正文
Revisiting Predictions Made a Year Ago: Who is on Earth, on the Moon and Who was a “Lunatic”
Nouriel Roubini | Oct 24, 2007
This author spent the last weekend in Washington at the annual meetings of the IMF to make several presentations and get a sense of the views of policy makers, scholars and market participants about the US and global economy prospects. To get the sense of the overall mood at these meetings there is a humorous anecdote that signals the new and more bearish state of mind heard in many off-the-record conversations at the IMF meetings this year. As reported to me by a colleague, during a public panel Vitorio Corbo - the distinguished governor of the Chilean Central Bank - was asked what were the mood and views of policy makers and market folks. His reply was along the following lines: “Usually at this kind of meetings I used to hear that the views of Nouriel Roubini about an impending financial and real hard landing are from the Moon. But this year there are plenty of “lunatics” around!” This is a fitting punch line for the fact that views that a year ago were considered way off consensus and "from the moon" are now becoming consensus, shared by many and considered as most soberly realistic among a larger numbers scholars, policy makers and market participants.
More specifically, having a little more than a year passed since this blogger first made in August 2006 his call for a 2007 housing bust, financial turmoil, credit crunch and hard landing (recession) for the U.S. economy it is worth revisiting such a call.
In the summer of 2006 this analyst first argued that the US economy would experience a housing bust, a credit crunch and hard landing in 2007 in a variety of writings (August 2006) and at an IMF seminar (September 2006). At that time he argued that:
- The U.S. would experience its worst housing recession in decades;
- home prices would follow sharply (at least 20% in the next few years);
- the housing troubles would start in the sub-prime mortgage market and lead to move severe problems and a credit crunch in broader mortgage and credit markets;
- housing woes would spillover to the rest of the economy and to other components of demand - including consumption - via a variety of channels;
- multiple bearish factors (housing slump, credit crunch, spillovers of housing to other sectors, high oil prices) would lead to a hard landing of the economy in 2007;
- the world would not decouple from such a U.S. hard landing.
Such views were very much out-of-consensus and controversial in the summer of 2006. They were greeted with thoughtful skepticism by the majority of intelligent and very sophisticated supporters of the modest housing slump, soft landing and decoupling view. But these hard landing views have now become more main-stream: even if the consensus is still for a US soft landing the probability of a recession has significantly increased in the view of a growing number of analysts.
And most mainstream analysts got it wrong about housing, its financial fallout and the credit crunch. As the IMF host kindly put it in introducing this author at his recent September 2007 talk at the IMF:
“today I am glad to welcome Nouriel Roubini back here to the Fund. …As a prologue I thought I would just briefly recall what he said at this time last year, at least my memory of what he said this time last year which may a little bit biased, and compare it to what has actually happened. Let me recall three predictions. First, Nouriel said that the U.S. housing correction would not go away quietly, but would go from bad to worse, and I think in this he has certainly been right on the nose. Second, he said that weakness in the U.S. subprime mortgage market would cause broader problems in the financial system, and here again Nouriel was certainly right, although for once perhaps not quite gloomy enough. (Laughter.) I think like most of the rest of us, I am not sure that Nouriel fully anticipated the extent of the damage that would be caused. Third, he put a high probability on the risk of a recession in the United States and a global hard landing. This has not happened yet. In fact, the U.S. economy continued to grow at a moderate pace over the past year at around 2 percent, and the global economy has accelerated. But the game ain't over yet, and we are again at a time when there is a lot of concern about recession risk.”
This analyst still holds the view that the US will experience a hard landing that is already in the making and that could formally be in full swing by the beginning of 2008.
Indeed, in his recent talk at the IMF this September this researcher presented the arguments on why the U.S. will experience a hard landing (a recession) and that the rest of the world will not decouple from such a hard landing. And indeed such views are now more generally discussed in a more thoughtful way rather than being outright dismissed as the chorus of analysts worrying about a US hard landing is increasing by the day.
