Bharat Rakshak

During much of the past year, British financial authorities have looked like Bertie Wooster-style, bumbling amateurs in the face of the banking meltdown. Now, finally – albeit belatedly – they have got something right.

Alistair Darling, chancellor of the exchequer, on Wednesday announced that the government would spend up to £400bn underpinning the banks. The only thing more startling than those dazzling zeroes is that Mr Darling is now overseeing a policy package that is arguably more sensible than anything else emanating from the western world.

For this package suggests that British mandarins have finally learnt to draw sensible lessons from the past, most notably from the 1990s crises in Japan and Sweden. More striking still, these moves could also provide pointers for how the US authorities could improve their own policies.

There are at least three reasons to cheer. The first is that the UK government has acknowledged something the Americans remain reluctant to admit: that when a banking crisis is this bad, it makes more sense to recapitalise banks by buying preference shares than by purchasing their duff assets.

That does not necessarily mean that a “Tarp” – the scheme the US is creating to purchase toxic debt – is a bad idea. On the contrary, if the Tarp creates a liquid market for mortgage debt and removes rot from bank books, then all financial players will benefit – including those in London. This puts the British authorities in an unusually favourable position in formulating their own policies. (Aunty making money on Unkil's woes )

However, the problem with the Tarp is that the toxic assets are so fiendishly complex that they cannot be easily valued or traded. Even in good times, it can take a computer several days to price complex collateralised debt obligations. That creates daunting logistical obstacles for a Tarp, which could delay or blur the balance sheet benefits.

Putting money directly into the banks, by contrast, is a fast and transparent way to help them. Moreover, it worked relatively well when it was employed by Japan and Sweden a decade ago, in tandem with various initiatives to purchase toxic assets. Better still, while both Sweden and Japan badly underestimated the scale of their crisis when it started, once they finally produced a hefty bail-out plan, they eventually recouped most of their investment. ( A nation of shopkeepers always knows how to make money it seem )

A second point of cheer is that the British now also seem ready to take other steps to get credit and money markets moving again. The most eye-catching element of this revolves around injections into the money markets. However, what is equally important is a pledge that debt issued by banks will be protected from default.

That may sound arcane. However, it is crucial. Until last month, European and US investors assumed that bonds issued by large banks were safe, since they had been protected in previous decades. But the manner of Lehman Brothers’ collapse shattered that belief in a manner that sparked a catastrophic chain of fear. The Federal Reserve’s apparent failure to anticipate that shock represents one of its biggest single policy mistakes. Wednesday’s announcement suggests the UK authorities have no intention of repeating this disastrous error. So much the better.

However, the third reason for cheer lies not in arcane finance – but sociology. Right now many voters are understandably furious with bankers. No wonder. When the banking crisis hit Japan a decade ago, bankers bowed to show their public remorse; this time, however, barely a single western banker has even said “sorry”.

Now, there is no guarantee that the British government can assuage this anger; but on Wednesday it did at least promise to impose more “discipline” on bankers. That may turn out to be mere window dressing; but it is more than anything offered by Washington so far.

Of course, none of this guarantees the UK can now end its banking woes, let alone avoid a recession. Unlike the Japanese and Swedish crises, this one is international. As a result, the fortunes of British finance now depend on more than UK policymaking alone.

But, with a bit of international co-ordination – and a hefty dose of luck – London does now have a chance of stabilising its banking system. The tragedy is that it took so much incompetence and denial – on both sides of the Atlantic – to arrive at this point. If nothing else, the next generation of bankers and financial bureaucrats should be compelled to start their careers by spending time studying financial history books.

Suraj wrote:Nikkei 225 is down 900 pts (9.5%) this morning. What's happening in Japan ? The Dow and Nikkei seem to be on a race to the bottom, each ending lower than the other on a daily basis the last few days.

Suraj wrote:Nikkei 225 is down 900 pts (9.5%) this morning. What's happening in Japan ? The Dow and Nikkei seem to be on a race to the bottom, each ending lower than the other on a daily basis the last few days.

