Meet the Economist Who Thinks We're Doomed
By
Stephen Mihm, The New York Times. Posted August 18, 2008.
Dr. Nouriel Roubini believes we face a housing bust, a huge credit
crisis, an oil shock and a deep recession. Just for starts.
On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund
and announced that a crisis was brewing. In the coming months and
years, he warned, the United States was likely to face a
once-in-a-lifetime housing bust, an oil shock, sharply declining
consumer confidence and, ultimately, a deep recession. He laid out a
bleak sequence of events: homeowners defaulting on mortgages, trillions
of dollars of mortgage-backed securities unraveling worldwide and the
global financial system shuddering to a halt. These developments, he
went on, could cripple or destroy hedge funds, investment banks and
other major financial institutions like Fannie Mae and Freddie Mac.
The audience seemed skeptical, even dismissive. As Roubini stepped
down from the lectern after his talk, the moderator of the event
quipped, “I think perhaps we will need a stiff drink after that.”
People laughed — and not without reason. At the time, unemployment and
inflation remained low, and the economy, while weak, was still growing,
despite rising oil prices and a softening housing market. And then
there was the espouser of doom himself: Roubini was known to be a
perpetual pessimist, what economists call a “permabear.” When the
economist Anirvan Banerji delivered his response to Roubini's talk, he
noted that Roubini's predictions did not make use of mathematical
models and dismissed his hunches as those of a career naysayer.
But
Roubini was soon vindicated. In the year that followed, subprime
lenders began entering bankruptcy, hedge funds began going under and
the stock market plunged. There was declining employment, a
deteriorating dollar, ever-increasing evidence of a huge housing bust
and a growing air of panic in financial markets as the credit crisis
deepened. By late summer, the Federal Reserve
was rushing to the rescue, making the first of many unorthodox
interventions in the economy, including cutting the lending rate by 50
basis points and buying up tens of billions of dollars in
mortgage-backed securities. When Roubini returned to the I.M.F. last
September, he delivered a second talk, predicting a growing crisis of
solvency that would infect every sector of the financial system. This
time, no one laughed. “He sounded like a madman in 2006,” recalls the
I.M.F. economist Prakash Loungani, who invited Roubini on both
occasions. “He was a prophet when he returned in 2007.”
Over the
past year, whenever optimists have declared the worst of the economic
crisis behind us, Roubini has countered with steadfast pessimism. In
February, when the conventional wisdom held that the venerable
investment firms of Wall Street would weather the crisis, Roubini
warned that one or more of them would go “belly up” — and six weeks
later, Bear Stearns
collapsed. Following the Fed's further extraordinary actions in the
spring — including making lines of credit available to selected
investment banks and brokerage houses — many economists made note of
the ensuing economic rally and proclaimed the credit crisis over and a
recession averted. Roubini, who dismissed the rally as nothing more
than a “delusional complacency” encouraged by a “bunch of self-serving
spinmasters,” stuck to his script of “nightmare” events: waves of
corporate bankrupticies, collapses in markets like commercial real
estate and municipal bonds and, most alarming, the possible bankruptcy
of a large regional or national bank that would trigger a panic by
depositors. Not all of these developments have come to pass (and
perhaps never will), but the demise last month of the California bank
IndyMac — one of the largest such failures in U.S. history — drew
only more attention to Roubini's seeming prescience.
As a
result, Roubini, a respected but formerly obscure academic, has become
a major figure in the public debate about the economy: the seer who saw
it coming. He has been summoned to speak before Congress, the Council on Foreign Relations and the World Economic Forum
at Davos. He is now a sought-after adviser, spending much of his time
shuttling between meetings with central bank governors and finance
ministers in Europe and Asia. Though he continues to issue colorful
doomsday prophecies of a decidedly nonmainstream sort — especially on
his popular and polemical blog, where he offers visions of “equity
market slaughter” and the “Coming Systemic Bust of the U.S. Banking
System” — the mainstream economic establishment appears to be moving
closer, however fitfully, to his way of seeing things. “I have in the
last few months become more pessimistic than the consensus,” the former
Treasury secretary Lawrence Summers told me earlier this year. “Certainly, Nouriel's writings have been a contributor to that.”