Indeed a year ago when this scholar – and a few other experts such as Bob Shiller and others – argued that the biggest housing bubble in US history would end up in the worst housing bust and recession in 50 years and that home prices would fall by 20% those views were considered as coming from the moon. When this author – and others - first spoke of a fall in home prices of 20% people replied very skeptically that home prices had never fallen nationally year over year since the Great Depression (actually they had already in the 1990-91 recession based on the Case-Shiller index); thus, there was no chance of a 20% fall, the consensus claimed. Now that home prices are starting to fall sharply Goldman Sachs is predicting a fall of 15% in home prices and 30% plus in some areas. While Bob Shiller is now – correctly – arguing that to bring back the price to rental ratio to its long terms average home prices may have to fall as much as 50%, not just 15-20%, in many housing markets.
A year ago when this scholar started to talk about the coming “subprime” disaster and its financial fallout and the risk of a credit crunch, the “subprime” term was unknown even to 99% of market participants; today it is a household term around the world. Indeed, in August 2006 (not today) when the conventional wisdom and consensus was of “housing slowdown” and no one had heard of “subprime” this analyst wrote the following about the reckless lending practices in subprime and mortgage markets:
The scariest thing is that the gambling-for-redemption behavior… are not the exception in the mortgage industry; they are instead the norm. There are good reasons to believe that this is indeed the norm as lending practices have become increasingly reckless in the go-go years of the housing bubble and credit boom. If this kind of behavior is – as likely – the norm, the coming housing bust may lead to a more severe financial and banking crisis than the S&L crisis of the 1980s. The recent increased financial problems of H&R Block and other sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg - and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs being unable to service their mortgages and defaulting on them; mortgage delinquencies and foreclosures sharply rising; the beginning of a credit crunch as lending standards are suddenly and sharply tightened with the increased probability of defaults; and finally mortgage lending institutions - with increased losses and saddled with foreclosed properties whose value is falling and that are worth much less than the initial mortgages – that increasingly experience financial distress and risk going bust. One cannot even exclude systemic risk consequences if the housing bust combined with a recession leads to a bust of the mortgage backed securities (MBS) market …The main, still unexplored issue, is where the risk from mortgages is concentrated: among the sub-prime lenders … or among commercial banks or among hedge funds and other financial intermediaries that purchased mortgage backed securities (MBSs) or among the GSEs (Fannie and Freddie)? Commercial banks claims that they have transferred a lot of their mortgage risk to other financial intermediaries – such as asset managers, hedge funds or insurance companies – who purchased large amounts of MBSs. But banks have still lots of mortgages on their books and, on top of it they have tons of consumer debt exposure (credit cards, auto loans, consumer credit) that may go really bad in a recession. If part of the housing risk has been off-loaded to hedge funds, the risk is not just of some of these hedge funds going bust but also their prime brokers (i.e. large investment banks) getting into trouble; counterparty risk will become serious once the hot potato of mortgage risk is pushed from one counterparty to the other. And finally, a large part of the housing risk is also in the hands of Fannie and Freddie… Either way, a serious housing bust followed by an economy-wide recession implies serious financial risks for the entire financial system, not just risks for the real side of the economy. A systemic risk episode triggered by a housing bust cannot be ruled out.
Indeed, a year later we have now seen the biggest housing recession in US history that is getting worse by the day, a collapse and total meltdown of the sub-prime market, the beginning of a massive credit crunch in near prime and prime mortgages and a massive episode of financial volatility and turmoil taking the form of a severe liquidity and credit crunch.
In the fall of 2006 when the consensus was that the housing was in a “slump”, not a recession, and that such slump would “bottom out” soon this author warned in detail on why the housing recession would get much worse and ugly and not bottom out until late 2008. Today, even the most mainstream and consensus analysts argue that housing starts – after falling already 42% from peak – they will fall another whopping 25% before bottoming out some time in the middle of 2008. Indeed, as recently reported housing starts have now fallen by 42% and now JP Morgan – one of the most respected research houses on Wall Street and a persistent proponent until recently of the view that the housing recession would bottom out – is predicting that housing starts will fall another 25% to a cumulative fall of 56% from peak and will bottom out at 999 thousand units some time in 2008. Compared to my initial March prediction of a bottom at 1.1 million this scholar turned out to be too optimist, not too pessimist.
In December 2006 when this scholar first warned about a half dozen sub-prime lenders going already belly-up and being a signal of many more to collapse it took three months until February for people to wake up to the subprime lenders and borrowers “carnage” and “meltdown” (terms that suddenly became mainstream to describe this mortgage disaster). By now of course about 60 plus such subprime lenders have closed shop and gone bankrupt.