Singha wrote:I believe Sakharovji and Igor Tammji made a small decimal placement error on the physics
yield calculations for placement of the fusion secondary. instead of the 52MT desired,
they built one for 520MT and lit the fuse

the shockwave has already circled the world 108 times and the mushroom cloud threatens
all of life.

ldev wrote:In your inimitable way, you have hit the nail on the head. The primary core was the imprudently doled out mortagages, the tamper was the mortage backed securities and the fusion secondary that you have so aptly described are the credit default swaps. And as Nassim Taleb says in his piece, they made a boo boo in the math modelling..... and instead of a 52MT yield, you have a 520MT yield!!

Arab economies ill-prepared for global shocks

http://www.gulfnews.com/business/Markets/10250923.html

Agencies
Published: October 10, 2008, 00:27

Beirut: Like anyone invested in global financial markets, Arab sovereign funds, investment banks and rich individuals are taking a severe beating.

Also getting queasy are those who have poured money into real estate ventures in boom towns like Dubai or Doha, or the frothy housing markets of Amman, Damascus and Beirut that have been fuel-led by remittances and investments from the Gulf.

"People who have money in the Middle East are deeply plugged into the global financial system. They have nowhere else to go," argued Rami Khouri, a Beirut-based Middle East commentator.

"We are getting a double whammy - the direct impact of the global financial crisis and the cumulative backlash of our own mediocre public policies in the last 40 years."

Change in fortunes

Middle East stock markets, at first shielded by the region's vast oil money inflows, saw panic selling this week amid fears that a five-year Gulf property boom was over and developers would have to merge as financing conditions worsened.

Kuwait slashed its benchmark discount rate by 125 basis point to 4.50 per cent from 5.75 on Wednesday to shore up its economy, putting pressure on other Gulf banks to follow suit.

A plunge in world oil prices to around $89.27 a barrel from a record $147 in July has provided another sharp reminder of the vulnerability of many Arab economies to global shocks - even those where free-market policies have made only slow inroads.

"The Arab region is not yet fully globalised. It represents no more than 2.5 per cent of the world economy, from which it is still disconnected, except for oil," said Louis Hobeika, an economics professor at Lebanon's Notre Dame University.

That disconnect might provide some protection from global upheaval, he added. "However, during a period of recovery, we lose a lot because we don't grow with the rest of the world."

In Egypt, the world crisis should make free-market reforms like privatisation all the more urgent, said Angus Blair, head of research at investment bank Beltone Financial in Cairo.

October 9, 2008, 2:45 pm
The Looming Lehman CDS Unwind
Posted by MarketBeat Staff

Geoffrey Rogow reports:

On the heels of similar auction processes for Fannie Mae, Freddie Mac and Washington Mutual late last month will be the expected Friday settlement for buyers of about $400 billion of protection on Lehman Brothers debt.

For now, traders in the equity market are concerned about the prospects for the settlement, adding that its uncertainty is casting a dark cloud over the most likely holders of the debt — big banks such as Morgan Stanley, Goldman Sachs and J.P. Morgan Chase.

This Lehman credit default swaps settlement auction will likely be one of the most expensive payouts in the history of that market, something the government is certainly keeping an eye on.

The Fed has called a second meeting to discuss the settlement of Lehman CDSs, among other issues, on Friday. “They think there is still counterparty risk out there. But, if we get through that hurdle without too many issues then you will see a more stable market into next week,” said John O’Donoghue, head of equities for Cowen & Co.

O’Donoghue said the Fed is trying to make sure there is a “smooth” settlement process where that agency can then move towards making the settlement process a more government-regulated, centralized market.
Permalink | Trackback URL: http://blogs.wsj.com/marketbeat/2008/10 ... trackback/

vina wrote: The "experts" and phony stat's guys based on time series analysis seems pretty confident on having a handle on the risks!.. Think of it. If these jokers cannot get something as simple as the stock market right, depsite pouring billions and the brightest PhDs from the best univs in the world, what chance in hell did they have in getting something as complex a national economy as India's by some ridiculously simplistic econometric models.. What chance do they have of getting something as complex as the human mind and social interactions with any degree of certainty in some linear regression models ? No wonder the damned things keep breaking all the time.

No sir.. The JNU/DSE/ISI/Oxbridge types are omniscient like god.. why ? because they got "Religion" at Oxbridge and they can do time series statistical math saar!.

