By Martin Wolf

Last week’s column on the views of New York University’s Nouriel Roubini (February 20) evoked sharply contrasting responses: optimists argued he was ludicrously pessimistic; pessimists insisted he was ridiculously optimistic. I am closer to the optimists: the analysis suggested a highly plausible worst case scenario, not the single most likely outcome.

Those who believe even Prof Roubini’s scenario too optimistic ignore an inconvenient truth: the financial system is a subsidiary of the state. A creditworthy government can and will mount a rescue. That is both the advantage – and the drawback – of contemporary financial capitalism.

In an introductory chapter to the newest edition of the late Charles Kindleberger’s classic work on financial crises, Robert Aliber of the University of Chicago Graduate School of Business argues that “the years since the early 1970s are unprecedented in terms of the volatility in the prices of commodities, currencies, real estate and stocks, and the frequency and severity of financial crises”*. We are seeing in the US the latest such crisis. (more…)

By Dani Rodrik and Arvind Subramanian

First large downhill flows of capital – from rich countries to poor countries – led to the Latin American debt crisis of the early 1980s. In the 1990s similar flows begat the Asian financial crisis.

Since 2002 the flows have been uphill, from emerging markets and oil-exporting countries to the developed world, especially the US. But the outcome has not been very different. So, it does not seem to matter how capital flows. That it flows in sufficiently large quantities across borders – the celebrated phenomenon of financial globalisation – seems to spell trouble.

Causes and consequences vary, depending on which way capital flows. Developing country borrowing was associated with unsustainable fiscal policies (Latin America) and inappropriate exchange rate policies (Asia). But the financial sector was not blameless: for every overborrower there was an overlender.

The pathologies were different when the US went on a borrowing binge. Large current account surpluses and the associated savings glut in the rest of the world fed a global liquidity boom, which stoked asset prices. Even though the roots of the subprime crisis lie in domestic finance, international capital flows magnified its scale.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Lawrence Summers

The American economic outlook remains highly uncertain. But macro­economic policy is now properly aligned, as the economy will benefit over the next several quarters from fiscal and monetary stimulus. To the extent conditions warrant and inflation risks permit, monetary and fiscal policy are appropriately poised to provide further stimulus.

Policy towards America’s failing housing sector is in a far less satisfactory state. All honest analysts accept that policies adopted so far, such as the “teaser freezer” limits on resetting mortgage interest rates and increased federal support for mortgage lending, have had only a marginal impact on what may be the most serious crisis in housing finance since the Depression.

It appears house prices are down by 5-10 per cent from their peak, with derivatives markets predicting further declines of about 20 per cent. Price falls of this magnitude are likely to mean more than 10m would have negative equity in their homes and more than 2m foreclosures would take place over the next two years.

Foreclosures are extremely costly. Between transaction costs that typically run at one-third or more of a home’s value and the adverse impact on neighbouring properties, foreclosures can easily dissipate more than the total value of the home being repossessed. They also inflict collateral economic damage, as reduced wealth and diminished borrowing capacity in homes reduces consumer spending, increases credit market fragility and depresses local tax bases.

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“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.” Alan Greenspan, The Age of Turbulence.

That used to be Mr Greenspan’s view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor.

Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”**. The characteristics of this scenario are, he argues: “A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.” (more…)

By Martin Wolf

At least he made the trains run on time. That was said of Benito Mussolini, Italy’s fascist dictator from 1922 to 1943. Much the same is now said of Vladimir Putin, Russia’s authoritarian president. He may have crushed the fragile shoots of democracy, but he has at least restored the economy, the state and his country’s place in the world.

This view is shared by Mr Putin himself. He stated only last week that: “We have worked to restore the country after the chaos, economic ruin and breakdown of the old system that we saw in the 1990s.” But it suffers from a drawback: it is false, as Michael McFaul and Kathryn Stoner-Weiss of Stanford University argue in a powerful article*.

True, between 1999, the year before Mr Putin became president, and 2007, the Russian economy expanded by 69 per cent. But the economies of 11 of the 15 former republics of the Soviet Union expanded by more than Russia’s. Indeed, only Kyrgyzstan did markedly worse. A number of the former Soviet republics did, it is true, benefit from an oil and gas bonanza. But so, too, did Russia: its oil and gas exports jumped from $76bn in 1999 to $350bn last year. Even so, the Russian economy expanded by less than Ukraine’s.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf

When will the next financial crisis come? We do not know. Yet of one thing we can be sure: unless we learn from this crisis, another one will put the world economy back on to the rocks in the not too distant future.

The FT has published a number of contributions on the lessons: Charles Goodhart of the London School of Economics and Avinash Persaud of Intelligence Capital offered “a proposal for how to avoid the next crash” (January 31); Francisco González of BBVA discussed “What banks can learn from this credit crisis” (February 4); and Daniel Heller of the Swiss National Bank argued for three ways to reform bank bonuses (February 4). The substance of Mr Heller’s argument was similar to a contribution of my own (“Regulators should intervene in bankers’ pay”, January 15), but without the regulatory coercion.

The big question, indeed, is whether lessons must be embedded in regulation. Optimistic opponents of regulation argue that the banks have learnt their lesson and will behave more responsibly in future. Pessimistic opponents fear that legislators might create a Sarbanes- Oxley squared. The Act passed by the US Congress in 2002, after Enron and other scandals, was bad enough, they say. The banks might now suffer something worse.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Kenneth Rogoff

Given the highly vulnerable state of the US and European economies, what would happen to global growth if the Chinese juggernaut also started sputtering? Few investors or policymakers seem to be seriously contemplating this scenario.

China’s remarkable resilience to both the 2001 global recession and the 1997-98 Asian financial crisis has convinced almost everyone that another year of double-digit growth is all but inevitable. In fact, the odds of a significant growth recession in China – at least one year of sub-6 per cent growth – during the next couple of years are 50:50. With Chinese inflation spiking, notable backpedalling on market reforms and falling export demand, 2008 could be particularly challenging.

The remainder of this column can be read here. Debate from our panel of economists appears below.