In the long run, says Martin Wolf, this crisis will be resolved. (Though the journey there may be “wretchedly uncomfortable”). Of course, “in the long run”, said Keynes, “we are all dead”.
Wolf repeats Nouriel Roubini’s 12 steps to financial disaster in Wednesday’s FT. It’s pretty clear that Mr Roubini’s analysis is gaining more and more traction as a realistic – if decidedly bleak – economic outcome.
In short, the 12 steps envisage further waves of distressed ABS smashing against banks, with contagion of subprime trouble into CMBS and consumer debt. After a bank, and several corporates default, the stage will be set for a meltdown in the shadow financial system, and following then, a deep and prolongued spiral of contraction in lending, far worse than the current liquidity problem.
All in, Roubini’s outlook perhaps explains why the Fed has cut interest rates by 2 per cent in the last six weeks. And also, perhaps, it explains why the authorities are moving swiftly on the bond insurers, since their collapse even has its own step – number 5.
Wolf’s conclusion – that the economy will, 12 steps later, be in need of the state to save its skin – certainly puts a new perspective on the current efforts of messrs Spitzer, Dinallo et al.
In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both.