One on One with Nouriel Roubini, Economics Professor at NYU's Stern School of Business
Tuesday, October 28, 2008
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SUSIE GHARIB: One person who predicted the financial crisis is Nouriel Roubini, economics professor at New York University's Stern School of Business. More than two years ago, he gave a speech at the International Monetary Fund warning of an impending crisis. Homeowners defaulting on mortgages, an oil price shock, the collapse of the global financial system and a deep recession. The audience was skeptical. Recently, I sat down with Roubini and asked him what he saw that others missed.
NOURIEL ROUBINI, PROF. OF ECONOMICS, NYU STERN SCHOOL OF BUSINESS: Usually in periods of time when there is excessive euphoria, irrational exuberance and people lose track of the economic and financial fundamentals. And to consider financial crisis, you have to take a bit of a holistic approach (INAUDIBLE). You have to look at experiences, history, other case studies and therefore take an approach that looks at a variety of elements. The exact timing of when a crisis may occur is hard to predict, but you know with a certain amount of certainty that this will (INAUDIBLE) eventually is going to lead to a crash.
GHARIB: Professor Roubini, who or what is the major culprit of this financial crisis?
ROUBINI: First of all the Fed kept interest rates too low for too long and created the housing bubble. Secondly the Fed and the other regulators were asleep at the wheel and allowed all these toxic mortgages to be created without controlling it. Three, there was plenty of greed and excessive risk taking on Wall Street. And four, the rating agencies had major conflicts of interest because they were being paid by those that were supposed to be rating. So the blame is to be shared by many different culprits.
GHARIB: Now what everybody wants to know is how long and how painful is this financial crisis going to be?
ROUBINI: Unfortunately, I do believe that this is going to be a pretty severe financial and banking crisis and also severe recession.
GHARIB: So you're saying that the worst is ahead of us. What is going to be the magnitude of it?
ROUBINI: Well, I expect that the recession is going to last two years. We're still at the beginning stages of a recession. I expect that the cumulative fall of output from the peak might be on the order of 5 percent, much bigger than the recent recessions. I worried that the unemployment rate might rise to be about 8 to 9 percent. Right now it's only 6.1 percent. So it's going to be severe and we'll have hundreds of smaller financial institutions (INAUDIBLE) are going to go bankrupt. And even some of the regional banks might be in severe trouble, might have to be closed down or merged with other institutions. So this is a severe crisis.
GHARIB: So how important are falling home prices in all of this?
ROUBINI: As long as they fall, there's a residential construction, recession's going to continue. Secondly, homeowners feel less rich and they're going to spend less. There is going to be less consumption. And three with falling prices so much, there will be about 20 million houses going to be under water with the value of their homes being less than the value of their mortgages and therefore with an incentive to walk away from their homes.
GHARIB: So Professor Roubini, what are you watching now that will tell you that things are getting better or worse?
ROUBINI: We have to look at what's happening to real consumption, since consumption is about 70 percent of aggregate demand. Right now consumption is falling because U.S. consumers are shopped out. They are saving less. They are debt burdened. The value of their home is falling. The value of their equity stock is falling. Employment is falling. So all the factors that determine consumption are going south and therefore we're in the middle of a severe consumer-led recession.
GHARIB: If you could pin it down to one thing, what would you say is the lessons learned from this crisis?
ROUBINI: The crucial lesson learned from this crisis is that you need financial regulation and supervision of the financial system, because self regulation is no regulation. And in a situation of irrational exuberance, then market discipline does not occur.
GHARIB: What advice would you give to the next president of the United States on how to solve this economic and financial crisis?
ROUBINI: The institutions that are solvent have to be recapitalized and rescued. Those that are insolvent should be shut down. Since demand is falling, we need government spending to boost demand and avoid the most severe recession and most likely the Fed will have to cut interest rates further as a way to stimulate the economy. So you need a comprehensive and consistent economic plan.
GHARIB: Professor Roubini, thank you so much for your time.
ROUBINI: Pleasure being with you today. Thanks.
