A well-deserved one too. Nouriel stuck to his core views — housing was massively over-valued, the financial system was heavily exposed to a fall in home prices and the fall out from a fall in US home prices wouldn’t be contained either nationally or globally – when those views were decidedly unpopular.
Back in early 2007, there was a great deal of complacency among America’s financial leadership. Many thought macroeconomic volatility had been vanquished, and as a result financial volatility was justly low. High levels of leverage consequently made sense — and a range of asset market prices reflected this. In the language of the time: credit markets weren’t over-valued, equity markets were under-valued. Recessions – or at least severe recessions and financial crises – were things that happened to other countries, not the US. The US had survived the .com bubble with only a shallow downturn. The 2003-2006 rise oil prices hadn’t put a big dent in the US economy. The large US current account deficit reflected high savings abroad and the attractiveness of the US financial assets; the US, after all, had a comparative advantage in financial-engineering. The IMF wrote that “innovative US fixed income markets [provided] many assets which simply aren’t available elsewhere” (see p. 12). There wasn’t much too worry about.
Read Michael Lewis’ argument that Davos man spent too much time worrying. He wrote in 2007:
Oil prices double, the U.S. housing market tanks — no matter what happens, financial markets adjust quickly and without hysteria. There are obviously a few things to worry about just now in the world, but the inability of traders to find a sensible price for the spread between European junk and European Treasuries isn’t one of them. So why do these people waste so much of their breath and, presumably, thought, with their elaborate expressions of concern?
Even the IMF – which is paid to worry – was tired of worrying. In late January of 2007, Chris Giles of the FT ran an article, based on an interview with the IMF’s Deputy Managing Director, that was titled “Big risks to global economy receding.” I thought that captured the mood of those times well.
Nouriel didn’t waver then. Others (myself included) did. Standing apart from the herd can be hard.
Over time, the focus of Nouriel’s concerns has shifted over time from the United States’ external deficit to the housing market and the financial system. But there has been a core consistency to his views: he never thought that it was healthy for the US to borrow heavily from the rest of the world to finance large fiscal deficits, high levels of consumption and lots of investment in suburban housing. And he thought this borrowing binge would end badly. Very badly.
Stephen Mihm notes that Nouriel’s book – which I co-wrote– doesn’t contain a single equation. That is true. I also think it is a little unfair. It was a book about responding to financial crises in emerging economies in the 1990s and the first few years of this decade. There were only a limited number of cases that could be examined. It didn’t take a huge regression to show that the IMF has extended large sums of money to countries with different levels of external debt and that in general, those countries with less debt paid the IMF back more quickly.
And I am not sure that it is possible build a formal model that captures all the dynamics of IMF lending to an emerging country. There is uncertainty about the amount of financing that will be made available. There is uncertainty about the policies that the country will actually adopt. There is uncertainty about the impact of those policies (a lot more uncertainty than there is over the impact of the US stimulus) that are adopted. There is uncertainty over how external bond holders will respond both to IMF financing – and to steps to limit the pressure private creditors can place on a country’s reserves through various rollover agreements and more or less market friendly debt restructurings. There is uncertainty over how domestic bank depositors will respond both to IMF financing, IMF conditionality and any debt restructuring. And all the developments in the crisis country can be overwhelmed by external shocks – like a big move in commodity prices or a major change in market conditions in the US or Europe.
It is possible to model IMF lending to an emerging economy. Nouriel co-authored a paper (with Corsetti and Guimaraes) that tried to model the IMF as a large player that can shape the dynamics of a small market. But the outcome of most such models seem determined by the assumptions used to create the model more than anything else.
I am biased, but I think it is possible to be analytically rigorous (and to use real data to inform your conclusions) even in the absence of a formal model.
Yale’s Shiller notes that Nouriel’s greatest strength his capacity to synthesize an enormous amount of information:“Nouriel has a different way of seeing things than most economists: he gets into everything.” I wrote Bailouts and Bail-ins with Nouriel and I then worked for Nouriel at RGEMonitor – and I fully agree. The breadth of Nouriel’s interests — and his ability to synthesize information from multiple sources — is extraordinary.
I wouldn’t mind if Dr. Roubini was proved to be a bit too pessimistic, and not all the near-term risks he sees come to pass. But I also think it would be a mistake to base policy on the assumption that the worst of the credit crisis is over.
Originally published at CFR and reproduced here with the author’s permission.