[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
CONDUCT OF MONETARY POLICY
Report of the Federal Reserve Board pursuant to
Section 2B of the Federal Reserve Act
and the State of the Economy
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 27, 2002
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-56
78-399 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Ohio JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
C O N T E N T S
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Page
Hearing held on:
February 27, 2002............................................ 1
Appendix:
February 27, 2002............................................ 55
WITNESSES
Wednesday, February 27, 2002
Greenspan, Hon. Alan, Chairman, Board of Governors, Federal
Reserve System................................................. 5
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 56
Greenspan, Hon. Alan......................................... 59
Additional Material Submitted for the Record
Greenspan, Hon. Alan:
Board of Governors of the Federal Reserve System, Monetary
Policy Report to the Congress, February 27, 2002........... 77
Written response to questions from Hon. Michael G. Oxley..... 112
Written response to questions from Hon. Christopher Cox...... 128
Written response to a question from Hon. Janice Schakowsky... 129
Written response to questions from Hon. Ronnie Shows......... 131
CONDUCT OF MONETARY POLICY
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WEDNESDAY, FEBRUARY 27, 2002
U.S. House of Representatives,
Committee on Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:05 a.m., in room
2128, Rayburn House Office Building, Hon. Michael G. Oxley,
[chairman of the committee], presiding.
Present: Chairman Oxley; Representatives Baker, Bachus,
Castle, King, Royce, Kelly, Paul, Cox, Biggert, Hart, Gillmor,
Shadegg, Miller, Cantor, Grucci, Capito, Ferguson, Rogers,
Tiberi, LaFalce, Frank, Kanjorski, Sanders, C. Maloney of New
York, Carson, Sherman, Sandlin, Meeks, Lee, Mascara, Inslee,
Schakowsky, Moore, Capuano, Ford, Hinojosa, Watt, Maloney,
Hooley, Gonzalez, Tubbs Jones, Lucas KY, Shows, Israel, and
Ross.
Chairman Oxley. The hearing will come to order. Before we
formally welcome Chairman Greenspan, I want to take a moment to
welcome the Committee back to our newly refurbished Committee
room. We've completed the bulk of our renovations to our
Committee hearing rooms, which have taken a full year to
accomplish.
Over the last 6 weeks, we replaced the original 40-year-old
audio system with a state-of-the-art digital sound system. The
new system will enable all of us, and the audience, to hear
each other clearly for the first time. We also added some
multimedia and broadcast capabilities to the tools available to
the Committee. All of these improvements will improve the work
of this Committee, and make its proceedings even more
accessible to the public.
I particularly want to thank Chairman Ney for all of his
support and hard work in helping us to complete this project.
It probably didn't hurt to have him on the Committee either. I
also want to thank all the Members of this Committee for their
strong support in making every aspect of this Committee,
including our hearing rooms, the best on Capitol Hill.
With that said, good morning, Chairman Greenspan, and thank
you for coming here today.
The world economy has been turbulent, and you've had issues
to deal with that even you've never seen before. The economy
has benefited greatly from your leadership at the Fed. In these
uncertain times, experience and steadiness at the helm with the
central bank are particularly important, so we're all grateful
for your continued service.
Before we begin today, I also wanted to say that this
Committee--and the Nation--owes you its appreciation for
everything the Fed did in the days immediately following
September 11th. The Fed, working with financial institutions of
all kinds, all over the country, made it possible for our
system to continue to work flawlessly at a time of great
confusion and great peril. It is a great story, one that not
enough people know about. And we owe you, and everyone at the
Fed, our gratitude and I remember our conversation when you
came back from Europe the day after the 11th tragedy, and your
experience and dedication are most appreciated.
Terrorism gave our stagnating economy a hard shove, but so
far the war has caused no lasting economic damage. In fact, our
economy is rebounding from recession despite the war, and
despite the difficulties experienced by individual companies in
many different markets. This is an amazing testament to our
fundamental economic strength.
We look forward to your views on what's happening in the
economy and what else can be done to speed the economic
recovery. Congress also must do its part in a number of areas.
We look forward to your opinions and reactions to many of those
issues.
This Committee overseas the growth engine of the economy--
the companies that provide the capital for all of our
businesses to expand, and to begin. That's why your visit here
twice a year, and that's why we always seek your advice on
things Congress can do that will help grow the economy.
Our Committee was the most productive in Congress after
September 11th. We've enacted bills ranging from the Patriot
Act to eliminating excess fees investors pay for operations of
the SEC--the second biggest tax cut of this Administration. We
passed terrorism insurance legislation and a host of other
bills. Throughout it all, we were doing much more than
responding to terrorism: we're trying to help the economy
recover and grow.
Economic growth remains our Committee's focus today. It's
more important than ever for this Committee to focus on all the
ways we can remove barriers to economic growth. As you state in
your testimony, ``deregulation and innovation in the financial
sector have been especially important in enhancing overall
economic performance.''
Congress has made great initial strides in the 1990s. We
began to deregulate financial and product markets in Gramm-
Leach-Bliley. We made sure the trading on the stock markets
occurred in decimals. We worked to help investors get more
information from companies so they can make informed decisions
about their portfolios.
The result was unprecedented prosperity--and the
unprecedented ability to bounce back after a recession after
September 11.
But it's no time to rest on those accomplishments. There's
a lot more to do. Now more than ever, we need to free up
capitol to seed new businesses and expand existing businesses.
We need to make sure that the whole value of every business is
reflected in its accounting and in its financial statements. We
need to increase the transparency and usefulness of financial
statements to the investing public so that as much light as
possible to be shed on the operations of every company.
We must continue to remove unnecessary economic and
regulatory burdens on our businesses so that they can lead the
economic recovery. We're trying to do that here, both by
reforming the deposit insurance system and by spearheading
regulatory relief for financial institutions.
On these issues, and many others, we look forward, Mr.
Chairman, to your continued advice and assistance and we
appreciate your appearance here today.
With that, let me yield to the gentleman from New York,
Ranking Member, Mr. LaFalce, for an opening statement.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 56 in the appendix.]
Mr. LaFalce. Thank you very much.
Chairman Greenspan, it's always a pleasure to have you
before us. I'd like to highlight two areas that I believe are
of great importance to the economy today. The fallout from the
systemic problem known as Enron, and conditions in both our
domestic and global economy.
But first, I want to address monetary policy directly. I do
not believe it is now appropriate to raise interest rates. I
believe a move to raise rates in the weeks ahead could well
jeopardize our fragile recovery in the domestic economy, and
would likely have adverse consequences for the global economy.
Much of my concern about the performance of the United States
economy in the months ahead relates to the aftermath of the
stock market bubble, the collapse of Enron, and what both have
meant for the soundness of corporate financial statements and
corporate governance.
Between 1995 and 2000, you and a few others grew
increasingly concerned about the possibility of a stock market
bubble. Essentially, the stock valuations did not reflect the
underlying earnings of publicly-traded companies. The concern
was that the inevitable market correction could be volatile and
steep, setting off adverse reactions in investor confidence,
consumer confidence, banks' willingness to lend, and so forth.
Then, most recently came Enron. Unfortunately, I believe
Enron is too symptomatic of a condition that has spread across
corporate America in tandem with the stock market bubble. The
desire to meet the expectations of an ever-rising market drove
grossly inappropriate accounting and corporate governance
practices, and exposed the shortcomings of regulation in these
areas.
I warned about these shortcomings shortly after our
Committee obtained jurisdiction in January of 2001. I began
calling in this Committee, the Rules Committee, the floor of
the House, for a 200 to 300 percent increase in the budget of
the SEC. In June of 2000, I sent all 600,000 of my constituents
a newsletter on this subject dealing with the protection of
investments and talking about the need to beware of Wall Street
recommendations and to beware of the numbers explaining the
earnings manipulation that has been taking place across
corporate America, calling the conditions that existed in June
2001 the tip of the iceberg and calling upon our Committee to
focus on one issue primarily: accounting.
It took Enron to give this issue the attention it deserves.
Unfortunately, I believe we have to be at least as concerned
about these very same issues internationally. If the United
States purportedly has the highest corporate financial
standards in the world, what are we to make of the potential
for Enrons in countries like Japan, China, India, even the EU,
all of which have well-developed financial markets but may have
less than adequate regulatory standards. And our Big Five
accounting firms are in virtually every major city in the world
and very often the same auditors of the largest global
companies.
With an eye toward the global economy, I now want to go
back to the issue of U.S. monetary policy. It's clear to me
that U.S. monetary policy has an increasingly long reach,
extending well beyond our domestic borders. In particular, I'm
concerned about the impact of premature rate increases in the
United States on the situations in Japan and in Europe. In
Japan, because they've had a stagnant economy for a decade, and
are the second largest economy in the world. In Europe, because
it's going through the difficult process of solidifying a
centralized monetary policy and achieving economic integration
while also bringing in about ten new countries into the union.
I believe it's critical that the United States be cognizant of
any policies that could impact economic conditions globally,
especially in Japan and the EU.
With respect to the EU, the member countries of it are in
the midst of a grand political, social, and economic experiment
not unlike the one our own founding fathers embarked on 226
years ago, and the global economy will be the ultimate
beneficiary of successful economic integration. I hope that we,
in our monetary and fiscal policy, will do all in our power to
help support that endeavor. And Dr. Greenspan, I hope in the
course of this morning's dialogue, you'll be able to discuss
some of these issues too.
Thank you.
Chairman Oxley. The Chair is now pleased to recognize the
gentlelady from New York, Mrs. Maloney.
Mrs. Maloney. Thank you.
Good morning, Mr. Greenspan, and thank you for appearing
before us today. After eleven interest rate cuts over the last
year, we are all hoping that the Fed will report that the
country is through the worst of the recession and that growth
is ahead. While we're all hoping for a turnaround in the coming
months, as many as two million Americans are expected to
exhaust their unemployment insurance. These families cannot
wait until a rising tide lifts all boats. The combination of
the recession and the economic impact of the World Trade Center
has made the situation particularly dire for your home State of
New York, where 71 percent more people are now on unemployment
insurance than at the same time last year.
Last quarter alone, 65,000 New Yorkers exhausted their
unemployment insurance benefits. The good news is that both the
Democrats and the Republicans agree that we should help these
families and pass a 13-week extension of unemployment benefits.
I hope the House will soon follow the Senate and pass a clean
unemployment extension.
I am concerned that the predictions of some of the
economists--and some of them have stated that they are
concerned that positive statements from you today could
foreshadow increases in interest rates; in fact, futures
traders are betting that the Federal fund rate will rise this
summer. My concern is that the Fed may reverse direction and
begin to put the brakes on the recovery before out-of-work
people benefit from the turnaround in our economy.
Other questions that I look forward to hearing from you
today are your views on the failure of Enron, and the crisis of
confidence it has caused in our financial markets. Also, in New
York City, constituents tell me that the lack of terrorism
insurance is holding back building projects, causing a credit
crunch, and stalling the City's overall recovery. I look
forward to your comments on insurance and its impact on our
economy.
Finally, since your last appearance, our Government
finances have turned 180 degrees. We have shrunk a $5.6
trillion unified surplus by $4 trillion. This is the most
radical fiscal reversal in my lifetime. New spending to fight
terrorism, to protect the homeland and to rebuild after the
attacks is definitely legitimate, but I am very much opposed to
the very expensive, retroactive special interest tax breaks
that are likewise proposed. One earlier version of the budget
even included a tax break for Enron. I look forward to your
testimony today, as always. Thank you for being here.
Chairman Oxley. The gentlelady's time has expired.
We now turn to our distinguished witness, the Chairman of
the Federal Reserve, Dr. Greenspan.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM.
Mr. Greenspan. Thank you very much, Mr. Chairman. I've a
rather extended statement and I will excerpt from it, but
request that the full statement be included for the record.
Chairman Oxley. Without objection.
Mr. Greenspan. Since last July, when I last reported to you
on the conduct of monetary policy, the U.S. economy has gone
through a period of considerable strain, with output
contracting for a time and unemployment rising. We in the
Federal Reserve System acted vigorously to adjust monetary
policy in an endeavor both to limit the extent of the downturn
and to hasten its completion. Despite the disruptions
engendered by the terrorist attacks of September 11, the
typical dynamics of the business cycle have re-emerged, and are
prompting a firming in economic activity. An array of
influences unique to this business cycle, however, seems likely
to moderate the speed of the anticipated recovery.
One key consideration in the assessment that the economy is
close to a turning point is the behavior of inventories. Stocks
in many industries have been growing down to levels at which
firms will soon need to taper off their rate of liquidation, if
they have not already done so. Any slowing in the rate of
inventory liquidation will induce a rise in industrial
production if demand for those products is stable or is falling
only moderately. That rise in production will, all other things
being equal, increase household income and spending.
But that impetus to the growth of that activity will be
short-lived unless sustained increases in final demand kick in
before the positive effects of the swing from inventory
liquidation dissipate. Through much of last year's slowdown,
spending by the household sector held up well and proved to be
a major stabilizing force. As a consequence, although household
spending should continue to trend up, the potential for
significant acceleration in activity in this sector is likely
to be more limited than in past cycles.
Changes in household financial positions in recent years
are probably damping consumer spending, at least to a degree.
Overall household wealth relative to income has dropped from a
peak multiple of about 6.3 at the end of 1999 to around 5.3
currently. Moreover, the aggregate household debt service
burden, defined as the ratio of households' required debt
payments to their disposable personal income, rose considerably
in recent years, returning last year to its previous cyclical
peak of the mid-1980s.
However, increased debt burdens appear disproportionately
attributable to higher income households. As a result, although
repayment difficulties have already increased, particularly in
the sub-prime markets for consumer loans and mortgages, the
overall levels of debt and repayment delinquencies do not, as
of now, appear to pose a major impediment to a moderate
expansion of consumption spending going forward.
We have already seen significant spending restraint among
the top fifth of income earners, presumably owing to the drop
in equity prices. Moderate income households have a much larger
proportion of their assets in homes, and the continuing rise in
the value of houses has provider greater support for their net
worth. Reflecting these differences in portfolio composition,
the net worth of the top fifth of income earners has dropped
far more than it did for the bottom 80 percent.
Accordingly, most of the change in consumption expenditures
that resulted from the bull stock market, and its demise,
reflected shifts in spending by upper income households. The
restraining effects from the net decline in wealth during the
past 2 years presumably have not, as yet, fully played out and
could exert some further damping effect on the overall growth
of household spending relative to that of income.
Perhaps most central to the outlook for consumer spending
will be developments in the labor market. The pace of layoffs
quickened last fall, especially after September 11th, and the
unemployment rate rose sharply. However, layoffs diminished
noticeably in January, and initial claims for unemployment
insurance have decreased markedly, on balance, providing
further evidence of an improvement in labor market conditions.
Even if the economy is on the road to recovery, the
unemployment rate, in typical cyclical fashion, may resume its
increase for a time, and a soft labor market could put
something of a damper on consumer spending.
However, the extent of such restraint will depend on how
much of any rise in unemployment is the result of weakened
demand for goods and services and how much reflects
strengthened productivity.
In the latter case, average real incomes of workers could
rise, at least partially offsetting losses of purchasing power
that stem from diminished levels of employment. Indeed,
preliminary data suggest that productivity has held up very
well of late, and history suggests that any depressing effect
of rapid productivity growth on unemployment is only temporary.
While the balance of factors influencing consumer demand
will have important consequences for the economic outlook in
coming months, the broad contours of the present cycle have
been, and will continue to be, driven by the evolution of
corporate profits and capital investment.
The retrenchment in capital spending over the past year-
and-a-half was central to the sharp slowing we experienced in
overall activity. New orders for equipment and software
hesitated in the middle of the year 2000 and then fell abruptly
as firms re-evaluated their capital investment programs. For
much of the last year, the decline in investment outlays was
fierce and unrelenting.
These cutbacks in capital spending interacted with, and
were reinforced by, falling profits and equity prices. Indeed,
a striking feature of the current cyclical episode relative to
many earlier ones has been the virtual absence of pricing power
across much of American business, as increasing globalization
and deregulation have enhanced competition. In this low
inflation environment, firms have perceived very little ability
to past cost increases on to customers.
Business managers, with little opportunity to raise prices,
have moved aggressively to stabilize cash flows by trimming
work forces. These efforts have limited any rise in unit costs,
attenuated the pressure on profit margins, and ultimately
helped to preserve the vast majority of private sector jobs.
