ROUBINI IN THE NEWS

Intelligent Investing with Steve Forbes

[00:08] Steve: A Destructive Court

Welcome, I'm Steve Forbes, it's a privilege and pleasure to introduce you to our
featured guest, New York University professor and economist Nouriel Roubini.
Nouriel had amazing prescience calling the markets downtown, earning his
infamous moniker, Dr. Doom. Now he'll tell us why he thinks there's a glimmer of
hope for the economy.

STEVE FORBES: Well, thank you for joining us. You have acquired quite a
reputation for calling the extent of the credit crisis, two or three years ago, that
something was rotten in the state of Denmark or Wall Street or whatever. But
you see some glimmers that things might be improving a smidgen, later this year
and early next year?

NOURIEL ROUBINI: They are improving in the following sense, that the degree
of economic contraction is not going to be as severe as the last quarter of last
year and first quarter of this year. So from minus six growth, we are going to go
towards minus two towards the end of the year.

But compared to the optimists that see already a recovery of positive growth by
the second half of this year are more bearish and for next year, the consensus
thinks a growth rate close to two percent, maybe it is going to be below one
percent and unemployment rate above 10 percent. So, while we are going to be
technically out of a recession, you know, it is going to feel like a recession.

So more optimist in the sense that the thing that the policy action are going to
avoid L-shaped near-depression, like the one that Japan experienced. We are in
the middle of a severe U-downturn. And we are going to eventually get out of it
by sometime next year.

So the tail risk of a depression has been reduced. That is good news. And the
rate of contraction is going to be less than otherwise. Secondary, rates are
becoming positive. But I do not see yet the light at the end of the tunnel, the
same way the consensus sees it.

STEVE FORBES: And so that, in turn, means that next year, 2010, if you only
have a one percent or even a less than one percent growth rate, unemployment
will go up. Will it stop at 10 percent? It is already at 8.5 percent now.

NOURIEL ROUBINI: It is. And in my view, probably is going to peak above 10

percent, might be more close to 11 percent. And even today, if you take a
broader measure of an unemployment rate that includes those who are partially
employed and those who are discouraged, that have left the labor force, the
number is already 15 percent. So by some standards, this is really rough worse
than losing 600,000 to 700,000 jobs per month. It's very painful.

[04:04] Stay on the Sidelines

STEVE FORBES: And what does this mean for investors? You have
recommended in the past, hold cash. Don't be plunging into these bear market
rallies. Do you see the current rally as another bear market rally and it is just
prudence should be the dictate?

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NOURIEL ROUBINI: Yeah, I would be prudent for the following reason. You
know, people usually joke and say the stock market has predicted 12 out of the
last nine recessions because sometimes it falls and there is no recession.

STEVE FORBES: You have an even better description.

NOURIEL ROUBINI: Yeah, this time around, the stock market predicted six out
of the last zero economic recoveries, because six times around, the last two
years, markets fell because of the bad news on banks. The economy, then there
is radical policy action. They recover and then the bad news, macro-financial
earnings and then you reach a new low.

Now of course, the lower you go, at some point, you might be closer to a true
bottom and more time passes, with the policy action, the closer we might be to
the bottom of earnings of the economy. Now is this rally a robust one? Is this
going to be the beginning of a real boom market rally?
I am still skeptical for three reasons. One is that if I am right on the macro view,
minus two rather than plus two and weak recovery, then there will be surprises
on the downside, in terms of the macro-economic, US and abroad. The second
reason is that I think that earnings are going to surprise, not just this quarter, but
also the next few quarters on the downside, because we have a weak economy.
And with deflationary pressures, then the pricing power, the corporate side, is
going to be limited.

Therefore, margins are going to be compressed. To have a very big rally of

earnings like people predict for next you need a boom of the economy, going to
potential above and then going away from deflation. And I see deflationary
forces for the next two or three years. So I see compression of earnings are
going to last and surprise people on the downside.

