Where The Economy Is Headed
And What Investors Should Watch For

Nouriel Roubini’s Blog points out “Ten Observations on the Coming Financial and Economic Hard Landing” that summarize his views of the current global financial turmoil and the prospects for the US and global economy.

1. The US economy will most probably experience a hard landing in 2007.

Last year Nouriel called for a recession for year end 2006. His fundamentals still seem in check as we are seeing more analysts leaning towards such a possibility. Recently even the former-Fed Chief Alan Greenspan cautioned of a chance for recession this year.

2. The housing recession is getting much worse not better. Housing is not bottoming out. Starts and home sales are in free fall and will get much worse before bottoming out in 2008, not in 2007. Home price action will be sharply downward.

3. There is clear contagion from housing to other sectors of the economy: we have now an auto recession, a manufacturing recession, a real investment recession as all four components of investment are now plunging; sharp slowdown of the service sector too; soon contagion to a saving-less consumer who is at its tipping point and on the verge of faltering.

4. Subprime problems (meltdown/carnage) are not limited to subprime sector. They are already a widespread problem for all parts of the mortgage market. Garbage lending practices used for subprime (zero or low down payments, low/no documentation on incomes and assets, interest rate only, option ARMs, teaser rates, negative amortization) were very widespread and common among near prime and prime mortgages (see ARMs, Alt-A, piggyback loans, home equity loans). Effectively measured subprime, near prime and dangerous lending was close to 50% of mortgage originations in 2005-2006, not the 13% share of subprime in the overall stock of mortgages.

5. There is a serious risk of a generalized credit crunch, first in subprime (where the crunch is already severe), then to all mortgage markets, then to consumer credit and overall credit markets. The market myth and spin of a credit crunch limited to subprime is faltering by the hour.

This is my general theory as well. Economic history has shown nothing more than a series of booms followed by inevitable busts. This is not something that was generated from recent years but two full decades of easy credit and cheap money. The effects will be felt. It’s a matter of time.

6. There are already serious signs of contagion to other credit spreads (CDS spreads on major brokers being now near junk, CDX, Itraxx, CMBX, swap spreads all significantly up); and increases in all sorts of measures of market volatility and risk aversion. This contagion will get much worse in the weeks and months ahead.

That in effect will probably hit the stocks hard leading the rest down in a decline. (May pose some great long-term shorting opportunities in lenders, banks and credit card companies.

7. This is not a temporary blip of volatility and turmoil (as in spring 2005 and spring 2006) as this time around there is a true and serious growth hard landing risk in the US rather than the temporary and unfounded inflation scare of spring 2006. Financial markets are now reacting to seriosly weakened economic fundamentals in the US and to dependence of global economy on the US business cycle. Thus, this is the beginning of a massive market fall after a period of excessive liquidity, bubbles in many assets and markets and underpricing of risk. All sorts of risky assets will be persistently under pressure.

This will definitely send stocks and equities lower. The question is though how low and how hard. One thing for certain is that the overall gains for stocks will not be that great in the coming years (and will most probably finish their consolidation lower than current levels).

8. The Fed will move – sooner rather than later – to ease. But Fed easing will not prevent a recession in the same way that Fed easing in 2001 did not prevent a recession. With a glut of housing and consumer durables that will take years to work out lower short and long rates will not help.

This is nonetheless a very short term outlook. After the recession the general trend for interest rates will most likely be up. Especially if we see a real Bond sell-off from foreign investors rates could sky rocket.

9. The world will not decouple from a US hard landing; it will experience a sharp slowdown if the US has a hard landing. Multiple channels of transmission from the US to the world. It is still the case that when the US sneezes the rest of the world gets a cold.

However, do bear in mind that the role of leadership may be transfered, albeit temporarily, to a nation such as Japan, similar to what we saw in the 30s and 70s. Japan also seems on the brink of a strong economic stance.

10. The bubble party is over. It will be a bumpy ride from now on for global financial markets and for the US and global economy.

And how!

Ten Observations on the Coming Financial and Economic Hard Landing
Nouriel Roubini
March 13, 2007


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