Global Economist Nuriel Roubini provides the following sober analysis of our current credit crisis:
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 crack – 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.
