By Nouriel Roubini
I was this morning on CNBC’s Squawk Box being interviewed – in part - by the legendary Mohamed El-Erian (co-CEO of Pimco) who is the lead guest for the show this morning. Mohamed is a friend/colleague and one of the most thoughtful and deep thinkers about financial markets and the global economy combining analytical academic rigor, senior policy experience (a decade long at the IMF) and the deepest and most sophisticated knowledge of financial markets. His latest book on global investing is a must read for all.

Let me elaborate the point I made in the interview and some additional points on the economy and financial markets…

In the interview I discussed my bearish outlook for the US and global economy with about a dozen major economies now at risk of a recessionary hard landing, the risks of global stagflation, the unraveling of Bretton Woods 2 regime, the deadly combination for the global economy of asset bubbles going bust with stagflationary shocks, the more sharply bearish outlook for US and global equities and my trillion dollar plus estimates for credit losses from the current financial crisis.

Those credit losses are now mounting and spreading from subprime to near prime to prime mortgages, to commercial real estate, unsecured consumer credit (credit cards, auto loans, student loans), leveraged loans financing reckless LBOs, muni bonds as many insolvent local government will go bankrupt, industrial and commercial loans, corporate bonds (as a tsunami of corporate defaults are ahead of us) and CDS.

As I argued in writings last February such credit losses would be at least $1 trillion and could be as high as $2 trillion, well above the $300 billion of subprime writedowns that have been recognized so far. At that time the $1 trillion estimate was considered as lunatic but by now the IMF estimates these losses at $945 billion, George Magnus of UBS estimated them at $1 trillion; Goldman Sachs put them at $1.1 trillion, the legendary hedge fund manager John Paulson (who made last year $3.5 billion of income on shorting subprime) put them at $1.3 trillion; and a couple of days ago Bridgewater Associates estimated such losses at $1.6 trillion. Thus, as I argued then $1 trillion would be floor, not a ceiling, to such credit losses.

Of course such losses have been in part transferred from US banks to capital market investors and to foreign investors via securitization. But with the entire capital of the US financial system at $1.3 trillion such staggering losses will lead to a systemic banking crisis and systemic financial crisis.

No wonder that Bernanke is now telling non-bank primary brokers that the Fed exceptional liquidity support (TAF, TSLF and especially PDCF) will be extended into 2009. And no wonder that Geithner, Paulson and Bernanke have now all three spoken of the need to find orderly ways to let even large and systemically important institutions go bankrupt if they are insolvent.

So brace yourself for a severe recession in the US and other advanced economies, a serious global growth slowdown and a systemic financial crisis. The worst is ahead of us rather than behind us and the financial and equity markets complacency and sucker’s rally that – in April and May - followed the Bears Stearns creditors rescue and the Fed bailout of non-bank broker dealers (the PDCF lender of last resort support extended to primary dealers) was gone by June with stock markets now back to bearish 20% plus downward adjustment.

The same pattern occurred in 2001. The economy entered into a recession in March 2001 but then 95% of professional forecasters predicted no recession as there was the delusion that the aggressive Fed easing – that had started in January 2001 – would prevent the recession and lead to a H2 growth recovery. Forecasters got it wrong; the Fed got it wrong (as it mispredicted the effects of the tech bust on the economy) and the stock market got it wrong too: in April and May 2001 the S&P500 had its sucker’s rally going up 18% on expectations that the Fed would rescue the economy from the recession.

It was only in June when markets realized that, in spite of a very aggressive Fed easing, the economy was spinning into a deeper recession, that stock prices resumed their free fall. The same pattern of complacency and delusional hope that the Fed could bail out investors and markets occurred this year: a sucker’s rally in April and May and a fall back to reality in June.
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