An economic Cassandra whose predictions are coming
true
By
Stephen Mihm
Published: August 16,
2008http://www.iht.com/articles/2008/08/15/business/wbroubini.1.php
NEW YORK:On Sept. 7, 2006, Nouriel Roubini, an economics professor at
New York University, stood before an audience of economists at the
International Monetary Fund and announced that a crisis was brewing. In the
coming months and years, he warned, the United Stateswas likely to face a
once-in-a-lifetime
housing bust, an oil shock, sharply declining consumer confidence and,
ultimately, a deep recession.
He laid out a bleak sequence of events:
homeowners defaulting on mortgages, trillions of dollars of mortgage-backed
securities unraveling worldwide and the global financial system shuddering to a
halt. These developments, he said, could cripple or destroy hedge funds,
investment banks and other major financial institutions like Fannie Mae and
Freddie Mac.
As Roubini stepped down from the lectern
after his talk, the moderator of the event said, "I think perhaps we will
need a stiff drink after that." People laughed - and not without reason.
At the time, unemployment and inflation remained low, and the economy, while
weak, was still growing, despite rising oil prices and a softening
housing market.
But Roubini was soon vindicated. In the year
that followed, subprime lenders began entering bankruptcy, hedge funds began
going under and the stock market plunged. There was declining employment, a
deteriorating dollar, ever-increasing evidence of a huge housing bust and a
growing air of panic in financial markets as the credit crisis deepened. By
late summer, the Federal Reserve was rushing to the rescue, making the first of
many unorthodox interventions in the economy, including cutting the lending
rate by half a percentage point and buying up tens of billions of dollars in
mortgage-backed securities.
Over the past year, whenever optimists have
declared the worst of the U.S.economic crisis over, Roubini has countered
with steadfast pessimism. In February, when the conventional wisdom held that
the venerable investment firms of Wall Street would weather the crisis, Roubini
warned that one or more of them would go "belly up" - and six weeks
later, Bear Stearns collapsed.
After the Fed's further extraordinary
actions in the spring - including making lines of credit available to selected
investment banks and brokerage houses - many economists made note of the
ensuing economic rally and proclaimed the credit crisis over and a recession
averted. Roubini stuck to his script of "nightmare" events: waves of
corporate bankruptcies, collapses in markets like commercial real estate and
municipal bonds and, most alarming, the possible bankruptcy of a large regional
or national bank that would lead to a panic by depositors. Not all of these
developments have come to pass, but last month's demise of the California bank
IndyMac - one of the largest such failures in U.S. history - drew only more
attention to Roubini's seeming prescience.
As a result, Roubini, a respected but
formerly obscure academic, has become a major figure in the public debate about
the economy: the seer who saw it coming. He has been summoned to speak before
Congress, the Council on Foreign Relations and the World Economic Forum at
Davos, Switzerland. He is now a sought-after adviser, spending
much of his time shuttling between meetings with central bank governors and
finance ministers in Europeand Asia.
The mainstream economic establishment
appears to be moving closer, however fitfully, to his way of seeing things.
"I have in the last few months become more pessimistic than the
consensus," Lawrence Summers, a former Treasury secretary, told me this
year. "Certainly, Nouriel's writings have been a contributor
to that."
On a cold and dreary day last winter, I met
Roubini over lunch in New York City. "I'm not a pessimist by nature,"
he insisted. I found the assertion hard to credit. With a dour manner and an
aura of gloom about him, Roubini gives the impression of being permanently
pained, as if the burden of what he knows is almost too much for him
to bear.
Roubini, who is 50, has been an outsider his
entire life. He was born in Istanbul, the child of Iranian Jews, and his family
moved to Tehran when he was 2, then to Tel Aviv and finally to Italy. He moved
to the United Statesto pursue his doctorate in international economics at
Harvard.
After completing his doctoral degree in
1988, Roubini joined the economics department at Yale, where he first met and
began sharing ideas with Robert Shiller, the economist now known for his
prescient warnings about the 1990s technology bubble.
The 1990s were an eventful time for an
international economist like Roubini. Throughout the decade, one emerging
economy after another was struck by crisis, beginning with Mexico's in 1994.
Panics swept Asia, including Thailand, Indonesiaand South Korea, in 1997 and
1998. The economies of Braziland Russiaimploded in 1998. Argentina's followed
in 2000. Roubini began studying
these countries and soon identified what he saw as their
common weaknesses.
On the eve of the crises that befell them,
he noticed, most had huge current-account deficits (meaning, basically, that
they spent far more than they made), and they typically financed these deficits
by borrowing from abroad in ways that exposed them to the national equivalent
of bank runs. Most of these countries also had poorly regulated banking systems
plagued by excessive borrowing and reckless lending. Corporate governance was
often weak, with cronyism in abundance.
