The World Is at Severe Risk of a Global Systemic Financial Meltdown and a Severe Global Depression
The US and advanced economies' financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.
On the real economic side all the advanced economies representing 55% of global GDP (US, Eurozone, UK, other smaller European countries, Canada, Japan, Australia, New Zealand, Japan) entered a recession even before the massive financial shocks that started in the late summer made the liquidity and credit crunch even more virulent and will thus cause an even more severe recession than the one that started in the spring. So we have a severe recession, a severe financial crisis and a severe banking crisis in advanced economies.
There was no decoupling among advanced economies and there is no decoupling but rather recoupling of the emerging market economies with the severe crisis of the advanced economies. By the third quarter of this year global economic growth will be in negative territory signaling a global recession. The recoupling of emerging markets was initially limited to stock markets that fell even more than those of advanced economies as foreign investors pulled out of these markets; but then it spread to credit markets and money markets and currency markets bringing to the surface the vulnerabilities of many financial systems and corporate sectors that had experienced credit booms and that had borrowed short and in foreign currencies. Countries with large current account deficit and/or large fiscal deficits and with large short term foreign currency liabilities and borrowings have been the most fragile. But even the better performing ones -- like the BRICs club of Brazil, Russia, India and China -- are now at risk of a hard landing. Trade and financial and currency and confidence channels are now leading to a massive slowdown of growth in emerging markets with many of them now at risk not only of a recession but also of a severe financial crisis.
The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity were excessive leveraging and bubbles were not limited to housing in the US but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.
At this point the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the US and advanced economies' contraction would be short and shallow -- a V-shaped six month recession -- has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the US and close to two years in most of the rest of the world. And given the rising risk of a global systemic financial meltdown the probability that the outcome could become a decade long L-shaped recession -- like the one experienced by Japan after the bursting of its real estate and equity bubble -- cannot be ruled out.
And in a world where there is a glut and excess capacity of goods while aggregate demand is falling soon enough we will start to worry about deflation, debt deflation, liquidity traps and what monetary policy makers should do to fight deflation when policy rates get dangerously close to zero.
At this point the risk of an imminent stock market crash -- like the one-day collapse of 20% plus in US stock prices in 1987 -- cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.
This disconnect between more and more aggressive policy actions and easings and greater and greater strains in financial market is scary. When Bear Stearns' creditors were bailed out to the tune of $30 bn in March the rally in equity, money and credit markets lasted eight weeks; when in July the US Treasury announced legislation to bail out the mortgage giants Fannie and Freddie the rally lasted four weeks; when the actual $200 billion rescue of these firms was undertaken and their $6 trillion liabilities taken over by the US government the rally lasted one day and by the next day the panic has moved to Lehman's collapse; when AIG was bailed out to the tune of $85 billion the market did not even rally for a day and instead fell 5%. Next when the $700 billion US rescue package was passed by the US Senate and House markets fell another 7% in two days as there was no confidence in this flawed plan and the authorities. Next as authorities in the US and abroad took even more radical policy actions between October 6th and October 9th (payment of interest on reserves, doubling of the liquidity support of banks, extension of credit to the seized corporate sector, guarantees of bank deposits, plans to recapitalize banks, coordinated monetary policy easing, etc.) the stock markets and the credit markets and the money markets fell further and further and at an accelerated rates day after day all week including another 7% fall in U.S. equities today.
When in markets that are clearly way oversold even the most radical policy actions don't provide rallies or relief to market participants you know that you are one step away from a market crack and a systemic financial sector and corporate sector collapse. A vicious circle of deleveraging, asset collapses, margin calls, cascading falls in asset prices well below falling fundamentals and panic is now underway.
At this point severe damage is done and one cannot rule out a systemic collapse and a global depression. It will take a significant change in leadership of economic policy and very radical, coordinated policy actions among all advanced and emerging market economies to avoid this economic and financial disaster. Urgent and immediate necessary actions that need to be done globally (with some variants across countries depending on the severity of the problem and the overall resources available to the sovereigns) include:
- Another rapid round of policy rate cuts of the order of at least 150 basis points on average globally.
- A temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made.
- A rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures
- Massive and unlimited provision of liquidity to solvent financial institutions.
- Public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses.
- A massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government.
- A rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers.
- An agreement between lender and creditor countries running current account surpluses and borrowing and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.
At this point anything short of these radical and coordinated actions may lead to a market crash, a global systemic financial meltdown and to a global depression. 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. And fiscal authorities that usually are spenders and insurers of last resort need to temporarily become the spenders and insurers of first resort. The fiscal costs of these actions will be large but the economic and fiscal costs of inaction would be of a much larger and severe magnitude. Thus, the time to act is now as all the policy officials of the world are meeting this weekend in Washington at the IMF and World Bank annual meetings.
