[lbo-talk] Roubini: The Rising Risk of a Systemic Financial Meltdown

joanna 123hop at comcast.net
Sat Nov 17 18:13:49 PST 2007


Since Bernanke has announced his unwillingness for further cuts, I wonder whether the crisis mongering is not simply a way of attempting to reverse that course,

Joanna

Ira Glazer wrote:


>http://www.rgemonitor.com/blog/roubini/227330
>
>Nouriel Roubini
>Nov 16, 2007
>
>It is increasingly clear by now that a severe U.S. recession is
>inevitable in next few months. Those of us who warned for the last 12
>months about a combination of a worsening housing recession, a severe
>credit crunch and financial meltdown, high oil prices and a saving-less
>and debt-burdened consumers being on the ropes causing an economy-wide
>recession were repeatedly rebuffed the consensus view about a soft
>landing given the presumed resilience of the US consumer. But the
>evidence is now building that an ugly recession is inevitable. Thus, the
>repeated statements by Fed officials that they may be done with cutting
>the Fed Funds rate are both hollow and utterly disingenuous. The Fed
>Funds rate will be down to 4% by January and below 3% by the end of 2008.
>
>More revealing of the change in mood the financial press and some of the
>most prominent market analysts are coming to the realization that a
>recession is highly likely. The Economist has a cover story and long
>piece arguing that a US recession highly likely
><http://economist.com/opinion/displaystory.cfm?story_id=10134118> (and
>citing this author's work with Menegatti and our views on the
>inevitability of such a recession).
>
>More importantly, on Wall Street some of the leading analysts that had
>been in the soft landing camp for the last year have now moved their
>forecast in the direction of hard landing. It is not just David
>Rosenberg of Merrill Lynch who has been informally in the hard landing
>camp and is now explicitly talking about a consumer recession. It is not
>just Jan Hatzius of Goldman Sachs
><http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aXHulkIznCr0>
>[ira -- that Doug referenced in an earlier post] who was always more
>bearish relative to the soft landing consensus and is today explicitly
>talking about a US recession and a credit crunch reducing lending by $2
>trillion.
>
>Even in soft landing houses such as Morgan Stanley and JP Morgan the
>tone is completely different now. At Morgan Stanley Steve Roach was the
>in-house bear while Richard Berner (a most sophisticated economist and
>analyst) was the in-house soft landing optimist. With Roach now gone to
>run Morgan Stanley Asia, the commentary by Richard Berner has become
>increasingly darker. And the latest Monday piece by Berner is titled
>“The Perfect Storm for the US Consumer
><http://www.morganstanley.com/views/gef/archive/2007/20071112-Mon.html#anchor5785>”
>where his points on the headwind forces hitting the US consumer are
>completely overlapping with my analysis of such risks in my recent “The
>Coming US Consumption Slowdown that Will Trigger an Economy-Wide Hard
>Landing <http://www.rgemonitor.com/blog/roubini/226072/>. Berner starts with
>
>/“Serious pressures are mounting on the US consumer on five fronts: Job
>growth is slowing, surging energy and food quotes are draining
>purchasing power, adjustable rate mortgages are resetting, lending
>standards are tightening, and housing wealth will likely decline. Do
>these dark clouds finally and ominously herald the perfect consumer
>storm?” /
>
>And he concludes with: “Risks to the consumer are rising, and _the risk
>of outright US recession is higher now than at any time in the past six
>years_: Housing is in sharp decline, consumers are vulnerable, and
>companies may cut capital spending and liquidate inventories. A strong
>contribution from global growth is still a huge positive, but spillovers
>from US weakness to trading partners may hobble that lone source of
>strength. These pressures could last longer or be more intense than I
>expect. And even if the economy skirts overall recession, corporate
>earnings will likely decline.”
>
>//
>
>An even more persistently bullish bank was JP Morgan that kept on
>warning for the last year that the biggest risks to the US economy was
>not a growth slowdown but rather a growth pickup and the risk that
>inflation would surprise on the upside and force a behind-the-curve Fed
>to raise the Fed Funds rate above 6%. This analysis obviously proved
>wrong and now the very smart – but mistaken - Bruce Kasman has had to
>throw in the towel and accept that the downside risks to grow are sharp
>and that the Fed will cut the Fed Funds rate to 4%. As he put it in his
>latest note:
>
>/"US// outlook change: More drag, more ease// //-- Drags from energy,
>and credit tightening push GDP forecast to 1% on average for current and
>upcoming quarter// //-- Fed is likely to recognize growing downside risk
>and ease 50bp, to 4% by end of 1Q08// //-- December meeting outcome
>remains close, but we now expect 25bp move from a proactive Fed// //As
>the US moves through the fourth quarter, incoming economic news remains
>consistent with our forecast of a growth “pot hole”. Powerful drags now
>in place — from tighter credit conditions and an intensified contraction
>in residential investment — are evident in the decline in output and
>employment in the goods producing industries and in a slowing in
>consumption spending….// //…three developments over the past month look
>set to increase downward pressure on growth.// /
>
>/"Oil on the boil. Global crude oil prices rose more than $10 dollars
>during October, and has held at an elevated level this month. If current
>levels are maintained, it would represent a drag on annualized household
>income of approximately one percentage point between now and the end of
>the first quarter. This drag, which has yet to have been felt, adds to
>the forces weighing on consumer spending.// /
>
>/"Temporary lifts to fade. Although an upward revision to 3Q07 growth to