But Nassem Nicholas Taleb was absolutely spot on. In fact his book "Black Swan" is in front of god for Saraswati Puja /Vijay Dashami from my side ,along with SHQ and the kid's books. In fact, if you read Black Swan, he talks about the previous banking crisises in the US and how in the south american default when ALL South American and Central American countries defaulted collectively at the same time , the US banks lost many times (did he say 1000)more money they had ever made in the collective existence of banking in the US until then! .. I knew the "Brady" bonds in the US, but I had no idea that the bail out was on such a massive scale back then. The S&L crisis was another one.

From Publishers Weekly
In late September 1998, the New York Federal Reserve Bank invited a number of major Wall Street investment banks to enter a consortium to fund the multibillion-dollar bailout of a troubled hedge fund. No sooner was the $3.6-billion plan announced than questions arose about why usually independent banks would band together to save a single privately held fund. The short answer is that the banks feared that the fund's collapse could destabilize the entire stock market. The long answer, which Lowenstein (Buffett) provides in undigested detail, may panic those who shudder at the thought of bouncing a $200 check. Long-Term Capital Management opened for business in February 1994 with $1.25 billion in funds. Armed with the cachet of its founders' stellar credentials (Robert Merton and Myron Scholes, 1997 Nobel Prize laureates in economics, were among the partners), it quickly parlayed expertise at reading computer models of financial markets and seemingly limitless access to financing into stunning results. By the end of 1995, it had tripled its equity capital and total assets had grown to $102 billion. Lowenstein argues that this kind of success served to enhance the fund's golden legend and sent the partners' self-confidence off the charts. As he itemizes the complex mix of investments and heavy borrowing that made 1994-1997 profitable years, Lowenstein also charts the subtle drift toward riskier (and ultimately disastrous) ventures as the fund's traditional profit centers dried up. What should have been a gripping story, however, has been poorly handled by Lowenstein, who obscures his narrative with masses of data and overwritten prose. Agent, Melanie Jackson.

shaardula wrote:
in psychology also, many models fail. but the meme of scientific study and their watered down word in Time and Newsweek have become so much of an accepted social norm that disasters are not tangible. Many products go from Lab to market with very little vetting. Ordinary folks are in no position to make value judgements on any of these.

who is going to sue anybody if it turns out that secularism is not the most condusive of environments to sustain the social ferment that academia itself peddles as the holy grail of human condition?

shaardula wrote:
* my father, a succesful first generation businessman, with experience in most of india bar the east and Kashmir, once told me that the only place where marvaaDis, whom he respected a lot and counts among the best of his friends, dont have a say is in South kanara where the konkanis are operant. from his travels across most of india, including villages in TN, that is the only place and konkanis the only people, not even the uber smart telugu speaking komati shettys who operate in most of SI, who have held their forts against the smarts of a marvaadi. Dakshina Kannada is the only bastion where the marvadis have no say. You can walk up and down downtown mangalore and udupi and even kundapura to test this.

Before delving into the minutiae of total costs to the government though, a brief recap of recent events as follows:

-Ireland guaranteed all bank deposits as well as interbank lending last week for all its banks, in effect providing a sovereign guarantee on the entire banking system at an indeterminate cost to taxpayers.
-Other countries in Europe including Greece followed suit in terms of guaranteeing all bank deposits. Anecdotally, this wasn't enough to actually stop outflows of funds from the banking sector in some countries.
-Germany stepped in to directly rescue Hypo Real Estate over the last weekend, after a previously agreed rescue plan involving other banks fell through, leaving the government with the wreckage.
-Even the usually insular French got into the act by suggesting the creation of cross-border bailout fund that was, however, rebuffed by Germany, as the latter believes its financial institutions aren't facing any imminent danger in the current market crisis.
-Iceland had to nationalize its largest bank Kaupthing on Thursday, marking the third bank after Glitnir and Landsbanki to be taken over by the government. This drove strategic trades that are discussed later in the article.
-The UK announced the most comprehensive series of bank interventions seen of late, marking a culmination of government involvement in the sector after the collapse of Northern Rock last year (see Rocking the land of Poppins, Asia Times Online, September 22, 2007); under the plan the government will provide up to 500 billion pounds (US$844 billion) in assistance for the sector including fresh injections of capital that have been modelled on the rescue of AIG by the US government.
-Spain announced a 50 billion euro (US$68 billion) emergency fund earlier this week to provide liquidity by buying assets directly from Spanish banks. Nordic countries like Sweden and Denmark also extended deposit guarantees and in some cases also covered unsecured debt issued by the banks.
-In conjunction with the US Fed, both the Bank of England and the European Central Bank this week cut interest rates by 50 basis points, signaling their willingness to provide greater liquidity to the broader economy while suspending inflation targeting for the interim period. This move will cut the incomes of millions of pensioners across Europe, therefore the overall economic impact on the "old" continent is not a straightforward positive as it is in the case of the US.

