Roubini Briefing Book - Forbes€¦ · Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist

BRIEFING BOOK

Data Information Knowledge WISDOM

NOURIEL ROUBINI

Location: Forbes, New York, New York

About Roubini..... ..............................................................................

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Roubini in Forbes "Light At The End Of The Tunnel," 04/02/09......................... "We Need A New Insolvency Regime for Banks," 03/26/09..... "The United States of Ponzi," 03/19/09.................................... "How Low Can The Stock Markets Go?,"03/12/09.................. "The U.S. Financial System is Effectively Insolvent," 03/05/09 "Best Analysts, Stock Pickers: #2 Meredith Whitney," 5/1/07...

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The Roubini Transcript........………………………………………......... 17

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ABOUT NOURIEL ROUBINI Intelligent Investing with Steve Forbes

Nouriel Roubini is a professor at the Stern Business School at New York University and chairman of Roubini Global Economics. He is a weekly columnist for Forbes.com and writes a blog on global economics, ranked the No. 1 Web site in economics by The Economist. He is also a research associate for the National Bureau of Economic Research and a research fellow for the Centre for Economic Policy Research. Before joining NYU Stern, Professor Roubini was a faculty member of the Economics Department at Yale University from 1988-1995. Roubini also served as adviser to the U.S. Treasury Department; senior adviser to the under secretary for International Affairs and senior economist for International Affairs, White House Council of Economic Advisers. Roubini has been a consultant to the World Bank and the International Monetary Fund. He has published papers on international macroeconomic issues, the Asian and global financial crisis, emerging markets and the reform of the international financial system. His is also the author of several books, including Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies. Roubini earned his undergraduate degree from Bocconi University in Milan, Italy. He received his doctorate in international economics from Harvard University.

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ROUBINI IN FORBES Intelligent Investing with Steve Forbes

Light At The End Of The Tunnel ... Nouriel Roubini, 04.02.09, 12:01 AM ET I was interviewed on Tuesday on CNBC's "Squawk Box" on my views on the economy, the stock market, the problems with the banks, the Geithner plan and whether there's light at the end of the tunnel. As I pointed out in the interview, the rate of economic contraction will slow from the -6% of the first quarter to a figure closer to -2%. And next year the economic recovery will be so weak--growth below 1% and the unemployment rate peaking at 10%--that it will still feel like a recession even if we may be technically out of it. So, compared with the bullish consensus that sees positive growth at 2% by the third and fourth quarters of this year and a return to potential growth by 2010, my views are consistently more bearish. Still, compared with the sharp contraction in U.S. and global growth in the first quarter of this year, the rate of economic contraction will slow down for the U.S. and other advanced economies by year-end. That is only a mild improvement in what is still a severe U-shaped recession, with a very weak and tentative recovery by 2010. I also pointed out on CNBC that the stock market has predicted six out of the last zero economic recoveries. For the last 18 months, we've had six bear market rallies, and at the beginning of each one of these suckers' rallies the delusional perma-bulls repeated that this was the beginning of a bull market rally. And for six times these perma-bulls were totally wrong as the rally fizzled and new lows were reached. And for six times I correctly pointed out that these were bear market rallies. But such perma-bulls have no shame in showing up over and over again on CNBC and talking up their books and being proved wrong over and over again. As I have never been a "perma-bear," in spite of the "Dr. Doom" nickname, I will be the first one to call the bottom of this severe recession and the bottom of the bear market when I see sustained evidence of robust and consistent economic recovery. I see the latest rally as another bear market rally, as over the next few months, the news--macro news, earnings news, financial news, corporate default news, financial firms insolvency news and so on--will be worse than expected by the consensus. Look how wobbly the stock market was on Monday when the expected news that the Big Three are in Big Trouble led to a 3% to 4% market fall. Do you listen to Tim Geithner, who says that some banks need "large amounts of assistance," and who is now pushing--like Bernanke--for fast-track

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Congressional approval of a law that will allow the takeover of systemically important financial institutions and bank holding companies? This market recovery has still very shaky legs, and it will continue to lurch until the U.S. and global economic recovery does occur and is more robust and sustained. The global economic contraction is still very severe: In the Eurozone and Japan there is no evidence of "green shoots" or positive second derivatives; and in the U.S. and China such evidence is still very, very weak. So investors and markets are way ahead of actual improvements in economic data. And the idea that stock prices are forward-looking and bottom out six to nine months before the end of a recession is incorrect. First, we've already had six bear market rallies and, despite the "prediction" of stock prices, not a single economic recovery. Second, in 2001 a short and shallow eight-month recession was over by November, but stock prices kept falling for another 16 months until March 2003. This time around, the recession will be of at least 24 months duration--three times as long and five times as deep, in terms of GDP contraction, as the one in 2001. This time the deflationary forces are global, not just in the U.S. and Japan. This time we have the worst financial and banking crisis since the Great Depression, while in 2001 there was no banking crisis. This time we've got the worst housing recession since the Great Depression, with home prices still bound to fall another 15% to 20% for a cumulative fall of 40% to 45%. This time corporate default rates on junk bonds are predicted by Moody's to peak at 20%, not the 13% of the previous recession. Thus, the idea that a weak U.S. and global recovery with massive deflationary pressures and a severe financial crisis and massive corporate defaults will lead to a robust recovery of earnings and a sharp persistent bull-market rally in equities is totally far-fetched. As I have argued before, the risk of an L-shaped near-depression will be significantly reduced if aggressive policy actions were undertaken. That risk of near-depression is now lower than it was three months ago--but not gone altogether--as policy makers in the U.S. and globally have finally gotten religion and taken out all their policy bazookas, missiles, rockets and artillery and started to use them. These more aggressive and front-loaded policies include massive monetary easing and zero policy rates; quantitative easing; unconventional monetary and credit actions to reduce the spread between market rates and government bond yields; significant--if in some cases still insufficient--fiscal policy stimulus; policies to restore credit growth and reduce the credit crunch; policies to clean up toxic assets of banks; policies to recapitalize banks and take over the insolvent ones; policies to reduce the tsunami of foreclosures and reduce the debt servicing and debt burden of distressed households; policies to support emerging market

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economies under stress; and policies of appropriate regulatory forbearance to restore credit and liquidity in financial market. These policies will not restore positive growth in advanced economies until next year, but will reduce the rate of economic contraction to a more moderate pace by the end of 2009. Thus, as I noted earlier, the rate of the advanced economies' economic contraction will slow down from the peak contraction of this year's first quarter (-6%) to a more modest contraction in the fourth quarter (-2%) and a very weak positive growth (0% to 1% in U.S., Europe and Japan) in 2010 with still sharply rising unemployment rates peaking at 10% in these advanced economies. This will be an improvement compared with the fourth quarter of 2008 and first quarter of the 2009 collapse of global economic activity, but still a much more bearish scenario than the bullish case of positive and high (2%) growth by the third and fourth quarters and return to potential growth by 2010. So the road ahead is still very, very bumpy. The worst for the degree of economic contraction may be behind us by the second or third quarter of this year, but there will not be any robust and sustained recovery as the damage of the financial and real excesses of the last few years will have lasting effects on actual and potential growth for the U.S. and global economies. And the burden of trillions of dollars of additional fiscal deficits and debts in advanced and emerging economies will be a drag on actual and potential growth for years to come. But if aggressive policy actions are accelerated after the G-20 meeting in London, one can expect a slow and painful process of mending the U.S. and global economy that will still take a long time. That will, however, allow us to see the light at the end of the tunnel some time next year, first for the real economies, next for financial markets and finally for the financial system and its wounded institutions. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.

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Doctor Doom We Need A New Insolvency Regime For Banks Nouriel Roubini, 03.26.09, 12:01 AM ET Finally, after a year of delays, the Treasury secretary and the Fed chairman have agreed about the need for a new insolvency regime for systemically important financial institutions (bank holding companies and non-bank financial institutions). This new insolvency regime will allow government to take over in an orderly way--as opposed to a disorderly Lehman-like bankruptcy--insolvent systemically important financial institutions. This new conservatorship/receivership regime of insolvency could be similar to the one used to manage the orderly takeover of Fannie Mae and Freddie Mac. While banks have a receivership regime based on the Federal Deposit Insurance Corp. taking over insolvent banks and working them out in an orderly way, bank holding companies and non-bank financial institutions do not have such a conservatorship/receivership regime outside of Chapter 11 or Chapter 7 bankruptcy. That is why the government had to bail out the creditors of Bear Stearns and AIG, and why the collapse of Lehman was disorderly. We need an orderly system to wind down systemically important financial institutions and bank holding companies as many assets, credit default swaps and bonds of banks are at the holding-company level, rather than at the bank level. Suppose the government was planning to nationalize a large bank--say Citigroup, for the sake of argument--that was to be deemed insolvent after the appropriate stress test. While the FDIC could then take over the bank, the relevant bank holding company would not be under the FDIC receivership; it would instead go into a Chapter 11 or Chapter 7 bankruptcy. And the other non-bank components of such large financial institutions--its broker dealer, insurance companies, etc.--would also end up in Chapter 11 bankruptcy. So in order to orderly take over large, systemically important banks, the FDIC receivership model works only for the bank leg of the bank; it does not work for the bank holding company or for its non-bank financial arms. And certainly FDIC receivership does not apply to independent broker dealers and other non-bank financial institutions for which a disorderly in-court bankruptcy is the only option. An orderly wind-down of Bears Stearns or Lehman or AIG would have required a special receivership/conservatorship, as Chapters 11 or 7 would have pushed into automatic default the unsecured debt of these institutions and triggered a mess with their credit default swaps (CDS). That is why the government decided to bail out--at huge cost to the taxpayers--the creditors/counterparties of Bear Stearns and AIG; and when it decided not to

