Economist who predicted 2008 crisis warns of 'severe recession', here’s how it will play out

He had warned that the housing bubble would burst, years before the fall of the mortgage market brought down the global economy, but stakeholders failed to take notes.

FPJ Web DeskUpdated: Saturday, September 24, 2022, 02:24 PM IST
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Nouriel Roubini |

Before the pandemic unexpectedly pushed the brakes on economic activity, the 2008 financial crisis was listed among major “black swan events”, which are categorised as unpredictable. But the truth is that there were people who saw it coming, and even warned the US about the housing bubble that burst and shattered the global economy. One of them was economist Nouriel Roubini who stood at the IMF in 2006, and predicted a once in a lifetime housing bust and deep recession that came a couple of years later. Now the man nicknamed Dr Doom has predicted another long and painful global recession ahead with persistent high inflation, that will last till the end of the year.

It’s out there for everyone to see

Months after calling predictions about a mild recession delusional, Roubini says that people simply have to look at the large debt ratios of governments and firms to realise the recession will be deep. Debt ratios mean the assets of a firm which have come from borrowed money, and it’s higher when an entity has taken more loans than it can repay.

Zombies infecting the market

According to Roubini, higher interest on borrowings will mean that “zombie institutions” such as zombie banks, companies, households and countries will collapse under the weight of rising rates, and the real economic positions will be revealed. Zombies in an economy are entities that only make enough money to get by after paying expenses, and aren’t left with enough to clear their debt.

After a 75 basis points hike in the recent US Federal meeting, Roubini expects a 50 basis points hike in November and the same in December, as he maintains that bringing inflation down to 2 per cent would be impossible without aggressive rate hikes. But he says that the inflation will remain persistent, and will be coupled with rising unemployment and marginal growth.

Painful recession, less relief

Roubini also rules out stimulus packages from governments to support the economy during the recession, which he says will last throughout 2023. This is because the government is running out of cash to provide fiscal support for the market. While households and banks fell during the 2008 crisis, Roubini says this time shadow corporations, non-banking financial companies, hedge funds and credit funds will bleed this time.

The S&P 500 will fall by 40 per cent according to Roubini’s warning, which will be close to a dip of 47 per cent during the 2007-2009 downturn. Like this time, in 2008 Roubini was simply showing the world what’s right in front of them, but greed prevented institutions from seeing the writing on the wall.

How are things on the homefront?

In the Indian context, zombie companies which are borrowing just to survive instead of investing in growth, are biting into the resources of banks and have a stranglehold on 10 per cent of credit in the country. The startup boom in India has also created zombie unicorns, which have borrowed at a record rate in 2021, but don’t have a business model, have frozen hiring and will soon become irrelevant without much growth.

As for corporations, Adani Group, which had recently made Gautam Adani the world’s second-richest man, has Asia’s second highest debt ratio at 2,021 per cent. It was even called deeply overleveraged by Fitch, but the ratings agency changed that after a call with Adani’s management. But Fitch still cited elevated leverage and acquisitions hurting credit as a risk, while only doing away with the word “deeply”.

In the past five years, Indian banks have written off bad loans worth Rs 10 lakh crore, which is twice the amount which they have recovered. One can make out the kind of pressure this has created on India’s banking system already hit by major loan frauds, and this might come back to haunt us during the recession.

Blinded by incurable greed?

Back then the housing market was thriving on subprime mortgages, which indicated home loans for individuals with an incomplete or non-existent credit history, at higher rates. It was rising since the late 90s and banks competing with each other kept on lending money without any verification, while mortgage backed securities were being sold. These assets were bundles of bonds, backed by these housing loans, bought by investors who had no idea about their unstable nature. When banks collapsed under the weight of loan defaults, they dragged these investors and the US as well as the global economy down with them in one go.

To sum it up, the banks chewed off a lot more than they could swallow, and eventually choked. Investors with mortgage-backed securities were standing on a platform elevated with a hollow foundation, and came crashing down.

Roubini got one economic catastrophe right, and now says a long period of darkness is on the horizon. He also recommends collecting a cash pile and going slow on stocks for investors, since the nominal value of cash will remain zero despite erosion, while equities can fall by as much as 30 per cent.

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