Nouriel Roubini

Brace yourself. Nouriel Roubini, whose gloom-and-doom predictions about the housing market collapse and subprime-mortgage debacle have come true, is getting even more bearish.

During an interview late last month, he offered up an even gloomier outlook for the economy than he did during an interview in March. Mr. Roubini said the failure of IndyMac Bancorp Inc. of Pasadena, Calif., just reinforces his earlier predictions, and he is now forecasting that more than 100 banks will blow up, the housing market won’t rebound before 2011, Fannie Mae of Washington and Freddie Mac of McLean, Va., will become insolvent, and financial losses from the credit crisis will top the $1.5 trillion mark.

Much of Wall Street snickered when Mr. Roubini, a professor at New York University’s Stern School of Business and founder of New York-based economic research firm RGE Monitor, first made dire predictions of a devastating economic downturn in a July 2006 report, “A Coming Recession in the U.S. Economy.” But as each frightening prediction turned into reality, skeptics became followers, and the market turned a nervous ear to his subsequent predictions.

Mr. Roubini’s 12-point forecast predicted that housing prices would plummet 20% to 30% from their peak, default rates would soar, subprime-mortgage losses would exceed $300 billion, a large regional or national bank would go bankrupt, and credit losses would spread to credit cards, auto loans and other areas. He also predicted a wave of defaults on corporate debt, a sharp drop-off in liquidity, a meltdown in commercial real estate, the collapse of a few hedge funds and possibly a broker-dealer, and a loss of at least 25% of the Standard & Poor’s 500 stock index’s value.

In the July interview, Mr. Roubini updated his bearish outlook.

Q. We have now seen another major bank, IndyMac, collapse, and the Federal Insurance Deposit Corp. of Washington has about 90 other banks on its watch list of entities at risk right now. Does this surprise you or do you think things will get a lot worse?
A. You have literally hundreds of smaller banks with less than $4 billion in assets that are exposed to real estate, and about 100 of those are going to go belly up. And there are about 30 large regional banks with massive exposure to real estate in California, Nevada, Arizona, Florida and so on that could go bankrupt. Not all of them are in distress, but a good chunk of them are, starting with Wachovia [Corp. of Charlotte, N.C.].

Q. Are we in a recession right now, and if so, how long will it last, and how bad will it get?
A. I predicted the recession would start in January [2008] — so in Q1, we were in a recession, and in Q2, because of the tax rebate, we had a little recovery. But retail sales for June were a disaster. So now, in my view, Q3 is going to be negative in terms of [gross domestic product] growth, Q4 is going to be negative, and my own analysis suggests the recession is going to last 12 to 18 months. The last recession lasted only eight months, so it’s going to be twice as long, or more than any recession we’ve seen in the last 20 or 30 years.

The 2001 recession started in March and was over by November, while the 1991 recession started in June of 1990 and was over by February of 1991. So they lasted eight months.

Q. Are you concerned about the health of Fannie and Freddie? There has been a big sell-off in the stocks over the past few quarters, and investors are wondering if they will be able to raise capital to cover potential losses in loans that go bad. The Federal Reserve stepped in to calm the markets: It opened up the discount window to them and assured the market that it would back the government-sponsored enterprises. Should investors be concerned?
A. When I wrote my piece two years ago on the housing recession, I said that Fannie and Freddie would be insolvent. So it doesn’t surprise me. If you use fair-value accounting, it’s already been stated by the regulator that they’re already in negative equity right now — they’re insolvent now.

It’s just part of a much more serious problem. Hundreds of institutions are going to go belly up. The four independent broker-dealers may not exist as independent entities two years from now. I mean, this is the worst crisis since the Great Depression.

Q. When we spoke in March, you said you thought that $1 trillion would be a floor, not a ceiling. Have you revised this estimate?
A. In February, I wrote a piece saying the credit losses would be at least $1 trillion and up to $2 trillion, and people thought I was a lunatic. But the International Monetary Fund [of Washington] a month later came up with a figure of $945 billion, [The] Goldman Sachs [Group Inc. of New York] had $1.1 trillion, UBS [AG of Zurich, Switzerland] had over $1 trillion, and Bridgewater Associates [Inc. of Westport, Conn.] said $1.6 trillion. So that $1 trillion, that looked so crazy six months ago, right now looks like a floor, not a ceiling. We had a massive credit bubble — the biggest in U.S. history — across the board with mortgages, with commercial real estate, with leveraged loans, with consumer credit, with junk bonds. It’s a credit boom that’s gone bust, and the beginning of it is happening right now.

