New YorkUniversityeconomist Nouriel Roubini is the author of, most recently, "Crisis Economics: A Crash Course In The Future Of Finance."
He is considered one of the most prominent and respected economists in the world. When both Wall Street bankers and Bush administration policymakers were insisting that everything was just fine, Roubini was warning about the most dire financial crisis since the Great Depression. In 2007, the financial elite laughed him off, but Roubini was vindicated by the crash of 2008. AlterNet economics editor Zach Carter recently spoke with Roubini about the financial crisis, the subsequent bailout, the financial reform bill moving through Congress, and the global economic outlook.
Zach Carter: How is the financial reform legislation going?
Nouriel Roubini: In my view, the financial reform bill goes in the right direction in terms of what needs to be done, but it doesn't go far enough in a number of dimensions. My view is that if banks are too big to fail, using higher capital charges and an insolvency regime is not going to work. If they're too big to fail, they're just too big, and they should be broken up.
If they're too big to fail, they're also becoming too big to be saved, too big to be bailed out, and too big to be managed. No CEO can monitor the activities of thousands of separate profit and loss statements, and the activities of thousands of different bankers and traders. So that's one dimension. We must be capable of going beyond the Volcker Rule, which is essentially Glass-Steagall-Lite. We need to go all the way and implement the kind of restrictions between commercial banking and investment banking that existed under Glass-Steagall.
ZC: Why do you see the Volcker Rule as insufficient? Why do we need Glass-Steagall?
Roubini: The Volcker Rule goes in the right direction, but in my view, the model of the financial supermarket where within one institution you have commercial banking, investment banking, underwriting of securities, market-making and dealing, proprietary trading, hedge fund activity, private equity activity, asset management, insurance—this model has been a disaster. The institution becomes too big to fail and too big to manage.
It also creates massive conflicts of interest. If you look at the cases against Goldman Sachs and Morgan Stanley, leaving aside whether there was any fraud or illegal activity—that's for a court to decide—there is still a fundamental conflict of interest. These institutions are always on every side of every deal. That's an inherent conflict of interest that cannot be addressed with Chinese walls [internal company barriers between different aspects of its business].
There are no benefits from these economies of scale and scope, as we've seen from the disasters at Citigroup, AIG and others. And there are massive conflicts of interest. So I would separate all of these financial businesses under separate institutions, and I would go back to the kind of restrictions that we had under Glass-Steagall.
ZC: An idea has been pushed by Sen. Blanche Lincoln recently to require the five big bank derivatives dealers to spin-off their swaps desks. Is that a good idea?
Roubini: Yes, I think it's a good idea, and I would go beyond it. I think there is not a good reason for these firms to be involved in dealer's markets where you're not having transactions on exchanges. Whenever you have a dealer market, there is no price transparency. For the same security, you get 10 different quotes, bid-ask spreads are wide, there is not enough liquidity in situations of stress and we've seen it happen.
During the recent financial crisis, things that were traded on exchanges like equities-- there was tumult, there was noise, but there was never a freeze-up of these markets. But in dealer's markets, we had totally frozen markets for bonds, for derivatives, for credit derivatives, for lots of stuff. So I think market-making and dealing is actually only a source of profit for financial institutions-- under the guise of market-making and dealing, they're doing a lot of proprietary trading. I would not just take that away from them, I would also move away from dealers markets altogether to exchanges where there is full transparency, where commissions and fees and bid-ask spread are low.
ZC: A lot of economic observers in the U.S. seemed to be saying recently that the financial sector was finally out of the woods. But what does the developing crisis in Europe say about the state of the global banking system?
Roubini: First of all, we're not out of the woods. The definition of a crisis is when you have a bunch of policymakers who need to spend all day Saturday and Sunday to devise some last-minute rescue before markets open on Monday morning. By that standard, we had that crisis in Bear Stearns, AIG, TARP, you name it. We thought that was over, but just the other weekend, we had all of the finance ministers of Europe getting together a rescue package before markets opened on Monday morning.
