Every Decade Sure To Have Their Very Own "Dr. Doom"

We usually will laud the bullish experts who got things right. Many will despise the naysayers, the bearish buggers who seem to be always pessimistic. However, some of them have been prescient in their big calls, and deserve to be applauded. You will find them being tagged as the Dr. Dooms, and every decade seems to have a major one. As a Dr. Doom, they will shout loudest when they feel strongly about something going wrong, but usually you will not hear from them when markets turn bullish - not that they do not like bull runs, but its their attention to detail and them usually having a very high disposition to fear that will cause them not to issue buy signals even they see them. Hence when its bullish, and they are quiet, its good. When its bullish and they keep getting louder, its bad.

Not all of them are as good as the title may hint at. I have rated them out of 10, 10 being excellent.

Dr. Henry Kaufman - Dr. Doom of the 1970s & early 80s (my rating 8.5/10)

He was well-known during the 1970s and early 1980s for the interest rate forecasts he wrote for Salomon, and for their bearish views, generally predicting that bond prices would decrease (interest rate would increase). Thus, he earned the nickname "Dr. Doom." Dr. Henry Kaufman is the president of Henry Kaufman & Company, Inc., a firm specializing in economic and financial consulting. He was previously a managing director at Salomon Brothers and was a member of the executive committee in charge of the firm's four research departments.

Dr. Kaufman was also a vice chairman of the parent company, Salomon Inc. Before joining Salomon Brothers, he was in commercial banking and served as an economist at the Federal Reserve Bank of New York. Unwittingly, this Dr. Doom also triggered a major market rally after years of doom and gloom predictions, Kaufman’s prediction on August 17, 1982 that interest rates would fall sparked a stock market rally that can be dated as the beginning of the 1980’s bull market.

Dr. Kaufman's book, On Money and Markets, A WallStreetMemoir, was published in June 2000. In 1987, Dr. Kaufman was awarded the first George S. Eccles Prize for excellence in economic writing from the Columbia Business School for his book, Interest Rates, the Markets, and the New Financial World.

Dr. Kaufman received his bachelor's degree in economics from NYU in 1948, an M.S. in finance from Columbia University in 1949 and a Ph.D in banking and finance from New York University Graduate School of Business Administration in 1958. He also received an honorary Doctor of Laws degree from New York University in 1982, and an honorary Doctor of Humane Letters degree from Yeshiva University in 1986 and from Trinity College in 2005.

Kaufman is known among the insiders in the financial community as a genius at contrarian investing. During the 1970s downturn in New York City he was the buyer of last resort for Con Edison bonds, which resulted in huge gains. Kaufman was buying Con Edison Bonds at 30 percent of face value when the city was told no help was coming from the federal government to keep the lights on in New York. Of course the bonds never defaulted, and the returns were in mega millions to Kaufman.

Kaufman was the largest shareholder of Apple Bank of New York along with many other holdings. He was the financial controller of all of the $320 million Maurice Kanbar received for selling Skyy Vodka and created $190 million in additional profits from this account. One of the investments was buying 32 percent of downtown Tulsa, Oklahoma, at distress prices starting in 2005. Tulsa is one of the few cities that has weathered the U.S. real estate crisis and actually has increased in value. He also was the funding source of capital for Heine Herzog (Mutual Shares which merged with Franklin Templeton), the largest over-the-counter market maker in the U. S. Kaufman also bought buildings in Soho at $30 square foot in the distress times of the 70s and became a legend in value investing when the market climbed to $200 a square foot. His latest venture was going big into Costa Rica real estate last year, let's see if its going to be another winner for him.

Latest Mantras: Kaufman thinks the banks should be broken up ... "A much better approach would be to prohibit any financial institution from remaining or becoming too big to fail. This would require that regulators downsize large financial conglomerates. In this process, the prime targets for divestiture should be financial activities that pose risk to the stability of the deposit function as well as operations that pose conflicts of interest.

Our financial system is at a crossroads. We can either succumb to the forces that are shifting markets toward greater government back-stopping and socialization. Or we can create a structure in which no institution is too big to fail, and a financial system that is supervised effectively by a modernized central bank."

"Why are we so poor at managing our key economic institutions while at the same time so accomplished in medicine, engineering and telecommunications? Why can we land men on the moon with pinpoint accuracy, yet fail to steer our economy away from the rocks? Why do our computers work so well, except when we use them to manage derivatives and hedge funds?"

Kaufman warns: "The computations were correct, but far too often the conclusions drawn from them were not." Why? Selfish, myopic politicians and bankers.

Dr. Marc Faber - Dr. Doom of the 1990s and present time (my rating 6.5/10)

Dr Marc Faber was born in Zurich, Switzerland. He went to school in Geneva and Zurich and finished high school with the Matura. He studied Economics at the University of Zurich and, at the age of 24, obtained a PhD in Economics magna cum laude.

Between 1970 and 1978, Dr Faber worked for White Weld & Company Limited in New York, Zurich and Hong Kong.

Since 1973, he has lived in Hong Kong. From 1978 to February 1990, he was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, MARC FABER LIMITED which acts as an investment advisor and fund manager.

Dr Faber publishes a widely read monthly investment newsletter "The Gloom Boom & Doom Report" report which highlights unusual investment opportunities, and is the author of several books including “ TOMORROW'S GOLD – Asia's Age of Discovery” which was first published in 2002 and highlights future investment opportunities around the world. “ TOMORROW'S GOLD ” was for several weeks on Amazon's best seller list and is being translated into Japanese, Chinese, Korean, Thai and German.

Latest Mantras: Marc continues his bashing of the governments of all developed and overleveraged nations, which he claims will sooner or later default on their obligations. This could be the most scathing critique of the fiat-money system to date, which is the primary cause for the facility with which governments have accumulated untenable debt loads.

"In the developed world we have huge debt to GDP, in terms of government debt to GDP and unfunded liabilities that will come due, and these unfunded liabilities are so huge that eventually these governments will all have to print money before they default."

Faber also said he is turning from a bull to a bear on stock markets in 2010 because there was too much bullish sentiment and whenever there’s a mid-term election then it becomes negative for stocks, “Everybody was looking for further gains in stocks.”

Marc Faber says "the average life span of the world's greatest civilizations has been 200 years ... Once a society becomes successful it becomes arrogant, righteous, overconfident, corrupt, and decadent ... overspends ... costly wars ... wealth inequity and social tensions increase; and society enters a secular decline."


Robert Shiller - Dr. Doom of 2000s (my rating 9.5/10)

Shiller received his B.A. from the University of Michigan in 1967, S.M. from MIT in 1968, and his Ph.D from MIT in 1972. He has taught at Yale since 1982 and previously held faculty positions at the Wharton School of the University of Pennsylvania and the University of Minnesota, also giving frequent lectures at the LSE. His book Macro Markets won first annual Paul A. Samuelson Award.

