Barron's and Roubini

I rely on many sources -- more than I can count -- for information about what is going on in the financial world. Barron's in one of them. I have been a regular reader of the weekly magazine (and an online subscriber) for years. One feature I always look forward to are the interviews with (genuine) experts and old hands. This week's issue features a Q&A with Nouriel Roubini, an individual who has consistently been ahead of the curve throughout the unfolding crisis (as I've noted many times at Financial Armageddon). Barron's Robin Goldwyn Blumenthal is the questioner in "Yes, That's $2 Trillion of Debt-Related Losses."

LIKE THE EXHORTATIONS OF JEREMIAH TO THE NATION OF Israel before the first temple's destruction, the warnings of economist Nouriel Roubini fell on deaf ears. For the past two years Roubini, a professor at New York University, has cautioned about a huge housing bubble whose bursting would lead to a 20% drop in home prices; a collapse in subprime mortgages; a severe banking crisis and credit crunch; the near-failure of Fannie Mae and Freddie Mac , and a U.S. recession of a magnitude not seen since the Great Depression. So far, this latter-day prophet of doom has been on the mark, though time will tell about the recession part.

A Turkish native who grew up in Italy, Roubini trained at Harvard and later advised the Clinton White House, after his blog on the Asian financial crisis attracted the attention of Washington's economic and political elite. Roubini still publishes the blog -- the RGE Monitor -- and teaches economics at NYU's Stern School of Business. We caught up with him recently at his offices in lower Manhattan, and continued the conversation at Barron's. For his latest predictions, please read on.

Barron's: Unfortunately for the rest of us, you have a pretty good track record. How much more misery lies ahead?

Roubini: We are in the second inning of a severe, protracted recession, which started in the first quarter of this year and is going to last at least 18 months, through the middle of next year. A systemic banking crisis will go on for awhile, with hundreds of banks going belly up.

Which banks, specifically, will fail?

I don't want to name names, but many, given the housing bust, will become insolvent. Their losses are mounting because they have written down only their subprime loans so far. They haven't started writing down most of their consumer-credit losses, and reserves for losses are much less than they should have been. The banks are playing all sorts of accounting gimmicks not to recognize them. There are hundreds of millions of dollars outstanding in home-equity loans that eventually could be worth zero, too.

So far, we have seen no recession in the technical sense: two consecutive quarters of negative growth in real GDP. Why not?

The definition of a recession isn't only two consecutive quarters of negative growth. The NBER (National Bureau of Economic Research) puts a lot of emphasis on things like employment, and employment has already fallen for seven months in a row. It also emphasizes income and retail and wholesale sales. Many of these things are declining.

Maybe the recession started in January; if you look at the data on gross domestic product on a monthly basis between February and April, GDP was falling. Saying this is not a recession is just a joke. Maybe instead of a 'U' recession and recovery, it will be a 'W,' with a rebound in the second quarter. But by the third quarter, the effect of the government's tax rebates is totally gone, because other forces on the consumer are more persistent and negative.

Which forces, for instance?

The U.S. consumer is shopped out and saving less. Debt to disposable income has risen to 140% from 100% in 2000. Hit by falling home prices, the consumer no longer can use his house as an ATM machine. The stock market is falling and (issuance of) home-equity loans (has) collapsed. We have a credit crunch in mortgages, and gas is around $4 a gallon. Everyone says, 'yeah, that's true, but as long as there is job generation there is going to be income generation and people are going to spend.' But for seven months in a row, employment in the private sector has fallen.

The most worrisome thing is that in spite of the rebates, retail sales in June were up only 0.1%. In real terms, they were down. If people were not spending their rebate checks in June, what will happen when there are no more checks?

Good question. How do you think Federal Reserve Chairman Ben Bernanke has handled the crisis so far?

The Fed's performance has been poor. More than a year ago the Fed said the housing slump would end, but it hasn't. They kept repeating this was a subprime-debt problem only, whereas the problems of excessive credit involve subprime, near-prime, prime, commercial real estate, credit cards, auto loans, student loans, home-equity loans, leveraged loans, muni bonds, corporate loans -- you name it.

