Top government economists, plus academic experts and industry leaders recently gathered to discuss the outlook for financial markets and the economy under President-elect Donald Trump.
The University of Maryland Robert H. Smith School of Business Center for Financial Policy and Ed Snider Center for Enterprise and Markets staged the Nov. 17, 2016, event in Washington, D.C., in the Reagan Building’s Smith School Suite.
A morning panel focused on microeconomic issues, including policies that would remove barriers to growth facing small businesses and large firms, as well as prepare the U.S. workforce for future opportunities. An afternoon panel covered macroeconomic topics, notably the prospects for a fiscal policy surge in 2017, and the likely response of monetary policy to changes in taxes and government spending.
David Rennie, Lexington columnist at The Economist, gave a keynote speech. Panelists and other contributors were:
- Rajshree Agarwal, Smith School entrepreneurship professor and director of Ed Snider Center for Enterprise and Markets
- Jim Allen, CFA Institute head of Americas capital markets policy
- James Burke, Community Bank of the Chesapeake president
- Dan Crowley, K&L Gates LLP partner
- Dino Falaschetti, U.S. House Committee on Financial Services chief economist
- Michael Faulkender, Smith School finance professor
- Traci Mach, Federal Reserve Board principal economist
- Andrew Sherman, Seyfarth & Shaw partner and Smith School adjunct professor
- Marc Sumerlin, Evenflow managing partner
- Phillip Swagel, UMD School of Public Policy professor and CFP fellow
- Russell Wermers, Smith School finance professor and Center for Financial Policy director
- Albert “Pete” Kyle, Smith School finance professor
Below are paraphrased comments from the participants. (Also read "Under President Trump: Six Questions on the Economy," a pre-event companion piece featuring participating Smith School faculty):
Mach: Small businesses (under 500 employees) are important to the U.S. economy. Net job growth comes from new businesses, which are disproportionately small. But formation of new firms and jobs created by those firms has not recovered to pre-financial crisis levels … Bigger firms are increasing their share of employment.
Large loans (greater than $1 million) recovered quickly after crisis. Smaller loans declined well into 2013, only now are ticking upward slowly. Small business optimism took an absolute nose-dive during recession, and is now climbing back to pre-recession levels.
Small businesses do not think it is a good time to expand. Government regulation has increased since the recession. Taxes are important. New legislation about small business should be based on better data based on better surveys … Controlling for pre-existing patterns, the small business lending program had no impact.
Agarwal: (Identifying the nuance of small business) Some firms are small, stay small and intend to stay small. Other young firms intend to grow… Some firms are non-tech and local; other firms are high-tech and intend to be national … On both sides of income distribution, marginal tax rates are so high that they incentivize people not to work. On the lower end of distribution, workers can lose 90-95-percent of marginal income. In families with one high-wage worker, the other becomes stay-at-home mom or dad even if highly skilled, benefitting their own children but not society as a whole.
Burke: Government needs to provide a stable and consistent environment so that small businesses face lower risks. Leadership is needed on both sides to incentivize small businesses to borrow more … Regulation increased over last eight years. Bankers subsequently have spent huge effort figuring out how to react to increased regulations. Many banks have abandoned particular lending segments because it is too complicated. Some banks getting out of business. Mergers have always been part of the banking business. And now, new banks are not being formed, so 25 percent of banks are gone as a result of consolidation … Banks have long been philanthropic local institutions, but they are going away. Reform is needed to provide a stable future for community banks to continue to exist … Banks have exited auto lending because of laws and regulations older than people in this room. This problem needs a regulatory fix.
Sherman: Internally, firms face barriers to innovation from red tape, layers of management, internal bureaucracy and intra-firm politics … Bringing down tax rates could spur M&A and angel investing. There are huge cash stockpiles on the sidelines and abroad -- maybe $3 trillion. A 10-percent tax (instead of current higher rates) could spur U.S. job creation … Workplace issues include health care benefits and Affordable Care Act regulations. These issues need to settle down so that employees do not worry about insuring 26-year-old children still at home. Trump’s policies are largely unknown, especially regarding technology issues like encryption … Trump is hard to predict and owes very few political favors. There are few lobbying firms that can claim to have connections with the new administration. This could make state lobbyists more important.
Faulkender: Tax repatriation holidays encourage corporations to keep capital overseas and wait for “the holiday.” Instead, we need long-term corporate tax reform. Cash “trapped” abroad is not physically trapped but only trapped in an accounting sense. Cash is in dollar assets. Apple can buy Pfizer bonds and vice versa; this will put the cash to work in the U.S. economy. Large multinationals recognize earnings in foreign countries to reduce taxes, but smaller domestic corporations pay the higher domestic tax rate. Mutual funds must disclose holdings if greater than $100 million, but corporations which hold billions are not subject to 13F filings. Tax holidays incentivize build-ups. We need to fix the “permanent problem.”
Worker Immigration Policy
Agarwal: A reverse brain drain is going on in the United States. Talented individuals originally from India are leaving the U.S. to go back to India. Pride and self-esteem are important. Reducing H1B visas (Trump has given mixed signals on this program that enables to U.S. firms to hire nonresidents for tech and other skilled positions) would tell students they are not welcome.