In 1981 Shiller published an article titled "Do stock prices move too much to be justified by subsequent changes in dividends?" He challenged the efficient markets model, which at that time was the dominant view in the economics profession. Shiller argued that in a rational stock market, investors would base stock prices on the expected receipt of future dividends, discounted to a present value. He examined the performance of the U.S. stock market since the 1920s, and considered the kinds of expectations of future dividends and discount rates that could justify the wide range of variation experienced in the stock market. Shiller concluded that the volatility of the stock market was greater than could plausibly be explained by any rational view of the future.


In 1991, he formed Case Shiller Weiss with economists Karl Case and Allan Weiss. The company produced a repeat-sales index using home sales prices data from across the nation, studying home pricing trends. The index was developed by Shiller and Case when Case was studying unsustainable house pricing booms in Boston and Shiller was studying the behavioral aspects of economic bubbles. The repeat-sales index developed by Case and Shiller was later acquired and further developed by Fiserv and Standard & Poor, creating the now famous Case-Shiller index. His book Irrational Exuberence (2000) – a NYT bestseller, and now you know where that phrase came from (no its not Greenspan) – warned that the stock market had become a bubble in March 2000 (the very height of the market top) which could lead to a sharp decline.

Writing in the Wall Street Journal in August 2006, Shiller again warned that "there is significant risk of a very bad period, with slow sales, slim commissions, falling prices, rising default and foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected.” Robert Shiller was awarded the Deutsche Bank Prize in Financial Economics in 2009 for his pioneering research in the field of financial economics, relating to the dynamics of asset prices, such as fixed income, equities, and real estate, and their metrics. His work has been influential in the development of the theory as well as its implications for practice and policy-making. His contributions on risk sharing, financial market volatility, bubbles and crises, have received widespread attention among academics, practitioners and policy makers alike.

Latest Mantras: Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997. Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Remember a decade ago with "Irrational Exuberance?" Now he's warning: "Bubbles are primarily social phenomena. Until we understand and address the psychology that fuels them, they're going to keep forming. We recently lived through two epidemics of excessive financial optimism, we are close to a third episode, only this one will spread irrational pessimism and distrust -- not exuberance."


Nouriel Roubini - The Latest Dr. Doom, although he is not comfortable with the tag (my rating: 7.5/10)

Nourel Roubini is an economist and professor at New York University. He was one of the only people to accurately predict the current global economic crisis. Roubini started predicting a possible financial meltdown in 2004, and received the nickname "Dr. Doom" after a 2006 IMF meeting. Roubini, once an obscure economist, has become an in-demand analyst due to his uncannily accurate and pessimistic predictions.NY Times: Dr. Doom (August 15, 2008)



Roubini hasn't always been right in his predictions: In an August 2008 interview with Barron's, he said as many as 1,400 U.S. banks could fail. That number has been closer to 200, and it doesn't appear that the Federal Deposit Insurance Corp. and state authorities will have to shutter anywhere near the number he predicted.

He warned that the Federal Reserve and other government central banks are fueling a massive new asset "bubble" that -- while not in imminent danger of bursting -- will someday do so with calamitous consequences.

Here is Roubini's argument: The Fed is holding short-term interest rates near zero. Investors and speculators borrow dollars cheaply and use them to buy various assets -- stocks, bonds, gold, oil, minerals, foreign currencies. Prices rise. Huge profits can be made. But this can't last, Roubini warns. The Fed will eventually raise interest rates. Or outside events (a confrontation with Iran, fear of a double-dip recession) will change market psychology. Then investors will rush to lock in profits, and the sell-off will trigger a crash. Stock, bond and commodity prices will plunge. Losses will mount, confidence will fall and the real economy will suffer.

"The Fed and other policymakers seem unaware of the monster bubble they are creating," writes Roubini. "The longer they remain blind, the harder the markets will fall."

Like home values a few years ago, asset prices have risen spectacularly. Since its March 9 low, the Standard & Poor's 500-stock index has gained more than 50 percent. An index of stocks for 22 "emerging-market" countries (including Brazil, China and India) has doubled from its recent low. Oil, now around $80 a barrel, has increased 150 percent from its recent low of $31. Gold is near an all-time high, around $1,090 an ounce. Meanwhile, the dollar has dropped against many currencies. Half of Roubini's story resonates.

...... So, Roubini's new bubble remains unproved. But this doesn't invalidate his warning. We've learned that there's a thin line between promoting economic expansion and fostering bubbles. With hindsight, lax Fed policies contributed to both the "tech" bubble of the late 1990s and the recent housing bubble, though how much is debated.

“ I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon.”

Latest Mantras: The shorting of USD is the “mother of all highly leveraged asset bubbles” now in progress. Shorts in the US dollar are being built up to unprecedented levels, and are being used to finance the purchase of every asset class, especially in energy, commodities, and precious metals. This bubble will be pricked by a huge snap back rally in the greenback, the exhaustion of Fed support measures, a growth surprise in the US leading to an early Fed tightening, or a real double dip recession. The inevitable collapse will make the last financial crisis look like a cake walk, and take all markets, especially equities, down to new lows.

Roubini's New Stance (I Mean Asserting His Old Stance)

This may have been a week old but now I am getting around to it. I didn't post/comment on it because Roubini said the same things. This time, he is sticking to his usual views but using it to reflect on the current stock market rally, saying that stocks have run ahead of fundamentals. My comments in colour.

Bloomberg: New York University Professor Nouriel Roubini, who accurately predicted the financial crisis, said stock and commodity markets may drop in coming months as the gradual pace of the economic recovery disappoints investors.

“Markets have gone up too much, too soon, too fast,” Roubini said in an interview in Istanbul yesterday. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U- shaped. That might be in the fourth quarter or the first quarter of next year.”

Stocks have surged around the world in the past six months as evidence mounts that the economy is emerging from its deepest recession since the 1930s. The S&P 500 has soared 51 percent from a 12-year low in March while Europe’s Dow Jones Stoxx 600 is up 48 percent. The euphoria contrasts with the cautious tone of Group of Seven policy makers, who said after their meeting in Istanbul yesterday that prospects for growth “remain fragile.”

“The real economy is barely recovering while markets are going this way,” Roubini said. If growth doesn’t rebound rapidly, “eventually markets are going to flatten out and correct to valuations that are justified. I see a growing gap between what markets are doing and the weaker real economic activities.”

‘Anemic’ Recovery

IMF predicts the global economy will expand 3.1 percent in 2010, led by growth in Asia, after a 1.1 percent contraction this year. That is still “anemic” and “very weak,” Roubini said.

U.S. stocks fell last week after manufacturing expanded less than anticipated and unemployment climbed to a 26-year high, fueling concern the economy is rebounding more slowly than forecast.

Gains in the S&P 500 have pushed valuations in the index to more than 19 times reported operating profits from the past year, data compiled by Bloomberg show. That’s near the most expensive level since 2004.

The performance of the U.S. economy is probably more sluggish than reflected in stock markets, risking a correction in equities, Nobel Prize-winning economist Michael Spence said last month. U.S. stock-market investors have “over processed” the stabilization of growth in the world’s largest economy, Spence said.