Originally posted October 9 at RGE Monitor.
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When i initially read Roubini recommendations, I thought them the rantings of someone truly fringe; a dangerous socialist offering advice to Obama, Pelosi, and the rest of the hooligans in Washington hoping to turn the America into a socialist state. Rather, it appears that Roubini is a rather mainstream capitalist with controversial perspectives and a knack for making nasty predictions that alas come true. If I read Roubini correctly, what he's proposing, at least in the short term, is the nationalization of banking and finance; also the obliteration of private US debt, ending foreclosures irrespective of circumstance, and the use of massive public works to mitigate the worst affects recession on citizens. Wow... He's not asking for much. I'm not enough of an economist to know if what he's proposing is reasonable but the idea of developed economies working with developing economies seems far-fetched. I wish this wasn't the case but honestly, nations remain locked into petty nationalism. Thanks to the Washington Consensus, the world got married without ever fully recognizing the consequences. The only way the world's nations can hope to achieve anything like the level of cooperation Roubini recommends would be if they stopped thinking nationalistically. I'm not confident the world's leaders have the ability to do this even with the fate of the world's economic life hanging in the balance.
I believe that in the long run this depression will do Americans good.
My husband and I are approaching retirement and while we didn't live through the Great Depression we know what it means to be poor. Our parents saved their money and with no credit cards they saved until they could pay cash for their vehicles. Our home was paid for. This was pre-cable and our 4 channels of tv were free. We grew our food, had a water well and ate most of our meals at home. This was also pre McDonalds and fast food, pre credit cards, pre WalMart. The late '50's - early 1960's - we're not THAT old!!
People today will have to learn to wait for rewards and it won't be easy. But the days of instant gratification and greed are over. Christmas at our house will be lean this year but for the last couple of years we have practiced a "Buy Nothing Christmas" and it is freeing not to buy, buy, buy, spend, spend, spend.
I hear people rolling their eyes and I’m not crazy, stingy, Amish or anything!! But leading a simple life can be gratifying. It’s a lot less stressful!
Don't worry, you'll get used to it. Greed, after all, is one of the seven deadly sins.
Obama ’08!!
We aren't talking about some kind of therapy course here, the deprivation and poverty caused by a depression will produce nothing but untold misery and hardship that will fall on our most vulnerable citizens..
Here's hoping that you and yours are the ones enjoying the greatest benefits of this therapy, living under a viaduct and rooting in the garbage cans for food,dying slowly of easily cured diseases. This is what a real depression means for many people, not just doing without cable TV!
I doubt you have any real idea what being really poor actually means, if you did you wouldn't wish this curse on your worse enemy, but I now wish it on you!
it is called a purge. my doc gives me the same thing before a colonoscopy. NOT a bad thing.
Finally, a respected economist on the site. He has been correct from 2006 in all his predictions. Hope to see him more on this site. I do hope he writes more here.
All valid points Mr, Roubini, but there is a fundamental point we need to recognize. We aren't seeing fractures in an otherwise stable system ... this is the unraveling of a quadrillion dollar ponzi scheme. Your rational suggestions, I fear, would prove impotent. What we have had occur is a nearly decade long, unregulated derivative and cds kiting scheme. Everyone is in this mess. The Banks, Hedge Funds, Money Markets, Pension Funds, and Corporations have no savings. The near totality of their liquid assets are invested in a massive collapsing cloud of fraudulent wealth.
You are right, extreme measures need to take place, but in formation of an alternate economic system for what we have known is on a perpetual motion path to extinction.
It's done, no monetary heroics will forestall the evaporation of wealth that is running ahead of the authorities ability to combat it and the lack of a window into the dynamics taking place due to deregulation has left the experts deaf, dumb and blind in terms of their ability to adequately intervene.
I could have told you this 5 years ago!
After the foodcrisis, the economic crisis. Will this result in a humanitarian crisis? The poorest will suffer first. See this post http://www.theroadtothehorizon.org/2008/10/news-after-global-financial-crisis.html
It's good to see you posting here, Mr. Roubini. I have been reading your wisdom at RGE monitor for a while now, and hope that your message connects in more forums like this one.
I can vouch for no stability in the markets whatsoever. On Friday there was a 1,000 point swing in the DJIA in the space of a few hours!!!!! It is not a possible crash, the stock market has crashed.
The smart money kept their money on the sidelines. They could buy now and perhaps stabilize the market but they want the stock to crash further. A DJIA of 5,000 or even 3,0000. The Fed dropped interest rates 50 points and the market crashed further, a new reaction to Fed rate cuts. 700B bailout and the market starts the crash cycle.
