A Bubble in Bearishness

Nouriel Roubini:

Last year’s worst-case scenarios came true. The global financial pandemic that I and others had warned about is now upon us. But we are still only in the early stages of this crisis. My predictions for the coming year, unfortunately, are even more dire: The bubbles, and there were many, have only begun to burst.
The prevailing conventional wisdom holds that prices of many risky financial assets have fallen so much that we are at the bottom. Although it’s true that these assets have fallen sharply from their peaks of late 2007, they will likely fall further still. In the next few months, the macroeconomic news in the United States and around the world will be much worse than most expect. Corporate earnings reports will shock any equity analysts who are still deluding themselves that the economic contraction will be mild and short.
Severe vulnerabilities remain in financial markets: a credit crunch that will get worse before it gets any better; deleveraging that continues as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus leading to cascading falls in asset prices, margin calls, and further deleveraging; other financial institutions going bust; a few emerging-market economies entering a full-blown financial crisis, and some at risk of defaulting on their sovereign debt.
Certainly, the United States will experience its worst recession in decades. The formerly mainstream notion that the U.S. contraction would be short and shallow—a V-shaped recession with a quick recovery like the ones in 1990–91 and 2001—is out the window. Instead, the U.S. contraction will be U-shaped: long, deep, and lasting about 24 months. It could end up being even longer, an L-shaped, multiyear stagnation, like the one Japan suffered in the 1990s.
As the U.S. economy shrinks, the entire global economy will go into recession. In Europe, Canada, Japan, and the other advanced economies, it will be severe. Nor will emerging-market economies—linked to the developed world by trade in goods, finance, and currency—escape real pain...
Thanks to the radical actions of the G-7 and others, the risk of a total systemic financial meltdown has been reduced. But unfortunately, the worst is not behind us. This will be a painful year. Only very aggressive, coordinated, and effective action by policymakers will ensure that 2010 will not be even worse than 2009 is likely to be.

Nouriel Roubini has become famous lately for being the one guy who predicted the financial crisis.  (Stiglitz fans claim he did, too, but I've never seen any evidence for that, and Stiglitz is most emphatically the kind of guy who would claim undeserved credit for it.)  But a stopped clock is right twice a day.  I wouldn't put too much credence in this.

Recessions in America have always passed quickly, except one.  "There's a first time for everything," so the saying goes (a married bachelor?) but I think as long as we don't have any Reconstruction Finance Corporations, Hawley-Smoot Tariffs, or New Deals in the next year or so, the US will be growing again by 2010.  No special insights here; just induction.

Russia could fall apart, like Indonesia in 1998.  There could be a revolution in China.  There could be a permanent upward shift in US savings rates-- probably a good thing.  Interesting times!

Comments

[nato]

I tend to agree with Nathan's analysis. Unlike Roubini*, I don't see any particular reason everything has to collapse. There was a big bubble and there's still some air left in it but I'd say we've fallen most of the way already. That said, while I think a "V" recovery is quite possible - a position I've defended before to doomsayers - there's plenty of room for a "U". Unless the 'down' side of the V-or-U goes down a lot further (because of a true panic lockup of credit markets) I think the 2010 is bound to be a better year than 2009.

*Who seems to think that large imbalances on paper are always on the brink of reverting in a sudden panic. Though I agree that it *can* happen and the conditions are perhaps most conducive to eventuation since the 1930s, I disagree that it is virtually inevitable, or even the most likely outcome. The equity bubble had to come down because financial markets had not actually conquered risk, but the other long-overdue corrections on tap (e.g. automotive) don't involve nearly as much capital.