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bail out the creditors of Lehman, a global financial meltdown followed Lehman’s bankruptcy. This is also the reason why the government has been, so far, wary of nationalizing large, systemically important banks. A special insolvency regime would give the Treasury time to figure out whether the unsecured debt of the institutions should be worked out, and how it should be worked out; it also allows a more orderly workout of CDS and other credit derivatives issued by the financial institution. Thus, the signal given by Messrs. Bernanke and Geithner--of their support of a special insolvency regime for systemically important non-bank financial institutions--is very important. It will allow the orderly takeover/nationalization of large banks and the same orderly takeover of non-bank financial institutions. It is high time to pass legislation that enables this special insolvency regime. If such a regime had been in place a year ago, the expensive bailout of the creditors/counterparties of Bear Stearns and AIG could have been avoided, and the collapse of Lehman would have also been prevented. Similarly, today--as soon as the stress tests are done--some large and systemically important banks (and their holding companies and non-bank financial arms) will have to be taken over. To do it an orderly way, we absolutely need a special insolvency regime like the one we have for the bank arms of bank holding companies, and like the one we had for Fannie and Freddie. So to nationalize large insolvent banks--and minimize the fiscal costs and financial collateral damage and systemic risk of such a takeover--we need to pass such legislation immediately. The time for Congress to act is now. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.

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Doctor Doom The United States Of Ponzi Nouriel Roubini, 03.19.09, 12:01 AM ET A reporter contacted me recently with the following question: "I am a reporter, and I am doing a story on Bernard Madoff's life after pleading guilty. As part of this, I was wondering if you could comment on what significance he will have in the history of this period. Will he represent more than a scamster who stole a lot of money from a lot of people? As Bernie Ebbers and Ken Lay came to embody corporate greed and deceit, what will Madoff symbolize?" Here is my answer fleshed out in full: Americans lived in a "Made-off" and Ponzi bubble economy for a decade or even longer. Madoff is the mirror of the American economy and of its over-leveraged agents: a house of cards of leverage over leverage by households, financial firms and corporations that has now collapsed in a heap. When you put zero down on your home, and you thus have no equity in your home, your leverage is literally infinite and you are playing a Ponzi game. And the bank that lent you, with zero down, a NINJA (no income, no jobs and assets) liar loan that was interest-only for a while, with negative amortization and an initial teaser rate, was also playing a Ponzi game. And private equity firms that did over a $1 trillion of leveraged buyouts (LBOs) in the last few years with a debt-to-earnings ratio of 10 or above were also Ponzi firms playing a Ponzi game. A government that will issue trillions of dollars of new debt to pay for this severe recession and socialize private losses may risk becoming a Ponzi government if--in the medium term--it does not return to fiscal discipline and debt sustainability. A country that has--for over 25 years--spent more than income and thus run an endless string of current account deficit--and has thus become the largest net foreign debtor in the world (with net foreign liabilities that are likely to be over $3 trillion by the end of this year)--is also a Ponzi country that may eventually default on its foreign debt if it does not, over time, tighten its belt and start running smaller current account deficits and actual trade surpluses. Whenever you persistently consume more than your income year after year (a household with negative savings, a government with budget deficit, a firm or financial institution with persistent losses, a country with a current account deficit) you are playing a Ponzi game. In the jargon of formal economics, you are not satisfying your long-run inter-temporal budget constraint as you borrow to finance

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the interest rate on your previous debt, and are thus following an unsustainable debt dynamics that eventually leads to outright insolvency. According to Hyman Minsky and economic theory, Ponzi agents (households, firms, banks) are those who need to borrow more to repay both principal and interest on their previous debt; i.e., Minsky's "Ponzi borrowers" cannot service either interest or principal payments on their debts. They are called "Ponzi borrowers" as they need persistently increasing prices of the assets they invested in to keep on refinancing their debt obligations. By this standard, U.S. households whose debt relative to income went from 65% 15 years ago, to 100% in 2000, to 135% today were playing a Ponzi game. And an economy where the total debt to GDP ratio (of households, financial firms and corporations) is now 350% is a Made-Off Ponzi economy. And now that home values have fallen 20% (and they will fall another 20% before they bottom out) and equity prices have fallen over 50% (and may fall further), using homes as an ATM to finance Ponzi consumption is not feasible any more. The party is over for households, banks and non-bank highly leveraged corporations. The bursting of the housing bubble, the equity bubble, the hedge funds bubble and the private equity bubble showed that most of the "wealth" that supported the massive leverage and overspending of agents in the economy was a fake bubble-driven wealth. Now that these bubble have burst, it is clear that the emperor had no clothes, and that we are the naked emperor. A rising bubble tide was hiding the fact that most Americans and their banks were swimming naked; and the bursting of the bubble is the low tide that shows who was naked. Madoff may now spend the rest of his life in prison. U.S. households, financial and non-financial firms, and government may spend the next generation in debtor's prison having to tighten their belts to pay for the losses inflicted by a decade or more of reckless leverage, over-consumption and risk-taking. Americans, let us look at ourselves in the mirror: Madoff is us and Mr. Ponzi is us! Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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Doctor Doom How Low Can The Stock Markets Go? Nouriel Roubini, 03.12.09, 12:00 AM ET For the last six months, I have been arguing that, in spite of the sharp fall in U.S. and global equities, there were significant downside risks to stock markets. Thus, repeated bear market rallies would fizzle out under the onslaught of worse than expected macro news, earnings news and financial markets/firms shocks. Put simply: If you take a macro approach, earnings per share of S&P 500 firms will be--quite realistically in 2009--in the $50 to $60 range. (Some may even argue that in a severe recession they could fall to $40). Then, the question is what the multiple, i.e., the price-to-earnings ratio, will be on such earnings. It is realistic to expect that the multiple may fall in the 10 to 12 range in a U-shaped recession. Then, even in the best scenario (earnings at $60 and P/E at 12), the S&P index would be at 720. If either earnings are closer to $50 or the P/E ratio is lower, at 10, then the S&P could fall to 600 (12 times 50 or 10 times 60) or even to 500 (10 times 50). Equivalently, the Dow Jones industrial average (DJIA) would be at least as low as 7,000 and possibly as low as 6,000 or 5,000. And using a similar logic, I have argued that global equities--following the U.S.-- had another 20%-plus downside risk. These predictions were made when the S&P 500 was close to 900 and the DIJA at 9,000. This basic macro approach was the reason why I've argued that the latest bear market sucker's rally--the one going from late November 2008 to early January 2009--would fizzle out, and new lows would be reached. Indeed, like previous bear market rallies of the last year, this one went bust--falling over 20%--and the DJIA and the S&P fell below the 7,000 and 700 upper limit of our range for U.S. equities. With the DJIA and the S&P now well below the "7" range, the next test for the markets may well be 6,000 and 600 for the two indexes. I have also argued that another bear market rally may occur some time in the second or third quarter of this year and may end up like the previous six. Indeed in the last 12 to 18 months, every time something dramatic happens (that leads to a lower stock market low) and the government reacts to it with a more aggressive policy action, optimists come out and say that this is the dramatic and cathartic event that suggests a bottom has been reached. They said that after Bear Stearns, after the collapse and rescue of Fannie Mae and Freddie Mac, after Lehman Brothers, after AIG, after the TARP was announced, after the G-7 communiqué and after the $800 billion fiscal stimulus package was announced last November (the onset of the latest sucker's rally).

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And after a while, markets are again "shocked, shocked" to discover that the macro news is much worse than expected in the U.S. and abroad; that earnings news is much worse than expected, not just for financials, realtors, home builders and consumer discretionary firms but also for most other non-financial firms; and that financial markets/firms shocks are worse than expected. This is what I see and argue: More financial institutions are effectively insolvent and will have to be taken over by the government; highly leveraged institutions--such as hedge funds--will be forced to de-leverage further and thus sell illiquid assets into illiquid markets; even non-levered investors (retail, mutual funds, etc.) that lost 50% plus into equities are burned out and want to reduce their exposure to equities; and a number of emerging-market economies are on the verge of a contagious financial crisis. Why do even small, open economies such as emerging-market ones matter for global risk asset prices? Take the case of Iceland, a small island of 300,000 souls in the middle of the Atlantic: The local banks borrowed abroad 12 times the gross domestic product (GDP) of the country and invested it in toxic assets. Now the banks are bust, and the Icelandic government is bust as the banks are too big to be saved. Thus, local banks now selling distressed and illiquid assets into illiquid global markets are having ripple effects on those global markets. So if tiny Iceland can have contagious effects, how much greater would the contagion be if a larger and more important emerging market were to enter a fully fledged financial crisis (Latvia or Hungary or Ukraine or Pakistan or Venezuela)? Even a mere rating downgrade of Ukraine a few days ago had a shocking effect on financial markets in Emerging Europe--and even in the E.U. What are the downside, and upside, risks to the bearish predictions for U.S. and global equities? On the downside, I have argued here that there is at least a probability of an L-shaped global near-depression rather than the mere current severe U-shaped recession. If a near-depression were to take hold globally, a 40% to 50% further fall from current levels in U.S. and global equities could not be ruled out. But in this L-shaped near-depression, the last thing one would have to worry about would be stock markets, as more severe issues would have to be addressed, such as unemployment rates in the mid-double digits--15% or above--and multi-year stagnation and deflation. On the upside, one could argue that the aggressive policy stimulus in the U.S. and other countries will lead to a faster sustained economic and financial markets recovery than expected here. We have discussed why this "sustained" as opposed to "temporary in second- to third-quarter" recovery is highly unlikely to take place. But the bullish argument for a non-bear market and early persistent recovery of global equities is based on a better than expected recovery of the U.S. and global economy.