At this point the unthinkable has happened. If Paulson wants to buy billions stocks in banks on Monday do so. It may be the last chance to stabilize the market.
Mr. Roubini provides perhaps the most cogent analysis of global economics and finance available any where and has been ahead of even our most lettered economists in predicting and understanding our current financial crisis. The current and certainly the next administration would be negligent if Mr. Roubini's insights were not sought.
If this is time for massive infrastructure projects, then do the following:
1. Follow Scientific American's proposal for a $400 billion Solar power project in the American southwest, consisting of solar panels, passive solar heating and other systems to supply 70% of the power grid.
2. A TGV rail system to put Europe's to shame.
3. Endowments in alternative energy research, engineering programs at universities and private industry partnerships. Make hybrid and electric private automobiles a reality as one goal from this.
4. Intensify efforts to make zero emission, clean coal power technology real. America has more coal than anyone. Use it.
5. Invest in clean water access globally.
I would add mass transit. No one can affor to buy a car.
Increased broadband access and capacity as well.
By voting for the $800 billion bailout, Sen. Obama has profoundly impacted the availability of such programs that are long overdue. This is a very real obstacle to the realization of such investment by the Federal government in such programs. If Obama disregards the budget deficit he risks devaluation of the dollar and hyper-inflation.
My suggestion is to establish local mechanisms for the disbursement of the funds, whether its local banks or neighborhood associations. There is no trickle down here that will ever reach the distressed communities, local businesses and workers in time.
Hoover's Reconstruction Finance Corporation was based on the same principles as the bailout and failed miserably, as did the New Deal in rebuilding the economy. World War 2 was the eventual source of the recovery. I sure hope we do not go that route again.
You're assuming that deficits matter at this point. They don't and that's one of Roubini points (and he isn't the only one saying it). Deficit spending will be required, massive amounts of it and $800 billion dollars is really a drop in the bucket. The government could easily afford the bailout and massive public works, and anything else necessary. But as the man suggests the US can;t do this alone because thanks to the Washington Consensus, the world's economies are inextricably intertwined. But if there was cooperation, keep in mind, government's make the rules and they could agree to do just about anything felt like doing.
Andrew
Excellent. My points exactly. I think the solar project could be huge. Here is the link again.
http://www.sciam.com/article.cfm?id=a-solar-grand-plan
Mr. Roubini
Thanks for the information.
Excellent!
If you have been resourceful, paid your house off and have put aside some savings, then the best course of action is to withdraw the nest egg and blow it all on canned goods. It's not crazy to invest in a sure thing. Food is guaranteed to go up by at least 10% a year.
No, the talk is DEflation.
I bought a lot of canned goods a while back and ended up throwing out most of it. Canned goods have a shelf life! may I recommend learning to eat less prepared and processed foods, grow a garden, buy a cow, and learn to ride a horse. LOL. These ideas make about as much sense as buying up canned goods. I about out of ideas.
Canned goods have a shelf life because grocers don't want to be sued. Canned goods can remain edible for decades.
Check out PossumLiving.com. Get good fishing/hunting gear and learn how to garden, wild harvest and can. Get a woodstove, axe, maul, chainsaw, truck. Keep no debt. Get and learn how to use a firearm. Find our what else your pets will eat and survive on if you get to where you can't afford pet food. I just cringe when I think about all the people who will suffer, but their poor pets will starve or be eaten themselves if this crisis devolves to its worse possiblr outcome. Otherwise. meditate in masses to try to alter the paradigm we possibly face.
And you might consider purchasing a trusty sidearm to protect that food horde, as crime will skyrocket. Hunger and want have no conscience.
There has only been one other melt down like we are fixing to experence and that was 1929. The samething happen then as now we let the Republicans and their deregulation and pro Big Business sink our boat one more time. We for got to read our history books and drank the cool aid it can't happen again.
Isn't the USA at war? Aren't the bankers doing Bin Laden's dirty work? They're greed has lead to treason.
This is also Bush's last hurrah.. He wants more money in his coffers before he bails to Paraguay or some other distant port to avoid prosecution. He thinks we are totally stupid. Unfortunately, Congress is the enabler in this. We want change and accountability and we want it NOW!!! The 2% have 40% of the wealth and they're getting rich on the backs of the people. It's time to stop this corruption. Vote all encumbants who've been in Congress for more than 5 years out of office. Unless you know for a fact they have fought for the majority of the people. That'll be a start. We need new people with fresh ideas and they need to be held accountable. We have the power if we unite.
Right by all means let's invite a bunch of inexperienced people to run government at a time when e need all the experience we can get. Personally, I wouldn't vote for a Republican for any office under any circumstance. Period. What we need are people with experience and some ability to work together. To hell with cleaning house. The best way to clean house is to send the GOP packing... permanently.
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