And three, I see financial shocks. Some banks will be found insolvent. We will
have to probably take them over, do something with them. That is going to be
bad news. We will have many financial institutions are going to go out of
business, like many hedge funds. And deleveraging by them and selling liquid
assets in liquid markets going to be negative.

And third, some emerging markets, in spite of IMF help, may have a fully-fledged
financial crisis. And then may have contagious effect. So, all in all, I think that
over the next few months, surprise on the macro side, on the earnings side, in
terms of the financial shocks, may imply that the previous lows might be tested
again.

STEVE FORBES: So, in terms of an investor, just stay on the sidelines for now.

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NOURIEL ROUBINI: I would stay on the sidelines. You know, people worry
about not getting the rally that is going to start. But if it is going to be a robust
rally, it is not going to be 20, 25. You know, we know eventually we'll have a
recovered economy. We will get it cleaned up and actually, I'm not a permabear.
I believe that actually, if we do the right things, US, Europe, Japan, but especially
emerging markets, can have a bright future of high economic growth.

So for the middle term, I am actually quite bullish about the global economy and
that high global economic growth, once we fix the problems. Equities should be
outperforming other asset classes. But I would not worry about losing the first 20
percent, because you might have another bear market rally, would wait until the
data show more robust and consistent, persistent improvement of the real
economy, of earnings. And then the market, they are going to rally on a more
robust basis.

[07:21] Fed's Easy Money

STEVE FORBES: Could this bubble, disastrous bubble, have reached the
proportions it did, if the Fed hadn't been so easy with money in the early part of
this decade?

NOURIEL ROUBINI: There were many mistakes. Certainly one of them was
that the Fed cut rates and kept them too low, from six and a half down to one, for
too long. In addition to that mistakes, the normalization from one back to 525,
was these moderate paced, step-by-step, 25 basis points every six weeks. And
that is one of the last things. It is not just how long you keep it low but then,
when you get out of this recession we have to normalize it fast enough.

That is going to be one little lesson. But there are also broader issue about poor
supervision and regulation of financial institution. I think that, while deregulation
is positive of the economic financial institution, we took it to an extreme, you
know. Even financial markets need laws, institution, rules; otherwise it is the law
of the jungle. Greed is good. There is nothing bad with greed.

You know, that's what drives capitalism. But greed has to be contained by fear of
losses and also realization you are not going to be bailed out in bad times. And I
think there were a number of distortions that Greenspan put, easy money, easy
credit, lack of supervision and regulation of the proper form.

STEVE FORBES: In terms of where we go from here, in terms of what new

regulations, rules, transparency, one suggestion has been made. We do need
real exchanges, clearing houses for some of these exotic instruments, so they
become standardized. People can actually see what is out there, what the
volumes are, what the trades are. And therefore, we can get some proper
collateral behind them. What other things do you think need to be done to
prevent a repetition of this in the future?
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NOURIEL ROUBINI: Well, many things. I think we have learned that all in all,
financial institutions need more capital, compared to what they had and what the
requirements were. That they probably have to be required to have less
leverage, both banks and on banks, shadow banks, that the liquidity risk is big
and therefore, liquidity buffers are important.

There is a whole issue with compensation. I think that the issue is not with
bonuses. Yes, last year and so on. But if you have a system in which you are
having incentive maximize the risk in the short run and essentially do things like
insurance over cataclysmic effect, events. And therefore, for a few years, you
are making lots of profits and revenues. You are paid that way. And when things
go bust because you took a big risk, the financial institutions go bad.
Compensation is not--

[09:46] Better Bonuses

STEVE FORBES: Do you think that is an area, where if you are a regulated
financial institution, where the government should say, "A bonus has to be paid
out over five years," or is this something boards of directors will learn if they know
they can actually fail?

NOURIEL ROUBINI: Ideally, you want a world in which a board of directors

would do that if you have appropriate corporate governance. You don't want the
government to impose it. But we saw also failure of corporate governance. You
know, there are the typical agency problems within principal and agents
shareholders and managers. And in financial institutions those agency problems
are bigger because the symmetric information is bigger.

