In These New Times

A new paradigm for a post-imperial world

Largest Bubble Burst in History

Posted by smeddum on October 15, 2008

Largest Bubble Burst in History
16 October 2008
By Nouriel Roubini MoscowTimes
The rich world’s financial system is headed toward a meltdown. Stock markets have been falling most days, money markets and credit markets have shut down as their interest-rate spreads skyrocket, and it is still too early to tell whether the raft of measures adopted by the United States and Europe will stem the bleeding on a sustained basis.

A generalized run on the banking system has been a source of fear for the first time in seven decades, while the shadow banking system — broker-dealers, nonbank mortgage lenders, structured investment vehicles and conduits, hedge funds, money market funds, and private equity firms — is at risk of a run on their short-term liabilities.

On the real economic side, all the advanced economies — representing 55 percent of global gross domestic product — entered a recession even before the massive financial shocks that started in late summer. So we now have a recession, a severe financial crisis and a severe banking crisis in the advanced economies.

Emerging markets were initially tied to this distress only when foreign investors began pulling out their money. Then panic spread to credit markets, money markets and currency markets, highlighting the vulnerabilities of many developing countries’ financial systems and corporate sectors, which had experienced credit booms and had borrowed short and in foreign currencies. Countries with large current-account deficits or large fiscal deficits and with large short-term foreign currency liabilities have been the most fragile. But even the better-performing ones — like Brazil, Russia, India and China — are now at risk of a hard landing. Many emerging markets are now at risk of a severe financial crisis.

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The crisis was caused by the largest leveraged asset bubble and credit bubble in history. Leveraging and bubbles were not limited to the U.S. housing market, but also characterized housing markets in other countries. Moreover, beyond the housing market, excessive borrowing by financial institutions and some segments of the corporate and public sectors occurred in many economies. As a result, a housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble and a hedge funds bubble are all now bursting simultaneously.

The delusion that economic contraction in the United States and other advanced economies would be short and shallow — a V-shaped six-month recession has been replaced by certainty that this will be a long and protracted U-shaped recession, possibly lasting at least two years in the United States and close to two years in most of the rest of the world. And, given the rising risk of a global systemic financial meltdown, the prospect of a decade-long L-shaped recession — like the one experienced by Japan after the collapse of its real estate and equity bubble — cannot be ruled out.

Indeed, the growing disconnect between increasingly aggressive policy actions and strains in the financial market is scary. When Bear Stearns’ creditors were bailed out to the tune of $30 billion in March, the rally in equity, money, and credit markets lasted eight weeks. When the U.S. Treasury announced a bailout of mortgage giants Fannie Mae and Freddie Mac in July, the rally lasted just four weeks. When the $200 billion rescue of these firms was undertaken and their $6 trillion in liabilities taken over by the U.S. government, the rally lasted one day.

Until the recent U.S. and European measures were announced, there were no rallies at all. When AIG was bailed out to for $85 billion, the market fell 5 percent. Then, when the $700 billion U.S. rescue package was approved, markets fell another 7 percent in two days. As authorities in the United States and abroad took ever more radical policy steps from Oct. 6 to Oct. 9, stock, credit and money markets fell further, day after day.

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