The Fed's other mistake was to believe the collapse of the housing market would have no effect on the rest of the economy, when housing accounted for a third of all job creation in the past few years. When the proverbial stuff started to hit the fan last summer, the Fed went into aggressive-easing mode. But it has always been kind of catching up.

What should Bernanke have done a year ago, or even prior to that?

The damage was done earlier, beginning when the Greenspan Fed lowered interest rates in 2001 after the bust of the technology bubble, and kept them too low for too long. They kept cutting the federal funds rate all the way to 1% through 2004, and then raised it gradually instead of quickly. This fed the credit and housing bubble.

Also, the Fed and other regulators took a reckless approach to regulating the financial sector. It was the laissez-faire approach of the Bush administration, and (tantamount to) self-regulation, which really means no regulation and a lack of market discipline. The banks' and brokers' risk-management models didn't make sense because no one listens to the risk managers in good times. As Chuck Prince (the deposed CEO of Citigroup) said, 'when the music plays you have to dance.'

Now the regulators are attempting to make up for lost time. What do you think of their efforts?

The paradox is they're going to the opposite pole. They are overregulating, bailing out troubled participants and intervening in every market. The Securities and Exchange Commission has accused others of trying to manipulate stocks, but the government itself is now the manipulator. The regulators should investigate themselves for bailing out Fannie Mae (FNM) and Freddie Mac (FRE), the creditors of Bear Stearns and the financial system with new lending facilities. They have swapped U.S. Treasury bonds for toxic securities. It is privatizing the gains and profits, and socializing the losses, as usual. This is socialism for Wall Street and the rich.

So the government should have let Bear Stearns fail, not to mention Fannie and Freddie?

If you let Bear Stearns fail you can have a run on the entire banking system. But there are ways to manage Bear or Fannie and Freddie in a fairer way. If public money is to be put at stake, first all the shareholders of these companies have to be wiped out. Management has to be wiped out, and the creditors of Bear should have taken a hit. Why did the Fed buy $29 billion of the most toxic securities, and essentially bail out JPMorgan Chase (JPM), which bought Bear Stearns?

Because JPMorgan was a counter-party?

Exactly. The government bailed out everyone. Even the unsecured creditors of Fannie and Freddie should have taken a hit. Sometimes it is necessary to use public money to rescue institutions, but you do it in a way in which you're not bailing out those who made the mistakes. In each one of these episodes the government bailed out the shareholders, the bondholders and to some degree, management.

At what point does the government run out of money to lend to troubled banks?

Many public institutions are themselves going bankrupt. The FDIC (Federal Deposit Insurance Corporation) has only $53 billion of funds, and has already committed almost 15% of it to bail out depositors of IndyMac. The FDIC's deposit-insurance premiums weren't high enough, and now it is asking Congress to raise them. Plus, the agency claims only nine institutions are on its watch list. IndyMac wasn't on the watch list until June, the month before it collapsed. Studies done by experts in banking suggest that at least 8% of U.S. banks are in big trouble. Eight percent of the roughly 8,500 that the FDIC essentially is insuring equals about 700 banks. Another 8% to 16% also are shaky, so some 700 potentially are going bust and another 700 eventually could join them. Yet the FDIC is watching only nine institutions. It's a joke.

What recourse will the taxpayer have?

The taxpayer's bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic. But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn't a ceiling, it's a floor. And the banks, as I've said, have written down only about $300 billion of subprime debt.

How long will it take for the collapse in the banking sector to play out?

It is happening in real time. Many smaller banks are going bust already. More than 200 subprime-mortgage lenders have gone bust in the past year alone. And many community banks will go bankrupt. Community banks usually finance everything: the homes, the stores, the downtown, the commercial real estate, the shopping center. If you are in a town or a municipality where there is a housing bust, the bank is gone. Of three dozen or so medium-sized regional banks, a good third are in distress. That includes the Wachovias and Washington Mutuals of the world. Half of this group might go bankrupt. Even some of the majors could end up technically insolvent, though they might be deemed too big to fail.