There's no way a CEO or a board can essentially know what the action of
thousands of P and L's were taking risks and trades and so on doing.

STEVE FORBES: Right

NOURIEL ROUBINI: Therefore, you need a system of compensation, as

bonusing models. They are changing. Some institutions are now having these
bonus models model, but there is an element of worries about stigma, of losing
the best kind of talent.

Therefore, at least the government, not forcing, but the frame-up right now was
agreed that by the G20's, one in which there has to be reform of compensation. I
would let institutions to do it their own. If they do not do it, then, in the context of
that regulation supervision, the form of compensation should be one of the
measures of whether you have an appropriate risk management system,
because appropriate risk management system means make sure that risk
management is done properly. And one element of it is compensation.
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STEVE FORBES: Do you feel the credit system is now going to start to function
again? Right now, we still have very wide spreads between treasuries and, say
single A, triple B corporates. Do you see any sign that that is going to narrow,
where credit is going to naturally start to flow again?

NOURIEL ROUBINI: It is going to be a very slow process in my view. Of

course, compared to the disaster after Lehman, when everything was frozen,
commercial paper, high grade, high yield. At least right now, the money market
spreads are lower. Corporates that are high grade can borrow again. In the
high-yield spreads, the spreads are still too wide. The market is shut down.

We will see whether TARP is going to work. Other actions reduce market
spreads, mortgage rates by buying MBS's and mortgage-backed security. I think
it will be a very, very difficult process because a lot of the shadow banking
system has collapsed. And a lot of the intermediation was not through banks, but
through securitization or through capital market. We have essentially destroyed
a good chunk of our capital market. We want to rebuild it. It is going to take
time.

[12:01] Bank Nationalization

STEVE FORBES: You proposed a few weeks ago, nationalizing some of the
banks. Do you feel that is still going to happen before this over?

NOURIEL ROUBINI: Oh, I think some of them will have to be taken over. I
mean, I proposed these from a market-friendly point of view. Nobody is in favor
of medium or long-term ownership of financial institutions by the government.
But in my view, paradoxically, the temporary nationalization is a more market-
friendly solution, because you know, if you don't do it, then you end up with
zombie banks and the fiscal costs are going to be large.

That's why, you know, fiscal conservatives have been in favor of it. That is why
people like Lindsay Graham, conservative Republican from Carolina, is in favor.
That's why Alan Greenspan, high priest of laissez-faire capitalism, has said we
may have to nationalize some banks. We will have to do it carefully, choose only
the ones that are really beyond pale, that even if you give time, time is not going
to heal their wounds.

We'll see. But I think in some cases that might be the appropriate thing. And if it
is not market-friendly, take IndyMac, was taken over middle of last year, cleaned
up, separated. And now, the bunch of investors, George Soros and John
Paulson, other, we bought it back and privatized it. It took six months, does not
have to take three years, if you do it right.

[13:11] Geithner's Gamble

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STEVE FORBES: What is your feeling about the latest Geithner plan?

NOURIEL ROUBINI: My view of it is actually, is that it can work for dealing with
the toxic assets of banks that are solvent, because even after you do this stress
test and you do a triage within solvent, insolvent. With the insolvent ones, you
cannot apply the Geithner plan because the losses are so big that if you apply to
them, they are underwater. You have to take them over.

But even with a solvent one, you have to still separate good and bad assets.
Now there are five different ways of doing them. We do not have time to go into
each detail. Each one of them has merits and some flaws. These one are
among the five different ways in which you can separate good and bad assets of
solvent banks is not the worst. There is some design issues, some flaws in
which the way the design can be fixed. In my view, all in all, it is actually a
reasonable plan.

STEVE FORBES: And are you upset at all about some of the details coming out
about it, that he wants to restrict it to only a handful of large institutions? Should
it be more open if an institution wants to or if a group wants to be part of it? It
should not be excluded?