In January this author pointed out – before there was not even a press mention of it – about a credit derivative index obscure to all but a few (the ABX) that looked like a canary in the coal mine as it was signaling serious risk of rising subprime defaults; it took until March before even the ABX became a household term and began to be widely traded.
In January at the Davos WEF meeting this scholar warned – as Summers, Trichet, Rhodes and many others did - about the coming re-pricing of risk and the risk of a credit crunch as risk spreads were then ridiculously low. We had then to endure the cheap and vulgar scorn (“Davos Is for Wimps, Ninnies, Pointless Skeptics”) of pundits that had the most shallow and empty mind. But by the summer of 2007 the global financial markets turmoil and volatility was in full swing, credit spreads had massively widened and we had a severe liquidity and credit crunch.
In March, when this author wrote a long (30 pages), serious semi-academic research analysis – with Christian Menegatti - of why the housing recession had not bottomed out and why home prices would sharply fall further, this scholarly analysis was summarily and cheaply dismissed in the most crass terms (“the paper is really just a longer-than-usual blog”) by a popular blogger who had barely bothered even to read it. At least Daniel Gross – a very smart blogger – had the decency to literally eat pages of his own writings – as he had promised he would – when one his financial predictions failed.
So too bad that too many analysts did not have the willingness to engage in a more intelligent discussion of the risks of the housing recession, its financial fallout and of its impact on the economy. So now some of the same critics have to play catch up with reality as the facts on the ground have repeatedly proven them altogether wrong on many of their consensus views: the housing recession did not bottom out; its spillovers to other sectors and final demand were not modest; the subprime did not turn out to be a niche and contained problem; the financial contagion and credit and liquidity crunch has been severe and persistent; the Fed did not raise rates as the “inflation hawks” worried its should but it was rather forced to cut the policy rates; and the risk of a hard landing were not minimal; they were large then and are sharply rising now.
As for decoupling of the rest of the world from the US slowdown this author argued as early as August of 2006 - and again throughout the fall of 2006 - that the decoupling view was conditional on the US achieving a soft landing; instead, conditional on a US hard landing twelve separate financial, trade, currency, confidence and other channels would imply that the rest of the world would not decouple from such a US hard landing. I.e. the decoupling view assumes that the US will achieve a soft landing. But by now there is no respectable analyst that would argue that the rest of the world could decouple from a US hard landing recession: in that scenario the rest of the world would not experience a full fledged recession as in the US but it would experience a serious growth slowdown. Even the IMF - in its excellent WEO chapter in April of 2007 - clarified that the decoupling view is conditional on a US soft landing. So the decoupling debate is moot as it is only a variant of one's view of the likelihood of a US hard landing.
For example today an interesting research piece by Citi came to the following conclusions about the decoupling myth being busted:
Myth: Decoupling; Busted, for Now
Asia ex Japan Strategy Markus Rosgen, Elaine Chu, Chris W Leung
October 24, 2007
- Growing consensus that Asia can decouple. We find no supportive
evidence - Correlations between Asian export growth & US/ G3 non-oil
have risen 2.1x over the last 20 years to 0.7. The same series using
intra-regional exports has shown a six-fold jump to 0.6.
- Asian ROE's fell more in the 2001 downturn than in the three prior US
recessions - The 2001 downturn did not lead to a recession, yet ROE in
Asia ex fell by 280 bps vs. an average of 150 bps in the prior three
recessions. Hardest hit in the post-1990 recessions: tech, other
financials, materials &industrials. ROEs actually rose for the
utilities, telecoms and banks.
- A common misconception: North Asia is more US growth sensitive -We
have found that India, Korea and Taiwan have elasticities of less than 1
to US GDP growth, whilst ASEAN ranges from 1.3 to 1.7. Yet investors are
overweight ASEAN on the belief that they are buying domestic
consumption.
- Domestic consumption-to-GDP ratios have fallen in Asia; export ratios
have risen - The ratio of consumption to GDP has fallen over the last
five years to 59%. At the same time, the contribution of net exports to
GDP growth is higher today than in the last 15 years. Nor have Asian
consumers ever behaved counter-cyclically.
