Global Economic Crisis

In his latest blog posting, Roubini offered the following dire pronouncement: “The process of socializing the private losses from this crisis has already moved many of the liabilities of the private sector onto the books of the sovereign…at some point a sovereign bank may crack, in which case the ability of the governments to credibly commit to act as a backstop for the financial system-including deposit guarantees-could come unglued.”

If what Nouriel Roubini has prophesized is in fact about to occur, the inevitable consequence will be global financial and economic Armageddon, a danger that I have also warned about on this blog. However, let’s put Roubini’s gloomy warning in context.

Last fall, the world’s financial system did indeed come to the brink of total systemic meltdown. The Libor rates and Ted Spreads were at sky-high levels, reflecting a global financial architecture that had just entered the Ice Age. The arteries of global finance simply froze solid, leading to U.S. Treasury Secretary Hank Paulson demanding that Congress grant him $700 billion virtually within hours, no strings attached, or witness the global economy implode. Even after the TARP Wall Street bailout was approved, Roubini warned that it was not nearly enough to stave off disaster. Apparently, only the intervention of the treasuries and central banks of the U.K., Eurozone, China and Japan, combined with the American TARP, prevented the world financial order from falling off a cliff. This was done through a variety of extraordinary means, including direct taxpayer injections of cash into virtually insolvent banks, quantitative easing, monetary policies that brought central bank prime rates to historic lows and raising the level of sovereign guarantees for depositor’s insurance. In effect, governments in the major economies acted as a backstop, putting their sovereign credit potential on the line to preserve a measure of confidence necessary to prevent a total run on the banks and unsustainable levels of deleveraging.

All the steps outlined above have the appearance of panic-driven improvisation. As this crisis has already proven, improvisation in never a substitute for thoughtful and strategic policy response. It appears, based on what Roubini is now suggesting, that in the year 2009 we will witness the futility of the debt-driven mania to socialize the losses incurred by private risk-takers. If a sovereign bank does indeed crack wide open, Nouriel Roubini seems to be suggesting that this may be the final nail in the coffin of a mindless policy whereby governments offer virtually unlimited financial backstops to cover the losses of banks that accumulated massive quantities of toxic assets on their balance sheets.

Which sovereign bank may crack? At this point, Roubini is not saying, however it seems clear that it must be a significant institution to have the potential of generating the apocalyptic ramifications being suggested. There are undoubtedly many candidates. To take just one example, Royal Bank of Scotland has already accumulated $40 billion in losses in just the past year, and has only been kept alive through a 70% equity stake being funded by the British taxpayer. Yet, the worst is still to come in the U.K. economy, which must certainly bring further massive losses to RBS as well as other British banks. It may be that the losses to come will be of such a stratospheric character, not even the deficit-crazed politicians will be able to cobble together the promissory notes required to avoid bankruptcy.

As the Global Economic Crisis worsens, comparisons with the Great Depression of the 1930s are being made more frequently. What must be remembered about our last great global economic disaster is that while the stock market crash of 1929 precipitated the Great Depression, it was the collapse of a single bank, the Kreditanstalt of Austria in 1931,that began a chain reaction that crippled the global financial world. It was that bank collapse which made the depression of the 1930s the Great Depression, leading to systemic economic collapse, massive GDP contraction and previously inconceivable levels of unemployment.

As with his previous warnings, Professor Roubini again provides us with a glimpse into the future, and it is indeed filled with gloom and doom.