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U.S. economy: likely worse before it gets better

Economic conditions in the United States and much of the rest of the world could get worse before they get better. But the current financial woes are nothing compared to what they could have been if the federal officials had not acted as quickly as they did in October.

Don Reynolds, an economist who managed pension funds for Texas for 12 years, said he expects the economy to continue to deteriorate for another six months before “bottoming out” in the spring. But it could be 2010 before the situation begins to show real improvement, he said.

“In 1933, it took the federal government three years to come up with a plan for getting us out of the Depression,” Reynolds told members of the Southern Crop Production Association at their annual meeting in Charleston, S.C. “Henry Paulson and Ben Bernanke (treasury secretary and chairman of the Federal Reserve Board) did it in two weeks.”

Reynolds, who was chairman of the Texas Investment Advisory Board when George W. Bush was governor, also said he believes Barack Obama may not be as difficult a choice to swallow as president as many John McCain supporters believe.

“If (Obama) is as smart as they say he is, he will move to the center,” said Reynolds. “If not, then your expectations will be met,” referring to reports that the Democrat will be one of the most liberal presidents in history.

“Most of what I’ve been hearing says that Obama has indicated he would let the Bush tax cuts expire. If that’s all he does, we can live with that. If he moves to tax 100 percent of Social Security income, as some have said he will, that could be a problem.”

Listing Obama’s three principle economic advisers — Robert Rubin, Paul Volcker and Lawrence Summers — Reynolds said all three are mainstream economists who will provide a touch of realism for Obama. (Rubin and Summers served as secretaries of the treasury under former President Bill Clinton and Volcker was chairman of the Federal Reserve in the Reagan era.)

Reynolds, who was chairman of the Texas Pension Board for 12 years, said a number of factors contributed to the current economic “mess” that the United States and most of the world currently finds themselves in.

Democrats must share in the blame for the problems because of a decision in 2003 by the House and Senate banking committees to amend the Community Re-investment Act to allow the Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Corp. (Freddie Mac) to buy subprime mortgages or “ninja loans” (not enough income to justify an application).

As interest rates — and the mortgage payments — rose on many of those adjustable rate loans, banks which had purchased them without as much as a glance at whether they met anyone’s underwriting standards began to report large numbers of nonperforming loans. Other companies which had written billions of dollars of credit default swaps to “insure” those mortgages, began going under, forcing the government to take action.

“This is truly a global economic event,” said Reynolds, who has lived overseas and visited 50 countries. “Over half of the bad mortgages that were written were sold outside the country. Other countries, particularly in Europe, where banks are more leveraged than those in the United States, will be hurt worse by this.”

Reynolds said he was in Rome the week before he spoke at the SCPA meeting. “I was riding in a cab and the driver asked me why we let Lehman Brothers go under. This is a taxi driver in Rome.”

The economic fallout has not been confined to the housing sector. Reynolds noted that GE, one of the six AAA credit-rated companies in the United States, had to go to Warren Buffet and ask to borrow $3 billion for five years after the commercial banks refused to lend to it. Buffet made the loan at 10 percent.

“If GE has to accept an interest rate of 10 percent, can you imagine what other companies that don’t have the credit rating of GE are having to pay?” asked Reynolds. “That’s why some companies I mentioned earlier that have been having problems may not survive the year in their current form.”

Reynolds said economic conditions are likely to worsen over the next six months. “It will take a while for the $700 billion the federal government is providing in the bailout to work down through the economy. It will decline for another six months, and then we’ll have about nine months of muddling through. By 2010, we should start to see some improvement.”

While the bailout has drawn sharp criticism from many observers, Reynolds said the government had no choice to move to rescue the financial sector. “If Paulson and Bernanke had not acted when they did, we would have had a total collapse. It would have made you wish we had only had a depression.”

Reynolds, who first attracted the attention of government officials in Texas with his “astonishingly accurate” predictions on oil prices, said he believes gasoline prices — and grain prices — will begin to rise after the election.

“They always bring them down right before an election,” he noted. “That will change once the dust settles.”


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