* OCTOBER 9, 2008

First Into Recession, California Shows Possible Future for U.S.
By CONOR DOUGHERTY, RHONDA L. RUNDLE and JUSTIN LAHART

Here's the latest trend that started in California and is spreading to the rest of the country: recession.

It's all but certain the U.S. economy is in a recession, as falling home prices and Wall Street turmoil have put the brakes on consumer spending and stoked unemployment. But California got there first. Now, the state provides a template of how a broad U.S. downturn could look.
California's current problems started with the housing bubble, which hit places like Moreno Valley, above, particularly hard.

With its export businesses, manufacturing sector, professional services and big retail employers, California looks like many other U.S. states, only more so. California's $1.8 trillion economy -- twice the size of India's and accounting for about 15% of the U.S. gross domestic product -- is powerful enough to have ripple effects nationally. It is home to Hollywood, five of 30 Major League Baseball franchises and the largest farming sector in the nation.

California was also at the leading edge of the nation's recent housing bubble, which is where its current problems started. Home prices in California rose higher and faster than in most of the U.S., and started weakening earlier, in 2005. Some mortgage-holders defaulted. Others struggle along under a mountain of debt. The problems spread to the state's financial sector, which was heavily exposed to local real estate. As Californians cut their spending, job losses spread from the housing sector to retail stores and auto dealers. Now the state's unemployment rate is 7.7%, among the highest in the nation.

Along with Sunbelt states such as Florida and Nevada, California is a big source of the shocks now working through the world's banks, corporations and stock markets. The financial crisis has frozen credit markets, cutting into companies' ability to engage in even the day-to-day borrowing they need to run their businesses.

But even before the most recent blows to the national economy, Californians were feeling the downward drag of a consumer-led recession -- in which shrinking home values caused people to rein in their spending, fueling unemployment and, in turn, sparking further spending cuts and joblessness.
[Chart]

John Luc has seen how housing problems bleed into the broader economy. Mr. Luc is the 36-year-old manager of Homestore Furniture in Ontario, a middle-class community 40 miles east of Los Angeles and one of the centers of the housing bust. Since last year, retail sales have fallen, while unemployment and office vacancies have soared. Eighteen months ago, he watched a nearby Levitz furniture store close down in a bankruptcy sale. Since then, he said, the few buyers who've visited his store ask for discounts. "Everybody negotiates," he says.

The other day, Mr. Luc was presiding over the store's going-out-of-business sale. Although the father of two young children expects to get a job at another Homestore outlet, he and his wife have checked their spending. He says he saves $50 or more each week by packing a lunch each day, and he makes coffee at home instead of stopping at Starbucks during his long commute. "I haven't gone into a steakhouse like a Black Angus for dinner in six to eight months," he says.

Consumer spending accounts for about 70% of U.S. economic activity, so as people like Mr. Luc cut back, job losses and other economic woes follow. In the third quarter of 2007, California's taxable sales declined 1.82% from the year-earlier period, the first annual decline since 2002. Taxable sales have fallen every quarter since. Now in addition to construction workers and mortgage brokers, people like retail clerks, accountants and information-technology consultants are losing their jobs.

A similar dynamic is playing out nationally. Retail sales recently started declining, after peaking in June. Rising job losses appear likely to cut into future sales. In September, the U.S. economy shed 159,000 workers from its payrolls. The unemployment rate was 6.1%, compared with 4.7% a year earlier.

