'Regime Uncertainty' Further Delays Economic Growth

Includes: DIA, KBE, QQQ, SPY, XLF
by: Carlos Lam

The end of mark to market accounting creates yet more "regime uncertainty," which may further delay economic recovery. As Professor Robert Higgs noted, "regime uncertainty" is created when government changes, creates, and removes rules. Businesses become more risk-averse because they do not know what the "rules of the game" will be in the future. Certainty is a must whenever one is planning for long-term business success; regime uncertainty reduces the required certainty.

Professor Higgs’s thesis about regime uncertainty sprang from his study of the Great Depression and the Roosevelt Administration’s responses to it. Professor Higgs’s research indicated that several business leaders were very concerned that President Roosevelt would become a socialistic or fascistic dictator. Of course, we have the comfort of looking back at the Roosevelt era and noting that this did not occur. Nevertheless, business leaders at that time considered it a real possibility. They believed that the Roosevelt administration would impair the future returns of their investments. Indeed, Professor Higgs’s data indicates that during the 1930s, net private investment—the sum of all purchases of capital goods, equipment, and other means of production—were negative $3.1 billion.

Interestingly, the Roosevelt administration and its Congressional allies did enact numerous regimes that sought to control production and consumption, including:

1933 – Agricultural Adjustment Act

1934 – Securities Exchange Act

1935 – National Labor Relations Act & Social Security Act

1937 – National Housing Act

1938 – Fair Labor Standards Act

1940 – Revenue Act of 1940 & Second Revenue Act of 1940

Professor Higgs theorizes that the economy “broke out” after the Second World War—he argues that the War itself did not “cure” the Great Depression—because of two factors. First, the War itself preoccupied the federal government, making it less likely to pass legislation that would potentially impair future returns on investment. Second, by the end of the war, President Roosevelt was dead; President Truman did not have the political capital to push through legislation that could cause more regime uncertainty.

To return to the present day, the regime uncertainty factors created by the current and former Presidents, the Federal Reserve, the U.S. Congress, and (now) the FASB cannot be discounted if one is investing for the long term (ironically, I believe, the regime uncertainty may actually HELP traders because it may create more volatility). Here is but a small list of the regime uncertainty factors created lately:

  • Secretary of the Treasury Hank Paulson planning to use the TARP funds to purchase "legacy assets" and then using the funds to recapitalize banks
  • U.S. House voting NO on TARP and then – after appropriate arm-twisting and earmarks like the tax benefit for an Oregon toy-arrow producer – voting yes
  • The U.S. Congress voting NO on bailouts for the U.S. automakers and then President Bush extending financing to them
  • The “stimulus plan,” originally supposed to fund “shovel-ready” infrastructure projects, became a way for Congressmen and Senators to obtain money for pet projects in their districts
  • The Federal Reserve began creating lending facilities with money out of thin air instead of allowing poorly-managed financial organizations to fail: Term Auction Facility, Term Securities Lending Facility, Primary Dealer Credit Facility, Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, Commercial Paper Funding Facility, Money Market Investor Funding Facility
  • The Federal Reserve began its Zero-Interest Rate Policy
  • The Federal Reserve began monetizing the Treasury’s debt
  • FASB ends mark-to-market accounting

The St. Louis Federal Reserve Bank notes that gross private domestic investment (purchases of nonresidential real estate, machinery, software) has fallen, as it does in almost all recessions. Instead of investing in machinery, land, and software, it seems like capital is heading toward stores of safety; the U.S. Mint reported that sales of the one-ounce American Eagle gold bullion coins surged over 400 percent in 2008. This is not to demean gold; it is a five thousand year-old store of value. However, gold in and of itself does not produce jobs or finished products.

It is very possible – even likely – that the regime uncertainty created by the government’s recent moves will depress domestic investment. This will, in turn, cause a delayed recovery. If the government continues to tinker with the rules, then the recovery will be that much more hindered and tepid. I admit that the government is operating in an area where it never has gone before. However, I would caution that the more it thrashes about attempting to find a “solution,” the more uncertainty it creates. If the government would be willing to take a single course of action—my favorite would be to allow bad banks, ailing automakers, and overleveraged homeowners to fail—it could dispel such uncertainty. Unfortunately, it seems that Treasury Secretary Tim Geithner, President Obama, and Fed Chairman Ben Bernanke are more intent on keeping the search for a “solution” alive.