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ROUBINI IN THE NEWS
Intelligent Investing with Steve Forbes
[00:08] Steve: A Destructive Court
Welcome, I'm Steve Forbes, it's a privilege and pleasure to introduce you to ourfeatured guest, New York University professor and economist Nouriel Roubini.Nouriel had amazing prescience calling the markets downtown, earning hisinfamous moniker, Dr. Doom. Now he'll tell us why he thinks there's a glimmer ofhope for the economy.
STEVE FORBES:
Well, thank you for joining us. You have acquired quite areputation for calling the extent of the credit crisis, two or three years ago, thatsomething was rotten in the state of Denmark or Wall Street or whatever. Butyou see some glimmers that things might be improving a smidgen, later this yearand early next year?
NOURIEL ROUBINI:
They are improving in the following sense, that the degreeof economic contraction is not going to be as severe as the last quarter of lastyear and first quarter of this year. So from minus six growth, we are going to gotowards minus two towards the end of the year.But compared to the optimists that see already a recovery of positive growth bythe second half of this year are more bearish and for next year, the consensusthinks a growth rate close to two percent, maybe it is going to be below onepercent and unemployment rate above 10 percent. So, while we are going to betechnically out of a recession, you know, it is going to feel like a recession.So more optimist in the sense that the thing that the policy action are going toavoid L-shaped near-depression, like the one that Japan experienced. We are inthe middle of a severe U-downturn. And we are going to eventually get out of itby sometime next year.So the tail risk of a depression has been reduced. That is good news. And therate of contraction is going to be less than otherwise. Secondary, rates arebecoming positive. But I do not see yet the light at the end of the tunnel, thesame way the consensus sees it.
STEVE FORBES:
And so that, in turn, means that next year, 2010, if you onlyhave a one percent or even a less than one percent growth rate, unemploymentwill go up. Will it stop at 10 percent? It is already at 8.5 percent now.
NOURIEL ROUBINI:
It is. And in my view, probably is going to peak above 10percent, might be more close to 11 percent. And even today, if you take abroader measure of an unemployment rate that includes those who are partiallyemployed and those who are discouraged, that have left the labor force, thenumber is already 15 percent. So by some standards, this is really rough worsethan losing 600,000 to 700,000 jobs per month. It's very painful.
[04:04] Stay on the SidelinesSTEVE FORBES:
And what does this mean for investors? You haverecommended in the past, hold cash. Don't be plunging into these bear marketrallies. Do you see the current rally as another bear market rally and it is justprudence should be the dictate?- 34 -
NOURIEL ROUBINI:
Yeah, I would be prudent for the following reason. Youknow, people usually joke and say the stock market has predicted 12 out of thelast nine recessions because sometimes it falls and there is no recession.
STEVE FORBES:
You have an even better description.
NOURIEL ROUBINI:
Yeah, this time around, the stock market predicted six outof the last zero economic recoveries, because six times around, the last twoyears, markets fell because of the bad news on banks. The economy, then thereis radical policy action. They recover and then the bad news, macro-financialearnings and then you reach a new low.Now of course, the lower you go, at some point, you might be closer to a truebottom and more time passes, with the policy action, the closer we might be tothe bottom of earnings of the economy. Now is this rally a robust one? Is thisgoing to be the beginning of a real boom market rally?
 
I am still skeptical for three reasons. One is that if I am right on the macro view,minus two rather than plus two and weak recovery, then there will be surpriseson the downside, in terms of the macro-economic, US and abroad. The secondreason is that I think that earnings are going to surprise, not just this quarter, butalso the next few quarters on the downside, because we have a weak economy.And with deflationary pressures, then the pricing power, the corporate side, isgoing to be limited.Therefore, margins are going to be compressed. To have a very big rally ofearnings like people predict for next you need a boom of the economy, going topotential above and then going away from deflation. And I see deflationaryforces for the next two or three years. So I see compression of earnings aregoing to last and surprise people on the downside.And three, I see financial shocks. Some banks will be found insolvent. We willhave to probably take them over, do something with them. That is going to bebad news. We will have many financial institutions are going to go out ofbusiness, like many hedge funds. And deleveraging by them and selling liquidassets in liquid markets going to be negative.And third, some emerging markets, in spite of IMF help, may have a fully-fledgedfinancial crisis. And then may have contagious effect. So, all in all, I think thatover the next few months, surprise on the macro side, on the earnings side, interms of the financial shocks, may imply that the previous lows might be testedagain.
STEVE FORBES:
So, in terms of an investor, just stay on the sidelines for now.- 35 -
NOURIEL ROUBINI:
I would stay on the sidelines. You know, people worryabout not getting the rally that is going to start. But if it is going to be a robustrally, it is not going to be 20, 25. You know, we know eventually we'll have arecovered economy. We will get it cleaned up and actually, I'm not a permabear.I believe that actually, if we do the right things, US, Europe, Japan, but especiallyemerging markets, can have a bright future of high economic growth.So for the middle term, I am actually quite bullish about the global economy andthat high global economic growth, once we fix the problems. Equities should beoutperforming other asset classes. But I would not worry about losing the first 20percent, because you might have another bear market rally, would wait until thedata show more robust and consistent, persistent improvement of the realeconomy, of earnings. And then the market, they are going to rally on a morerobust basis.