Mach: H1B visas are being cut back. Highly skilled workers going back to their home countries will reduce business activity here related to banks, credit unions and FinTech (software-based financial services)
Barriers to professional managers investing in small business and non-listed companies
Mach: There is less angel investing, and (investors) are coming in at later stages … Funding of small projects exists in real estate, but it has not transferred to rest of the small business space … (Responding to ‘Why did Mach’s optimism index turn down in 2014?’) Not clear. Sales expectations dropped off. Upcoming presidential elections lead to a drop-off. Firms expected a sales turnaround which did not happen.
Sherman: Private equity funds in general moved towards larger and later-stage investments. This has reduced access to startup capital. There is a gap in the market regarding investments in hundreds of small companies because monitoring and compliance infrastructure does not exist … The SBC (Senate Committee on Small Business and Entrepreneurship) tracks small business owners. Their survey results show that the uptick in consumer demand did not happen as anticipated.
Mach: The Securities Exchange Commission was slow to put forward rules for non-accredited equity investors after the JOBS (Jumpstart our Business Startups) Act. In the meantime, many states passed laws which relaxed regulations for at-home breweries and distilleries ... Real estate crowd funding is growing rapidly.
Sherman: It is not easy to be an equity platform because meeting requirements of the JOBS Act takes time.
New priorities and unfinished business for the SEC?
Allen: The CFA Institute surveyed members with an 18-percent response rate. Top issues were enforcement, cybersecurity and fiduciary duty. The CHOICE Act tries to redirect fiduciary duty issue to the SEC. The CFA thinks anyone called an “adviser” should be bound by the Investment Advisers Act.
Crowley: Policy has consequences. Over three decades, public policy killed broker business (fixed commissions). The Department of Labor tried unilaterally to extend regulation to investment advisers. This issue is at the top of the agenda. Fundamentally, the SEC is about protecting investors. The SEC gets into trouble as a macro-regulator of systemic risk … Regulation has reduced risk in the system. This is the goal of bank regulators. It should not be the goal of the SEC, which should facilitate risk taking and not be a macro- or micro-prudential regulator.
Should the SEC stick to its job [of investor protection] and leave macro-regulation to the FSOC (Financial Stability Oversight Council)?
Swagel: Around 2010, the idea of cooperation among regulators morphed into systemic risk, which is a red herring. It’s created new problems without solving anything.
Allen: The FSOC was designed to prevent the next AIG. Which regulator -- of banking or insurance -- was in a position to foresee that something was coming? Labeling non-banks as systemically important got several regulators involved: the FSOC, SEC, OFR, and Financial Stability Board (overseas).
Falaschetti: The FOMC was debating whether we were in a recession in 2008. What is the potential to regulate systemic risk when you could not see a recession, when the financial system was on fire?
Sumerlin: Central banks have outsourced macro-supervision too much to other agencies. You can see financial crises coming in advance, when credit expansion does not lead to GDP growth. This is an inherently macro problem. The 1978 Humphrey-Hawkins Full Employment Act says that the Fed should regulate aggregate credit growth in the economy. Problem is that the Fed took its eye off credit growth to pursue other objectives.
Crowley: The decision to exempt swaps in the year 2000 amplified expansion of credit through credit default swaps and made the credit crisis worse than it would have otherwise been. Despite Dodd-Frank, the problem of derivatives remains.
CHOICE Act: Does it have more bipartisan support than is commonly appreciated?
Falaschetti: Corporate governance is on the right side of the balance sheet. The CHOICE Act says if you are going to make bets, bet with your own money. Small banks can more easily comply with regulations than large banks. We heard this morning from Neel Kashkari (Minneapolis Fed chairman) about a capital requirement. You better get capital requirement right. If it is too high, the activity will be pushed out to somewhere else where it is not monitored. That is why it [10-percent capital requirement] is an election, not a requirement, in the CHOICE Act.
Allen: Dodd-Frank was motivated by the idea we were paying too much attention to credit-rating agencies in 2008.
Crowley: Seventy percent of U.S. capital formation occurs outside the banking system. We should not regulate all capital formation like banking. Congress made massive changes over 13 months, delegating many difficult issues to regulatory agencies. Regulators have been given great responsibilities and have taken on responsibilities not given to them
Falaschetti: Many Dodd-Frank policies were already on the shelf.
Does the election result imply a mandate concerning financial regulation?
Sumerlin: The center of power in government runs through the Midwest, with a mandate to make the lives of people in the Midwest better. The message here is ‘We need higher growth and we do not trust Wall Street.’ In this respect, tax reform is important for preventing outflow of capital and therefore attracting jobs back into the country. The Paul Ryan bill makes the tax system indifferent as to location of a company. You deduct sales overseas but pay tax on imports. There is definitely a political mandate to have more production in the U.S.
Swagel: If you tax imports and subsidize exports, this is neutral after exchange rate adjustments, but it may facilitate a move to consumption tax.
