Nouriel Roubini's Nightmare Scenario Options
Hold on to your hats
by Evan Cooper
February 27, 2008
Evan Cooper is the senior
managing editor and online editorial director of InvestmentNews.
As a rule, Wall Street’s rosy prognosticators see any glass as three-
quarters full, while journalists see it as one-quarter empty. Let me
introduce you to Nouriel Roubini—he sees the glass as bone dry and
about to shatter.
A professor of economics at the Stern School of Business at New York
University and the founder of Roubini Global Economics LLC, an
independent research service in New York that publishes the online RGE
Mr. Roubini is the Ursa Major of economic bears. He believes the United
States is headed for a whopper of a financial collapse, leading to a deep
Since economic reality often turns out to be a middle ground between the
utopian highlands and the chasms of ruin, you might want to put Mr. Roubini
into the “Why listen to that nut?” category.
But since he predicted our current economic problems as early as July 2006
-- and because many institutional investors pay for his insights—perhaps his
opinions are worth noting.
Mr. Roubini offers a 12-step scenario for what he sees as “a rising
probability of a catastrophic financial and economic outcome.”
He starts with the assumption that a recession began in December and that it
will be worse than recent recessions because housing prices are likely to
fall 20% to 30% and because the ongoing credit bust will lead to a severe
credit crunch, hurting over-indebted consumers.
“So let us suppose that the recession of
2008 will last at least four quarters and, possibly, up to six
quarters,” he recently wrote. “What will be the consequences of it?”
Here comes the gore, according to Mr. Roubini:
The recession will lead to more credit card and consumer debt defaults.
Next, the credit- rating insurers will lose their AAA ratings, which will
lead to further, massive write-offs of asset-backed securities portfolios.
This, in turn, will lead to losses at the banks and money market funds that
hold ABS paper. Add a drop in the commercial real estate business and he
predicts that at least one major commercial bank is likely to fail.
Next, some highly leveraged loans will fail, further limiting banks’ lending
ability and leading to bankruptcy among some overleveraged companies. The
nation’s non-bank financial system will be stressed, leading some mutual
funds, hedge funds and investment banks, among others, to go belly up.
Once investors realize that this is no ordinary recession, the gloom will
infect stock prices. Credit will contract further and there will be fire
sales of assets.
“In this meltdown scenario, U.S. and global
financial markets will experience their most severe crisis in the last
quarter of a century,” Mr. Roubini wrote.
Anything we can do about this, Mr. Roubini?
“One should be pessimistic about the ability
of policy and financial authorities to manage and contain a crisis of
this magnitude; thus, one should be prepared for the worst—a systemic
A Sobering 12-Step Scenario
February 25, 2008
Legendary bear Nouriel Roubini's case for a global financial meltdown:
At this point it is clear that U.S.
home prices will fall between 20% and 30% from their bubbly peak
Losses to the financial system from the
subprime disaster, estimated to be as high as $300 billion, are now
spreading to near-prime and prime mortgages
The recession will lead—as it is already
doing—to a sharp increase in defaults on other forms of unsecured
While there is serious uncertainty about
the losses that monoline insurance companies will take on their
insurance of residential mortgage-backed securities, collateralized
debt obligations and other toxic asset-backed securities products,
it is now clear that such losses are much higher than the $10
billion-to-$15 billion rescue package that regulators are trying to
The commercial real estate loan market
will soon enter into a meltdown similar to the subprime one
It is possible that some large regional
or even national banks that are very exposed to mortgages,
residential and commercial, will go bankrupt.
Banks' losses will grow
Once a severe recession is under way, a
massive wave of corporate defaults will take place.
The “shadow banking system” (as defined
by Pimco), or more precisely the “shadow financial system” (as it is
composed by non-bank financial institutions), will soon get into
Stock markets in the U.S. and abroad
will start pricing in a severe U.S. recession
The credit crunch that is affecting most
credit markets and credit derivative markets will lead to a drying
up of liquidity in a variety of financial markets
A vicious circle of losses, capital
reduction, credit contraction, forced liquidation and fire sales of
assets at below fundamental prices will ensue, leading to a mounting
cycle of losses and further credit contraction.
The perfect storm!