Part of the reduction in pricing power observed in this
cycle should be reversed as firming demand enables companies to
take back large price discounts. Though such an adjustment
would tend to elevate price levels, underlying inflationary
cost pressures should remain contained. Slack in labor markets
and further increases in productivity should hold labor costs
in check and result in rising profit margins even with
inflation remaining low.
Improved margins and more assured prospects for rising
final demand would likely be accompanied by a decline in risk
premiums from their current elevated levels toward a more
normal range. With real rates of return on high tech equipment
still attractive, that should provide an additional spur to new
investment.
The recovery in overall spending on business fixed
investment is likely to be only gradual; in particular, its
growth will doubtless be less frenetic than in 1999 and early
2000--a period during which outlays were boosted by the
dislocations of Y2K and the extraordinarily low cost of equity
capital available to many firms.
Even a subdued recovery beginning soon would constitute a
truly remarkable performance for the American economy in the
face of so severe a decline in equity asset values and an
unprecedented blow from terrorists to the foundations of our
market systems. For, if the tentative indications that the
contraction phase of this business cycle is drawing to a close
are ultimately confirmed, we will have experienced a
significantly milder downturn than the long history of business
cycles would have led us to expect. Crucially, the imbalances
that triggered the downturn and that could have prolonged this
difficult period did not fester. The obvious questions are what
has changed in our economy in recent decades to provide such
resilience and whether such changes will persist into the
future.
Doubtless, the substantial improvement in the access of
business decisionmakers to real time information has played a
key role. The large quantities of data available virtually in
real time allow businesses to address and resolve economic
imbalances far more rapidly than in the past.
The apparent increased flexibility of the American economy
arguably also reflects the extent of deregulation over the past
quarter century. Certainly, if the energy sector was still in
the tight regulatory fetters of the 1970s, our flexibility
today would be markedly less. Airline, trucking, and rail
deregulation has added flexibility to the movement of people
and goods across our Nation.
Both deregulation and innovation in the financial sector
have been especially important in enhancing overall economic
resilience. New financial products--including derivatives--have
enabled risk to be dispersed more effectively to those willing
to, and presumably capable of, bearing it. Shocks to the
overall economic system are accordingly less likely to create
cascading credit failure. Lenders have the opportunity to be
considerably more diversified, and borrowers are far less
dependent on specific institutions for funds. Financial
derivatives, particularly, have grown at a phenomenal pace over
the past 15 years, evidently fulfilling a need to hedge risks
that were not readily deflected in earlier decades. Despite the
concerns that these complex instruments have induced--an issue
I will address shortly--the record of their performance,
especially over the last couple of stressful years, suggests
that on balance they have contributed to the development of a
far more flexible and efficient financial system.
As a consequence of increased access to real time
information and, more arguably, extensive deregulation in
financial and product markets, and the unbundling of risk,
imbalances are more likely to be readily contained, and
cyclical episodes overall should be less severe than would be
the case otherwise.
However, the very technologies that appear to be the main
cause of our apparent increased flexibility and resiliency may
also be imparting different forms of vulnerability that could
intensify or be intensified by a business cycle.
From one perspective, the ever-increasing proportion of our
gross domestic product that represents conceptual, as distinct
from physical value added, may actually have lessened cyclical
volatility. In particular, the fact that concepts cannot be
held as inventories means a greater share of GDP is not subject
to the type of dynamics that amplify cyclical swings. But an
economy in which concepts form an important share of valuation
has its own vulnerabilities.
As the recent events surrounding Enron have highlighted, a
firm is inherently fragile if its value-added emanates more
from conceptual as distinct from physical assets. A physical
asset, whether an office building or an automotive assembly
plant, has the capability of producing goods even if the
reputation of the managers of such facilities falls under a
cloud. The rapidity of Enron's decline is an effective
illustration of the vulnerability of a firm whose market value
largely rests on capitalized reputation. The physical assets of
such a firm comprise a small proportion of its asset base.
Trust and reputation can vanish overnight; a factory cannot.
The implications of such a loss of confidence for the macro
economy depend importantly on how freely the conceptual capital
of the fading firm can be replaced by a competitor or a new
entrant into the industry. Even if entry is relatively free,
macro economic risks can emerge if problems at one particular
firm tend to make investors and counterparties uncertain about
firms that they see as potentially similarly situated. The
difficulty of valuing firms that deal primarily with concepts
and the growing size and importance of these firms may make our
economy more susceptible to this type of contagion.
Another more conventional determinant of stability will be
the economy's degree of leverage, the extent to which debt,
rather than equity, is financing the level of capital. Clearly,
firms find some leverage advantageous in enhancing returns on
equity, and thus moderate leverage undoubtedly boosts the
capital stock and the level of output. A sophisticated
financial system, with its substantial array of instruments to
unbundle risks, will tend toward a higher degree of leverage at
any given level of underlying economic risk. But, the greater
the degree of leverage in any economy, the greater its
vulnerability to unexpected shortfalls in demand and mistakes.
Although the fears of business leverage have been mostly
confined to specific sectors in recent years, concerns over
potential systemic problems resulting from the vast expansion
of derivatives have reemerged with the difficulties of Enron.
To be sure, firms like Enron, and Long-Term Capital Management
before it, were major players in the derivatives markets. But
their problems were readily traceable to an old-fashioned
excess of debt, however acquired, as well as to opaque
accounting of that leverage and lax counterparty scrutiny.
Swaps and other derivatives throughout their short history,
including over the past 18 months, have been remarkably free of
default. Of course, there can be latent problems in any market
that expands as rapidly as these markets have. Regulators and
supervisors are particularly sensitive to this possibility.
Derivatives have provided greater flexibility to our financial
system. But their very complexity could leave counterparties
vulnerable to significant risk that they do not currently
recognize, and hence these instruments potentially expose the
overall system if mistakes are large. In that regard, the
market's reaction to revelations about Enron provides
encouragement that the force of market discipline can be
counted on over time to foster much greater transparency and
increased clarity and completeness in the accounting treatment
of derivatives.
How these countervailing forces for stability evolve will
surely be a major determinant of the volatility that our
economy will experience in the years ahead. Monetary policy
will have to be particularly sensitive to the possibility that
the resiliency our economy has exhibited during the past 2
years signals subtle changes in the way our system functions.
Although there are ample reasons to be cautious about the
economic outlook, the recuperative powers of the United States
economy, as I have tried to emphasize in my presentation this
morning, have been remarkable. When I reported on monetary
policy to the Committee last summer, few if any of us could
have anticipated events such as those to which our Nation has
subsequently been subjected. The economic consequences of those
events and their aftermath are an integral part of the many
challenges that we now collectively face. The U.S. economy has
experienced a substantial shock, and, no doubt, we continue to
face risks in the period ahead. But the response thus far of
our citizens to these new economic challenges provides reason
for encouragement.
Thank you very much, Mr. Chairman. I look forward to your
questions.
[The prepared statement of Hon. Alan Greenspan can be found
on page 59 in the appendix.]
Chairman Oxley. Thank you, Mr. Chairman, and it's always
good to have you here in front of the Committee. Let me begin.
Obviously, your statements regarding Enron were timely and
probably predictable as well, and I suspect the questions will
be in that regard as well.
In light of recent market movements, in the wake of Enron,
it has been suggested by some that ultimately the market does a
far better job of deterring abuses than does Government.
What are your thoughts in that regard, and what would be
some suggestions that you would give this Committee as we work
our way through some of these difficult issues?
Mr. Greenspan. I think Enron, as I indicated to the Senate
Budget Committee the other day, is not a significantly negative
event to the economy and, in fact, in the long run, its
emergence may alter the way we govern corporations. That the
long history of corporate governance will continue to be a very
substantial and positive force for economic growth and
productivity. I do believe that something fundamentally
different has happened in this most recent period, and I think
it's important for us to go back and look at the causes of it.
I would say particularly what has changed from the way I
recall corporate governance, stock prices, stock markets,
security analysis, years ago, is that in earlier years there
was not any really significant emphasis of the type we see
today on short-term corporate earnings. Indeed, dividends were
exceptionally high. In fact, the yield on dividends before 1950
for several years was 6 percent; it's now a little more than 1
percent. And if most of what you get from a corporation is
cash, you don't worry about how it was calculated, you just
take the money and that's it. But one with the significant
change that occurred with the propensity to buy back stock,
which only occurred in the early 1980s with rulings which
somehow delimited the concerns that stock buybacks would be
perceived as price manipulation. That very act caused a very
major shift from cash dividends to stock purchase.
Two other events were very important in that context to
create the environment which ultimately led to the Enron
debacle. One was the unfortunate reversal of the FASEB ruling
in the early 1990s about stock option accounting. We estimate
that over the past--or say the period 1995 to the year 2000--
almost 3 full percentage points of the annual average gain in
earnings resulted from the fact that stock options, rather than
cash, was used as compensation amongst our major corporations.
This undoubtedly had an effect of accelerating the earnings
outlook which in turn had been very significantly propelled
upward by the structural change in productivity.
And so what occurred as a consequence of all of these
forces was an endeavor to try to game the accounting systemin a
manner to create the perception of short-term earnings growth
which would be confused with long-term earnings growth. If
long-term earnings growth were properly evaluated over this
period, I don't think we would have had very much of the type
of problems that we've had, but there's been a significant
endeavor to make the data look as though something
fundamentally different is going on in corporate America, and
that has been unfortunate.
Much of that has already been reversed by the market. There
is now a very significant shift toward corporations endeavoring
to be far more transparent on what they are doing, the markets
are clearly creating price earnings premiums for corporations
which are perceived to be without spin, so to speak. And so a
goodly part of what needs to be done to restore corporate
governance to where it was in earlier years, and I must say
back then it did a pretty good job, and the vast majority of
corporate governance in today's markets, even with Enron
debacle, is of superior nature and indeed far superior than any
other place in the world, but we do need to fix what is wrong
with our system, and I would suggest that a proper diagnosis is
clearly the first step in determining what should be done.
Chairman Oxley. Thank you, Mr. Chairman. My time has
expired.
Let me now yield now to the gentleman from New York, the
Ranking Member, Mr. LaFalce.
Mr. LaFalce. Thank you very much, Mr. Chairman. I disagree
with you fundamentally and also with Dr. Greenspan in some of
his introductory comments. First of all, I think we've shown
that we cannot rely on the unfettered magic of the marketplace
alone. That with respect to publicly traded there must be
significant regulation. That the SROs, the self-regulatory
organizations have not worked. They've not worked with respect
to the securities analysts, they've not worked with respect to
the accounting firms. We need a significantly enhanced role for
the Securities & Exchange Commission. We need to appropriate
moneys for pay parity. We need to significantly enhance their
resources to do the job, because so many Americans today do
have almost all of their wealth in the markets. They have
defined contribution plans today rather than defined benefit
plans. They're not putting their money in banks where you,
Chairman Greenspan, have your examiners there on a daily basis,
where the State bank examiners are there on a daily basis.
They're in the markets and we need to protect them.
I disagree with you when you say that Enron is not a
significant event. I think Enron is a most significant event. I
think we can, you know, make lemonade out of lemons to be sure
but we can never deal with the fact that four to five trillion
dollars of American money has been lost in the markets, a great
amount due to the excesses, to the bubble, to the speculation,
but a significant amount due to earnings manipulation.
Now, where I do agree with you strongly is with respect to
stock options. So much of what took place was done by corporate
officers and the audit committees of boards of directors, all
with stock options that were interested in one thing and one
thing only. And that was enhancing market capitalization so
that they could have a good return on those stock options. And
we must deal with all of those.
Now who's we? We is Government. The marketplace will be
more vigilant now for a month, for two, maybe a year or so, but
nothing can substitute for a strong regulatory environment for
our publicly traded companies, and that's what we must achieve.
And if anybody thinks that we can achieve the end result of
protection of American investors without that, they are
deluded.
Now, having said that----
Mr. Greenspan. Can I respond?
Mr. LaFalce. Sure.
[Laughter.]
Mr. Greenspan. You are quite correct, I might add, in
saying that we need more resources for the Securities &
Exchange Commission, especially on the pay parity issue, which
I think is long overdue. I did not say, nor do I believe that
there are not adjustments that are required and indeed ought to
be made and I would start off with the way we account for stock
options, I would account for a number of other issues as to the
way we have corporate governance, because significant things
have happened in the recent decades which require adjustment.
I want to emphasize, however, that the overall level of
corporate governance has served us well over recent decades
including the current period by the vast majority of
corporations who see their, management sees their self-interest
as coincident with those of shareholders. I don't want to get
into the economics of this, but if we could make that tie
locked in some manner or another, we will maximize the
allocation of capital in this economy.
There has been a severance, in my judgment, of the
interests of the chief executive officer in many corporations
from those of the shareholders, and that should be pulled
together. Stock options help but not if they are functioning in
the manner in which they currently are.
Mr. LaFalce. Dr. Greenspan, if I could just get one
question. Could you comment on the conduct of United States
monetary policy within the global context, given the fact that
there is now one monetary policymaker in Europe that they are
achieving integration with, while at the same time expanding,
that Japan has been in the doldrums for a decade or so and the
interplay that goes on in your decisionmaking between the
domestic and the global economy.
Mr. Greenspan. Well, Congressman, as you well know, our
mandate is to maximize long-term sustainable economic growth in
the United States. I mean, we consider foreign conditions only
to the extent statutorily as they impact on us, and obviously
as they increasingly do so, we become far more interested in
what's going on in the world and respond to it. And indeed, we
have. In other words, a considerable part of our analysis of
what's been going on in the American economy in recent years
has had a very high level of international interrelationship
and fallout in certain respects. So we do evaluate the European
economy, the Japanese economy, East Asia, Latin America, at a
fairly extensive level to make certain that our policy, which
is implemented here and focused on the American system is not
going to be deflected by events that we perceive are occurring
more abroad.
Chairman Oxley. The gentleman's time has expired. The Chair
is now pleased to recognize the gentleman from New York, Mr.
King.
Mr. King. Thank you, Mr. Chairman. Good morning, Mr.
Greenspan. It's always a pleasure to have you here. Let me just
at the outset, as a New Yorker and as an American commend you
for the critical role you and the Fed played in providing the
liquidity that was so important after September 11th. It was
very reassuring and I want to thank you for that.
I'm going to focus my questions on the question of interest
rates. And this in a way is a follow-up to what Mr. LaFalce was
talking about with the Japanese economy being in the doldrums.
I would ask you if you could just make some comments on how low
interest rates can go before the cutting of the interest rates
loses its impact. Now Japan has had low interest rates for a
number of years and it appears that has had no impact as far as
rebuilding the economy. If you could tell us how close you
think we are to that level where perhaps it can't go any lower.
Second, in that regard, even though the rates have gone
down, the discount rate has gone down, the long-term rates have
not gone down. How essential do you believe the reduction of
long-term rates are to the long-term growth of the economy?
Mr. Greenspan. Well, Congressman, I would not view the
Japanese experience as a general experience with respect to how
low interest rates could or could not go. The problem in Japan,
as I've indicated on many occasions, is that they have only one
major form of financial intermediation, which is their banking
system, and their banking system, as you know, is in very
serious difficulty, so that the ability of monetary policy to
function, in my judgment, is impaired in a manner which makes
it very difficult to read what basically the level of rates and
the level of economic activity are doing. I think it's very
difficult and one should not generalize from the Japanese
experience.
The issue of long-term rates is quite an important one
because, while undoubtedly short-term rates do have significant
impacts on the American economy, far more it relates to longer-
term rates. Longer term rates are a function essentially of,
one, inflation expectations, and the underlying real rate
itself. And what we have observed in this economy is that long-
term rates did come down quite materially at the tail end of
the year 2000, but have essentially stabilized, as I think you
pointed out, for the last year or so. But they have stabilized
their relatively low historic rate and indeed one can observe
what's occurring in the housing market to basically see the
impact of what mortgage rates have done.
So it's a complex issue but at the moment I think that we
do not see any really significant inflation premiums embodied
in long-term rates and that frankly is a good sign.
Mr. King. One follow up question, Chairman Greenspan, is
regarding the Argentine and Japanese economies. How significant
do you think their doldrums are going to have on our prospects
for long-term growth?
Mr. Greenspan. Well, as difficult as the problems in
Argentina are, and they're really having considerable
structural problems, and we only hope that they can correct
them as quickly as possible, they have not had a contagion
effect where one would ordinarily have expected them to have an
effect, specifically in Brazil where markets are doing
reasonably well and especially in Mexico, which has done quite
well. So in Latin America, it's important that Argentina
stabilize as quickly as they are capable of doing, but
fortunately, there's not been significant fallout.
