Economics professor and author of Crisis Economics comments on the financial services industry’s fight against reform.
May 12, 2010
Economics professor Nouriel Roubini
Labeled alternately a sage and "Dr. Doom," economist Nouriel Roubini predicted the current financial crisis. The Stern School of Business (NYU) professor—who Foreign Policy named to its list of the "top 100 global thinkers"—served in the White House and the U.S. Treasury. He also spent time at the IMF and taught at Yale. Roubini was born in Turkey and lived in Iran, Israel and Italy before moving to the U.S. to pursue his doctorate in international economics at Harvard. He's the author of several books, including Crisis Economics.
Tavis: Nouriel Roubini is a professor of economics at NYU Stern School of Business and a former policy adviser to the Clinton White House. He is the coauthor of the new book “Crisis Economics: A Crash Course in the Future of Finance.” He joins us tonight from New York. Professor Roubini, good to have you on the program, sir.
Professor Nouriel Roubini: Great being with you today.
Tavis: So some years ago you predicted that this crisis was going to happen, and your friends – I say that jokingly, of course – your friends on Wall Street labeled you, in a number of media outlets, Dr. Doom. How did it feel being called Dr. Doom then and how do you look now back on what you predicted some years ago?
Roubini: Well, rather than Dr. Doom I prefer to be called “Dr. Realist.” Unfortunately, my prediction about a severe financial crisis, a housing bust. A recession that went from the U.S. to become global turned out to be true, and my work had been for a long time about financial crises in emerging markets led me to see the kind of policy and financial vulnerabilities in the United States. This was not just a subprime mortgage problem.
There was a subprime financial system. It was subprime mortgages, near prime and prime mortgages, commercial real estate, credit cards, auto loans, student loans, leverage loans, commercial loans. The entire financial system was in a bubble of excessive risk-taking, credit and leverage, and that’s what led first to an asset bubble and boom, and then to a crash and a bust.
Tavis: Obviously you are a noted professor and regarded around the world for the work that you do on the issue of economics. I say that to say this: With all due respect, you’re not the only bright guy studying and teaching economics and in the field of economics, so how is it that you saw what – I guess I could call names if I wanted to, but how is it that you saw what Greenspan and Rubin and Summers and others didn’t see?
Roubini: Well, first of all, it was not just myself. There were a number of other economists and policymakers that were warned about this impending bubble. For example, Bob (unintelligible) my former colleague at Yale, spoke about the housing bubble, and there were many other, like Nassim Taleb, who wrote “The Black Swan.” I connected many ways the dots.
The reason why the general public and the policymakers didn’t see it coming is that whenever there’s a bubble, people believe in things that are not sustainable. In the ’90s we believed that tax cuts could double every year. In this past decade we believed that home prices could go up by 20 percent or more every year.
When there is a bubble, everybody benefits from it. The U.S. consumer could use their homes as an ATM machine, borrowing against it. The policymakers were happy because the economy was doing well because of the bubble and they were getting reelected. The Fed and others were also believing in this bubble, and of course Wall Street traders and bankers were making dozens of billions of dollars of profits through essentially creating this toxic junk and underwriting it and selling it to investors.
So profits on Wall Street were huge, so everybody was living in a bubble and everybody believed in the bubble. That’s what happens when you have an asset bubble or a housing bubble.
Tavis: How much of what happened, Professor, had to do with plain old greed and if so, greed on the part of whom? All of us?
Roubini: Certainly there is an element of greed, of arrogance, of excessive risk-taking by financial institutions and traders and bankers, but in some sense in my view if I’m asking myself is the average trader or banker today more arrogant or more greedy than, say, the famous Gordon Gecko, who was the character in Oliver Stone’s “Wall Street” film 20 years ago, in some sense the bankers today are not more greedy than those 20 years ago.
In capitalism, people try to maximize their own income, profits, bonuses. I think that what’s different today is that the way we are compensating Wall Street bankers and traders has become outrageous. In good times you can take huge amounts of risk and you make a profit and you have a huge bonus, and if then your firm gets bankrupt you will not be punished for that. At maximum, you don’t get your bonus.
That’s why one of the proposals in my book for reforming the system is a bonus model system. When you make the profits, you don’t receive the bonus the same year. We’re going to keep it into a vault and see three years down the line whether on a risk-adjusted basis this was a good investment or a bad investment.
