Summarized from Nouriel Roubini on Bloomberg.com
2008 In Review
The global financial system in 2008 experienced its worst crisis since the Great Depression of the 1930s. Major financial institutions went bust. Others were bought up on the cheap or survived only after major bailouts. Global stock markets fell by more than 50 percent from their 2007 peaks. Interest-rate spreads spiked. A severe liquidity and credit crunch appeared. Many emerging-market economies on the verge of a crisis had to ask for help from the International Monetary Fund.
The global financial system literally went into a cardiac arrest after the Lehman Brothers Holdings Inc. collapse and a meltdown was barely avoided through very aggressive policy responses.
So what lies ahead in 2009?
Is the worst behind us or ahead of us? Unfortunately, the worst is ahead of us. The entire global economy will contract in a severe and protracted U-shaped global recession that started a year ago. The U.S. will certainly experience its worst recession in decades, a deep and protracted contraction lasting at least through the end of 2009. Even in 2010 the economic recovery may be so weak — 1 percent growth or so — that it will feel terrible even if the recession is technically over.
We now are seeing the demise of the shadow banking system, the complex of non-bank financial institutions that looked like banks as they borrowed short term and in liquid ways, leveraged a lot, and invested in longer term and illiquid ways. As a result, the biggest asset and credit bubble in financial history is going bust, with overall credit losses likely to be more than $2 trillion.
While the odds of a systemic financial meltdown have been reduced by the actions of the Group of Seven and other economies, severe vulnerabilities remain.
The credit crunch will persist and spread beyond mortgages. Deleveraging will continue, as thousands of hedge funds — many of which will go bust — and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing price declines and driving more insolvent financial institutions out of business.
Painful Year Ahead
So 2009 will be a painful year of global recession and further financial stresses, losses and bankruptcies. Currently, the probability of an L-shaped, stag-deflation is now rising to a third, while the probability of a severe U-shaped recession is two-thirds. Only aggressive, coordinated and effective policy actions by advanced and emerging-market countries can ensure that the global economy starts to recover — however slowly –in 2010, rather than entering a more protracted period of economic stagnation.