Stories by Bloomberg and Reuters on a talk by Kenneth Rogoff, former chief economist for the IMF and currently a Harvard professor, fail to mention perhaps his most relevant credential as far as opining on the US credit crunch is concerned. He and Carmen Reinhart of the University of Maryland have done an extensive study of financial crises, going back 900 years, and have done more intensive work on post 1800 and post World War II episodes. Rogoff and Reihart, among other things, put together a short presentation comparing the US’s woes to what they called the post-war “Big Five” that makes for sobering reading.
`The worst is yet to come in the U.S.,” Rogoff, a Harvard University professor of economics, said in an interview in Singapore today. “The financial sector needs to shrink; I don’t think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.”…
Freddie Mac and Fannie Mae “should have been closed down 10 years ago,” he said. “They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds.”
Reuters, which first reported the story, provided further detail:
“We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one, one of the big investment banks or big banks,” said Rogoff….
“We have to see more consolidation in the financial sector before this is over,” he said, when asked for early signs of an end to the crisis.
“Probably Fannie Mae and Freddie Mac — despite what U.S. Treasury Secretary Hank Paulson said — these giant mortgage guarantee agencies are not going to exist in their present form in a few years.”…
Rogoff said multi-billion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits because they had not taken into account the broader market conditions that the industry faces.
“There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they’re great buys, sovereign wealth funds come in and make a lot of money by buying them.
“That view neglects the point that the financial system has become very bloated in size and needed to shrink,” Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup…
Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as “dramatically” as it did.
“Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States.”