U.S. may face years of sluggish economic growth

Across the economy, this reduced appetite for risk may take its toll. From consumers who binged on houses thinking values would only rise to financial institutions that gambled on hopelessly complicated products, investors badly underestimated risk in the pre-crisis years. New government regulations should provide greater stability and safety, but at a potential cost in lost opportunities. It's as if Uncle Sam were moving the nation's portfolio from a riskier, growth-oriented mutual fund to the money market.

Changing focus

Finally, human and financial resources are being reallocated across the economy. A nation that had too many investment bankers and mortgage brokers now must switch focus to other endeavors. Resources will stand idle while that process plays out, further constraining the economy's potential. And eventually, the tax bill to pay for the enormous government borrowing used to battle the crisis will come due.

"I expect slow growth for five to seven years. There will be years of subpar growth, maybe even years of zero to negative growth," Rogoff says.

Thursday's stress-test results will require several major banks, including Bank of America, to raise tens of billions of dollars in new capital. Investors were cheered by test results they interpreted as more positive than originally expected. But there still may be bad news lurking in the financial system. The IMF's recent Global Financial Stability Report said U.S. banks required between $275 billion and $500 billion in new capital — far more than the stress-test conclusion that $75 billion is needed.

The financial system that emerges from the crisis will little resemble the one that caused it. There will be more government regulation, less use of debt, reduced net flows of money across borders and perhaps even smaller institutions. The IMF says "far-reaching changes in the shape and functioning of financial markets" will be required to provide protection against a repeat crisis.

"It will look substantially different. All types of securities markets will be a lot more regulated and less vibrant. … The trade-off will be fewer crises," said Menzie Chinn, associate director of the Robert M. LaFollette School of Public Affairs at the University of Wisconsin.

One area likely to be especially heavily affected: the so-called shadow banking system of hedge funds, investment banks and other non-bank vehicles that held assets worth roughly $10 trillion in 2007 — as much as the traditional banking industry — yet was almost wholly unregulated.

Already, the nation's investment banks have morphed into plain-vanilla banks to obtain government guarantees and protection. New regulations on the national and global level will further limit running room for financial innovators in the years to come, economists say.

But not all the changes will necessarily hurt prospects for growth.

Much of the fancy financial engineering of recent years, which produced difficult-to-fathom products such as collateralized debt obligations and credit default swaps, actually had little impact on productive investment in the bricks-and-mortar part of the economy.

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