Greenspan Goes Conceptual
The markets braced for a busy -- and eventful -- series of speeches and testimony from Federal Reserve Chairman Alan Greenspan last week, and they weren't disappointed.
In his Feb. 24 testimony before a Senate panel, Greenspan offered unusually pointed criticism of government-sponsored enterprises like Fannie Mae and Freddie Mac -- and made a forceful call for a regulatory overhaul of the mortgage-finance giants. Testifying before a House committee on Feb. 25, the central banker took aim at another big target, issuing a blunt warning about the need to reform Social Security and Medicare -- in an election year, no less.
Here, BusinessWeek Online features highlights from each of the chairman's appearances during the week -- and gets behind the "Greenspeak" with the help of experts from Standard & Poor's and economic research outfit Informa Global Markets.
Friday, Feb. 27
Greenspan spoke at the Stanford Institute for Economic Policy Research Economic Summit.
What he said: "In recent decades, for example, the fraction of the total output of our economy that is essentially conceptual rather than physical has been rising. This trend has, of necessity, shifted the emphasis in asset valuation from physical property to intellectual property and to the legal rights inherent in intellectual property. Though the shift may appear glacial, its impact on legal and economic risk is beginning to be felt....
"It is, thus, no surprise that as a result of the increasing conceptualization of our GDP over the decades, the protection of intellectual property has become an important element in the ongoing deliberations of both economists and jurists....
"Of particular current relevance to our economy overall is the application of property right protection to information technology.... Dramatic gains in information technology have markedly improved the ability of businesses to identify and address incipient economic imbalances before they inflict significant damage. These gains reflect new advances in both the physical and the conceptual realms. It is imperative to find the appropriate intellectual property regime for each....
"If our objective is to maximize economic growth, are we striking the right balance in our protection of intellectual property rights? Are the protections sufficiently broad to encourage innovation, but not so broad as to shut down follow-on innovation?....
"If the form of protection afforded to intellectual property rights affects economic growth, it must do so by increasing the underlying pace of output per labor hour, our measure of productivity growth. Ideas are at the center of productivity growth....
"Understanding the interplay of ideas and economic growth should be an area of active economic analysis, which for so many generations has focused mainly on physical things. This work will not be easy.... We must begin the important work of developing a framework capable of analyzing the growth of an economy increasingly dominated by conceptual products."
What it means: When Greenspan isn't discussing economic policy from the perspective of a central banker, one of his favorite topics is intellectual property rights. He was early to note the increasing "conceptualization" of U.S. GDP -- the degree to which economic output is driven by intellectual, rather than physical, capital.
The Fed chairman also continues to stress the need to find the "appropriate intellectual property regime" to protect both physical and conceptual capital. This is especially important in the technology sector, as escalating patent disputes in key segments stand to get settled in courtrooms rather than by policymakers.
What he didn't say: Greenspan's discussion of the framework of intellectual property protection appeared to be kept within the confines of the U.S. and its trading partners. However, in this speech, he didn't tackle the challenges of combating persistent intellectual property problems, such as piracy (i.e., software, recorded media) and patent infringement, that originate overseas. Wednesday, Feb. 25
Greenspan testified before the House Budget Committee.
What he said: "The most recent indicators suggest that the economy is off to a strong start in 2004, and prospects for sustaining the expansion in the period ahead are good.... At the same time, increases in efficiency and a significant level of underutilized resources should help keep a lid on inflation....
"This favorable short-term outlook for the U.S. economy, however, is playing out against a backdrop of growing concern about the prospects for the federal budget.... According to the latest projections from the Administration and the Congressional Budget Office (CBO), if current policies remain in place, the budget will stay in deficit for some time....
"The ratio of federal debt held by the public to GDP has already stopped falling and has even edged up in the past couple of years -- implying a worsening of the starting point from which policymakers will have to address the adverse budgetary implications of an aging population and rising health-care costs....
"In 2008 -- just four years from now -- the first cohort of the baby-boom generation will reach 62, the earliest age at which Social Security retirement benefits may be claimed and the age at which about half of prospective beneficiaries choose to retire; in 2011, these individuals will reach 65 and will thus be eligible for Medicare.... This dramatic demographic change is certain to place enormous demands on our nation's resources -- demands we almost surely will be unable to meet unless action is taken. For a variety of reasons, that action is better taken as soon as possible.
