(edited for copyright purposes-proud patriot Moderator Democratic Underground)

This paper is very long, but well worth a read for anyone who wants to understand what's going on in the financial markets and wider economy.

Nouriel Roubini ia a professor of economics at New York University. He has been warning of impending economic crisis for a while now. This is a paper from last February that I dug out of my files earlier this week.

Everything Roubini predicted would happen has happened, in the order that he predicted it would. We are now at step 12 (in red below). Roubini went on to predict that the Feds would engineer a large scale bailout like the one Bush signed into law yesterday. Roubini believes it will not work and may make the crisis worse because it doesn't address the underlying causes and adds to the growing sense of insecurity, among other reasons.

The Rising Risk of a Systemic Financial Meltdown:
The Twelve Steps to Financial Disaster

by Nouriel Roubini
February 5, 2008

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past
January? It is true that most macro indicators are heading south and suggesting a deep
and severe recession that has already started. But the flow of bad macro news in mid-
January did not justify, by itself, such a radical inter-meeting emergency Fed action
followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a
“catastrophic” financial and economic outcome, i.e. 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. The Fed
is seriously worried about this vicious circle and about the risks of a systemic financial
meltdown.

That is the reason the Fed had thrown all caution to the wind – after a year in which it
was behind the curve and underplaying the economic and financial risks – and has taken
a very aggressive approach to risk management; this is a much more aggressive approach
than the Greenspan one in spite of the initial views that the Bernanke Fed would be more
cautious than Greenspan in reacting to economic and financial vulnerabilities.

To understand the risks that the financial system is facing today I present the “nightmare”
or “catastrophic” scenario that the Fed and financial officials around the world are now
worried about. Such a scenario – however extreme – has a rising and significant
probability of occurring. Thus, it does not describe a very low probability event but rather
an outcome that is quite possible.

that was forced to assume a staggering debt load because its wages had simply not kept pace with true inflation.

Yes, speculation in real estate and hedge fund funny securities are contributing to the collapse, but the lack of real indexing of wages is the root problem.

When people are forced into debt in lieu of wages while wealth concentrates, look out, because the whole edifice becomes topheavy and will always collapse.

bought too much house -- as if there were all these hobos squating in mcmansions that led us into this financial mess.

If it thinks we're only going to hit 1970s style recession, hell, I lived through that. I even got married and started a family through that. What's to worry about?

I've been putting together container gardening and resources for a huge depression. What am I going to do with all these potato eyes? lol

If it's too late to edit, please provide the link in a reply. A senior moderator may be able to snip the text.

Longhorn
DU Moderator

This is off of Roubini's web site:

http://media.rgemonitor.com/papers/0/12_steps_NR

eta: it took me a while to format it properly. Can it be restored now?

There may be a copyright disclaimer at the main site. Thank you.

http://www.rgemonitor.com/

The site is copyrighted, as noted at the bottom of the home page.

e-mail last Feb.

I e-mailed them RGE to try and clear it up, though. Hopefully they reply.

Here's the twelfth stage of a "scenario of systemic financial meltdown associated with this severe economic recession" according to Roubini's paper.

Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation
and fire sales of assets at below fundamental prices will ensue leading to a cascading and
mounting cycle of losses and further credit contraction. In illiquid market actual market
prices are now even lower than the lower fundamental value that they now have given the
credit problems in the economy. Market prices include a large illiquidity discount on top
of the discount due to the credit and fundamental problems of the underlying assets that
are backing the distressed financial assets. Capital losses will lead to margin calls and
further reduction of risk taking by a variety of financial institutions that are now forced to
mark to market their positions. Such a forced fire sale of assets in illiquid markets will
lead to further losses that will further contract credit and trigger further margin calls and
disintermediation of credit. The triggering event for the next round of this cascade is the
downgrade of the monolines and the ensuing sharp drop in equity markets; both will
trigger margin calls and further credit disintermediation.

Based on estimates by Goldman Sachs $200 billion of losses in the financial system lead
to a contraction of credit of $2 trillion given that institutions hold about $10 of assets per
dollar of capital. The recapitalization of banks sovereign wealth funds – about $80 billion
so far – will be unable to stop this credit disintermediation – (the move from off balance
sheet to on balance sheet and moves of assets and liabilities from the shadow banking
system to the formal banking system) and the ensuing contraction in credit as the
mounting losses will dominate by a large margin any bank recapitalization from SWFs. A
contagious and cascading spiral of credit disintermediation, credit contraction, sharp fall
in asset prices and sharp widening in credit spreads will then be transmitted to most parts
of the financial system. This massive credit crunch will make the economic contraction
more severe and lead to further financial losses. Total losses in the financial system will
add up to more than $1 trillion and the economic recession will become deeper, more
protracted and severe.

