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McKay Whisenhunt IIINouriel Roubini's Global EconoMonitor
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Alfred ReichRGE Monitor delivers ahead-of-the-curve global economic insights that financial professionals need to know.
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This disconnect between more and more aggressive policy actions and easings and greater and greater strains in financial market is scary. When Bear Stearns’ creditors were bailed out to the tune of $30 bn in March the rally in equity, money and credit markets lasted eight weeks; when in July the US Treasury announced legislation to bail out the mortgage giants Fannie and Freddie the rally lasted four weeks; when the actual $200 billion rescue of these firms was undertaken and their $6 trillion liabilities taken over by the US government the rally lasted one day and by the next day the panic has moved to Lehman’s collapse; when AIG was bailed out to the tune of $85 billion the market did not even rally for a day and instead fell 5%. Next when the $700 billion US rescue package was passed by the US Senate and House markets fell another 7% in two days as there was no confidence in this flawed plan and the authorities. Next as authorities in the US and abroad took even
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Lambert HellerFrom Nouriel Roubini, Professor of Economics and International Business, Stern School of Business, New York University
economics politics finance scienceblog roubini lang:en research
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04 Dec 07
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Events in the last few weeks have clearly shown that the liquidity and credit crunch that started last August in financial markets in the US and Europe not only has not improved; it has rather worsened in many dimensions.
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with the growth in this quarter already likely to be close to 0%
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It is also still the case that when the US sneezes the rest of the world catches the cold; and in this case the US will not suffer just of a common cold but rather experience a protracted and severe pneumonia; thus, the rest of the world should be ready for a severe viral contagion.
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n spite of hundred of billions of dollars and euros of injections of liquidity in financial markets since August, and in spite of a 75bps cut of the policy interest rate by the Fed, the liquidity crunch is now as severe if not worse than last summer.
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Also, the size of the financial losses are staggering and growing by the day: financial institutions have so far recognized about $50 billion of losses but a variety of analysts estimate that total losses in sub-prime alone could add up to $300 to $400 billion;
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It will all add up to a staggering figure closer to $1,000 billion of losses.
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his is indeed the first crisis of financial globalization and securitization.
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Easing by the Fed will not prevent the coming recession as it will be too little too late and as monetary policy becomes less effective once you have a massive glut of homes, of consumer durables, of autos and motor-vehicles. It will take years to work out this glut.
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The rest of the world – including Europe – has so far deluded itself that it can decouple from a US slowdown. But decoupling would occur only if the US experienced a soft landing
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if the US experiences a recessionary hard landing there will be no decoupling and global growth will sharply slowdown
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Economists distinguish between “Risk” and “Uncertainty”: the former can be priced by financial markets while the latter cannot. The distinction between the two was made by the famous economist Frank H. Knight in his seminal book, Risk, Uncertainty, and Profit (1921). In brief, “Risk is present when future events occur with measurable probability” while “Uncertainty is present when the likelihood of future events is indefinite or incalculable”.
This distinction between risk and uncertainty helps to explain the recent market panic and turmoil. Today, the FT cites a market economist at Lehman who said: “We are in a minefield. No one knows where the mines are planted and we are just trying to stumble through it”. A few days ago another market participant put it this way: “It is not the corpses at the surface that are scary; it is the unknown corpses below the surface that may pop up unexpectedly”.
Unknown minefield; unexpected corpses: this is “uncertainty” rather than “risk”. Risk can be measured and priced because it depends on know distributions of events to which investors can assign probabilities. Uncertainty cannot be priced by markets because it relates to “fat tail” distributions and extreme events that cannot be easily predicted or measured.
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A few days ago the CFO of Goldman Sachs justified the massive – 30% plus - losses of the two Goldman Sachs hedge funds by arguing that these were unpredictable “25 standard deviation events” that should occur only once in a million years. The same thing was said by the LTCM “masters of the universe” when their highly leveraged hedge fund went belly up in 1998.
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The proliferation of such products, as I have often noted before, carries many benefits for the financial system (most notably that they disperse risk across a much wider pool of investors). But this trend also carries at least one downside; it is adding to the opacity of the financial world.
For although many corners of the structured credit universe are becoming more transparent, almost as soon as one chink of light emerges, another shadowy wave of activity emerges that is far more opaque.
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