Oh, what a way to start the week! Morgan Stanley’s Stephen Roach is sinking further and further into the depths of despair.
Just three weeks ago, Roach opined that given the state of things – tight spreads on risky assets, policy makers’ cavalier attitudes, etc – “it no longer makes sense to maintain an optimistic prognosis of the world.”
Now, says Roach, The Great Unravelling may be upon is, and subprime is to blame.
It’s a painfully familiar saga from one bubble to the next, Roach writes. “First equities, now housing. First denial, then grudging acceptance. It’s the pattern and its repetitive character that is so striking.” For the second time in seven years, “asset-dependent America has gone to excess.”
And once again, the bubbles are bursting – “most likely with greater-than-expected consequences for the US economy, a US-centric global economy, and world financial markets.”
For Roach, subprime is today’s dot-com — the pin that pricks a much larger bubble. “As was the case seven years ago [when tech stocks tanked,] I suspect that a powerful dynamic has now been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the US economy as a whole,” Roach writes.
Roach deplores the current narrow focus on damage to housing and mortgage finance markets incurred from the subprime meltdown. For him, the real debate is about “spillovers — whether the housing downturn will spread to the rest of the economy.”
This being Roach, today’s spillovers are “perfectly capable of triggering yet another post-bubble recession.”
But it didn’t have to be this way – expect for Alan Greenspan, who, according to Roach, crossed the line by “encouraging reckless behavior in the midst of each of the last two asset bubbles.”
And it was Greenspan who, in early 2005, extolled the virtues of sub-prime borrowing. “Alan Greenspan turned into an unabashed cheerleader for the excesses of an increasingly asset-dependent US economy,” says Roach. “I fear history will not judge the Maestro’s legacy kindly. And now he’s reinventing himself as a forecaster. Figure that!”
So is the Great Unravelling finally at hand? It’s hard to tell, says Roach.
But the exit strategy is painfully simple: “Ultimately, it is up to Ben Bernanke — and whether he has both the wisdom and the courage to break the daisy chain of the “Greenspan put.” If he doesn’t, Roach is convinced that this liquidity-driven era of excesses and imbalances will ultimately go down in history as the outgrowth of a huge failure for modern-day central banking. In the meantime, prepare for the downside — spillover risks are bound to intensify as yet another post-bubble shakeout unfolds.”