Creating Bubbles

The global equity rally has added about $20.1 trillion to the value of stocks worldwide since this year’s low on March 9. Governments have poured about $2 trillion of stimulus into the global economy while central banks have cut interest rates to close to zero in efforts to revive growth.

“In the short run we need monetary and fiscal stimulus to avoid another tipping point and to avoid deflation, but now this easy money has already started to create asset bubbles in equities, commodities, credit and emerging markets,” Roubini said. “For the sake of achieving growth stability again and avoiding deflation, we may be planting the seeds of the next cycle of financial instability.”

Comments: Yes, there is a gap between the stock market valuations and the real economy. Is the gap justified, its debatable, I think it is. To have a second dip in 4Q 2009 or 1Q 2010 would require probably another big bank to need a bailout or risk failing - Citigroup??... probably not likely. To have a second dip, we might have to see some major central banks tightening too soon... again that is not likely. Central banks are more concerned about jobs and corporate spending, and as long as these two factors do not show significant improvements, we are not going to see any rate hikes. So far only the robust Australian economy have started to hike rates. Norway might follow suit but not the rest.

In fact the longer it takes jobs and corporate spending to recover, the better it is for stock markets - its silly but true. That means low interest rates will prevail, thus forcing funds flow into equities. Yes, it is more likely that we will see an expensive equity markets situation globally over the next two quarters rather than a second major dip like Roubini predicted. Yes, I agree this will be the second bubble in the making if left unchecked, but I see things coming to a head only mid-2010, and even then we have to see how the employment improvement scene is like.

The other point for my views is the willingness of corporations to tap funds to do M&A. This is brought on with a corresponding downturn in risk aversion. Too many companies have been sitting around (on piles of cash) not doing anything for the past 10 months. We have seen a trickling of major M&A activity over the past two weeks and that should pick up steam. Each time a major M&A deal happens, it energises that sector and subsequently the overall market as well.

p/s photo: Angelababy Yang Wing

Latest US Economic Outlook By Roubini

July 16, 2009

STATEMENT ON U.S. ECONOMIC OUTLOOK BY DR. NOURIEL ROUBINI


The following is a statement from Dr. Nouriel Roubini, Chairman of RGE Monitor and Professor, New York University, Stern School of Business:


“It has been widely reported today that I have stated that the recession will be over “this year” and that I have “improved” my economic outlook. Despite those reports - however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

“I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19 months into that recession. If as I predicted the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year's end.

“Indeed, last year I argued that this will be a long and deep and protracted U-shaped recession that would last 24 months. Meanwhile, the consensus argued that this would be a short and shallow V-shaped 8 months long recession (like those in 1990-91 and 2001). That debate is over today as we are in the 19^th month of a severe recession; so the V is out of the window and we are in a deep U-shaped recession. If that recession were to be over by year end – as I have consistently predicted – it would have lasted 24 months and thus been three times longer than the previous two and five times deeper – in terms of cumulative GDP contraction – than the previous two. So, there is nothing new in my remarks today about the recession being over at the end of this year.

“I have also consistently argued – including in my remarks today - that while the consensus predicts that the US economy will go back close to potential growth by next year, I see instead a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%.

“I have also consistently argued that there is a risk of a double-dip W-shaped recession toward the end of 2010, as a tough policy dilemma will emerge next year: on one side, early exit from monetary and fiscal easing would tip the economy into a new recession as the recovery is anemic and deflationary pressures are dominant. On the other side, maintaining large budget deficits and continued monetization of such deficits would eventually increase long term interest rates (because of concerns about medium term fiscal sustainability and because of an increase in expected inflation) and thus would lead to a crowding out of private demand.

“While the recession will be over by the end of the year the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector; and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and public debt accumulation.

“Also, as I fleshed out in detail in recent remarks the labor markets is still very weak: I predict a peak unemployment rate of close to 11% in 2010. Such large unemployment rate will have negative effects on labor income and consumption growth; will postpone the bottoming out of the housing sector; will lead to larger defaults and losses on bank loans (residential and commercial mortgages, credit cards, auto loans, leveraged loans); will increase the size of the budget deficit (even before any additional stimulus is implemented); and will increase protectionist pressures.

“So, yes there is light at the end of the tunnel for the US and the global economy; but as I have consistently argued the recession will continue through the end of the year, and the recovery will be weak and at risk of a double dip, as the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing will be daunting.


p/s photos: Kristy Yeung Kung Yu

Roubini's 10 Risks To Global Economy Growth Prospects (Part 2)

Nouriel Roubini:

Fifth, the socialization of private losses and debt implies a sharp rise in public debt burdens. In the U.S. alone, the CBO estimates that the public debt-to-GDP ratio will rise from 40% to 80%, or about $9 trillion. If long-term rates then increase to 5%, the resulting increase in the interest rate bill alone would be about $450 billion, or 3% of GDP.

The fiscal primary surplus will have to be permanently increased by 3% of GDP (via an increase in taxes or cuts in government spending) to prevent an unsustainable Ponzi increase in the stock of public debt as a share of GDP. The burden of trillions of dollars of additional public debt in the advanced economies will be a medium-term drag on growth. High debt levels may be financed only with default (an option that advanced economies have not followed in recent decades), a capital levy on wealth, and use of the inflation tax to wipe out the real value of public debt--or a painful increase in regular taxes, or reduction in government spending.

Rising government debt ratios will eventually lead to increases of real interest rates that may crowd out private spending and may even lead to a sovereign refinancing/default risk. Indeed, sovereign risk that was until recently limited to emerging-market economies is now on the rise in advanced economies, especially those in the Eurozone.

If one rules out defaults and the inflation tax as options--since their costs in advanced economies would be serious--a painful process of increases in taxes and reduction in government spending may reduce the rate of economic growth over the medium term (2010 and beyond). Such fiscal adjustment may be necessary to ensure medium-term debt sustainability, but its immediate effect would lead to a reduction in private and public aggregate demand. So it will be a drag on economic growth over the medium term.

Sixth, the massive monetization of fiscal deficits that has been pursued by central banks this year is not yet inflationary, as there are massive deflationary forces at work in the world. But if central banks don't find a clear exit strategy from very easy monetary policies that have led to the doubling or tripling of the monetary base in the U.S. alone, eventually inflation and/or another dangerous asset and credit bubble will ensue when the global economy gets out of this severe recession. And some of the recent rise in equity, commodity and other risky asset prices is already clearly liquidity driven, rather than being fully justified by the improving economic fundamentals.

Inflation may indeed become the path of least resistance for policymakers, as it is easier to run the printing presses and cause inflation than it is to implement politically difficult tax increases or spending cuts. But inflation is not a cheap solution to high public debt and the debt-deflation problems of the private sector. If central banks were to allow the inflation genie out of the bottle, at some point a painful Volcker-style recessionary disinflation policy would have to be implemented to break the back of inflation expectations.

Seventh, employment is still sharply falling in the U.S. and other economies. According to the OECD, the unemployment rate in advanced economies will be close to 10% by 2010. And low medium-term growth will only lead to a slowly falling unemployment rate once the recession is over. Years of high and rising unemployment rates have corrosive effects on growth. Chronically unemployed workers lose skills and human capital, and they become less employable.