>close to 5% now looks likely, this outcome is partly borrowing from
>growth in the quarters ahead. Defense spending, which has grown at a 9%
>annualized pace in the past two quarters, is almost certainly due for a
>pause. And a significant upward revisions to inventory building in 3Q07,
>points to an adjustment ahead. Indeed, the latest rise in ISM customer
>inventory index, combined with auto production schedules pointing to
>cutbacks through year end, suggests that stockbuilding is likely to
>subtract from growth this quarter and next.// /
>
>/"Credit tightening broadens. Results of the Fed’s latest Senior Loan
>Officers Survey indicates that credit conditions are tightening broadly
>and that demand for credit is slowing. Most recently, credit conditions
>have tightened significantly for commercial construction projects with
>CMBS securitizations plunging over the past couple of months. While the
>quantitative effects of this tightening is hard to measure, credit
>conditions look set to remain tight for a longer period than anticipated
>in our current forecast.// /
>
>/"Taken together, these developments warrant a downward revision to an
>already sluggish growth forecast for the coming quarters. The trajectory
>of GDP growth is being lowered by one half percentage point per quarter
>through the middle of 2008, with the path of consumption, stockbuilding,
>and nonresidential construction activity shouldering much of the
>burden.// //During this quarter and next, GDP growth is expected to be
>particularly soft, averaging a meager 1% percent. The underlying
>resiliency of the US corporate sector will be severely tested through a
>period in which profits are expected to contract. While we continue to
>believe that firms are unlikely to retrench in a manner that produces a
>recession, the risks of a recession remain uncomfortably high.// //We
>currently place the risk of a recession taking hold in the coming two
>quarters at 35%.// // //The Federal Reserve has made it clear that it is
>willing to act preemptively in the face of elevated recession risks.
>Having moved 75bp in two meetings, its October statement signalled that
>it viewed the risks to growth and inflation as balanced — a message that
>the bar for further easing was high. Against this backdrop, the Fed will
>need to shift materially its perceptions of risks about the outlook in
>the direction of our forecast change to produce ease. We now believe
>such a shift will take place and produce 50bp of additional ease by the
>end of the 1Q08./ "
>
>
>When the most prominent and respected and sophisticated “soft-landing”
>analysts on Wall Street turn this bearish and start talking about high
>probability of a recession and downside risks to growth and of a
>consumer recession you know that these are code words for admitting
>implicitly – short of an official and explicit endorsement of such view
>that very few analysts of Wall Street can afford to have because of
>sell-side research constraints - that they believe that a recession is
>highly likely.
>
>So at this point the debate is less and less on whether we are going to
>have a recession that looks inevitable; but it is rather moving towards
>a debate on how deep, protracted and severe such a recession will be.
>But the financial and real risks are much more severe than those of a
>mild recession.
>
>I now see the risk of a severe and worsening liquidity and credit crunch
>leading to a generalized meltdown of the financial system of a severity
>and magnitude like we have never observed before. In this extreme
>scenario whose likelihood is increasing we could see a generalized run
>on some banks; and runs on a couple of weaker (non-bank) broker dealers
>that may go bankrupt with severe and systemic ripple effects on a mass
>of highly leveraged derivative instruments that will lead to a seizure
>of the derivatives markets (think of LTCM to the power of three); a
>collapse of the ABCP market and a disorderly collapse of the SIVs and
>conduits; massive losses on money market funds with a run on both those
>sponsored by banks and those not sponsored by banks (with the latter at
>even more severe risk as the recent effective bailout of the formers’
>losses by theirs sponsoring banks is not available to those not being
>backed by banks); ever growing defaults and losses ($500 billion plus)
>in subprime, near prime and prime mortgages with severe known-on effect
>on the RMBS and CDOs market; massive losses in consumer credit (auto
>loans, credit cards); severe problems and losses in commercial real
>estate and related CMBS; the drying up of liquidity and credit in a
>variety of asset backed securities putting the entire model of
>securitization at risk; runs on hedge funds and other financial
>institutions that do not have access to the Fed’s lender of last resort
>support; a sharp increase in corporate defaults and credit spreads; and
>a massive process of re-intermediation into the banking system of
>activities that were until now altogether securitized.
>
>When a year ago this author warned of the risk of a systemic banking and
>financial crisis – a combination of global liquidity and solvency/credit
>problems - like we had not seen in decades, these views were considered
>as far fetched. They are not that extreme any more today as Goldman
>Sachs is writing today on the risk o a contraction of credit of the
>staggering order of $2 trillion dollars in the next few years causing a
>severe credit crunch and a serious recession
><http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aXHulkIznCr0>.
>As I will flesh out in a forthcoming note the risks of such a
>generalized systemic financial meltdown are now rising. Hopefully by now
>some folks at the New York Fed and at the Fed Board are starting to
>think about this most dangerous systemic financial crisis that could
>emerge in the next year and what to do to prepare for it.
>
>
>
>
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