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Earlier this year--at the peak of the latest bear market rally--I met Abby Cohen--the ever-bullish equity markets expert at Goldman Sachs who predicted a 25% equity rally for 2008 and is making again a similarly bullish call for 2009. I asked her if we disagreed on earnings or on the multiple (P/E). It turns out that our forecasts for earning per share for S&P 500 firms are similar: in the 50 to 60 range for me and the 55 to 60 range for her. But she argued that a P/E in the 1,012 range was too low, as investors would ignore the bad earnings numbers for 2009. If a rapid recovery of earnings was to occur in 2010 and beyond, investors would discount the 2009 bad number and assign to them a much higher multiple of 17, or even more. The trouble with that argument is that, with the U.S. and global economy in a massive slump, and with deflationary forces at work, it is hard to believe that a massive economic recovery will occur in 2010, thus lifting earnings sharply. Even in a U-shaped scenario, U.S. growth in 2010 would be 1% or lower, and Eurozone and Japanese growth would be close to 0%. With weak growth, deflationary pressure would still be lingering, putting pressure on profits, the pricing power of firms and, thus, profit margins. So even in a U-shaped scenario, a rapid rally of equities is highly unlikely. It is true that equity prices are forward-looking; they usually tend to bottom out six to nine months before the end of a recession, as they see--ahead of the curve--the light at the end of the tunnel. So the optimists seeing a recovery of growth in the second half of 2009 argue that equities should start to rally on a sustained basis now. But this severe U-shaped recession in the U.S. may not be over at the 24th month date (December 2009). Most likely, the unemployment rate will rise throughout 2010 well above 10%, and the growth rate will be so weak (1% or closer to 0%) that we will remain in a technical recession for most of 2010 (36 months if the recession is over only in December 2010). Thus, the bottom of the stock market may occur in late 2009, at the earliest, or possibly some time in 2010. Also the "six to nine months ahead forward-looking stock market view" is not always borne out in the data. During the last recession, the economy bottomed out in November 2001 and GDP growth was robust in 2002 but the U.S. stock markets kept on falling all the way through the first quarter of 2003. So not only were the stock markets not "forward looking," they actually lagged the economic recovery by 18 months--rather than lead it by six to nine months. A similar scenario could occur this time around. The real economy sort of exits the recession some time in 2010, but deflationary forces keep a lid on the pricing power of corporations and their profit margins, and growth is so weak and anemic, that U.S. equities may--as in 2002--move sideways for most of 2010. A number of false bull starts would occur as economic recovery signals remain mixed.

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Thus, most likely, we can brace ourselves for new lows on U.S. and global equities in the next 12 to 18 months. Eventually, a more sustained recovery will occur once we are closer to clear signals that this ugly global U-shaped recession is not turning into an L-shaped near-depression, and that the global economic recovery is clear and sustained. Until then, expect very volatile and choppy U.S. and global equity markets--with new lows reached in the next months and the year ahead. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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Doctor Doom The U.S. Financial System Is Effectively Insolvent Nouriel Roubini 03.05.09, 12:01 AM ET For those who argue that the rate of growth of economic activity is turning positive--that economies are contracting but at a slower rate than in the fourth quarter of 2008--the latest data don't confirm this relative optimism. In 2008's fourth quarter, gross domestic product fell by about 6% in the U.S., 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the U.S. There is, in fact, a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession. Here's why: First, note that most indicators suggest that the second derivative of economic activity is still sharply negative in Europe and Japan and close to negative in the U.S. and China. Some signals that the second derivative was turning positive for the U.S. and China turned out to be fake starts. For the U.S., the Empire State and Philly Fed indexes of manufacturing are still in free fall; initial claims for unemployment benefits are up to scary levels, suggesting accelerating job losses; and January's sales increase is a fluke--more of a rebound from a very depressed December, after aggressive post-holiday sales, than a sustainable recovery. For China, the growth of credit is only driven by firms borrowing cheap to invest in higher-returning deposits, not to invest, and steel prices in China have resumed their sharp fall. The more scary data are those for trade flows in Asia, with exports falling by about 40% to 50% in Japan, Taiwan and Korea. Even correcting for the effect of the Chinese New Year, exports and imports are sharply down in China, with imports falling (-40%) more than exports. This is a scary signal, as Chinese imports are mostly raw materials and intermediate inputs. So while Chinese exports have fallen so far less than in the rest of Asia, they may fall much more sharply in the months ahead, as signaled by the free fall in imports. With economic activity contracting in 2009's first quarter at the same rate as in 2008's fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.

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Fiscal and monetary stimulus is becoming more aggressive in the U.S. and China, and less so in the euro zone and Japan, where policymakers are frozen and behind the curve. But such stimulus is unlikely to lead to a sustained economic recovery. Monetary easing--even unorthodox--is like pushing on a string when (1) the problems of the economy are of insolvency/credit rather than just illiquidity; (2) there is a global glut of capacity (housing, autos and consumer durables and massive excess capacity, because of years of overinvestment by China, Asia and other emerging markets), while strapped firms and households don't react to lower interest rates, as it takes years to work out this glut; (3) deflation keeps real policy rates high and rising while nominal policy rates are close to zero; and (4) high yield spreads are still 2,000 basis points relative to safe Treasuries in spite of zero policy rates. Fiscal policy in the U.S. and China also has its limits. Of the $800 billion of the U.S. fiscal stimulus, only $200 billion will be spent in 2009, with most of it being backloaded to 2010 and later. And of this $200 billion, half is tax cuts that will be mostly saved rather than spent, as households are worried about jobs and paying their credit card and mortgage bills. (Of last year's $100 billion tax cut, only 30% was spent and the rest saved.) Thus, given the collapse of five out of six components of aggregate demand (consumption, residential investment, capital expenditure in the corporate sector, business inventories and exports), the stimulus from government spending will be puny this year. Chinese fiscal stimulus will also provide much less bang for the headline buck ($480 billion). For one thing, you have an economy radically dependent on trade: a trade surplus of 12% of GDP, exports above 40% of GDP, and most investment (that is almost 50% of GDP) going to the production of more capacity/machinery to produce more exportable goods. The rest of investment is in residential construction (now falling sharply following the bursting of the Chinese housing bubble) and infrastructure investment (the only component of investment that is rising). With massive excess capacity in the industrial/manufacturing sector and thousands of firms shutting down, why would private and state-owned firms invest more, even if interest rates are lower and credit is cheaper? Forcing state-owned banks and firms to, respectively, lend and spend/invest more will only increase the size of nonperforming loans and the amount of excess capacity. And with most economic activity and fiscal stimulus being capital- rather than labor-intensive, the drag on job creation will continue. So without a recovery in the U.S. and global economy, there cannot be a sustainable recovery of Chinese growth. And with the U.S, recovery requiring lower consumption, higher private savings and lower trade deficits, a U.S. recovery requires China's and other surplus countries' (Japan, Germany, etc.)

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growth to depend more on domestic demand and less on net exports. But domestic-demand growth is anemic in surplus countries for cyclical and structural reasons. So a recovery of the global economy cannot occur without a rapid and orderly adjustment of global current account imbalances. Meanwhile, the adjustment of U.S. consumption and savings is continuing. The January personal spending numbers were up for one month (a temporary fluke driven by transient factors), and personal savings were up to 5%. But that increase in savings is only illusory. There is a difference between the national income account (NIA) definition of household savings (disposable income minus consumption spending) and the economic definitions of savings as the change in wealth/net worth: savings as the change in wealth is equal to the NIA definition of savings plus capital gains/losses on the value of existing wealth (financial assets and real assets such as housing wealth). In the years when stock markets and home values were going up, the apologists for the sharp rise in consumption and measured fall in savings were arguing that the measured savings were distorted downward by failing to account for the change in net worth due to the rise in home prices and the stock markets. But now with stock prices down over 50% from peak and home prices down 25% from peak (and still to fall another 20%), the destruction of household net worth has become dramatic. Thus, correcting for the fall in net worth, personal savings is not 5%, as the official NIA definition suggests, but rather sharply negative. In other terms, given the massive destruction of household wealth/net worth since 2006-07, the NIA measure of savings will have to increase much more sharply than has currently occurred to restore households' severely damaged balance sheets. Thus, the contraction of real consumption will have to continue for years to come before the adjustment is completed. In the meanwhile the Dow Jones industrial average is down today below 7,000, and U.S. equity indexes are 20% down from the beginning of the year. I argued in early January that the 25% stock market rally from late November to the year's end was another bear market suckers' rally that would fizzle out completely once an onslaught of worse than expected macro and earnings news, and worse than expected financial shocks, occurs. And the same factors will put further downward pressures on U.S. and global equities for the rest of the year, as the recession will continue into 2010, if not longer (a rising risk of an L-shaped near-depression). Of course, you cannot rule out another bear market suckers' rally in 2009, most likely in the second or third quarters. The drivers of this rally will be the improvement in second derivatives of economic growth and activity in the U.S. and China that the policy stimulus will provide on a temporary basis. But after the effects of a tax cut fizzle out in late summer, and after the shovel-ready