Japan has been essentially stable for a decade now. Growth
has been effectively zero. And it's difficult to read exactly
how changes in the Japanese economy impact the rest of the
world. Clearly to the extent that they are the second largest
economy in the world, they do affect us, and clearly what is
going on in Japan is negative to the United States outlook. But
I do not perceive it as a major factor containing a recovery in
the United States which we believe is just beginning to get
underway.
Mr. King. Thank you, Chairman Greenspan, Mr. Chairman.
Chairman Oxley. The gentleman's time has expired.
The gentlelady from New York, Mrs. Maloney.
Mrs. Maloney. Thank you, Mr. Chairman.
Mr. Chairman, I want to likewise thank you for moving
quickly and dropping interest rates 50 basis points in the very
uncertain environment the day the financial markets opened
shortly after September 11th. As New York works to recover from
the terrorist attack, it's critical that we have an accurate
assessment of the economic damage to our city, State and the
private sector.
After having contacted CBO and many other agencies, no
single Federal entity is compiling an in-depth analysis of the
economic impact on New York and costs to its institutions. I
know the New York Federal Reserve has a very large and
accomplished research staff and I would like to appeal to you,
and will do so separately, to President McDonough, for just
such a well-researched economic analysis. New York really needs
your help. Could you help us with this?
Mr. Greenspan. Well, Congresswoman, I agree with you that
the Federal Reserve economic staff is first rate and a
considerable part of what they do is a continuous evaluation of
the Second District, obviously New York City being a very major
part of that district. But I will communicate to them, and I
assume you will speak to President McDonough, and my impression
is that they probably are fairly far along in examining the
type of issues that you think are important to be examined.
Mrs. Maloney. That would be extremely helpful. As a
Representative from New York, I am spending a great deal of my
time on the recovery effort. One of the areas that I am hearing
tremendous concern from my constituents is the lack of
availability of terrorism insurance, the escalating cost of
insurance. Many building projects and proposals have not been
funded and turned down by the banks as being too risky, and
there appears to be a credit crunch that is stalling the
recovery of New York City and New York State. I would like to
hear your comments on the fallout from the lack of insurance,
terrorism insurance, and do you think a Federal reinsurance
program is necessary? Could you share your thoughts?
Mr. Greenspan. Well, we have obviously spent a good deal of
time on exactly that issue, because it's a crucial aspect of a
fairly large segment of the economy. The difficulty that one
has when dealing with terrorism insurance is that it is
exceptionally difficult for an insurer or even a reinsurer to
have any sense whatever of what the probability distribution of
a terrorist event is and, more importantly, what is its
magnitude. In all insurance, you have to have some general
knowledge of what the parameters of what could happen are, or
you cannot set premiums. In this case, it is virtually
impossible to do so and a number of people have argued I think
somewhat effectively that what may be necessary here is for the
Congress to stipulate that in the event of a terrorist attack
clearly defined as a terrorist attack, that the Federal
Government, with some deductible, would cover the cost of that.
The problem that you have with trying to do it before the
event is it's almost impossible to know precisely how to
construct a response to it, but if individuals know that after
the fact that it will, in fact, be covered one may hope that
you can construct a means by which there can be some form of
reinsurance to remove the types of problems that we see. This
is an issue which I think there is considerable dispute on,
because we don't know what the nature of what it is we are
facing. But I'm one who thinks that we ought to be addressing
this not solely because of its impact on the economy, but there
is a very difficult problem of how one handles things over
which one is not responsible. The issue of home security is
now, in fact, indistinguishable from our national defense
budgets, and much of that has the same basis of taxation for
financing.
Mrs. Maloney. Thank you very much. And I ask unanimous
consent to add additional questions to the record. Thank you.
Chairman Oxley. Without objection.
The Chair now is pleased to recognize the gentleman from
Alabama, the Chairman of the Financial Institutions
Subcommittee, Mr. Bachus.
Mr. Bachus. Thank you, Mr. Chairman.
Chairman Greenspan, first of all I welcome your written
testimony on Enron. You're on the President's working group and
I think what you said here is very valid as to what happened at
Enron.
My question is--I'm not going to ask you for a prediction--
I'm going to ask you for what's happening real time. I know you
have folks at the Fed who look over data. You spend a lot of
time focusing on productivity. My question is a simple one. You
talked about through the last decade a surge in productivity.
Real time, are we continuing to see an increase in
productivity, or is it slackening, is it constant, or is it
declining?
Mr. Greenspan. Well, Congressman, the data that now appear
to be in real time, as you put it, probably are exaggerating
the underlying trend in productivity, if for no other reason
than the numbers look just too large to be credible. We're
going to have another upward revision in the fourth quarter's
productivity numbers, and if you take a look at the first
quarter, we already have a good deal of data in on both the
numerator and denominator of output per hour. And at this
particular stage, unless average hours worked rises very
sharply in the February-March period, for which we don't as yet
have data, and/or payroll numbers rise significantly, we're
going to have a very large increase in the first quarter. So
while I doubt very much if they will be representative of the
true underlying trend, the do nonetheless confirm that the
long-term trend of productivity has managed to sustain itself
through these very difficult times of say the second quarter of
the year 2000 to date. That doesn't necessarily mean it will
continue, but since you didn't ask me for a forecast----
Mr. Bachus. No, that's right.
Mr. Greenspan. And I think the real time data are really
quite impressive.
Mr. Bachus. Thank you very much, appreciate that. I'm going
to yield the balance of my time to the gentlelady from
Pennsylvania, Ms. Hart.
Ms. Hart. Thank you, Mr. Bachus. I have a question actually
regarding interest rates. They've obviously been quite helpful
to some businesses we've heard. However, in my district there
are some smaller and medium-sized businesses that now are
having serious trouble getting access to credit caused by the
new pressure on loan portfolios. Do you have evidence of the
tightening of that kind of credit, particularly available to
kind of the main street-type businesses? And if so, do you
expect that to have a negative impact on our efforts to pull
out of the recession?
Mr. Greenspan. Congresswoman, the evidence there is mixed.
We are observing certain tightening in some of the banks of a
modest type. We've not yet seen, or I don't know whether you
could say not yet, but we do not see the general pressure on
small business as reported by the National Federation of
Independent Business. They have a fairly extensive survey of
their members, of credit conditions available to them, and
their series have not indicated any really serious concerns.
But it's highly unlikely, in a period such as we've been
running through, that there wouldn't be some difficulties.
Indeed, if somebody told me there were none, I would say the
data are wrong. So there clearly are such events.
Hopefully, if the economy continues to show the signs that
it has been exhibiting of late, some of that pressure will be
removed, and I would hope that the opening up of profit margins
and improved balance sheets would bring a number of especially
smaller enterprises up to a level where credit availability is
no longer a difficulty for them.
Ms. Hart. Is there an action regarding that that you think
the Fed could take or should take that would be appropriate
that would help them?
Mr. Greenspan. I don't think that there's anything that we,
the Federal Reserve, can do and at the moment frankly I don't
think anything really needs to be done because, unless I'm
mistaken and this whole change in the economic environment is a
false dawn, then things should improve.
Ms. Hart. Thank you. Also there was a report released
yesterday. This is dealing with the steel issue and all the
bankruptcies we've had in the steel industry. American
University released a report that if the Administration didn't
act strongly regarding the 201 and either implementing a tariff
rate of maybe 40 percent or so, that about 325,000 American
steel jobs would be lost in the coming months.
Mr. Greenspan. How many?
Ms. Hart. About 325,000.
Mr. Greenspan. There aren't 325,000.
Ms. Hart. I think it's steel producing jobs around that
industry.
Mr. Greenspan. I see.
Ms. Hart. Anyway, there already are a significant number of
bankruptcies. There are many more companies, especially in the
area that I represent, and I think a lot of the areas in the
midwest and in the east, that would lose a lot more jobs. And
the bankruptcies are also affecting office suppliers and
others.
What effect do you think that would also have on the
economy in general? Do you think it's large enough to affect it
in general? And do you think it would slow our pulling out of
the recession as well?
Mr. Greenspan. Now, as you know, the President has to make
a judgment before March 6th on the 201. It's a difficult
decision for lots of obvious reasons. But I think the important
issue which is on the table is not only the impact that it has
on, one, jobs, and the 600,000 retirees in the steel industry,
who have as we call significant legacy costs, but it's also an
issue of what a marked increase in steel import prices would do
to the costs of steel using industries, of which the numbers
are quite significantly larger than the roughly 150,000,
175,000 who work directly in the steel industry.
In my judgment, far more important than that, because
neither of those two issues are big as far as the domestic
economy is concerned, is the implication for our international
trade posture. And here the whole question of the importance of
international trade and how we handle it is critical to, in my
judgment, the next number of years, because even though I raise
the issue of the flexibility and resiliency of our economy
being the major reason for the fact that we didn't go into a
severe contraction in this most recent period, but what I
didn't mention but which is also the case is a very substantial
part of the economic growth that we've experienced in the post-
World War II period occurs as a consequence of the opening up
of international markets for which the United States has been
the largest recipient of growth as far as I can evaluate. So I
think the President's got a very difficult set of choices
before him, and I wish him well.
[Laughter.]
Chairman Oxley. The gentleman's time has expired.
Ms. Hart. Thank you Mr. Bachus, thank you, Mr. Chairman.
Chairman Oxley. The gentleman from Massachusetts, Mr.
Frank.
Mr. Frank. This illustrates the dilemma, the colloquy you
just had, which is this. You and many others believe, and I
share that to some extent, that the increased open trade regime
is helpful to the economy. One of the major obstacles is
precisely the resistance engendered by the only 175,000 people
who may lose their jobs. They tend not to think of themselves
as ``only.'' Well, from the macro standpoint, they're only; for
them, they're it.
And I am afraid that we may be exacerbating that. I read
the Administration's analytical perspectives on the budget and
they, in their analysis on page 24, come back to something
we've discussed before, the NAIRU, the non-accelerating
inflation rate of unemployment and give it a much higher rate
than I think experience has shown. And their projection is that
given everything they want to do, this is their optimistic
projection. If the Administration gets all that it wants in the
budget, unemployment will level off at 4.9 percent for the next
decade and stay at 4.9 percent. It's about 25 percent higher
than we had managed to get it during the growth. Here's what
troubles me.
You say, and I hope you're right and I'm inclined to agree
that the productivity gains that we have been having are not
going away. It's the productivity gains in part that helped us
get the unemployment rate lower consistent with low inflation.
If in fact, you're accurate, I hope you're going to tell me you
don't agree with this, because if you're going to go to a 4.9
percent best case unemployment, we're talking about 4.9 percent
after the recession and full recovery. If that's as low as we
can get it, if, in fact, the Administration is correct, and I
don't believe they are, that there's an economic rule that says
we can't go below 4.9 percent for any considerable period lest
we trigger inflation. Then not only is that going to be
socially a problem but it's going to exacerbate precisely the
resistance to the kind of trade regime you want to see. So I'd
be interested in your comment.
Do you agree with them. I know you've been skeptical about
the whole concept of NAIRU but is it, in fact, the case that
we're going to have 4.9 percent unemployment best case, going
out, 25 percent higher than we've been able to get to?
Mr. Greenspan. I don't consider the fact that there's a
50,000, 100,000, 175,000 jobs at stake an irrelevant
consideration. Indeed, it's much less than that because, as you
know, half the industry is minimills, and they're not in the
same difficulties that the so-called traditional coke operated
and blast-furnace steel type of operation is in.
But my own judgment is that we should focus very
significantly on making certain that those, who through no
fault of their own lose their jobs because of the opening up of
international markets, that we make certain that they are
appropriately compensated and taken care of by any number of
programs which one can conceive of.
Mr. Frank. All right, let me just ask in the written part.
I want to get to some other questions. I'd be interested if you
would give me a list of the ways of compensating people who are
getting hurt this way that the Federal Reserve would think was
a good idea.
And the problem of course is that we're in a budgetary
situation in which some of those things are being cut and not
expanded, but I'd be interested in the programs you supported.
Mr. Greenspan. Let me put it this way. In this regard, I'm
speaking for myself, not the Federal Reserve.
Mr. Frank. Well, I'll take a few personally. It's OK, the
rest are on their own. I'll ask for that from you personally.
But do you think 4.9 percent, though--let's get back to the
macro question--do you think 4.9 percent is as good as we can
do for the next 10 years unemployment?
Mr. Greenspan. No, Congressman. I have not changed my view
on that since we discussed it last. And I have serious
questions about the concept itself, because I don't believe
it's a stable number and I don't believe that one can
categorize.
Mr. Frank. Well, I appreciate that and I think having the
Administration's official projection be that again, this is
assuming that they get everything they want in terms of policy,
we're going to be at 4.9 percent. That's very discouraging so I
hope the next time you and Mr. Hubbard are talking, you might
bring that up.
Let me ask you another question about long-term interest
rates. In the written report we got, on page 23, it talks about
the failure of long-term rates to continue to drop, although,
as you said, they've dropped some, and the report says, ``they
may also have been held up last year by an increased likelihood
of Federal budget deficits and investors' optimism about future
economic prospects.'' Now that's another issue. Some have
argued that the budget deficit is irrelevant or has only very
slight relevance to long-term interest rates. Would you
elaborate on that?
Mr. Greenspan. I've always argued that there is a
relationship and indeed I think the markets respond as though
there is a relationship, and I think quite properly so.
Mr. Frank. Well if the markets respond that way, then there
is obviously.
Mr. Greenspan. Of course.
Mr. Frank. So you think there is a--you're unusually
reticent. I hope it's not simply the reluctance to disagree
with the Administration that gives us the shortest answer I've
ever heard you give on an important issue.
[Laughter.]
Mr. Frank. Would you elaborate a little more? Do you
believe that the switch in the Federal fiscal situation from
expected surplus to expected deficit has had an impact in
keeping long-term interest rates from dropping as much as they
otherwise might?
Mr. Greenspan. No. As I've commented and testified
previously, I do believe that the extent to which interest
rates have not come down as much as they ordinarily would have
in a period say such as this is partly the result of a change
in the long-term fiscal policy.
Mr. Frank. That's two things to talk to Mr. Hubbard about.
Chairman Oxley. The gentleman from Louisiana, Mr. Baker.
Mr. Greenspan. I agree with most of what he says, however.
Mr. Frank. Well, the Republicans can ask you that, Mr.
Greenspan.
Chairman Oxley. Call on Mr. Baker.
Mr. Baker. Thank you, Mr. Chairman.
Chairman Greenspan, welcome. I wanted to return to what I
believe is the underlying economic perspective of the statement
this morning which is essentially that an information-based
economy must have access to accurate free flow of information
in order for it to function properly. Even with the free flow
of such accurate information, that would not predetermine the
advisability of some particular capital investment decision,
but real time accurate information enables proper balancing of
equities to minimize potential market distortions which have
resulted from the release of misleading data. Thus, any
revision of a rule, regulation, or statute that provides for
additional transparency, responsibility for disclosure of
material facts, even more forward-looking statement
responsibility should, to the contrary opinion of some,
minimize, not enhance, market volatilities.
As I understand your statement, reputational capital or the
belief that a non-marketed idea has significant value,
underscores the need for meaningful corporate disclosure.
Additionally, it is appropriate I think for careful review of
all corporate governance standards, given the fact that
reputation has driven many investment decisions. Some have
suggesting that Government regulation can move faster than the
markets to preclude unwarranted activity. I don't believe that
is well-founded. Certainly smart investment individuals know
that Rule 10.b[5] exists and fraudulent conduct can take you
directly to jail without going anywhere else first.
And for those who choose to distort and misrepresent,
Government can provide for consequences of that inappropriate
behavior, but we cannot preclude such behavior. However, real
time disclosure of accurate information to the markets provides
a much more difficult problem for those who choose to pursue
ill advised course, and that is an inability to secure the
capital in the first place to engage in an ill advised
investment practice. Therefore, my question goes to the
advisability of the Committee's future work, not only to
examine but to modify where justified disclosure requirements,
the nature of the disclosures to be made, the timing of the
disclosures, to define more clearly the responsibilities of
corporate executives and members of the board, not only to
disclose material facts but to ensure the independence of the
audit team in reporting of the accurate financial condition of
the corporation.
Such a system should ensure that markets, and by that I
mean every investor, has a platform to make a decision from
which real information leads to sound investment strategies,
not always success but the best possible strategy one can
devise from his own perspective.
