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Post-subprime economy means subpar growth as new normal in U.S.


A normal U.S. economy is likely to look a lot different, and worse, after the credit crisis is over and financial markets settle down.

Companies will continue to struggle to raise cash for expansion and innovation as investors and lenders remain focused on conserving capital. Workers, too, may have less flexibility to go after new opportunities, because many will be stuck where they are -- in homes worth less than the balances on their mortgages.

``Once you've made terrible, overly optimistic errors, that paralyzes you for some time,'' says economist Paul Samuelson, a Nobel laureate.

The bottom line: The U.S. may have to get used to a new definition of normal, characterized by weaker productivity gains, slower economic growth, higher unemployment and a diminished financial-services industry.

Long-term growth in the U.S. may drop to 2 percent to 2.5 percent a year from the 3 percent rate of the last 15 years, according to Peter Hooper, chief U.S. economist at Deutsche Bank Securities in New York and a former Federal Reserve official.

Even after markets recover, ``the cost of risk capital is likely to be significantly higher than during the credit bubble,'' he says.

A record three-quarters of U.S. banks the Fed surveyed in April said they were charging corporate borrowers a higher premium over what the lenders pay for funds. More than half reported tightening lending standards.

Credit Losses

Behind the stricter terms: loans and investments made during the credit boom that went sour. Banks and financial institutions worldwide have racked up more than $340 billion in credit losses and asset writedowns since the start of 2007. David Rubenstein, chairman of the Washington-based private- equity firm Carlyle Group, says there's more to come, telling reporters May 12 that ``enormous losses'' have yet to be recognized.

``Credit conditions are more likely to tighten further in the near term than to ease,'' says Andrew Tilton, an economist at Goldman Sachs Group Inc. in New York.

Citigroup Inc. Chief Executive Officer Vikram Pandit told shareholders May 9 he plans to get rid of about $400 billion of assets during the next three years after the biggest U.S. bank lost $5.1 billion in the first quarter.

High-Yield Bonds

Companies also face a tougher borrowing environment in the bond market. The spread investors charge over Treasury securities for high-yield bonds has narrowed since the height of the credit crisis in mid-March. Still, at 663 basis points, it's well above the 495-point average since 1985.

And it's likely to remain higher, says John Lonski, chief economist at Moody's Investors Service Inc. in New York. He sees the spread averaging about 600 basis points next year.

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Companies are also issuing fewer high-yield bonds, and Lonski forecasts a drop of more than 40 percent this year, to $80 billion. ``Next year, we'd do very well to reach $100 billion,'' he says. In 2006, before the onset of the credit crisis, more than $150 billion in new junk bonds were sold.

Equity capital is also harder to come by. Initial public offerings for fledgling businesses fell to the lowest level in almost five years in the first quarter, the National Venture Capital Association reported.

``There are an awful lot of firms who are having trouble fundraising, no doubt about it,'' says Mark Heesen, president of the Arlington, Virginia-based association.

Scrapped IPO

Medical-technology company Emphasys Medical Inc. last week scrapped a planned initial public offering of as much as $86.25 million. The Redwood City, California-based company blamed ``market conditions.''

Less risk-taking can mean a less-vibrant economy, says Samuelson, 93, an emeritus professor at the Massachusetts Institute of Technology in Cambridge, Massachusetts. ``What you could lose are some new ideas that would otherwise get to be practical and get their chance,'' he says.

Even well-established companies may have a hard time retrenching. Wall Street analysts say General Electric Co. Chief Executive Officer Jeffrey Immelt might have difficulty selling slow-growing financial-services assets, including GE's credit-card unit. The Fairfield, Connecticut-based company might even sell its century-old appliance business.

Credit-Crisis Fallout

Workers too are feeling the fallout from the credit crisis. The share of respondents in a May 1-8 Bloomberg/Los Angeles Times poll who described themselves as financially secure fell to the lowest level since 1992.

The declining value of houses -- the biggest asset for many Americans -- has a lot to do with their pessimism. The median price for a single-family home fell 7.7 percent in the first quarter, the biggest drop in at least 29 years, according to the National Association of Realtors.

Zoltan Pozsar, senior economist at Moody's Economy.com in West Chester, Pennsylvania, reckons that about 8.5 million homeowners -- roughly 11 percent of the total -- owed more on their mortgages than their homes were worth in the first quarter. He forecasts that the number of people in this predicament will rise to more than 12 million next year.

The depressed housing market may keep some workers from pulling up stakes to pursue new employment. ``Many times, job candidates are willing to talk to you about an opening,'' says Sally Stetson, co-founder of Salveson Stetson Group, an executive-search firm in Radnor, Pennsylvania. ``But then reality sets in as they look at their home price and they pull back.''

Americans' Mobility

A less-mobile labor force may be a less-productive one. Economic studies suggest mobility has been a key reason productivity has increased faster in the U.S. than in Europe during the last 15 years, says Martin Baily, senior fellow at the Brookings Institution in Washington and a former chief White House economist.

Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University in New York, says the nation is ``in the grip of some structural forces that are moving the economy permanently to a lower level of economic activity, with an unemployment rate somewhere between 5 and 6 percent.'' Unemployment in April was 5 percent.

The financial-services industry is particularly hard-hit. The world's biggest banks and securities firms have cut at least 50,000 jobs in the past year, with more to come.

Thomas Philippon, a professor at New York University, says his work suggests the industry's wage costs are about 10 percent too high after the credit bubble. If the excess were all recouped through job cuts, it would imply an additional reduction of more than half a million.

``The financial engine is a major source of increased productivity and growth,'' says Allen Sinai, chief economist at Decision Economics in New York. ``As it consolidates, we'll be looking at a stagnant U.S. economy for a while.'' (Bloomberg)

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