Take Citigroup. In 1991 there was a small real-estate bust, though the quarterly fall in home prices was only 4%, based on the S&P/Case-Shiller indices. Citi was effectively bankrupt and signed a memorandum of understanding with the Fed that allowed the government to give the bank regulatory forbearance. Citi was allowed to ride it out and try to recapitalize in a few years, and thereby avoid bankruptcy protection. This time around the S&P/Case-Shiller indices indicate home prices already have fallen 18%. The decline could be as much as 30%, because the excess supply is huge.

Nouriel, have you always been so negative about everything?

No. I'm actually a pretty mainstream economist. I was trained first in Italy and then in the U.S. and earned my Ph.D. at Harvard. My interests are in international market economics and international finance, and I'm not a 'perma-bear' on the stock market nor an eternal pessimist.

Leaving aside the fact that we are going to have a pretty nasty recession and international crisis, the global economy is going to grow at a sustained rate once this downturn is over. There are significant financial and economic problems in the U.S., and that's why I'm bearish about the U.S. But the emergence of China and India and other powers is going to shift global economics and politics radically, and the world is going to be more balanced in the future, rather than relying on one engine, which has been the U.S. There are big issues ahead: How do you integrate the 2.2 billion Chinese and Indians into the global economy? There will be transitional costs and the displacement of workers, both blue-collar and white, in the advanced economies. But I'm quite bullish about the state of the global economy, and I'm positive about the medium and long term.

That's a relief. Thank you.

Comments

[Michael MacLeod]

Great interview. Thanks for posting. What's truly fascinating about this experience is the rate of acceleration we're starting to see. Those who doubted that real estate prices could fall, or that the U.S. Superpower economy could ever falter are now snapping awake, startled. As Mr. Roubini notes, he was not that long ago, considered a lunatic.

I've been there, and know the feeling, though I'd rather we were in a situation where my (and Mr. Roubini's, not to mention yours, Michael) predictions were still looking like they might not happen. Unfortunately, we're past that.

Again, thanks for posting an excellent interview.

[Independent Accountant]

Viva Roubini!

[farang]

Great, thanks for posting. He is always fascinating to read.

I do mildly disagree with a couple of statements made, though:

1) Roubini says our government is "privatizing the gains and profits, and socializing the losses, as usual. This is socialism for Wall Street and the rich."

Well, not certain I agree with the terminology, since the ones in control of the government economic policies came directly from the very corporations they were supposed to be regulating and are now bailing out, while dumping their losses on the peon masses, along with rampant nationalism and military build up... that sounds like FASCISM to me. Or as some dictator once stated: "...Fascism is more properly called Corporatism..." I'm sure Mr. Roubini, who grew up in Italy, knows who that is.

2) I strongly disagree "Globalism" is anything other than a system to centralize into a world corporate-run government, with the vast majority of the world population taking it in the shorts. Roubini can be as bullish as he likes on the future, mid and long range. He certainly did nail the downside, so perhaps he is correct.

I see an entirely different system of economics coming. To me, any system that rewards these CEO bozos with billions untied to performance, any economy shipping it's manufacturing out of country as a POLICY, is doomed to fail. Will not survive as a dominant economy long term.

Someone needs to explain to me how we aren't just shuffling the same money around looking for a bubble, when we don't produce exports, how we lead ourselves out of this mess economically? Look to Wall Street geniuses for more financial "innovations"? Goodness.

What IS the model, the scenario, of financial recovery from this incredible mess, eh?

[roger]

of possible interest for some people(http://londonbanker.blogspot.com/2008/07/whats-up-with-covered-bond-push.html

[davinits]

well since the federal reserve is a private corporation run by big bankers it is just a plan. You can talk all you want about the reasons but we all know the reasons. The bankers have a plan just like they did during the Great Depression.

My great grandmother came directly from Sicily and she always said that she never trusted banks and kept money in her mattress. Until my recent understanding of the federal reserve I thought she was an old kook.

The baby boomers and their children and their children do not understand what the Great Depression was like. They have no concept, they think life is xbox and American Idol. They do not care if their brothers and sisters are killing innocent people in other countries hey the new iphone is out. It is sickening and I partly blame my parents as I was raised in the 1980s and that was a decadent time for kids. Cable tv was coming to everyhome, pop stars were gods and mtv ruled kids minds. Parents came from the 1950s where their parents had houses and cars and barbques even with no college educations. Today kids are growing up with more but know less and less.