Financial Meltdown - Your 12 Step Guide
by Alex Evans
February 11, 2008
Time to remind ourselves that while we’ve all been cooing over Obama and
fretting over NATO cohesion, the small matter of the security of the world’s
financial system has continued to smoulder.
At dinner with a group of hedge
fund analysts last week, it was abundantly clear that just because the issue
has disappeared from the front pages for a time doesn’t mean it’s gone away:
au contraire, one analyst was bluntly stating that all we’ve seen so far has
been no more than the trailer.
Nouriel Roubini, bearish as ever (though let’s remember that he’s been
consistently right so far), asks the big question:
Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days
this past January? It is true that most macro indicators are heading south
and suggesting a deep and severe recession that has already started. But the
flow of bad macro news in mid-January did not justify, by itself, such a
radical inter-meeting emergency Fed action followed by another cut at the
formal FOMC meeting.
To understand the Fed actions one has to realize that there is now a rising
probability of a “catastrophic” financial and economic outcome, i.e. a
vicious circle where a deep recession makes the financial losses more severe
and where, in turn, large and growing financial losses and a financial
meltdown make the recession even more severe. The Fed is seriously worried
about this vicious circle and about the risks of a systemic financial
So to cheer you on your way on a foggy London morning in February, here’s
Roubini’s 12-step, “‘nightmare’ or ‘catastrophic’ scenario that the Fed and
financial officials around the world are now worried about” - which “has a
rising and significant probability of occurring”.
Here’s the executive summary for those of you
too lazy to set up a free subscription to read the whole thing:
This is already the worst housing
recession in US history; prices will fall 20-30% from their peak.
That would imply about 10 million homes in negative equity.
Financial system subprime losses are now
estimated at $250 to $300 billion; and now spreading to near-prime
and prime, through the same lax lending criteria: “this is a
generalized mortgage crisis and meltdown, not just a subprime one”.
And don’t forget all the off-balance sheet
Vehicles etc., and the fact that “because of securitization the
securitized toxic waste has been spread from banks to capital
markets and their investors in the US and abroad, thus increasing –
rather than reducing systemic risk – and making the credit crunch
“The recession will lead – as it is
already doing – to a sharp increase in defaults on other forms of
unsecured consumer debt: credit cards, auto loans, student loans.”
All of which makes the credit crunch even more severe - and takes it
from large banks through to smaller banks. [Loan companies are
already scrambling to
tighten up lending criteria in the UK, as the
FT set out over the weekend.]
“While there is serious uncertainty
about the losses that
monolines will undertake on their insurance of
CDO and other toxic
ABS products, it is now clear that such
losses are much higher than the $10-15 billion rescue package that
regulators are trying to patch up.” As a result, their debt rating
will probably get downgraded; which will lead to large losses for
funds that invested in them, and another sharp drop in US equity
markets. [For more background, here's a story about monolines from
last week that made the
front page of the FT.]
Next, “the commercial real estate loan
market will soon enter into a meltdown similar to the subprime one”,
thanks to - guess what? - similarly reckless lending criteria. So,
“the housing crisis will lead – with a short lag – to a bust in
non-residential construction as no one will want to build offices,
stores, shopping malls/centers in ghost towns”. [FT
outflows from UK commercial property up 76 per cent from third
It’s entirely possible that a large
regional or even national bank will go bust. “The Fed will have to
reaffirm the implicit doctrine that some banks are too big to be
allowed to fail. But these bank bankruptcies will lead to severe
fiscal losses of bank bailout and effective nationalization of the
affected institutions.” [Sound
Bank losses on
leveraged loans are
already large, and rising - “leading to a freezing up of the
market and to growing losses for financial institutions”.
“Once a severe recession is underway a
massive wave of corporate defaults will take place.” Roubini adds,
“in a typical year US corporate default rates are about 3.8%
(average for 1971-2007); in 2006 and 2007 this figure was a puny
0.6%. And in a typical US recession such default rates surge above
The “shadow financial system” - non-bank
financial institutions - will shortly get into serious trouble. And
unlike proper banks, “these non-bank financial institutions don’t
have direct or indirect access to the central bank’s lender of last
resort support as they are not depository institutions”.
