You’re probably asking yourself how Nouriel Roubini could possibly be more bearish than he has been, but his latest note is bordering on disturbing.
It is now clear that this is the worst financial crisis since the Great Depression and the worst economic crisis in the last 60 years. While we are already in a severe and protracted U-shaped recession (as the deluded hope of a short and shallow V-shaped contraction has now evaporated) there is now a rising risk that this crisis will turn into an uglier multi-year L-shaped Japanese style stag-deflation (a deadly combination of stagnation, recession and deflation).
The latest data on Q4 2008 GDP growth (at an annual rate) around the world are even worse than the first estimate for the US (-3.8%): -6.0% for the Eurozone; -8% for Germany; -12% for Japan; -16% for Singapore; -20% for Korea. The global economy is now literally in free fall as the contraction of consumption, capital spending, residential investment, production, employment, exports and imports is accelerating rather than decelerating.
The U.S. has done more (with its aggressive monetary easing and large fiscal stimulus putting it ahead) but two key elements are key to avoid a near-depression and still seriously missing: a proper clean-up of the banking system that may require a proper triage between solvent and insolvent banks and the nationalization of many banks, even some of the largest ones; and a more aggressive and across-the-board reduction unsustainable debt burden of millions of insolvent households (i.e. principal reduction of the face value of the mortgages, not just mortgage payments relief).
Moreover, in many countries the banks may be too-big-to-fail but also too- big-to-save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system. Traditionally only emerging markets suffered — and still suffer – from such a problem. But now such sovereign risk — as measured by the sovereign spread – is also rising in many European economies whose banks may be larger than the ability of the sovereign to rescue them: Iceland, Greece, Spain, Italy, Belgium, Switzerland and, some suggest, even the UK.
The process of socializing the private losses from this crisis has already moved many of the liabilities of the private sector onto the books of the sovereign: banks, other financial institutions and, soon enough possibly, households and some important non-financial corporate companies. At some point a sovereign bank may crack, in which case the ability of governments to credibly commit to act as a backstop for the financial system — including deposit guarantees — could come unglued.
It is clear that the Anglo-Saxon model of supervision and regulation of the financial system has failed. It relied on self-regulation that, in effect, meant no regulation; on market discipline that does not exist when there is euphoria and irrational exuberance; on internal risk management models that fail because — as a former chief executive of Citi put it — when the music is playing you gotta stand up and dance
Roubini is excessively bearish in my opinion, but he has been dead right so don’t discount anything he says….