"A Path to Growth"

Sydney M. Williams

Thought of the Day

“A Path to Growth”

July 28, 2011

The rhetoric surrounding the debt ceiling manifests the dysfunctional government we have in Washington, and the lies that course through the halls of Congress, unchallenged by mainstream media. The most obvious is “cuts in spending”, a term used unwaveringly by both parties. It is a misnomer. Every proposal from the most austere to the most liberal are not cuts in spending. They are cuts in the growth rate of spending. Projected federal government expenditures over the next ten years are expected to be in the range of $44.5 trillion. Federal government spending in fiscal 2011 is expected to be $3.7 trillion. A four percent increase in annual expenditures takes federal spending to $5.5 trillion in 2021, for an average of $44.5 trillion. A $4 trillion “cut” in spending simply reduces the growth rate in expenditures from 4% to 3%.

Entitlement spending will increase, as our population ages and as 75 million baby boomers reach retirement age. There are things we can do to slow the rate of growth in Social Security spending such as means tests and raising the retirement age to 68 or 70. We can slow the rate of growth in Medicare and Medicaid by allowing healthcare companies to compete for the business. We cannot afford to allow programs like Medicaid to expand at the rate that it has over the past forty-five years – 9.6% at an annual compounded rate.

We all know that politicians lie, but their lies have become so ubiquitous that it distorts the debate, has soured the electorate, and puts at risk all of our futures.

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The U.S., not just the capital markets, is trapped in a funk of frustrated anger. Washington is not working. Congressmen regularly snipe at one another in public, elevating an already elevated discourse. It was depressing yesterday to watch those three blind mice – Senators Reid, Schumer and Durbin – go on TV, not to speak positively about a bi-partisan plan, but to bash a Republican plan that cannot even get every Republican vote. The President and his Treasury Secretary warn of cataclysmic events if they don’t get what they want. It is more anger than despair people feel, because they know that the answer to the problem of debt and deficits lies in unleashing the economy.

A year ago Congress gave birth to the Dodd-Frank Bill. One provision of that Act was the establishment of the Financial Stability Oversight Council (FSOC,) a group with broad authority to “monitor excessive risks to the U.S. financial system arising from the distress or failure of large interconnected bank holding companies or non-bank financial companies, or from risks that could arise outside the financial system; to eliminate expectations that any American financial firm is ‘too big to fail;’ and to respond to emerging threats to U.S. financial stability.” That’s a mouthful, and it remains to be seen whether the ten voting and five non-voting members will be able to foresee and prevent every possible scenario that could bring the capitalist system down.

Jaret Seiberg, a financial services policy analyst at MF Global’s Washington Research Group, recently reported to Bloomberg: “The FSOC was supposed to be the centerpiece of Dodd-Frank and is still not functioning.” Plans to designate systemically risky firms have been set back, according to Bloomberg, because the “criteria were too vague.” While bank holding companies with more than $50 billion (there are thirty-three such banks) are considered “too big to fail,” non banks with equivalent assets may need the same designation. Ironically, with AIG being blamed for causing the near collapse of the financial system in 2008, the insurance industry was not represented on the Council at its start. Only now is the Senate Banking Committee considering President Obama’s nominee, S. Roy Woodall, a former Kentucky insurance commissioner.

Three years after the financial meltdown, federal officials have said that the U.S. financial system remains vulnerable to shocks. Deborah Solomon, in Wednesday’s Wall Street Journal, referring to their first annual report, cited the $2.7 trillion short-term funding market, including the “tri-party repo” market , and Europe’s debt crisis. To increase stability and reduce money market funds’ “susceptibility to runs, the FSOC made the (bizarre to me) recommendation that the SEC consider “moving to a floating share price, instead of a fixed $1 price, and imposing buffers.” The report also reiterated a call for national mortgage servicing standards. But apparently it did not address the role Congress played in pressuring banks to make mortgage loans to less-than-credit worthy potential homeowners.

The world’s financial system and global economic growth are based on confidence. Trade depends on credit, and the word credit derives from the Latin, “credo,” meaning “I believe.” It is not financial regulation that hinders growth as much as it is the availability of credit and, more importantly, the elimination of the uncertainty as to what rules will be implemented and when. While the FSOC has been considering rules to regulate “too big to fail” financial institutions, the largest of all, JP Morgan Chase has increased assets from $1.7 trillion at the end of 2008 to $2.1 trillion at the end of 2010. If banks were too big to fail three years ago, they are even bigger today.

The best way out of the mess is through economic growth. Growth will drive employment, which in turn will increase tax revenues and help bring down federal deficits. It is not austerity that will lead us to prosperity, it is a growing economy. Hamstringing the economy with bickering in Congress or through persistent and ever-changing regulation at the state and local level is hindering economic growth and job creation.

Capitalism and capitalists are not four-letter words. If government starves the engine that drives our economy, joblessness and high deficits will persist. It is government that threatens our way of life. My wife’s dermatologist recently sent me a quote of Abraham Lincolns’, spoken at the age of twenty-eight but filled with wisdom of the ages. It is worth pondering, as our dysfunctional government causes our economy to slow and our capital markets to go into hibernation. Lincoln is speaking about what could cause our country to fail, and he argues it will not be due to danger from afar. He goes on: “At what point then is the approach of danger to be expected? I answer, if it ever reach us, it must spring up amongst us. It cannot come from abroad. If destruction be our lot, we must ourselves be its author and finisher. As a nation of freemen, we must live through all time, or die by suicide.”

Amen! Washington, are you listening?

[1] A tri-party repo is when a custodian bank or international clearing organization acts as an intermediary between the two parties to a repurchase agreement.