Not the Usual Suspects
What's Ailing the Recovery? The Real Reasons Aren't What You Ooften Hear

October 2011

Many commentators blame taxes, regulation and uncertainty for the inability of the U.S. economy to create jobs or grow at anywhere close to its usual rate, even two years after the end of the Great Recession.

Northern Trust's Chief Economist Paul Kasriel doesn't agree with that analysis. "There's always uncertainty," he says. "Is there any more uncertainty now than during the Great Depression? Yet from 1934 through 1937, the U.S. economy grew in real terms by 9.4% per year. That's the second-fastest growth rate over any consecutive four-year period since 1900. Yes, there's uncertainty, but that is not what's been holding back economic growth."

Then it must be sky-high taxes, right? Wrong again, according to Kasriel. He points out that after-tax profits for U.S. corporations are at an all-time high, both in absolute terms and as a percentage of GDP. And last year, individual taxes fell to the lowest level as a percentage of GDP since 1950.1

"A lot of people think federal taxes have gone up, but they've actually come down," Kasriel says.

Then maybe burdensome government regulations are the problem. Kasriel acknowledges that some companies may be hamstrung by government red tape. Yet he notes that when the Roosevelt administration imposed massive new regulations on businesses after taking office in March 1933, economic growth went through the roof, not the floor.

To Kasriel, the cause of the current economic malaise is really no mystery. He's seen it before, albeit in a less draconian form.

"The 1990 recession was a dress rehearsal for the recent one," Kasriel says. "In each case, a damaged financial system impaired the normal creation of credit." Two decades ago, the problem stemmed largely from the savings and loan crisis. This time, it was an even larger bust in the residential housing market that inflicted huge losses on lending institutions.

"The financial sector suffered more damage from the 2007–2009 recession in terms of profits contraction than it did from the 1990 recession and the run-up to the Great Depression," Kasriel says. And since credit makes the economic world go 'round, when it dries up, bad things usually happen.

Kasriel has observed a strong historical correlation between the growth rate of private monetary financial institution credit and gross domestic purchases. Since 1953, combined credit from commercial banks, savings and loans and credit unions has grown at an average annual rate of 7.4%; recently, that number dropped back below zero after having recovered modestly following the Great Recession.

But why? After all, borrowing rates are at rock-bottom levels.

Two reasons, notes Kasriel. First, lending standards were tightened after the global financial crisis. Also, lending institutions are hesitant to make loans because they know or fear the value of mortgages being carried on their books is still too high.

"If those mortgages are subsequently written down," Kasriel says, "the banks could find themselves undercapitalized."

Extraordinary measures taken by the Federal Reserve kept the global financial system alive following what was essentially a near-fatal heart attack in 2008. The patient is now up and walking, but that's about it.

"The financial sector is out of intensive care but hasn't been discharged from the hospital," Kasriel says.

So what's the prognosis? Kasriel thinks more treatment options are available to the Fed, but they are unlikely to be prescribed in the near term given internal central bank opposition and the upcoming political peak season.

But there is reason for optimism as well.

"Time heals all," Kasriel says.


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