I am mad at my parents for leaving the mess up to me and my kids to fix. To be ignorant and living off the fat of the land and not caring for so long. They did raise me with a distrust of the government however and that I will always be forever grateful for that. However I have met too many people my age and younger that just do not care. Their parents never showed an interest in government or the policies that are running their lives and others they just follow along. Hey lets go get drunk and party who cares if we can only do it in our backyard before 10pm. Yeah government. Its a blind patriotism that is so disturbing I can not believe that my grandfathers fought wars to protect the American people and the majority of Americans are so ignorant and lazy that they actually make fun of people who care.

I mean it is sad that people are losing their houses and causing financial hardship but I have always lived even as a kid from paycheck to paycheck so if this financial depression opens some peoples eyes in the end it wil be a good thing.

We can change the illegal Federal Reserve. We can make the people of this country free from the whims of the corporate elite. When enough people find out it will change. It always has.

for better or worse it has to.

[roger]

davinits: everybody is born in a world not of his/her making as children we absorb a lot of garbage info. there is noting harder in the world than to shed all the brain washing be it religion philosophy political or whatever as the saying goes it comes with the milk of our mothers.And nobody but nobody can learn till they have completely emptied their brains of all these preconcieved ideas, same goes for our parents,we are products of history so I would not be to harsh on past generation

[ninakat]

farang, good points. I see it as FASCISM too, not socialism for the rich (although I've also seen others use that same terminology recently). But regarding Roubini's mid- and long-term bullishness, I don't get it. Maybe he doesn't believe in peak oil, peak natural gas, peak everything else too. I mean, we're at the point (or not far from it) where resources are becoming less plentiful and cheap. How can you have any meaningful growth in the future without (a) a new source of cheap energy, which is unlikely at this late stage -- we would have seen it by now; or (b) demand destruction through population reduction, aka die-off. I don't even like contemplating the latter. But without a concerted effort to curb population growth, how can this planet and its limited resources just continue to have endless economic growth? Unless, of course, the vast majority of us will live in squalor as slaves to the new world order where economic growth is a rich-man's club. Come to think of it, that's pretty much what we have now if you look at the entire world -- I just think it will become much more extreme and overt in western societies, especially the U.S. (no more middle class, for example).

So, anybody else have some thoughts about how Roubini's bullish future?

[Waiting for the Other Shoe to Drop]

Good post farang, roger and davinitis.

I too used to blame past generations. But the truth of the matter is this system has been going on for a very long time. Back to the Roman Empire and beyond.

Every generation has had thier own worries and wars. Wars and terorist attacks have been used to manipulate the masses going way back. Also, here in America, the masess have been dumbed down with chemicals such as flouride, MSG, aspartame, heavy metals, etc., to name a few. They have become numb to outside events and are economicly illiterate.

I agree that more are waking up. But it will take a personal event like losing your job and not being able to find another for many to wake up. Unfortunately, I fell this is coming for a lot of people. Things will get worse before they get better. Maybe we'll bottom out in 2012.

Love this site. keep up the good work.

[roger]

(So, anybody else have some thoughts about how Roubini's bullish future.)Yes Roubini's views are those of a very well informed present day economist,my disagreement with him would be: 1 present day consumerism can not be sustained.2 100% of the economists view this crisis as the result of greed & bad management,for me this a fundamental error,crisis & depressions are built in the system and will happen no matter what.I know I'm the minority of one & not even an economist

[BlackStarRanch]

...fantastic interview. After raising 5-kids and finally "waking up", I realized my generation, including myself, turned out to be a bunch of self-centered whiners that indulged, spent, and consumed much more than we ever gave back. Much was complained about by us from the 60's thru to the present, but very little was accomplished to remedy the problems we so fervently objected to. Greed has proliferated and self-improvement is accomplished by "knocking down and/or talking down" our neighbor. We felt we had to force-feed "democratic ideals" thru-out the globe whether it was wanted or not. That's why everyone hates us (egotistical Americans). Our government from the top down REGARDLESS OF PARTY, has regressed to the point of fraud & deceit. Nothing can be believed coming from any politician or press release (with the exception of a VERY, VERY few), and our 'national stores' are currently being looted before the flood waters arrive. Have you ever tried to get a phone call from an elected official? Have you ever gotten him/her to answer even a simple question? Do you know how they stand on anything? How they are going to vote on a particular bill? Most likely you won't. Prior to answering any of YOUR questions, they (an aide)will ask you for your name, address, phone number, eMail address and how YOU feel about "it" and then will get back to you later with a "warm & fuzzy" form letter. No REAL answer is usually ever forthcoming. Most are FRAUDS and CHARLATANS - using effusive flowery words only for reasons of deception).