High unemployment rates are associated with lower incomes, lower consumption spending and thus lower growth. The ability of households to service their high debts is corroded by high unemployment rates and sluggish income growth. Default rates and recovery rates on a variety of bank assets--mortgages, credit cards, student and auto loans--are highly correlated to the unemployment rate. And the pressures that globalization, technology and trade are putting on real wages will remain a challenge.

Eighth, for the last decade the U.S. and a few other deficit countries have been the consumers of first and last resort, spending more than their income and running large current-account deficits. Meanwhile, China, Germany, Japan, most of Asia and most emerging markets (with the exception of emerging Europe) have been the producers of first and last resort, spending less than their income, running large current-account surpluses, and thus relying on the demand of deficit countries for their growth. But this system of imbalances is now challenged, as the consumers in the deficit countries need to consume and import less. And for deficit countries to be able to go back to their potential growth while domestic demand is falling relative to GDP, they will need net exports to improve over time.

The resulting reduction of global current-account imbalances implies that the current-account deficits of the overspending countries will lead to a reduction of the current-account surpluses in the over-saving countries. But if net exports shrink in surplus countries, they can go back to their potential growth rate only if domestic demand rises faster than GDP. But if it does not, the resulting lack of global aggregate demand relative to supply will lead to a weaker recovery of global growth.

Ninth, while the rising role of government is necessary to prevent severe recession from spiraling into near-depression, mistaken public policies may lead to sub-par growth for years to come. Think of trade protectionism and its potential costs; think of financial protectionism and its likely restrictions to foreign direct investment. Think of rising public debts and deficits leading to higher real rates and the need to raise distortionary taxes to avoid debt-sustainability problems. Think of the effect that greater necessary regulation and supervision of financial institutions will have on credit growth, which will remain limited for a long time. Think of the greater degree of government intervention in economic affairs and the risk that this intervention will distort private-sector development and growth.

Tenth, there is a real risk that we may also observe a significant fall in potential growth in advanced economies. This could be the result of several factors: first, of demographic trends, such as aging. Second, of a reduction in the rate of human capital accumulation as long-term unemployed workers lose skills, younger unemployed workers do not acquire on-the-job training and there is lower investment in education and training. Third, several years of sub-par capital expenditure and capital accumulation will reduce trend productivity growth. Fourth, the crowding-out effect on the private sector of public-sector deficit and rising real interest rates on public debt will imply less growth. Fifth, a lot of the growth of the last decade in deficit countries was artificial and driven by excessive borrowing, leveraging and overspending.

In conclusion, several medium-term yellow weeds may constrain the ability of the global economy to return to sustained high growth. Unless structural weaknesses are resolved, the global economy may grow in 2010-11 at a rate well below its potential--and even experience a reduction of its potential growth.

p/s photo: Francine Roosenda

Roubini's 10 Risks To Global Economy Growth Prospects (Part 1)

Nouriel Roubini: This week, I will discuss why the recovery will be sub-par and below trends for a few years once it does occur, and why there is even the risk of a double-dip W-shaped recession.

The crucial issue facing us is not whether the global economy will bottom out in the third or fourth quarter of this year, or in the first quarter of next year. It's whether the global growth recovery, once the bottom is reached, will be robust or weak over the medium term--say 2010-11. As I argued last week, one cannot rule out a sharp snapback of GDP for a couple of quarters, as the inventory cycle and the massive policy boost lead to a short-term growth revival. My analysis, however, suggests that there are many yellow weeds that may lead to a weak global growth recovery over 2010-11.

The current consensus among "green shoot" optimists sees U.S. economic growth going back in 2010 to a rate that is close to the 2.75% potential growth rate, and returning to potential by 2011. Many optimists go even further, arguing that the snapback of demand and production after the depressed levels of the current recession will lead growth to be well above trend (3.5% to 4%) for a couple of years, as most previous U.S. recessions have been followed by a period of above-trend growth once the recovery gets going. Yet a detailed analysis suggests that growth will remain well below potential for at least two years--if not longer--as the severe vulnerabilities and excesses of the last decade will take years to resolve. Let us examine 10 factors that will cause below-potential economic growth over the medium term even after this recession is over.

First, an incorrect interpretation of the causes of this crisis has led to a policy response that doesn't resolve the fundamental causes. The right way to think of this crisis is of its being caused by: excessive over-borrowing and overspending by households; excessive and risky borrowing and lending by financial institutions; and excessive leverage of the corporate sector in a global economy where housing, asset and credit bubbles got out of hand and eventually went bust. So this is a crisis of debt, credit and solvency, not just illiquidity. The alternative interpretation is that this is a crisis of confidence--an animal-spirit-driven, self-fulfilling recession--that has led to a collapse of liquidity (as counterparties don't trust one another) and of aggregate demand (as concerned households and firms cut consumption and investment in ways that can turn a regular business-cycle recession into a near-depression).

Note that even those who believe that this is a crisis of over-leverage and overspending agree that aggressive monetary and fiscal easing is necessary to prevent a severe recession triggered by such excesses from turning into a near-depression. But while such easing is necessary to prevent the global economy from falling off a cliff into the depression abyss, the ability of these over-leveraged economies to resume lending, borrowing, spending, investment and growth depends on the resolution of the excesses that caused the crisis in the first place.

Yet true de-leveraging by households, corporate firms and financial institutions has not even started, as private losses and debts are being socialized and put on the balance sheet of governments. The lack of true de-leveraging--or appropriate debt restructuring--will lead to a corrosive debt deflation and limit the ability of households to spend, of firms to invest, and of banks and other financial institutions to lend. In other words, if this is a crisis of credit and solvency rather than just illiquidity and confidence, much more is needed than easy money and massive fiscal stimulus to resume high economic growth. Worse, the socialization of private losses creates--down the line--another dangerous debt and solvency problem, this time for the sovereign, with risks of a more severe financial crisis once a refinancing crisis occurs and/or the ability of the sovereign to borrow more is curtailed.

The right way to resolve a problem of excessive debt relative to equity capital is to reduce such debt and convert it into equity. Corporate debt and the financial sector's unsecured liabilities should be converted into equity. Even household debt can be converted into equity by reducing the principal value of mortgages and providing an equity upside to the mortgage creditor in the form of a warrant.

Second, in current-account deficit countries (i.e., where the country spent more than its income), consumers need to cut spending and save more: shopped-out, savings-less and debt-burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt-servicing ratios and falling incomes and employment. These deficit countries include not only the U.S., but also the U.K., Ireland, Iceland, Spain, many emerging European economies, Australia and New Zealand.

In these economies, the retrenchment of consumption and buildup in savings to reduce debt, restore net worth and resume robust spending will take several years. In the U.S., consumption averaged 65% of GDP (and household savings averaged 11% of disposable income) for a long time before the latest decade-long housing bubble and consumption binge.

