Nouriel Roubini says cut rates to 0 to avoid risk of a global systemic financial meltdown and a severe global depression

Nouriel Roubini, an economist who predicted the credit crisis said in a speech yesterday that the world is teetering on the brink of a financial meltdown. He offered several steps that he think should be taken immediately to prevent a severe global depression, including cutting rates by 150 basis points, which for the US would bring the Fed Funds rate to 0.

Nouriel Roubini, an economist who predicted the credit crisis wroter yesterday that the world is teetering on the brink of a financial meltdown.  Roubini is the Chairman of RGE Monitor and Professor of Economics at the NYU Stern School of Business.  In 2006 and 2007, before markets started their descent, he was speaking of the dangers of our overleveraged world and was widely dismissed.  Times have changed and he is now one of the most closely followed economists.  That, by the way, doesn't mean he is still right.  But he has bought himself some measure of credibility, for now.

According to him, the global economy has entered a new period and is danger or a stock market collapse as well as a severe global depression.  He said today in an email to subsribers of his site:

"The U.S. and advanced economies’ financial systems are now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid, and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms."

He continues to say that:

"At this point the risk of an imminent stock market crash – like the one-day collapse of 20% plus in U.S. stock prices in 1987 – cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown."

So all of you who were thinking that you would buy into the market at a low point might want to be cautious.  According to Roubini we might see further collapse and we are not near the bottom.  Is he right?  Judging by the fear and panic I see on people's faces, it's a possibility.  Entire markets are unwinding as hedge funds, private equity companies, corporations etc. are stuck in a trap.  They are being cut off from the short term funds they need to stay in operation and their assets are locked up in long-term investments.  Thus, if they receive calls to repay loans they can't get sell their assets fast enough and are forced to liquidate.  This maelstrom of destruction has no end in sight and it is for this reason that the Fed nd Treasury have tried to intervene.  Unfortunatley, the intervention doesn't seem to be working. 

He offered several steps that he think should be taken immediately to prevent a severe global depression.  These steps would have been unthinkable just a month ago.  His plan includes a coordinated, global policy rate cut of at leat 150 basis points.  The US Fed Funds rate is currently at 1.5% so this cut would bring it to 0.  He also recommends:

  • a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made;
  • a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures;
  • massive and unlimited provision of liquidity to solvent financial institutions;
  • public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses;
  • a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;
  • a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers;
  • an agreement between lender and creditor countries running current account surpluses and borrowing, and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.

These steps amount to not only the rescue of the financial system, but an attempt to rescue the consumer via mortgage foreclosures and debt reduction.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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