Image: Bruce Gilden/Magnum Photos
On March 28, 2007, Federal Reserve Chairman Ben Bernanke appeared before the congressional Joint Economic Committee to discuss trends in the U.S. economy. Everyone was concerned about the “substantial correction in the housing market,” he noted in his prepared remarks. Fortunately, “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.” Better still, “the weakness in housing and in some parts of manufacturing does not appear to have spilled over to any significant extent to other sectors of the economy.” On that day, the Dow Jones industrial average was above 12,000, the S&P 500 was above 1,400, and the U.S. unemployment rate was 4.4 percent.
That assurance looks bad in retrospect, as do many of Bernanke’s claims through the rest of the year: that the real-estate crisis was working itself out and that its problems would likely remain “niche” issues. If experts can be this wrong—within two years, unemployment had nearly doubled, and financial markets had lost roughly half their value—what good is their expertise? And of course it wasn’t just Bernanke, though presumably he had the most authoritative data to draw on. Through the markets’ rise to their peak late in 2007 and for many months into their precipitous fall, the dominant voices from the government, financial journalism, and the business and financial establishment under- rather than overplayed the scope of the current disaster.
With the celebrated exception of Nouriel Roubini, an economist from the Stern School of Business of New York University. At just the time Bernanke was testifying about the “contained” real-estate problem, Roubini was publishing a paper arguing that the depressed housing market was nowhere near its bottom, that its contraction would be the worst in many decades, and that its effects would likely hurt every part of the economy. In September 2006, with markets everywhere still on the rise, he told a seminar at the International Monetary Fund’s headquarters that the U.S. consumer was just about to “burn out,” and that this would mean a U.S. recession followed by a global “hard landing.” An economist who delivered a response dismissed this as “forecasting by analogy.” The IMF’s in-house newsletter covered Roubini’s talk as a curiosity, under the headline “Meet Dr. Doom.”
Roubini is thus enjoying his moment as the Man Who Was Right, a position no one occupies forever but which he is entitled to for now. As markets have collapsed, the demand for his views and predictions has soared. He travels constantly, and late this spring I met him in Hong Kong to ask what he was worried about next.
Roubini, who is 50, has a tousled look, from his curly black hair to his rumpled clothing. The initial impression he gave was of total physical exhaustion. When he spoke, at mid-afternoon in Hong Kong, he would scrunch his eyes closed tight, as if forcing himself awake, and shove his suit jacket sleeves and shirt sleeves high up from his wrists to his forearms in the same effort.
You often see this paralyzing fatigue in people who’ve recently made the flight to Asia. What was unusual in Roubini’s case is that even with eyes closed he kept emitting high-speed and complex answers, which proved on transcription to consist of well-formed sentences and logical sequences. They were delivered in an accent that is what you might imagine from someone who spent his first 20-plus years in Turkey, Iran, Israel, and Italy before going to the United States as a graduate student at Harvard. In a few cases, I later realized, the polish of his responses was because he was reciting passages from papers he had written, as if from an invisible teleprompter. But mostly he seemed to be drawing on data points and implications that were so much on his mind they could be processed and expressed even when the rest of him was spent.
The conversation was surprising in three ways: for the relatively high grades Roubini gave Treasury Secretary Timothy Geithner, generally the least-praised member of the Obama economic team; for the overall support (with one significant exception) he expressed for the administration’s response to the economic crisis; and for his willingness to look far enough beyond today’s disaster to speculate about the problems a recovery might bring. He was also full of advice about China’s reaction to the world financial crisis, including the suggestion that its options are narrower than its leaders may grasp.
Roubini’s compliments for Geithner were in the context of the intellectual and policy history of how the crash had developed and why its effects have been so severe. The dot-com and larger tech-industry crash of 2000 eliminated a tremendous amount of stock-market wealth. During the panicky sell-off of 1987, nearly a quarter of the New York Stock Exchange’s total value was lost in one day. By comparison, defaults on subprime mortgages would seem more limited in their capacity to harm the economy. Why, then, had so much gone so deeply wrong?
Roubini said that the difference was partly “debt versus equity.” That is, a loss of stock-market value is damaging, but defaults on loans, which put banks themselves in trouble, had a “multiplier” effect: “When there’s a credit crunch, for every dollar of capital the financial institution loses, the contraction of credit has to be 10 times bigger.” This was the process at work last fall, when banks that were concerned about their own survival cut off working capital to everyone else.
The more important difference between this crash and others, Roubini said, was that the speculative bubble involved so much more of the economy than the term “subprime” could suggest. “It was subprime, it was near-prime, it was prime mortgages,” he said, warming up to rattle off a long list. “It was home-equity-loan lines. It was commercial real estate, it was credit cards, it was auto loans.” The list was just getting started, and he used it to emphasize that almost every form of borrowing had been taken beyond reasonable limits, and that most forms of asset had been bid unreasonably high. And not just in the United States: “People talk about the American subprime problem, but there were housing bubbles in the U.K., in Spain, in Ireland, in Iceland, in a large part of emerging Europe, like the Baltics all the way to Hungary and the Balkans,” and most parts of the world. “That’s why the transmission and the effects have been so severe. It was not just the U.S., and not just ‘subprime.’ It was excesses that led to the risk of a tipping point in many different economies.”
Roubini’s case against Ben Bernanke and his predecessor Alan Greenspan is that they kept interest rates too low for too long—and downplayed the significance of the bubble they helped create. “They kept on arguing that this was a minor housing slump, and this housing slump was going to bottom out,” he said. “They kept repeating this mantra that the subprime problem was a ‘niche’ and ‘contained’ problem.” These were serious analytic errors, he said, of a sort that is common near the end of a bubble. “Bernanke should have known better, but it’s not really about him. It’s in everybody’s interest to let the bubble go on. Instead of the wisdom of the crowd, we got the madness of the crowd.