At the peak of the bubble, consumption had risen from 65% to 72% of GDP, and the savings rate plunged to zero and even negative for a few quarters. Currently, consumption has fallen from 72% to 70% of GDP and saving has increased from near zero to about 5% of disposable income. Even if one were--heroically--to assume that consumption will not revert to the long-term average, a fall from 70% to, say, 67% is likely and necessary, while the savings rate goes toward double digits.

But how can households reduce debt ratios that have increased from 65% of disposable income in the early 1990s to 100% in 2000 and 135% today? And the debt ratio risks rising even further as price deflation leads to debt deflation (a rise in the real value of nominal debts). One solution might be to save a lot to reduce debt and rebuild net worth, but the "paradox of thrift" scuttles this. If households sharply cut spending and save more, the recession becomes a near-depression and the ensuing fall in income further increases the debt-to-income ratio. The only remaining solution is debt default and debt reduction.

Third, the financial system (specifically, traditional commercial banks) is severely damaged, and the credit crunch will thus not ease very fast. Most of the shadow banking system is either gone or in severe difficulty. The equivalent of a bank run has hit most of the highly leveraged institutions of this system: 300 non-bank mortgage lenders are bust; the system of conduits and structured investment vehicles is gone; two major broker-dealers are gone, one merged with another bank and the last two converted into bank holding companies; money-market funds cannot even cover their costs, as interest rates are zero and now under the umbrella of a government guarantee; half of all hedge funds may close shop in the next couple of years; even private equity will experience a serious refinancing crisis once "covenant lite" clauses and payment-in-kind toggles run their course; finance companies and insurance companies are also in trouble and need government support and recapitalization. Securitization is a shadow of its recent peaks and the attempt to revive it--TALF--has been a mixed bag.

After $12 trillion of liquidity support, guarantees, insurance and recapitalization, most of the U.S. financial system is under effective government control. And the financial sector damage is not limited to the U.S.: Most major U.K. banks--with the exceptions of HSBC and Barclays -are under effective government control. The IMF estimates massive losses on loans and securities of other European banks, given their exposure to both domestic borrowers and emerging Europe, a region on the verge of a broader financial crisis. According to the IMF, even Japanese and other Asian banks are not immune to significant losses on loans and securities.

Over time, financial institutions in the U.S. and around the world will clean up their balance sheet. But systemic banking crises are not resolved in a few months: They usually last several years and are associated with a persistent credit crunch. Given that a lot of economic activity is financed with debt/credit, this crunch will inflict persistent damage and restrict the ability of households and corporate firms to borrow, consume, spend and invest.

Fourth, a large part of the corporate sector is also under severe financial stress, and its ability to increase production, employment and capital spending will be restricted by poor profitability driven by slow revenue growth, deflationary pressures and rising corporate defaults. While most U.S. corporations are less leveraged than they were in 2000-01, the corporate sector has a large fat tail--similar to that of the household sector--that is severely indebted.

Firms that in the past would have been able to roll over their loans, bonds and debts coming to maturity now face a liquidity crisis that may lead them into costly debt restructuring. Some firms that would have gone into Chapter 11 debt restructuring will end up in socially costly liquidation (Chapter 7) because of the lack of financing. This process of corporate debt restructuring or outright liquidation may take years.

But the main constraint to a recovery in the corporate sector will be a weak recovery of corporate profitability. If the global economy grows at sub-par rates in 2010-11, corporate revenues will grow slower than otherwise; and if deflationary pressures remain across the world--given the glut of supply relative to aggregate demand--pricing power of firms will be limited and profit margins will be further squeezed. The ability to control costs and restore earnings by slashing employment will reach a limit, and excessive employment contraction has negative macro effects: Fewer jobs means less income, less consumption, less corporate revenue and lower profits and earnings.

p/s photos: Hanako Takigawa

Randy Roubini, Not That There's Anything Wrong With That!

Its a tough life being Nouriel Roubini. He has been written disparagingly a number of times for his now famous parties at his NY loft. Party-having economist Nouriel Roubini is no longer inviting reporters to parties in his vagina-studded we hear! *(A single tear)*

So, what makes his parties so great?

"Fun people and beautiful girls," Roubini said, grinning. "I look for ten girls to one guy." His friend Bill Clinton, he added, is a fan of this ratio.

Nouriel Roubini has quite the reputation. A Turkish-born Iranian-Jew that was educated in Italy and the US, Roubini’s name recognition shot through the roof after his stubbornly bearish outlook on the US economy turned out to be true. Since 2008, the head of RBE Monitor has made countless appearances on most of the network business news channels, pushing his gloomy views of the US, and the world economy in general. His private party boy life came into mainstream media when a leaked email which Roubini invited his friends to one of his parties, boasting Scarlett Johansson had moved in upstairs to him having paid more than he had for his. Details of the artwork in his loft were rumoured to resemble some aspect of the female genitalia. Hilarity ensued when the Gawker started referring to Roubini as the “playboy professor” who inhabited a “vulva” and “vagina-encrusted Tribeca loft”.

Its bound to happen when you are so high profile. I like it when business experts and professors can party, it shows they have a good sense of balance between professional work and play time. I am also happy to see that my subscription to RGE is being well spent.

Dissecting Nouriel Roubini

Just who is Nouriel Roubini? A lucky guy? Like I always say, if you are bullish or bearish long enough, you will eventually be right. My two New York fund manager friends who were down a few months back told me that Roubini is a party animal when he is not speaking like a diplomat on TV. Not that there is anything wrong with that!

The following is a revealing piece on him from The New Republic:

Some economists--strict academics mostly--have long considered Roubini a quack. They sneer at his approach, which is wide, deep, and deeply unconventional. When he travels, for instance, he says his research includes talking to "everyone from the airport cab driver all the way to the finance minister." One prominent economist who studies recession indicators recently slammed Roubini for his "subjective," "wild man" predictions because they don't always rely on econometric modeling. And Roubini certainly didn't help his case at an IMF conference in September 2006, when he guesstimated the chances of a world recession at 70 percent before offering, by way of explanation, that he had pulled the number "just out of my nose."

Anirvan Banerji, an economist with the Economic Cycle Research Institute, has been particularly dismissive of Roubini's forecasting abilities: "The average time between recessions is about five years in the postwar period," he says. "So, if you forecast a recession one year and it doesn't happen, and you repeat your forecast year after year ... at some point the recession will arrive."

And Roubini has undeniably overshot. In 2004, he predicted that the oncoming recession would precipitate the crash of the dollar. The crisis has mainly buoyed it. On September 1, 2005, three days after Hurricane Katrina made landfall, Roubini told Reuters that economic disaster was imminent. What followed instead was a bump in financial activity that forestalled the recession for more than two years.

Nouriel Roubini. Credit: Jonathan Twingley

All the while, though, Roubini understood better than anyone just how weak the fundamentals of our economy were. The day after the now-famous 2006 IMF talk, he went on "Kudlow & Company," on CNBC. Roubini was, as always, the foil to Kudlow's chipperness. "All my friends are in a great mood, Nouriel. They're in a terrific mood. They love America," Kudlow sang. Roubini countered starkly: "Well, they're all rich," he said. "The average American actually is in debt"--a sign to Roubini that housing would only be the catalyst of something larger.

