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RGE Monitor

October 9, 2008



On Thursday, October 09, 2008, Nouriel Roubini - Chairman of RGE Monitor and
Professor of Economics at the NYU Stern School of Business - lays out his
latest views on the global economic and financial crisis and the urgent
necessary actions that need to be undertaken globally.


Nouriel Roubini: The world is at severe risk of a global systemic financial
meltdown and a severe global depression



The U.S. and advanced economies\' financial systems are 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 (U.S., 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 deficits 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 where excessive leveraging and bubbles
were not limited to housing in the U.S. 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 U.S. 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 U.S. 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 U.S. 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 the 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
U.S. 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 U.S. government, the rally lasted one day, and by the next day
the panic had 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 U.S. rescue package was passed by the
U.S. 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 U.S. and abroad took even more radical policy actions between October
6^th and October 9^th (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 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 crash and a systemic financial
sector and corporate sector collapse. A vicious circle of deleveraging,
asset collapses, margin calls, and 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. 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.