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A Modest Agenda for a New GOP Congress

What the Republicans could do with a majority that would give certainty to businesses, calm the markets, and reignite the economy.

by
David H. Horwich

Bio

October 27, 2010 - 12:00 am

Let’s engage in some thought experiments. November 2 is less than a week away. The GOP is widely expected to take over control of the House of Representatives and has a decent chance at winning over the Senate. What might happen to the economy when this occurs?

The economy, while unemployment is way up, is not in a complete shambles. There is business activity underway. In the wake of the financial meltdown in 2008, most companies that survived have restructured and become, if not as profitable as they had been, at least are hanging in there.

Consumers, while having new-found thriftiness thrust on them, are beginning to spend discretionary income. Part of our practice follows the restaurant business and we’ve noted that much of the casual sector is beginning to show a bottoming out of same store sales over last year (coming, of course, from a very low base), and in some cases, seeing improvements, suggesting that consumers are loosening up a little bit.

Money center banks have recapitalized to shore up balance sheets following the mortgage meltdown. Most large lenders have raised fresh, albeit dilutive, equity over the past couple of years and have repaid TARP money taken down in late 2008. There is a current crisis in foreclosures that will further threaten profitability, but it is reasonable to believe that most banking institutions have adequately, if not over-reserved for bad loans in both residential and commercial real estate loan assets.

If there is a dark and unknown cloud on the horizon, it is that the other shoe hasn’t yet dropped in commercial real estate; look around you: there are plenty of boarded up storefronts begging for tenants. On a tony street near where I live, over 20% of the retail space is looking for new tenants. Many commercial loans are coming due over the next several years and lenders don’t have significant leeway to renegotiate these loans without an infusion of fresh equity that isn’t likely to happen. There is credit available for businesses, but it is credit that will be available only if it is secured by solid collateral.

Uncertainty is the biggest drag on the economy: Uncertainty with taxes, uncertainty with cap-and-trade costs, uncertainty due to Obamacare costs and regulations and general uncertainty surrounding an administration that seems hell-bent on punishing success and imposing costs and regulations on businesses of every size. This is what’s really harming employment decisions: after all, why should a business owner, making hard-nosed business decisions, want to hire without knowing what it will cost? Moreover, there is equity and quasi-equity capital to fund growth, but it will be on strike until the political class provides consistency and clarity.

What should the GOP do if it is able to capture one or both of the Houses of Congress in November’s election?  I’ve laid out a case by saying that many fundamentals of the economy seem to be in battered but sound shape, and that there are basic policies a new Congress will need to put in place to help the economy begin to grow in a more robust fashion.

First things first: policymakers will need to create an environment in which businesses can operate with certainty that the rules aren’t (a) either ill or undefined, and, (b) subject to massive sweeping change (e.g., tax increases and cap-and-trade), and, secondly, roll back spending at the Federal level. Several other things can also be done that will help as well: Obamacare must be repealed (although little support will come from the administration) and market-based solutions should be enacted. Furthermore, signals to the states that no more bailouts are forthcoming will force states to confront their giant funding problems.

Congress can’t force the Fed to take anti-inflationary action or curtail dramatic quantitative easing (e.g., running the printing presses) or buying bonds (a direct violation of an independent charter), but it must force accountability rules on the Fed (audits, etc.) and bring about more transparency.

If the lame duck Congress doesn’t address it, HR1 should be an extension of the Bush tax cuts for at least another five years, if not permanently. Penalizing success has become a great left-wing standby that the polity rejected years ago as antithetical to realization of the great American dream. As JFK, Reagan, Bush 2 and countless countries around the world have understood, low tax rates promote capital formation, investment, and, ultimately, jobs. Assurance of a continuation of low tax rates will rapidly grow Federal and individual state tax revenues from higher overall incomes, consumption and investment. In the long run, Congress should consider a complete overhaul of the tax system to a flat tax.

Furthermore, Congress would do a world of good by examining the overwhelming volumes of regulations that every business operates in. Countless examples of ludicrous hoop-jumping exist in the real world that have cost, profitability and, at the end of the day, employment consequences. In my world (corporate finance), it would be very useful for Congress to re-examine the several thousand page Dodd-Frank legislation and roll back provisions that don’t add any meaningful protections to consumers. For example, my firm generally markets financial instruments or M&A transactions to institutions or corporate investors and holds no individual retail accounts, yet we are subject, generally speaking, to operating as if we did hold retail client assets.

Finally, the liberal establishment of significant additional regulation and cost (I’m thinking, particularly, of cap-and-trade) without any demonstrable or tangible benefit to society or the environment should be scrapped. Any bill that is pending in either the House or the Senate should be proactively killed to clear the field for business to operate.

The size of the national debt is so large and staggering that it defies the ability to get one’s mind around it. It is exceedingly destructive to both the national economy and to current, and future, citizens’ well-being. To say that we’re spending now to pass on to our children and grandchildren understates the case by many factors. In just the past two years, the deficit run up by the Obama administration exceeds the national debt run up cumulatively over the preceding history of the United States.

Clearly, this can’t continue.

With interest rates being held low by the Fed (Treasury Bonds are at 2.5%), the size of the debt masks the future destructiveness of more “normalized” interest rates required to service the debt. Imagine if rates for 10 year Treasury bonds were trading closer to 6%, the eyeballed average of the bellwether for the past 45 years; more to the point, imagine if rates were closer to 12%, where they were during the destructive Carter inflation years and a more likely scenario should the Fed resort, again, to turning the printing presses on full-steam. The catastrophe would be enormo — and immediate.

One of the best things I have heard from putative Speaker John Boehner is that he intends to roll spending back to 2008 levels and also to pass smaller (e.g., not omnibus) budgets for individual departments. He also intends to introduce sunset provisions for every new legislation or department to ensure regular examination. If successful, this should lead to limited additional deficits and perhaps even a reduction in the size of the Federal government. We can’t hope too much for the last.

If Congress is successful in rolling back spending and limiting further growth insofar as the national debt is concerned, and, if Congress succeeds in extending the existing tax rates, several good things can happen. While the national debt is staggering and unwieldy, growth in the economy can provide the ability to retire the debt over a lengthy period of time. It would be a very good idea for Congress to mandate 30-year notes be floated after imposing discipline on spending (providing confidence to the bond markets that inflation won’t eat away at the principal value).

Furthermore, a signal is sent when additional outrageous deficit spending is curtailed as helping the value of the dollar in the currency markets. Contrary to a misguided trade policy that favors a weak dollar to improve the ability to export, a strong dollar provides worldwide confidence in trade and interrelated economies.

Finally, clearing away cost and regulations and taxation at all levels will dramatically improve the employment situation, creating jobs and adding to wealth, incomes and tax revenues.

In the long run, there are many other policies that a serious Congress will need to deal with, such as entitlements (Social Security and Medicare, to start); far too powerful government worker unions that have too much influence on policy; clearing out entrenched bureaucracies; market-based education policies that push decision-making to local levels; enacting constitutional amendments that subject elected officials to the same programs, rules and regulations that the rest of us out here in the hinterlands must live with.

And, I’m sure, readers here can think of a few of their favorite outrages to add.

David H. Horwich is a managing director at the investment banking firm of PGP Capital Advisors, LLC in Los Angeles.
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