last January – at a time when the consensus was starting to worry about rising global inflation - I wrote a piece titled Will the U.S. Recession be Associated with Deflation or Inflation (i.e. Stagflation)? On the Risks of “Stag-deflation” rather than “Stagflation” where I argued that the US and other economies would soon have to worry about price deflation rather than price inflation.

As I put it at that time last January:
the S-word (stagflation that implies growth recession cum high and rising inflation) has recently returned in the markets and analysts’ debate as inflation has been rising in many advanced and emerging markets economies. This rise in inflation together with the now unavoidable US recession, the risk of a recession in a number of other economies (especially in Europe) and the likelihood of a sharp global economic slowdown has lead to concerns that the risks of stagflation may be rising.

Should we thus worry about US and global stagflation? This note will argue that such worries are not warranted as a US hard landing followed by a global economic slowdown represents a negative global demand shock that will lead to lower global growth and lower global inflation. To get stagflation one needs a large negative global supply-side shock that, as argued below, is not likely to occur in the near future. Thus the coming US recession and global economic slowdown will be accompanied by a reduction – rather than an increase – in inflationary pressures. As in 2001-2003 inflation may become the last of the worries of the Fed and one may actually start hearing again concerns about global deflation rather than inflation.

Let me elaborate next why…
…unlike a true negative supply side shock – that reduces growth while increasing inflation - a US recession followed by a global economic slowdown is a negative demand shock that has the effect of reducing US and global growth while at the same time reducing US and global inflationary pressures. Specifically such a negative demand shock will reduce inflation and across the world because of a variety of channels.

First, a US hard landing will lead to a reduction in aggregate demand relative to the aggregate supply as a glut of housing, consumer durables, autos and, soon enough, other goods and service takes places. Such reduction in aggregate demand tends to reduce inflationary pressures as firms lose pricing power and then to cut prices to stave off the fall in demand and the rising stock of inventories of unsold goods. These deflationary pressures are already clear in housing where prices as falling and in the auto sector where the glut of automobiles is leading to price discounts and other price incentives. Obviously, inflation tends to fall in recession led by a fall in aggregate demand.

Second, during US recessions you observe a significant slack in labor markets: job losses and the rise in the unemployment rate lead to a slowdown in nominal wage growth that reduces labor costs and unit labor cost, thus reducing wage and price inflationary pressured in the economy.

Third, the same slack of aggregate demand and slack in labor markets will occur around the world as long as the negative US demand shock is transmitted – through trade, financial, exchange rate and confidence channels – to other countries leading to a slowdown in growth in other countries (the recoupling rather than decoupling phenomenon). The reduction in global aggregate demand – relative to the global supply of goods and service – will lead to a reduction in inflationary pressures.

Fourth, during any US hard landing and global economic slowdown driven by a negative demand shock the US and global demand for oil, gas, energy and other commodities tends to fall leading to a sharp fall in the price of all commodities. A US hard landing followed by a European, Chinese and Asian slowdown will lead to a much lower demand for commodities pushing down their price. The fall in prices tends to be sharp because – in the short run – the supply of commodities tends to be inelastic; thus any fall in demand leads to a greater fall in price – given an inelastic supply curve – to clear the commodity prices. And indeed in recent weeks the rising probability of a US hard landing has already lead to a fall in such prices: for example oil prices that had flirted with a $100 a barrel level are now down to a price closer to $90; or the Baltic Dry Freight index – that measures the cost of shipping dry commodities across the globe and that had spike for most of 2007 given the high demand and the limited supply of such ships – is now sharply down by over 20% relative to its peak in the fall of 2007. Similar downward pressure in prices is now starting to show up in other commodities.

