Why Business Leaders Remain Gloomy

The economy is healing, but these 10 worries threaten to keep the nation's bosses from hiring.

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If you're inclined toward optimism, there are certainly a few economic trends that will soothe your frontal lobe. The economy is growing again after a grueling recession that probably lasted close to two years. Massive government intervention has helped reeling banks get back on their feet. And a year-long stock market rally has helped investors rebuild battered portfolios.

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But business leaders aren't convinced that an enduring recovery is underway—and they're the ones who decide whether to start hiring again, which is the most important step back toward a healthy economy. At a recent conference sponsored by the nonprofit Milken Institute in Los Angeles, dozens of executives, financiers, economists, and entrepreneurs expressed deep skepticism about a recovery built largely on government spending and companies doing more with less. "The economy is bifurcated into a strong and recovered corporate sector, and a weak and beleaguered consumer sector," says banking analyst Meredith Whitney. While a few things are going right, the people paid to anticipate future risks still see a lot of them. Here are 10 top worries, in the words of business leaders themselves:

Job growth is anemic. Employers are finally adding more jobs than they eliminate, on average, but the pace of job growth is far below what it will take to absorb 15 million unemployed Americans. And there's a good chance it could take longer for jobs to return than after any other recession since the 1930s. "If you don't have job creation you're not going to have this economy really growing," says Marc Lasry, CEO of investing firm Avenue Capital Group. "This economy is so dependent on consumers that you need job growth."

Consumers are tapped out. Spending has risen more than expected so far this year, but incomes haven't kept up, which means consumers will probably put their wallets away before long. "The American consumer is toast," says economist Stephen Roach of Morgan Stanley. He predicts that consumer spending, which peaked at 71 percent of GDP a few years ago, will drift back down toward a historical norm of about 66 percent. And if consumer spending doesn't propel economic growth, it's not clear what will. "Consumers are shell-shocked," adds John Engler, CEO of the National Association of Manufacturers. "They're not going to lead us back."

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Housing is likely to stay depressed. The housing bust should finally end within a year or less, as prices in most cities stop falling. But foreclosures are still near record levels and it could be years before housing generates significant numbers of new jobs. "We're going to be bouncing along the bottom for awhile," says Donald Brownstein, CEO of investing firm Structured Portfolio Management. Once the housing market recovers, he expects prices to appreciate at about the rate of inflation, or a bit more. After past recessions, a strong housing market has typically been the catalyst that got the economy growing again. Not this time.

Small business is reeling. As politicians frequently point out, small businesses provide about 65 percent of the new jobs in America. But they're suffocating from lack of credit and closing at record rates. "The credit markets for larger companies are fully functioning, but for smaller ones they're not," says Ron Bloom, the Treasury Department's "jobs czar." Healthcare reform and other new regulations from Washington are further spooking small businesses and making them reluctant to hire.

Banks are still in trouble. Despite record profits at a few big firms, banking analyst Whitney believes many banks still have major amounts of bad loans they haven't accounted for yet. "They're just not dealing with their problem loans," she says. "It's a question of when these banks take the losses." And new regulations from Washington, while likely to create a more stable financial system, could also make banks less profitable, which means it will take longer to recover losses from bad loans. Americans don't sympathize with banks losing money, but as long as banks are struggling, they'll withhold the credit that's vital to economic growth.

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Unemployment could become self-perpetuating. If high unemployment persists, it could further threaten fragile parts of the economy, since people out of work tend to default on loans and mortgages and run out of money to spend. That could depress consumer spending and the housing market, and add to bank losses "If we have 9 or 10 percent unemployment next year we're locking ourselves into a structural morass," warns Ken Griffin, CEO of the hedge fund Citadel Investment Group.

Commercial real estate is still tumbling. Losses in commercial real estate haven't been as dire as some predictions, but falling values for retail space and office and apartment buildings have still left hundreds of banks with billions in loans likely to go bad. That could get worse as interest rates start to rise, which could trigger defaults by many commercial borrowers unable to refinance. "When rates go up we'll see significant losses taken," says David Simon, CEO of Simon Property Group, which owns more than 300 malls and other properties. Those losses won't hit consumers directly, but they'll hit banks—which is one big reason they're sitting on money instead of lending it.

The economy is too dependent on the government. It's easy to forget that a huge chunk of the economy is functioning only because of government intervention. The insolvent housing agencies Fannie Mae and Freddie Mac, under federal conservatorship, back nearly 90 percent of all new mortgages, with a major assist from the Federal Reserve. The $787 billion stimulus program is a big reason why GDP has stopped falling and started growing. And government is one of just two sectors that have added jobs over the last two years. The government largesse eventually has to end, and strapped state and local governments could become job killers as they struggle with huge deficits and cut staff. "The government can't fix it all," says Patrik Edsparr, a top executive at Citadel Investment Group. "The question is can you phase it out without wrecking the whole house of cards."

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Washington is dysfunctional. Business leaders in general are appalled by the profligate spending of the federal government, which many believe is becoming a full-blown national crisis—while Republicans and Democrats dicker over blame. "What worries me most is that a $10 trillion debt is unsustainable and the two parties are completely divided," says economist Nouriel Roubini of New York University's Stern School of Business. "Runaway fiscal deficits lead to high inflation. And there's no willingness in Washington to do anything."

No part of the economy is hot. Usually after a recession, there's rapid growth in one or two key sectors of the economy, which helps drag all the others out of the dumps. But this time, housing is moribund, growth in consumer spending seems unsustainable, and credit, the lifeblood of capitalism, remains scarce. "We all feel better, but what is driving the U.S. economy over the next two years other than the stimulus package?" wonders Marc Lasry. When the answer becomes clear, business leaders will start to cheer up.