Transcript of IMF Seminar -- The Risk of a U.S. Hard Landing and Implications for the Global Economy and Financial Markets
IMF News, September 19, 2007
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- Published: September 19, 2007
Seminar summary and central questions
- Event: Thursday, September 13, 2007, Washington, D.C.; Featured Speaker: NOURIEL ROUBINI; Moderator: CHARLES COLLYNS.
- Framing questions addressed by Professor Roubini:
- Will the U.S. achieve a soft landing or face a hard landing (recession or growth recession) in the next few quarters?
- Will current turmoil and volatility in financial markets persist and worsen, producing a credit crunch and broader real-economy effects?
- How much will the Fed and other central banks cut rates and can they avoid a hard landing and resolve liquidity and credit problems?
- Will the rest of the world decouple from a U.S. slowdown or hard landing, particularly emerging market economies?
Key findings on housing and the real economy
- Characterization of the U.S. episode:
- One of the biggest housing bubbles in U.S. history; real home prices rose by about 93 percent starting in 1997.
- Home prices are falling for the first time since the Great Depression and are expected to fall further.
- Channels keeping excess housing supply and downward price pressure:
- Housing starts have fallen by a little more than 30 percent (typical U.S. recession peak-to-bottom fall is 50 percent).
- Foreclosures and repossessions (estimates cited: 2.2 million could occur).
- Lower demand due to mortgage-credit tightening (Goldman Sachs estimate: reduction this year of about 200,000 units).
- About $800 billion to $1 trillion in ARMs coming to maturity in the next year or so at much higher interest rates.
- "Condo flippers" and low-equity sellers increasing distressed supply.
- Divergent estimates of house price declines (preserved verbatim):
- "Case-Shiller already says that they will fall about 3.9, annualized 9 percent"
- Goldman Sachs estimates 15
- Roubini: at least 15 to 20
- Bob Shiller: adjustment could be as high as 50 percent
- Wealth, credit, and consumption links:
- Even a 20 percent home price decline could imply about a $4 trillion loss in home values (discussion of wealth effects).
- Residential investment is about 5 percent of GDP; transmission to the broader economy is required to produce a recession.
- Private consumption is about 72 percent of GDP; its retrenchment is the main trigger for recession risk.
- Private consumption growth: around 4 percent for several years; slowed to 1.3 percent in 2007:Q2.
- Home equity withdrawal: fell from $700 billion to less than $200 billion.
- Consumption impact example: with conservative estimates, withdrawal/wealth channels could reduce consumption by 1.6 percent of disposable income (as cited from Greenspan and Kennedy estimates and debate over 50 percent vs 25 percent allocations).
Financial-market dynamics, liquidity, and solvency concerns
- Credit repricing and tighter financial conditions:
- Junk bonds have gone up 200 basis points (wider credit spreads).
- Spreads wider imply higher borrowing costs for firms, homeowners, and consumers.
- Broadening of problem beyond subprime:
- Reckless lending characteristics (zero down, no verification, interest-only, negative amortization, teaser rates) were present in ARM primes, piggyback loans, home equity and alt-A—not only subprime.
- 50 to 60 percent of mortgage origination in 2005–2006 had reckless characteristics (as discussed).
- 50 to 70 subprime mortgage lenders have failed; some non-subprime lenders are in distress.
- From liquidity crisis to solvency issues:
- Comparison with LTCM (1998): current episode judged more severe and persistent because of underlying solvency problems across households, lenders, and some corporations, not just a temporary liquidity squeeze.
- Corporate-default context (Ed Altman citations preserved):
- In a normal year about 3 percent of corporations go belly-up.
- Altman had predicted 2.5 percent; actual corporate defaults last year were 0.6 percent.
- Rising credit spreads and tighter conditions could increase defaults, affecting corporate bond CDOs later.
- Intermediation and opacity problems:
- Seizure of liquidity observed across interbank, money, MBS, CDO, CLO, conduits, and asset-backed commercial paper markets.
- Opacity from complex securitization (CDOs of CDOs, marked-to-model valuation, rating-agency conflicts) exacerbates uncertainty.
- Two central uncertainties highlighted:
- Size of eventual losses on mortgage-related products ($50 billion, $100 billion, or $150 billion on subprime alone were discussed as possibilities).
- Who holds the losses ("Where's Waldo" problem) increasing counterparty risk and distrust among institutions.
Macro and international transmission: decoupling and global risks
- Roubini's conditional view on decoupling:
- If the U.S. achieves a soft landing, the rest of the world may largely avoid a meaningful setback.
- Conditional on a U.S. hard landing (Roubini’s preferred scenario), global decoupling is unlikely; significant slowdown and transmission via trade, financial, and exchange-rate channels is expected.