On a cold and dreary
day last winter, I met Roubini over lunch in the TriBeCa neighborhood
of New York City. “I'm not a pessimist by nature,” he insisted. “I'm
not someone who sees things in a bleak way.” Just looking at him, I
found the assertion hard to credit. With a dour manner and an aura of
gloom about him, Roubini gives the impression of being permanently
pained, as if the burden of what he knows is almost too much for him to
bear. He rarely smiles, and when he does, his face, topped by an unruly
mop of brown hair, contorts into something more closely resembling a
grimace.
When I pressed him on his claim that he wasn't
pessimistic, he paused for a moment and then relented a little. “I have
more concerns about potential risks and vulnerabilities than most
people,” he said, with glum understatement. But these concerns, he
argued, make him more of a realist than a pessimist and put him in the
role of the cleareyed outsider — unsettling complacency and puncturing
pieties.
Roubini, who is 50, has been an outsider his entire
life. He was born in Istanbul, the child of Iranian Jews, and his
family moved to Tehran when he was 2, then to Tel Aviv and finally to
Italy, where he grew up and attended college. He moved to the United
States to pursue his doctorate in international economics at Harvard.
Along the way he became fluent in Farsi, Hebrew, Italian and English.
His accent, an inimitable polyglot growl, radiates a weariness that
comes with being what he calls a “global nomad.”
As a graduate student at Harvard, Roubini was an unusual talent, according to his adviser, the Columbia economist Jeffrey Sachs.
He was as comfortable in the world of arcane mathematics as he was
studying political and economic institutions. “It's a mix of skills
that rarely comes packaged in one person,” Sachs told me. After
completing his Ph.D. in 1988, Roubini joined the economics department
at Yale,
where he first met and began sharing ideas with Robert Shiller, the
economist now known for his prescient warnings about the 1990s tech
bubble.
The '90s were an eventful time for an international
economist like Roubini. Throughout the decade, one emerging economy
after another was beset by crisis, beginning with Mexico's in 1994.
Panics swept Asia, including Thailand, Indonesia and Korea, in 1997 and
1998. The economies of Brazil and Russia imploded in 1998. Argentina's
followed in 2000. Roubini began studying these countries and soon
identified what he saw as their common weaknesses. On the eve of the
crises that befell them, he noticed, most had huge current-account
deficits (meaning, basically, that they spent far more than they made),
and they typically financed these deficits by borrowing from abroad in
ways that exposed them to the national equivalent of bank runs. Most of
these countries also had poorly regulated banking systems plagued by
excessive borrowing and reckless lending. Corporate governance was
often weak, with cronyism in abundance.
Roubini's work was
distinguished not only by his conclusions but also by his approach. By
making extensive use of transnational comparisons and historical
analogies, he was employing a subjective, nontechnical framework, the
sort embraced by popular economists like the Times Op-Ed columnist Paul
Krugman and Joseph Stiglitz
in order to reach a nonacademic audience. Roubini takes pains to note
that he remains a rigorous scholarly economist — “When I weigh
evidence,” he told me, “I'm drawing on 20 years of accumulated
experience using models” — but his approach is not the contemporary
scholarly ideal in which an economist builds a model in order to
constrain his subjective impressions and abide by a discrete set of
data. As Shiller told me, “Nouriel has a different way of seeing things
than most economists: he gets into everything.”
Roubini likens his style to that of a policy maker like Alan Greenspan,
the former Fed chairman who was said (perhaps apocryphally) to pore
over vast quantities of technical economic data while sitting in the
bathtub, looking to sniff out where the economy was headed. Roubini
also cites, as a more ideologically congenial example, the sweeping,
cosmopolitan approach of the legendary economist John Maynard Keynes,
whom Roubini, with only slight exaggeration, calls “the most brilliant
economist who never wrote down an equation.” The book that Roubini
ultimately wrote (with the economist Brad Setser) on the emerging
market crises, “Bailouts or Bail-Ins?” contains not a single equation
in its 400-plus pages.