"The degree of uncertainty about whether future resources will be adequate to meet our current statutory obligations to the coming generations of retirees is daunting.... [U]ncertainty [about the outlook for Medicare] is an important reason to be cautious -- especially given that government programs, whether for spending or for tax preferences, are easy to initiate but can be extraordinarily difficult to shut down once constituencies for them develop....
"I believe that a thorough review of our spending commitments -- and at least some adjustment in those commitments -- is necessary for prudent policy....
"I certainly agree that the same scrutiny needs to be applied to taxes. However, tax-rate increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. The exact magnitude of such risks is very difficult to estimate, but they are of enough concern, in my judgment, to warrant aiming to close the fiscal gap primarily, if not wholly, from the outlay side.
"The dimension of the challenge is enormous. The one certainty is that the resolution of this situation will require difficult choices and that the future performance of the economy will depend on those choices....
"History has shown that, when faced with major challenges, elected officials have risen to the occasion. In particular, over the past 20 years or so, the prospect of large deficits has generally led to actions to narrow them. I trust that the recent deterioration in the budget outlook and the fast-approaching retirement of the baby-boom generation will be met with similar determination and effectiveness."
What it means: Greenspan took a noticeably harder line on the need to reduce government spending -- and scale back entitlement benefits -- in this appearance. Of course, such recommendations may not go down too well with lawmakers -- Democrat or Republican -- in an election year, notes Beth Ann Bovino, senior economist at S&P.
He was gloomier than usual when it came to discussing long-term structural issues facing the economy. Greenspan said reforms for Social Security are needed as soon as possible with the first round of baby boomers nearing retirement age -- and the trust fund projected to go into the red as the number of workers for every benefit recipient drops to only about two in future years. Especially sobering: CBO projections cited by the Fed chief that federal outlays under Social Security and Medicare would increase to 12% of GDP by 2030 from less than 7% currently.
S&P's Bovino notes that Greenspan made several references to the need to reduce retirement benefits in his testimony. He suggested that Congress consider using a different cost-of-living measure or another possible adjustment related to the age at which benefits will be provided.
Either way, notes Informa, the reality is that Congress faces a huge shortfall between future benefit payments against payroll taxes collected to fund the program. As with his earlier testimony on subjects such as government-sponsored entities Freddie Mac and Fannie Mae, job prospects, and the federal deficit, the Fed chief tried, somewhat unsuccessfully, to avoid criticizing Bush Administration policy, Bovino says.
Informa notes that Greenspan warned in earlier testimony that tax increases pose a threat to growth. In his view, spending cuts should be the focus of reining in the budget deficit. On monetary policy, he repeated that it's highly accommodative but offered no hint as to when that would change.
The chairman kicked off his testimony with upbeat remarks about the pace of the current recovery. S&P MarketScope notes that his statement that the lingering output gap "should help keep a lid on inflation" bolsters the argument of those who say the Fed won't tighten until 2005.
What he didn't say: He didn't change his tune on the economy, which was encouraging to investors who worried he might give a nod to persistent worries that job creation is lagging in this economic recovery. His decision to stand pat on the state of the economy -- that it's neither overheating nor cooling off -- leads them to believe rates won't be rising soon. The major stock indexes were able to snap a five-session losing streak on Wednesday, Feb. 25.
Next up: Greenspan takes a day off from public pronouncements on Thursday, Feb. 26, the only break during the week. Tuesday, Feb. 24
Greenspan testified before the Senate Committee on Banking, Housing & Urban Affairs
What he said: "Why do [government-sponsored enterprises, or GSEs] Fannie [Mae] and Freddie [Mac] now generate such substantial concern? The unease relates mainly to the scale and growth of the mortgage-related asset portfolios held on their balance sheets....
"Importantly, the [GSEs'] scale itself has reinforced investors' perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the debt [of these mortgage-finance firms]. This view is widespread in the marketplace despite the privatization of Fannie and Freddie and their control by private shareholders, because these institutions continue to have government missions, a line of credit with the Treasury, and other government benefits, which confer upon them a special status in the eyes of many investors....
"Congressional Budget Office and other estimates differ, but they come to the essentially same conclusion: A substantial portion of these GSEs' implicit subsidy accrues to GSE shareholders in the form of increased dividends and stock-market value. Fannie and Freddie, as you know, have disputed the conclusions of many of these studies....
"I should emphasize that Fannie and Freddie, to date, appear to have managed these risks well and that we see nothing on the immediate horizon that is likely to create a systemic problem. But to fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later....