Looking backward, Rule FAS-133, for example, on the
treatment of derivatives reporting, even the fair disclosure
regulation I would suggest has not resulted in the type of
disclosure regimes which I think enable competent investment
decisions to be made. And we should be encouraging real time
material fact disclosure, forward-looking statements in order
to ensure that information flows precedent to the decision
being made. Can you comment?
Mr. Greenspan. Yes. Congressman, I generally agree with the
whole thrust of your remarks. Let me just say this, that it's a
very complex issue and clearly as we move toward an
increasingly conceptual environment, the values that are
relevant to producing future income flows and hence the market
value of a firm, depend very much on, as I said in my prepared
remarks, ideas which you cannot physically feel.
Mr. Baker. Let me interrupt on that. Particularly on that
point, a report that indicates the historical position of the
corporation, which is 90 days old does not indicate where an
idea-driven corporation is going in the next 30 days, and the
reporting system itself leads to some misrepresentation in the
investor's mind.
Mr. Greenspan. I think that is a very relevant
consideration. I would say that in periods in the past when
most wealth was visible, in other words, you had automotive
plants, petrochemical feedstock operations, steel mills, there
was real assets which one could evaluate and you couldn't spin
what your open hearth furnace capacity was, it was real.
In today's environment, it is very important that the form
of disclosure essentially fit the nature of the value creation
process.
Mr. Baker. And that the disclosure is complete so there's
not off-balance-sheet obligations which do not reflect the true
financial condition of the corporation.
Mr. Greenspan. I would say, however, that it is important
to remember that no matter what you do, unless you changes the
incentives to game the GAAP accounting system, it will be
gamed.
Mr. Baker. Well, if an executive has a no-cost----
Chairman Oxley. The gentleman's time has expired.
Mr. Baker. Just three seconds. If an executive has a no-
cost option, can run up the stock price, capture that, and then
do a restatement of earnings 6 months later, the shareholder
takes the loss, the executive doesn't, and I think that's
something we need to look at.
Mr. Greenspan. Agreed.
Chairman Oxley. The gentleman from Pennsylvania, Mr.
Kanjorski.
Mr. Kanjorski. Thank you, Mr. Chairman.
Mr. Chairman, following up on Mrs. Maloney's question on
terrorism insurance, we are going to have a hearing later on
this afternoon on that very issue to see what the risk is to
the economy. But, I would like to find out whether or not the
Federal Reserve has gathered any evidence to demonstrate that
this lack of coverage has caused any drag on the economy, or
what the potential future of the economy is, and most of all,
how you see the potential risk and exposure of our banks? Has
there been any use of the failure to acquire terrorism
insurance as a default mechanism in some of our financial
institutions?
Mr. Greenspan. Congressman, we haven't seen any impact of
that nature on the banks. Indeed, much of the problem is it's
presumed that banks won't lend unless a particular borrower has
forms of insurance which previously they did not need. So the
problem is not threats to the banking system, the problem
basically is whether or not the types of real estate activity
which occurred in the past very readily is being held up.
Whether construction's being held up, whether, in fact, there's
a significant impact on the economy.
To date, in an aggregative sense, it does not appear to be
the case. We are still struggling to get enough adequate data
to make judgments but clearly there have been effects. What we
do not know is what the aggregate size of those effects are
because we largely are dealing with anecdotal rather than macro
economic data systems. Hopefully at some point, we'll be able
to get considerably more information but at this stage, I think
it's actually too early to make a judgment of that type.
Mr. Kanjorski. But could I assume, though, that you feel
that the Congress should take action and provide some sort of
backstop?
Mr. Greenspan. I personally do, yes.
Mr. Kanjorski. Now, moving to an entirely different matter,
the Federal Reserve and the Treasury Department have had under
consideration a proposal that would allow national banks and
financial holding companies to engage in real estate management
and brokerage. The proposal has attracted considerable
opposition here on the Hill. As you know, in passing the Gramm-
Leach-Bliley Act, Congress did not intend for banks to engage
in commerce. But this proposal, in my estimation, would subvert
congressional intent. What is the status of this ill-conceived
regulation? Could we get a report?
Mr. Greenspan. Well, Congressman, as you point out, there
has been considerable discussion on this issue, and the
consequence of that is an extraordinary amount of comment that
we have been getting as a consequence of our request for
comment on various different types of rulings. The result is we
have a lot of processing to do so we will work through it. And
obviously since we have to coordinate with the Treasury
Department, we will move as quickly sa we can, but at the
moment it's going to be, in my judgment, a while just
effectively dealing with the processing of comments that we
have so far today.
Mr. Kanjorski. Thank you, Mr. Chairman. I yield back my
time.
Chairman Oxley. The gentleman yields back.
The Chair now recognizes the gentleman from the First
State, Mr. Castle.
Mr. Castle. Thank you, Mr. Chairman.
Chairman Greenspan, let me preview a question I'm not going
to ask you but I'd like to submit in writing to you. I mean I
know you've probably heard it before but it relates to the
creation of money and the selling of money by the United States
the Bureau of Engraving and Printing and the Mint which, as you
know, are done fundamentally differently, and it seems to me
that the BEP's methodology is clear, more transparent in terms
of what they're doing and also accounts for the dollars in a
better sense. The Mint I think the way they do it has a lot of
obfuscation to it that perhaps there's some controls on the
Mint which are not totally in place, not that they're doing
anything wrong with it, and obviously it doesn't score income
for Congress and the 50-state quarter program which I was
involved with is going to produce now $5 to $10 billion in so-
called profits and that's something I think we need to look at.
I'll submit in writing.
My question I want to ask you, questions I want to ask you
today relate to the economy, if you will. A year ago, your
outlook report delivered here predicted, and I quote:
``Stronger economic additions to emerge as the year
progresses'' with the economy growing at a rate of 2 percent to
2.5 percent. The report also said, and I quote again: ``an end
to the profitable investment opportunities in the technology
area does not yet seem to be in sight.'' I guess that was a
longer term than a year statement, since households and
businesses are still in the process of putting recent
innovations in place. Even without the 9/11 attacks, it does
not appear that the economy would have achieved the results,
the 2 percent to 2.5 percent results.
To what do you attribute this under performance?
Mr. Greenspan. Well, Congressman, I'm not sure that that
statement is accurate.
Mr. Castle. You believe it was 2 to 2.5 percent?
Mr. Greenspan. Well, no. I think it was less but not all
that much less. As we were going into the month of August, the
economy was clearly gathering some stability and as we've seen
what's happened in the last few months, I'm sure we would not
have made the actual, the Federal Market Committee's forecast
would have fallen short, but I'm not sure it would have fallen
short by a particularly large among.
Mr. Castle. So you're saying without September 11th, we
would have come close, even though we might not have achieved
it?
Mr. Greenspan. Clearly, without September the 11th, the
third quarter would likely have been no change or maybe a small
plus or very small minus, and the fourth quarter would probably
have done better. Now whether or not that would have added up
to the figures that we have, I don't know, but I think that the
quality of the forecast, if I may differentiate from the
numbers, was not all that far off in my judgment.
Mr. Castle. Well, let me extrapolate all that and carry it
to the future which is what I guess we're all more concerned
about right now. Economic indicators demonstrate that we're
coming out of the recession, at least some of them do that I've
seen, if we're not out already on a technical basis. I would
like to factor into that what the economic impact of the long
term war on terrorism may be, which I think it is going to be,
and also the Enron effect, which appears to be reduced capital
markets of a substantial nature and other corporate uncertainty
which is going on out there. Will these eventually trigger a
recession, going back into a recession? If so, what steps
should we be taking in Congress to prevent or mitigate this?
Mr. Greenspan. Congressman, I think not. Indeed, as I said
earlier, I think after the fact, we'll look back on this Enron
episode as a period when we put our corporate governance back
on track, which would not have happened without it, in my
judgment, not fully. That is favorable to the long-term
outlook. If it were going to have a significant impact on the
economy in the short run, we'd already be seeing it, and we are
not. And I don't deny that there may be other Enrons out there
which we just have not, have not been exposed, it's conceivable
to me, but it cannot be a large issue. It's almost too late for
it to have had delayed effects which would be material. If they
were going to occur, much of what we would have seen, much of
what occurred would have likely occurred earlier rather than
later.
Mr. Castle. I don't mean to get in an argument with you
about this; you know much more than I do, or split hairs, but
it does seem to me that some of these effects could be long-
term.
Mr. Greenspan. Oh, yes.
Mr. Castle. Much longer term than we seen so far in terms
of the accounting aspect of it, the effect on the corporations,
capital markets, just a whole variety of changes which are
going to occur.
Mr. Greenspan. Congressman, I don't deny that. I'm just
basically saying that the order of magnitude is not material
for the long term outlook.
Chairman Oxley. The gentleman's time has expired.
Mr. Greenspan. It will affect, there's no question that
there will be long-term effects of Enron and I think that's
good, not bad.
Chairman Oxley. The gentleman's time has expired.
The gentleman from Vermont, Mr. Sanders.
Mr. Sanders. Thank you very much, Mr. Chairman, and it's
nice to see you again, Mr. Greenspan.
Mr. Greenspan. Thank you.
Mr. Sanders. Mr. Greenspan, as the Nation's chief
economist, I would like to tap your expertise. Over the years,
I think, as you know, you and I have disagreed on some major
economic issues. As I recall the last time you were here, you
informed us, to my amazement, that you actually believe in the
abolition of the minimum wage at a time when many of us think
we should substantially raise the minimum wage.
I also have a very difficult time in recognizing the kind
of rosy economy that you are portraying, and that is not the
economy that I see in Vermont and not the economy I think that
exists in many areas of this country. The reality is, as you
know, the tens of millions of Americans today are working
longer hours for lower wages. Twenty-five or 30 years ago, when
you and I were a little bit younger, the norm was that in the
middle class one breadwinner, one person could earn enough
money to take care of the family, and today for the middle
class that is very much the exception to the rule. The
statistics are amazing about how many two-worker families there
are because of the decline in real wages. With a $400 billion
trade deficit, some folks my colleagues talked about steel, but
it's not just steel. We have lost millions of decent-paying
manufacturing jobs to China, Mexico, and elsewhere and they are
often being replaced by part time temporary jobs in the service
economy which have no benefits, which are low wage. We have 44
million Americans who have no health insurance, millions of
senior citizens can't afford their prescription drugs. One end
of the country to the other, there's a housing crisis. Middle
class families are paying 50 to 60 percent of their incomes for
housing. Families are going in debt to pay for college. The
childcare situation is a national disgrace. So I don't quite
see the economy that you are talking about for the working
families of this country.
But, in fact, the issue that I wanted you to comment on had
to deal with a front page story that appeared in the Wall
Street Journal on Monday. And that dealt with the growth of
economic oligarchies in this country, and the reality that a
small handful of corporate executives have enormous power today
over the U.S. economy, and perhaps never before in our history
have so few people had so much power over the American economy
as is the case today.
The Wall Street Journal gave some examples, and let me give
some others. Twenty years ago, there were thousands of small
cable TV companies; today a pending deal would leave three
companies in control of two-thirds of the market. We used to
have many defense contractors selling defense products to the
Government. Today there are five. We used to have many, or at
least eight, Baby Bell telephone companies; today there are
four. In terms of the media, fewer and fewer giant media
corporations control television, radio, newspapers, and
magazines. Oil, in the wake of oil company mergers, five
companies control more than two-fifths of domestic production.
Agribusiness five firms now account for over 80 percent of the
beef packing market. Six firms account for 75 percent of pork
packing. Airline competition is almost non-existent in many
parts of this country.
So my question to you is has the Government been too lax in
terms of enforcing antitrust regulations. Have we allowed fewer
and fewer corporate executives to have huge amounts of economic
power by controlling industry after industry. Is it morally
right that CEOs of large corporations now make over 500 times
what their workers make, and seem to make more money to the
degree that they lay off American workers. Do you have any
concern about any of these issues?
Mr. Greenspan. Well, Congressman, let me just say there are
a few qualifications I would make to the data that you cite.
First, to be sure, there has been a very considerable
consolidation of defense procurement activities because the
defense budget, as a percent of the GDP, is very much smaller
than it was in periods past, so when you have a declining
industry, you'd expect that to happen.
Mr. Sanders. Several hundred billion dollars is not
insignificant.
Mr. Greenspan. Several hundred billion dollars is a good
deal less than the--remember we're talking about the
relationship within the economy--so that if you go back 20, 30
years, the proportion of the economy which represented defense
was much larger and you can afford--or put it this way; there
was enough business for a much larger number of companies to
function.
Mr. Sanders. But it's not just defense, Mr. Greenspan.
Mr. Greenspan. No, I understand that. Let me go down to--I
mean, to be sure, there's been a consolidation in the oil
industry, but remember that a very significant change has
occurred in the last generation or so when most of the oil, a
very significant part of the oil-producing properties have
effectively been taken over by host countries, especially in
the Middle East, so that the nature of the international oil
companies have changed.
Now I'm not going to say what is in the media. The media is
a very significantly controlled operation and that really gets
down to what Government policy should or should not be. But we
have an extraordinarily competitive economy today. It's more
competitive than I ever recall it and indeed the international
aspects of the competition is one of the reasons why I think,
contrary to the remarks that you made, that the standard of
living of this country is higher than it's ever been on
average, and two----
Mr. Sanders. I would respectfully disagree with you. I
think the facts do not speak to what you say.
Chairman Oxley. The gentleman's time has expired. Does the
Chairman wish to continue?
Mr. Greenspan. I just basically wish to stipulate that we
have an extraordinary standard of living. I don't deny that
there are, as there always will be, significant parts of our
population which are basically in difficulty in one form or
another with respect to the economy. I think we ought to work
as hard as we can to alleviate that but I don't think it
changes the fact that the economy is doing extraordinarily well
in an historic context, that all of the data that most
economists would adhere to believe the standard of living is
higher than ever before on average. And if you wish to dispute
that then to be sure we do have a very significant disagreement
as we always do.
Chairman Oxley. The gentleman's time has expired.
The pivoting from one corner of the philosophical divide to
another, I now recognize the gentleman from Texas, Mr. Paul.
[Laughter.]
Mr. Paul. Thank you, Mr. Chairman.
Welcome, Chairman Greenspan. I wanted to start by referring
to a speech you gave in January at the American Numismatic
Society where you spoke profoundly about monetary policy and
said that central bankers have had relative success over the
past decades, and it raises hopes that the fiat monetary system
can be managed in a responsible way. So I think you're still at
the point of hoping that this system will work. I maintain that
the jury is still out on whether or not fiat money will work
over the long-term.
And then you followed it up by saying, in case it didn't
work, and I don't know whether you had tongue-in-cheek or not
about this, but you said that we might have to go back to sea
shells and oxen as our medium of exchange.
And then you reassured everybody that the discount window
would have an adequate supply of oxen. Chairman Oxley, if we
get to this point, which I suspect we will someday, I ask you
that we have hearings to debate the issue of what medium of
exchange we have before the Fed starts using oxen as a medium
of exchange.
Chairman Oxley. Are you referring to the Chairman here?
Mr. Paul. Yes, I hope that you will at least consider that.
But I think it is an important point and I want to relate that
to the Enron issue, because in many ways, I think the system
that you have been asked to manage is similar to being asked to
manage an Enron system. Because Congress is notoriously in
favor of deficit spending, we're currently expanding the
national debt at $250 billion a year, and we have nearly a $6
trillion debt.
Now we create that debt by buying votes. We spend a lot of
money. Then the Federal Reserve comes in and they buy that debt
in order to maintain the interest rate that they think is the
right interest rate. And they take that and use it as an asset.
You put it in the bank. You call this debt that we created an
asset, and you use it as collateral for our Federal Reserve
notes. So that's a pretty good scheme, and I think in the moral
terms, as well as the economic terms, it's very similar to how
Enron operates. I'm not convinced the system works very well
because a lot of people here praise you for the adequate amount
of liquidity and that's what inflation is: create more money,
lower interest rates. Every time you ask for liquidity, and
every time you ask for lower interest rates, you're asking for
inflation of the money supply. I think that what we fail to do
is to ask about the cost. Do we ever concern ourselves about
the people who have had two-thirds of their income removed
because they happened to be savers and living off interest? We
gouge them with inflation, the loss of purchasing power, and
taxes. A lot of people in this country have suffered from this
particular system.
Now the analogy I would like to draw is something you said
in your testimony on page 13, and you have mentioned several
times now that Enron may be a good lesson, and I think it is.