Stock markets in the US and abroad will
start pricing in a severe recession rather than just a slowdown.
Roubini notes that “in a typical US recession the S&P 500 falls by
Liquidity in financial markets will dry
up all over again; the easing pf the liquidity crunch after central
banks’ massive interventions in December and January will reverse.
“A vicious circle of losses, capital
reduction, credit contraction, forced liquidation and fire sales of
assets at below fundamental prices will ensue leading to a cascading
and mounting cycle of losses and further credit contraction”.
All in all:
A near global economic recession will ensue
as the financial and credit losses and the credit crunch spread around
the world. Panic, fire sales, cascading fall in asset prices will
exacerbate the financial and real economic distress as a number of large
and systemically important financial institutions go bankrupt.
A 1987 style stock market crash could occur
leading to further panic and severe financial and economic distress.
Monetary and fiscal easing will not be able to prevent a systemic
financial meltdown as credit and insolvency problems trump illiquidity
The lack of trust in counterparties – driven
by the opacity and lack of transparency in financial markets, and
uncertainty about the size of the losses and who is holding the toxic
waste securities – will add to the impotence of monetary policy and lead
to massive hoarding of liquidity that will exacerbates the liquidity and
Can the Fed and other financial officials avoid
this nightmare scenario that keeps them awake at night?
The answer to this question – to be detailed in
a follow-up article [here] – is twofold: first, it is not easy to manage and
control such a contagious financial crisis that is more severe and dangerous
than any faced by the US in a quarter of a century; second, the extent and
severity of this financial crisis will depend on whether the policy response
– monetary, fiscal, regulatory, financial and otherwise – is coherent,
timely and credible.
I will argue – in my next article - that one
should be pessimistic about the ability of policy and financial authorities
to manage and contain a crisis of this magnitude; thus, one should be
prepared for the worst, i.e. a systemic financial crisis.
The Current U.S.
Recession and the Risks of a Systemic Financial Crisis
by Nouriel Roubini
February 26, 2008
Economics at the Stern School of Business,
New York University
and Chairman of RGE Monitor
Written Testimony for the House of Representatives’ Financial
Hearing on February 26th, 2008
A vicious circle is currently underway in the United States, and its reach
could broaden to the global economy.
America’s financial crisis has triggered a
severe credit crunch that is making the U.S. recession worse, while the
deepening recession is leading to larger losses in financial markets, thus
undermining the wider economy.
There is now a serious risk of a systemic
meltdown in US financial markets as huge credit and asset bubbles collapse.
At this point the debate in the U.S. is no longer about soft landing versus
hard landing (recession); it is rather on how hard the hard landing will be.
An analysis of the macro data published in recent weeks suggests that the
economy has already entered into a recession in December 2007. So the
question now is whether this recession is going to be relatively short and
shallow (lasting two quarters in Q1 and Q2 of 2008 as several analysts
suggest) or much longer, deeper and more protracted (four to six quarters).
The fact that the US is now in a recession is, at this point, without much
doubt even if the consensus forecast – always behind the curve – now gives
only even odds (49% according to the WSJ panel of forecasters, 50% according
to the Bloomberg panel) to a recession outcome.
The latest data point to a severe recession
ahead lasting at least four quarters rather than mild recession that most
forecasters are now predicting:
a fall in employment in January
very high and elevated levels of initial
and continued unemployment claims
a non-manufacturing ISM that literally
the Philly Fed report and other forward
looking indicators being in recession territory
falling – in real term – retail sales in
the holiday season; mediocre results and falling sales for most
retailers in January
plunging auto sales
very weak and further falling consumer
a credit crunch that is becoming more
severe in credit market as measured by a variety of credit spreads
the beginning of a severe recession in
commercial real estate
a worsening housing recession; sharply
falling home prices
evidence of a serious credit crunch in
the banking system based on the Fed survey of loan officers
a correction in all major stock markets
and the beginning of a bear market in the NASDAQ
serious evidence of a global economic
slowdown, especially in Europe, with outright recession ahead in
some European countries
All these indicators points towards a severe
(Keep reading this article here
The Alex Jones Show
Feb 29, 2008
Prof. Nouriel Roubini