"Most of the concerns associated with systemic risks flow from the size of the balance sheets that these GSEs maintain. One way the Congress could constrain the size of these balance sheets is to alter the composition of Fannie's and Freddie's mortgage financing by limiting the dollar amount of their debt relative to the dollar amount of mortgages securitized and held by other investors....
"The Congress needs to create a GSE regulator with authority on a par with that of banking regulators, with a free hand to set appropriate capital standards, and with a clear process sanctioned by the Congress for placing a GSE in receivership. However, if the Congress takes only these actions, it runs the risk of solidifying investors' perceptions that the GSEs are instruments of the government and that their debt is equivalent to government debt. The GSEs will have increased incentives to continue to grow faster than the overall home mortgage market....
"Thus, GSEs need to be limited in the issuance of GSE debt and in the purchase of assets, both mortgages and non-mortgages, that they hold."
What it means: This is the Fed chief's most public criticism to date of the mortgage-finance giants. It's significant that he's emphasizing the need for a new regulator of housing GSEs like Freddie Mac and Fannie Mae, notes Informa, with powers to set capital standards and limit the issuance of GSE debt and purchase of assets.
Greenspan did say Fannie and Freddie, to date, appear to have managed these risks well. But to fend off possible future systemic difficulties, which he sizes up as likely if GSE expansion continues unabated, he believes preventive measures must be put in place.
Greenspan wants Congress to clarify the "implicit subsidy" question before the pool of associated investments grows even larger. While the agency-debt market appeared to have shrugged off the chairman's remarks, Informa says traders are nervous and are keeping track of what his comments may portend going forward.
Analyst Erik Eisenstein, who follows Fannie and Freddie for Standard & Poor's Equity Research, doesn't think a workable consensus exists to reduce Fannie's and Freddie's implicit subsidy, though there's a stronger consensus for tighter regulation, possibly with the power to raise capital requirements.
What he didn't say: S&P's Eisenstein thinks it's a "slight positive" for the GSEs that Greenspan chose not to focus on the ongoing accounting controversy at Freddie -- which Eisenstein would see as a call for immediate action -- and instead homed in on the "less politically viable" subsidy issue.
Next up: The markets are bracing for Greenspan's Feb. 25 testimony to the House Budget Committee about the economic outlook. The Fed chief is likely to be "guardedly optimistic," according to Standard & Poor's MarketScope. Informa says Greenspan is likely to offer predictions of eventual robust job growth, while suggesting "patience" until that prediction is realized -- nothing new there. But, notes informa, any twists on Greenspan's basic story could pose a risk for the markets.
Monday, Feb. 23
Greenspan spoke before the Credit Union National Assn. 2004 Governmental Affairs Conference
What he said: "Elevated bankruptcy rates are troubling because they highlight the difficulties some households experience during economic slowdowns. But bankruptcy rates are not a reliable measure of the overall health of the household sector because they do not tend to forecast general economic conditions, and they can be significantly influenced over time by changes in laws and lender practices.
"Delinquency rates may be a bit better measure of the overall health of the household sector. The recent experience with some delinquency rates has been encouraging, with rates falling for several measures of credit-card and automobile debt.
"Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress. And, in fact, during the past two years, debt service ratios have been stable."
What it means: Greenspan has held to the view that the U.S. household sector seems to be in good shape throughout the recession and into the recovery. He sees no stress on household finances indicated by the rise in household debt levels, nor does he see elevated credit-card use as a sign of weakness. He points to mortgage refinancing as a big help to consumer finances and the economy as a whole. And like the rather bland endorsement of the labor market's prospects that he delivered to Congress on Feb. 20, these remarks suggest that Greenspan sees few inhibitions to continued good growth.
What he didn't say: The central bank boss didn't mention the performance of household income. That's a measure more pessimistic analysts often use to show the risk to demand from the household sector, Informa says.
Next up: On Tuesday, Feb. 24, Greenspan speaks before the Senate Banking and the House Urban Affairs committees. According to Standard & Poor's MarketScope, he's expected to reaffirm his support for a new regulator with more sweeping powers than the Office of Federal Housing Enterprise Oversight to oversee government sponsored enterprises (GSEs) such as Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. Such powers would include raising minimum capital requirements, a move neither the Bush Treasury nor the GSEs themselves support, according to Informa.
Another issue is whether such a new regulator should be housed outside the Treasury Dept. as an independent body. For the most part, questions from lawmakers in the Q&A portion of Greenspan's testimony are likely to be restricted to GSE governance, rather than monetary-policy issues.
Edited by William Andrews