`This is a systemic financial crisis, there is no end to it,'' Nouriel Roubini, professor of economics and international business at New York University, told Bloomberg Television. ``It's a vicious circle between a contracting economy and greater credit and financial losses feeding on the economy.''/
Regular readers of this blog are familiar with my views. But here is a summary and significant extended update of my views that this will turn out to be the worst financial crisis since the Great Depression and the worst US recession in decades…
* This is by far the worst financial crisis since the Great Depression
* Hundreds of small banks with massive exposure to real estate (the
average small bank has 67% of its assets in real estate) will go bust
* Dozens of large regional/national banks (a’ la IndyMac) are also
bankrupt given their extreme exposure to real estate and will also
go bust
* Some major money center banks are also semi-insolvent and while
they are deemed too big to fail their rescue with FDIC money will
be extremely costly.
* In a few years time there will be no major independent broker
dealers as their business model (securitization, slice & dice and
transfer of toxic credit risk and piling fees upon fees rather
than earning income from holding credit risk) is bust
and the risk of a bank-like run on their very short term liquid
liabilities is a fundamental flaw in their structure (i.e. the
four remaining U.S. big brokers dealers will either go bust or
will have to be merged with traditional commercial banks). Firms
that borrow liquid and short, highly leverage themselves and lend
in longer term and illiquid ways (i.e. most of the shadow banking
system) cannot survive without formal deposit insurance and formal
permanent lender of last resort support from the central bank.
* The FDIC that has already depleted 10% of its funds in the rescue
of IndyMac alone will run out of funds and will have to be
recapitalized by Congress as its insurance premia were woefully
insufficient to cover the hole from the biggest banking crisis
since the Great Depression
* Fannie and Freddie are insolvent and the Treasury bailout plan
(the mother of all moral hazard bailout) is socialism for the
rich, the well connected and Wall Street
it is the continuation of a corrupt system where profits are
privatized and losses are socialized. Instead of wiping out
shareholders of the two GSEs, replacing corrupt and incompetent
managers and forcing a haircut on the claims of the
creditors/bondholders such a plan bails out shareholders, managers
and creditors at a massive cost to U.S. taxpayers.
* This financial crisis will imply credit losses of at least $1
trillion and more likely $2 trillion
* This is not just a subprime mortgage crisis; this is the crisis of
an entire subprime financial system
losses are spreading from subprime to near prime and prime
mortgages; to commercial real estate; to unsecured consumer credit
(credit cards, student loans, auto loans); to leveraged loans that
financed reckless debt-laden LBOs; to muni bonds that will go bust
as hundred of municipalities will go bust; to industrial and
commercial loans; to corporate bonds whose default rate will jump
from close to 0% to over 10%; to CDSs where $62 trillion of
nominal protection sits on top an outstanding stock of only $6
trillion of bonds and where counterparty risk – and the collapse
of many counterparties – will lead to a systemic collapse of this
market.
* This will be the most severe U.S. recession in decades with the
U.S. consumer being on the ropes and faltering big time
as soon as the temporary effect of the tax rebates will fade out
by mid-summer (July). This U.S. consumer is shopped out, saving
less, debt burdened and being hammered by falling home prices,
falling equity prices, falling jobs and incomes, rising inflation
and rising oil and energy prices. This will be a long, ugly and
nasty U-shaped recession lasting 12 to 18 months, not the mild 6
month V-shaped recession that the delusional consensus expects.
* Equity prices in the US and abroad will go much deeper in bear
territory
In a typical US recession equity prices fall by an average of 28%
relative to the peak. But this is not a typical US recession; it
is rather a severe one associated with a severe financial crisis.
Thus, equity prices will fall by about 40% relative to their peak.
So, we are only barely mid-way in the meltdown of stock markets.
* The rest of the world will not decouple from the US recession and
from the US financial meltdown; it will re-couple big time.
Already 12 major economies are on the way to a recessionary hard
landing
while the rest of the world will experience a severe growth
slowdown only one step removed from a global recession. Given this
sharp global economic slowdown oil, energy and commodity prices
will fall 20 to 30% from their recent bubbly peaks.
* The current U.S recession and sharp global economic slowdown is
combining the worst of the oil shocks of the 1970s with the worst
of the asset/credit bust shocks (and ensuing credit crunch and
investment busts) of 1990-91 and 2001
like in 1973 and 1979 we are facing a stagflationary shock
<http://www.rgemonitor.com/roubini-monitor/252837/the_specter_of_global_stagflation>
to oil, energy and other commodity prices that by itself may tip
many oil importing countries into a sharp slowdown or an outright
recession. Also, like 1990-91 and 2001 we are now facing another
asset bubble and credit bubble gone bust big time: the housing and
overall household credit boom of the last seven years has now gone
bust in the same way as the 1980s housing bubble and 1990s tech
bubble went bust in 1990 and in 2000 triggering recessions. And a
similar housing/asset/credit bubble is going bust in other
countries – U.K., Spain, Ireland, Italy, Portugal, etc. – leading
to a risk of a hard landing in these economies.
* But over time inflation will be the last problem that the Fed will
have to face as a severe US recession and global slowdown will
lead to a sharp reduction in inflationary pressures in the U.S.:
slack in goods markets with demand falling below supply will
reduce pricing power of firms; slack in labor markets with
unemployment rising will reduce wage pressures and labor costs
pressures; a fall in commodity prices of the order of 20-30% will
further reduce inflationary pressure. The Fed will have to cut the
Fed Funds rate much more – as severe downside risks to growth and
to financial stability will dominate any short-term upward
inflationary pressures. Leaving aside the risk of a collapse of
the US dollar given this easier monetary policy the Fed Funds rate
may end up being closer to 0% than 1% by the end of this financial
disaster and severe recession cycle.
* The Bretton Woods 2 regime of fixed exchange rates to the US
dollar and/or heavily managed exchange will unravel
– as the first Bretton Woods regimes did in the early 1970s – as
US twin deficits, recession, financial crisis and rising commodity
and goods inflation in emerging market economies will destroy the
basis for it existence.
* Thus, the scenario of 12 steps to a financial disaster that I
outlined in my February 2008 paper
<http://www.rgemonitor.com/redir.php?sid=1&tgid=10000&cid=244929>
is unfolding as predicted. If anything financial conditions are
now much worse than they were at the previous peak of this
financial crisis, i.e. in mid-march of 2008.