Nouriel Roubini's Global EconoMonitor

Archive for October, 2007

  • WSJ: Economists React: GDP Growth ‘Not Built to Last’

    Courtesy of WSJ a sampling of the reactions of economists to the Q3 GDP report.  October 31, 2007, 10:16 am Economists React: GDP Growth ‘Not Built to Last’ Economists and others weigh in on the 3.9% increase in third-quarter GDP. This may have been the summer of the housing market’s discontent but it clearly wasn’t for […]

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  • The Recessionary Macro Effect of the Worst U.S. Housing Bust Ever

    A friend of mine who is a senior professional in one of the largest financial institutions in the world has sent me privately – and confidentially – the following email messages. Like me, he predicted a year ago that this would be the worst housing recession in US history and described a bust process that […]

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  • Revisiting Predictions Made a Year Ago: Who is on Earth, on the Moon and Who was a “Lunatic”

    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 pie
    ce 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

    – 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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  • The First Crisis of Financial Globalization and Securitization. And the Coming Generalized Credit Crunch

    Project Syndicate has recently published a comment of mine on the “First Crisis of Financial Globalization and Securitization“.  And I presented similar views at a seminar at the recent annual meetings of the IMF. A more extensive version of my thoughts is provided below.    The recent turmoil and volatility in U.S. and global financial markets and the […]

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  • First Week of the Europe EconoMonitor: A Great Start!

    The first week of the new RGE Europe EconoMonitor was amazingly successful with fifteen excellent contributions on a variety of topical macro, financial and policy issues. This new venture is one of the most popular – based on traffic – parts of the RGE Monitor and, in addition to the excellent contributions, a very good […]

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  • Video Interview with Bloomberg on the Economy, the Dollar, the Financial Turmoil, SIVs and the Super-Conduit

    Here is the link to a interview that Bloomberg TV conducted with me at the margins of the IMF annual meetings in Washington. Many  interesting meetings, presentations, conferences, events, interviews this weekend during this annual wonk-fest. Roubini, Economist, Says SIVs Should Have Been Forbidden: Video October 19 (Bloomberg) — Nouriel Roubini, chairman of Roubini Global Economics LLC […]

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  • Have We Learned the Lessons of Black Monday? No and Why It Could Happen Again

    Foreign Policy magazine asked me to write a piece on whether we have learned the lessons of the Black Monday (October 19th 1987) whose 20th anniversary is this week on Friday. My simple answer is no as I see many similarities between the macro and financial conditions that led to the market crash in 1987 and current macro and financial conditions. A systemic risk episode such as the one in 1987 could happen again.

    Here is the text of my article that can also be read on Foreign Policy:

    Have We Learned the Lessons of Black Monday?

    by Nouriel Roubini


    A rookie central banker. Rising, unsustainable deficits. Rampant financial speculation. A burgeoning trade war with China. Why another financial meltdown is more likely than ever.

    MARK WILSON/Getty Images
    Fear in his eyes? Fed Chairman Ben Bernanke looks worried. He should be.

    Twenty years ago this week, the U.S. stock market tumbled in the worst single-day decline in history. Looking back at the economic circumstances surrounding Black Monday, one can’t help but wonder: Could such a dramatic stock-market crash happen again?

    Indeed, there are many parallels between the macroeconomic and financial conditions of late 1987 and the market conditions of today. Both times there has been new leadership at the Fed. In 1987, Alan Greenspan was newly minted as chairman of the Federal Reserve. Inflation was rising, and Greenspan responded by raising the fed funds interest rate by 50 basis points. Nevertheless, investors were skeptical about his ability to be a strong leader in difficult times. For example, on a Sunday television news show early in his tenure, he expressed his concerns about inflation; the next day stock markets sharply wobbled. Greenspan learned his lesson, realized the risks to his reputation, and never again gave a television interview on the economy, instead gaining a reputation for becoming altogether Delphic in his public pronunciations.

    Similarly, relatively new Chairman Ben Bernanke also inherited an economy with high and rising inflation, and has responded by raising interest rates three times for a total of 75 basis points since he became Fed chairman last year. And like Greenspan, he too has had missteps with the media. Last spring, after making comments in front of Congress that investors interpreted as dovish, he told CNBC anchor Maria Bartiromo that he had been misunderstood and was more hawkish than the market perceived him. The next day, equity markets sharply contracted and Bernanke’s reputation was shaken. You can be sure that, like Greenspan, Bernanke will likely never speak to any TV reporter again.

    The similarities between 1987 and today go far deeper than media dust-ups. Take, for example, twin deficits—the existence of both large and unsustainable budget deficits and current account deficits that are leading to an accumulation of a large stock of public debt and foreign debt in the United States. In the years leading up to Black Monday, unsustainable tax cuts and excessive military spending during President Ronald Reagan’s first term led to a strong dollar and a large current account deficit. After 1985, driven by the unsustainable external imbalance, the dollar started to fall. Likewise, today we bear the consequences of unsustainable tax cuts and runaway military spending. And since 2002, the dollar has started to fall under the pressure of the external imbalance.

