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Economist tips recession -

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Economist tips recession

The World Today - Tuesday, 23 September , 2008 12:22:00

Reporter: Stephen Long

ELEANOR HALL: An economist who predicted the current crisis four years ago says that the US
government's planned bailout of the financial system is flawed and will not prevent a major
recession.

Nouriel Roubini is a professor of economics at New York University.

He says the intervention will fail unless it assists the homeowners who are struggling with debt,
and stops the wave of foreclosures crippling the US economy.

Professor Roubini spoke to economics correspondent Stephen Long

NOURIEL ROUBINI: If it's implemented in right way it could be a step in the right direction, I feel
however it is not going to do the appropriate job.

STEPHEN LONG: Why not?

NOURIEL ROUBINI: Because in addition to buying the bad assets from financial institutions, you have
to make sure that the houses that are burdened with excessive mortgage and other debt have a
reduction of that burden, otherwise they are not going to continue to spending and the recession is
going to continue, so it's not enough to buy the assets and pack them into a bad bank, you have to
work them out, you have to reduce their face value, so as to ensure that many houses are not going
to end up in foreclosure, losing their homes.

STEPHEN LONG: Well this seems to be a criticism that's being raised both in political terms and
economic terms of the package, that it's socialising the losses and debts for Wall Street but doing
nothing for the home owners who are struggling to meet their commitments?

NOURIEL ROUBINI: Yes, that's certainly the case. We're essentially privatising the gain and now
we're socialising the loses, and we're doing it for the rich, the well-connected and Wall Street.
It's necessary of course to buy the stuff and work it out, the important thing is the borrower
should have that reduction because of that overhang and that's an important part of what needs to
be done, and so far that doesn't seem to be the centre of his program.

STEPHEN LONG: Do you think that they critics in Congress and the US Senate are right to be holding
up the package whilst they push for those measures?

NOURIEL ROUBINI: Yeah, first of all you need oversight of these, you cannot just give unlimited
power for the sake of the (inaudible), then you have to make sure that there are conditions for
having the work out and that reduction, and third, most likely banks, after they have written down
disasters, they need more capital.

STEPHEN LONG: That also seems to be a problem with the package, these are essentially worthless
assets, the debt, the assets on the balance sheets of the banks are essentially worthless, so if
they are bought at value, then there will be little injection of capital, and conversely, if
they're not bought at value, then you've got a massive taxpayer transfer to the banks?

NOURIEL ROUBINI: Yes, that's absolutely the case. If you essentially offer a subsidy to the
lenders, then you're subsidising them, and the fiscal cost is going to increase. If you don't do
that, you're writing down the assets and then the banks are severly undercapitalised and then
unless the government or somebody else injects capital in it, these banks are not going to be able
to lend again and provide credit, and the credit crunch is going to continue as it is now.

So you need also something of recapitalisation with public money of the banking system.

STEPHEN LONG: Well how will the United States afford that?

NOURIEL ROUBINI: That's going to be very expensive. You are right, the fiscal deficit that is
already very large, $400 billion by next year, could be a trillion dollars. You're putting $700
billion in this package, you put $200 billion in Fannie and Freddie, you put $85 billion in AIG,
you're going to have to recapitalise the insurance service because they are running out of money,
they put $30 million into Bear Sterns, and many, many their financial institutions and
non-financial that may be bailed out. So the US are left to probably borrow from abroad all this
money.

STEPHEN LONG: People are saying that that will push down the value of the American dollar. Do you
think that realistically there is a prospect that China and the oil rich nations will no longer be
willing to fund the massive and growing current account deficit by buying Treasury bonds and the
like?

NOURIEL ROUBINI: There is certainly a risk that that's going to happen, if China and other
creditors of the US were to pull the plug, then the dollar would collapse, interest rates would sky
rocket.

It might not be in the short term interest in China of doing that, because the financing of their
currency may become excessive and they will destroy their own economic export-led growth, but over
time, there are links to how much even China, let alone other central banks, and some wealth funds
want to pile more public debt on the US on their own balance sheet.

STEPHEN LONG: In your view, what is the consequence if it doesn't include all those steps including
assistance to home owners?

NOURIEL ROUBINI: Right now we are already in a recession in a severe financial and banking crisis
in the United States, so the only debate is how long it's going to be. If you do it right, then
maybe this recession is going to last only 18 months, if you don't do it right, you might end up
like Japan in the 90s when after the bursting of its real estate and equity bubble, it was almost a
decade long of lost growth, of economic stagnation.

ELEANOR HALL: Professor Nouriel Roubini of New York University, speaking to Stephen Long.