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Anatomy of a Financial Meltdown

In this February 2008 commentary, I warned that the 2006-07 US housing bust would lead to a severe US and global recession and a global financial crisis. Fifteen years later, we may once again be on the verge of a twin economic and financial crisis – only this time the outcome could be even worse. After all, private and public debt-to-GDP ratios are much higher today, and the past few years have laid bare the costs and limitations of unconventional monetary, fiscal, and credit policies.

Moreover, back in early 2008, inflation was falling and leading to deflation, and a demand shock and a credit crunch allowed for unconventional policy easing on a massive scale. Today, negative supply shocks have caused inflation to surge, forcing central banks to tighten monetary and credit policies even as many economies have been heading toward recession.

And, on top of it all, serious new megathreats – stemming from a “geopolitical depression,” climate change, and the risk of new pandemics – are looming, and a widespread populist backlash continues to jeopardize the future of globalization and democratic capitalism. Across many dimensions, the risks are even more severe today than in 2008.
– Nouriel Roubini, February 2023

A vicious circle is currently underway in the United States, and its reach could broaden to the global economy. America’s financial crisis has triggered a severe credit crunch that is making the US recession worse, while the deepening recession is leading to larger losses in financial markets – thus undermining the wider economy. There is now a serious risk of a systemic meltdown in US financial markets as huge credit and asset bubbles collapse.

The problem is no longer merely sub-prime mortgages, but rather a “sub-prime” financial system. The housing recession – the worst in US history and worsening every day – will eventually see house prices fall by more than 20%, with millions of Americans losing their homes. Delinquencies, defaults, and foreclosures are now spreading from sub-prime to near-prime and prime mortgages. Thus, total losses on mortgage-related instruments – including exotic credit derivatives such as collateralized debt obligations (CDOs) – will add up to more than $400 billion.

Moreover, commercial real estate is beginning to follow the downward trend in residential real estate. After all, who wants to build offices, stores, and shopping centers in the empty ghost towns that litter the American West?

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