These packages are becoming larger—the latest one is $1 trillion. To me, that says that policymakers are desperate, the European Union is in crisis, a lot of the countries using the euro are insolvent, and $1 trillion is not going to be enough. The euro is weakening again, going toward 1.75 times the value of the U.S. dollar. It's not enough because the fundamental problem is that these countries need to do a massive amount of fiscal conservation. It will be politically and socially painful, and this conservation, necessary as it may be, is going to reduce economic output. When you raise taxes and cut spending, in addition to public debt and deficit problems, all of these countries have massive problems in terms of loss of competitiveness. Already a decade ago, they were losing market share to China and Asia, then wages and productivity have been leveled off for a decade, and the final nail in the coffin was the appreciation of the euro between 2002 and 2008.
So in order to stabilize the economy to resume growth, in order to resume competitiveness, that requires real depreciation of the euro against other currencies. That's a separate problem from the fiscal problem and the other structural problems. So I think Europe is going to be a mess and very difficult, regardless of whether you have $1 trillion on the table or $2 trillion on the table. All of this money is conditioned on painful fiscal austerity and on painful structural reforms. So I see it being very difficult for countries to find an effective way to solve all of these issues.
ZC: We've had a strong dollar policy in the United States for decades, accompanied by a very large trade deficit. Did either of those factors contribute to the crash in 2008?
Roubini: They contributed in the sense that all of the big problems-- this big housing asset bubble, the U.S. public and private sectors spending more than they had—these were associated with a large current account deficit. And that large current account deficit was associated with a strengthening of the U.S. dollar until the early part of the past decade that also adversely affected the U.S. trade balance.
During the crisis, paradoxically, the dollar strengthened rather than weakened because of an investor flight to safety. Then in the last year, the dollar started to weaken again, and now that trend has started to reverse in the last few months because of the weakness of the euro.
The dollar should be falling much more in order to restore U.S. competitiveness and promote economic growth. But the U.S. needs a weak dollar to grow its exports, Europe needs a weak euro to grow its exports, the U.K. needs a weaker pound to grow its exports and Japan needs a weaker yen to grow its exports. You cannot have all currencies falling relative to each other. By comparison, Europe looks like it's in worse shape than the U.S., so that's why the euro is weakening and the dollar is strengthening.
ZC: So what should be done? If we have five major currencies that need to be weakened, is there a way to sort out this mess?
Roubini: One way to think about it is that major currencies of advanced economies should weaken relative to the currencies of emerging market economies—the Chinese, Asia, all of these countries.
That would be the right thing to do. The trouble is, China has pegged its currency to the U.S. dollar, and then other emerging market countries do not want to be losing market share to China, so they adjust their own currencies and keep them from strengthening against the dollar. So in reality, the necessary adjustment between the currencies of advanced economies and emerging market economies is not occurring, because the Chinese are lagging behind the pace of the problems.
Even when they do let their currency appreciate, they'll do it by so little—3 percent or 4 percent per year—that it will not make much of a difference for dealing with global imbalances.
ZC: So what does that mean for the United States? We haven't seen much serious action on fiscal stimulus since February 2009. Is there anything that can be done to fight what appears to be a long-term structural problem?
Roubini: My forecast is that whatever we do in terms of policy, we'll have to accept that economic growth is going to be subpar and un-dynamic, because the private sector has to de-leverage by spending less and saving more, and soon enough, even the public sector cannot afford having these large fiscal deficits. Otherwise, we're going to end up like Europe and Greece. So over time, we're going to have to raise taxes and cut spending. Ultimately, both the public and private sectors will have to spend less and save more, and that implies that economic growth is going to be weak.
Trying to counter that by drugging the economy with more economic stimulus or more bailouts is not going to work, it's actually going to make the problems worse. Eventually, the bond market vigilantes are going to wake up to the United States the way they've woken up to Greece and Portugal and Spain and the U.K. and Ireland and Iceland. We cannot run a $1 trillion deficit for the next decade without the currency markets developing a panic at some point.
