Roubini: Short-term nationalisation of US banks is best means to end recession

"The current approach of trying to keep zombie banks alive by providing guarantees after first losses or buying bad assets is not going to work. Those measures would work if banks were simply illiquid, but not if they're insolvent, which a large chunk of US banks are, and if the hole in the financial system is so large [some banks will] have to be taken over," said Nouriel Roubini, professor of economics at the Stern School of Business at New York University.

Roubini's appraisal is based on the results of his recent analysis, which concluded that credit losses for financial institutions around the world could peak at as much as $3.6 trillion by the end of the financial crisis - markedly higher than the International Monetary Fund's (IMF) latest $2.2 trillion estimate.

Of that $3.6 trillion sum - which includes $2 trillion in losses on securities and $1.6 trillion on loans - Roubini estimated that $1.8 trillion will be borne by US banks and broker dealers. Working from a $1.4 trillion estimate of collective US bank capital as of the third quarter of 2008, Roubini concluded that, in aggregate, the US banking system is already insolvent, despite the significant capital injections the US Treasury has infused into systemically important firms over the past 18 months.

"US banks will need at least another $1.4 trillion to bring them back to the same capital position the banks were in before the financial crisis started. Trying to keep banks alive by providing public capital will not work, and it is therefore better to nationalise them on a temporary basis, separate the bad assets then sell them back to the private sector," argued Roubini, speaking at the Chicago Board Options Exchange risk management conference in Dana Point, California.

"That approach is a better one, since the alternative of keeping zombie banks alive could lead to a situation like Japan in the 1990s, which experienced stagnation and deflation that lasted for a decade. If we want to be market-friendly, temporary nationalisation is a more market-friendly solution," he added.

Roubini went on to highlight the fact that the current recession is now in its sixteenth month - based on a starting date of December 2007 - twice as long as the length of the last two recessions in 2002 and 1991. Rather than short and shallow "v-shaped" recessions like the previous two, Roubini characterised the current downturn as a longer, deeper "u-shaped" recession, which he sees lasting at least 24 months until December 2009 at the earliest, making it the longest recession since the Great Depression.

Even if GDP growth resumes next year, however, growth in the region of 1% or less will do little to dampen the effects of the recession since unemployment, a lagging indicator of economic activity, is likely to rise to more than 10% by the end of 2010, the professor predicted.

Roubini has been lauded for predicting the financial crisis as early as 2005, asserting that the housing bubble in both the US and Europe would inevitably lead to an unprecedented crash - most famously saying as much to a sceptical meeting of the International Monetary Fund in September 2006.

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