April 30, 2015 | By Scott Minerd, Global CIO
Milton Friedman once said that “when that crisis occurs, the actions that are taken depend on the ideas that are lying around.” After the 2008–2009 financial crisis, there was no shortage of ideas for how to prevent catastrophic financial events from ever happening again. What ultimately resulted was forceful and wide-ranging regulatory responses that included Dodd Frank, the Volcker Rule, Basel III, Solvency II, the Federal Reserve Supplemental Leverage Ratios… the list goes on and on. Today, policymakers have coined a term for the cog wheels of overlapping regulations: they call it “macroprudential policy.”
While you may not be familiar with the concept of macroprudential policy, it is one of the most important factors in determining the long-term growth potential of the U.S. economy and the ability for all its citizens to share in that growth. Without significant adjustment, actions taken by policymakers today may come at a great cost to future generations.
The rationale for macroprudential policy is that it is in everyone’s best interest to never face a financial crisis like the one we did in 2008–2009. Prior to the crisis, policymakers believed that it was generally hard to identify bubbles, but that once a bubble developed and subsequently collapsed, the tools existed to clean up the mess. This meant that capital, usually in the form of credit, would sometimes be allowed to flow to marginal borrowers, who ultimately would default.
Post-crisis legislation aimed at curbing bank lending activity is evident in the leveraged loan market, where bank participation in new transactions has declined. During the first quarter of 2015, banks represented only 12.1 percent of non-arranger allocations of newly issued leveraged loans, less than half their 30 percent share of allocations in 2009. This has caused corporate borrowers to rely on non-bank entities for financing.
Source: S&P LCD. Data as of March 31, 2015.
Under the new era of macroprudential policy, the theory is that regulations will restrain the availability of credit—even to the extent that some good borrowers may not have access to capital—in order to avoid allowing bad loans to exist. This means that growth, on balance, will be lower over the business cycle and there will be less upward pressure on interest rates. Credit will only be accessible by certain borrowers, some of whom are likely to become overleveraged and allocate capital into marginal investments, while other, more speculative credits, will have to access capital in the shadow banking system.
The principal problem with macroprudential policy is that the regulation of banks’ ability to lend has become so restrictive that people who would normally qualify for a mortgage or a loan or who need capital to start a business can’t get it. Proof of that is when Ben Bernanke announced that he couldn’t get a mortgage. When you get to the point where we can’t give the chairman of the Federal Reserve a loan on his house then regulation has probably become too restrictive.
For macroprudentialists, however, the risk of stalling the economy by restricting credit is a small price to pay for what is believed to be a regulatory system that will prevent catastrophic collapse. The macroprudentialists’ argument is that even if the current web of regulations results in lower average growth in the economy over time, long-term output can still be higher by mitigating deep downturns and financial crises along the way. In the real world, however, these restrictive policies are making it more difficult for the economy to gain traction, to create jobs, and to invest in productivity gains necessary for sustainable growth. And, despite all of this macroprudential policy, debt continues to pile up—at 234 percent, nonfinancial sector debt to U.S. GDP is still near the highest on post-war record and climbing.
In the near term, the negative impact of macroprudential policy isn’t likely to be obvious. The U.S. economy for the next few years will likely continue to be strong. But macroprudential policy will ultimately lead to mal-investment, which will result in lower levels of productivity, making the economy less resilient to increases in real interest rates. As the Fed begins “lift off” later this year or in 2016, there will be less headroom for rate increases before inducing a recession.
The bottom line is that a policy that intentionally leads to a misallocation of capital in the long run leads to lower levels of efficiency, productivity, and growth. That’s just basic economics. What’s worse is that by restricting access to capital only to the wealthiest borrowers, these policies fuel the income inequality that is already tearing at the fabric of our society. Lower growth and greater income inequality are the real economic crises. These crises cannot be cured by policies designed to prevent the economic crises of the past. When will policymakers awaken to this reality? As Milton Friedman suggests, it may take another crisis. Let’s hope that it will not take another generation before policymakers find ideas “lying around” to unwind the current cobwebs of over-regulation and set the stage for a stronger, more equitable economy.
Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
This article is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product or as an offer of solicitation with respect to the purchase or sale of any investment. This article should not be considered research nor is the article intended to provide a sufficient basis on which to make an investment decision.
The article contains opinions of the author but not necessarily those of Guggenheim Partners, LLC its subsidiaries or its affiliates. Although the information presented herein has been obtained from and is based upon sources Guggenheim Partners, LLC believes to be reliable, no representation or warranty, express or implied, is made as to the accuracy or completeness of that information.
The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and nonproprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed as to accuracy.
This article may be provided to certain investors by FINRA licensed broker-dealers affiliated with Guggenheim Partners. Such broker-dealers may have positions in financial instruments mentioned in the article, may have acquired such positions at prices no longer available, and may make recommendations different from or adverse to the interests of the recipient. The value of any financial instruments or markets mentioned in the article can fall as well as rise. Securities mentioned are for illustrative purposes only and are neither a recommendation nor an endorsement.
Individuals and institutions outside of the United States are subject to securities and tax regulations within their applicable jurisdictions and should consult with their advisors as appropriate.
©2015, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim Partners, LLC and Guggenheim Investments. For information, call 800.345.7999 or 800.820.0888.
Member FINRA/SIPC GI FIO 0415 #17675
History shows that once our recession forecast model reaches current levels, aggressive policy can delay recession, but not avoid it.
Credit spreads could get tighter in this liquidity-driven rally, but history has shown that the potential for widening from here is much greater.
Rational immigration policy, not rate cuts, is the way to avoid recession.
Portfolio Manager Adam Bloch and Matt Bush, a Director in the Macroeconomic and Investment Research Group, share insights from the third quarter 2019 Fixed-Income Outlook.
Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.
You are now leaving this website.Guggenheim assumes no responsibility of the content or its accuracy.
Your browser does not support iframes.
2019 Guggenheim Partners, LLC. All rights reserved. Guggenheim, Guggenheim Partners and Innovative Solutions. Enduring Values. are registered trademarks of Guggenheim Capital, LLC.