The shift in power in Washington D.C. is likely to have more adverse effects on businesses than positive ones as the economy continues to struggle, according to panelists at the annual Southeastern Venture Conference Thursday.

Former Maryland Gov. Robert Ehrlich called last year's election a "major realignment." He said that while there are some pro-business Democrats in Congress, chairmanships of the major committees went to veteran, more liberal legislators. "We're certainly seeing the effects of that in both the debates and the politics," he noted.

He also pointed to President Barack Obama's recent economic address to Congress. Ehrlich said major trends in the speech focused on health, energy and education policy. "Those are important issues," he said, but there was no talk about bailouts, credit markets, investors, TARP or "the central causes of the downturn and what we're going to do about it. Those aren't the priorities on Capitol Hill and with the executive branch."

Ehrlich said the political change contains five key elements that affect business:

•    Policy initiatives that will lead to higher taxes. "History shows that raising taxes during a recession is likely to prolong the downturn," he noted.
•    More government regulation.
•    Tort law, where "the tort lawyers are in charge of the committees now" in Congress.
•    Capital formation, which remains difficult during the credit market freeze.
•    Workforce development.

Who will be the winners and losers in the new landscape? Ehrlich said, "In this type scenario, investors typically lose and depositors typically win."

Rich Karlgaard, publisher of Forbes Magazine, drew parallels between the current political environment and the late 1970s. "It wasn't pretty, but somehow we got through that."

He added that not many people realize the 1970s were "the most fertile decade this century for startups:" Companies such as Southwest Airlines, FedEx, Microsoft, Apple and Oracle launched during that decade. "In bad times, the best and brightest are not getting Wall Street jobs - they're entrepreneurs," he said. "This could be a really great time to be an entrepreneur.

Additional highlights of the panel:

Regulatory policy
 
Mark-to-market accounting rules are adding to the problem, Karlgaard said. He called on the Obama administration to rollback the rules, saying such a move could push up the stock market's value by 20 to 30 percent in a short period of time. "We should make it a disclosure item rather than a regulatory club," he said. "It's forcing banks to sell assets at distressed prices to keep their capital levels up." He added banks "are actually in better shape" than they appear to be because of mark-to-market rules.

He said several regulatory policies deepened the economic crisis. Most of his criticism focused on mark-to-market, which President Franklin Roosevelt "got rid of in 1938." He said the "SEC is not enforcing its own short-selling rules." Overall, regulators have "tilted the playing field to favor short-sellers," Karlgaard added.

David Wyss, chief economist at Standard & Poor's, said he is not optimistic about the short-term financial outlook but he believes the long-term outlook is favorable. Whenever there is a major crisis, more regulation follows, Wyss said, pointing to the Great Depression of the 1930s and the 1970s' recession. "When markets fail - and this was a market failure - there is a swing to more regulation, followed by things slowly getting back into balance."

The stimulus package

Wyss said he is not as concerned about the impact of higher income taxes as he is about the coming funding deficits in Social Security and Medicare. "The government has made promises to people that exceed the amount of taxes available to pay them," he said. The $2 trillion in higher budget and stimulus spending "is a rounding error" compared to the challenges coming in five to 10 years when baby boomers retire. "How will we pay for that on top of the new spending?"

Economists generally agree that stimulus spending needs to be "timely, temporary and targeted." Wyss said. He said the first goal has been reached but the other criteria "have been forgotten." For example, the stimulus package includes increases to Medical and No Child Left Behind that will continue beyond the current economic situation. Most of the stimulus spending "is not aiding the sectors that are in the most trouble," he added.

Will the stimulus package lead the U.S. out of the recession? "I doubt it," said Dr. Thomas Boston, an economist at Georgia Tech. "But it should slow the tailspin and hopefully help us find the bottom. Only when we get to the bottom can we figure out how to come back."

Ehrlich said much of the spending now taking place "is not about stimulating the economy at all. The process is more like appropriations on steroids that spending to stimulate the economy of our country."

Boston said the recent election indicates "people felt things need to be managed better than they were. Now there is concern that things may be over-managed - and in some ways, they are."

He added, "If problems can be solved by markets, they should be." Government intervention is generally the least effective solution and should only be applied in certain situations on a temporary basis. Boston added the government has been "throwing tax money at the problems. And when there are no improvements, they just throw more money at it."

Karlgaard said the first step towards economic improvement is resolving the mortgage crisis. "There will be no recovery until the financial institutions recover," he said. Changing regulatory practices is also key to "unclogging the banking system. Banks - just like individuals - are not going to increase lending if they don't think the person can pay it back." He said Treasury Secretary Timothy Geithner "is such a poor communicator that we can't tell if he's telling the truth about whether nationalizing the banks is under consideration."

Boston agreed the banking outlook is tied to the general economic situation. "Nobody is going to be lending money if they don't think they'll get it back."Wyss added, "Banks don't make money by lending money; they make money by getting loans paid back."

What's next?

Wyss said resolving the banking crisis requires two main thrusts: address capital shortages and stabilizing the mortgage market. He said the real issue with mortgages is not that they are being repackaged into securities: it is homeowners with multiple mortgages on the same property. "When there are two mortgage holders, they are having problems getting the second lien holder to agree to modify the mortgage terms." Since the primary mortgage holder will not modify those terms unless the second one goes along, "you end up with bankruptcy being the only solution." Wyss said S&P estimates there are four million mortgages in the country that need to be modified so people can keep their homes, "and most of those have a second mortgage." He added there are only 634 bankruptcy judges: "who is going to hear those four million cases?"

Wyss agreed that many of the banking problems "are caused by regulatory policy. Mark-to-market is a stupid rule." He also asked, "What sense does it make to convert (government-owned) preferred stock into common stock? No cash is added to the bank" if that occurs.

Asked about the crisis' roots in the housing downturn, Wyss said, "As far back as 2005 I was writing that we had a housing bubble." He said the problem began with low rates around the globe, which encouraged home investments and helped drive up prices.  In the United States, housing prices rose 72 percent during that time; in the United Kingdom, 155 percent. Fannie Mae and Freddie Mac pulled back from the subprime mortgage market, so private institutions stepped in." Mortgage fraud and easy credit also fueled the bubble, he added.

Overall, the panelists said they feel optimist about the economy's long-term prospects - but the short-term outlook is not positive. 



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