After analyzing the markets that
collapsed in the '90s, Roubini set out to determine which country's
economy would be the next to succumb to the same pressures. His
surprising answer: the United States'. “The United States,” Roubini
remembers thinking, “looked like the biggest emerging market of all.”
Of course, the United States wasn't an emerging market; it was (and
still is) the largest economy in the world. But Roubini was unnerved by
what he saw in the U.S. economy, in particular its 2004 current-account
deficit of $600 billion. He began writing extensively about the dangers
of that deficit and then branched out, researching the various effects
of the credit boom — including the biggest housing bubble in the
nation's history — that began after the Federal Reserve cut rates to
close to zero in 2003. Roubini became convinced that the housing bubble
was going to pop.
By late 2004 he had started to write about a
“nightmare hard landing scenario for the United States.” He predicted
that foreign investors would stop financing the fiscal and
current-account deficit and abandon the dollar, wreaking havoc on the
economy. He said that these problems, which he called the “twin
financial train wrecks,” might manifest themselves in 2005 or, at the
latest, 2006. “You have been warned here first,” he wrote ominously on
his blog. But by the end of 2006, the train wrecks hadn't occurred.
Recessions
are signal events in any modern economy. And yet remarkably, the
profession of economics is quite bad at predicting them. A recent study
looked at “consensus forecasts” (the predictions of large groups of
economists) that were made in advance of 60 different national
recessions that hit around the world in the '90s: in 97 percent of the
cases, the study found, the economists failed to predict the coming
contraction a year in advance. On those rare occasions when economists
did successfully predict recessions, they significantly underestimated
the severity of the downturns. Worse, many of the economists failed to
anticipate recessions that occurred as soon as two months later.
The
dismal science, it seems, is an optimistic profession. Many economists,
Roubini among them, argue that some of the optimism is built into the
very machinery, the mathematics, of modern economic theory. Econometric
models typically rely on the assumption that the near future is likely
to be similar to the recent past, and thus it is rare that the models
anticipate breaks in the economy. And if the models can't foresee a
relatively minor break like a recession, they have even more trouble
modeling and predicting a major rupture like a full-blown financial
crisis. Only a handful of 20th-century economists have even bothered to
study financial panics. (The most notable example is probably the late
economist Hyman Minksy, of whom Roubini is an avid reader.) “These are
things most economists barely understand,” Roubini told me. “We're in
uncharted territory where standard economic theory isn't helpful.”
True
though this may be, Roubini's critics do not agree that his approach is
any more accurate. Anirvan Banerji, the economist who challenged
Roubini's first I.M.F. talk, points out that Roubini has been peddling
pessimism for years; Banerji contends that Roubini's apparent foresight
is nothing more than an unhappy coincidence of events. “Even a stopped
clock is right twice a day,” he told me. “The justification for his
bearish call has evolved over the years,” Banerji went on, ticking off
the different reasons that Roubini has used to justify his predictions
of recessions and crises: rising trade deficits, exploding
current-account deficits, Hurricane Katrina,
soaring oil prices. All of Roubini's predictions, Banerji observed,
have been based on analogies with past experience. “This forecasting by
analogy is a tempting thing to do,” he said. “But you have to pick the
right analogy. The danger of this more subjective approach is that
instead of letting the objective facts shape your views, you will
choose the facts that confirm your existing views.”
Kenneth
Rogoff, an economist at Harvard who has known Roubini for decades, told
me that he sees great value in Roubini's willingness to entertain
possible situations that are far outside the consensus view of most
economists. “If you're sitting around at the European Central Bank,”
he said, “and you're asking what's the worst thing that could happen,
the first thing people will say is, 'Let's see what Nouriel says.' ”
But Rogoff cautioned against equating that skill with forecasting.
Roubini, in other words, might be the kind of economist you want to
consult about the possibility of the collapse of the municipal-bond
market, but he is not necessarily the kind you ask to predict, say, the
rise in global demand for paper clips.
