Nouriel Roubini writes: 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. (10/09/08)
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