Roubini's work was distinguished not only by
his conclusions but also by his approach. By making extensive use of
transnational comparisons and historical analogies, he was employing a
subjective, nontechnical framework, the sort embraced by popular economists
like Paul Krugman, columnist for The New York Times, and the Nobel laureate
Joseph Stiglitz to reach a nonacademic audience.
Roubini takes pains to note that he remains
a rigorous scholarly economist, but his approach is not the contemporary
scholarly ideal in which an economist builds a model in order to constrain his
subjective impressions and abide by a discrete set of data. The book that
Roubini ultimately wrote (with the economist Brad Setser) on the
emerging-market crises, "Bailouts or Bail-Ins?," contains not a
single equation in its 400-plus pages.
After analyzing the markets that collapsed
in the 1990s, Roubini set out to determine which country's economy would be the
next to succumb to the same pressures. His surprising answer: the United
States. Roubini was unnerved by what he saw in the U.S.economy, in particular
its 2004 current-account
deficit of $600 billion.
He began writing extensively about the
dangers of that deficit and then branched out, researching the various effects
of the credit boom - including the biggest housing bubble in the nation's
history - that began after the Federal Reserve cut rates to close to zero in
2003. Roubini became convinced that the housing bubble was going to pop.
By late 2004 he had started to write about a
"nightmare hard landing scenario for the United States." He predicted that
foreign investors
would stop financing the fiscal and current-account deficit and abandon the
dollar, wreaking havoc on the economy.
What economic developments does Roubini see
on the horizon? When Jim Nussle, the White House budget director, announced
last month that the United Stateshad "avoided a recession,"
Roubini was incredulous. For months, he has been predicting that the United
Stateswill suffer through an 18-month recession
that will eventually rank as the "worst since the Great Depression."
Though he is confident that the economy will enter a technical recovery toward
the end of next year, he said job losses, corporate bankruptcies and other
drags on growth would continue to take a toll for years.
Roubini has counseled various policy makers,
including Federal Reserve governors and senior Treasury Department officials,
to mount an aggressive response to the crisis. He applauded when the Fed cut
interest rates to 2 percent from 5.25 percent beginning last summer. He also
supported the Fed's willingness to engineer a takeover of Bear Stearns.
Roubini argues that the Fed's actions
averted catastrophe, though he says he believes that future bailouts should
focus on mortgage owners, not investors. Accordingly, he sees the choice facing
the United States as stark but simple: either the government backs up a
trillion-plus dollars' worth of high-risk mortgages (in exchange for the
lenders' agreement to reduce monthly mortgage payments), or the banks and other
institutions holding those mortgages - or the complex securities derived from
them - go under.
"You either nationalize the banks or
you nationalize the mortgages," he said. "Otherwise, they're
all toast."
For months, Roubini has been arguing that
the true cost of the housing crisis will not be a mere $300 billion - the amount
allowed for by the housing legislation sponsored by Representative Barney
Frank, Democrat of Massachusetts, and Senator Christopher Dodd, Democrat of
Connecticut - but something between a trillion and a trillion and a half
dollars. But most important, in Roubini's opinion, is to realize that the
problem is deeper than the housing crisis.
"Reckless people have deluded
themselves that this was a subprime crisis," he told me. "But we have
problems with credit-card debt, student-loan debt, auto loans, commercial real
estate loans, home-equity loans, corporate debt and loans that financed
leveraged buyouts." All of these forms of debt, he argues, suffer from
some or all of the same traits that first surfaced in the housing market:
shoddy underwriting, securitization, negligence on the part of the
credit-rating agencies and lax government oversight. "We have a subprime
financial system," he said, "not a subprime
mortgage market."
Roubini argues that most of the losses from
this bad debt have yet to be written off, and the toll from bad commercial real
estate loans alone may help send hundreds of local banks into the arms of the
Federal Deposit Insurance Corp. "A good third of the regional banks won't
make it," he predicted.
In turn, these bailouts will add hundreds of
billions of dollars to an already gargantuan federal debt, and someone,
somewhere, is going to have to finance that debt, along with all the other debt
accumulated by consumers and corporations. "Our biggest financiers are China,
Russiaand the Gulf states," Roubini noted. "These are
rivals, not allies." The United States, Roubini went on, will most likely
muddle through the crisis but will emerge from it a different nation, with a
different place in the world.
"Once you run current-account deficits,
you depend on the kindness of strangers," he said, pausing to let out a
resigned sigh. "This might be the beginning of the end of the
American empire."
Stephen Mihm is an assistant professor of
economic history at the Universityof Georgia.
[Non-text portions of this message have been removed]