What sets Roubini apart from his fellow economists (and what occasionally gets him in trouble) is his willingness to intuit broad patterns and connect the dots, something that became apparent early in his career. While others spent years refining one econometric model or drilling down on one microsubject, Roubini gorged on a range of diverse topics that, to him, were all related: Japanese public debt, tax evasion, liquidity and exchange rates, monetary policy in the newly formed European Union, the effect of political cycles on industrial economies. As a graduate student, he attracted the attention of older, more established academics both for his ambitiously sweeping econometric analyses and his ability to synthesize vast swaths of seemingly unrelated information.

But the first real test of Roubini's eclectic methodology didn't come until 1997. That summer, the government of Thailand--highly in debt and over-leveraged after a long and poorly regulated real-estate boom--cut its currency from its peg to the dollar. Investors panicked, and Thailand's surging economy froze, triggering massive layoffs in real estate, finance, and construction. The crisis, which quickly spread to the rest of the region, took most economists by surprise.

Roubini, by then a young professor at NYU, was trying to stay on top of the rapidly shifting situation in Asia for a class he was teaching. He found it nearly impossible until he hit on a relatively new technology: a website. He hired some students versed in HTML and set up the Asia Crisis Homepage. The bright yellow portal pooled news reports, academic work, and policy debates on the subject, filtering, organizing, and contextualizing the information in real time under no fewer than 32 headings.

Wading through the data on Thailand, Roubini found that corruption and bad policy created a vacuum that sucked in a flood of foreign capital. This skewed the country's financial reality and accelerated an unsustainable boom. (Roubini later spotted this distinctive pattern in the United States when the Chinese, Russians, and Gulf states were hungrily snapping up U.S. debt and inundating the market with foreign cash.) But, at the height of the Asian financial crisis, Roubini was, again, in the minority. Many economists saw it as a simple comedy of errors: Misinformed investors panicked, they said, and pulled the rug out from under the Thais. Roubini, on the other hand, saw the crisis as a systemic failure rooted in Thailand's policies. And he was right.

More than a decade later, Roubini-ism--sprawling, non-linear, and hypercaffeinated--looks pretty much the same. His prescient February 2008 blog post that predicted the Rube Goldbergian collapse of the world financial system, for example, was called "The Twelve Steps to Financial Disaster," but, if you include all the sub-steps and sub-sub-steps, the real number is likely twice that. On television, his talking points are similarly pluralized, rushing out quickly, like a magician's scarves, to a grand and logical finale. (At the diner, I clocked him: 295 words on the intricacies of the European monetary crisis in under 90 seconds.) This, of course, means that brevity goes out the window. Roubini's weekly Web column for Forbes comes in at close to 3,000 words and runs at half that length. A recent Roubini academic paper tracks no less than 47 emerging countries over the course of 32 years using more than 50 variables. Giancarlo Corsetti, who was Roubini's advisee at Yale and is now a frequent collaborator, presents with Roubini at conferences, and sometimes finds this expansive approach frustrating. "I go up, I present one or two points," Corsetti says. "Nouriel goes up and gives you twenty-six points, three or four of which are contradictory."

Robert Shiller, who also worked with him at Yale and was one of the first people to warn of a housing bust, isn't surprised that Roubini, of all the great minds staring down our financial future, emerged as the one to piece it together. "A financial crisis needs general thinking, and a team of specialists will have difficulty understanding the whole thing," he says. "Nouriel's approach has always been worldwide, which is not rewarded in academia. There's an element of luck in everything, but it's not random who he is."

This is what the life of a prophet looks like: Two days after we met at the diner, Roubini is back at the airport. He's off on another long jag--four continents, seven countries, eight cities, ten days.

He's been thinking a lot not just about the way down but the way out. With the help of the Obama administration's policies (not great, he says, but better than nothing), he sees "a light at the end of the tunnel." To actually get to the end of it, though, the United States will have to get used to consuming less, which means China, Germany, and Japan will have to get used to producing less, which means that all the intermediaries--Chile, Australia, Brazil--will have to scale back and turn inward like everyone else. The world may curve and warp a bit, and it will be difficult, but Roubini sees good in this. Given the right changes, perhaps the United States can develop with the productive long view in mind, and maybe its human talent can be spread more equitably. "When you have more financial engineers than computer engineers, you know that the brightest minds have gone into something where, probably, the margin was excessive," he had told me earlier. "Maybe some of these bright people are going to do something entrepreneurial, more creative, or go into government. I think that's actually a good change. The transition is painful, but the result may be good."

On the other end of the line, I can hear him fumbling with his luggage as he talks, and there's a sense of noble resignation in his tone. He hasn't had any rest since we met, but, he insists, "I cannot get sick. I can't stop." His is hard, life-shortening work, but someone has to tell the world that only its wholesale rewiring will get us out of this.

p/s photo: Rachel Maryam

Nouriel Roubini's Interviews With Time and SCMP

Got to keep up with what Nouriel Roubini is saying now. More gloom? We also need to keep in mind that Roubini's views may be tempered as he is now advising Obama's inner circle on economics policy and strategy.

From Time Magazine:

Roubini Sees More Economic Gloom Ahead

Economist Nouriel Roubini, chairman of New York City–based research firm RGE Monitor, earned the nickname "Dr. Doom" by warning as early as 2005 that America's speculative housing boom could trigger an economic crisis. At the time, he was dismissed by many as a perpetual pessimist. Today, he's a sought-after analyst and a popular guest on financial-news programs and websites — and he is as gloomy as ever. Over breakfast in Hong Kong this week, the New York University professor talked with TIME's Michael Schuman about the perils that lie ahead if governments do not do more to confront the myriad problems facing global financial markets and economies.

TIME: Where is the global economy heading from here? Roubini: My concern right now is that this U-shaped recession we are in could turn into something much uglier, meaning a Japanese-style L-shaped recession: near stagnation or stag-deflation. We're in the worst global synchronized recession in the last 60 years. Unless we take the right policy actions, we'll end up in a near depression. I did not want to use that term six months ago. At that time, I said the chances of a near depression were only 10%. But today those chances are 33% or so. (Read "25 People to Blame for the Financial Crisis.")

How can this be avoided? You have to have a set of concerted, coherent policies done not just by the U.S. but by Europe, Japan, China and everyone else. The credit crunch is just massive. One thing that's needed is much more aggressive monetary easing. The second dimension is that you need much more fiscal stimulus — in the countries that can afford it — that is front-loaded. The U.S. [stimulus package] is $800 billion, but only $200 billion is front-loaded. Of that $200 billion [in stimulus] this year, half of it is tax cuts. That's going to be a waste of money, because people are not going to spend it.

Why hasn't the banking mess been cleaned up? You have to do triage between banks that are illiquid and undercapitalized but solvent and those that are insolvent. The insolvent ones you have to shut down. You need more aggressive credit creation by the government, or you have to force the banks to lend. We're in a war economy. You need command-economy allocation of credit to the real economy. Otherwise, the incentive individually for every institution is to pull out, not extend credit. Not enough is being done. (See which businesses are bucking the recession.)