- Stock market correlations stand at 30-year highs - Never over last 30
years have market correlations been negative nor been as high as now,
between Asia & the USA & Europe. Correlation coeff of 0.6 and above
doesn't make for decoupling.
So much for decoupling. And the anti-decoupling arguments made by Citi for Asia hold even more strongly for Europe, Latin America and other emerging market economies.
But back to the present now. In his recent IMF talk this September (you can read the transcript or watch the video webcast or read a summary of his views) this author fleshed out again and elaborated the arguments for a U.S. hard landing, the implications of such a hard landing for financial markets and asset prices, the reasons why the current global financial markets turmoil and volatility will lead to a persistent liquidity and credit crunch, and the reasons why the rest of the world will not decouple from such U.S. hard landing. The details of these arguments are fleshed out in the author’s IMF talk that elaborates on views expressed and developed for the last 12 months. In other writing he has argued that we will soon see a worsening of the liquidity and credit crunch and will experience a generalized credit crunch; and that monetary policy or shell game schemes like the Super-Conduit will not rescue the financial system or the real economy from such a hard landing.
Was this author wrong on his 2007 recession call? The exact timing may have been slightly off as he expected a recession by Q2 of 2007; but his substantial call about an impending hard landing is still likely to be right. With housing and capex spending falling and the US saving-less and debt-burdened consumer is on the ropes (latest weekly data point: October same store sales are falling relative to September) one cannot exclude a growth rate of close to zero by Q4 of this year and a full fledged hard landing by early 2008.
Petty critics of this blogger keep on hammering (in comments on this blog) that the recession did not occur by Q2 of 2007. But, as the Bible put it: “Why do you notice the splinter in your brother's eye, but do not perceive the wooden beam in your own eye?” Indeed, most of these soft landing optimists kept on predicting a modest housing slump that would bottom out by early 2007; they kept on repeating the mantra of subprime as a “niche problem” that would “remain contained”; they dismissed concerned about a severe financial contagion and the risk of a liquidity and credit crunch; they kept on predicting sustained growth rates above 3% while the economy sharply slowed down since H2 of 2006 and were then forced to revise downward their growth forecasts quarter after quarter; and they kept on saying that the rest of the economy would be sheltered from the biggest housing bust in US history and that it would achieve a “soft landing”. So these optimists got four predictions out of five totally wrong; while this analyst got so far four predictions out of five exactly right in timing and magnitude. And, as for the fifth, there is increasing consensus among a growing rank of distinguished experts that the likelihood of a hard landing is significantly rising.
Soon enough the debate will shift from whether we will have a soft landing or a hard landing to how hard the landing is going to be and how protracted in time and deep in size the contraction is going to be. A year ago this author was being challenged on his hard landing call. Most recently in a variety of presentation the questions asked are not whether we will have a hard landing but rather whether it is going to be worse and longer than the 1990-91 one or the 2001 one.
So those – this author and a few other bears in academia and markets - who were accused a year ago of being on the moon have been proven to be fully grounded on planet Earth in their bearish views about housing, credit, financial markets and the economy. While those who lived in a Goldilocks bubble ended up looking now like the true lunatics. Luckily the housing bubble and the credit bubble and the delusional bubble has now burst and such folks living in moon dream-land will soon get a reality check and crash back to planet Earth.
One could have certainly had respectable and intelligent disagreements on whether the end game would be an economy-wide hard landing or a soft landing and argue that, in spite of the housing shock and its fallout a soft landing would occur. Arguing for a soft landing is legitimate and respectable. But too many analysts and policy makers dismissed altogether for too long the severity of the housing recession hiding behind the “it is only a modest correction and it will soon bottom out” myth; they kept on deluding themselves with the mantra that “this was only a niche and contained subprime problem”; they ignored the risk of a seizure of financial markets, a systemic risk episode and a severe liquidity and credit crunch. And they never considered seriously the arguments that all these shocks – together with high and rising energy prices and a Fed behind the curve too worried about inflation and not worried enough about growth – could end up leading to a hard landing. The few bears (actually there were a good number of them already in 2006) already won three quarters of the arguments about the nature and the consequences of this housing bubble, its bust and its financial fallout. The next few months will determine whether the last shoe – the US hard landing – will drop. At this point the soft-landing optimists are facing severe head-winds.
