One of the world’s most respected economists believes the banking crisis is far from over, and that U.S. authorities are merely buying themselves some time by insisting the banking system is “sound.”
Nouriel Roubini, chief executive of consulting firm Roubini Macro Associates, argued on Friday that the financial system will be unable to cope with the sheer scale of private and public debt that has already been amassed, spawning a “trilemma” that will soon trigger another phase of panic.
“We cannot achieve price stability, maintain economic growth, [and] have financial stability at the same time,” he told Bloomberg Television. “So eventually, we’ll have an economic and financial crash.”
Roubini, nicknamed “Dr. Doom” on Wall Street after predicting the 2008 global financial crisis, said concerns about the stability of U.S. lenders should not center solely around the banking system’s collective $620 billion in unrealized losses from underwater securities.
Instead, he argued, attention should be given to the Fed’s 13-month campaign to hike interest rates by a cumulative four and three-quarter points—which Roubini said meant banks’ portfolios of long-duration loans like fixed-rate mortgages are now far less valuable.
Once these risks are factored into the equation, the unrealized losses figure grows to $1.7 trillion, according to research published earlier this month from New York University’s Stern School of Business, where Roubini is a professor emeritus.
By comparison, the authors of the paper wrote, the entire banking system’s combined equity—in other words, its ability to absorb losses before going bankrupt—stands at just $2.1 trillion.
“Hundreds of smaller banks are literally insolvent, so that’s the fundamental problem,” Roubini said. “When interest rates go higher, the value of securities and loans is lower, and then we have mass liquidity and solvency problems.”
Roubini told Bloomberg he disagreed with European Central Bank president Christine Lagarde, who argued last week that price stability and financial stability were not mutually exclusive, since sound, well-managed banks could see out a credit crunch as long as their liquidity is backstopped by monetary authorities.
In his view, this would work only when stresses are highly localized rather than systemic. In fact, he argued the problems are more deeply rooted than Lagarde would have people believe.
Heading towards a hard landing
What started out as a funding mismatch and liquidity problem will snowball into balance sheet problems, Roubini predicted.
“Economic recession is going to lead us from duration and market risk to credit risk,” he warned.
That’s because the current crisis sparked by the depositor run on Silicon Valley Bank will force other regional lenders to cut back their supply of credit to small community businesses and households.
As a result, credit growth will drop from an annual rate of 10% to potentially close to zero. Once U.S. gross domestic product moves from expansion to contraction, Roubini said, an economy swimming in debt will no longer be in a position to service its financial obligations.
“In the 1970s when we had the stagflationary shock that led to inflation and recession, debt ratios in advanced economies were only about 100% of GDP— private and public debt. Today they are 420%,” he said.
The U.S. economy had one major advantage the last time its balance sheet was stretched back in 2008 and 2009. The global financial crisis brought about a sharp decline in consumer demand that helped to depress prices, allowing the Federal Reserve to cut rates to zero and crank up the printing press.
With little sign that consumer prices in the foreseeable future will return to the Fed’s 2% target growth rate, Roubini believes neither the U.S. central bank nor an indebted federal government will have the maneuvering room needed to sufficiently stimulate the economy.
“So we have the worst of the ’70s in terms of negative supply shock, reduced growth, and inflation, and we have debt ratios that are much higher than after the great financial crisis,” Roubini said. “We’re headed towards a hard landing.”
