Worst ahead of US, says subprime seer

Nouriel Roubini believes the markets are still in denial

HONG KONG: In early 2006, economist Nouriel Roubini broke rank from the prevailing consensus opinion and blew the whistle on the US housing bubble and held out grim warnings of a US ‘recession’.

That contrarian bearish outlook has been proved spectacularly right two years later, and Roubini, a former White House aide and chairman of the Roubini Global Economics Monitor, is justifiably credited with having first ‘called’ the sub-prime crisis.

“It was pretty obvious to me then that a housing bubble was building up and would soon burst,” Roubini said in response to questions from DNA Money in Hong Kong on Thursday. “I’m not sure why the others didn’t see it... With a bubble, there’s always wishful thinking, and people believe it will go on forever.”

Today, the consensus opinion grudgingly concedes that the US economy is tottering on the brink of a recession, but comforts itself with the hope that it will be “short and shallow”.  It draws solace from US GDP figures for the first quarter of 2008, which recorded 0.6% growth.

But Roubini’s bearish view is no less diminished.

“The worst is ahead of us rather than behind us,” says  the author of ‘Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies, Political Cycles and the Macroeconomy’.

The US housing recession - the worst since the Great Depression — “is nowhere near the bottom, and US home prices will fall for another two or three years.”  And, worse, he notes, it’s effect has spread to the rest of the economy.

But the markets are still in denial, says Roubini. “Until March 2008, the (US) markets were reacting negatively, but since then there’s been a bit of a rally. I call this a bear market sucker’s rally, born of the hope that the US Federal Reserve Board’s policy of monetary easing will prevent a recession or at least make it a shallow one.”

But when people realise that the real economy is contracting, there will, he warns, be “more severe downturns in the equity market”.

In Roubini’s estimation, the US recession will last 12 to 18 months - and it will have a contagion effect in Europe and in Asia as well.
 
“If the US recession were short and shallow, the slowdown in Asia may have been modest. But conditional on a severe US recession, we will see an economic contraction in Japan, and a recession in some parts of Europe... And if most of the advanced economies are in recession or growing weakly, the negative effect on Asia  - in terms of trade and financial consequences - will be severe,” he says. There will be a “significant slowdown of growth - more than the markets are pricing in this part of the world.”

Beneath the US first-quarter GDP figure - of a 0.6% growth - “the details are ugly and in fact confirm that the US is in recession,” says Roubini.

That’s because inventories of unsold goods added an artificial 0.8% to growth.

“If that’s taken away, the actual aggregate demand - the actual measure of growth of true demand - fell in the quarter to minus 0.2%. And the build-up of inventories means the fall in GDP in the second quarter will be larger than otherwise as firms will have to reduce that large inventory of unsold goods via a further reduction in production and employment…”

Roubini believes that the Fed, which called a pause to its policy of monetary easing, may have to lower interest rates further.

“The chances of that are actually very high. The market actually expects the Fed to start raising rates by the end of the year, but in my reckoning, the Fed’s pause will be very short. The chances are they’re going to cut rates yet again.”

But grim though Roubini’s outlook is, he does not foresee a period of protracted economic stagnation similar to Japan’s experience of the 1990s.

“Japan waited almost two years after its asset bubble collapsed to ease monetary policy and provide a fiscal stimulus, whereas in the US both steps came early.”