In my first estimate, I did not include about $200 billion to $300 billion that will be needed to eventually fix the hole in Fannie and Freddie. So right now, I would raise those credit losses to at least $1.5 trillion.

You have this phenomena now of jingle mail [whereby homeowners mail their keys back to the lender and walk away from a mortgage] that can lead to financial losses of up to $1 trillion. So that alone is a time bomb because 40% of all households with a mortgage will be underwater, based on what prices for homes will be two years from now.

Q. Forty percent of mortgaged homes will be underwater? How did you arrive at that number?
A. The [home] price declines are going to continue in 2009 and 2010. So if home prices fall 30% [from their peak in mid-2006], about 21 million households will be underwater, and you have 51 million households that have a mortgage, so that’s 40%. Not everybody is going to walk away, but you’ve easily got $1 trillion in losses.

Q. When do you see the housing market bottoming? Some economists and analysts are predicting a bottom in mid-2009. Do you agree?
A. Prices are going keep falling in my view into 2010 because of excess inventory.

Q. So we are looking at 2011 before prices rebound?
A. Yes.

Q. You predicted stocks would fall 40% from their peak. Are you still expecting that?
A. Yes. In a typical U.S. recession, the peak-to-trough fall in the S&P 500 is about 30%. But this is not going to be a typical recession, and this is not going to be a typical financial crisis. So I see another 20% to go for the major indices, absolutely.

Q. What should the government do to turn things around?
A. At this point, a severe recession and a severe financial crisis is unavoidable. The only question is the kind of policies that will make the recession slightly shorter and less deep.

If you have problems with debt, you need debt reduction. So if there are millions of homeowners who cannot pay to service their mortgages — the face value of their mortgages has to be reduced by 20%, or 30% or 40%, or whatever it takes for them not to be underwater and to keep on paying. The [recently passed housing] bill goes in that direction. Banks are going to take a haircut, and if the haircut isn’t enough, the government is going to guarantee the remaining part of it. So the banks should take this opportunity and try to reduce the face value of the debt. It’s not going to solve everything, but it’s a step in the right direction.

All of these other things, like freezing resets of mortgages, do not make any sense. Even [Federal Reserve Board Chairman Ben S.] Bernanke said even if you freeze the resets of the mortgages, people are underwater, and they’re going to walk away. You have to reduce the face value of their debt and the debt servicing. That’s the only thing that’s going to prevent foreclosure and a massive amount of people walking away.

Q. We have an election coming up. Do you favor one party over an-other when it comes to policies and being aggressive at taking steps to resolve the housing and economic crisis?
A. I’m personally a Democrat. I worked for the Clinton administration for three years, 1998 to 2000. So I have my own personal kind of views. But putting aside any partisanship, [Sen. John] McCain [R-Ariz.] has not proposed anything. He was of the view that the market was going to take care of the housing crisis, and we know that doesn’t work. The main government action so far has been a totally piecemeal approach of reacting. Every time something blows up, they try to plug one hole, and then two other holes open up, and they don’t have any logic or strategy to what they’ve been doing. This has been a total disaster. Both Bernanke and [Secretary of the Treasury Henry] Paulson have done a pretty lousy job.

Action has to be taken today. If you wait six months from now or eight months from now, it’s too late.

Q. Will this get as bad as the Great Depression?
A. No. I don’t believe it’s going to be as bad as the Great Depression, and I also don’t believe it’s going to be as bad as Japan in the 1990s when you had an L-shaped recession — meaning a slump and then no recovery for a decade. People think of me as being one of the biggest pessimists about the economy. The size of the financial crisis is not going to be as bad as the Great Depression, but it’s the worst we’ve had since the Great Depression.

E-mail Janet Morrissey at [email protected].