    Most notably, there are troubling parallels between 1987 and the present in trade. In the months leading up to Black Monday, the United States blamed Germany’s and Japan’s “weak” currencies for the continued U.S. trade deficit. In particular, American politicians stoked fears that a rising export giant like Japan would hollow out the U.S. manufacturing sector. The tensions came to a boil on October 18, when Treasury Secretary James Baker strongly suggested the need for a further fall in the dollar and implied that the reluctance of Germany and Japan to let the mark and yen appreciate could be met with retaliatory trade actions. The following day, the infamous Black Monday of October 19, 1987, the stock market crashed: The Dow Jones industrial average went into a free fall, losing 22.6 percent of its total value. The S&P 500 collapsed by 20.4 percent. This was the largest loss that Wall Street had ever experienced in a single day.

    The risks of such a systemic financial crisis are just as serious today. Today’s scaremongering about “unfair” trade practices focuses not on Germany and Japan, but on China. U.S. politicians blame China for the United States’ low savings and external deficit. And American manufacturers fear that China will hollow out the U.S. traded sector (textiles, apparel, labor-intensive consumer products, auto parts and, soon enough, even cars) with its unstoppable export boom. There are several bills in Congress to slap tariffs against China if it does not allow its currency to sharply appreciate. The slowing growth of the U.S. economy and the upcoming presidential election in 2008 are increasing the protectionist mood in Congress regarding trade in goods. Markets are skittish and investors more risk averse after this summer’s financial volatility. And the growth of derivative instruments is much more massive than 20 years ago: These instruments can be used to hedge risks (such as the default risk on mortgages or corporate debt) but, in conjunction with high leverage, they are often used for highly risky speculative bets on risky assets, and thus they contribute to greater systemic risk.

    In these conditions, it usually doesn’t take much to rattle markets and trigger a meltdown. Hopefully, Treasury Secretary Hank Paulson will avoid bullying China and the countries that are financing the U.S. current account deficit. It is not only bad manners to bite the hand that feeds you, but it’s also dangerous financial behavior: The United States badly needs this cheap foreign financing. The United States still needs to borrow about $800 billion every year—on top of all the previous stock of past borrowing—to finance its still increasing external deficit.

    All these factors mean that there’s an even greater risk today than in 1987 that things will get out of hand and trigger a financial free fall. Today you have the following: trade protectionism and asset protectionism (the increasing restrictions to foreign direct investments in the United States); hedgy and trigger-happy investors and rising geopolitical risks; the risk of a disorderly fall in the U.S. dollar that is now sharply weakening; a slush of financial and credit derivatives that are a black box of opaque financial innovation that no one truly understands; increasingly risky investment strategies based on growing levels of leverage (i.e. the ability to multiply risk bets by borrowing a lot to finance such bets); frothy markets where years of easy money created bubbles galore—the latest in housing—that have now started to burst; greater opacity and lack of transparency as there is no supervision or regulation of the activities of many highly leveraged and opaque financial institutions; risk management techniques in financial institutions that fail to truly test the risk of large losses in extremely rare events (such as a major market meltdown like in 1987 or in 1998 at the time of the near collapse of Long-Term Capital Management, then the biggest U.S. hedge fund); risk-hedging strategies that—like in 1987—can hedge nothing once everyone is rushing to the doors and dumping assets at the same time (with this summer’s liquidity cru
    nch a perfect example of the vulnerabilities associated with the poor management of liquidity risk); a housing market whose rout has already triggered systemic effects through the subprime carnage; and the fact that subprime mortgages had been pooled in mortgage-backed securities and that these in turn were repackaged in other risky, complex, and illiquid securities (the various tranches of collateralized debt obligations) that were then given a misleadingly high rating by the rating agencies.

    The credit and liquidity crunch of this past summer was just the first sign that this toxic and combustible mix of elements could lead to a financial meltdown. It may only take any small match to trigger it: the collapse of a large hedge fund, a bankruptcy declaration by a large U.S. corporation, a trade war with China, a further spike in oil prices, a major terrorist incident, or wider conflict in the Middle East. There is indeed an embarrassment of riches in events that could trigger a systemic financial-risk episode. A single factor among those discussed above may not be enough to trigger it, but the risk that a variety of such factors may simultaneously emerge is increasing. To avoid such a meltdown, we need many reforms: better regulation and supervision of mortgages and of financial institutions, including the lightly or unregulated hedge funds; more transparency on who is holding which risky assets; better risk management by investors; avoidance of a bailout of reckless lenders and investors; a more competitive market for ratings as the small set of only three rating agencies seriously misread very complex and risky instruments; and hopefully a modest and soft—rather than hard—landing for the U.S. economy. We need these and other reforms. Otherwise, the next Black Monday will be a whole lot darker.


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  • Super-Conduit or Super-Bailout Shell Game?

    What should we make of the SIV rescue plan, the so called Master Liquidity Enhancement Conduit (MLEC), also informally referred to as the Super-Conduit? Does it make financial and economic sense? Is it all a smoke and mirrors con game or a serious attempt to deal with the liquidity crunch in the SIV/ABCP market? Is […]

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  • RGE Monitor Launches Today the New Europe EconoMonitor

    Dear RGE Monitor readers, we are launching today the new Europe EconoMonitor.The URL for this is:  A group of about twenty-five leading European economists or experts in European economic issues will write regularly in this new venue and provide their insights and views on the important economic issues faced by Europe, both as a […]

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  • AEI Event on the Deflating Mortgage and Housing Bubble, Part II

    I presented yesterday at a AEI event on Deflating Mortgage and Housing Bubble, Part II. The first event was last March when the subprime carnage was emerging; this one was a follow-up debate on what is happening now and next to housing, mortgages, subprime and the financial system.  The presentations at this event – by […]

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