Post-Crisis Secular Shifts in the Capital Markets and the Global Economy Could Foster a New Normal

Abstract

Seven years of subpar growth in the slowest U.S. economic recovery since the Great Depression raises the question of a new paradigm that limits future expansion. The problem derives from prolonged tepid global demand largely born of retrenchment in China. But it is also rooted in adverse fiscal, monetary and regulatory policies in the major economies, linked by a common political bent in the West that weighs on the private economy. U.S. measures taken in the aftermath of the financial crisis have created possible secular changes in the capital markets and the economy that could permanently hamper general prosperity, despite current record high stock prices and low reported unemployment. Obstacles include the Dodd-Frank Act, rock-bottom interest rates, the demise of private-label securitization, and the possible reinstatement of the Glass-Steagall Act. Regulatory capital restrictions on financial institutions based on an exaggerated perception of risk unnecessarily limit bank profitability, credit availability and market liquidity, disrupting their traditional intermediation role between lenders, investors and borrowers. Financial and non-financial regulation has suppressed business investment essential for economic growth. Chronic historically low short-term and long-term interest rates imposed by the Fed have misdirected massive capital into stocks and bonds at the expense of goods and services. In the process, savers and investors dependent on interest income suffer while borrowers pile on debt, including the government. The current $4.2 trillion balance sheet the Fed has amassed as a result, as well as expanded powers assigned by Congress, unduly empower that institution. The demise of mortgage securitization by private banks has curtailed lending and exacerbates the predominance of nationalized Fannie Mae and Freddie Mac in the housing market. This further puts the taxpayer at risk of defaults from economic downturns and the government’s social justice agenda imposed on their underwriting standards. In addition, the misguided call for the return of the Glass-Steagall separation of commercial and investment banking, particularly in respect of certain proprietary trading, would deny banks capital-bolstering revenue diversification, as well as limit liquidity in the securities markets raising the cost of capital as a result. In addition to regulation, growing government intrusion through spending and taxation sustain the malaise. Sadly, this intervention garners growing popular support from those disaffected by stagnant growth who call for ever more wealth redistribution from the haves to the have nots. Accordingly, the national debt, which has nearly doubled since the Great Recession, continues to grow unabated, further choking off the ability of the private economy to prosper. Indeed, the political class, and too many Americans, increasingly eschew the traditional meritocratic model of past success in favor of the egalitarian state. All told, post-crisis changes augur continued sclerosis at the cost of millions of jobs. As such, current restraints could contribute to structural unemployment marked by greater income inequality, a wider skills gap, and a lower standard of living, notwithstanding certain misleading nominal measures to the contrary.Without question, normalized interest rates and sufficiently less government spending, taxation and regulation can get America, and the world, growing again. Over time, secular change is inevitable and often beneficial. But the continuation of unduly suppressed free markets will assure a new normal in the future where the weak 2% annual growth of the last seven years might seem quixotic.