NOURIEL ROUBINI: That was actually, absolutely one of the important flaws. I
think they have just announced that actually, they are going to open up the
bidding process also to smaller financial institutions. You do not have to have 10
billion plus of assets and so on, in order to do that. So, I think, you know, they
have been responsive to some of the criticism.

I think that by the time they implement it, there will be a number of other things
you have to fix it. And there may be even incentives for insiders to buy at face
value, you know, the stuff and then get an only cost loan and default on it. So
you should make sure that banks cannot buy their own things. This idea of rivals
buying each other's assets also is subject to gaming. And plus the whole point is
about making sure banks do not have toxic assets, not to buy more of them. So I
think there are many things in the design you can fix.

STEVE FORBES: Now, the Federal Reserve surprised some of us that between
December and March, they actually shrunk their balance sheet, after expanding it
in the fall, shrunk it by $400 billion. Now they are gingerly bringing it up. Is the
Fed being aggressive enough in this, right now? Should it be more, buying
mortgage-backed assets and the like to try to get the system more, better
functioning?

NOURIEL ROUBINI: I would say they have been very aggressive, you know,
with ups and downs. You know, yeah, the balance sheet went from, you know,
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800 2.2, now down to a 1.8. But now, with the new initiative, is going to be about
three trillion. It is zero interest rates. It is quantitative easing.

And it is a variety of unconventional things, like buying treasuries, buying an

agency-backed, a mortgage-backed security reduced mortgage rates. You
know, intervening in the securitization market with the tariff and other things that
over time are going to restore credit and securitization. They are very
aggressive. And so are their central banks, like the Bank of England, the Swiss
national banks, the Japanese.

Even Europe eventually is going to get to zero rates and quantitative easing and
some of the unconventional stuff. Unfortunately, you know, traditionally, since
the banks are the lender of last resort, in this crisis, since banks do not lend to
each other, they do not lend to no banks. They do not lend even to the corporate
sector for a while.

The central banks have become the lender of first and only resort. I mean, that is
the paradox of the market failure we have been observing. It is not a normal
situation. We do not want it to be permanent, but that is the current situation.
And I think the margin, those policy actions are actually the correct ones.

[16:31] Risky Leverage

STEVE FORBES: You had mentioned earlier that banks are going to have to, in
the future, deal with less leverage. What have we learned about risk in this
crisis?

NOURIEL ROUBINI: We have learned that, you know, leverage can be

dangerous and is excessive. That you have to have a system of incentives and
compensation that avoids excessive risk taking, regardless of leverage. That
liquidity risk is important. That shadow banks, in many ways, look like banks,
because they were borrowing short, highly leveraged, lend only liquid.

But unlike banks, they did not have access to the lender of last resort support or
deposit insurance. Therefore, the entire collapse of the shadow banking system
is an example of what happens when you have a run on bank-like institutions.
And therefore, to have a safer system for these known banks. You know, was
non-bank mortgage lender went by...hedge funds, you know, broker dealers,
now...financing crisis for private equities. Just a variant of the same idea.

If you borrow short, overnight, you leverage 30 times. You lend only liquid.
Eventually, you are going to get in trouble. That is not a stable system. That is
why I predicted, over a year ago, before Bear Stearns, the collapse of major
broker dealers. I said, "Two of them are going to go bust. In a matter of two
years, none of them is going to remain independent." I was too optimistic. The
intake, two years, took seven months.
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STEVE FORBES: By the way, do you think in the future, partnerships are going
to come back, where, if you do have an investment house, you know it is your
money on the line and not somebody else's?

NOURIEL ROUBINI: Certainly, either partnership or a situation which then

shareholders or bankers have some of their own skin in the game, because
again, you want to avoid excessive retaking. Paradoxically, crisis not of hedge
funds but more crises of traditional banks. Why? Because hedge funds, the
owners have some of the skin in the game.

Therefore, the risk management is different. So whether it is going back to

partnership or other things, whatever implies more capitals, more of the skin in
the game, so that you avoid excessive risk-taking, should be part of, makes
valuable financial institutions.

STEVE FORBES: What is the big one misplaced assumption, still, out in the
markets today that you see?