ZC: But what about a short-term plan for more economic stimulus coupled with long-term plans to cut the deficit?
Roubini: In theory, you could certainly afford more stimulus in the short-run. But the reality is that we've already done three rounds of fiscal stimulus, the latest round looks like $138 billion in a job deal. So we're doing some short-term stimulus, but we're not taking any action on medium-term fiscal conservation, or controlling spending or raising taxes. Politically, the Democrats are resisting spending cuts, the Republicans are dead set against tax increases, and this gridlock implies that the deficit is going to remain large. This is an election year, so there's no chance of anything being accomplished until next year, and the parties are so divided, I don't see any bipartisan agreement to do the right thing. So the deficit is going to stay above $1 trillion for the next three years, and something is going to snap in the bond market during that time.
ZC: There are a lot of different types of spending. There are a lot of people like me who would have no problem axing the defense budget, while other people want to gut Social Security. But what about bank bailouts? How expensive are those, and can we endure another bank bailout without a currency crisis?
Roubini: One of the reasons why we have a sovereign debt problem is that we started with a crisis caused by too much debt in the private sector—financial institutions, households, etc. Now we've socialized some of those private losses and put them on the balance sheet of the government. That's why the advanced economies have, on average, a budget deficit of 10 percent of GDP and public debt has doubled to 100 percent of GDP. And that's a problem. Eventually the risk is that we're either going to monetize these deficits like Greece, or for countries that can't do that, default on the debt.
My worry is that the next stage of the financial crisis is not going to be in the private sector but the public sector, which has added a huge amount of leverage. It started with Greece, Portugal and Spain, but in all of the advanced economies we see this phenomenon, and eventually there is the risk of a fiscal train wreck.
ZC: So what should policymakers have done in 2007 and 2008 in the U.S. when the banking system was going off the rails?
Roubini: Many of the things that were done were in fact appropriate. We learned the lessons of the Great Depression and we used monetary policy, we used fiscal stimulus, and even some backstopping of the financial sector was ultimately probably necessary. If Wall Street would have actually collapsed, the damage to Main Street would have been even more severe.
However, I think we still bailed out too many institutions, and we kept too many zombie banks alive. We could have taken the unsecured credit of some of these banks—their debts—and converted them into equity. That's what you do in bankruptcy. You take a firm that's in Chapter 11, and you take some of their debts and you convert them into equity.
If we'd done that, some of the creditors of the banks would have become equity holders, and that would have recapitalized the banks without using public money. We would not have had to bailout the creditors and the shareholders of the banks. I would have done that as part of the solution in order to limit the amount of public money and taxpayer money used for bailouts.
ZC: Has the crisis changed Wall Street significantly?
Roubini: Not really. Right now I fear that we're back to business as usual with prop trading, leverage, and banks generally behaving as if these last few years never happened. They don't even realize that many of them are only alive because there were 10 different government programs that either straightforwardly bailed them out or allowed them to borrow at artificially low rates. The bonuses are getting to be high again, getting to be outrageous and unrelated to long-term performance. It's back to business as usual, and that's dangerous.
ZC: You talk in your book about compensation, both for traders and bankers and also for regulators. Can you talk about that some?
Roubini: Yeah. For what concerns bankers and traders, one of the biggest problems in the crisis was the way they were compensated. There were huge incentives for them to take on a lot of risk and leverage. If the risky investments turn out right, they get large profits and bonuses, and if they turn out to be wrong further down the line, they've already pocketed their bonuses. The worst thing that happens is you don't get another bonus.
I'd prefer a system in which you don't get the bonus right away—there are clawbacks. Your bonus is put into an account, and then we'll wait and see if three years from now, your investments were really good, or if they ultimately contributed to losses. We need to incentivize bankers and traders not to take too much risk.
What concerns regulators, I think we have to make them more independent to try to prevent regulatory capture—this situation where the bank lobbyists totally corrupt the thinking of the regulators. There are lots of things you can do, and one of them is to just pay them better so that they don't have the same incentive to go and work for the private sector as soon as there's a change in the administration.