Twelve steps to financial disaster

Economist Nouriel Roubini recently detailed the inevitable consequences of the mad credit expansion. And the US central bank's latest hints of further monetary easing makes his list even more frightening.

I couldn't miss the headline on the front page of the Financial Times on Thursday 28th February: "Dollar hits low as Fed Chief hints at rate cut".

Bernanke's willingness to abandon the dollar is on the one hand very good for gold investments, for which we thank him, but on the other it also says something quite scary about the view he must have from the inside of what's going on in the US economy.

Unbelievably, since last summer the Fed have cut rates from 5.25% to 3% and are still intimating more in March, the market is saying another 50 basis points.

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On 20th February Martin Wolf wrote one of his regular excellent articles in the Financial Times, headlined "America's economy risks the mother of all meltdowns". It was a review of a recent paper by Nouriel Roubini, of New York University's Stern School of Business. Professor Roubini was one of the early voices concerned about the inevitable consequences of the mad credit expansion and in this latest paper he spells out his twelve steps to financial disaster, as follows:

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 percent from their peak, wiping out between $4,000bn and $6,000bn in household wealth.

Step two would be further losses, beyond the $250bn-$300bn now estimated for subprime mortgages because he says about 60% of all mortgages originating between 2005 and 2007 had "reckless or toxic features".

Step three would be big losses on unsecured consumer debt, credit cards, auto loans, student loans, etc.

Step four, the downgrading of monoline insurers [we would comment that recently the market was cheered by the apparent return to safety for the two biggest monoline insurers, Ambac and MBIA, whose AAA status now seems more secure, although that presupposes further deterioration in the US economy won't re-ignite their problems.]

Step five would be the meltdown of the commercial property market.

Step six, bankruptcy of a large regional or national bank.

Step seven, losses on reckless leveraged buy-outs. [A point made very forcibly this week by Jon Moulton, head of the private equity firm Alchemy Partners. He said that there will be large private equity failures this year. Absolutely guaranteed.]

Step eight would be a wave of corporate defaults. [Recent widening of credit spreads gives rise to genuine concern that this could be the next key issue.]

Step nine would be a meltdown of the shadow financial system. [In other words, some hedge funds could be in distress.]

Step ten would be a further collapse of stock markets. [We absolutely expect this.]

Step eleven would be a drying up of liquidity of financial markets.

Step twelve would be a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices.

An alarming list, one that makes more sense than might otherwise be the case because of how the Federal Reserve, led by Bernanke, is behaving.

By John Robson & Andrew Selsby at fullCircle Asset Management, as published in the threesixty Newsletter, a fortnightly newsletter that gives insight into the investment markets.

For more from FullCircle, visit