Regulatory uncertainty is a significant factor in the slow recovery from the recession. Once-in-a-generation changes are being made in the regulations governing the health care, financial services, energy and communications industries, which collectively account for a substantial percentage of GDP. Congress also must address the imminent expiration of the Bush tax cuts; probably after the November elections.
At the same time, a sluggish economic recovery is underway, marked by low levels of corporate investment despite the lowest borrowing costs in a half-century. Enterprises are reluctant to invest because they cannot predict the changes in business models, staffing and infrastructure that will be necessary to respond to the regulatory incentives and disincentives government will adopt. Two examples illustrate the problem.
Financial Services: To implement the massive reform legislation, federal regulatory agencies must issue hundreds of rules that will determine how financial institutions may operate. Treasury hopes to release by year's end a list of agency priorities and a schedule for rulemakings that will span several years. This long regulatory cycle will slow new investments.
This sweeping legislation already has had unintended consequences. For example, a minor change in the law made ratings agencies subject to suit when they lend their opinions to bond issuers introducing new products. In response, the ratings agencies prohibited clients from using their opinions in SEC registration documents. As a result, the market for securitizing car loans and consumer loans shut down. The SEC was forced to suspend its rule requiring underwriters to include credit ratings in prospectuses. The uncertainty regarding use of these ratings also has delayed indefinitely the government's imposition of enhanced risk-based capital standards on smaller banks.
Communications: To encourage Internet Service Providers (ISPs) to invest in broadband infrastructure, the Bush FCC classified DSL services as "information services," which subjected them to a lesser degree of regulation than would treatment as "telecommunications services," a regulatory regime originally designed for natural monopolies such as the old AT&T. The Obama FCC wants to impose "net neutrality" rules that would prevent ISPs from discriminating against customers in the priority and speed of service. Stung by court decisions limiting its legal authority over information services, the FCC reacted by proposing to reclassify broadband as a telecommunications service, which would subject it to more intrusive regulatory controls. Opponents object that reclassification would deter many billions of dollars in new investment. To break this impasse, after extensive negotiations leading antagonists Google and Verizon agreed on their own framework to prevent discrimination, under which ISPs could not block content producers or offer them a "fast lane" (paid prioritization). Cellphone networks, however, would be excluded from this framework. Announcement of this private sector alternative likely will force Congress to intervene and solve the problem by legislation. Investments will be deterred until Congress can settle this holy war over the principles governing the Internet.
Political and financial markets operate to their own rhythms. Unfortunately, the cycle of the regulatory process currently is creating disincentives to investments that could accelerate recovery from the recession.
John F. Cooney is a partner in the Washington, D.C., office of Venable.