Nouriel Roubini | Oct 24, 2007
This author spent the last weekend in Washington at the annual meetings of the IMF to make several presentations and get a sense of the views of policy makers, scholars and market participants about the US and global economy prospects. To get the sense of the overall mood at these meetings there is a humorous anecdote that signals the new and more bearish state of mind heard in many off-the-record conversations at the IMF meetings this year. As reported to me by a colleague, during a public panel Vitorio Corbo - the distinguished governor of the Chilean Central Bank - was asked what were the mood and views of policy makers and market folks. His reply was along the following lines: “Usually at this kind of meetings I used to hear that the views of Nouriel Roubini about an impending financial and real hard landing are from the Moon. But this year there are plenty of “lunatics” around!” This is a fitting punch line for the fact that views that a year ago were considered way off consensus and "from the moon" are now becoming consensus, shared by many and considered as most soberly realistic among a larger numbers scholars, policy makers and market participants.
More specifically, having a little more than a year passed since this blogger first made in August 2006 his call for a 2007 housing bust, financial turmoil, credit crunch and hard landing (recession) for the U.S. economy it is worth revisiting such a call.
In the summer of 2006 this analyst first argued that the US economy would experience a housing bust, a credit crunch and hard landing in 2007 in a variety of writings (August 2006) and at an IMF seminar (September 2006). At that time he argued that:
- The U.S. would experience its worst housing recession in decades;
- home prices would follow sharply (at least 20% in the next few years);
- the housing troubles would start in the sub-prime mortgage market and lead to move severe problems and a credit crunch in broader mortgage and credit markets;
- housing woes would spillover to the rest of the economy and to other components of demand - including consumption - via a variety of channels;
- multiple bearish factors (housing slump, credit crunch, spillovers of housing to other sectors, high oil prices) would lead to a hard landing of the economy in 2007;
- the world would not decouple from such a U.S. hard landing.
Such views were very much out-of-consensus and controversial in the summer of 2006. They were greeted with thoughtful skepticism by the majority of intelligent and very sophisticated supporters of the modest housing slump, soft landing and decoupling view. But these hard landing views have now become more main-stream: even if the consensus is still for a US soft landing the probability of a recession has significantly increased in the view of a growing number of analysts.
And most mainstream analysts got it wrong about housing, its financial fallout and the credit crunch. As the IMF host kindly put it in introducing this author at his recent September 2007 talk at the IMF:
“today I am glad to welcome Nouriel Roubini back here to the Fund. …As a prologue I thought I would just briefly recall what he said at this time last year, at least my memory of what he said this time last year which may a little bit biased, and compare it to what has actually happened. Let me recall three predictions. First, Nouriel said that the U.S. housing correction would not go away quietly, but would go from bad to worse, and I think in this he has certainly been right on the nose. Second, he said that weakness in the U.S. subprime mortgage market would cause broader problems in the financial system, and here again Nouriel was certainly right, although for once perhaps not quite gloomy enough. (Laughter.) I think like most of the rest of us, I am not sure that Nouriel fully anticipated the extent of the damage that would be caused. Third, he put a high probability on the risk of a recession in the United States and a global hard landing. This has not happened yet. In fact, the U.S. economy continued to grow at a moderate pace over the past year at around 2 percent, and the global economy has accelerated. But the game ain't over yet, and we are again at a time when there is a lot of concern about recession risk.”
This analyst still holds the view that the US will experience a hard landing that is already in the making and that could formally be in full swing by the beginning of 2008.
Indeed, in his recent talk at the IMF this September this researcher presented the arguments on why the U.S. will experience a hard landing (a recession) and that the rest of the world will not decouple from such a hard landing. And indeed such views are now more generally discussed in a more thoughtful way rather than being outright dismissed as the chorus of analysts worrying about a US hard landing is increasing by the day.