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infrastructure projects are done, the policy stimulus will slacken by the fourth quarter, as most infrastructure projects take years to be started, let alone finished. Similarly in China, the fiscal stimulus will provide a fake boost to non-tradable productive activities while the traded sector and manufacturing continue to contract. But given the severity of macro, household, financial-firm and corporate imbalances in the U.S. and around the world, this second- or third-quarter suckers' market rally will fizzle out later in the year, like the previous five ones in the last 12 months. In the meantime, the massacre in financial markets and among financial firms is continuing. The debate on "bank nationalization" is borderline surreal, with the U.S. government having already committed--between guarantees, investment, recapitalization and liquidity provision--about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure). Thus, the U.S. financial system is de facto nationalized, as the Federal Reserve has become the lender of first and only resort rather than the lender of last resort, and the U.S. Treasury is the spender and guarantor of first and only resort. The only issue is whether banks and financial institutions should also be nationalized de jure. But even in this case, the distinction is only between partial nationalization and full nationalization: With 36% (and soon to be larger) ownership of Citi, the U.S. government is already the largest shareholder there. So what is the non-sense about not nationalizing banks? Citi is already effectively partially nationalized; the only issue is whether it should be fully nationalized. Ditto for AIG, which lost $62 billion in the fourth quarter and $99 billion in all of 2008 and is already 80% government-owned. With such staggering losses, it should be formally 100% government-owned. And now the Fed and Treasury commitments of public resources to the bailout of the shareholders and creditors of AIG have gone from $80 billion to $162 billion. Given that common shareholders of AIG are already effectively wiped out (the stock has become a penny stock), the bailout of AIG is a bailout of the creditors of AIG that would now be insolvent without such a bailout. AIG sold over $500 billion of toxic credit default swap protection, and the counter-parties of this toxic insurance are major U.S. broker-dealers and banks. News and banks analysts' reports suggested that Goldman Sachs got about $25 billion of the government bailout of AIG and that Merrill Lynch was the second largest benefactor of the government largesse. These are educated guesses, as the government is hiding the counter-party benefactors of the AIG bailout.

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(Maybe Bloomberg should sue the Fed and Treasury again to have them disclose this information.) But some things are known: Goldman's Lloyd Blankfein was the only CEO of a Wall Street firm who was present at the New York Fed meeting when the AIG bailout was discussed. So let us not kid each other: The $162 billion bailout of AIG is a nontransparent, opaque and shady bailout of the AIG counter-parties: Goldman Sachs, Merrill Lynch and other domestic and foreign financial institutions. So for the Treasury to hide behind the "systemic risk" excuse to fork out another $30 billion to AIG is a polite way to say that without such a bailout (and another half-dozen government bailout programs such as TAF, TSLF, PDCF, TARP, TALF and a program that allowed $170 billion of additional debt borrowing by banks and other broker-dealers, with a full government guarantee), Goldman Sachs and every other broker-dealer and major U.S. bank would already be fully insolvent today. And even with the $2 trillion of government support, most of these financial institutions are insolvent, as delinquency and charge-off rates are now rising at a rate--given the macro outlook--that means expected credit losses for U.S. financial firms will peak at $3.6 trillion. So, in simple words, the U.S. financial system is effectively insolvent. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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Doctor Doom The U.S. Financial System Is Effectively Insolvent Nouriel Roubini 03.05.09, 12:01 AM ET For those who argue that the rate of growth of economic activity is turning positive--that economies are contracting but at a slower rate than in the fourth quarter of 2008--the latest data don't confirm this relative optimism. In 2008's fourth quarter, gross domestic product fell by about 6% in the U.S., 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the U.S. There is, in fact, a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession. Here's why: First, note that most indicators suggest that the second derivative of economic activity is still sharply negative in Europe and Japan and close to negative in the U.S. and China. Some signals that the second derivative was turning positive for the U.S. and China turned out to be fake starts. For the U.S., the Empire State and Philly Fed indexes of manufacturing are still in free fall; initial claims for unemployment benefits are up to scary levels, suggesting accelerating job losses; and January's sales increase is a fluke--more of a rebound from a very depressed December, after aggressive post-holiday sales, than a sustainable recovery. For China, the growth of credit is only driven by firms borrowing cheap to invest in higher-returning deposits, not to invest, and steel prices in China have resumed their sharp fall. The more scary data are those for trade flows in Asia, with exports falling by about 40% to 50% in Japan, Taiwan and Korea. Even correcting for the effect of the Chinese New Year, exports and imports are sharply down in China, with imports falling (-40%) more than exports. This is a scary signal, as Chinese imports are mostly raw materials and intermediate inputs. So while Chinese exports have fallen so far less than in the rest of Asia, they may fall much more sharply in the months ahead, as signaled by the free fall in imports. With economic activity contracting in 2009's first quarter at the same rate as in 2008's fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.

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Fiscal and monetary stimulus is becoming more aggressive in the U.S. and China, and less so in the euro zone and Japan, where policymakers are frozen and behind the curve. But such stimulus is unlikely to lead to a sustained economic recovery. Monetary easing--even unorthodox--is like pushing on a string when (1) the problems of the economy are of insolvency/credit rather than just illiquidity; (2) there is a global glut of capacity (housing, autos and consumer durables and massive excess capacity, because of years of overinvestment by China, Asia and other emerging markets), while strapped firms and households don't react to lower interest rates, as it takes years to work out this glut; (3) deflation keeps real policy rates high and rising while nominal policy rates are close to zero; and (4) high yield spreads are still 2,000 basis points relative to safe Treasuries in spite of zero policy rates. Fiscal policy in the U.S. and China also has its limits. Of the $800 billion of the U.S. fiscal stimulus, only $200 billion will be spent in 2009, with most of it being backloaded to 2010 and later. And of this $200 billion, half is tax cuts that will be mostly saved rather than spent, as households are worried about jobs and paying their credit card and mortgage bills. (Of last year's $100 billion tax cut, only 30% was spent and the rest saved.) Thus, given the collapse of five out of six components of aggregate demand (consumption, residential investment, capital expenditure in the corporate sector, business inventories and exports), the stimulus from government spending will be puny this year. Chinese fiscal stimulus will also provide much less bang for the headline buck ($480 billion). For one thing, you have an economy radically dependent on trade: a trade surplus of 12% of GDP, exports above 40% of GDP, and most investment (that is almost 50% of GDP) going to the production of more capacity/machinery to produce more exportable goods. The rest of investment is in residential construction (now falling sharply following the bursting of the Chinese housing bubble) and infrastructure investment (the only component of investment that is rising). With massive excess capacity in the industrial/manufacturing sector and thousands of firms shutting down, why would private and state-owned firms invest more, even if interest rates are lower and credit is cheaper? Forcing state-owned banks and firms to, respectively, lend and spend/invest more will only increase the size of nonperforming loans and the amount of excess capacity. And with most economic activity and fiscal stimulus being capital- rather than labor-intensive, the drag on job creation will continue. So without a recovery in the U.S. and global economy, there cannot be a sustainable recovery of Chinese growth. And with the U.S, recovery requiring lower consumption, higher private savings and lower trade deficits, a U.S. recovery requires China's and other surplus countries' (Japan, Germany, etc.)

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growth to depend more on domestic demand and less on net exports. But domestic-demand growth is anemic in surplus countries for cyclical and structural reasons. So a recovery of the global economy cannot occur without a rapid and orderly adjustment of global current account imbalances. Meanwhile, the adjustment of U.S. consumption and savings is continuing. The January personal spending numbers were up for one month (a temporary fluke driven by transient factors), and personal savings were up to 5%. But that increase in savings is only illusory. There is a difference between the national income account (NIA) definition of household savings (disposable income minus consumption spending) and the economic definitions of savings as the change in wealth/net worth: savings as the change in wealth is equal to the NIA definition of savings plus capital gains/losses on the value of existing wealth (financial assets and real assets such as housing wealth). In the years when stock markets and home values were going up, the apologists for the sharp rise in consumption and measured fall in savings were arguing that the measured savings were distorted downward by failing to account for the change in net worth due to the rise in home prices and the stock markets. But now with stock prices down over 50% from peak and home prices down 25% from peak (and still to fall another 20%), the destruction of household net worth has become dramatic. Thus, correcting for the fall in net worth, personal savings is not 5%, as the official NIA definition suggests, but rather sharply negative. In other terms, given the massive destruction of household wealth/net worth since 2006-07, the NIA measure of savings will have to increase much more sharply than has currently occurred to restore households' severely damaged balance sheets. Thus, the contraction of real consumption will have to continue for years to come before the adjustment is completed. In the meanwhile the Dow Jones industrial average is down today below 7,000, and U.S. equity indexes are 20% down from the beginning of the year. I argued in early January that the 25% stock market rally from late November to the year's end was another bear market suckers' rally that would fizzle out completely once an onslaught of worse than expected macro and earnings news, and worse than expected financial shocks, occurs. And the same factors will put further downward pressures on U.S. and global equities for the rest of the year, as the recession will continue into 2010, if not longer (a rising risk of an L-shaped near-depression). Of course, you cannot rule out another bear market suckers' rally in 2009, most likely in the second or third quarters. The drivers of this rally will be the improvement in second derivatives of economic growth and activity in the U.S. and China that the policy stimulus will provide on a temporary basis. But after the effects of a tax cut fizzle out in late summer, and after the shovel-ready