His defenders contend
that Roubini is not unduly pessimistic. Jeffrey Sachs, his former
adviser, told me that “if the underlying conditions call for optimism,
Nouriel would be optimistic.” And to be sure, Roubini is capable of
being optimistic — or at least of steering clear of absolute
worst-case prognostications. He agrees, for example, with the
conventional economic wisdom that oil will drop below $100 a barrel in
the coming months as global demand weakens. “I'm not comfortable saying
that we're going to end up in the Great Depression,” he told me. “I'm a
reasonable person.”
What economic developments does
Roubini see on the horizon? And what does he think we should do about
them? The first step, he told me in a recent conversation, is to
acknowledge the extent of the problem. “We are in a recession, and
denying it is nonsense,” he said. When Jim Nussle,
the White House budget director, announced last month that the nation
had “avoided a recession,” Roubini was incredulous. For months, he has
been predicting that the United States will suffer through an 18-month
recession that will eventually rank as the “worst since the Great
Depression.” Though he is confident that the economy will enter a
technical recovery toward the end of next year, he says that job
losses, corporate bankruptcies and other drags on growth will continue
to take a toll for years.
Roubini has counseled various policy
makers, including Federal Reserve governors and senior Treasury
Department officials, to mount an aggressive response to the crisis. He
applauded when the Federal Reserve cut interest rates to 2 percent from
5.25 percent beginning last summer. He also supported the Fed's
willingness to engineer a takeover of Bear Stearns. Roubini argues that
the Fed's actions averted catastrophe, though he says he believes that
future bailouts should focus on mortgage owners, not investors.
Accordingly, he sees the choice facing the United States as stark but
simple: either the government backs up a trillion-plus dollars' worth
of high-risk mortgages (in exchange for the lenders' agreement to
reduce monthly mortgage payments), or the banks and other institutions
holding those mortgages — or the complex securities derived from them
– go under. “You either nationalize the banks or you nationalize the
mortgages,” he said. “Otherwise, they're all toast.”
For months
Roubini has been arguing that the true cost of the housing crisis will
not be a mere $300 billion — the amount allowed for by the housing
legislation sponsored by Representative Barney Frank and Senator Christopher Dodd
– but something between a trillion and a trillion and a half dollars.
But most important, in Roubini's opinion, is to realize that the
problem is deeper than the housing crisis. “Reckless people have
deluded themselves that this was a subprime crisis,” he told me. “But
we have problems with credit-card debt, student-loan debt, auto loans,
commercial real estate loans, home-equity loans, corporate debt and
loans that financed leveraged buyouts.” All of these forms of debt, he
argues, suffer from some or all of the same traits that first surfaced
in the housing market: shoddy underwriting, securitization, negligence
on the part of the credit-rating agencies and lax government oversight.
“We have a subprime financial system,” he said, “not a subprime
mortgage market.”
Roubini argues that most of the losses from
this bad debt have yet to be written off, and the toll from bad
commercial real estate loans alone may help send hundreds of local
banks into the arms of the Federal Deposit Insurance Corporation.
“A good third of the regional banks won't make it,” he predicted. In
turn, these bailouts will add hundreds of billions of dollars to an
already gargantuan federal debt, and someone, somewhere, is going to
have to finance that debt, along with all the other debt accumulated by
consumers and corporations. “Our biggest financiers are China, Russia
and the gulf states,” Roubini noted. “These are rivals, not allies.”
The
United States, Roubini went on, will likely muddle through the crisis
but will emerge from it a different nation, with a different place in
the world. “Once you run current-account deficits, you depend on the
kindness of strangers,” he said, pausing to let out a resigned sigh.
“This might be the beginning of the end of the American empire.”
© 2008 The New York Times
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See more stories tagged with: nouriel roubini
Stephen
Mihm, an assistant professor of economic history at the University of
Georgia, is the author of “A Nation of Counterfeiters: Capitalists, Con
Men and the Making of the United States.” His last feature article for
the magazine was about North Korean counterfeiting.
