[R-G] [BillTottenWeblog] Dr Doom

[Bill Totten]

by Stephen Mihm

The New York Times (August 17 2008)


On September 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 States was 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
went on, could cripple or destroy hedge funds, investment banks and
other major financial institutions like Fannie Mae and Freddie Mac.

The audience seemed skeptical, even dismissive. As Roubini stepped down
from the lectern after his talk, the moderator of the event quipped, "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. And then there was the espouser
of doom himself: Roubini was known to be a perpetual pessimist, what
economists call a "permabear". When the economist Anirvan Banerji
delivered his response to Roubini's talk, he noted that Roubini's
predictions did not make use of mathematical models and dismissed his
hunches as those of a career naysayer.

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 fifty basis points and buying up tens of billions of
dollars in mortgage-backed securities. When Roubini returned to the IMF
last September, he delivered a second talk, predicting a growing crisis
of solvency that would infect every sector of the financial system. This
time, no one laughed. "He sounded like a madman in 2006", recalls the
IMF economist Prakash Loungani, who invited Roubini on both occasions.
"He was a prophet when he returned in 2007".

Over the past year, whenever optimists have declared the worst of the
economic crisis behind us, 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. Following 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, who dismissed the
rally as nothing more than a "delusional complacency" encouraged by a
"bunch of self-serving spinmasters", stuck to his script of "nightmare"
events: waves of corporate bankrupticies, 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
trigger a panic by depositors. Not all of these developments have come
to pass (and perhaps never will), but the demise last month of the
California bank IndyMac - one of the largest such failures in US 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. He
is now a sought-after adviser, spending much of his time shuttling
between meetings with central bank governors and finance ministers in
Europe and Asia. Though he continues to issue colorful doomsday
prophecies of a decidedly nonmainstream sort - especially on his popular
and polemical blog, where he offers visions of "equity market slaughter"
and the "Coming Systemic Bust of the US Banking System" - 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", the former Treasury secretary Lawrence
Summers told me earlier 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 the
TriBeCa neighborhood of New York City. "I'm not a pessimist by nature",
he insisted. "I'm not someone who sees things in a bleak way". Just
looking at him, 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. He rarely smiles, and when he does, his face, topped by
an unruly mop of brown hair, contorts into something more closely
resembling a grimace.

When I pressed him on his claim that he wasn't pessimistic, he paused
for a moment and then relented a little. "I have more concerns about
potential risks and vulnerabilities than most people", he said, with
glum understatement. But these concerns, he argued, make him more of a
realist than a pessimist and put him in the role of the cleareyed
outsider - unsettling complacency and puncturing pieties.

Roubini, who is fifty, 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 two, then to Tel Aviv and finally to Italy, where he grew up
and attended college. He moved to the United States to pursue his
doctorate in international economics at Harvard. Along the way he became
fluent in Farsi, Hebrew, Italian and English. His accent, an inimitable
polyglot growl, radiates a weariness that comes with being what he calls
a "global nomad".

As a graduate student at Harvard, Roubini was an unusual talent,
according to his adviser, the Columbia economist Jeffrey Sachs. He was
as comfortable in the world of arcane mathematics as he was studying
political and economic institutions. "It's a mix of skills that rarely
comes packaged in one person", Sachs told me. After completing his PhD
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 tech bubble.

The 1990s were an eventful time for an international economist like
Roubini. Throughout the decade, one emerging economy after another was
beset by crisis, beginning with Mexico's in 1994. Panics swept Asia,
including Thailand, Indonesia and Korea, in 1997 and 1998. The economies
of Brazil and Russia imploded 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 the Times Op-Ed
columnist Paul Krugman and Joseph Stiglitz in order to reach a
nonacademic audience. Roubini takes pains to note that he remains a
rigorous scholarly economist - "When I weigh evidence", he told me, "I'm
drawing on twenty years of accumulated experience using models" - 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. As Shiller told me,
"Nouriel has a different way of seeing things than most economists: he
gets into everything".

Roubini likens his style to that of a policy maker like Alan Greenspan,
the former Fed chairman who was said (perhaps apocryphally) to pore over
vast quantities of technical economic data while sitting in the bathtub,
looking to sniff out where the economy was headed. Roubini also cites,
as a more ideologically congenial example, the sweeping, cosmopolitan
approach of the legendary economist John Maynard Keynes, whom Roubini,
with only slight exaggeration, calls "the most brilliant economist who
never wrote down an equation". 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. "The United
States", Roubini remembers thinking, "looked like the biggest emerging
market of all". Of course, the United States wasn't an emerging market;
it was (and still is) the largest economy in the world. But Roubini was
unnerved by what he saw in the US 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. He said that these problems,
which he called the "twin financial train wrecks", might manifest
themselves in 2005 or, at the latest, 2006. "You have been warned here
first", he wrote ominously on his blog. But by the end of 2006, the
train wrecks hadn't occurred.

