Nouriel Roubini: Big Crash Coming

October 23, 2009 You recently co-authored a report in which you and your colleagues ranked the U.S. third in world financial markets, after London and
. Was regulation a big component of that?

Roubini: The
U.S. might have been No. 3 overall, but it was ranked No. 38 out of 55 in financial stability, because we’ve had a disastrous banking and financial crisis. That was in part due to poor regulation and supervision of financial institutions. That’s one of many factors and reasons why the
U.S. was ranked so low on that particular pillar. Certainly there has been a massive failure of regulation and supervision of the financial system. But the regulatory failure was more in the direction of unwillingness by regulators to apply regulations. The Fed had all the powers to regulate toxic underwriting of mortgages, but they believed in laissez faire markets, and they created a disaster. How does this get fixed?

Roubini: I don’t believe in market discipline. It doesn’t work. That was the ideology of the last 10 years; self-regulation means no regulation. Market discipline doesn’t exist with irrational exuberance and reliance on internal risk management models that don’t work. Nobody listens to risk managers, because it’s risk takers that make the profits. The reliance on ratings agencies that have their own conflicts of interest, the reliance on soft-touch regulation, the focus on principles instead of rules—that particular regulatory philosophy has been a disaster, and we’ve learned it the hard way. We have to go to simpler rules, tougher rules and more binding rules. That’s the right approach. You’ve been clear that you think most assets are currently overvalued. Do you think there are opportunities for investors in certain asset classes or certain geographies?

Roubini: Well, there is a wall of liquidity chasing assets. That liquidity can chase those assets higher for the time being until the huge carry trade—the asset bubble and the wall of liquidity—comes crashing down. You can still have all the risky assets going higher. Of course, the higher they go, the more they diverge from fundamentals, and the riskier the situation becomes. But eventually, if the recovery of the economy is going to be anemic, sub-par, below-trend and U-shaped, there is going to be a correction. And therefore my view is to stay away from risky assets. Stay in liquid assets. I don’t know when the correction is going to occur, it could be a while longer, but eventually it will be a pretty ugly correction, across many different asset classes. When you say “stay away from risky assets,” many people hear that and think, “Aha, gold!”

Roubini: I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon. Thanks for taking some time with us today. We look forward to seeing you in November.

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