[07:21] Fed's Easy MoneySTEVE FORBES:
Could this bubble, disastrous bubble, have reached theproportions it did, if the Fed hadn't been so easy with money in the early part ofthis decade?
NOURIEL ROUBINI:
There were many mistakes. Certainly one of them wasthat the Fed cut rates and kept them too low, from six and a half down to one, fortoo long. In addition to that mistakes, the normalization from one back to 525,was these moderate paced, step-by-step, 25 basis points every six weeks. Andthat is one of the last things. It is not just how long you keep it low but then,when you get out of this recession we have to normalize it fast enough.That is going to be one little lesson. But there are also broader issue about poorsupervision and regulation of financial institution. I think that, while deregulationis positive of the economic financial institution, we took it to an extreme, youknow. Even financial markets need laws, institution, rules; otherwise it is the lawof the jungle. Greed is good. There is nothing bad with greed.You know, that's what drives capitalism. But greed has to be contained by fear oflosses and also realization you are not going to be bailed out in bad times. And Ithink there were a number of distortions that Greenspan put, easy money, easycredit, lack of supervision and regulation of the proper form.
STEVE FORBES:
In terms of where we go from here, in terms of what newregulations, rules, transparency, one suggestion has been made. We do needreal exchanges, clearing houses for some of these exotic instruments, so theybecome standardized. People can actually see what is out there, what thevolumes are, what the trades are. And therefore, we can get some propercollateral behind them. What other things do you think need to be done toprevent a repetition of this in the future?- 36 -
 
 NOURIEL ROUBINI:
Well, many things. I think we have learned that all in all,financial institutions need more capital, compared to what they had and what therequirements were. That they probably have to be required to have lessleverage, both banks and on banks, shadow banks, that the liquidity risk is bigand therefore, liquidity buffers are important.There is a whole issue with compensation. I think that the issue is not withbonuses. Yes, last year and so on. But if you have a system in which you arehaving incentive maximize the risk in the short run and essentially do things likeinsurance over cataclysmic effect, events. And therefore, for a few years, youare making lots of profits and revenues. You are paid that way. And when thingsgo bust because you took a big risk, the financial institutions go bad.Compensation is not--
[09:46] Better BonusesSTEVE FORBES:
Do you think that is an area, where if you are a regulatedfinancial institution, where the government should say, "A bonus has to be paidout over five years," or is this something boards of directors will learn if they knowthey can actually fail?
NOURIEL ROUBINI:
Ideally, you want a world in which a board of directorswould do that if you have appropriate corporate governance. You don't want thegovernment to impose it. But we saw also failure of corporate governance. Youknow, there are the typical agency problems within principal and agentsshareholders and managers. And in financial institutions those agency problemsare bigger because the symmetric information is bigger.There's no way a CEO or a board can essentially know what the action ofthousands of P and L's were taking risks and trades and so on doing.
STEVE FORBES:
Right
NOURIEL ROUBINI:
Therefore, you need a system of compensation, asbonusing models. They are changing. Some institutions are now having thesebonus models model, but there is an element of worries about stigma, of losingthe best kind of talent.Therefore, at least the government, not forcing, but the frame-up right now wasagreed that by the G20's, one in which there has to be reform of compensation. Iwould let institutions to do it their own. If they do not do it, then, in the context ofthat regulation supervision, the form of compensation should be one of themeasures of whether you have an appropriate risk management system,because appropriate risk management system means make sure that riskmanagement is done properly. And one element of it is compensation.- 37 -
STEVE FORBES:
Do you feel the credit system is now going to start to functionagain? Right now, we still have very wide spreads between treasuries and, saysingle A, triple B corporates. Do you see any sign that that is going to narrow,where credit is going to naturally start to flow again?
NOURIEL ROUBINI:
It is going to be a very slow process in my view. Ofcourse, compared to the disaster after Lehman, when everything was frozen,commercial paper, high grade, high yield. At least right now, the money marketspreads are lower. Corporates that are high grade can borrow again. In thehigh-yield spreads, the spreads are still too wide. The market is shut down.We will see whether TARP is going to work. Other actions reduce marketspreads, mortgage rates by buying MBS's and mortgage-backed security. I thinkit will be a very, very difficult process because a lot of the shadow bankingsystem has collapsed. And a lot of the intermediation was not through banks, butthrough securitization or through capital market. We have essentially destroyeda good chunk of our capital market. We want to rebuild it. It is going to taketime.
[12:01] Bank NationalizationSTEVE FORBES:
You proposed a few weeks ago, nationalizing some of thebanks. Do you feel that is still going to happen before this over?
NOURIEL ROUBINI:
Oh, I think some of them will have to be taken over. Imean, I proposed these from a market-friendly point of view. Nobody is in favorof medium or long-term ownership of financial institutions by the government.But in my view, paradoxically, the temporary nationalization is a more market-
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