- 22 -

infrastructure projects are done, the policy stimulus will slacken by the fourth quarter, as most infrastructure projects take years to be started, let alone finished. Similarly in China, the fiscal stimulus will provide a fake boost to non-tradable productive activities while the traded sector and manufacturing continue to contract. But given the severity of macro, household, financial-firm and corporate imbalances in the U.S. and around the world, this second- or third-quarter suckers' market rally will fizzle out later in the year, like the previous five ones in the last 12 months. In the meantime, the massacre in financial markets and among financial firms is continuing. The debate on "bank nationalization" is borderline surreal, with the U.S. government having already committed--between guarantees, investment, recapitalization and liquidity provision--about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure). Thus, the U.S. financial system is de facto nationalized, as the Federal Reserve has become the lender of first and only resort rather than the lender of last resort, and the U.S. Treasury is the spender and guarantor of first and only resort. The only issue is whether banks and financial institutions should also be nationalized de jure. But even in this case, the distinction is only between partial nationalization and full nationalization: With 36% (and soon to be larger) ownership of Citi, the U.S. government is already the largest shareholder there. So what is the non-sense about not nationalizing banks? Citi is already effectively partially nationalized; the only issue is whether it should be fully nationalized. Ditto for AIG, which lost $62 billion in the fourth quarter and $99 billion in all of 2008 and is already 80% government-owned. With such staggering losses, it should be formally 100% government-owned. And now the Fed and Treasury commitments of public resources to the bailout of the shareholders and creditors of AIG have gone from $80 billion to $162 billion. Given that common shareholders of AIG are already effectively wiped out (the stock has become a penny stock), the bailout of AIG is a bailout of the creditors of AIG that would now be insolvent without such a bailout. AIG sold over $500 billion of toxic credit default swap protection, and the counter-parties of this toxic insurance are major U.S. broker-dealers and banks. News and banks analysts' reports suggested that Goldman Sachs got about $25 billion of the government bailout of AIG and that Merrill Lynch was the second largest benefactor of the government largesse. These are educated guesses, as the government is hiding the counter-party benefactors of the AIG bailout.

- 23 -

(Maybe Bloomberg should sue the Fed and Treasury again to have them disclose this information.) But some things are known: Goldman's Lloyd Blankfein was the only CEO of a Wall Street firm who was present at the New York Fed meeting when the AIG bailout was discussed. So let us not kid each other: The $162 billion bailout of AIG is a nontransparent, opaque and shady bailout of the AIG counter-parties: Goldman Sachs, Merrill Lynch and other domestic and foreign financial institutions. So for the Treasury to hide behind the "systemic risk" excuse to fork out another $30 billion to AIG is a polite way to say that without such a bailout (and another half-dozen government bailout programs such as TAF, TSLF, PDCF, TARP, TALF and a program that allowed $170 billion of additional debt borrowing by banks and other broker-dealers, with a full government guarantee), Goldman Sachs and every other broker-dealer and major U.S. bank would already be fully insolvent today. And even with the $2 trillion of government support, most of these financial institutions are insolvent, as delinquency and charge-off rates are now rising at a rate--given the macro outlook--that means expected credit losses for U.S. financial firms will peak at $3.6 trillion. So, in simple words, the U.S. financial system is effectively insolvent. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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Will The Economic Crisis Split East And West In Europe? Nouriel Roubini, 02.26.09, 12:01 AM ET Nouriel Roubini co-wrote this essay with Mary Stokes, Jelena Vukotic and Elisa Parisi-Capone, analysts at Roubini Global Economics. The Central and Eastern Europe region is the sick man of emerging markets. While the global crisis means few--if any--bright spots worldwide, the situation in the CEE area is particularly bleak. After almost a decade of outpacing worldwide growth, the region looks set to contract in 2009, with almost every country either in or on the verge of recession. The once high-flying Baltics--Estonia, Latvia, Lithuania--look headed for double-digit contractions, while countries relatively less affected by the crisis--the Czech Republic, Slovakia and Slovenia--will have a hard time posting even positive growth. Meanwhile, Hungary and Latvia's economies have already deteriorated to the point where International Monetary Fund (IMF) help was needed late last year. Central and Eastern Europe's ill health is primarily driven by two factors: collapsing exports and the drying up of capital inflows. Exports were key to the region's economic success, accounting for 80% to 90% of gross domestic product in the Czech Republic, Hungary and Slovakia. By far the biggest market for CEE goods is the Eurozone, now in recession. Meanwhile, the global credit crunch has sapped capital inflows to the region. An easy flow of credit fueled Eastern Europe's boom in recent years, but the good times are gone. According to the Institute of International Finance, net private capital flows to emerging Europe are projected to fall from an estimated $254 billion in 2008 to $30 billion in 2009. Whether this is formally considered a "sudden stop" of capital or not, it will necessitate a very painful adjustment process. This begs the question: Is this a classic emerging markets crisis in the works? What is especially worrisome is that the days of easy credit flows were accompanied by rising external imbalances that rival or even exceed the build-up of imbalances in pre-crisis Asia (for example, current account deficits in Southeast Asia from 1995-1997 fell within the 3% to 8.5% of GDP range, while those in Central and Eastern Europe were in the double digits in Romania, Bulgaria and the Baltics in 2008). The vulnerabilities in many CEE countries--high foreign-currency borrowing, hefty levels of external debt, massive current-account deficits--suggest the classic makings of a capital account crisis à la Asia in the late 1990s.

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Will this spill over to the rest of the world? Like the Asia crisis of 1997 to 1998, a regional crisis in Eastern Europe would have far-reaching effects. As Harvard professor Kenneth Rogoff noted in a recent New York Times article: "There's a domino effect. International credit markets are linked, and so a snowballing credit crisis in Eastern Europe and the Baltic countries could cause New York municipal bonds to fall." Western Europe looks set to be particularly affected through its strong trade and financial linkages. Of particular concern is the strong presence of Western European banks (via subsidiaries) in Central and Eastern Europe, where they hold 60% to 90% market share, depending on the country, paving the way for contagion. So is this the making of a cross-border banking crisis? It could be. Given the sharp contraction in Eastern Europe's economies, combined with high foreign-currency-denominated lending (particularly in Croatia, Hungary and Romania), weakening currencies and heavy reliance on non-deposit external financing, Eastern Europe's banks will likely see a large spike in non-performing loans. Banking systems in the region are likely only as strong as their weakest link--or, in this case, weakest country. This is because of the "common lender" phenomenon. As many Central and Eastern European countries share foreign parent banks, this paves the way for problems in just one of these countries to have ripple effects into other CEE countries. So even a relatively healthy economy and banking system like the Czech Republic's--with a reasonable loan-to-deposit ratio and scant foreign exchange-denominated lending to households--is still vulnerable. Austria is far and away the Western European country most heavily exposed to the CEE region, via Austria-based banks like Raiffeisen and Erste Bank. These banks' collective exposure to the region amounts to over 70% of Austria's GDP. Notably, however, other Western European countries' total exposure is far less. Belgium and Sweden are the next in line after Austria; their lenders' total exposure to the region amounts to a still significant 20% to 25% of GDP. Some fear that parent banks, if they get into trouble, could either fire-sell subsidiaries or simply walk away. Another concern is Europe's fragmented regulatory system, which means that if a cross-border bank needs to be unwound, the process is likely to be extremely messy. Central and Eastern European policymakers are in a virtual straitjacket, having fairly limited tools to cope with the crisis. Fiscal policy is constrained by the fact that belt-tightening is required to restore order to the balance of payments in some countries (such as Hungary, Romania, Ukraine and the Baltics), while euro-adoption ambitions limit the fiscal response in others (such as Poland).

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Meanwhile, monetary policy easing is constrained in countries with heavy foreign currency-denominated lending, like Hungary and Romania, where a weakening of the local currency could potentially trigger defaults, thereby shaking financial stability. In others (like Bulgaria, Estonia, Latvia and Lithuania), monetary policy is not an available tool due to fixed exchange rates. Owing to limited fiscal and monetary policy options, other Central and Eastern European countries might need to follow in the footsteps of Latvia and Hungary and call on IMF help. In a nod to the difficult situation of many CEE countries, European Union leaders called last week for IMF resources to be doubled to $500 billion to help head off new problems in crisis-hit countries. It remains to be seen, however, whether IMF help will be enough to return financial stability to the region. In a recent research report, economists from Danske Bank point to the increasing concern of spill-back from problems in Eastern Europe to the Eurozone. Polish authorities, and commentators such as the Financial Times' Wolfgang Munchau, recently made the point that East European countries should be given a shortcut to join the euro and access to its safety and stability net. However, current problems faced by some European Monetary Union members show that EMU membership alone is no panacea. Moreover, previous experience shows that currency pegs can be double-edged swords that often end in capitulation. The current test case for the entire region is Latvia, whose currency peg looks increasingly fragile even after its IMF-led 7.5 billion-euro bailout package. Devaluation, with its ripple effects, would be devastating for the mostly foreign-owned banks in the region. Unlike EMU member countries, E.U. countries that have not yet adopted the euro have access to the "medium-term financial assistance" facility worth 25 billion euros, of which 10 billion euros in loans have already been extended to Latvia and Hungary. Additional assistance to the region will have to come from a revamped IMF, as noted before, and the European Bank for Reconstruction and Development is also providing funds to banks in the region. Despite a 20% funding boost, however, its resources are much smaller. Which brings us to Ukraine. European banks are also exposed to vulnerable economies outside of the E.U. Russia is the second-largest borrower from E.U. banks, and it has over $100 billion of debt that must be financed this year. However, it is the Ukraine that may pose the biggest contagion risk, particularly if the next tranche of IMF-funding continues to be deferred. Austrian, French, Swedish, Italian and German banks have a collective exposure of around 30 billion euros to Ukraine. The country has $46 billion in foreign debt obligations falling due in 2009, and the swift plunge of the Hyrvnia has boosted the cost of servicing these debts even as corporate debts are on the rise.