NOURIEL ROUBINI: I would say that, you know, there is excessive optimism
about the system being able to heal itself, without taking the proper action.
Monetary, fiscal, credit policy, clean up the banks, proper forms of forbearance,
helping emerging markets. I think we still need aggressive policy action. I think
that the system, unfortunately, as well as a significant market failure is not going
to heal itself. And that means that also, the appropriate balance between the
markets, because we all believe in markets and having the appropriate forms of
government regulations is going to be a challenge.

[19:10] Bail Out Balkan Banks

STEVE FORBES: Looking here and briefly around the world, what has not been
done that needs to be done?

NOURIEL ROUBINI: Oh, some countries are behind the curve. The ACB are
behind the curve. Fiscal and stimulus in Europe could be a little bit larger than
otherwise. I think that for the banks that are insolvent, should in US and other
countries, to be taken over, not to end up with zombie banks like Japan. I think
that more aggressive policies to reduce the risk of mortgage foreclosures should
be done.

STEVE FORBES: Do you think the Fed, maybe some other central banks, are
ready to help out, say, banks in Ukraine or central and eastern Europe that, if
allowed to fail, could have systemic risk?

NOURIEL ROUBINI: They may be doing it directly, like you see, we give money
directly to Hungary. The Europeans are going to be helping some of emerging
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Europe. But the way it has been done internationally now is that the G20 and
agreement to triple the resources of IMF, so that the IMF can give money to
some of these countries.

Now emerging market have two groups, those that are victims of collateral
damage, with good fundamentals. The Chiles and Brazils of the world. And then
there are the other countries, some of them in emerging Europe, that have
massive financial, fiscal vulnerabilities and policy mistakes. For those countries,
it is not enough to give them money. They need policy correction. If you give
them money and there is no policy correction, you end up like Argentina or like
Russia or like Ecuador. So you need the combination of money and appropriate
policy actions.

STEVE FORBES: What is the best financial lesson you have ever learned?

NOURIEL ROUBINI: It is that, you know, it is better to be safe and be cautious

and not to leverage too much. You know, leverage can be deadly. I mean, I
think it is crucial that all of capital and equity, in corporations, in financial
institution and also in the household sector. You know, when your households
that were buying homes with zero down payment, the leverage was infinite, was
even worse than financial institutions. So I think leverage is deadly. I think that
is the lesson. We need more capital or equity. A little bit less debt, relatively
speaking.

[21:06] The Great Crash

STEVE FORBES: And finally, other than your own books, what is the best book
you have ever read, financial book?

NOURIEL ROUBINI: Some of the classic selections, you know, The Great
Crash by Galbraith. You know, you go and reread those books and you change
the dates. And it is amazing how much things look like exactly the same. It
means that history repeats their selves, you know? In many ways, financial crisis
are very similar to each other. And as we know, if we do not learn from the past,
we are going to be bound to repeat the same mistakes. Hopefully, next time
around, we will learn the lesson and we will have a more robust system.

STEVE FORBES: One final thing I just want to ask you, given your historic
perspective. And that is, we've had bubbles in the last 30 years. We had the
great inflation of the '70s. We had the problems in Asia, Russia. High tech
bubble much bigger than the normal, new industry bubble, what happened in
housing. Do we need a new international monetary system, like we had before
1971 or what we had before World War I?

NOURIEL ROUBINI: We will have to think about the redesign. I am not

convinced about things like going back to gold or a system of fixed exchange
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rates. I think that that is not going to be likely and desirable, overall. But having
a system which these imbalances, these excesses, do not occur. We will have to
rethink, also, that all of reserve currencies and so on.

So first, we have to fix this crisis. Then we have to fix the banks. Then we have
to think about how we design a new, international monetary system. Things are
going to take a while. For the time, we have already our hands full of problems.
And having to fix them.

STEVE FORBES: Well thank you very much. Appreciate it.

NOURIEL ROUBINI: It was a great pleasure being with you today. Thanks.