- Specific regional vulnerabilities and channels:
- China: despite acceleration, China is vulnerable because a U.S. consumer-led downturn reduces demand for Chinese consumer goods; China could be a first victim of U.S. hard landing.
- East Asia: integrated production chains mean a Chinese slowdown transmits to regional exporters.
- Commodities exporters (Asia, Latin America, Africa): would be hurt by lower commodity prices.
- Europe: a strong euro (moving toward 140 cited) poses competitiveness risks; Club Med countries signal loss of competitiveness.
- Japan: Q2 growth estimated as negative (citation in transcript); domestic demand weak; yen appreciation could hamper fragile recovery.
- Emerging markets:
- Many EMs entered the episode with improved fundamentals (small budget deficits, fiscal surpluses, independent central banks, low inflation, large reserves—$5 trillion aggregate cited); less vulnerable to classic sudden-stop crises.
- Caveat: improved fundamentals were partly due to a benign global environment (high growth, high commodity prices, low global policy rates, low risk aversion). Roubini warns that his scenario implies lower global growth, lower commodity prices, wider credit spreads, and greater risk aversion—raising pressures on EMs even if large crises are less likely.
Scenarios and outlook presented by Roubini
- Roubini’s baseline concern:
- He "expects still a U.S. hard landing and a recession."
- Financial turmoil will persist and create a vicious circle between financial tightening and real-economy weakness.
- He does not believe the Fed will be able to avoid a hard landing; Fed easing may limit depth but not prevent recession (analogy to 2001).
- He is "not expecting a global recession, but a more significant slowdown of global growth than the one that people are currently pricing."
- Policy tools and limits:
- Fed easing may be "too little, too late" given concerns about inflation and moral hazard and because much of the crunch is in nonregulated sectors (hedge funds, investment banks, SIVs/conduits) where traditional open-market operations may not fully unclog credit.
- Even aggressive easing may not rapidly resolve gluts (housing, autos, consumer durables) as monetary policy cannot quickly clear excess physical inventories.
Policy implications and recommendations discussed
- Regulatory and supervisory lessons:
- Monetary policy alone is not the right tool to manage asset bubbles; prudential supervision and regulation must be strengthened to limit excessive financial-sector risk-taking on the way up.
- The recent ideological trend toward regulatory laissez-faire contributed to the buildup of excesses; the system of multiple regulators (federal and state) allowed race-to-the-bottom dynamics.
- Need for improved transparency, valuation practices, and addressing rating-agency conflicts of interest.
- The IMF and other institutions have a role in studying systemic risk, financial globalization, securitization practices, and proposing regulatory solutions.
- Moral-hazard trade-off:
- Easing to limit real-economy fallout creates moral-hazard concerns (the "Greenspan/Bernanke put"); the policy challenge is to combine lender-of-last-resort support with better ex ante regulation to limit future excesses.
- Expected policy responses:
- Anticipated Fed easing (debate whether 50 basis points vs 25 basis points cuts were appropriate—Mishkin cited as more likely to push for 50 basis points).
- International coordination and analysis of regulatory reforms (FSF study and other initiatives noted in discussion).
Notable numeric and factual items (preserved exactly)
- Seminar date: September 13, 2007.
- Housing bubble: real home prices up by about 93 percent starting in 1997.
- Housing sector weight: housing/residential investment "now 5 percent of GDP."
- Private consumption share: "about 72 percent of GDP."
- Private consumption growth: "now in 2007:Q2 — even before this most recent turmoil — private consumption growth slowed down already to 1.3 percent."
- Housing-starts decline cited: "a typical U.S. recession, from peak to bottom, housing starts fall by 50 percent," current fall "a little more than 30 percent."
- Foreclosure estimate: "some estimates are 2.2 million."
- ARMs maturing: "about $800 billion to $1 trillion in ARMs coming to maturity in the next year or so."
- Home-equity withdrawal: "from $700 billion to less than $200 billion now."
- House-price decline estimates (verbatim):
- "Case-Shiller already says that they will fall about 3.9, annualized 9 percent"
- "Goldman Sachs estimates 15"
- Roubini: "at least a 15 to 20 percent decline"
- Shiller: "could be as high as 50 percent"
- Loss-in-wealth example: "a 20 percent decline or $4 trillion loss in home values" (discussion context).
- Credit-markets repricing: "junk bonds have gone up 200 basis points."
- Corporate-default context (Ed Altman):
- Normal year corporate bankruptcy: "3 percent"
- Altman predicted: "2.5 percent"
- Actual last year: "0.6 percent"
- Aggregate EM reserve "war chest": "$5 trillion" cited.
- IMF seminar transcript publication date at top: "September 19, 2007" (document header).
Transcript of IMF Seminar -- The Risk of a U.S. Hard Landing and Implications for the Global Economy and Financial Markets (IMF External Relations Department, Public Affairs), September 19, 2007.