Stopped clock or underrated prophet?

A lot of people have brought up Nouriel Roubini's name in the last few days; he's the economist who has been predicting an explosive unwinding of our bubbly markets for a while.

Well, he certainly called that. Sort of. For years now, Roubini has been warning about the dangers of America's overvalued dollar and the resulting current account deficit. Deficits in the current account, of course, must always be balanced by equal and opposite surpluses in the capital account--foreigners will not give us their goods for free, and America receives surprisingly little foreign aid. That river of capital has been rolling through Wall Street for quite some time, and long before much of anyone else was worried, Roubini was warning that when the floodwaters receded, the damage was going to be pretty spectacular.

But pretty much everyone, including IIRC Roubini, was expecting that the proximate cause of the collapse would be a sudden reverse of the capital flows, either because of a dollar crisis or because Asian central banks started to get worried about the massive piles of US securities they've stockpiled in the course of keeping their currencies artificially low. That would trigger a financial crisis, probably through the vehicle of a housing price collapse.

What happened was the reverse. The housing bubble popped, then the banks started having problems. Now we're worried about the capital outflows.

Roubini is now arguing that this is a solvency crisis, not just a liquidity crisis. I'm not sure what he means by this. Given where subprime defaults stand today, several years after the housing market peaked, I find it unlikely that the market as a whole is likely to experience solvency problems; most of those securities will continue generating cash flow. Yes, I expect defaults to increase in other segments too, but from record lows. While I'm sure that this will continue to be a solvency problem for individual firms, I don't see how you get that a solvency problem--rather than a liquidity crisis--is causing the current meltdown.

But he basically got the big thing right, which is that the enormous capital surpluses were making the economy incredibly vulnerable to a radical event. Other people were saying this too, of course--indeed, I wrote article after article on the problem of "global imbalances". But he said it loudest and longest, and always stuck to his guns.

The name I'm surprised I haven't heard more is Nassim Taleb, who has long been arguing that people in the financial industry are systematically underestimating the likelihood of rare but catastrophic events in the finance market, such as the Russian bond crisis that brought down LTCM. That seems like a pretty good explanation of what we're seeing now. His book, The Black Swan, is highly recommended if you're interested in finance and risk; he did a podcast on it last year with Russ Roberts that is worth listening to if you're trying to understand how so many smart people could be so dumb.