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Ukraine's political divisions and economic contraction of at least 6% suggest further sovereign and corporate ratings downgrades are on the way. Ukraine may thus be forced to make the budget cuts required by the IMF, but it is also reaching out to the U.S., Russia, China, Japan and the E.U. for additional funds. There's more in the region to worry about. The series of riots that erupted in Bulgaria, Lithuania and Latvia in January, followed by Latvia's government collapse last week, raise concerns that Eastern European countries may experience a period of deep destabilization and social strife as the economic crisis deepens and unemployment rates soar. The recent wave of popular unrest was not confined to Eastern Europe. Ireland, Iceland, France, the U.K. and Greece also experienced street protests, but many Eastern European governments seem more vulnerable as they have limited policy options to address the crisis and little or no room for fiscal stimulus due to budgetary or financing constrains. Deeply unpopular austerity measures, including slashed public wages, tax hikes and curbs on social spending will keep fanning public discontent in the Baltic states, Hungary and Romania. Dissatisfaction linked to the economic woes will be amplified in the countries where governments have been weakened by high-profile corruption and fraud scandals (Latvia, Lithuania, Hungary, Romania and Bulgaria). The political forces most likely to benefit from public disaffection are those running on populist platforms, which could disrupt efforts to battle the effects of the economic crisis. Latvia could be a case in point, as there are growing concerns that the coming election campaign might suspend the fiscal austerity measures required by the IMF bail-out package. Two other political hot spots that are at risk of early elections are Romania and Estonia, while Bulgarian national elections are due in mid-2009. In sum, the crisis could put the E.U.'s free market rules under pressure. A big rise in support for populist and radical parties in the region could put social, structural and environmental reforms on hold and even call into question the economic and political model Eastern European countries have followed since the 1990s. The eastern E.U. member states' decisions to open their markets and move toward greater integration with the E.U. are now being second-guessed by some. Moreover, the protectionist measures implemented in some western E.U. states in support of their automotive and financial sectors are threatening the E.U.'s single-market rules and could particularly hurt Eastern European economies. Meanwhile, a backlash over immigrant labor is likely. With the 2009 unemployment rate set to rise to 8.75% in the EU-27--according to the European

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Commission--member states are tempted to interpret the laws in a way more favorable to their own nationals. This suggests that migration trends will reverse and eastward flow of remittances will dwindle. The return of Eastern European migrant workers, in turn, may add to social discontent in their countries of origin. The financial crisis has exacerbated the East/West divide within the E.U. The persistent bickering between the Czech Republic--the current holder of the E.U. presidency--and France over trade and protectionist bailout packages that hurt automotive industries in Poland, Czech Republic, Slovakia and Hungary illustrates this. So far, the E.U. has helped economically troubled Latvia, Poland and Hungary with swap lines and loans and called for the resources of the IMF to double in order to help the countries facing the crisis. Yet, there has been a growing number of calls for E.U.-led coordinated support to the Eastern European economies (recently echoed by the World Bank). If there is a perceived lack of help, the financial crisis could deepen the divide between so-called "Old Europe" and "New Europe" and bring structural changes to the political landscape in Eastern Europe, such as strengthening the nationalist, euro-skeptic voices in Central Europe--Czech Republic, Poland--and the pro-Russian parties in the Baltic states. Nouriel Roubini, a professor at the Stern Business School at NYU and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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Doctor Doom Laissez-Faire Capitalism Has Failed Nouriel Roubini 02.19.09, 12:01 AM ET It is now clear that this is the worst financial crisis since the Great Depression and the worst economic crisis in the last 60 years. While we are already in a severe and protracted U-shaped recession (the deluded hope of a short and shallow V-shaped contraction has evaporated), there is now a rising risk that this crisis will turn into an uglier, multiyear, L-shaped, Japanese-style stag-deflation (a deadly combination of stagnation, recession and deflation). The latest data on third-quarter 2008 gross domestic product growth (at an annual rate) around the world are even worse than the first estimate for the U.S. (-3.8%). The figures were -6.0% for the euro zone, -8% for Germany, -12% for Japan, -16% for Singapore and -20% for Korea. The global economy is now literally in free fall as the contraction of consumption, capital spending, residential investment, production, employment, exports and imports is accelerating rather than decelerating. To avoid this L-shaped near-depression, a strong, aggressive, coherent and credible combination of monetary easing (traditional and unorthodox), fiscal stimulus, proper cleanup of the financial system and reduction of the debt burden of insolvent private agents (households and nonfinancial companies) is necessary in the U.S. and other economies. Unfortunately, the euro zone is well behind the U.S. in its policy efforts for several reasons. The first is that the European Central Bank is behind the curve in cutting policy rates and creating nontraditional facilities to deal with the liquidity and credit crunch. The second is that the fiscal stimulus is too modest, because those who can afford it (Germany) are lukewarm about it, and those who need it the most (Spain, Portugal, Greece, Italy) can least afford it, as they already have large budget deficits. The last reason is that there is a lack of cross-border burden sharing of the fiscal costs of bailing out financial institutions. With its aggressive monetary easing and large fiscal stimulus putting it ahead, the U.S. has done more. Except for two elements, both key to avoiding a near-depression, which are still missing: a cleanup of the banking system that may require a proper triage between solvent and insolvent banks and the nationalization of many banks, even some of the largest ones; and a more aggressive, across-the-board reduction of the unsustainable debt burden of millions of insolvent households (i.e., a principal reduction of the face value of the mortgages, not just mortgage payments relief). Moreover, in many countries, the banks may be too big to fail but also too big to save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system.

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Traditionally, only emerging markets suffered--and still suffer--from such a problem. But now such sovereign risk, as measured by the sovereign spread, is also rising in many European economies whose banks may be larger than the ability of the sovereign to rescue them: Iceland, Greece, Spain, Italy, Belgium, Switzerland and, some suggest, even the U.K. The process of socializing the private losses from this crisis has already moved many of the liabilities of the private sector onto the books of the sovereign. Among these liabilities are banks, other financial institutions and, soon possibly, households and some important nonfinancial corporate companies. At some point a sovereign bank may crack, in which case the ability of governments to credibly commit to act as a backstop for the financial system, including deposit guarantees, could come unglued. Thus the L-shaped, near-depression scenario is still quite possible (I assign it a 30% probability), unless appropriate and aggressive policy action is undertaken by the U.S. and other economies. This severe economic and financial crisis is now also leading to a severe backlash against financial globalization, free trade and the free-market economic model. To paraphrase Churchill, capitalist market economies open to trade and financial flows may be the worst economic regime--apart from the alternatives. However, while this crisis does not imply the end of market-economy capitalism, it has shown the failure of a particular model of capitalism. Namely, the laissez-faire, unregulated (or aggressively deregulated), Wild West model of free market capitalism with lack of prudential regulation, supervision of financial markets and proper provision of public goods by governments. There is the failure of ideas--such as the "efficient market hypothesis," which deluded its believers about the absence of market failures such as asset bubbles; the "rational expectations" paradigm that clashes with the insights of behavioral economics and finance; and the "self-regulation of markets and institutions" that clashes with the classical agency problems in corporate governance--that are themselves exacerbated in financial companies by the greater degree of asymmetric information. For example, how can a chief executive or a board monitor the risk taking of thousands of separate profit and loss accounts? Then there are the distortions of compensation paid to bankers and traders. This crisis also shows the failure of ideas such as the one that securitization will reduce systemic risk rather than actually increase it. That risk can be properly

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priced when the opacity and lack of transparency of financial firms and new instruments leads to unpriceable uncertainty rather than priceable risk. It is clear that the Anglo-Saxon model of supervision and regulation of the financial system has failed. It relied on several factors: self-regulation that, in effect, meant no regulation; market discipline that does not exist when there is euphoria and irrational exuberance; and internal risk-management models that fail because, as a former chief executive of Citigroup put it, when the music is playing, you've got to stand up and dance. Furthermore, the self-regulation approach created rating agencies that had massive conflicts of interest and a supervisory system dependent on principles rather than rules. In effect, this light-touch regulation became regulation of the softest touch. Thus, all the pillars of the 2004 Basel II banking accord have already failed even before being implemented. Since the pendulum had swung too much in the direction of self-regulation and the principles-based approach, we now need more binding rules on liquidity, capital, leverage, transparency, compensation and so on. But the design of the new system should be robust enough to counter three types of problems with rules. A tendency toward "regulatory arbitrage" should be kept in mind, as bankers can find creative ways to bypass rules faster than regulators can improve them. Then there is "jurisdictional arbitrage," as financial activity may move to more lax jurisdictions. And, finally, "regulatory capture," as regulators and supervisors are often captured--via revolving doors and other mechanisms--by the financial industry. So the new rules will have to be incentive-compatible, i.e., robust enough to overcome these regulatory failures. Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes.com.