What do you think of President Barack Obama's progress so far? I have to give [the members of Obama Administration] credit. In about six weeks, they have done three major things: the $800 billion stimulus package, a mortgage program that is much more than the previous Administration did and a bank plan that, however flawed, at least has the benefit of not having another bailout of the banks. The glass is half full. But for each one, there are some flaws ... the bank plan wants to pretend that the government is half pregnant with the banks. The debate is between partial and full nationalization, not between nationalization or no nationalization. Go and do the job and do it right by taking over the banks and restructuring them and selling them back to the private sector.

What's the best-case scenario? If you do everything right, you avoid an L, and that's really good news. But you still have a situation in which global growth this year is negative. GDP growth in advanced economies is going to be negative through the fourth quarter of this year, and next year, growth will be anemic — probably 1% or lower. Job creation is going to be negative. Even in the best scenario, there will be job losses through the end of next year. In the best of circumstances, we have a two- to three-year recession in advanced economies.

Is there a part of the world you are especially worried about right now? I'm worried about every part of the world. People thought the rest of the world would decouple from the U.S. That was nonsense. Emerging Europe is on the verge of a fully fledged sovereign-debt, banking and currency crisis. I think China is in a near recession right now. Many emerging markets, even those that are in better shape, are in severe trouble. I don't think there is any economy in the world right now that is safe.

Is a breakup of the European monetary union possible? I don't see that as being likely, but the probability of that eventually happening is rising. Right now, we are facing a situation in which many countries now have banking systems that are too big to fail and also too big to be saved. If Ireland or Greece go bust, then there is already a commitment from the Germans and French to, one way or another, bail them out — because they know that otherwise the monetary union is going to collapse. But if you have to rescue on top of them Austria and Italy, Portugal and Spain, and Belgium and the Netherlands, then that is not going to be possible. I am still of the view that we can avoid a collapse of the monetary union, but this is really the very first true test of its stability.

Many people are pinning their hopes on the Chinese government to stimulate demand. Is that justified? I have to give credit to the Chinese. Their fiscal stimulus will contain the degree of economic contraction. But China is radically dependent on U.S. growth. Forcing state-owned enterprises and banks to spend more when you have overcapacity, or to lend more when there are already large [amounts of bad debt], is going to postpone a problem, maybe by a few months. But it will lead to a harder fall down the line. A hard landing is unavoidable, given what has happened to the rest of the world.

Any good news out there? Honestly, as of now, I don't see any. Policy is moving in the right direction. My concern is this is too little, too late.

-----------------------------

From South China Morning Post:

A small glimmer of hope at breakfast with Dr Doom

Tom Holland

The prophet of doom was in a relatively cheerful mood yesterday.

"Honestly, as of now I don't see any good news," he said brightly, tucking into breakfast at Hong Kong's Four Seasons Hotel.

This economic crisis has been no respecter of reputations. Financiers, regulators and politicians have all seen their good names shredded since the credit crunch first began to bite in mid-2007.

Even Warren Buffett's halo has slipped. Last week, his Berkshire Hathaway investment firm announced a 10 per cent decline in asset value for last year after ill-timed bets on oil company ConocoPhillips and shares in Irish banks.

But not everybody has suffered. If anyone emerges from this crisis with his reputation enhanced, it will be Nouriel Roubini, the New York University economics professor who was one of the few forecasters to see the crash coming.

As long ago as July 2007, before most of us had even heard of the term subprime, Professor Roubini was warning that the bursting of the US credit bubble would lead to recession.

Then in February last year, he published a paper entitled Twelve Steps to Financial Disaster, in which he forecast, among other things, the collapse of the US stock market, the failure of a number of Wall Street investment houses and government intervention to rescue America's crumbling banks.

Ever since, Professor Roubini has become the go-to guy for media in search of catastrophic predictions about markets and the economy, earning himself the nick-name Dr Doom in the process.

Yet, while Professor Roubini's current forecasts are suitably gloomy, they are not entirely black.

Although he says a protracted and deep global recession is unavoidable, he believes concerted government action can still prevent the inevitable U-shaped recession from turning into a worst-case L-shaped depression.

Unfortunately, the risk that recession will become depression is rising. Part of the trouble is that fears of a downturn are self-fulfilling. Anticipating a slump in demand, companies are cutting capital investment, production and jobs.

Of course, that suppresses incomes, which makes it even harder for savers whose wealth has been eroded by the 27 per cent decline in US property prices and the 55 per cent fall in the stock market to repair their balance sheets. As a result, the downturn in consumer demand will be even deeper and more drawn-out than many economists expect, warns Professor Roubini.

That, in turn, is bad news for Asia, and especially for China, which remains heavily reliant on exports and export-related investment to power economic growth.

With declining imports of raw materials and intermediate goods signalling that further falls in China's exports are on the way, Professor Roubini has few expectations that Beijing's stimulus spending can keep growth ticking over for long. Although he gives China's leaders full credit for trying to support demand with public spending, he says official stimulus efforts are only likely to postpone the economic crunch for a few months.

"A hard landing is inevitable, given what's happened in the rest of the world," he warns.

Retooling the Chinese economy to run primarily on domestic consumer demand will take five to 10 years. In the meantime, Professor Roubini says, world governments need to co-ordinate their policies across six key areas if they are to revive global demand and prevent recession from slipping into depression.

First, central banks need to loosen monetary policy far more drastically than they have done already, adopting "quantitative easing" measures, for example by buying more types of securities.

Even so, loosening monetary policy when demand has stalled tends to be as effective as pushing on a string so, secondly, governments especially in Europe need to ramp up fiscal spending further to boost demand.

At the same time, governments must do whatever it takes - including full nationalisation - to clean up their banking systems or risk ending up facing a lost decade like Japan in the 1990s.

Fourth, policymakers need to force banks to resume lending. Professor Roubini explains that the present credit drought is partly a problem of collective inaction. With a lack of credit threatening the survival of businesses throughout the economy, no bank wants to be the only one to lend money, even to creditworthy companies, lest its borrowers are hurt by failures at other credit-starved companies.

Fifth, governments of economies hit by property slumps should introduce an across-the-board reduction in the principal value of mortgage debts to relieve the pressure on insolvent households.

And finally, major shareholders should sanction an immediate doubling of the International Monetary Fund's capital base so it can extend effective assistance to emerging markets facing liquidity problems because of the crisis.

Even in a best-case scenario where everything happens according to his script, Professor Roubini warns that the world still faces an economic contraction this year and growth of less than 1 per cent next year, with the developed economies growing at below trend rates through 2011.

Yet, despite his gloomy reputation, he still believes his worst-case scenario of an L-shaped depression can be avoided. And he gives a cautious thumbs-up to the administration of United States President Barack Obama, awarding its economic programme so far an A for effort, if only a B for results. "At least policy is moving in the right direction," he says.