And I'm not for more of this regulation by SEC. I think you're
correct that derivatives provide a market tool that is
worthwhile, but you also said the Enron decline is an effective
illustration of the vulnerability of a firm whose market value
largely rests on capitalized reputation, with very little on no
physical assets. That's exactly what our monetary system is all
about, and that's why I believe the dollar is vulnerable. We in
Congress do not have a responsibility to run Enron. Some other
government has the responsibility to deal with fraud. We have a
responsibility to the dollar, and I think that's what we fail
so often to address around here.
In addition, you said that Enron provides encouragement
that the force of market discipline can be counted on over time
to foster a much greater transparency. That's exactly what the
market does with money. If you look at the rapid and the sudden
devaluations of the fiat currencies around the world, such as
what happened to us in 1979 and 1980, that was the market
coming in and forcing vulnerability and transparency on us. Now
gold gives you a hint as to what's happening. Gold has sent a
mild message in this past year. In spite of the fact that
central banks and others continually sell and loan out gold and
push the price of gold down, there is a message there.
So I would ask you, can you see any corollary whatsoever on
what you're asked to do in running our monetary system to that
which Enron was involved in?
Mr. Greenspan. I hope there are fundamental differences.
First, dealing with essentially a fiat currency, what it is
that we are doing is that the currency is granted value by fiat
of the sovereign, as it is said in the textbooks. The issue
there is that in years past, there has been considerable
evidence that fiat currencies have been mismanaged in general,
and that inflation has been too often the result. What I was
mentioning in the speech that you were referring to is the fact
there is some evidence that we're learning that lesson,
learning how to manage a fiat currency. I've always had some
considerable skepticism about whether that in the long run can
succeed, but I must say to you that the evidence of recent
decades is that it has been succeeding. Whether that continues
is a forecast which I can't really project on.
The Enron situation is essentially one in which there was
an endeavor to imply that earnings were much greater than they
really were, that increasing debt was hidden. I can think of no
reason to have done what they did with their off-balance sheet
transactions other than to obscure the extent of the debt they
had, and what essentially was squandered in that process was
the reputational capital which they had succeeded in achieving
over a period of time. And I don't perceive that anything that
we are doing as a Central Bank involves anything related to
that. I hope that where we need to be transparent and indicate
what we are doing we do so, and we do so except in those areas
where it, as I mentioned to you previously, inhibits the
ability to actually function as a Central Bank.
But as I say in summary, I hope your analogy is
inappropriate.
Mr. Paul. I guess we'll all keep hoping.
Chairman Oxley. The gentleman from California, Mr. Sherman.
Mr. Sherman. Thank you.
Thank you, Chairman Greenspan, for an outstanding
presentation. As before, I've got far more questions than the 5
minutes allotted so, as in the past, I'd like to start off with
some questions that I hope that you and the Fed Staff would
respond to for the record.
We met here a year ago. Of course, you come every 6 months,
but a year ago is the last time I'd had a chance to ask you a
question, and we dealt with the incredible deficit and I'd coin
the term ``trade debt,'' that is to say, the trade deficit
building up year after year, the transfer of assets abroad, and
I'm still amazed that the dollar sells for more than the euro,
and that we hope that this trade debt and deficit reach a soft
landing. I don't know anyone who could have predicted a decade
ago that the country could run a trade deficit as long and as
large as we have and still have such a strong currency.
I'd like to restate the concern that I expressed to you in
this room a year ago, and echo the comments of Mr. Kanjorski
that real estate brokerage was never designed to be something
included in the grant of powers to national banks and financial
institutions. Not only is it bad public policy, but I think
that if the bank regulators go down that road, it will undercut
your relationship with Congress. We were in this room for
literally hundreds of hours over half-a-dozen or more years
trying to paint a picture for ourselves as to what financial
reform would mean and under particular statutory text.
None of us in this room ever put forth the idea that the
bill we passed would open this huge industry to those insured
financial institutions. And I noted that you have not acted
precipitously in this area. You indicated that you're going to
wait for a chance to respond to all the incoming comment and if
what it takes to avoid precipitous action is additional
incoming comment that needs response, I'm sure that can be
arranged.
First, as to economic stimulus, there's two ways to do it,
monetary and fiscal. The monetary has immediate effect. You
could meet in the next day. The interest rates are lower. It
may not have an immediate impact. Fiscal takes months, it
seems, for the IRS to even get the checks out to even have an
effect, let alone an impact. Yet it's odd that this country is
now thinking in terms of fiscal stimulus and monetary sedative,
for want of a word to express the opposite of stimulus. First,
let me urge you to consider cutting interest rates one more
time instead of increasing them.
But second, putting aside your well-known preference for
lower total Federal expenditures, and assuming those
expenditures are going to remain the same, does it make any
sense for Congress to be thinking of fiscal stimulus while the
Fed is at least rumored to be considering monetary sedative?
Mr. Greenspan. The problem with fiscal policy, as
economists have begun to realize over the decades is that it's
very difficult to implement in a timely manner largely because
our capacity to forecast in a specific timeframe itself is
limited.
Nonetheless, as I indicated over the last year or two, if
it turns out that you can fortuitously time a tax cut in a
period of economic weakness, it obviously does do some good. I
do think that the tax cuts of last year in the middle of the
year did show up as increased expenditures in July and August.
That's not the way they were constructed in that timing, but
they turned out to be actually quite effective as best I could
judge.
But the broader question still remains whether it is
possible to implement an effective fiscal policy with the
inevitable time lags that are involved. I'm skeptical myself
that it is feasible.
Mr. Sherman. Do we need stimulus at this time, let alone is
there any evidence that we need stimulus 6 months from now, or
a year from now?
Mr. Greenspan. Well, the question really rests on whether
the level of final sales will kick in, as I put it in my
prepared remarks, prior to when the obvious significant
positive thrust coming from a reduction in inventory
liquidation dissipates. It's too soon to make that judgment at
this particular point. So one can argue that if one believes
that it might not, that as an insurance policy, you might want
some fiscal stimulus.
My own impression is that it's probably not necessary, as I
indicated in previous testimony. But there is a credible
argument for it as an insurance policy for those who believe
that the economy may be at risk of not being able to follow
through after we get the inventory turnaround.
Chairman Oxley. The gentleman's time has expired.
Mr. Sherman. If I could have just ten seconds, though.
Chairman Oxley. The gentleman from California, Mr. Cox.
Mr. Cox. I'd yield ten seconds to my colleague.
Mr. Sherman. I just want to point out that the cheaper
insurance policy is for you to cut interest rates which would
have the stimulus effect if that was determined to be needed
without increasing the national debt. I thank the gentleman.
Mr. Cox. Mr. Chairman, welcome. As you point out in your
testimony, the proper functioning of our markets depends upon
investor confidence. And the Enron debacle, which is in major
part an accounting scandal, has eroded public confidence in,
among other things, financial reports generally. It has put a
glaring light on the role of directors, particularly members of
the audit committee. It has cast into doubt the adequacy of the
entire accounting profession.
To address these problems you, regulators, Congress, the
SROs and the private sector know that we have got to take every
responsible step to increase auditor independence, to
strengthen the role of the audit committee, of an independent
audit committee, to fortify the accounting profession to
attract highly skilled, intelligent people of integrity. And
yet if we survey the lay of the land today, we know that the
market forces, the trends, the incentives are all running in
the opposite direction.
At a time when we need the very best people to serve on
boards, the risk to such service is greater than ever. We can
ask ourselves based on very real experience of late, who would
want to volunteer for service on an audit committee of any
large enterprise today? Whereas, 30 years ago, many top
graduates of the Nation's business schools headed for the
accounting profession. That's no longer the case, and Enron has
almost certainly made the problem worse.
The question I'd like to put to you is what we as Congress
can do and what the private sector can do, what regulators and
SROs can do to address the problem of auditor compensation
while still--or not while still, but while actually increasing
auditor independence? And what can we do to encourage people of
character and reputation to risk those irreplaceable assets to
serve on the boards and the audit Committees of the Nation's
businesses?
Mr. Greenspan. Congressman, this is an issue which the
President's Working Group is deeply involved in at this
particular stage. One of the things that I think is becoming
evident is that the change in corporate governance which has
occurred over the generations where you very rarely now have
shareholder control in a limited number of hands so that
effectively the directors are appointed and work for the
shareholders and the CEO is appointed and works for the
directors.
The fact that such a substantial amount of shareholding is
now for investment and not for control has effectively switched
the locus of control from shareholders to the CEO. And if the
CEO endeavors to run the company wholly in the interests of
shareholders, then there's no loss in the structure of
corporate governance. And it's in our judgment that what we
have to start to do is to try to find those areas where the
CEO's self-interest has diverged from that of shareholders and
try to find means and incentives which would restore what, I
think, was the case 20 or 30 years ago before short-term
earnings expectations became such a critical issue in what
individual corporate managements were able to do.
My own judgment is that you have to be careful about trying
to presume that directors are really, truly independent. I've
served on innumerable boards in the private sector, and there
is an asymmetry of information between an insider in a
corporation and an outside director which will never be
breached, which will never be brought together, I should say.
The result of that is that it is crucially important that
the incentives require that the CEO behave in a certain manner
or be incentivized in a certain manner. I've served on too many
audit committees to know that even though I would consider
myself independent, I would consider myself knowledgeable, I
did not know what questions to ask the chief financial officer
during meetings to find out what it is that conceivably is
going wrong in the corporation, and he wasn't about to tell me.
So that there is a very difficult problem that one
confronts, and the mere presumption that you somehow make a
bunch of people independent and have an independent audit
committee, it won't work that simply because if you make
everybody on the board independent, what's going to happen is
you're going to have competing power centers within a
corporation. And in my judgment, corporate governance will
suffer as a consequence.
Mr. Cox. Mr. Greenspan, I wonder also if--you're making the
case for the complexity of the problem. I wonder if you could
address the concern which is no matter how we address corporate
governance issues remains, and that is how you attract quality
people. Because I think the accounting profession has taken a
hit. I think that the ranks of boards and audit committees are
going to take a hit. And we've got to have good people in these
positions if we're going to lick these problems.
Chairman Oxley. If I could interfere just briefly. We have
a vote on the floor. Make that the last question. The Chairman
could respond and then we'll take a break for the vote.
Mr. Greenspan. Why don't I answer it later then, if that's
the case?
Mr. Cox. Well, I'm happy to put the question to you now and
hear your response and not put any further questions so that we
can that wrap it up, Mr. Chairman.
Chairman Oxley. Yes. If the Chairman would like to respond.
Mr. Greenspan. Which specific question did you want to ask
quickly?
Mr. Cox. The burden of my question is, we are seeing
increasing risk to the individuals who we want to be even more
responsible than they have been in the past, and we've got to
attract persons of training and integrity to these positions.
What structurally can you recommend to the Congress that we
might do to fortify the accounting profession and the ranks of
our directors?
Mr. Greenspan. It's my impression on the basis of
experience I've had in an innumerable number of boards on which
I have served that if you get a chief executive officer who
looks toward his outside auditor as somebody to tell him what
he is doing wrong rather than somebody who should try to
acquiesce in a particular set of accounting principles, he will
change the whole nature of the relationship between directors,
CEOs, and he will certainly create the type of independence of
the audit function that will attract numbers of people back
into the accounting profession and create the type of directors
who will be most effectively helpful to the CEO and to the
shareholders in getting appropriate corporate governance.
Chairman Oxley. The gentleman's time has expired. The Chair
would declare a recess of the hearing for the vote, and we will
reconvene in 10 minutes.
[Recess.]
Chairman Oxley. The hearing will come to order. And the
Chair now recognizes the gentleman from Pennsylvania, Mr.
Mascara.
Mr. Mascara. Thank you, Mr. Chairman.
I'd like to revisit the steel crisis issue, Mr. Chairman. I
come from Southwestern Pennsylvania where steel and coal used
to be king. And as we all know, there is an apparent steel
crisis. The steelworkers will be here tomorrow at a rally to
stand up for steel and I certainly will visit with them.
First of all, I happen to believe that the steel crisis is
a microcosm of our failed trade policies. And I don't want to
get into that, because that's a long story. But, I respectfully
disagree with you in an earlier comment to a question about
what effect tariffs would have on steel, and that perhaps
prices would increase as a result of even as high as 40
percent. The President, on March the 6th, will make a decision
about the percentage of increase on steel tariffs.
I don't believe that I've seen any decrease in the cost of
automobiles, appliances as a result of the consumer consumption
or the domestic steel users in this country of that cheap steel
passing that profit on or any part of it to the people who buy
automobiles and appliances. That's one point I want to make.
And I'm wondering whether you have any feel for what the
President--I'm not asking you to guess the President--but what
the President should do in regards to the March 6th decision
that he has to make?
On Sunday, I was on KDKA television in Pittsburgh with the
CEO of Weirton Steel that employs 3,500 steelworkers. He said
that 20 percent would be of no help and that eventually the
steel industry would die on the vine, that companies continue
to go into Chapter 11. In fact, Wheeling-Pittsburgh Steel plant
in my district is now in Chapter 11. And I was wondering
whether you had any feel where that number should go from 40
percent down, given that 20 percent won't work.
Mr. Greenspan. Well, first of all, I'm not clear as to what
you mean if you put a tariff on that the price will not go up.
If it doesn't go up then it has no impact on the domestic steel
price that the traditional steel operations are still under
severe pressure because their margins are not going to change.
I'm not sure if a tariff doesn't increase the domestic price
its impact on domestic profitability and employment is zero.
Mr. Mascara. What I said, Mr. Chairman, is that the savings
that the domestic users of steel to make their products with,
that savings has not been passed on to the consumers.
Mr. Greenspan. Well, if it hasn't, then the profits of the
steel-using industry must have risen significantly and there's
no evidence of that happening, Congressman.
Mr. Mascara. Well, I don't have those facts here. But there
is a concern that the steel industry will cease to exist. Have
you considered the national security impact? Bethlehem Steel,
which is one of the only producers of the steel that's used in
ships and tanks, is also in Chapter 11 now. And do you feel
that if the steel industry does, in fact, cease to exist in
this country--and those kinds of talks are going on currently--
what will we do in the event that we need to produce that kind
of steel? Would we have to depend on foreign production of that
type of steel?
Mr. Greenspan. Are you talking about defense?
Mr. Mascara. Yes.
Mr. Greenspan. You're talking about steel plate and the
like?
Mr. Mascara. Yes.
Mr. Greenspan. Well, first of all, I don't believe that
it's credible to presume that the steel industry will no longer
exist, because half of the mills, as you know, are electric arc
furnace, steel scrap consumers and while they're under some
pressure because of the obvious weakness in steel prices,
they're doing reasonably well. And there's no evidence of which
I am aware would suggest that they're going out of business.
The crucial issue that really is involved with the notion
of the traditional steel industry is there are certain types of
steel which cannot be made effectively in a scrap furnace. In
other words, the chemical control that you have of the scrap
makes it difficult to create the type of steel which for
example you need in an automobile for forming purposes and the
like.
And so that there is a need in the country for a certain
what I would call ore-originated steel, because you can
essentially control the metallurgy in an appropriate manner.
But that's not a very large number. And indeed, as you know,
there's a good deal of slab imports which are made from ore and
which are rolled into a type of cold-rolled sheet which the
automobile manufacturers need.
As far as steel for defense, the amounts that we need are
extraordinarily small. And I'm not convinced, at least from
what I understand it, that with the appropriate amount of
pellets within say a scrap mix that a goodly part of the actual
heavy steel that we need is not available.
But in any event, I mean there's certainly not going to be
a disappearance of the traditional steel industry. I do agree
with you that it's under severe difficulty and as one who is
old enough to have visited the old Homestead Works when they
were really extraordinarily effective and productive, I know
what it means for that type of industrial structure to fade.
Mr. Mascara. My time has expired. But apparently we
disagree on some issues as it relates to the stability of steel
industry. There are hundreds of thousands of retired
steelworkers who now may lose their health care and pensions. I
think the President ought to do something and do it very
quickly. Thank you, Mr. Chairman.
Chairman Oxley. The gentleman's time has expired.
The gentlelady from New York, Mrs. Kelly.
Mrs. Kelly. Thank you, Mr. Chairman.
Mr. Greenspan, you've been here a long time and so I really
want to make this fast. But I noticed something that I wanted
to ask you about. We saw in the news this morning the Commerce
Department said that durable goods rose by 2.6 percent in
January and they rose in December by .9 percent. But in your
testimony on page 4, you said, as a consequence, although
household spending should continue to trend up, the potential
for significant acceleration in activity in that sector--this
sector is likely to be more limited than in past cycles.
