July 17 (Bloomberg) -- Nouriel Roubini, an economics professor at New York University's Stern School of Business, talked with Bloomberg's Carol Massar in New York on July 15 about the outlook for U.S. stocks and the economy, Federal Reserve Chairman Ben S. Bernanke's testimony today before Congress and the government's efforts to help stabilize Fannie Mae and Freddie Mac. (Source: Bloomberg)

(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)

CAROL MASSAR, BLOOMBERG NEWS: Joining us for his outlook on the economy, and to preview Ben Bernanke's testimony on Capitol Hill, it's Nouriel Roubini. He's a former Treasury and economic adviser under the Clinton administration. He's now chairman of Roubini Global Economics, and Professor of Economics at NYU's Stern School of Business. Good morning.

NOURIEL ROUBINI, PROFESSOR, NEW YORK UNIVERSITY'S STERN SCHOOL OF BUSINESS: Good morning.

MASSAR: Jim Rogers just speaking. And he's saying that we're going to see one of the worst recessions we've seen in some time, that the central bank, the Fed, the Treasury all making mistakes in terms of how they're handling things. What do you think?

ROUBINI: I agree with him, this is going to be the worst U.S. recession in decades, and this is also the worst U.S. financial crisis since the Great Depression. This is very severe. We'll have a systemic financial and banking crisis.

MASSAR: So wait. So it feels pretty bad right now. How much worse can it get? What is the worst-case scenario here, in your view?

ROUBINI: In my view, things are going to get worse in financial markets where Fannie and Freddie, they're insolvent, where hundreds of smaller banks are insolvent, where major regional banks that are bankrupt, even some of the national major banks are insolvent. A year from now or three years from now maybe there's not going to be any major independent broker dealers. This is a systemic financial crisis. There is no end to it. The home prices are falling; the housing recession is getting worse. It's spreading to the entire economy. And it's a vicious circle between a contracting economy and greater credit and financial losses feeding on the economy.

MASSAR: You know everybody's been working overtime. It certainly seems that way. The Fed, the Treasury Department, Hank Paulson, you know, trying to figure out how to kind of shore up the financials. Is there something that they could do to prevent that from happening?

ROUBINI: At this point, you cannot prevent the recession. You cannot prevent a severe financial crisis.

MASSAR: Well, what about shoring up some of those financials? I know we talk moral hazard. And let's put that aside for a moment. But is there something more that can be done to prevent it from going even worse from here?

ROUBINI: No. Many banks are going to go belly up. And FDIC is going to again run out of money. So we'll have to recover the loss of the FDIC. They already lost 10 percent of the money they had just to solve the problems of IndyMac. So we have a severe financial problem. At this point, these are credit problems, they're not problems of liquidity. There's a system of insolvency in the economy. Homeowners, mortgage lenders, financial institutions, homebuilders, even corporate firms. There's systemic

MASSAR: And there's no reversing the trend at this point?

ROUBINI: No. At this point it's going to get worse. So we have a severe recession. Eventually we're going to get out of it through easing money, fiscal policy, and a big bailout.

MASSAR: So lucky for Mr. Ben Bernanke to be up on Capitol Hill today, giving his semi-annual testimony. What kind of questions do you think lawmakers will be asking, should they be asking, at this point?

ROUBINI: Well, you wonder. I think he's going to talk about growth and inflation, his worries about upside risk to inflation, like last month. But the reality of it is now what's happening with the banking system, and Freddie and by Fannie's overshadowing completely anything else. His testimony's going to be shorter because they're going to have a separate meeting on financial markets. At this point, all the questions are going to be about Fannie, Freddie and the banks and its risk to financial rundown.

MASSAR: Jimmy Rogers we had on yesterday, and certainly saying that the government is making a mistake in terms of its plans for Fannie and Freddie. Do you agree, or did the government have no choice here?

ROUBINI: I agree with him. I think this bailout of Wall Street, of the rich and the well connected, is not right. You have to first wipe out the shareholders.

(CROSSTALK)

MASSAR: But what would happen if we didn't bail them out? What would happen then?