Indeed a year ago when this scholar – and a few other experts such as Bob Shiller and others – argued that the biggest housing bubble in US history would end up in the worst housing bust and recession in 50 years and that home prices would fall by 20% those views were considered as coming from the moon. When this author – and others - first spoke of a fall in home prices of 20% people replied very skeptically that home prices had never fallen nationally year over year since the Great Depression (actually they had already in the 1990-91 recession based on the Case-Shiller index); thus, there was no chance of a 20% fall, the consensus claimed. Now that home prices are starting to fall sharply Goldman Sachs is predicting a fall of 15% in home prices and 30% plus in some areas. While Bob Shiller is now – correctly – arguing that to bring back the price to rental ratio to its long terms average home prices may have to fall as much as 50%, not just 15-20%, in many housing markets.
A year ago when this scholar started to talk about the coming “subprime” disaster and its financial fallout and the risk of a credit crunch, the “subprime” term was unknown even to 99% of market participants; today it is a household term around the world. Indeed, in August 2006 (not today) when the conventional wisdom and consensus was of “housing slowdown” and no one had heard of “subprime” this analyst wrote the following about the reckless lending practices in subprime and mortgage markets:
The scariest thing is that the gambling-for-redemption behavior… are not the exception in the mortgage industry; they are instead the norm. There are good reasons to believe that this is indeed the norm as lending practices have become increasingly reckless in the go-go years of the housing bubble and credit boom. If this kind of behavior is – as likely – the norm, the coming housing bust may lead to a more severe financial and banking crisis than the S&L crisis of the 1980s. The recent increased financial problems of H&R Block and other sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg - and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs being unable to service their mortgages and defaulting on them; mortgage delinquencies and foreclosures sharply rising; the beginning of a credit crunch as lending standards are suddenly and sharply tightened with the increased probability of defaults; and finally mortgage lending institutions - with increased losses and saddled with foreclosed properties whose value is falling and that are worth much less than the initial mortgages – that increasingly experience financial distress and risk going bust. One cannot even exclude systemic risk consequences if the housing bust combined with a recession leads to a bust of the mortgage backed securities (MBS) market …The main, still unexplored issue, is where the risk from mortgages is concentrated: among the sub-prime lenders … or among commercial banks or among hedge funds and other financial intermediaries that purchased mortgage backed securities (MBSs) or among the GSEs (Fannie and Freddie)? Commercial banks claims that they have transferred a lot of their mortgage risk to other financial intermediaries – such as asset managers, hedge funds or insurance companies – who purchased large amounts of MBSs. But banks have still lots of mortgages on their books and, on top of it they have tons of consumer debt exposure (credit cards, auto loans, consumer credit) that may go really bad in a recession. If part of the housing risk has been off-loaded to hedge funds, the risk is not just of some of these hedge funds going bust but also their prime brokers (i.e. large investment banks) getting into trouble; counterparty risk will become serious once the hot potato of mortgage risk is pushed from one counterparty to the other. And finally, a large part of the housing risk is also in the hands of Fannie and Freddie… Either way, a serious housing bust followed by an economy-wide recession implies serious financial risks for the entire financial system, not just risks for the real side of the economy. A systemic risk episode triggered by a housing bust cannot be ruled out.
Indeed, a year later we have now seen the biggest housing recession in US history that is getting worse by the day, a collapse and total meltdown of the sub-prime market, the beginning of a massive credit crunch in near prime and prime mortgages and a massive episode of financial volatility and turmoil taking the form of a severe liquidity and credit crunch.
In the fall of 2006 when the consensus was that the housing was in a “slump”, not a recession, and that such slump would “bottom out” soon this author warned in detail on why the housing recession would get much worse and ugly and not bottom out until late 2008. Today, even the most mainstream and consensus analysts argue that housing starts – after falling already 42% from peak – they will fall another whopping 25% before bottoming out some time in the middle of 2008. Indeed, as recently reported housing starts have now fallen by 42% and now JP Morgan – one of the most respected research houses on Wall Street and a persistent proponent until recently of the view that the housing recession would bottom out – is predicting that housing starts will fall another 25% to a cumulative fall of 56% from peak and will bottom out at 999 thousand units some time in 2008. Compared to my initial March prediction of a bottom at 1.1 million this scholar turned out to be too optimist, not too pessimist.
In December 2006 when this scholar first warned about a half dozen sub-prime lenders going already belly-up and being a signal of many more to collapse it took three months until February for people to wake up to the subprime lenders and borrowers “carnage” and “meltdown” (terms that suddenly became mainstream to describe this mortgage disaster). By now of course about 60 plus such subprime lenders have closed shop and gone bankrupt.