Note that a cyclical drop in commodity prices – led by a US hard landing and global economic slowdown - does not mean that commodity prices will remained depressed over the middle term once this global growth slowdown is past. If in the medium term the supply response to high prices is modest while the medium-long term demand for commodities remains high once the US and global economy return to their potential growth rates commodity prices could indeed resume their upward trend. But in a cyclical horizon of 12 to 18 months a US hard landing and global economic slowdown would lead to a sharp fall in commodity prices. Note that even in the case of oil that is the commodity with the weakest supply response to prices – as the investments in new production in a bunch of unstable petro-states (Nigeria, Venezuela, Iran, Iraq and even Russia) are limited - a cyclical global slowdown could lead to a very sharp fall in oil prices. Indeed while oil today is closer to the $90-100 range in the last 12 months oil prices drifted downward at some point close to a $50-60 range even before a US hard landing and global slowdown had occurred. Thus, one cannot rule out that in such a hard landing scenario oil prices could drift to a price close to $60.

The four factors discussed above suggest that – conditional on the negative global demand shock (US hard landing and global economic slowdown) materializing even the risks of stagflation-lite are exaggerated; rather US and global inflationary force would sharply diminish in this scenario and, if anything, concerns about deflation may reemerge again.
This is not a far fetched scenario as one looks back at what happened in the 2000-2003 cycle. Until 2000 the Fed was worried about the economy overheating and rising inflation risk. But once the economy spinned into a recession in 2001 US and global inflationary pressures diminished and by 2002 the great scare became one of US and global deflation rather than inflation. Indeed the Fed aggressively cut the Fed Funds rate all the way to 1% and Ben Bernanke – then only a Fed governor – wrote speeches about using heterodox policy instruments to fight the risk of deflation once and if the Fed Funds rate were to reach its nominal floor of zero percent.

Today, following a US hard landing and a global economic slowdown, the risks of outright deflation would be lower than in the 2001-2003 episode because of various factors: US inflation starts higher than in 2001; the Fed needs to worry about a disorderly fall of the US dollar that may increase inflationary pressures; the rise and persistence of growth rates in Chindia and other emerging market economies implies that – even if such economies likely recouple to the US hard landing – a global growth slowdown will not turn into an outright global recession that would be truly deflationary. Still, while the scenario outlined here – US recession and global slowdown – may not lead to outright deflationary pressures it would certainly lead to a slowdown of US and global inflation.

The fact that the most likely scenario in the global economy in 2008 is one of a negative global demand shock is the one that is priced by bond markets: if investors were really worried about a rise in US and global inflation – or about true stagflationary shocks – the yield on long term government bonds would have not fallen as sharply as it has since last summer. With US 10 year Treasury yield now well below 4% and sharply falling in the last few weeks it is hard to see a bond market that is worried about global inflation or global stagflation. And while until recently commodity prices pointed to the other directions, recent weakness in oil prices, the cost of shipping commodities and the price of some other commodities also signals that commodity markets are now pricing the risk of a US recession and the risk that – with a lag – a US recession will lead to a broader global economic slowdown.

So in conclusion “stag-deflation” (i.e. low growth or recession with falling inflation rates and possible deflationary pressures) is more likely than “stagflation” (low growth or recession with rising inflation rates) if a US hard landing materializes and leads – as likely – to a slowdown in global demand and growth.
So last January I argued that four major forces would lead to a risk of deflation (or stag-deflation where a recession would be associated with deflationary forces) rather than the inflation risk that at that time – and for most of 2008 – mainstream analysts worried about: slack in goods markets, re-coupling of the rest of the world with the US recession, slack in labor markets, and a sharp fall in commodity price following such US and global contraction would reduce inflationary forces and lead to deflationary forces in the global economy.
How have such predictions fared over time? And will the US and global economy soon face sharp deflationary pressures? The answer deflation and stag-deflation will in six months become the main concern of policy authorities. Let me now explain in more detail why…
First, what has happened in the last few months? The US has entered a severe recession that is already leading to deflationary forces in sectors where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.) while now aggregate demand is sharply falling below aggregate supply; the unemployment rate is sharply up while employment has been falling for 10 months in a row; and commodity prices are sharply down – about 30% from their July peak - in the last three months and likely to fall much more in the next few months as the advanced economies recession is becoming global. So both in the US and in other advanced economies we are clearly headed towards a collapse of headline and core inflation.

