The NYT has a big feature on Nouriel Roubini, whose forecasts have brought him to prominence.

The dismal science, it seems, is an optimistic profession. Many economists, Roubini among them, argue that some of the optimism is built into the very machinery, the mathematics, of modern economic theory. Econometric models typically rely on the assumption that the near future is likely to be similar to the recent past, and thus it is rare that the models anticipate breaks in the economy. And if the models can’t foresee a relatively minor break like a recession, they have even more trouble modeling and predicting a major rupture like a full-blown financial crisis. Only a handful of 20th-century economists have even bothered to study financial panics. (The most notable example is probably the late economist Hyman Minksy, of whom Roubini is an avid reader.) “These are things most economists barely understand,” Roubini told me. “We’re in uncharted territory where standard economic theory isn’t helpful.” 

Quite. Although standard economic theory isn’t helpful in charted territory, either.

Some critics are dismissing Roubini’s prescience as luck, saying that he has been a bear for a long time and the present situation represents luck or coincidence, rather than skill. While it is certainly true that being early is indistinguishable from being wrong, this bubble has been growing for a long time. It became much larger than most forecasters who saw it, including myself, were prepared to believe.

Seeking Alpha has done us the service of plotting the GDP estimates for 2008 provided by 63 economists surveyed by Bloomberg. The unanimity is appalling and to me indicates systematic bias.

As one can clearly see, only two are forecasting a recession and a brief, mild one at that. A new Los Angeles Times/Bloomberg poll found that 71% of Americans now believe that a recession is likely. All I can say is let’s review this chart this time next year and see whether the economists are smarter than the man in the street. I’m with the man in the street (surprise!). I don’t know who the surveyed shills economists are; I do know that Paul Kasriel and Nouriel Roubini are both expecting a recession.

George Santayana said: “”Those who cannot remember the past are condemned to repeat it.”

Roubini: You can call it whatever you like but one thing is obvious: the Fed easing is perceived by the stock market as an action aimed to prevent a recession from occurring and stock prices rally - in spite of worsening macro news that are signaling recession ahead - because of the hope - that I will show is only wishful thinking - that the Fed will be able to avoid such a hard landing. Thus, what has been mostly driving up the stock market in the cycles since last summers is Fed policy expectations of easing. The same pattern of market delusion and serial sucker’s rallies occurred in 2001: the economy entered in a recession in March 2001 but the S&P 500 index rallied by a whopping 18% in April and May because the market and investors expected that the aggressive Fed easing - that had started in January - would prevent a 2001 recession (the famed and deluded hope of a second half of 2001 “growth rebound” that never occurred).

The myth of the omnipotent Fed is all the more alarming because even the Fed believes it in the face of 94 years of counter-examples. The power of faith is amazing, isn’t it?

Edit: Futures are up tonight, apparently because Bernanke made a speech which hinted at further rate cuts. Well with T-bills at 2.8%, Ben, the rate cut has already happened. And by the way, now that cutting rates didn’t help, the solution is to cut them again? Like it will work now when it didn’t before? Because? Oh and Ben also said the decision will depend on data between now and the meeting. Ben, you have to be kidding. That has to be noise in terms of any trends, you can’t possibly project months out based on data over 8 days. At least Greenspan covered up the fact that he didn’t know what he was doing with doubletalk. Ben, you are an embarrassment.

Nouriel Roubini lays it out with his usual eloquence.

“I now see the risk of a severe and worsening liquidity and credit crunch leading to a generalized meltdown of the financial system of a severity and magnitude like we have never observed before. In this extreme scenario whose likelihood is increasing we could see a generalized run on some banks; and runs on a couple of weaker (non-bank) broker dealers that may go bankrupt with severe and systemic ripple effects on a mass of highly leveraged derivative instruments that will lead to a seizure of the derivatives markets (think of LTCM to the power of three); a collapse of the ABCP market and a disorderly collapse of the SIVs and conduits; massive losses on money market funds with a run on both those sponsored by banks and those not sponsored by banks (with the latter at even more severe risk as the recent effective bailout of the formers’ losses by theirs sponsoring banks is not available to those not being backed by banks); ever growing defaults and losses ($500 billion plus) in subprime, near prime and prime mortgages with severe known-on effect on the RMBS and CDOs market; massive losses in consumer credit (auto loans, credit cards); severe problems and losses in commercial real estate and related CMBS; the drying up of liquidity and credit in a variety of asset backed securities putting the entire model of securitization at risk; runs on hedge funds and other financial institutions that do not have access to the Fed’s lender of last resort support; a sharp increase in corporate defaults and credit spreads; and a massive process of re-intermediation into the banking system of activities that were until now altogether securitized.”

Thanks to Nouriel Roubini for this little piece of analysis. Level 3 assets are the “mark to model” assets where the company is basically making up the valuations. Nouriel has noticed that the Level 3 asset to capital ratios for some of the leading Wall Street outfits show that the ones that have confessed their problems are those with the smallest problems. Hmmm. Here are the ratios, read Nouriel’s piece for the really gruesome details:

1. Morgan Stanley 251%
2. Goldman Sachs 185%
3. Lehman Brothers 159%
4. Bear Stearns 154%
5. Citigroup 105%
6. Merrill Lynch 38%