In January this author pointed out – before there was not even a press mention of it – about a credit derivative index obscure to all but a few (the ABX) that looked like a canary in the coal mine as it was signaling serious risk of rising subprime defaults; it took until March before even the ABX became a household term and began to be widely traded.
In January at the Davos WEF meeting this scholar warned – as Summers, Trichet, Rhodes and many others did - about the coming re-pricing of risk and the risk of a credit crunch as risk spreads were then ridiculously low. We had then to endure the cheap and vulgar scorn (“Davos Is for Wimps, Ninnies, Pointless Skeptics”) of pundits that had the most shallow and empty mind. But by the summer of 2007 the global financial markets turmoil and volatility was in full swing, credit spreads had massively widened and we had a severe liquidity and credit crunch.
In March, when this author wrote a long (30 pages), serious semi-academic research analysis – with Christian Menegatti - of why the housing recession had not bottomed out and why home prices would sharply fall further, this scholarly analysis was summarily and cheaply dismissed in the most crass terms (“the paper is really just a longer-than-usual blog”) by a popular blogger who had barely bothered even to read it. At least Daniel Gross – a very smart blogger – had the decency to literally eat pages of his own writings – as he had promised he would – when one his financial predictions failed.
So too bad that too many analysts did not have the willingness to engage in a more intelligent discussion of the risks of the housing recession, its financial fallout and of its impact on the economy. So now some of the same critics have to play catch up with reality as the facts on the ground have repeatedly proven them altogether wrong on many of their consensus views: the housing recession did not bottom out; its spillovers to other sectors and final demand were not modest; the subprime did not turn out to be a niche and contained problem; the financial contagion and credit and liquidity crunch has been severe and persistent; the Fed did not raise rates as the “inflation hawks” worried its should but it was rather forced to cut the policy rates; and the risk of a hard landing were not minimal; they were large then and are sharply rising now.
As for decoupling of the rest of the world from the US slowdown this author argued as early as August of 2006 - and again throughout the fall of 2006 - that the decoupling view was conditional on the US achieving a soft landing; instead, conditional on a US hard landing twelve separate financial, trade, currency, confidence and other channels would imply that the rest of the world would not decouple from such a US hard landing. I.e. the decoupling view assumes that the US will achieve a soft landing. But by now there is no respectable analyst that would argue that the rest of the world could decouple from a US hard landing recession: in that scenario the rest of the world would not experience a full fledged recession as in the US but it would experience a serious growth slowdown. Even the IMF - in its excellent WEO chapter in April of 2007 - clarified that the decoupling view is conditional on a US soft landing. So the decoupling debate is moot as it is only a variant of one's view of the likelihood of a US hard landing.
For example today an interesting research piece by Citi came to the following conclusions about the decoupling myth being busted:
Myth: Decoupling; Busted, for Now
Asia ex Japan Strategy Markus Rosgen, Elaine Chu, Chris W Leung
October 24, 2007
- Growing consensus that Asia can decouple. We find no supportive
evidence - Correlations between Asian export growth & US/ G3 non-oil
have risen 2.1x over the last 20 years to 0.7. The same series using
intra-regional exports has shown a six-fold jump to 0.6.
- Asian ROE's fell more in the 2001 downturn than in the three prior US
recessions - The 2001 downturn did not lead to a recession, yet ROE in
Asia ex fell by 280 bps vs. an average of 150 bps in the prior three
recessions. Hardest hit in the post-1990 recessions: tech, other
financials, materials &industrials. ROEs actually rose for the
utilities, telecoms and banks.
- A common misconception: North Asia is more US growth sensitive -We
have found that India, Korea and Taiwan have elasticities of less than 1
to US GDP growth, whilst ASEAN ranges from 1.3 to 1.7. Yet investors are
overweight ASEAN on the belief that they are buying domestic
consumption.
- Domestic consumption-to-GDP ratios have fallen in Asia; export ratios
have risen - The ratio of consumption to GDP has fallen over the last
five years to 59%. At the same time, the contribution of net exports to
GDP growth is higher today than in the last 15 years. Nor have Asian
consumers ever behaved counter-cyclically.