That might not be much, but it is something. Clearly, with Dr Doom, cheerfulness is relative.

p/s photo: Michelle Yip Shuen

Opinions On Bad Bank Idea

Overview: Geithner aims to add private funding as a new component of proposals to address the toxic debt clogging banks’ balance sheets next to government guarantees of ring-fenced toxic assets. Aspects of the plan that have been settled include a new round of injections of taxpayer funds into banks, targeted at those identified by regulators as most in need of new capital. Previously, the comprehensive solution that aimed at keeping banks in private hands as outlined in Tim Geithner's confirmation hearing was the set-up of an 'aggregator bank' that buys toxic assets. The main sticking point is the toxic asset valuation issue--> markets gain on prospect of easing mark-to-market accounting rules. Major headache is systemic impact of too-big-to-fail banks. Treasury will outline action plan on February 10.


• Amount of toxic assets: WSJ says combination of guarantee and aggegator bank likely, with the latter buying about $2 trillion in toxic assets. Compare with size of U.S. originated shadow banking system pushing for re-intermediation and access to central bank liquidity is $10 trillion (see Geithner speech June 9). Of these, about $6T in U.S., $4t abroad according to Fed research based on flow of funds data (compare with Goldman estimates (not online) that amount of toxic assets in U.S. is at $5.7T). Moreover, IMF notes in October GFSR that $10T is the likely amount of asset deleveraging at global banks. Simon Johnson estimates U.S. bank rescue will cost $3-4T with net cost to taxpayer of about $1-2T or range of 5-10% of GDP as in past banking crises (via Fortune).

• RGE: for U.S. banks: $1.1T in total loan losses, $600-700bn in current mark-to-market losses based on derivatives and cash bond prices. Compare with Chris Whalen (IRA) estimate for accumulated bank charge offs for 2009 in the neighborhood of $1 trillion vs. $1.5 trillion in Tier 1 Risk Based Capital at all US banks. "The good news, though, is that 2/3 to 3/4 of that loss number comes from the top 4 - Citigroup, Bank of America, JPMorganChase and Wells Fargo, in that order of risk profile."

• Industry proposal with private sector involvement (via Fortune): The idea, as drafted and as articulated by Citigroup's Flexner, is for the government to create a massive new fund to lend money at a fair price to professional investors -- pension funds, hedge funds, private equity funds and endowment funds -- for the sole purpose of providing reliable long-term financing to allow these investors to buy the various "toxic assets" in the secondary market that are now frozen on the balance sheets of financial institutions the world over--> The bet would be that these securities would increase in value over time

• similarly Michael Jaliman 'MBS Economic Freedom Bonds' (without temporary nationalization) and Luigi Spaventa's Brady Bond proposal to clear toxic asset overhang and sever market and funding liquidity negative feedback loop.

• Jeffrey Sachs: The bank can be recapitalized at fair value to taxpayers and without inducing a squeeze on bank capital and lending. The government can swap 20 in government bonds for the 20 in toxic assets plus contingent warrants on bank capital, the value of which depends on the eventual sale price of the toxic assets. The government would then dispose of the 20 in toxic assets at a market price over the course of the next year or two and exercise its contingent warrants at that time. During the period of liquidating the toxic assets, the government would exercise a kind of receivership over the banks in order to prevent asset stripping or 'Hail-Mary' incentives on the part of managers --> In this process, there are no taxpayer bailouts, and there is also no squeeze on bank capital resulting from the exchange of toxic assets at less than face value.
  

• Nouriel Roubini: in the bad bank model the government may overpay for the bad assets as the true value of them is uncertain; even in the guarantee model there can be such implicit over-payment (or over-guarantee that is not properly priced). Thus, paradoxically nationalization may be a more market friendly solution: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – possibly – even the unsecured creditors in case the bank insolvency is too large; it provides a fair upside to the tax-payer; it can resolve the problem of government managing the bad assets by reselling most of the assets and liabilities of the bank to new private shareholders after a clean-up of the bank.

• Robert Pozen: Here's a practical solution to the valuation issue: suppose the Treasury estimates that a toxic asset is worth $700,000. It would pay the bank $560,000 in cash (=80%) plus a capital certificate for $140,000 (=20%). If the government later sold that security for $660,000, the bank would receive an additional cash payment of $80,000 (80% of $100,000, the excess of $660,000 over $560,000). The Treasury would receive the remaining $20,000 of the excess. On the other hand, if the government later sold the security for $550,000, the bank would receive nothing more. The Treasury would absorb a loss of $10,000.

• Willem Buiter (similar arguments by Stiglitz/Romer/Soros): Government should finance and run temporarily one or more good banks, i.e. buy the good assets for which there IS a price by definition and leave the bad assets with the old legacy banks and its shareholders, creditors. Latter will most likely fail and at that point Chapter 7 and 11 are ready--> the state meets its three key objectives: first, its short-run economic stabilisation and crisis-fighting objective; second, its medium and long-term banking sector incentive-enhancing, moral-hazard-minimising objective; and third, its fairness objectives: the polluter pays or, you break it, you own it.

• Paul Krugman: The only way to make effectively insolvent banks viable again without explicit but temporary government takeover and restructuring is if the government pays much more for toxic assets than private buyers are willing to offer. There is no guarantee that paying near fair value prices will make banks solvent again which would require additional capital injections. A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

• Luigi Zingales: Avoid putting any further taxpayer money at risk at all and mandate a sizable debt to equity swap and adjust distributional issues with equity warrants (change in legislation needed).

• Nationalization (Swedish Model):
  Pro: write down toxic assets to market value, then nationalize insolvent banks (receivership) in order to align institution's and taxpayer incentives (Zombie banks are likely to engage in gambling), wipe out equity holders (maybe also debt restructuring needed) instead of subsidizing them with taxpayer money, dismiss management, dispose of them via a new RTC (or bad bank), wind down unviable banks, refinance viable ones, start afresh.
  Con: Government is not in the business of running a commercial bank; potentially large upfront government outlays, what do you do with debt holders?, stigma.

• Backstop guarantee of ring-fenced assets on banks' balance sheets of Citi and BoA:
  Pro: Little upfront outlays for the government
  Con: Open-end government commitment, question of asset valuation unresolved; assets that are good today may turn bad tomorrow (coming loan losses) which may need additional capital, persistent lack of transparency on who holds what, ongoing subsidization of existing share- and debt holders by taxpayers, banks might need additional capital injections.

• Bad Bank or Aggregator Bank (to be run by FDIC):
  Pro: Government purchase of toxic assets off banks' balance sheets contributes to price discovery and helps deleverage balance sheets.
  Con: Big question is at what price should toxic assets be bought? If government buys at market values, many banks will be insolvent anyway as they have to mark down asset values to new price. If price is too high, taxpayer is once again subsidizing eqyity and debt holders. Bernanke advocates 'hold-to-maturity' prices above current market prices.

• 'Bad bank' without nationalization and full writedown of toxic assets to market value is reminiscent of super-SIV that industry did not want to back itself due to asymmetric exposures.

• IMF: Fair value accounting has its problems but it is still the best option available.

p/s photos: Kim Ok Bin