That seems to be somewhat in conflict with the numbers, and
I wanted to know if you believe that this is a trend in durable
goods and one that's likely to continue. I wonder if you'd
address that for me.
Mr. Greenspan. I would say looking at the data that we saw
today, clearly it's encouraging that the markets are coming
back. But they went down in an awfully extended way and they
were under really severe pressure. So I think that it's going
to take a while to be sure that we're getting the type of
response that we're going to ultimately need.
There are a number of elements in the capital goods markets
which are still quite weak. And indeed, some of the anecdotal
stuff especially. And in the telecommunications area, for
example, orders are not showing very much. They did improve in
this morning's numbers and that was encouraging. But all I
would say to you is that, yes, the durable goods orders were
somewhat better than I would have expected this morning. That
if they continue that way, then I think things will clearly
improve.
But it's too soon to make those types of judgments. We need
a good deal more time to see that this recovery is integrating,
is taking shape in an integrated form.
Ms. Kelly. So you don't feel that the numbers over the
past--I know the projects in December had projected zero growth
or negative, and we got a .9 percent. And here we are in
January with a 2.6 percent. You're saying you don't feel that
that yet, that that's enough to make a trend?
Mr. Greenspan. No. I think it's certainly enough to
indicate that the hypothesis that we're coming out of what has
been a period of significant stress that the probability is
improving. It's nonetheless still early in the sequence.
Ms. Kelly. Let me just throw something else in that
equation. According to the National Association of Realtors,
existing home sales for January set a monthly record. They
topped out a $6 million mark for the first time.
On page 5 of your testimony, you say in recent months, low
mortgage interest rates and favorable weather have provided
considerable support to homebuilding. Moreover, attractive
mortgage rates have bolstered the sales of existing homes and
the extraction of capital gains embedded in home equity that
those sales engender.
With all that said, do you feel that this is a trend in the
new home sales and you think that's a sustainable trend for the
near future or do you think that trend may slow down?
Mr. Greenspan. You mean $6 million annual rate figure?
That's clearly not going to be sustained. I mean, there's just
no evidence that we're off on a different track. Because
remember that existing home sales are essentially a rate of
turnover of the existing single family housing stock plus
condominiums. And historically, that ratio doesn't change all
that much. It's a gradual change in households, and the
turnover is related very largely to demographic forces as well
as the obvious economic forces which I cited.
So if you're asking me do I think the $6 million number
will stay up there, I think unlikely. But nonetheless, it's
still impressive.
Ms. Kelly. Would you say that you feel that the trend
toward increasing home sales would continue whether it hits
that mark or not?
Mr. Greenspan. Well, I think the trend of existing home
sales has been relatively flat at a reasonably high level for
quite a long period of time. And if we can even maintain that,
I think we're doing well.
Ms. Kelly. Thank you very much. My time is up. Thank you,
Mr. Chairman.
Chairman Oxley. The gentlelady's time has expired.
The gentleman from Washington, Mr. Inslee.
Mr. Inslee. Thank you.
Mr. Chairman, we've all been talking about the concerns
about Enron and the prospect of other Enrons out there, of
other organizations that would overstate revenues and
understate costs. And I know of at least one other large
organization that's exactly in that position of deceiving
essentially their shareholders in that regard. You're smiling.
You see where I'm going with this. Which is the United States
Federal Government.
And it's my belief that our deceit of our shareholders sort
of makes Enron look like small potatoes, considering the phony
accounting that we indulge in that I believe is leading us to
chronic deficits over the next decade unless something happens.
And let me just list three of those that I believe that are
phony bookkeeping that disguises the fact that we're going to
have these chronic deficits. We're already over $100 billion
this year, as you know.
You know, we tell the American people that tax exemptions
that are now in the Code aren't going to be renewed when the
Administration makes their projections. We all know that's not
true. They're going to be renewed. Everybody in this town knows
it, including the folks in the White House.
We know that the AMT eventually is going to be fixed, has
to be fixed, because so many millions of Americans will be
subject to it. Everybody in this town knows that, and yet we
don't tell the American people that. We base projections on
that phony statement.
We know there's going to be relief for Medicare of some of
the cuts that have damaged health care in this country, and
everybody in this town knows that this is going to happen.
Now assuming that's true, looking at the numbers, we're in
for, at least in my view, long-term deficits somewhat
approaching the history of the 1980s, which was a movie we saw
once before, of big tax cuts, big defense buildup, and
unrestrained domestic spending. And I guess my question to you
is, if we end up back in that pickle because of our Enron-like
activities at the Federal level, what impact do you think could
that have on the U.S. economy in the next decade?
Mr. Greenspan. Well, obviously, if we resort to a
significant amount of deficit spending, the question
essentially is how is it financed? And it's financed basically
by extracting capital from the private sector. And to the
extent that you do that, obviously, the capital assets which
are produced are generally less productive in producing
economic goods than is the case when the Government's drain on
resources is neutral or zero even or slightly in surplus so
that it's merely a simple question of how it's financed and
what the implications of that are, and history tells us that
it's not very helpful.
Mr. Inslee. I think there's another downside, too, and let
me just ask you about this. And that is that essentially the
Administration is financing this budget deficit by raiding
Social Security. And of course, Congress and the Administration
has told Americans for the last couple of years that raiding
Social Security was no longer going to be countenanced in this
town, and that's exactly what we're doing.
And now, because of these faulty, phony numbers that we're
posing about, we're going to be again raiding Social Security
for the next decade to finance this deficit. I've heard it
expressed that that in itself is a problem when you talk about
Americans' confidence. And I can tell you that people right
now, because of that seriously question whether Social Security
is going to be there for them.
I was meeting with a group of young people in their early
twenties. They honestly don't believe Social Security is going
to be there for them. And one of the reasons they do is because
of this budget that the majority--and I'm not a part of that
here--as past will put us back in these deficits.
So I guess is that a factor that we should consider when we
look at what people are doing in their personal investment
decisions?
Mr. Greenspan. Well, first of all Congressman, remember
that the types of accounts which are kept both at OMB and CBO
are reflective of the laws passed by the Congress. In other
words, if the statute stipulates that a certain law is to end
as of a certain date, it, meaning OMB--well, it's basically
CBO, because OMB can assume that and extend it if it wants, but
CBO cannot. In other words, it's not making the laws, it's
merely registering what the accounts imply under existing
statute.
So I would think that if you want to alter that, you're
going to have to change the statute or change the rules on
which you request CBO to give you the types of data which they
do.
With regard to the issue of Social Security, if the Social
Security trust fund goes to zero, the chances that benefits
will be curtailed in my judgment is zero. And the reason for
that is I see no credible scenario in which the Congress would
fail to adhere to the benefits as now appear in law. So I don't
think it's a credible issue to be concerned about what is
happening to the Social Security trust fund if the issue is
whether benefits will be continued. Because I've been around
this town long enough to know that that's not the way it works
and I think if you're talking about making certain we keep the
books balanced, I would also suggest that we try to resolve the
issues that are real and I don't think it's a real issue, nor
do I think the American people have to be concerned about their
benefits disappearing if the fund disappears.
Now what I think younger people are concerned about is the
rate of return that they're getting in benefits from the
numbers that they put in the fund is much lower than, for
example, my generation. I mean, if you look at what I put in
and what I got out or what I would have gotten out if I retired
at 65, is an extraordinary rate of return. And Social Security
was remarkably popular for my generation. I don't think it is
for the younger generation. But, because of the fact that
they're not perceived as getting back an adequate return.
Chairman Oxley. The gentleman's time has expired.
Mr. Inslee. Thank you, Mr. Chairman.
Chairman Oxley. Mr. Chairman, we're glad you didn't retire
at 65. The gentlelady from Illinois.
Mrs. Biggert. Thank you, Mr. Chairman. And thank you, Mr.
Chairman for staying this long to allow us to ask questions.
As you're aware, the electronic transfer of value was not
interrupted by the tragedy of September 11th, but as I
understand it, for a period after September 11th, many of the
banks really didn't know what their true financial position was
because it was impossible to move the checks and payments
around the country, particularly because of the airlines not
flying and for various other reasons.
But is the Fed doing anything to ensure that the payments
mechanism really is going toward or using the technology such
as electronification of paper checks to facilitate the
stability of that system?
Mr. Greenspan. We are, Congresswoman. We were sort of taken
aback by the extent to which the amount of telephonic exchange
and data processing exchange which presumably was supposed to
be back up in the lower Manhattan area during the period
subsequent to September the 11th, we had assumed that a goodly
part of that backup would work. The trouble, unfortunately, is
a lot of the backup went over the same cable lines that the
original systems went and were quite useless for a while. And
as you point out, we had a very significant amount of float in
the system as a consequence of the airlines effectively
stopping and not delivering.
We have a proposal, I believe it's up to the Hill now, on
truncation of checks and the effect of implementation of a
significant amount of electronic processing to move the checks
through the system in a much more facile way.
Mrs. Biggert. Do you think that Congress needs to pass such
a bill on check truncation? Or can the Federal Reserve do it
through their rules and regulations?
Mr. Greenspan. No. I think we need legislation.
Mrs. Biggert. Thank you. Let me turn for a minute to trade.
I don't think we've talked too much about that. What effect
would a free trade area of the Americas have on the U.S.
economy? And can we afford to wait for the time that it seems
to be taking to get that through?
Mr. Greenspan. Well, I think the evidence increasingly is
persuasive that the greater the amount of cross-border trade,
the higher the standards of living everywhere. And to the
extent that we can facilitate the emergence of greater trade
irrespective of where, provided that the individual trade
groups do not themselves become protectionist, then it's all to
the good. And all I can say, Congresswoman, is I trust that we
will move forward expanding trade and gain the benefits and
recognize that the problems that that invariably creates for a
number of our industries which are under severe competitive
pressures, that we recognize that we should find ways to
assuage those problems.
Mrs. Biggert. Is there any difference between bilateral
trade agreements or multilateral? Should we be looking if we
can't get the free trade area, start with bilateral?
Mr. Greenspan. Well, no. I would say that the greater the
number of players, if I may put it that way, the better. So
multilateral and indeed global is by far the best. Bilateral
trade is helpful but only as a fallback position, because it is
better than no trade but certainly not as good as global trade.
Mrs. Biggert. Thank you. Thank you, Mr. Chairman.
Chairman Oxley. The gentleman from Kansas, Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
And Chairman Greenspan, I very much appreciate your being
with us again today. Secretary Paul O'Neill recently requested
that Congress increase the statutory limit on the public debt
from $5.9 trillion to $6.65 trillion, about three-quarters of a
trillion dollars. I guess my question is, and I don't know if
there's any good answer to this, are we opening up the
checkbook so to speak if we increase it by three-quarters of a
trillion dollars, say, as opposed to $250 billion? Do you have
any thoughts about that?
Mr. Greenspan. Well, first of all, I think that I'm not a
great proponent of this type of legislation to begin with,
because I think that the Congress enacts tax structure and it
enacts appropriations, and the difference between those two is
the change in the debt.
To then have to reauthorize a different level of debt is
very much like trying to restructure arithmetic. I mean, you've
already done it. And it's not really appropriate to then put on
a debt ceiling and then find yourself with contrary law.
Because clearly, you cannot simultaneously have your tax
legislation, your appropriations and your debt ceiling, they
may not be in agreement, in which case some law is being
violated, and I think that is inappropriate.
Mr. Moore. Is there any benefit, though, to such a check
and saying we're going to have a public discussion about this
before we increase the public debt any more?
Mr. Greenspan. Well, first of all, I should hope one does
that in the appropriations discussions.
Mr. Moore. Certainly.
Mr. Greenspan. I mean, that's where theoretically it
occurs. The problem I have with the specific legislation is
that if you're going to do it, and as I say, that's not what I
would do, I would put it on the debt to the public, which is
truly the difference between receipts and outlays in the
unified budget. The inclusion of the two-odd-trillion dollars--
a little more than two trillion dollars--in intragovernmental
holdings in my judgment serves no useful purpose, and that as a
consequence of that, even granting, I mean, even granting that
a debt ceiling might be usable, that's not the one I would use.
Mr. Moore. Chairman Greenspan, you talked about the
importance of confidence of people in the economy and how that
affects the economy. And I wonder, is there a relationship
between fiscal surpluses and/or debts and long-term interest
rates? And I've heard some people in the past, for example,
say--and maybe this is too simplistic, and you can tell me if
it is--that if we're able to pay down $100 billion or $300
billion or a half a trillion dollars in debt, that it would
beneficially affect interest, long-term interest rates.
Mr. Greenspan. I think that's right. And indeed, just
remember, it's other things equal.
Mr. Moore. Yes, sir.
Mr. Greenspan. I think the evidence pretty much is
conclusive on that, although I must tell you that there's a
very considerable degree of differences amongst economists. And
clearly, I don't want to get into the details of it, but you
will find people who don't agree with that. And I think
everyone agrees that under extreme circumstances where, in
fact, you have huge deficits and inflation is being engendered
that long-term interest rates go up and indeed, in those types
of economies, you cannot sell long-term debt. No one will buy
it.
But there is a legitimate dispute as to what the
relationship is between surpluses and deficits when those are
in a relatively narrow range, is it conceivable that the
changes are very modest? And the answer is yes, it is
conceivable, and that may indeed be the case.
Mr. Moore. One of the Members said that they were happy
that you hadn't retired when you were 65, and I was listening
to NPR this morning. They were talking about the possibility of
your departure prior to the expiration of your term. And I for
one hope you stay.
Mr. Greenspan. Thank you very much.
Chairman Oxley. The gentleman's time has expired.
The gentleman from California, Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman.
Welcome, Chairman Greenspan. What I wanted to ask you about
specifically were some of the incentives that are currently in
place for management. Incentives, especially in terms of the
evolution of compensation packages with stock options, which at
times in some firms have management pushing for very aggressive
accounting methodologies, and then at the same time have
management deciding who is going to do the audit and then
trying to influence the outcome of that audit.
And it seems to me that one of the questions would be can
we change the structure in some way so that either the audit
committee is truly independent and truly picking the auditor,
the auditor responding to the audit committee rather than to
management, and do you do that by setting up some special
regulatory structure where the audit committee reports
separately? Or do you do that by maybe requiring audit
insurance perhaps rather than the mandate of an outside audit,
have the insurer have the vested interest for transparency in
the accounting? Or do you look at these public companies that
are on the New York Stock Exchange or the Nasdaq and say, all
right, give the Exchange the responsibility of picking the
auditor?
Any of these approaches might make the audit truly
representative, even in these cases like Enron's, because it
would change the incentive structure. Either that or change the
incentives for management's compensation, which would be
another way to approach the same problem and have management
act in the interest of the shareholders.
But could you maybe respond to those concepts and whether
you think they're viable?
Mr. Greenspan. Yes. Well, I do agree that how a firm is
audited and by whom is quite important. The issue that I think
is crucial here is that if properly constructed and I would say
the structure of corporate governance, that it's interest of
the CEO to see that you have an effective external audit,
remembering that it's an audit of the internal auditing system,
you certainly want an auditor who knows your business, knows
your company and consequently the reason why it's important to
at least have the corporation either choose or acquiesce in a
specific choice of an auditor is that it is quite credible to
get somebody who doesn't have a clue as to what, in fact, he's
auditing.
And the experience of the auditing profession is under such
conditions you find that embezzlements occur far more readily
in the early years of a new audit system than they do later on.
So you have to be careful about unintended consequences of
alternating a system which has evolved over the years.
The President's Working Group has been instructed to look
into this issue in some considerable detail, and we are in the
process of doing that.
My general impression personally, having looked at a whole
series of ways of coming at this, that because under the vast
majority of corporate relationships with outside auditors, the
outside auditor not only is a good independent auditor but also
is very helpful to the CEO in overseeing how his own internal
system works and suggesting to him what he can do to improve
the internal workings of the system. And it's my judgment,
having seen this function for decades, it's best when you have
a good relationship between the auditor and the CEO.
If, however, it turns out, as I fear regrettably seems to
have been the case in the Enron situation, that a number of
internal strategies thought up by internal auditors were agreed
to by the external auditor only to find later on that it had to
be reversed. Now that is very unfortunate circumstance and
probably regrettably as a consequence of incentives not being
appropriately positioned.