There's no universal definition of recession, and little agreement of what constitutes one in a state economy. But by most measures economists use -- rising job losses, shrinking consumer sales -- California fits the bill. "There is no question that this area is in a recession," says John Husing, an economist in Redlands, Calif., who tracks the Inland Empire region east of Los Angeles. "We're the canary in the mine shaft."

It's unclear whether the state, as one of the first to enter an economic slowdown, will be among the first to emerge. Problems in the broader economy could also hit California in a second wave. Stephen Levy, director of the Center for Continuing Study of the California Economy, expects the state's economy to get worse before it gets better. He expects job loss to continue through 2009, as consumers continue to pull back. While the housing sector probably won't fall much further, Mr. Levy said, many consumers aren't able to tap the equity in their homes for purchases. Falling stock prices and expensive gasoline and food will continue to eat into spending, he says.
Not Always a Bellwether

California isn't always a bellwether for the nation's economy. In fact, in the past two national recessions, the state was stung by sharp job losses in important industries -- aerospace and defense in the early 1990s, and technology in the early 2000s -- but was among the last group of states to succumb to recession.

But this time around, after years of double-digit price rises, median home prices stood far above what a household with a median income could afford. Permits for new homes began dropping sharply in fall 2005, something that didn't happen for the nation as a whole until spring 2006. Home prices in the state's largest real-estate markets fell earlier and further than those countrywide. Prices in San Francisco, Los Angeles and San Diego are currently down an average of 28% from their 2006 levels, compared with 19% for the S&P/Case-Shiller 20-City Composite Home Price index nationally.

The mortgage-lending frenzy was at its hottest in California, and the state's financial firms were at the forefront of extending untraditional mortgages that were then folded into complex securities. Those firms were also among the first to face disaster when the value of those securities collapsed.
[chart]

In April of last year, New Century Financial Corp., a subprime lender in Irvine, filed for bankruptcy protection. Four months later, Calabasas-based Countrywide Financial Corp. was at the center of the credit-market convulsions. The fallout continued into this year: When federal regulators seized Pasadena-based IndyMac Bancorp Inc. in July, it was the third-biggest U.S. bank failure to date.

California's losses prefigured the later fallout on Wall Street. Through August, California had seen finance-related jobs fall 6.8% over the past two years, compared with 1.5% nationally.

California's consumers are among the country's most indebted. For every dollar they take home, Californians spend about 19 cents on mortgages, cars, credit cards and other debt payment, compared with about 15 cents nationally, according to Equifax and Moody's Economy.com. As consumers pay down that debt, there will be less left over for purchases, which is better in the long run for the economy's health but hard on retailers now.
Pool and Pet Toys

With banks tightening the flow of credit, even companies with rising consumer demand are having a hard time expanding. For the past decade, CoopSport in Vista has sold its beach, pool and pet toys mostly in specialty retailers. But last month, it received orders for the first time from mass merchants Target Corp., Wal-Mart Stores Inc. and Toy "R" Us Inc.

In the past, says owner Scott Cooper, CoopSport was able to get credit from its Chinese factories at an annual interest rate of about 10%. But as the credit crisis spreads globally, Chinese factory owners won't provide him the usual financing. He also can't get the credit he needs from the U.S. banks he has contacted. So he has stitched together loans from a series of nontraditional lenders, which charge as much as 18% annual interest.

Mr. Cooper says he has sold a 7.5% equity stake to raise additional capital to fund the expansion. Far from adding staff as he gets ready to expand, CoopSport eliminated eight warehouse workers and two office staff. The company further cut costs by switching to a cheaper box manufacturer and a cheaper truck company. "It's all the things you do when you go into survival mode in this economy," he said.

California's big technology sector could also get hit hard by slowing overseas growth and the troubled financial sector. Santa Clara-based semiconductor-equipment manufacturer Applied Materials Inc., for example, fetches more than 80% of its revenue from overseas sales. And financial firms are among the technology sector's biggest customers.

Of course, even in recession California has its strengths. With its universities producing new technologies and entrepreneurial talent, the state has a disproportionate share of well-paying jobs in sectors like telecommunications, biotechnology and energy-efficient technology. Its health-care sector, like that of the rest of the U.S., has continued to add jobs.