Is there any doubt about this ongoing inflation capitulation and the beginning of sharp deflationary forces? Take the current views of the economic research group at JP Morgan; this group was in 2007-2008 the leading voice arguing about the risks of rising global inflation, about the associated risks of a global growth reflation and arguing that policy rates would be sharply increased in 2008-2009.

This week instead this JP Morgan research group published its latest global economic outlook arguing that we are headed towards a global recession, negative global inflation and sharply lower policy rates in the US and advanced economies (a 180 degree turn from its previous position). As written in the most recent JP Morgan Global Data Watch:

Continued on Page 2

[Bottomfeeder]

Continued from Page 1                                                                 Page 2


“A bad week in hell
Increasingly, the signs point to a deep and synchronized global recession. Today’s reported slide in UK 3Q08 GDP is expected to be followed by contractions in the United States (next week), the Euro area, and Japan—confirming that the global downturn began last quarter. More troubling is the additional loss of momentum at quarter end, combined with collapsing October survey readings. These developments appear to be part of a negative loop in which economic and financial weakness are feeding on each other, making the prospects for growth in the coming months decidedly grim. Once again we have taken an axe to near-term growth forecasts for the developed world and will likely follow up with additional downward revisions for emerging market economies in the coming weeks. Already, our forecasts suggest that global GDP will contract at a near 1% annual rate in 4Q08 and 1Q09.
It is still too early to accurately gauge the depth of the downturn, as the outlook depends on how well policy actions contain the financial crisis. From a US perspective, our current forecasts place the contraction in GDP somewhere between the last two mild recessions and the deep contractions of 1973-75 and 1981-82. This picture masks the degree to which the pain of the current downturn is falling on households. From the perspective of wealth losses and declines in real consumption, the current recession is likely to prove more severe than any of the previous ten in the post World War II era (see Special report: How deep is the ocean? Gauging US recession contours). For Western Europe, the current downturn is currently projected to look similar to the one in the early 1990s—the last episode in which regional GDP contracted…

Inflation and real policy rates to go negative
With part of this year’s slide in global growth linked to an inflation shock, the recent collapse in global commodity prices should be seen as an important factor cushioning the downturn. In the six months through August 2008, global consumer prices rose at a 5.6% annual rate, prompting stagnation in real consumption across the globe. Based on recent moves in the price of oil and other commodities, it is likely that the coming six months will see headline inflation dip below zero. While this swing will be a plus for consumers across the globe, it is also a development that will promote a significant growth rotation towards the G3 and Emerging Asian economies that were hurt most severely by this negative shock. In the developed world, this backdrop of contracting GDP, collapsing inflation, and financial market stress opens the door to a powerful monetary policy response.

So the leading supporters of the view that the global economy risked rising inflation, rising growth reflation and sharply higher policy rates to fight this inflation are now predicting a global recession, global deflation and sharply falling policy rates. What a difference a year makes!

Any further doubt that we are headed towards a global deflation or – better – a global stag-deflation? Aggregate demand is now collapsing in the US and advanced economies and sharply decelerating in emerging markets; there is a huge excess capacity for the production of manufactured goods in the global economy as the massive and excessive capex spending in China and Asia (Chinese real investment is now close to 50% of GDP) has created an excess supply of goods that will remain unsold as global aggregate demand falls; commodity prices are in free fall with oil prices alone down over 50% from their July peak (and the Baltic Freight Index - the best measure of international shipping costs - is 90% from its peak in May); while labor market slack is sharply growing in the US and rising in Europe and other advanced economies.

And what are financial markets telling us about the risks of stag-deflation?
First, yields on 10 year Treasury bonds fell by about 50bps since October 14th getting close to their previous 2008 lows; also two-year Treasury yield have fallen by about l50bps in the last month. Second, gold prices – a typical hedge against rising global inflation – are now sharply falling. Finally, and more importantly, yields on TIPS (Treasury Inflation-Protected Securities) due in five years or less have now become higher than yields on conventional Treasuries of similar maturity. The difference between yields on five-year Treasuries and five-year TIPS, known as the breakeven rate, fell to minus 0.43 percentage points; this is a record. Since the difference between the conventional Treasuries and TIPS is a proxy for expected inflation the TIPS market is now signaling that investors expect inflation to be negative over the next five years as a severe recession is ahead of us.