Recessions are signal events in any modern economy. And yet remarkably,
the profession of economics is quite bad at predicting them. A recent
study looked at "consensus forecasts" (the predictions of large groups
of economists) that were made in advance of sixty different national
recessions that hit around the world in the 1990s: in 97 percent of the
cases, the study found, the economists failed to predict the coming
contraction a year in advance. On those rare occasions when economists
did successfully predict recessions, they significantly underestimated
the severity of the downturns. Worse, many of the economists failed to
anticipate recessions that occurred as soon as two months later.

The dismal science, it seems, is an optimistic profession. Many
economists, Roubini among them, argue that some of the optimism is built
into the very machinery, the mathematics, of modern economic theory.
Econometric models typically rely on the assumption that the near future
is likely to be similar to the recent past, and thus it is rare that the
models anticipate breaks in the economy. And if the models can't foresee
a relatively minor break like a recession, they have even more trouble
modeling and predicting a major rupture like a full-blown financial
crisis. Only a handful of 20th-century economists have even bothered to
study financial panics. (The most notable example is probably the late
economist Hyman Minksy, of whom Roubini is an avid reader.) "These are
things most economists barely understand", Roubini told me. "We're in
uncharted territory where standard economic theory isn't helpful".

True though this may be, Roubini's critics do not agree that his
approach is any more accurate. Anirvan Banerji, the economist who
challenged Roubini's first IMF talk, points out that Roubini has been
peddling pessimism for years; Banerji contends that Roubini's apparent
foresight is nothing more than an unhappy coincidence of events. "Even a
stopped clock is right twice a day", he told me. "The justification for
his bearish call has evolved over the years", Banerji went on, ticking
off the different reasons that Roubini has used to justify his
predictions of recessions and crises: rising trade deficits, exploding
current-account deficits, Hurricane Katrina, soaring oil prices. All of
Roubini's predictions, Banerji observed, have been based on analogies
with past experience. "This forecasting by analogy is a tempting thing
to do", he said. "But you have to pick the right analogy. The danger of
this more subjective approach is that instead of letting the objective
facts shape your views, you will choose the facts that confirm your
existing views."

Kenneth Rogoff, an economist at Harvard who has known Roubini for
decades, told me that he sees great value in Roubini's willingness to
entertain possible situations that are far outside the consensus view of
most economists. "If you're sitting around at the European Central
Bank", he said, "and you're asking what's the worst thing that could
happen, the first thing people will say is, 'Let's see what Nouriel
says' ". But Rogoff cautioned against equating that skill with
forecasting. Roubini, in other words, might be the kind of economist you
want to consult about the possibility of the collapse of the
municipal-bond market, but he is not necessarily the kind you ask to
predict, say, the rise in global demand for paper clips.

His defenders contend that Roubini is not unduly pessimistic. Jeffrey
Sachs, his former adviser, told me that "if the underlying conditions
call for optimism, Nouriel would be optimistic". And to be sure, Roubini
is capable of being optimistic - or at least of steering clear of
absolute worst-case prognostications. He agrees, for example, with the
conventional economic wisdom that oil will drop below $100 a barrel in
the coming months as global demand weakens. "I'm not comfortable saying
that we're going to end up in the Great Depression", he told me. "I'm a
reasonable person".

What economic developments does Roubini see on the horizon? And what
does he think we should do about them? The first step, he told me in a
recent conversation, is to acknowledge the extent of the problem. "We
are in a recession, and denying it is nonsense", he said. When Jim
Nussle, the White House budget director, announced last month that the
nation had "avoided a recession", Roubini was incredulous. For months,
he has been predicting that the United States will suffer through an
eighteen-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 says that job
losses, corporate bankruptcies and other drags on growth will 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 Federal Reserve
cut interest rates to two 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 and Senator
Christopher Dodd - 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 Corporation. "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, Russia and the gulf states", Roubini noted. "These
are rivals, not allies".

The United States, Roubini went on, will 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, an assistant professor of economic history at the
University of Georgia, is the author of A Nation of Counterfeiters:
Capitalists, Con Men and the Making of the United States (2007). His
last feature article for the magazine was about North Korean counterfeiting.

http://www.nytimes.com/2008/08/17/magazine/17pessimist-t.html


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