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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 our featured guest, New York University professor and economist Nouriel Roubini. Nouriel had amazing prescience calling the markets downtown, earning his infamous moniker, Dr. Doom. Now he'll tell us why he thinks there's a glimmer of hope for the economy. Our conversation follows in a minute. But first-- Innovation flourishes in a benign environment of low taxes, commonsense regulation and a sensible, restrained judiciary. The U.S. Supreme Court certainly fell short of those principles when it ruled against medical innovation in Wyeth vs. Levine. The court gave a green light to plaintiff's lawyers who would steamroll pharmaceutical companies at the cost of lifesaving drugs and treatments for the rest of us. The plaintiff in this case lost an arm to gangrene after she was injected with the Wyeth drug Phenergan. The drug was clearly labeled with a warning that gangrene could result if the drug were directly injected into a patient's vein and the tragedy was the result of a mistake of a doctor's assistant. She sued the hospital and won. But she also sued Wyeth, arguing that a stronger warning should have been provided. Wyeth's warning label has been specifically approved by the FDA. The plaintiffs don't deny that. The hospital employee that made the mistake acted outside of Wyeth's control. Again, the plaintiff's don't deny that. She also prevailed in her suit against the hospital. A court can't make everything right or take away the pain of such a loss, but the victim had and pursued her case against a legitimate defendant. In the wake of this precedent, companies can now be held liable and suffer substantial losses when a third party misuses their products, even though they'd been amply warned in language approved by the federal government. This is destructive to innovation, imagination and, ultimately, to the health of the nation. In a moment, my conversation with Nouriel Roubini. [02:06] Glimmer of Hope

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STEVE FORBES: Well, thank you for joining us. You have acquired quite a reputation for calling the extent of the credit crisis, two or three years ago, that something was rotten in the state of Denmark or Wall Street or whatever. But you see some glimmers that things might be improving a smidgen, later this year and early next year? NOURIEL ROUBINI: They are improving in the following sense, that the degree of economic contraction is not going to be as severe as the last quarter of last year and first quarter of this year. So from minus six growth, we are going to go towards minus two towards the end of the year. But compared to the optimists that see already a recovery of positive growth by the second half of this year are more bearish and for next year, the consensus thinks a growth rate close to two percent, maybe it is going to be below one percent and unemployment rate above 10 percent. So, while we are going to be technically 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 to avoid L-shaped near-depression, like the one that Japan experienced. We are in the middle of a severe U-downturn. And we are going to eventually get out of it by sometime next year. So the tail risk of a depression has been reduced. That is good news. And the rate of contraction is going to be less than otherwise. Secondary, rates are becoming positive. But I do not see yet the light at the end of the tunnel, the same way the consensus sees it. STEVE FORBES: And so that, in turn, means that next year, 2010, if you only have a one percent or even a less than one percent growth rate, unemployment will 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 10 percent, might be more close to 11 percent. And even today, if you take a broader measure of an unemployment rate that includes those who are partially employed and those who are discouraged, that have left the labor force, the number is already 15 percent. So by some standards, this is really rough worse than losing 600,000 to 700,000 jobs per month. It's very painful. [04:04] Stay on the Sidelines STEVE FORBES: And what does this mean for investors? You have recommended in the past, hold cash. Don't be plunging into these bear market rallies. Do you see the current rally as another bear market rally and it is just prudence should be the dictate?

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NOURIEL ROUBINI: Yeah, I would be prudent for the following reason. You know, people usually joke and say the stock market has predicted 12 out of the last 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 out of the last zero economic recoveries, because six times around, the last two years, markets fell because of the bad news on banks. The economy, then there is radical policy action. They recover and then the bad news, macro-financial earnings and then you reach a new low. Now of course, the lower you go, at some point, you might be closer to a true bottom and more time passes, with the policy action, the closer we might be to the bottom of earnings of the economy. Now is this rally a robust one? Is this going 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 surprises on the downside, in terms of the macro-economic, US and abroad. The second reason is that I think that earnings are going to surprise, not just this quarter, but also the next few quarters on the downside, because we have a weak economy. And with deflationary pressures, then the pricing power, the corporate side, is going to be limited. Therefore, margins are going to be compressed. To have a very big rally of earnings like people predict for next you need a boom of the economy, going to potential above and then going away from deflation. And I see deflationary forces for the next two or three years. So I see compression of earnings are going to last and surprise people on the downside. And three, I see financial shocks. Some banks will be found insolvent. We will have to probably take them over, do something with them. That is going to be bad news. We will have many financial institutions are going to go out of business, like many hedge funds. And deleveraging by them and selling liquid assets in liquid markets going to be negative. And third, some emerging markets, in spite of IMF help, may have a fully-fledged financial crisis. And then may have contagious effect. So, all in all, I think that over the next few months, surprise on the macro side, on the earnings side, in terms of the financial shocks, may imply that the previous lows might be tested again. STEVE FORBES: So, in terms of an investor, just stay on the sidelines for now.

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NOURIEL ROUBINI: I would stay on the sidelines. You know, people worry about not getting the rally that is going to start. But if it is going to be a robust rally, it is not going to be 20, 25. You know, we know eventually we'll have a recovered 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 especially emerging markets, can have a bright future of high economic growth. So for the middle term, I am actually quite bullish about the global economy and that high global economic growth, once we fix the problems. Equities should be outperforming other asset classes. But I would not worry about losing the first 20 percent, because you might have another bear market rally, would wait until the data show more robust and consistent, persistent improvement of the real economy, of earnings. And then the market, they are going to rally on a more robust basis. [07:21] Fed's Easy Money STEVE FORBES: Could this bubble, disastrous bubble, have reached the proportions it did, if the Fed hadn't been so easy with money in the early part of this decade? NOURIEL ROUBINI: There were many mistakes. Certainly one of them was that the Fed cut rates and kept them too low, from six and a half down to one, for too 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. And that 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 poor supervision and regulation of financial institution. I think that, while deregulation is positive of the economic financial institution, we took it to an extreme, you know. Even financial markets need laws, institution, rules; otherwise it is the law of 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 of losses and also realization you are not going to be bailed out in bad times. And I think there were a number of distortions that Greenspan put, easy money, easy credit, lack of supervision and regulation of the proper form. STEVE FORBES: In terms of where we go from here, in terms of what new regulations, rules, transparency, one suggestion has been made. We do need real exchanges, clearing houses for some of these exotic instruments, so they become standardized. People can actually see what is out there, what the volumes are, what the trades are. And therefore, we can get some proper collateral behind them. What other things do you think need to be done to prevent a repetition of this in the future?

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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 the requirements were. That they probably have to be required to have less leverage, both banks and on banks, shadow banks, that the liquidity risk is big and therefore, liquidity buffers are important. There is a whole issue with compensation. I think that the issue is not with bonuses. Yes, last year and so on. But if you have a system in which you are having incentive maximize the risk in the short run and essentially do things like insurance over cataclysmic effect, events. And therefore, for a few years, you are making lots of profits and revenues. You are paid that way. And when things go bust because you took a big risk, the financial institutions go bad. Compensation is not-- [09:46] Better Bonuses STEVE FORBES: Do you think that is an area, where if you are a regulated financial institution, where the government should say, "A bonus has to be paid out over five years," or is this something boards of directors will learn if they know they can actually fail? NOURIEL ROUBINI: Ideally, you want a world in which a board of directors would do that if you have appropriate corporate governance. You don't want the government to impose it. But we saw also failure of corporate governance. You know, there are the typical agency problems within principal and agents shareholders and managers. And in financial institutions those agency problems are bigger because the symmetric information is bigger. There's no way a CEO or a board can essentially know what the action of thousands 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, as bonusing models. They are changing. Some institutions are now having these bonus models model, but there is an element of worries about stigma, of losing the best kind of talent. Therefore, at least the government, not forcing, but the frame-up right now was agreed that by the G20's, one in which there has to be reform of compensation. I would let institutions to do it their own. If they do not do it, then, in the context of that regulation supervision, the form of compensation should be one of the measures of whether you have an appropriate risk management system, because appropriate risk management system means make sure that risk management is done properly. And one element of it is compensation.