Exports also have been a bright spot as a weak U.S. dollar has made goods cheaper abroad. The ports of Long Beach and Los Angeles are the nation's two largest, and have seen a rising stream of goods headed overseas. Through August this year, 22% more full containers were shipped out of the ports combined, compared with the first eight months of last year. With the world economy slowing, exports are expected to slow locally and across the country.

Some economists also believe the state's housing market may hit bottom before the rest of the nation's, and could start an upward tick earlier as well. The loss of construction and finance jobs has slowed. In San Diego, one of the first housing markets to falter, home prices are roughly in line with the city's incomes and rental rates. "Housing is becoming affordable again," said Steve Cochrane, an economist at Moody's Economy.com.
Trouble in Stockton

The pain of the housing bust has been harder on inland areas than it has been in coastal cities such as San Francisco and Los Angeles, which generally have more high-paying jobs.

Stockton, a bedroom community to the Bay Area known for its asparagus festival, saw a boom in home-building and subprime loans this decade. Now, median home values are down nearly 50% from the market's peak, according to real-estate information service Zillow.com. Stockton's unemployment rate has risen 2.8 percentage points, to 10.3% over the past two years. In San Francisco, which has a greater concentration of jobs in areas like technology and professional services, the unemployment rate has risen 1.1 percentage point, to 5.1% over the same period.

In the Bay Area, the creep of economic weakness unfolds in an hour's drive from the San Francisco exurbs. Cities like Antioch and Brentwood, past the last stop on the BART commuter rail line, are among the hardest hit by the housing bust. Closer to the coast are Concord and Walnut Creek, two San Francisco suburbs that have previously thrived with light industrial and office buildings that are a lower-cost alternative to downtown San Francisco and the Silicon Valley.

Now, downtown Walnut Creek's commercial vacancy rate for Class A space has risen to 14.7% from 9.9% last year. Concord's commercial vacancy rate has jumped to 21% from 9.5% in 2007.

Ed Del Beccaro, an office broker and senior managing partner at Colliers International in Walnut Creek, says his office's income is down about 20% this year. Mr. Del Beccaro cut four of his 38 brokers in January. Others, he says, have left for "real jobs" because their commissions were so low.
Car Sales Down

As East Bay consumers have struggled, so has Darren Anderson, whose family owns Lehmer's Buick Pontiac GMC in Concord. Mr. Anderson says Buick Pontiac GMC dealers in Northern California sold about 1,000 cars in August, compared with around 1,900 last year. In the past few months, Lehmer's has cut 10 of its roughly 50 employees.

As sales fall, so have the taxes collected by California governments, whose spending can offer a buffer during times of economic weakness. Through the first three quarters of this year, California's sales tax revenue is down about 5% compared with the first three quarters of 2007. Ongoing budget troubles resulted in a $15 billion deficit this year for California.

Budget troubles are déjà vu for many Californians. In the aftermath of the dot-com bust, falling incomes and stock-market losses created a $38 billion budget deficit, and the ensuing furor sparked a recall election that brought current Gov. Arnold Schwarzenegger to power.

Today's budget troubles are potentially even worse than in the late 1990s: Falling home prices have reduced property taxes on which local governments depend, at a time when the state is cutting aid to municipalities. Also, the credit crunch has made it harder to sell bonds to fund longer-term capital projects such as roads and schools.

Write to Conor Dougherty at [email protected], Rhonda L. Rundle at [email protected] and Justin Lahart at [email protected]

shaardula wrote:I mean c'mon, why do I have to discard the theories of personal money that ..................

ALERT
RGE Monitor
October 9, 2008


On Thursday, October 09, 2008, Nouriel Roubini – Chairman of RGE Monitor and Professor of Economics at the NYU Stern School of Business – lays out his latest views on the global economic and financial crisis and the urgent necessary actions that need to be undertaken globally.

Nouriel Roubini: The world is at severe risk of a global systemic financial meltdown and a severe global depression

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.

