A sobering 12-step scenario
Legendary bear Nouriel Roubini lays out the case for a global financial meltdown. Pass the Prozac, please.
Legendary bear Nouriel Roubini lays out the case for a global financial meltdown. Pass the Prozac, please.
To understand the Federal Reserve's recent actions, one has to realize that there is now a rising probability of a catastrophic financial and economic outcome—a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.
Such a meltdown is likely to unfold in this 12-step scenario:
1. At this point it is clear that U.S. home prices will fall between 20% and 30% from their bubbly peak; that would wipe out between $4 trillion and $6 trillion of household wealth. Moreover, soon enough a few very large home builders will go bankrupt, leading to another free fall in home builders' stock prices.
2. Losses to the financial system from the subprime disaster, estimated to be as high as $300 billion, are now spreading to near-prime and prime mortgages as the same reckless lending practices as in subprime were occurring across the entire spectrum of mortgages; about 60% of all mortgage origination from 2005 through 2007 had these reckless and toxic features. So this is a generalized mortgage crisis and meltdown, not just a subprime one. And losses among all sorts of mortgages will sharply increase as home prices fall sharply and the economy spins into a serious recession.
Add to these losses the meltdown of hundreds of billions in off-balance-sheet structured investment vehicles and conduits, as roll-off of the asset-backed commercial paper market has forced banks to bring back on balance sheet these toxic off-balance-sheet vehicles. And because of securitization, the toxic waste has been spread from banks to capital markets and their investors in the United States and abroad, thus increasing—rather than reducing—systemic risk and making the credit crunch global.
3. The recession will lead—as it is already doing—to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. There are tens of millions in subprime credit cards and subprime auto loans in the United States. And again, defaults in these consumer debt categories will not be limited to subprime borrowers. So add these losses to the financial losses of banks and of other financial institutions, which will lead to a more severe credit crunch.
4. While there is serious uncertainty about the losses that monoline insurance companies will take on their insurance of residential mortgage-backed securities, collateralized debt obligations and other toxic asset-backed securities products, it is now clear that such losses are much higher than the $10 billion-to-$15 billion rescue package that regulators are trying to patch together. The resulting downgrade of the monolines will lead to another $150 billion in write-downs on asset-backed securities portfolios for financial institutions that already have massive losses. It will also lead to additional losses on their portfolios of muni bonds, and to losses and potential runs on the money-market funds that invested in some of these toxic products.
5. The commercial real estate loan market will soon enter into a meltdown similar to the subprime one, as lending practices in commercial real estate were as reckless as those in residential real estate. The housing crisis will lead—with a short lag—to a bust in non-residential construction, as no one will want to build offices, stores or shopping malls/centers in ghost towns.
6. It is possible that some large regional or even national banks that are very exposed to mortgages, residential and commercial, will go bankrupt. Thus some big banks may join the 200-plus subprime lenders that have gone bankrupt, adding to an already severe credit crunch.
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(contd)
Such a meltdown is likely to unfold in this 12-step scenario:
1. At this point it is clear that U.S. home prices will fall between 20% and 30% from their bubbly peak; that would wipe out between $4 trillion and $6 trillion of household wealth. Moreover, soon enough a few very large home builders will go bankrupt, leading to another free fall in home builders' stock prices.
2. Losses to the financial system from the subprime disaster, estimated to be as high as $300 billion, are now spreading to near-prime and prime mortgages as the same reckless lending practices as in subprime were occurring across the entire spectrum of mortgages; about 60% of all mortgage origination from 2005 through 2007 had these reckless and toxic features. So this is a generalized mortgage crisis and meltdown, not just a subprime one. And losses among all sorts of mortgages will sharply increase as home prices fall sharply and the economy spins into a serious recession.
Add to these losses the meltdown of hundreds of billions in off-balance-sheet structured investment vehicles and conduits, as roll-off of the asset-backed commercial paper market has forced banks to bring back on balance sheet these toxic off-balance-sheet vehicles. And because of securitization, the toxic waste has been spread from banks to capital markets and their investors in the United States and abroad, thus increasing—rather than reducing—systemic risk and making the credit crunch global.
3. The recession will lead—as it is already doing—to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. There are tens of millions in subprime credit cards and subprime auto loans in the United States. And again, defaults in these consumer debt categories will not be limited to subprime borrowers. So add these losses to the financial losses of banks and of other financial institutions, which will lead to a more severe credit crunch.
4. While there is serious uncertainty about the losses that monoline insurance companies will take on their insurance of residential mortgage-backed securities, collateralized debt obligations and other toxic asset-backed securities products, it is now clear that such losses are much higher than the $10 billion-to-$15 billion rescue package that regulators are trying to patch together. The resulting downgrade of the monolines will lead to another $150 billion in write-downs on asset-backed securities portfolios for financial institutions that already have massive losses. It will also lead to additional losses on their portfolios of muni bonds, and to losses and potential runs on the money-market funds that invested in some of these toxic products.
5. The commercial real estate loan market will soon enter into a meltdown similar to the subprime one, as lending practices in commercial real estate were as reckless as those in residential real estate. The housing crisis will lead—with a short lag—to a bust in non-residential construction, as no one will want to build offices, stores or shopping malls/centers in ghost towns.
6. It is possible that some large regional or even national banks that are very exposed to mortgages, residential and commercial, will go bankrupt. Thus some big banks may join the 200-plus subprime lenders that have gone bankrupt, adding to an already severe credit crunch.
.
.
.
.
(contd)
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