So goods markets, labor markets, commodity markets, financial markets and bond markets are all sending the same message: stagnation/recession and deflation (or stag-deflation) is ahead of us in the US and global economy.

So, don’t be surprised if six months from now the Fed and other central banks in advanced economies will start to worry – as they did in 2002-03 after the 2001 recession – about deflation rather than inflation. In those years where the US experienced a deflation scare Bernanke wrote several pieces explaining how the US could resort to very unorthodox policy actions to prevent a deflation and a liquidity trap like the one experienced by Japan in the 1990s. Those writings may have to be soon carefully read and studied again as the US and global economy faces its worst recession in decades and as deflationary forces envelop the US and other advanced economies.

Finally, while in the short run a global recession will be associated with deflationary forces shouldn’t we worry about rising inflation in the middle run? This argument that the financial crisis will eventually lead to inflation is based on the view that governments will be tempted to monetize the fiscal costs of bailing out the financial system and that this sharp growth in the monetary base will eventually cause high inflation. In a variant of the same argument some argue that – as the US and other economies face debt deflation – it would make sense to reduce the debt burden of borrowers (households and now governments taking on their balance sheet the losses of the private sector) by wiping out the real value of such nominal debt with inflation.

So should we worry that this financial crisis and its fiscal costs will eventually lead to higher inflation? The answer to this complex question is: likely not.
First of all, the massive injection of liquidity in the financial system – literally trillions of dollars in the last few months – is not inflationary as it accommodating the demand for liquidity that the current financial crisis and investors’ panic has triggered. Thus, once the panic recede and this excess demand for liquidity shrink central banks can and will mop up all this excess liquidity that was created in the short run to satisfy the demand for liquidity and prevent a spike in interest rates.

Second, the fiscal costs of bailing out financial institutions would eventually lead to inflation if the increased budget deficits associated with this bailout were to be monetized as opposed to being financed with a larger stock of public debt. As long as such deficits are financed with debt – rather than by running the printing presses – such fiscal costs will not be inflationary as taxes will have to be increased over the next few decades and/or government spending reduced to service this large increase in the stock of public debt.
Third, wouldn’t central banks be tempted to monetize these fiscal costs - rather than allow a mushrooming of public debt – and thus wipe out with inflation these fiscal costs of bailing out lenders/investors and borrowers? Not likely in my view: even a relatively dovish Bernanke Fed cannot afford to let the inflation expectations genie out of the bottle via a monetization of the fiscal bailout costs; it cannot afford/be tempted to do that because if the inflation genie gets out of the bottle (with inflation rising from the low single digits to the high single digits or even into the double digits) the rise in inflation expectations will eventually force a nasty and severely recessionary Volcker-style monetary policy tightening to bring back the inflation expectation genie into the bottle. And such Volcker-style disinflation would cause an ugly recession. Indeed, central banks have spent the last 20 years trying to establish and maintain their low inflation credibility; thus destroying such credibility as a way to reduce the direct costs of the fiscal bailout would be highly corrosive and destructive of the inflation credibility that they have worked so hard to achieve and maintain.