On the real economic side, all the advanced economies representing 55% of global GDP (U.S., Eurozone, UK, other smaller European countries, Canada, Japan, Australia, New Zealand, Japan) entered a recession even before the massive financial shocks that started in the late summer made the liquidity and credit crunch even more virulent and will thus cause an even more severe recession than the one that started in the spring. So we have a severe recession, a severe financial crisis and a severe banking crisis in advanced economies.

There was no decoupling among advanced economies and there is no decoupling but rather recoupling of the emerging market economies with the severe crisis of the advanced economies. By the third quarter of this year global economic growth will be in negative territory signaling a global recession. The recoupling of emerging markets was initially limited to stock markets that fell even more than those of advanced economies as foreign investors pulled out of these markets; but then it spread to credit markets and money markets and currency markets bringing to the surface the vulnerabilities of many financial systems and corporate sectors that had experienced credit booms and that had borrowed short and in foreign currencies. Countries with large current account deficits and/or large fiscal deficits and with large short-term foreign currency liabilities and borrowings have been the most fragile. But even the better performing ones – like the BRICs club of Brazil, Russia, India and China – are now at risk of a hard landing. Trade and financial and currency and confidence channels are now leading to a massive slowdown of growth in emerging markets with many of them now at risk not only of a recession but also of a severe financial crisis.

The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity where excessive leveraging and bubbles were not limited to housing in the U.S. but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.

At this point the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the U.S. and advanced economies contraction would be short and shallow – a V-shaped six month recession – has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the U.S. and close to two years in most of the rest of the world. And given the rising risk of a global systemic financial meltdown, the probability that the outcome could become a decade long L-shaped recession – like the one experienced by Japan after the bursting of its real estate and equity bubble – cannot be ruled out.

And in a world where there is a glut and excess capacity of goods while aggregate demand is falling, soon enough we will start to worry about deflation, debt deflation, liquidity traps and what monetary policy makers should do to fight deflation when policy rates get dangerously close to zero.

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.

This disconnect between more and more aggressive policy actions and easings, and greater and greater strains in the financial market is scary. When Bear Stearns’ creditors were bailed out to the tune of $30 bn in March, the rally in equity, money and credit markets lasted eight weeks; when in July the U.S. Treasury announced legislation to bail out the mortgage giants Fannie and Freddie, the rally lasted four weeks; when the actual $200 billion rescue of these firms was undertaken and their $6 trillion liabilities taken over by the U.S. government, the rally lasted one day, and by the next day the panic had moved to Lehman’s collapse; when AIG was bailed out to the tune of $85 billion, the market did not even rally for a day and instead fell 5%. Next when the $700 billion U.S. rescue package was passed by the U.S. Senate and House, markets fell another 7% in two days as there was no confidence in this flawed plan and the authorities. Next, as authorities in the U.S. and abroad took even more radical policy actions between October 6th and October 9th (payment of interest on reserves, doubling of the liquidity support of banks, extension of credit to the seized corporate sector, guarantees of bank deposits, plans to recapitalize banks, coordinated monetary policy easing, etc.), the stock markets and the credit markets and the money markets fell further and further and at accelerated rates day after day all week, including another 7% fall in U.S. equities today.

When in markets that are clearly way oversold, even the most radical policy actions don’t provide rallies or relief to market participants. You know that you are one step away from a market crash and a systemic financial sector and corporate sector collapse. A vicious circle of deleveraging, asset collapses, margin calls, and cascading falls in asset prices well below falling fundamentals, and panic is now underway.

At this point severe damage is done and one cannot rule out a systemic collapse and a global depression. It will take a significant change in leadership of economic policy and very radical, coordinated policy actions among all advanced and emerging market economies to avoid this economic and financial disaster. Urgent and immediate necessary actions that need to be done globally (with some variants across countries depending on the severity of the problem and the overall resources available to the sovereigns) include:


* another rapid round of policy rate cuts of the order of at least 150 basis points on average globally;
* 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.


At this point anything short of these radical and coordinated actions may lead to a market crash, a global systemic financial meltdown and to a global depression. The time to act is now as all the policy officials of the world are meeting this weekend in Washington at the IMF and World Bank annual meetings.
***

Read more of Nouriel’s views on the current economic situation on Nouriel Roubini’s Global EconoMonitor at http://www.rgemonitor.com/blog/roubini.