ROUBINI: Even if you want to bail them out and put public money, first thing you do, you wipe out the shareholders. These are insolvent. So if you're going to put public capital, the shareholders should be gone. You replace management that was corrupt and inefficient. And even then, bond dollars should take a haircut. Why should the U.S. taxpayer pay for the cost of this insolvency? So the plan is a plan that essentially bails out management, shareholders, and bondholders. And it's not correct, and it's not going to work.

MASSAR: Something I talked to Jim about yesterday, if it was another industry, would we be seeing this bailout?

ROUBINI: Of course not, of course not. There has been a systemic moral hazard in financial markets. This is just privatizing the gains and socializing the losses. At this point, this is just reckless. This is not the right plan.

MASSAR: All right. Sit tight, Nouriel. We're going to take a break though, and come back and talk some more, because I do want to get your thoughts in terms of the inflation, what the Fed can do in terms of this. Would you be doing something differently if you were back at Treasury?

ROUBINI: Yes. I wouldn't bail out, essentially, the shareholders, the management, and the bondholders of Fannie and Freddie. This is really a wasteful use of taxpayers' money. You have to wipe out management, the shareholders, and even the bondholders should not be made whole. They should take a haircut. So that's the right solution.

MASSAR: All right. So this is what you think is going to be talked about, mostly, on Capitol Hill today with Ben Bernanke. You've also got a second panel. What have you got? The recent market developments and regulatory responses to them with Ben Bernanke, Paulson, and also Chris Cox over at the SEC. So again, they're going to be talking about this, right?

ROUBINI: Yes. They're shortening, actually, the time given to the Bernanke testimony and the economy. They're going to concentrate most of the day on financial markets, as they're severe.

MASSAR: Is that a mistake though, we're watching inflation levels, and so on and so forth? We talk about commodities every day and the run-up that we're seeing. Should, are we worried about

ROUBINI: No. In my view, inflation is going to be the last of the problems of the Fed.

MASSAR: Really?

ROUBINI: Yes, because we have downside risk to growth. We're going to be severe financial crisis, you're going to have slacking labor market that's going to control wage and labor costs. You're going to have a slacking goods market controlling the price

(CROSSTALK)

MASSAR: OPEC cutting oil prices.

ROUBINI: And even oil prices are going to fall sharply. So inflation is going to fall. It's going to be the last thing that the Fed has to worry about. It's going to be growth, severe recession, and severe financial crisis. Those are the things that Bernanke should be worrying about.

MASSAR: If you had one question only that you could ask Ben Bernanke today, Hank Paulson, Chris Cox, what would it be?

ROUBINI: It would be what are you going to do to resolve the worst financial crisis in the U.S. since the Great Depression. Bernanke's a student of the Great Depression. He knows it inside out. So what is he going to do? This is the worst financial crisis. They should recognize it, and should figure out what they're going to do about it.

MASSAR: So if you were an investor, what would you do? I'm hearing more and more people say put it in cash.

ROUBINI: Absolutely. Now the stock market's corrected only 20 percent. I think its going to fall another 20 percent this year alone. In the typical U.S. recession, the fall in equity falls around 30 percent. This time is a worse recession. Equity price is going to go further and more sharply.

MASSAR: We've had a couple of other crisis. The S&L crisis, we had the telecom fallout and so on and so forth. How do these compare, in comparison?

ROUBINI: This is much worse. The S&L was a bunch of thrifts in the South of the U.S. This is a systemic financial crisis for the entire United States. And the telecom problems were, again, 5 percent of the economy. This is much more severe, much more deep, much more protracted. We haven't seen a recession like this and a severe financial crisis like this since the Great Depression.

MASSAR: Right. So some interesting questions for Mr. Bernanke and company today. All right. Nouriel, thank you so much.

ROUBINI: Pleasure being here.

MASSAR: Nouriel Roubini.

***END OF TRANSCRIPT***

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#<840630.1057402.1.0.82.31279.25># -0- Jul/17/2008 15:27 GMT

Last Updated: July 17, 2008 11:27 EDT