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We paraphrase. Nouriel Roubini, of RGE Monitor, actually thinks that this current market turmoil is “much worse” - not just worse - than the liquidity crisis experienced in 1998 following the LTCM episode.

Why? Insolvency versus illiquidity.

A liquidity problem occurs when a household, firm, country, etc is still solvent, but faces a sudden crisis, where a creditor is unwilling to refinance their claims for example. An insolvent debtor does not only face a liquidity problem, but could not pay the claims upon them over time, even if there were no liquidity problem. One, broadly, suggests sound fundamentals; the other very much not so.

LTCM, says Roubini, was mostly a liquidity crisis:

The US was growing then at 4% plus, the internet bubble had not burst yet, we were in the middle of the “New Economy” productivity boom, households were not financially stretched and corporations were not financially stretched with debt either….

Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase of the latest Minsky credit bubble.

[Minsky modelled asset bubbles driven by credit cycles whereby periods of economic and financial stability lead to a lowering of investors’ risk aversion and a process of releveraging. In this process, you’ll have sound borrowers, speculative borrowers, who can service only their interest payments and need refinancing to service their principal, and “Ponzi borrowers”, who can service neither and are banking on rising asset prices to keep on refinancing their debts.]

The real factors at stake in this unfortunate situation are, says Roubini:

• “You have hundreds of thousands of US households who are insolvent on their mortgages. And this is not just a subprime problem: the same reckless lending practices used in subprime….were used for near prime, Alt-A loans, hybrid prime ARMs, home equity loans, piggyback loans.”
• “You also have lots of insolvent mortgage lenders - not just the 60 plus subprime ones who have gone out of business - but also plenty of near prime and prime ones.”
• “You will also have - soon enough - plenty of insolvent home builders. Many small ones have gone out of business; now it is likely that some of the larger ones will follow in the next few months.”
• “We also have insolvent hedge funds and other funds exposed to subprime and other mortgages.”

Moreover, the recent widening in corporate credit spreads, says Roubini, is not a sign of a liquidity crunch. It is a sign that investors are realising that there are serious credit/insolvency problems in some parts of the corporate system.Low default rates, he says, have been driven in part by corporate profitability and robust balance sheets but also by easy credit. When the ‘hot money’ departs, historical patterns of default should reassert themselves.

This is not just liquidity crisis like in the 1998 LTCM episode. This is rather a liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the US and global economy…

… We are indeed at a “Minsky Moment” and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic - will not work; they will only postpone and exacerbate the eventual and unavoidable insolvencies.

Tin hats, dear readers.