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Thread: America's economy risks the mother of all meltdowns

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    Elite Member celeb_2006's Avatar
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    Default America's economy risks the mother of all meltdowns

    America's economy risks the mother of all meltdowns - Yahoo! News

    "I would tell audiences that we were facing not a bubble but a froth - lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy." Alan Greenspan, The Age of Turbulence.
    That used to be Mr Greenspan's view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University's Stern School of Business, founder of RGE monitor.
    Recently, Professor Roubini's scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is "a rising probability of a 'catastrophic' financial and economic outcome"**. The characteristics of this scenario are, he argues: "A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe."
    Prof Roubini is even fonder of lists than I am. Here are his 12 - yes, 12 - steps to financial disaster.
    Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.
    Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had "reckless or toxic features", argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks' ability to offer credit.
    Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The "credit crunch" would then spread from mortgages to a wide range of consumer credit.
    Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.
    Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.
    Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.
    Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a "fat tail" of companies has low profitability and heavy debt. Such defaults would spread losses in "credit default swaps", which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.
    Step nine would be a meltdown in the "shadow financial system". Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.
    Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.
    Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.
    Step 12 would be "a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices".
    These, then, are 12 steps to meltdown. In all, argues Prof Roubini: "Total losses in the financial system will add up to more than $1,000bn and the economic recession will become deeper more protracted and severe." This, he suggests, is the "nightmare scenario" keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.
    Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about "decoupling". If it lasts six quarters, as Prof Roubini warns, offsetting policy action in the rest of the world would be too little, too late.

    Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.
    The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.
    The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable.

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    Elite Member louiswinthorpe111's Avatar
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    First, Greenspan is negligent here. With the Fed, he dropped rates too low, too fast, creating a refi boom. In general, refi booms are not bad because they spur the economy in many aspects. It frees up money for cars, home improvement, furniture, electronics, etc... It made the subprime rates VERY low to entice those credit challenged people to get loans. THEN, the Fed raised rates, too high, too fast to combat inflation. It then maxed out the interest rates when the ARM's adjusted. Right now, I see the Fed making the same mistake with lowering rates too quickly, too much.

    The reason why we are in the situation we are in is not only due to the subprime crisis. Bush put a lot of it in motion, once he revised bankruptcy laws, increased the minimum payments on credit cards, and with skyrocketing gas prices. and you think and extra $1600 is going to help anyone? People that are in real trouble need more than $1600.
    RELIGION: Treat it like it's your genitalia. Don't show it off in public, and don't shove it down your children's throats.

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    Elite Member Grimmlok's Avatar
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    ahh the repuke mantra of letting industry (in this case, financial) regulate itself..
    I am from the American CIA and I have a radio in my head. I am going to kill you.

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    Elite Member sluce's Avatar
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    The American public must also take serious responsibility here. Too many people rushed out and bought houses, cars, vacations, etc - all on credit hoping they could cover the minimums due each month. They put themselves in a position of living paycheck to paycheck so they could have the material things they wanted right then. Guess what - the payments are now due. I am sick of seeing people complaining that the government did this to them and needs to bail them out from their own greed and inability to budget and live within their means. We are all now suffering as our taxes will be used to bail out greedy people.

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    Elite Member Grimmlok's Avatar
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    actually for the most part people are going bankrupt and the Fed is bailing out banks and financial institutions to the tune of hundreds of billions... using your tax dollars of course.
    I am from the American CIA and I have a radio in my head. I am going to kill you.

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    Elite Member tkdgirl's Avatar
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    The real problem is two-fold: one, shady subprime lenders who convinced home buyers they can afford more home than they really could, and two, uninformed, over trusting home buyers who didn't do research before financing, etc. Buying a home is not like buying a value meal at McDonalds.

    My problem, as an American taxpayer, is that ultimately, *I'M* bailing out these people who decided, whether on their own or by misinformation, to live beyond their means. It isn't the government's responsibility to save you from stupidity. Nor should it be mine.

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    Elite Member dolem's Avatar
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    I think in general credit is too easy to come by. There is no reason why teenagers should have credit cards. Or people just out of college have credit limits in the tens of thousands of dollars. A few years ago my friend mentioned that his credit limit was something like $20,000, there is no way that's normal for a 24 year old.

    I think the way our grandparents and parents lived is a much better way of life (I'm 28, btw). They didn't buy everything on credit, hoping to make the minimum payment. They worked and saved their money in order to purchase new things. I believe my g-parents purchased their house in San Diego outright at the time, because that's what you did.

    The attitude of "I want it all, and I want it now" is truly disgusting to me. People need to be more responsible for their actions. If you are in over your head, find a way out.

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