So we need to have a clawback of bonuses to make sure that people don’t take too much risk. So it’s the incentive we give in terms of compensation that affect how greedy or how silly or arrogant, or how excessive the risk-taking individuals are in financial markets.
Tavis: How do you think an idea like that, Professor Roubini, this notion of delayed compensation three years down the road? How would an idea like that play or not play on Wall Street, you think?
Roubini: Well, we need to do it and in my view the government has to impose it because no financial institution is going to do it on its own. Every one of them says if I go first and I change my compensation I’m going to lose my best (unintelligible) to the competition, so there is a coordination problem.
The way of resolving this coordination problem is for the government to come and say the compensation is distorted, is outrageous, and we have to have a system with a bonus (unintelligible) with delayed compensation, with clawbacks on bonuses so that we align the incentives of traders and bankers with the benefits of the financial institution in the long term (unintelligible) society.
So the government has to intervene because there is a market failure in the system of compensation.
Tavis: To your point about what the government ought to be doing or what they will do, you’re reading the same stuff that I’m reading and obviously, given your profession, you’re following this more closely than I am, but what’s your sense of where or not this conversation about financial reform is going to take us?
Roubini: Well, in my view, the kind of proposals that are being submitted now to the Senate and Congress are not going far enough. They’re going in the right direction but I have a couple of chapters in my book in which I discuss how would I change the system of supervision and regulation of the financial system and banking institution to avoid another crisis of this sort.
Unfortunately, I think we’re not doing enough. We’re not doing enough on the reform of compensation of bankers and traders, we’re not doing enough with these “too big to fail” institutions. These institutions were already too big to fail, and now they are even bigger to fail because the policy has been consolidation of banks.
JP Morgan took over Wamu and then another institution like Bear Stearns, Bank of America took over Countrywide and then took over Merrill Lynch. Wells Fargo took over Wachovia. So these institutions that were already too big to fail have become even bigger to fail and we’re not doing the reforms that are going to constrain their behavior.
I would go back to the Glass-Steagall restrictions that separated commercial banking from investment banking. This idea of a financial supermarket where you have commercial banking, investment banking, underwriting, hedge fund activities, private equity, insurance, prop trading has become a bit of a disaster, like we have seen in episodes like Citigroup.
These institutions are not only too big to fail but also way too complex to manage. There is no way in which a CEO or even a board can control the behavior of thousands of separate P&L centers, because each banker and each trader is a separate P&L center.
So we need smaller institutions, we need to break them up; we have to go back to the Glass-Steagall restrictions to avoid these too big to fail distortions. That’s not what’s happening in the proposals in Congress, so I would go to more radical reforms.
Tavis: To your point now, Nouriel Roubini, if these banks, these institutions are bigger now than they were before we found ourselves in this drama, in this economic mess, if they’re bigger now than they were then, doesn’t that suggest that what happened over the last few years can repeat itself?
Roubini: Yes. My worry is that one, these institutions are bigger. They know that (unintelligible) big they’re not going to be bailed out again, even if they do risk-taking. The mood on Wall Street is we’re back to business as usual, prop trading, risk-taking, leverage, outrageous compensation, outrageous bonuses as if what has just happened a year or two ago has never happened, and we’re not yet doing the kind of reform that’s going to prevent the next asset bubble.
If anything, with the Fed having zero interest rates, any bank, any hedge fund can borrow short-term at zero rates and start doing the same kind of leverage plays and risk behavior that eventually led to an asset bubble and eventually led to financial crisis.
So my worry is that not this year but in two or three years from now, unless we change the system, we’re going to have another big bubble and it’s going to be a bigger bust, and the damage to the real economy is going to be even more severe than the one we had this time around.
The fiscal cost, the social cost, the employment cost, the world cost of this financial crisis has been absolutely dramatic. We’ve lost 8.4 million jobs; we’ve destroyed $30 billion in wealth between housing and stock market. The fiscal cost of bailing out financial institutions has led the U.S. budget deficit now to be $1 trillion for the next decade.
So the damage has been very severe. We have to stop it. We have to prevent another financial crisis of this sort.
Tavis: He’s a professor at NYU’s Stern School of Business. His name is Nouriel Roubini, his new book is called “Crisis Economics: A Crash Course in the Future of Finance.” Professor Roubini, good to have you on the program. Thanks for your book, sir.
Roubini: Great being with you tonight.
Last modified: April 26, 2011 at 12:28 pm