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Is Washington Stifling Recovery?

Economist says ‘policy risk’ is the chief obstacle holding back U.S. businesses.

Uncertainty over future tax burdens and the availability of credit is driving U.S. businesses to hoard cash rather than lead the economic recovery, according to a real estate economist.

The private sector has squirreled away trillions of dollars that could revitalize the economy, but businesses are reluctant to spend money they may need for operating capital or to pay taxes, says Dr. Mark Dotzour, chief economist at the Real Estate Center at Texas A&M University.

“We are used to thinking of the federal government as the solution to these problems for economic growth, and it has rapidly become the source of the problem because of the uncertainty that it has created for business people,” says Dotzour, who addressed the CCIM Central Texas chapter on Feb. 23 in Austin.

Call to action

Dotzour is begging audiences to demand more results from lawmakers in fixing the financial system and easing concerns that are holding back the economy.

The threat of tax hikes is a huge source of anxiety in the business community, particularly at a time when the economy is so fragile. The Obama administration's 2011 budget proposal would allow the 2001 and 2003 Bush tax cuts to expire for high-income families and individuals. Another provision to raise the capital gains tax rate from 15% to 20% would reduce initial returns on investments in commercial real estate, Dotzour says.

A higher capital gains tax would lower the price an investor can pay for commercial real estate and further depress asset values, Dotzour says. That prospect will discourage acquisitions by investors who feel they may get better deals later under a revised tax code.

Dotzour draws a parallel to the Tax Reform Act of 1986, which removed tax breaks by taxing all capital gains at the higher rates imposed on ordinary income. “What happened to the value of real estate? It dropped about 40%, and 3,000 financial institutions went out of business.”

The possibility of rising energy costs as a result of proposed cap and trade legislation, plus the uncertain outcome of the health care debate, also weigh on the minds of business owners and entrepreneurs. Dotzour warns that rising costs will stifle economic growth just as tight credit and tax hikes by President Herbert Hoover's administration in 1932 fueled the Great Depression.

The federal government's bank bailouts and $787 billion stimulus package have propped up ailing financial institutions and state governments without doing enough to correct underlying problems that led to the credit crunch and banking crisis, Dotzour contends.

By allowing banks to extend loan maturities rather than realize losses on bad loans, the federal government is delaying inevitable write-downs, he says. Until those debts are cleared out, credit will remain inaccessible to many small businesses.

Dotzour criticizes a decision by the Financial Accounting Standards Board (FASB) that redefined fair market value under FASB Statement No. 157 to reflect an owner's asking price, rather than what a willing buyer would pay for a real estate asset. That practice enables banks to avoid write-downs on loans that would otherwise be deemed underwater, he says.

He compares the practice of extending bad loans at U.S. banks to the Japanese government's policies from 1992 through 2002 that allowed banks to keep non-performing loans on their books, which mired bank balance sheets and crippled that nation's economic growth for more than a decade.

Different perspectives

Another presenter at the Austin CCIM conference took a more reserved view of Washington's approach to bad real estate loans. In a presentation on the capital markets, Phil Capron, president of Austin-based real estate investment firm Falcon Southwest, agreed that the federal government is “supporting the fiction of minimal loan problems.”

By allowing banks to extend loans, however, government regulators are enabling banks to write off bad debts a little each year and work through their problems gradually, Capron said.

One economist in particular believes that the criticisms leveled by Dotzour against the federal government's response to the recession are too harsh. “I certainly agree that policy uncertainty has contributed to business indecision, but we would be in so much worse shape without the extraordinary steps the government has taken to date,” says Josh Scoville, director of strategic research at Boston-based Property & Portfolio Research. “I'll take the indecision over the alternative.”

Dotzour sees an even greater source of uncertainty in the looming fiscal crisis for state and local governments that have relied on federal stimulus dollars to help balance their 2010 budgets rather than cut programs and staffing.

With major indices showing commercial real estate values down by 40% or more from their peak in 2007, tax appraisal rolls must soon realize a massive decline in the tax base that funds everything from state government to schools.“That is the biggest threat to a double-dip recession,” Dotzour says. “Government entities from the states on down are going to have to lay people off to balance their budgets.”

The positives are that consumers are paying off debt, corporate profits and shareholder earnings are on the rise, and businesses have cut spending, he adds.

Dotzour's presentation struck a chord with Tim Hendricks, senior vice president in the Austin office of Atlanta-based Cousins Properties (NYSE: CUZ). Hendricks says the Resolution Trust Corp. in 1989 enabled the banking sector to deal with bad real estate loans and resume lending.

“The RTC dealt with flushing through those buildings, and we're going to need to do something similar to that this time around,” says Hendricks, who was among the more than 200 real estate professionals gathered in Austin. “The Feds are going to have to make that happen and make the banks work through their problems.”

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