- Stock market correlations stand at 30-year highs - Never over last 30
years have market correlations been negative nor been as high as now,
between Asia & the USA & Europe. Correlation coeff of 0.6 and above
doesn't make for decoupling.
So much for decoupling. And the anti-decoupling arguments made by Citi for Asia hold even more strongly for Europe, Latin America and other emerging market economies.
But back to the present now. In his recent IMF talk this September (you can read the transcript or watch the video webcast or read a summary of his views) this author fleshed out again and elaborated the arguments for a U.S. hard landing, the implications of such a hard landing for financial markets and asset prices, the reasons why the current global financial markets turmoil and volatility will lead to a persistent liquidity and credit crunch, and the reasons why the rest of the world will not decouple from such U.S. hard landing. The details of these arguments are fleshed out in the author’s IMF talk that elaborates on views expressed and developed for the last 12 months. In other writing he has argued that we will soon see a worsening of the liquidity and credit crunch and will experience a generalized credit crunch; and that monetary policy or shell game schemes like the Super-Conduit will not rescue the financial system or the real economy from such a hard landing.
Was this author wrong on his 2007 recession call? The exact timing may have been slightly off as he expected a recession by Q2 of 2007; but his substantial call about an impending hard landing is still likely to be right. With housing and capex spending falling and the US saving-less and debt-burdened consumer is on the ropes (latest weekly data point: October same store sales are falling relative to September) one cannot exclude a growth rate of close to zero by Q4 of this year and a full fledged hard landing by early 2008.
Petty critics of this blogger keep on hammering (in comments on this blog) that the recession did not occur by Q2 of 2007. But, as the Bible put it: “Why do you notice the splinter in your brother's eye, but do not perceive the wooden beam in your own eye?” Indeed, most of these soft landing optimists kept on predicting a modest housing slump that would bottom out by early 2007; they kept on repeating the mantra of subprime as a “niche problem” that would “remain contained”; they dismissed concerned about a severe financial contagion and the risk of a liquidity and credit crunch; they kept on predicting sustained growth rates above 3% while the economy sharply slowed down since H2 of 2006 and were then forced to revise downward their growth forecasts quarter after quarter; and they kept on saying that the rest of the economy would be sheltered from the biggest housing bust in US history and that it would achieve a “soft landing”. So these optimists got four predictions out of five totally wrong; while this analyst got so far four predictions out of five exactly right in timing and magnitude. And, as for the fifth, there is increasing consensus among a growing rank of distinguished experts that the likelihood of a hard landing is significantly rising.
Soon enough the debate will shift from whether we will have a soft landing or a hard landing to how hard the landing is going to be and how protracted in time and deep in size the contraction is going to be. A year ago this author was being challenged on his hard landing call. Most recently in a variety of presentation the questions asked are not whether we will have a hard landing but rather whether it is going to be worse and longer than the 1990-91 one or the 2001 one.
So those – this author and a few other bears in academia and markets - who were accused a year ago of being on the moon have been proven to be fully grounded on planet Earth in their bearish views about housing, credit, financial markets and the economy. While those who lived in a Goldilocks bubble ended up looking now like the true lunatics. Luckily the housing bubble and the credit bubble and the delusional bubble has now burst and such folks living in moon dream-land will soon get a reality check and crash back to planet Earth.
One could have certainly had respectable and intelligent disagreements on whether the end game would be an economy-wide hard landing or a soft landing and argue that, in spite of the housing shock and its fallout a soft landing would occur. Arguing for a soft landing is legitimate and respectable. But too many analysts and policy makers dismissed altogether for too long the severity of the housing recession hiding behind the “it is only a modest correction and it will soon bottom out” myth; they kept on deluding themselves with the mantra that “this was only a niche and contained subprime problem”; they ignored the risk of a seizure of financial markets, a systemic risk episode and a severe liquidity and credit crunch. And they never considered seriously the arguments that all these shocks – together with high and rising energy prices and a Fed behind the curve too worried about inflation and not worried enough about growth – could end up leading to a hard landing. The few bears (actually there were a good number of them already in 2006) already won three quarters of the arguments about the nature and the consequences of this housing bubble, its bust and its financial fallout. The next few months will determine whether the last shoe – the US hard landing – will drop. At this point the soft-landing optimists are facing severe head-winds.
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