Fourth, inflation can reduce the real value of debts as long as it is unexpected and as long as debt is in the form of long-term nominal fixed rate liabilities. The trouble is that an attempt to increase inflation would not be unexpected and thus investors would write debt contracts to hedge themselves against such a risk if monetization of the fiscal deficits does occur. Also, in the US economy a lot of debts – of the government, of the banks, of the households – are not long term nominal fixed rate liabilities. They are rather shorter term, variable rates debts. Thus, a rise in inflation in an attempt to wipe out debt liabilities would lead to a rapid re-pricing of such shorter term, variable rate debt. And thus expected inflation would not succeed in reducing the part of the debts that are now of the long term nominal fixed rate form. I.e. you can fool all of the people some of the time (unexpected inflation) and some of the people all of the time (those with long term nominal fixed rate claims) but you cannot fool all of the people all of the time. Thus, trying to inflict a capital levy on creditors and trying to provide a debt relief to debtors may not work as a lot of short term or variable rate debt will rapidly reprice to reflect the higher expected inflation.
In conclusion, a sharp slack in goods, labor and commodity markets will lead to global deflationary trends over the next year. And the fiscal costs of bailing out borrowers and/or lenders/investors will not be inflationary as central banks will not be willing to incur the high costs of very high inflation as a way to reduce the real value of debt burdens of governments and distressed borrowers. The costs of rising expected and actual inflation will be much higher than the benefits of using the inflation/seignorage tax to pay for the fiscal costs of cleaning up the mess that this most severe financial crisis has created. As long – as likely – as these fiscal costs are financed with public debt rather than with a monetization of these deficits inflation will not be a problem either in the short run or over the medium run.

To summarize:  From Bottomfeeder, were F'ed

[MetalMeister]

First off.

This is old news.  It is obvious the article is 2-3 weeks old.

Where is the link to it?

Second, Roubini has since come out publicly and stated that he has been shocked to the the quickness with which the global economy has disintegrated.

Third.  Read this paragraph from the second page fo this article:

It is still too early to accurately gauge the depth of the downturn, as the outlook depends on how well policy actions contain the financial crisis. From a US perspective, our current forecasts place the contraction in GDP somewhere between the last two mild recessions and the deep contractions of 1973-75 and 1981-82. This picture masks the degree to which the pain of the current downturn is falling on households. From the perspective of wealth losses and declines in real consumption, the current recession is likely to prove more severe than any of the previous ten in the post World War II era (see Special report: How deep is the ocean? Gauging US recession contours). For Western Europe, the current downturn is currently projected to look similar to the one in the early 1990s—the last episode in which regional GDP contracted…

What is obvious here is that 2-3 weeks ago or a month ago it WAS too early to gauge anything.  Now it is not.

Have we not seen the collapse of Iceland??

Have we not read the articles on Taiwan getting out of US debt??

Have we not seen the front page of Chinese Government newspapers questioning whether or not to continue to purchase US debt or get out of it altogether.

Have we not seen the speculation about the BRIC countries going to a gold standard and thereby destroying the US currency?

Lastly,  as you get to the end of the second page, notice all the "ifs" in his arguments.  The "ifs" were not present on the first page.

We are headed to a global depression of a magnitude never sene in the history of mankind.

That's my story and I'm sticking to it.

Cheers!

Marshall

[Bottomfeeder]

Actually the article was posted on Roubini's site.  The article was dated 10/25/08.  So it is kind of current, what 2-3 DAYS.

 http://www.rgemonitor.com/blog/roubini/   IF you register you can read it there for yourself.

As far as what you beleive or what your sticking too, I could care less as it is not relevant to me.

[MetalMeister]

I am a fully registered member on Roubini's site.

The reason I said the article appeared old was that it referenced $90 oil.

Actually the article was posted on Roubini's site.  The article was dated 10/25/08.  So it is kind of current, what 2-3 DAYS.

 http://www.rgemonitor.com/blog/roubini/   IF you register you can read it there for yourself.

As far as what you beleive or what your sticking too, I could care less as it is not relevant to me.

[Bottomfeeder]

Hey YC....looks like you made alot of comments and statements that were just wrong.

You know we dont get wiser by flappin our lips and assuming we know everything all the time. 

That is a losers game.

[MetalMeister]

I'm a fair minded individual. please tell me where I was wrong instead of taking a pot shot at me.

I'll listen.

Hey YC....looks like you made alot of comments and statements that were just wrong.

You know we dont get wiser by flappin our lips and assuming we know everything all the time. 

That is a losers game.