I reemphasize as I've said to your colleagues in earlier
questioning, if you can somehow find a way to create a set of
incentives for the chief executive officer to function solely
in the interests of the long-term values of the shareholders,
then the whole issues of independent directors, independent
auditors and good corporate governance system comes into play.
Mr. Royce. As part of that, just to follow up, would part
of that potentially be looking at the way in which proxy votes
are manipulated by management and vesting more direct power in
the shareholders by making changes or recommending changes in
the system where management can't corral basically proxy votes
in order to----
Mr. Greenspan. Well, that obviously is the type of thing
which I think is an appropriate issue for evaluation. The way,
regrettably, the system works today is that the vast, vast
majority of votes by shareholders are either 99-to-1, 98-to-2
if it's 95-to-5, it's perceived to be a disaster for
management.
Now what that clearly tells you is that the slate of
directors, the various issues presented to shareholders for
authorization, largely comes from the CEO. And unless and until
you change the incentives for the CEO to do things in a
different way, the issue of gaming the system, gaming the GATT
rules, endeavoring to make it appear as though short-term
earnings growth reflects longer-term earnings growth, so long
as there are incentives for management and specifically the CEO
to do that, I don't care what else you do, it will not work.
Chairman Oxley. The gentleman's time has expired.
Mr. Royce. Thank you, Chairman Greenspan.
Chairman Oxley. The gentleman from Massachusetts, Mr.
Capuano.
Mr. Capuano. Thank you, Mr. Chairman.
Chairman Greenspan, thank you for that last clarification.
You just answered one of the questions I was going to ask you.
I don't think your answer earlier was as clear as the answer
you just gave in differentiating short-term interests from
long-term interests. I think you just did it, and I appreciate
that clarification.
One of the questions I do want to ask you, though, is have
you had an opportunity to review the CBO report that came out
roughly about a month or two ago that looked at the economic
stimulus proposals that are currently floating around Capitol
Hill?
Mr. Greenspan. I'm aware of it, but I must say to you,
Congressman, I did not look at it in detail.
Mr. Capuano. Fair enough.
Mr. Greenspan. I'm familiar with the general procedures.
Mr. Capuano. OK. At some point, since you're not familiar,
in general their conclusions were that the proposals currently
floating around will not sufficiently or accurately stimulate
the economy in a short-term basis. I would appreciate it if you
and your staff could review that report and comment on it to
see if you would agree with their conclusions or not, if that's
an appropriate request to make of you.
Mr. Greenspan. Well, what I'd like to point out, however,
is remember that the agreed procedures in which they make those
evaluations are what economists call a static model in which
feedback effects are not counted. Everybody who works in this
field knows that that's a very major shortcoming of this
procedure. But, because there's such dissent as to what to do
with respect to the feedbacks, there's sort of a fallback
position that we all agree, at least that's the first
approximation.
So I think you have to be a little careful about making
judgments as to what the economic effects of particular
proposals are with a static model. We'll be glad to take a look
at that and respond to it, obviously, but I just wanted to
clarify that the ability of those models to forecast even in a
dynamic sense has not been impressive. And therefore, their
ability to project the economic consequences of a program are
somewhat marginal.
Mr. Capuano. I understand that, and I respect their
limitations, but that's why I'm asking you to take a look at it
so we can have somebody else with a different view take a look
at it.
I guess the thing I always ask you when you come by relates
to productivity and a little bit on unemployment. I'd like to
start with the unemployment rate. The numbers in the report,
not your statement, but the report that accompanies it, cites a
5.6 percent rate in January. Do you know whether that report--I
had read earlier that that number did not include 900,000
unemployed people who had been taken off the rolls because they
had stopped seeking employment. Is that an accurate belief or
an inaccurate belief?
Mr. Greenspan. Well, it is certainly the case that the
unemployment rate is measured by the number of people who are
seeking jobs in a certain actively defined way and that the
ratio of those who are employed plus unemployed by that
definition is the labor force. And the unemployment rate is the
ratio of the unemployment to the total.
To the extent that people withdraw from the labor force--
either go back to school or are discouraged workers or have any
of a number of reasons not to be seeking a job, according to
the definition--they do not appear in the unemployment data.
Mr. Capuano. The reason that it concerns me obviously is
900,000 is a big number and any number in addition to that is a
big number. But also as the unemployment rate, whatever level
it is, once it levels off, those people, many of them will try
to get back into the workforce, therefore extending the length
of time that the unemployment rate is high. That's why I wanted
to get a clarification.
Mr. Greenspan. Let me just say one quick question about the
900,000. That's a sample statistic, and my suspicion is that
it's exaggerated, because we only have a 50, 60 thousand sample
of households. But the issue you're raising is a valid one.
Mr. Capuano. And I guess I'm going to make a comment that
I've made to several members of the Administration. That when I
read unemployment rates, I hate reading percentages alone, and
I would ask that in the future as you talk about them, you talk
about absolute numbers. Even a 5.6 percent unemployment rate is
8.1 million Americans, which is larger than the workforce, the
total workforce of all but three States, which is larger than
the combined workforce of 16 States. It's a huge number of
individuals, and I just think that out of respect to them and
to get a real handle on what a percentage really means, that
absolute numbers should be at least in a footnote someplace.
Mr. Greenspan. They actually are reported in some detail in
the reports themselves.
Mr. Capuano. OK. I didn't see them here.
Chairman Oxley. The gentleman's time has expired.
Mr. Capuano. Thank you, Mr. Chairman.
Chairman Oxley. The gentlelady from California, Ms. Lee.
Ms. Lee. Thank you, Mr. Chairman.
Good to see you. Let me ask you a couple of things about
CRA ratings. but first let me just preface this by saying that
we all on both sides of the aisle agree that home ownership is
key to the accumulation of wealth, to acquiring equity so that
working men and women, working families, minorities, can send
their children to college, can start a small business. Equity
in one's home is really the primary way that the majority of
Americans ever see any wealth in terms of accumulation.
One of the areas which many of us have been concerned about
is the disparity in home ownership in the minority community. I
believe nationally it's about 47 percent, as compared to white
home ownership at about 72 percent. So we've been in touch with
you with regard to the lending practices of some of the banks
in California which have received very outstanding or highly
satisfactory CRA ratings yet have a very poor record or
minority lending.
Let me just give you an example of what I'm talking about.
Citibank, for example, less than 2 percent of its California
conventional home loans were made to African Americans, also
for Latinos. Yet it received an outstanding on the lending
test. Bank United made less than 1 percent of their homeowner
loans to African Americans but also received an outstanding in
terms of their CRA ratings. Chase Manhattan received a high
satisfactory CRA rating, and I could go on and on. And I thank
you for providing the basic raw data for us to compile this
analysis which was actually put together by the Greenlining
Institute.
So what I'm asking you today, Mr. Chairman, is how do you
reconcile these great CRA ratings with the poor lending
practices of these institutions and what do you think we can do
about it? I actually wrote to you February 20th and made some
suggestions in terms of follow-meeting and to really begin to
sort this through. But I'd like to get your take on this.
Mr. Greenspan. Let me just say, I just signed off on a
response to you and you'll probably be getting it this
afternoon. Let me just say briefly that there are a number of
issues that we take into consideration by law on CRA rating.
More generally, it's got to do with making certain that the
individual institution have appropriate credit availability for
the total community and that there are a number of other issues
involved other than mortgage loans.
Second, as I think we may have discussed with you at
another time, it's important in looking at the issue of
mortgage extensions to look not only at the bank itself but its
subsidiaries, because many banking organizations do a goodly
part of their mortgage lending through subsidiaries rather than
through the bank itself. And these numbers which you are citing
refer to as I recall conventional mortgages only. And you'll
find that FHA and VA, which is a fairly significant amount of
the lending, show very significantly different figures from the
ones that you cited.
Now I don't know what those data will show, because we have
not compiled them. But I do suggest to you that before you
reach conclusions on this issue that it's probably worthwhile
to look at it in the broader sense. There are a number of other
technical issues which are involved in our CRA ratings which I
try to outline in the letter we're sending up to you and I hope
it's a satisfactory response. If not, come back and I'll try to
respond again.
Ms. Lee. Thank you, Mr. Chairman. I appreciate that. And
let me just, while I still have a couple of seconds left, I
would like to just ask you with regard to the issue of housing
production as a viable economic stimulus initiative or plan.
Housing production creates jobs. Yet we haven't been able to
find the resources to establish a massive affordable housing
production strategy.
I've introduced a bill with my colleague Congressman
Sanders to call for a $15 billion Federal investment in
affordable housing production. How do you see this right now in
terms of the recession? And does a housing production program
make sense in terms of job creation?
Mr. Greenspan. Well, Congresswoman, as I mentioned
previously, residential building has been holding up remarkably
well through this period of contraction. And by all historical
standards, it's reasonably high at this stage. And as you know,
even though you point out the differentials between minority
and non-minority home ownership, both are rising significantly.
You may recall when I was in San Francisco I think I quoted
a number of those statistics, and the rise in minority home
ownership, the black and Hispanic, is really quite impressive.
I mean, I grant you it's still not where I would like to see
it. I think that the more people who own homes, the greater
their interest in the community in which they function and the
more effective they are as citizens. So that's clearly a desire
over and beyond the economics that are involved.
But so far as home residential construction is concerned,
it's doing reasonably well. And you have to ask yourself in
allocating funds as to whether, in fact, that's the most
appropriate and effective use of the funds you're referring to
rather than some other priority, and that's a judgment that the
Congress has to make.
Ms. Lee. Thank you very much.
Mr. Greenspan. You're welcome.
Chairman Oxley. The gentlelady's time has expired.
The gentlelady from Illinois, Ms. Schakowsky.
Ms. Schakowsky. Thank you Mr. Chairman.
And Chairman Greenspan, I appreciate your spending so much
time with us this morning and that I have the opportunity to
ask a few questions. I'm going to ask them all, and if you have
time to respond to all of them, fine. Maybe otherwise in
writing later, I hope you will.
Last year, you stated some support for a large tax cut, and
that support I think was based at least in part about some
concerns that you had about too quickly paying down the public
debt. I'm assuming that those concerns have changed somewhat,
and I wanted to ask you if you have a different view on the
wisdom of those large tax cuts, particularly those that go to
the very wealthiest of Americans.
Second, on the economic stimulus package, the one that
passed the House and others that have been recommended by the
leadership emphasize major tax cuts it seems to me over
investment. That is, speeding up the tax cuts that were passed,
giving new ones, largely to corporations, some to very
profitable corporations. The one that passed the House would
have given a rebate of $254 million to Enron. I wondered if you
had comments on the thrust of the economic stimulus package,
the one that passed and the ones that are being considered in
the House.
Third, on the issue of predatory lending, which has been
very dear to my heart, I know that the Fed and other regulators
have suggested that Congress should act. We haven't acted yet
in any way. I'm wondering if you feel that we still should take
some steps to deal with that problem.
And finally, I can't stay away from Enron too far. Your
Board of Governors disclosed that Ken Lay at some point last
October during a period when the company was looking for some
help from senior Government officials did make a call to you. I
was wondering what he said in that call and what your response
was.
Those are my questions.
Mr. Greenspan. First of all, the issue that I was concerned
about a year ago reflected the notion that if you believe the
CBO data that we would create far too rapid a decline in the
debt outstanding which would require an accumulation of assets
by the Federal Government which I thought was very bad policy.
In the event taxes were cut, spending was increased and
that problem was, if you want to put it that way, taken care
of. So I no longer have that problem. But it was the tax cuts
and the spending increases which obviously obviated further
action. So, yes, it is no longer a concern of mine.
Second, on the economic stimulus proposals, as I said
previously, it' really comes down to a judgment as to whether
you think that the emerging stabilization that has now occurred
after the significant weakness in the economy is a prelude to a
self-adjusting recovery after the rate of inventory liquidation
dissipates. If you believe that there is not enough potential
final demand, then one could argue for some form of stimulus
program. I've argued that it's probably not necessary. The
economy is very likely to recover without it. And that would be
my judgment. But it is a credible argument to stay that
stimulus might be helpful in this particular context.
Ms. Schakowsky. And the stimulus being, as I said, heavily
weighted toward tax cuts rather than investment?
Mr. Greenspan. I'm sorry. Tax cuts instead of investment?
Ms. Schakowsky. Instead of, for example, housing, school
construction, and so forth.
Mr. Greenspan. That's a judgment that the Congress has got
to make. I'm not certain that, without getting into the full
detail you can very easily determine----
Ms. Schakowsky. Well, I guess the question is, though,
whether or not you believe that tax cuts, speeding up the
current tax cuts or giving more corporate tax cuts is viable as
an economic stimulus.
Mr. Greenspan. If you're asking me would it stimulate the
economy, the answer is probably yes.
On the issue of predatory lending, as you know, we have
just recently come out with a ruling related to that and the
Congress has it under consideration, and it's a disputable
issue. Because there's sort of a fairly strong argument that
subprime lending as a general issue is not a bad thing under
certain conditions. When carried to what we call predatory
levels, it is. And a lot of people have difficulty
differentiating what is and is not predatory in the subprime
categories. And I think that's one of the reasons why it's
getting difficult to come to conclusions on this issue.
Chairman Oxley. The gentlelady's time has expired.
The gentleman from Tennessee.
Mr. Greenspan. I'll answer the others for you.
Mr. Ford. Thank you, Mr. Chairman, Mr. Oxley and Chairman
Greenspan. In fairness to my good friend Ms. Schakowsky, what
you may call ``spending'' we call ``investment'' up here, so I
think that's what she might have been referring to, Mr.
Chairman.
I have two quick questions. Last year before the Committee,
at least one of your trips to the Committee, you advocated the
idea of a trigger mechanism where tax cuts would be delayed if
the fiscal situation worsened, obviously meaning if our
projections or expectations of revenues did not meet the
grandiose projections made by some of my colleagues.
In your testimony last year, I think you specifically said
you supported a trigger mechanism largely because of the
uncertainties that one has with respect to 10-year budget
forecast are very high. Two parts to the question. In
retrospect, with the dramatic reduction or deterioration of
projected revenues that we've experienced, do you think a
trigger mechanism would have been helpful? And two, there's
been considerable talk here from some of my colleagues on the
other side of the Hill in the Senate and here regarding efforts
to revisit the tax cut and that parts of the tax cut and even
to revoke parts of it that have not gone into effect yet.
President Bush has eloquently and forcefully suggested that
he would not support such an idea and has even equated a
revisiting the tax cut with actually raising taxes. I'd be
curious to get your thoughts on both strands of that question,
Mr. Chairman. And I, too, am glad you didn't decide to retire
once you reached the eligible age.
Mr. Greenspan. Thank you. First of all the trigger I was
referring to was a trigger on both taxes and spending
initiatives. And the reason for that is that the Federal
budgetary process which 15, 20, 30 years ago never really got
beyond 1 or 2 years out, largely because the vast proportion of
it was discretionary and the Congress could very readily
reverse or sunset any type of program it wanted with ease.
That's increasingly less credible as the greater proportion of
spending outlays become what we used to call uncontrollables,
entitlement programs of some form or another.
Under those conditions, you have no choice but to make
long-term forecasts, because even if you don't make a forecast,
there is an implicit forecast in the actions you're taking in
the Congress. So it's better to have a bad forecast than none
at all. But those forecasts, as you point out, are bad. And
hence, it's far superior to have some form of mechanism which
recognizes the fact that if they are really very far off that
the actions which were promulgated on them will not take place.
So I still believe that that process should still exist.
I have no particular comments on the issue of what one
would do or not do about existing programs. But the point that
the President is making with respect of changing the existing
tax structure now, say, reversing, implying some form of tax
increase is correct in the sense that there are some parts of
the economy where people are making judgments about the future,
making current investments about which are go-no go
investments, depending on what the presumed tax structure is in
the future.
So if you change rates, if, for example, you had a tax cut
pending and you go back to neutral, that effectively creates an
effective tax increase for somebody who is making an
investment.
Mr. Ford. I understand that. But I guess obviously a lot of
things have changed since we passed that tax cut, and as you
indicated, the fiscal situation irrespective of what occurred
on September 11th has changed things dramatically. And I would
imagine as you chair a Board that has consistently lowered
short-term rates for a period of time, you are in the business
of adjusting. So as much as I appreciate your point, I'm a
little confused by it.