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STEVE FORBES: Do you feel the credit system is now going to start to function again? Right now, we still have very wide spreads between treasuries and, say single 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. Of course, compared to the disaster after Lehman, when everything was frozen, commercial paper, high grade, high yield. At least right now, the money market spreads are lower. Corporates that are high grade can borrow again. In the high-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 market spreads, mortgage rates by buying MBS's and mortgage-backed security. I think it will be a very, very difficult process because a lot of the shadow banking system has collapsed. And a lot of the intermediation was not through banks, but through securitization or through capital market. We have essentially destroyed a good chunk of our capital market. We want to rebuild it. It is going to take time. [12:01] Bank Nationalization STEVE FORBES: You proposed a few weeks ago, nationalizing some of the banks. 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. I mean, I proposed these from a market-friendly point of view. Nobody is in favor of medium or long-term ownership of financial institutions by the government. But in my view, paradoxically, the temporary nationalization is a more market-friendly solution, because you know, if you don't do it, then you end up with zombie banks and the fiscal costs are going to be large. That's why, you know, fiscal conservatives have been in favor of it. That is why people like Lindsay Graham, conservative Republican from Carolina, is in favor. That's why Alan Greenspan, high priest of laissez-faire capitalism, has said we may have to nationalize some banks. We will have to do it carefully, choose only the ones that are really beyond pale, that even if you give time, time is not going to heal their wounds. We'll see. But I think in some cases that might be the appropriate thing. And if it is not market-friendly, take IndyMac, was taken over middle of last year, cleaned up, separated. And now, the bunch of investors, George Soros and John Paulson, other, we bought it back and privatized it. It took six months, does not have to take three years, if you do it right. [13:11] Geithner's Gamble

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STEVE FORBES: What is your feeling about the latest Geithner plan? NOURIEL ROUBINI: My view of it is actually, is that it can work for dealing with the toxic assets of banks that are solvent, because even after you do this stress test and you do a triage within solvent, insolvent. With the insolvent ones, you cannot apply the Geithner plan because the losses are so big that if you apply to them, they are underwater. You have to take them over. But even with a solvent one, you have to still separate good and bad assets. Now there are five different ways of doing them. We do not have time to go into each detail. Each one of them has merits and some flaws. These one are among the five different ways in which you can separate good and bad assets of solvent banks is not the worst. There is some design issues, some flaws in which the way the design can be fixed. In my view, all in all, it is actually a reasonable plan. STEVE FORBES: And are you upset at all about some of the details coming out about it, that he wants to restrict it to only a handful of large institutions? Should it be more open if an institution wants to or if a group wants to be part of it? It should not be excluded? NOURIEL ROUBINI: That was actually, absolutely one of the important flaws. I think they have just announced that actually, they are going to open up the bidding process also to smaller financial institutions. You do not have to have 10 billion plus of assets and so on, in order to do that. So, I think, you know, they have been responsive to some of the criticism. I think that by the time they implement it, there will be a number of other things you have to fix it. And there may be even incentives for insiders to buy at face value, you know, the stuff and then get an only cost loan and default on it. So you should make sure that banks cannot buy their own things. This idea of rivals buying each other's assets also is subject to gaming. And plus the whole point is about making sure banks do not have toxic assets, not to buy more of them. So I think there are many things in the design you can fix. STEVE FORBES: Now, the Federal Reserve surprised some of us that between December and March, they actually shrunk their balance sheet, after expanding it in the fall, shrunk it by $400 billion. Now they are gingerly bringing it up. Is the Fed being aggressive enough in this, right now? Should it be more, buying mortgage-backed assets and the like to try to get the system more, better functioning? NOURIEL ROUBINI: I would say they have been very aggressive, you know, with ups and downs. You know, yeah, the balance sheet went from, you know,

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800 2.2, now down to a 1.8. But now, with the new initiative, is going to be about three trillion. It is zero interest rates. It is quantitative easing. And it is a variety of unconventional things, like buying treasuries, buying an agency-backed, a mortgage-backed security reduced mortgage rates. You know, intervening in the securitization market with the tariff and other things that over time are going to restore credit and securitization. They are very aggressive. And so are their central banks, like the Bank of England, the Swiss national banks, the Japanese. Even Europe eventually is going to get to zero rates and quantitative easing and some of the unconventional stuff. Unfortunately, you know, traditionally, since the banks are the lender of last resort, in this crisis, since banks do not lend to each other, they do not lend to no banks. They do not lend even to the corporate sector for a while. The central banks have become the lender of first and only resort. I mean, that is the paradox of the market failure we have been observing. It is not a normal situation. We do not want it to be permanent, but that is the current situation. And I think the margin, those policy actions are actually the correct ones. [16:31] Risky Leverage STEVE FORBES: You had mentioned earlier that banks are going to have to, in the future, deal with less leverage. What have we learned about risk in this crisis? NOURIEL ROUBINI: We have learned that, you know, leverage can be dangerous and is excessive. That you have to have a system of incentives and compensation that avoids excessive risk taking, regardless of leverage. That liquidity risk is important. That shadow banks, in many ways, look like banks, because they were borrowing short, highly leveraged, lend only liquid. But unlike banks, they did not have access to the lender of last resort support or deposit insurance. Therefore, the entire collapse of the shadow banking system is an example of what happens when you have a run on bank-like institutions. And therefore, to have a safer system for these known banks. You know, was non-bank mortgage lender went by...hedge funds, you know, broker dealers, now...financing crisis for private equities. Just a variant of the same idea. If you borrow short, overnight, you leverage 30 times. You lend only liquid. Eventually, you are going to get in trouble. That is not a stable system. That is why I predicted, over a year ago, before Bear Stearns, the collapse of major broker dealers. I said, "Two of them are going to go bust. In a matter of two years, none of them is going to remain independent." I was too optimistic. The intake, two years, took seven months.

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STEVE FORBES: By the way, do you think in the future, partnerships are going to come back, where, if you do have an investment house, you know it is your money on the line and not somebody else's? NOURIEL ROUBINI: Certainly, either partnership or a situation which then shareholders or bankers have some of their own skin in the game, because again, you want to avoid excessive retaking. Paradoxically, crisis not of hedge funds but more crises of traditional banks. Why? Because hedge funds, the owners have some of the skin in the game. Therefore, the risk management is different. So whether it is going back to partnership or other things, whatever implies more capitals, more of the skin in the game, so that you avoid excessive risk-taking, should be part of, makes valuable financial institutions. STEVE FORBES: What is the big one misplaced assumption, still, out in the markets today that you see? NOURIEL ROUBINI: I would say that, you know, there is excessive optimism about the system being able to heal itself, without taking the proper action. Monetary, fiscal, credit policy, clean up the banks, proper forms of forbearance, helping emerging markets. I think we still need aggressive policy action. I think that the system, unfortunately, as well as a significant market failure is not going to heal itself. And that means that also, the appropriate balance between the markets, because we all believe in markets and having the appropriate forms of government regulations is going to be a challenge. [19:10] Bail Out Balkan Banks STEVE FORBES: Looking here and briefly around the world, what has not been done that needs to be done? NOURIEL ROUBINI: Oh, some countries are behind the curve. The ACB are behind the curve. Fiscal and stimulus in Europe could be a little bit larger than otherwise. I think that for the banks that are insolvent, should in US and other countries, to be taken over, not to end up with zombie banks like Japan. I think that more aggressive policies to reduce the risk of mortgage foreclosures should be done. STEVE FORBES: Do you think the Fed, maybe some other central banks, are ready to help out, say, banks in Ukraine or central and eastern Europe that, if allowed to fail, could have systemic risk? NOURIEL ROUBINI: They may be doing it directly, like you see, we give money directly to Hungary. The Europeans are going to be helping some of emerging

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Europe. But the way it has been done internationally now is that the G20 and agreement to triple the resources of IMF, so that the IMF can give money to some of these countries. Now emerging market have two groups, those that are victims of collateral damage, with good fundamentals. The Chiles and Brazils of the world. And then there are the other countries, some of them in emerging Europe, that have massive financial, fiscal vulnerabilities and policy mistakes. For those countries, it is not enough to give them money. They need policy correction. If you give them money and there is no policy correction, you end up like Argentina or like Russia or like Ecuador. So you need the combination of money and appropriate policy actions. STEVE FORBES: What is the best financial lesson you have ever learned? NOURIEL ROUBINI: It is that, you know, it is better to be safe and be cautious and not to leverage too much. You know, leverage can be deadly. I mean, I think it is crucial that all of capital and equity, in corporations, in financial institution and also in the household sector. You know, when your households that were buying homes with zero down payment, the leverage was infinite, was even worse than financial institutions. So I think leverage is deadly. I think that is the lesson. We need more capital or equity. A little bit less debt, relatively speaking. [21:06] The Great Crash STEVE FORBES: And finally, other than your own books, what is the best book you have ever read, financial book? NOURIEL ROUBINI: Some of the classic selections, you know, The Great Crash by Galbraith. You know, you go and reread those books and you change the dates. And it is amazing how much things look like exactly the same. It means that history repeats their selves, you know? In many ways, financial crisis are very similar to each other. And as we know, if we do not learn from the past, we are going to be bound to repeat the same mistakes. Hopefully, next time around, we will learn the lesson and we will have a more robust system. STEVE FORBES: One final thing I just want to ask you, given your historic perspective. And that is, we've had bubbles in the last 30 years. We had the great inflation of the '70s. We had the problems in Asia, Russia. High tech bubble much bigger than the normal, new industry bubble, what happened in housing. Do we need a new international monetary system, like we had before 1971 or what we had before World War I? NOURIEL ROUBINI: We will have to think about the redesign. I am not convinced about things like going back to gold or a system of fixed exchange

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rates. I think that that is not going to be likely and desirable, overall. But having a system which these imbalances, these excesses, do not occur. We will have to rethink, also, that all of reserve currencies and so on. So first, we have to fix this crisis. Then we have to fix the banks. Then we have to think about how we design a new, international monetary system. Things are going to take a while. For the time, we have already our hands full of problems. And having to fix them. STEVE FORBES: Well thank you very much. Appreciate it. NOURIEL ROUBINI: It was a great pleasure being with you today. Thanks.