Financial crisis termed 'biggest...since Depression'

MURFREESBORO -- Economic forecaster Dr. Donald Ratajczak said on Friday that, while he doesn't forecast a return to bread lines, the current financial crisis is "the biggest event since the Great Depression" in terms of an upheaval in economic philosophy.

Dr. James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, said that the impact of the crisis is still to be determined and called the near-term outlook for economic growth and inflation uncertain.

Bullard was the keynote speaker and Ratajczak was the luncheon speaker at Middle Tennessee State University's annual Economic Outlook Conference, which was held off-campus for the first time at the Embassy Suites Hotel and Conference Center.

Bailout defended

Both Bullard and Ratajczak defended the proposed $700 billion bailout, at least in its original form. But Ratajczak was critical of Treasury Secretary Henry Paulson, calling him "the black knight" and saying Paulson's role in allowing the crisis to happen will not be looked on favorably by history.

"The word 'bailout' is a loaded word," said Bullard, who said the proposal would get the financial industry moving again, provide liquidity and relieve uncertainty.

The legislation the Bush administration is promoting would allow the government to buy bad mortgages and other assets held by investors, most of which are financial companies. Relieving them of those burdens would make it easier for them to loan money again.

Both Bullard and Ratajczak said that the government would have the assets connected to those mortgages and, with proper management, might even be able to turn a profit on them.

The always-animated Ratajczak, a professor emeritus at Georgia State University and a frequent guest on TV financial news programs, marveled that he had been called for advice by both of Georgia's U.S. Senators in the 48 hours before his speech.

"They didn't even ask me for money," he joked, "so I know they were serious."

Loans cause crisis

Ratajczak talked about the origin of the crisis. He said he had recognized for some time that housing prices were too high but didn't know why. The problem was that mortgage bankers, driven by bonuses, were signing up people for mortgage loans who were poor risks. In many cases, the borrower would be tempted with a temporary "teaser rate" even lower than the borrower was paying in rent. Loans were issued without proper documentation of the borrower's earning capacity or of other loans agains the home.

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The free availability of mortgages increased the demand for homes, which artificially increased prices, even for legitimate borrowers with legitimate credit.

"Bad underwriting skewed the prices of homes everywhere," said Ratajczak.

Meanwhile, brokers took the non-investment-grade mortgage debt and carved it up to sell to investors in a way that made some of it look like investmet-grade debt.

When the housing market finally corrected itself, the true valuation of those homes meant that the borrowers had less in collateral than had been assumed. Ratajczak said that Fannie Mae and Freddie Mac were actually making responsible home loans but got caught by this collapse in the artificially-inflated home values.

"Fannie and Freddie were the only ones doing the right underwriting," said Ratajczak.

Ratajczak said it might have been possible for the government to avoid its bailout of Fannie Mae and Freddie Mac if it had simply worked harder at reassuring investors that the companies had the backing and support of the government. Bullard said many foreign investors were shocked when they first heard about a bailout of Fannie Mae and Freddie Mac; the foreign investors had been assuming that they were already automatically backed by the federal government.

Bullard said, however, that the federal government has gotten "tremendous cooperation" from other countries' central banks as it works to resolve the crisis.

Recession in progress

Ratajczak said he believes that economists will eventually say that a recession started in January of 2008, and will ignore the brief upturn caused by the stimulus checks issued in the spring and early summer. Ratajczak predicted the recession would last about 12-15 months and predicted a poor holiday season for merchants.

"Christmas is dead," he said. "Sorry.... Last Christmas wasn't great. This one is going to be worse."

He said that by the second quarter of 2009, the economy should begin to improve, aided -- somewhat unexpectedly -- by the housing market.

"What pulls us out is what put us in," said Ratajczak.

He also noted that U.S. productivity is high and predicted that some outsourced jobs will be brought back from India. He said "dirty industry" which has moved to China will likely stay there.

Ratajczak said that he believes oil will stay at $100 or $110 per barrel for the next year but predicted it will shoot up to $200 in the next few years. And he said the storms in the midwest caused by the remnants of Hurricane Ike will keep food prices high.

Ratajczak said he's not certain whom he will support in the coming presidential election and hasn't been impressed by the economic plans of either candidate. He warned Democratic candidate Barack Obama not to return to a previous theme of increasing taxes on the wealthy, saying that any tax increase in a fragile economy is a bad idea.

Robert A. McKay Jr. of Pinnacle Financial Partners was presented with the annual Jennings A. Jones Champion of Free Enterprise Award during the conference. David A. Penn of MTSU's Business and Economic Research Center discussed Middle Tennessee employment and economic trends during the conference; Penn's remarks will be covered in a future issue.