Falaschetti: After China came on line, many people there began to do better. Now 25 percent of world manufacturing occurs in China. This is great for consumers and horrible for competing manufacturing firms and workers. The U.S. has the lowest rate of labor force participation since the 1970s. Aging does not explain this. The 1970s had higher labor force participation even though people were on average 10 years younger. Our labor and welfare policies have not created a resilient labor force. Putting people on disability of other welfare programs does not incentivize people to get back into the workforce. We need policies that tell people, ‘If you get displaced, then you need a way back in.’
Crowley: The underlying political dynamic of Brexit is identical to the U.S. election result. This election was a vote about free market capitalism versus European style corporatism.
Swagel: (Disagreeing) Trump mimicked (Bernie) Sanders on many issues.
Does stock market reaction to the election suggest that election results can boost growth?
Sumerlin: Under Obama, loose monetary policy, neutral fiscal policy and tight regulatory policy netted next to nothing. After the initial stock market decline in the hours following the election result, Trump mentioned infrastructure but not tariffs. Maybe markets have given him a mandate [to pursue infrastructure]. Raw material prices, like copper, are up … The market thinks Trump will take infrastructure spending from Democrats and tax reform from Republicans. The pragmatic Trump takes the pragmatic ideas of both parties … The list of initial appointment candidates is a mixed bag of pragmatic Republicans and loyalists.
Crowley: Much of what Trump said during campaign is metaphor. For example, building a wall calls for more border enforcement. Voters took Trump seriously, not literally. Media took Trump literally, not seriously.
Question: Can a new type of economy, a new America, happen in the next few years so that it is seen as great?
Crowley: Growth requires investment confidence with functional regulation that prevents people from being defrauded. Markets, thus, are the most effective regulators.
Allen: Robo-advisers (electronic advice) affect CFA members. Robo-advisers will increase access to CFA-quality advice to a much broader spectrum of the economy. Problems can result from new technology not fitting into current regulatory structures. Fiduciary duties need to apply.
Crowley: The brokers who became investment advisers are not otherwise regulated by SROs (self-regulatory organizations). FinTech is either disruptive or productivity improvement on current processes.
Falaschetti: Independent monetary policy works better if the Fed does not have other regulatory things to do.
Sumerlin: Central bank is so big that it cannot get away from needing to stabilizing economy.
Faulkender: The Congressional Budget Office forecasts a $600 billion deficit, which will continue to climb. Trump seems to have taken entitlement reform off the table. Where do we go from here?
Swagel: Clinton had growth and welfare reform.
Kyle: The Clinton growth was likely based on a speculative bubble.
Crowley: National debt is $19 trillion, and we cannot pay it off. We need to grow rapidly to dwarf the debt, like a student investing in income growth to pay off student loans.
Sumerlin: We need to have faster economic growth and slow growth of entitlements, but entitlements are likely to be put off to later.
Sumerlin: The peso is still down 7 percent since Trump was elected because the President can opt out of NAFTA with one signature. Mexico’s supply chains are fully integrated into the U.S. economy. We have leverage because Trump has threatened to withdraw from NAFTA. We are familiar with border adjustments of VAT (Value Added Tax) rebates. Maybe the tariff is a metaphor, too, but there is a better way to do it. Trump exaggerated some things, like crime, which is up but not as much as Trump seemed to suggest.
Crowley: Trump is an internationalist, not globalist, because he has properties all over the world. Governments and regulators cannot stop globalization.
David Rennie’s Keynote Highlights
Why does the Economist believe in openness? There is a revolt against international trade and globalization but also against competition. You cannot be against globalization: China came back after a 200-year absence; this is a fact which you cannot be against.
Politicians do not know how to protect workers, so they accuse the other side of stealing the American (or British) dream. People in the (U.S.) Midwest or northern England demonize employers, or Margaret Thatcher, by accusing them of sending jobs away.
A common factor is an explosion of nostalgia remembering a U.S. which did not face competition after World War II. But between 1989 and 1999, the global stock of workers doubled. The balance of power between labor and capital shifted.
One world leader said, capitalism has become financial, directed at empty speculation. What is needed is for capitalism to be made moral again. The doctrine of corporatism—managed capitalism with paternalistic corporate leaders—started with the Pope in 1931.
Pro-Trump Americans talk about following rules and are opposed to people who do not abide by rules. Dig into some of this. Trump wants to keep talented foreigners in the country, but (Steve) Bannon (Trump’s chief strategist and senior counselor) thinks a country is more than an economy …This is European-style “Volk” nationalism rearing its head in the U.S. … People say that when voters are this angry, we should give them a bit of nationalism to calm them down. The idea that such homeopathic policies will help matters is wrong … If you give a homeopathic dose, it makes people feel that they are right. You also hear that the left needs to be more populist, that Bernie Sanders could have won. This would have been catastrophic policy but also bad politics.
Populism of the left is also bad politics because it will lose competition with the right. Left-wing fairness loses to right-wing safety, order and control. What is coming next is automation. This may destroy jobs more than globalization … What would the Midwestern women who does not believe in globalization think about automation?
The Economist cannot beat Donald Trump by out-promising him. We can only beat him by out-thinking him … Trump sounds more European than American. People have a need to believe that things will not become really, really bad. But be careful. Things might get really, really bad.