Some feel it's too late for this country and people. Unemployment is soaring, tens of thousands are losing their homes, homelessness is skyrocketing, we're producing less, and we manufacture almost nothing anymore. American business ownership is declining - being sold to foreigners (have a Bud!), afterwhich the foreign owners/conglomerates "hollow out" the business - relocate or "outsource" the manufacturing end of it to Mexico or China. Any American branch is then turned into an assembly plant only utilizing marginally paid American employees and illegals.

The cost for necessities (food, water, housing, heating & fuel costs) are stratospheric and about to increase substantially shortly thru hyper-inflation.

I figure we have literally one last chance. If we don't do what we have to do in the next 5-10 years, we're a 3rd world country or worse. The solution and concept is pretty simple. The "doing" is as always the hardest - and, if it's not done NOW, there will be no tommorow:

1. Get your SELF in order. (I quit smoking, drinking, doing drugs and procrastinating - The rest can't be attained if you're a mess).
2. Get your own HOUSE in order. (Extend the concept to your entire family)
3. Do not contribute to the irresponsible thievery going on in Washington. Complain a lot to Washington - Phone calls work - get names and a promise to call back.
4. Be American, BUY American (Utilize companies only OWNED by US citizens)
5. Become an isolationist - think how any daily decision you make will affect your country (I can make do without that $10 frying pan made in China).
6. Get out of debt.
7. Become more local in spending habits.
8. Drive MUCH less - spend much less.
9. Put a nest egg away that DOESN'T require you to visit a bank, ATM machine, or store to access (Gold has historically always worked).
10. Always be ready for a "run on the bank" or a "run on the store" -and,
11. Keep a tank load of gas in one of your vehicles, have food and water for a month, and have a place to go if things "go south".

Our generation was too self-centered and using. Some subsequent generations have too gullible a belief of media and 'world'; "Our (..fill in the blank..) won't let anything happen to our (..fill in the blank..)!" Grow a brain folks - nobody cares about what happens to you - with the exception of only your family .... Semper Fi......

BTW, you provide a GREAT service - keep it up. One of the better sites out there!

[tbiggs]

Mussolini was an interesting character. Though portrayed as a buffoon, because he paraded around in silly uniforms, he was actually a very smart man. (Smart doesn't necessarily mean honest or moral, of course.) Before WWI, he had actually been a "true believer" in International Socialism. Then when the war came, he saw that it was a hopeless dream, because when push comes to shove, "the masses" become extremely nationalistic.

So he took what he liked about Socialism, but dropped the "international" part. He basically invented a "National Socialism"... does that term sound familiar? Of course he also perverted it into Corporatism - and he was honest enough to say so. Mr. Hilter copied Mussolini's scheme almost exactly, except that he added in anti-Semitism, which wasn't part of the Italian Fascism.

We truly have been turned into a Corporatist state, so gradually that most people never even noticed. Garet Garret called it a "Revolution within the Form", i.e., keep the outer shell, the old forms and traditions, praise Freedom and the Constitution - but replace the inner core with anti-Constitutional Corporatism.

The 1776 Revolution was a world-shattering event. No single effort could turn back the clock. So the counter-revolution came in waves: the 1861 war made the Federal government dominant over the states (counter to the Founders' intent) and tested the people's tolerance for gross violations of their Constitutional rights; the Progressive movement got co-opted and gave us the Federal Reserve, income taxes, and prohibition; FDR stole our gold and created a "kinder and gentler" form of Corporatism; WWII and the Cold "War" entrenched the military-industrial complex. From there it was pretty much on rails...