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Tuesday, October 14, 2008

Nouriel Roubini was right again
Posted by Jill | 6:03 AM
Yesterday Nouriel Roubini predicted that by the end of the day, markets would rally, but he cautioned against thinking that happy days are here again:
Are we close to the bottom of this financial crisis? Today stock markets – and other financial markets - will rally on the news that terrified policy makers peering into the abyss got religion and started to do in a consistent way what is necessary but financial markets will remain volatile with significant downside risks over the next few weeks as:

- details of these plans are still very fuzzy and ambiguous and with uncertain effects on various assets classes (common shares, preferred shares, unsecured debt of financial institutions, etc.);

- macro news will surprise on the downside as the economies sharply weaken and contract while fiscal policy stimulus is lagging;

- earnings news for financial and non financial firms will surprise on the downside;

- the damage done to confidence and to levered investment is already severe and the process of deleveraging of the shadow financial system will continue;

- major sources of future stress in the financial system remain; these include the risk of a CDS market blowout, the collapse of hundreds of hedge funds, the rising troubles of many insurance companies, the risk that other systemically important financial institutions are insolvent and in need of expensive rescue programs, the risk that some significant emerging market economies and some advanced ones too (Iceland) will experience a severe financial crisis, the ongoing process of deleveraging in illiquid financial markets that will continue the vicious circle of falling asset prices, margin calls, further deleveraging and further sales in illiquid markets that continues the cascading fall in asset prices, further downside risks to housing and to home prices.


He then goes on with a prescription for how to get us out of this mess:
A key policy tool – that is currently missing in the G7 and EU plans is to use fiscal policy to boost aggregate demand. Indeed, given the current collapse of private aggregate demand (consumption is falling, residential investment is falling, non-residential investment in structures is falling, capex spending by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate) it is urgent to provide a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than spending and investing it is necessary now to boost directly public consumption of goods and services via a massive spending program (a $300 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be sharply increased together with a targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and growing budget deficits; but $300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets. Is such fiscal stimulus plan is not rapidly implemented any improvement in the financial conditions of financial institution that the rescue plans will provide will be undermined – in a matter of six months – with an even sharper drop of aggregate demand that will make an already severe recession even more severe. So a fiscal stimulus plan is essential to restore – on a sustained basis – the viability and solvency of many impaired financial institutions. If Main Street goes bust in the next six months rescuing in the short run Wall Street will still lead Wall Street to go bust again as the real economy implodes further.


Roubini hasn't been wrong yet, for all that he's been derided by the very same Republicans and so-called "free-marketeers" who got us into this mess.

Funny how Roubini's prescription echoes the Obama/Biden rescue plan for the middle class that was unveiled yesterday:
The Obama emergency plan would make $25 billion immediately available in a Jobs and Growth fund to help ensure that in-progress and fast-tracked infrastructure projects are not sidelined...

[snip]

Barack Obama proposes a permanent tax cut of $500 for workers and $1000 for families. A first round of these tax cuts could be mailed out quickly by the IRS based on tax returns already filed for tax year 2007.

[snip]

Obama believes Congress should immediately extend unemployment insurance for an additional 13 weeks to help families that are being hit hardest by this downturn.


While Henry Paulson continues to attempt to address the crisis by using taxpayer money to bail out banks and corporations and entire industries to prop up the markets while the economy continues to hemorrhage jobs, Roubini -- and the Obama campaign -- recognize that even the preposterously wealthy cannot keep an economy the size of that of the U.S. afloat all by themselves.

Meanwhile, the Republican backlash against attempts to address their failures has already started. David Brooks' knee is jerking already.

Glenn Greenwald has his own theory about the rally.

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