Post-Crisis US Economy Seen Settling Lower

Source : The Business Times, May 20, 2008

Productivity gains will be weaker, joblessness higher

(NEW YORK) A normal US economy is likely to look a lot different, and worse, after the credit crisis is over and financial markets settle down.

Companies will continue to struggle to raise cash for expansion and innovation as investors and lenders remain focused on conserving capital. Workers, too, may have less flexibility to go after new opportunities, because many will be stuck where they are - in homes worth less than the balances on their mortgages.

'Once you've made terrible, overly optimistic errors, that paralyses you for some time,' says economist Paul Samuelson, a Nobel laureate.

The bottom line: The US may have to get used to a new definition of normal, characterised by weaker productivity gains, slower economic growth, higher unemployment and a diminished financial services industry.

Long-term growth in the US may drop to 2 per cent to 2.5 per cent a year from the 3 per cent rate of the last 15 years, according to Peter Hooper, chief economist at Deutsche Bank Securities in New York and a former Federal Reserve official.

Even after markets recover, 'the cost of risk capital is likely to be significantly higher than during the credit bubble', he says.

A record three-quarters of US banks that the Fed surveyed last month said that they were charging corporate borrowers a higher premium over what the lenders pay for funds. More than half reported a tightening in lending standards.

Behind the stricter terms: loans and investments made during the credit boom that went sour. Banks and financial institutions worldwide have racked up more than US$340 billion in credit losses and asset writedowns since the start of last year. David Rubenstein, managing director of the Washington-based private equity firm Carlyle Group, says that there is more to come, telling reporters on May 12 that 'enormous losses' have yet to be recognised.

'Credit conditions are more likely to tighten further in the near term than ease,' says Andrew Tilton, an economist at Goldman Sachs Group Inc in New York.

Citigroup Inc chief executive officer Vikram Pandit told shareholders on May 9 that he plans to get rid of about US$400 billion of assets over the next three years after the biggest US bank lost US$5.1 billion for the first quarter.

Companies also face a tougher borrowing environment in the bond market. The spread that investors charge over Treasury securities for high-yield bonds has narrowed since the height of the credit crisis in mid-March. Still, at 663 basis points, it is well above the 495-point average since 1985.

And it is likely to remain higher, says John Lonski, chief economist at Moody's Investors Service Inc in New York. He sees the spread averaging about 600 basis points next year.

Companies are also issuing fewer high-yield bonds, and he forecasts a drop of more than 40 per cent this year, to US$80 billion. 'Next year, we'd do very well to reach US$100 billion,' he says. In 2006, before the onset of the credit crisis, more than US$150 billion in new junk bonds were sold.

Equity capital is also harder to come by. Initial public offerings for fledgling businesses fell to the lowest level in almost five years in the first quarter, the National Venture Capital Association reported.

Less risk-taking can mean a less-vibrant economy, says Mr Samuelson, 93, an emeritus professor at the Massachusetts Institute of Technology in Cambridge, Massachusetts. 'What you could lose are some new ideas that would otherwise get to be practical and get their chance,' he says.

Even well-established companies may have a hard time retrenching. Wall Street analysts say. General Electric Co chief executive officer Jeffrey Immelt might have difficulty selling slow-growing financial services assets, including GE's credit card unit. The Fairfield, Connecticut-based company might even sell its century-old appliance business.

Workers too are feeling the fallout from the credit crisis. The share of respondents in a May 1-8 Bloomberg/Los Angeles Times poll who described themselves as financially secure fell to the lowest level since 1992.

The declining value of houses - the biggest asset for many Americans - has a lot to do with their pessimism. The median price for a single-family home fell 7.7 per cent in the first quarter, the biggest drop in at least 29 years, according to the National Association of Realtors. -- Bloomberg