A near global economic recession will ensue as the financial and credit losses and the
credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will
exacerbate the financial and real economic distress as a number of large and systemically
important financial institutions go bankrupt. A 1987 style stock market crash could occur
leading to further panic and severe financial and economic distress. Monetary and fiscal
easing will not be able to prevent a systemic financial meltdown as credit and insolvency
problems trump illiquidity problems. The lack of trust in counterparties – driven by the
opacity and lack of transparency in financial markets, and uncertainty about the size of
the losses and who is holding the toxic waste securities – will add to the impotence of
monetary policy and lead to massive hoarding of liquidity that will exacerbates the
liquidity and credit crunch.

In this meltdown scenario US and global financial markets will experience their most
severe crisis in the last quarter of a century.

Another 4 paragraphs. I believe this is the section that was highlighted in the original post. Thanks for posting and linking. I'm trying to get up to speed on this stuff. For something published in February, this article is looking fairly prescient.

HE DOESN'T CONSIDER THAT OUR CONGRESS WILL ENABLE THE SAME PEOPLE ThaT CAUSED THESE LOSSES TO recieve the congress' EMBEZZLEMENT OF AN ADDITIONAL THREE FOURTHS OF A TRILLION - that fact that Congress did that is just beyond belief.

It is so far beyond belief that Roubini did not even consider it!!

Instead of indicting some of the top people in Wall Street firms for racketeering, those felons are now allowed to take our country away from us. With the approval of a bought out Congress!! And even some here on DU clamored for it to happen!!

Are we to hoard seeds, land, ammo, hone our skills in order to barter for necessities?

Is this what we're talking about?

but I don't know that it will be that different.

I know it feels that way to many people, but that's just because we are in the midst of a panic. Remember when everyone was seeing terrorists down every dark alley after 9/11.

Having real world skills can't hurt.

for the perspective and information you have brought to DU. I enjoy reading your posts.

I do have a question - it seems to me that Fannie and Freddie ARE a large part of this problem - but obviously not the only problem.

republicans are talking about this in house hearings and placing the blame for this crisis with the Clinton administration.

To me, it is one leg of problem - it is one thing to ease borrowing but quite another to make irresponsible loans. or to fail to disclose to borrowers what they are agreeing to - I don't think our level of economic intelligence is overwhelming and especially among those who are already in the lower income brackets.

Greenspan also has responsibility for urging risky arms and for having too much faith in a self-regulating market. The investment banks bear responsibility for the shell game mbs's that hid poor risk mtgs within investment pkgs so that even those who WANTED to invest conservatively were not able to pick and choose in those larger investments... and this entire bubble really means that the investment class (not those with 401ks as part of a pension... will be in a position to buy cheap assets that are no longer affordable to wannabe homeowners.

Congress and all presidents for many decades bear responsibility for passing tax cuts that hurt funding for infrastructure that create jobs that are not outsourced (and that pay far better than working at the quickie mart.

Congress and all presidents over the last two decades bear responsibility for allowing offshore accts to avoid taxes, for failing to pass a minimum wage increase that keeps up, even at the most minimal level, with costs of living... not to mention a failure to create a living wage.

Members of Congress bear responsibility for protecting pharma and insurance profits and for failing to insure affordable health care to the middle and working classes (if you're desperately poor, there are some options, even if they're not wonderful, afaik.) In fact, health care as a for-profit system is a problem if a nation thinks that health care should be considered a human right in a modern western democracy.

I suppose what I'm getting at is that there is enough blame to go around all over the place. However, the underlying problem is the redistribution of the tax burden, combined with stagnant wages.

so, what's incorrect in all that?

But I think you have the fundamentals down.

There was a redistribution of wealth up to the top. There was easy credit which encouraged enormous amounts of speculation, largely centered around housing and mortgage loans (this was worldwide), but later it spread into commodities. Wages didn't keep pace with all of the inflation. People who took out adjustable rate loans and interest only loans couldn't pay them when they reset. Overbuilding contributed to a sudden decline in prices (builders could afford to undersell). Speculators walked away from loans. Now even people who can afford their mortgage payments are walking away from upside down loans.

For a while, it wasn't clear if we would see continuing inflation or deflation. Now it looks pretty certain that deflation is going to be unavoidable, at least in the short term. A lot of wealth is disappearing out of hedge funds and managers are forced to sell stocks to pay clients who are cashing out. Investors are getting margin calls. That's why the dollar is going up and the market is going down.

ETA: also, in response to another comment upthread, any time you have a concentration of wealth at the top, you see this kind of speculation.

Figure 3B: Changes in hourly and annual wages and productivity, 1995-2005
http://www.stateofworkingamerica.org/tabfig_03.html

Is there any particular reason why wages and productivity
stopped moving in tandem? Wages go one direction (down)
productivity goes another (up).

In the past, when productivity rose, so did wages. Not anymore.