Nicholas Watson in Prague -
It should come as no surprise that Nouriel Roubini, professor of economics at NYU's Stern School of Business, thinks the worst of the financial crisis is yet to come. After all, it was he who stood in front of a group of economists at the International Monetary Fund in 2006 and predicted disaster for the global financial system to much incredulity.
Since then, this so-called "permabear" has, of course, been proved horribly correct and is now hailed as a prophet - the bubble in the US housing market burst, sub-prime lenders defaulted en masse, trillions of dollars of mortgage-backed securities unravelled and the global financial system crashed, bringing down with it economies, banks, hedge funds and other financial institutions like Fannie Mae.
So does he think, as some are saying, that the worst phase of the financial-system meltdown may be over in the US, while here in Europe the worst may be yet to come? Not a bit of it. "For the US, I don't think we are out of it in any shape or form. Most US banks are insolvent and will have to be taken over by the government. I don't agree with the idea that the worst is behind us." Europe, alas, "is pretty much a disaster," he agrees in an interview with bne. "The economic recession in the Eurozone currently is as bad, or even worse, than the US and now there is a severe hard landing in many parts of emerging Europe."
Roubini is dismissive of those who, just a few months ago, were confidently predicting that emerging Europe would escape the worst of the financial crisis, since the banks had little to no exposure in those toxic securitised assets. "A couple of years ago, I wrote a long paper suggesting that the fiscal deficits, the current account deficits, overvalued currencies, borrowing short term in foreign currencies, would lead to significant turmoil and the countries were signalling trouble - the Baltics, Hungary, Romania and Bulgaria all the way down to Turkey, Belarus, Ukraine. Those with large current account deficits kept on saying, 'it's okay, it's okay,' but it wasn't okay. So I don't think it's a black swan event, it was highly predictable."
Many economists had also touted the predominance of foreign banks in CEE as a pillar of strength in the face of any downturn, but which is now looking increasingly like a weakness. "The large foreign bank ownership [in emerging Europe] was a problem that again was recognised in advance. There's been studies for years, including from the New York Fed[eral Reserve] suggesting that the credit cycle of advanced economies bangs into their affiliated emerging markets - it's pro-cyclical, in good times they over lend and in bad times they try to cut back significantly, creating these cyclical effects. The idea that you have foreign banks and everything is fine would not be correct. It's good to have foreign banks in your economy, but when a shock occurs at the centre of the financial system, the risk is it impacts by contracting credit and there was excessive credit creation in emerging Europe to begin with by local banks as well as foreign banks. So again, to me it's not a surprise," he says.
Things are so bad that Roubini has coined the term "stagdeflation" - a combination of stagnation, recession and deflation - to describe the situation when four forces begin operating: a slack in goods markets, a "recoupling" of the rest of the world with the US recession, a slack in labour markets, and a sharp fall in commodity prices. Given the need for such dire terms, it will obviously take a fair bit of time and wide-ranging policy action to drag us out of it. "Technically speaking, recession is going to continue all the way to the end of this year and next year, even if there is a technical recovery of growth to positive. Whether there will be a recovery in 2011 is not something that we can take for granted either - it depends very much on the policy actions to be undertaken. There is a meaningful chance of an L-shaped Japanese-style stagnation or even depression - I would not rule that out."
Unfortunately, in Europe the policy action has been found wanting: the European Central Bank is behind the curve in terms of monetary response, and fiscal policy is weak because those who can afford it are those like Germany don't want to do it, while those who need to do it the most like Spain, Italy, Greece, Portugal are already burdened by lots of debt and deficits. "And the other problem is the European banks being too big to fail on one side, but being too big to save on the other because they're way too large compared to the size of the country."
Ironically, one of the few bright spots - if you can call it that - is the place of Roubini's birth and one that has suffered more crises than most over the past few decades. "I don't expect a full-fledged crisis in Turkey, but it's going to be a rough year... I don't expect a real financial crisis in Turkey like the one they experienced in 2001 - the banks are much better shape, much better regulation of the financial system, the fiscal position is sounder... and I think if they can reach an agreement with the IMF, it will provide a buffer of liquidity."
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