Research

Encouraging Prognosis for the U.S. Economy

The U.S. GDP will begin to rise and the credit freeze will begin to thaw by the end of this year, according to Professor Robert Smiley, who was invited to present his analysis of the recession to more than 150 wine industry professionals and business owners at the Second Annual Napa Valley Grape Growers Association meeting in March.

Smiley explained how the financial crisis began in the U.S. housing market and spread like wildfire through the global economy. He described Clinton and Bush administrations policies that strongly encouraged homeownership during the late 1990s and into 2005, primarily by reducing credit standards through Fannie Mae and Freddie Mac. Smiley said this easing of credit boosted homeownership from 60% to 70%, but the 10% increase was comprised primarily of people who had poor credit or did not have the means to make their loan payments. In short, according to Smiley, the banks were encouraged to grant higher risk, subprime mortgage loans to people who could not afford them.

Smiley then described how subprime mortgages were bundled with other mortgages and sold on the market as collateralized mortgage obligations or mortgage backed securities. The bundles received investment grade ratings from Standard and Poor’s, Moody’s or Fitch Group that encouraged hedge funds, banks and pension funds to buy them. According to Smiley, these inflated ratings were created because the companies that put together the bundles hired the rating firms to assess the value of those bundles—an obvious conflict of interest. Then these mortgage bundles were allowed to be insured by companies like AIG, which, according to Smiley, did not keep a sufficient reserve in the event the bundles would fail. When the mortgage bundles did fail, AIG could not cover the losses, leading to the federal bailout.

Smiley concluded that the economy will begin to recover by the end of 2009 and into 2010 as banks are reporting increased profits, stock prices are rising and manufacturers have sold off most of their surplus inventory. However, his enthusiasm was guarded. He contends that this economic meltdown is unique compared to past recessions.

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