I know my time is running and I'd love to maybe get a
longer answer from you, Mr. Chairman, on that. But the last
time you were before the Committee I raised it, the last time I
had an opportunity to address some of my thoughts to you before
the Committee, my State of Tennessee, where I'm from, and other
States were experiencing enormous budget shortfalls, and we see
now that many other States are faced with the same crisis. The
National Governors Association met last week here. I don't know
if you had an opportunity to address them. I know some of my
colleagues and Members of the Administration had that
opportunity.
One of the things that they declared, Mr. Chairman, was
that the current, quoting, the current fiscal crisis for States
compounded by unsustainable growth in the Medicaid program is
creating a situation in which States are faced with either
making massive cuts in programs or being forced to raise taxes
significantly.
My question last time dealt with I couldn't understand for
the life of me how you could reconcile the idea of growing
exploding surplus projections with the reality of States facing
budget shortfalls. And I guess my question is, as those of us
at the Federal level try to boost the economy, and you tried to
address some of these questions here, while maintaining some
fiscal discipline, what will be the effect of the budget
problems off the 50 States and will any drastic spending cuts
or even tax increases at the State level offset our efforts
here at the Federal level? And for that matter, offset the
Herculean efforts that your organization has engaged in over
the last year.
Mr. Greenspan. Well, as I think I may have answered last
year, one of the reasons why we had this extraordinary Federal
surplus and difficulties in the State areas is that there were
a significant amount of tax cuts that occurred within the
States to essentially remove considerable surpluses that were
emerging. And so when the situation turned around, you would
expect, as indeed has happened, States are in far greater
difficulty than even the Federal budget system is.
But as you point out, Congressman, from the point of view
of looking at the economy overall, you consolidate the Federal
and the State and local systems so that clearly cuts in
spending in State and local authority or an increase in taxes
has the same effect essentially as that which would occur at
the Federal level.
Mr. Ford. Mr. Chairman, I know my time is up, but just one
last point. You mentioned how there may be those who are
depending on the tax cut that was passed and the idea that tax
cuts will kick in. I just can't imagine that too many of my
friends, at least the ones I've spoken to, and I don't know a
lot of friends with big estates, but the or two I do know,
they've indicated they've not made any dramatic changes in
their estate planning as a result of what we passed last year.
So as much as I appreciate that comment, I can't imagine----
Mr. Greenspan. I wasn't referring to the estate taxes. I
was referring to individual income taxes.
Mr. Ford. Right, fair enough. Fair enough. Thank you for
letting me go over my time. Thank you, Mr. Chairman.
Chairman Oxley. The gentleman's time has expired.
The gentleman from Texas, Mr. Hinojosa.
Mr. Hinojosa. Thank you, Mr. Chairman.
Chairman Greenspan, could you give us an idea of how the
decline in long-term rate would impact the household incomes
and possibly what effect it would have on individuals like the
one you were just talking about in making decisions to make
investments, whether they be in their investment portfolio of
securities or businessmen wanting to invest in say equipment
and machinery in their factories?
Mr. Greenspan. Congressman, in our type of economy, long-
term interest rates play a fairly significant role. Most of us
deal with it wholly from the mortgage market only and that
clearly what the interest rate is on these 30-year fixed rate
mortgages has a fairly significant impact on what your monthly
payment is and does, has a major effect on how one behaves.
They are also relevant where you are involved in investing
in plant and equipment, as you point out, because to the extent
that you're borrowing money over the long run, that has very
major effect on the potential profitability of that investment
and clearly, lower interest rates imply that the profitability
under any existing state of technology will be higher for
corporations who borrow money to finance it.
So it's generally a very important element within the
economy. And one of the reasons why we are so focused on
keeping inflation expectations down is inflation expectations
are a critical factor in the determination of long-term
interest rates. And if inflation expectations go up, it tends
to inhibit a lot of economic activity in this country.
Chairman Oxley. The gentleman's time has expired.
The gentlelady from Indiana, the very patient lady, is now
recognized.
Ms. Carson. Thank you very much, Mr. Chairman.
And thank you very much, Mr. Chairman, for your patience.
I'm going to ask you this question because you are perceived--
and correctly so--to know everything, and that is a compliment.
It is not a put-down at all, and we appreciate very much that
you're here today.
Indiana has a spiraling rate of foreclosures, housing, home
foreclosures among its citizens. Could you tell me why that is?
Mr. Greenspan. Well, I think the foreclosure rate
generally, and more importantly, the bankruptcy rate for
individuals has been going up recently, in large part because
the economy is weak, the unemployment rate has gone up and
there's been obviously specific difficulties. I don't know the
situation specifically in Indiana, but there's no reason to
believe that that is dramatically different.
I should say that the foreclosure rate, while it is up, is
not up a great deal as I recall at the national level, and it
varies by whether it's FHA, VA, conventional. And as a
consequence of that, it's very hard to generalize. But the
basic reason is that the economy has been weak.
Ms. Carson. Do you see, Mr. Chairman, one quick other
question, any reversal of that trend, given all of these people
that are going to be propelled into homelessness, if you will?
These are homeowners. People that were taxpayers. People that
were long-time employees and now they're losing their place of
abode. Do you see any reversal of the trends that has
precipitated that chronic situation among so many people?
Mr. Greenspan. I think so, Congresswoman. The evidence that
we're seeing nationwide is that we seem to have stabilized. A
lot of the weakness that we saw earlier seems to be
dissipating. And while I've argued that it's too soon to say
that we're on our way back and moving at a reasonable pace,
nonetheless, there are signs that those types of improvements
are taking place. And if they do, that will be by far the most
effective program to address the particular concerns that you
have in that regard.
Ms. Carson. How are they beginning to reverse? And I don't
want to hold you. But what signs do you see related to what?
Mr. Greenspan. Well, what we see, for example, is that the
gross domestic product, which was negative during the third
quarter and appeared to be going into the fourth quarter as a
significant negative, at the end turned out to be a small
positive. And for the first quarter, the numbers do at this
moment appear to be positive as well. So we are beginning to
see the forces which engendered the rise of unemployment
starting to simmer down, and while we're not to the point where
I think you can essentially say that we're over the hump with
respect to unemployment, we're approaching it.
Chairman Oxley. The gentlelady yields back. The Chair now
recognizes the gentleman from New York, Mr. LaFalce.
Mr. LaFalce. Chairman Greenspan, in my introductory remarks
I asked some largely global questions which we didn't have an
opportunity to get into. Now I'd like to get into some more
local and specific questions.
You and I, I'm sure, are equally concerned about unfair and
deceptive practices within the field of financial services.
It's my understanding that some 25 years or so ago, a law was
passed that delegated responsibility to the Federal Reserve
Board to promulgate regulations articulating what an unfair and
deceptive practice is. Correct me if I've been misinformed. But
it's my understanding that we haven't seen regulations in the
past 25 years from the Federal Reserve Board.
I've also been advised that the Comptroller of the Currency
recently brought a lawsuit saying that we could operate under
the aegis of the law itself absent regulations, and that was
challenged in the courts by the financial institutions. The
initial lower court holding was that indeed the Comptroller was
correct. I don't know the status of that case on appeal. But
could either you or Mr. Mattingly advise me as to what the
status of that is?
Mr. Greenspan. I would say you would be much better advised
by Mr. Mattingly.
[Laughter.]
Mr. LaFalce. Virgil?
Chairman Oxley. Would the gentleman identify himself for
the record, please?
Mr. Mattingly. Virgil Mattingly. I'm the General Counsel of
the Federal Reserve.
Chairman Oxley. Thank you.
Mr. Mattingly. The Comptroller has taken that position, the
one you articulated in several cases, and so far, my
understanding is he's been upheld on that.
Mr. LaFalce. OK. But can we go to the first issue, Virgil?
And that's what's taken 25 years to articulate those regs?
Mr. Mattingly. The Board wasn't required to issue regs. It
was given the authority to identify practices for banks that
would be unfair and deceptive. And I think the Board has done
that my recollection is once, only once.
Mr. LaFalce. Only once in 25 years. But it's also my
understanding that there's an expectation that the Federal
Reserve will promulgate regulations. As a matter of fact, that
was the gravamen of the argument that was used against the
Comptroller, and the Comptroller--nobody seems to dispute that.
I mean, 25 years and one example. It seems to me you could be a
bit more aggressive.
[Laughter.]
Mr. Mattingly. Well, that may be so. But as you are well
aware, during that 25 years, Congress itself has passed a lot
of laws that have applied to banks.
Mr. LaFalce. But the unfair and deceptive practices have
not been dealt with adequately. You need to become much more
aggressive on this. And I would like to have a meeting with
Chairman Greenspan and you and the other member of the Federal
Reserve Board who is responsible for this issue in order to
discuss the possibility of a much more aggressive Federal
Reserve Board on this issue.
Mr. Mattingly. Certainly.
Mr. LaFalce. Thank you.
Chairman Oxley. The gentleman yields back. Let me if I can,
Mr. Chairman, use the prerogative of the Chair to ask a few
questions as we wrap up here. And you've been very gracious
with your time and we most appreciate it.
Recently, Secretary of the Treasury O'Neill suggested that
CEOs of public companies be required to personally certify
financial statements and such CEOs be held personally liable
for such certifications, thereby avoiding or not having the
protection of insurance. Do you have any opinion on that
proposal?
Mr. Greenspan. The general proposal is to switch the onus
of decisionmaking with respect to a whole series of corporate
governance questions which we've been discussing today to the
CEO. I fully support that. I think having served on many
boards, indeed, Paul O'Neill and I served on the Alcoa Board
together, there's no question in my mind that unless you get
the CEO effectively saying not we have met every GAAP
requirement and therefore we have no liability further that he
has to be able to say that irrespective of any particular GAAP
regulation the accounts which we have appropriately certify
what this company is all about.
Now the question, getting down to the issue of penalties to
induce the CEO to make sure that that is done, gets to the
question in his mind on the degree of D&O insurance, director
and officer liability insurance. And that there's no doubt in
my mind that there's no doubt in my mind that if you created
some inability to get fully liability insurance under certain
circumstances, it might be helpful. Although the law as I
understand it now stipulates that deceptive certifications do
not cover you under a particular insurance requirement.
My general view is I think that Secretary O'Neill is
definitely going in the right direction on this. There is a
question that has arisen with respect to if you construct an
issue of increased liability on the part of the CEO that you
will engender a huge new flood of lawsuits which clearly will
not be to the interests of either the company, the country and
I do suspect it's something we ought to try to avoid. So there
are possibilities of doing what the Secretary wants to do, but
to delimit the way in which the individual CEO's liability is
adjudicated.
Chairman Oxley. Along those lines, some folks have
suggested that corporate governance issues should be dealt with
at the Federal level as opposed to the traditional State level.
Do you have any comments in that regard?
Mr. Greenspan. I really don't. I'm aware of the arguments.
I don't feel myself sufficiently in control of the facts to
make a judgment at this stage.
Chairman Oxley. That hasn't deterred others from making
those same suggestions.
[Laughter.]
Chairman Oxley. But I'll pass on that. Let me ask you a
couple of questions on derivatives since they have been
mentioned a number of times in several different areas. In the
year 2000, Congress passed the Commodity Futures Modernization
Act which exempted or excluded many types of derivatives
transactions from the Commodity Exchange Act. Some have
recently questioned this decision certainly in the wake of
Enron. Is this still sound policy or is it in need of
discussion?
Mr. Greenspan. I think not, Mr. Chairman. I think that the
legislation that you passed in the year 2000 strikes me as
appropriate and still valid.
Chairman Oxley. And why would you say that in light of a
great deal of criticism that has come from a number of quarters
that at least part of the reason for the Enron collapse was
this, quote, ``deregulatory move'' by the Congress in 2000?
Mr. Greenspan. That's not impression of what happened. I
mean, what I sense happened is that they ran into losses which
they basically endeavored to obscure. And there's nothing that
they did which just could not have been done in 20 different
ways, had nothing to do with derivatives except that
derivatives happened to be one of the vehicles that were
involved, but the issue that I'm aware of had nothing to do
with the legislation that you passed in the year 2000.
There is a question as to whether the specific issue of
exempting over-the-counter energy derivatives from the
Commodity Exchange Act. And the argument there is that somehow
that Enron was not controlled and it should have been. But what
that issue is is in the law that regulation of transactions
between professionals is wholly inappropriate in that specific
regard. And I see nothing that's changed from the discussions
we all had when that particular Act was under review.
Chairman Oxley. Mr. Chairman, some would say that in the
case of Enron that the Enron collapse really began when the
price of commodities, particularly oil and gas, declined. And
as a matter of fact, you can look at some rather startling
charts that indicate that Enron's stock went up almost equally
with the commodity prices and then plunged at the same rate. Is
that a valid trigger for the Enron collapse, or is there some
other theory out there that's just as credible?
Mr. Greenspan. Well, as far as I can see, there are two
issues involved. One is the underlying earning power that Enron
engendered. And I would presume that since they were very
heavily in the issue of energy that the higher the price at any
fixed margin, the higher would be their earnings. But I think
the evidence will probably show when we finally know what all
of the evidence is that the triggering point had nothing
whatever to do with that. It had to do with the loss of I guess
I would call it reputation capital.
That is, as I indicated earlier on, Enron is a classic case
of a company whose market value is very significantly dependent
on the reputation of the firm. And when it became apparent that
the data that they were putting forth as representing their
earnings figures were indeed false and had to be recalculated,
they lost a very large part of their reputational value and
indeed, it was that that ultimately did them in. Had they, for
example, recognized the losses that they actually had in these
affiliates early on, I have no doubt it would have hit their
stock some, but it would have had a negligible impact relative
to what actually happened.
It was a very expensive business mistake which they made. I
do not think that had they a correct set of accounts that
they'd still be in business. Their stock price would be lower.
Their stock price would be lower because basically, energy
prices are lower, and their margins presumably wouldn't have
changed, so their earnings would have been less viable. But
they would not be in Chapter 11.
Chairman Oxley. One of the former officers stated publicly
that he thought that the Enron situation was a classic run on
the bank and that seems to be what you are referring to.
However, I guess there are some differences as to what
triggered that run on the bank. Your estimation is that it was
this reputational capital that was depleted rapidly, which goes
to the whole question of public confidence and the like in the
system.
Mr. Greenspan. As I said in my prepared remarks, Mr.
Chairman, a company whose assets are substantially physical,
real, and I used the example of an automobile assembly plant,
could conceivably have the reputation of its management sullied
considerably or come under a cloud and yet the company would
still have sufficient physical assets to engender incomes which
would give it a considerable capital value. But that was not
the case of Enron. Their actual real assets--pipelines and
various energy-related assets--were a relatively small part of
the market value of the firm.
Chairman Oxley. And finally, I couldn't let this pass by,
and that is a question on netting. You and I have had these
discussions numerous times. And as you know, the netting
provisions are currently in the bankruptcy bill that's in the
Conference Committee. Mr. LaFalce and I are both conferees, and
as you know, Mr. Toomey of our Committee has introduced
legislation also in that regard. I know you haven't changed
your mind on this, but I'm wondering if you could help us and
help the listening public understand the importance of enacting
netting legislation this year.
Mr. Greenspan. Mr. Chairman, as I indicated in my prepared
remarks and later, I think that the extraordinary expansion of
derivatives has been a major factor in creating an increased
degree of flexibility and resiliency in our system and that
they are a very effective tool that used for good is
exceptionally effective and used for ill can be just the same.
It's neutral with respect to that.
But, because it's such a valuable potential tool, it's
important that it function as efficiently as possible. The
legal uncertainty that still exists on certain types of
derivatives which did not appear in the original act which gave
legal certainty to netting are a cloud over these markets
which, if we can dissipate sooner rather than later, would be
very helpful. There is no downside of which I am aware of in
passing this legislation. And as you know, it was in the
bankruptcy legislation there solely for the purpose of trying
to integrate something which I presume has fairly broad support
in a bill which had some conflicts associated with it.
So I would just merely argue that unless I am mistaken
about this issue of there being no downside, there's an awful
lot of upside to its enactment.
Chairman Oxley. Thank you. Let me yield to my friend from
New York.
Mr. LaFalce. I thank the Chair for yielding. Chairman
Greenspan, I couldn't agree with you more on the issue of
netting. And I don't think there's a controversy about that
issue but there is great controversy about the bankruptcy bill.
Now in the previous Congress, we separated the netting bill
from bankruptcy and passed it independently.
In light of the Enron, Global Crossing and other debacles,
don't you think it is advisable to separate the netting bill
from the banking conference, pass it separately in the House
and separately in the Senate and send it to the President for
his signature as soon as possible?
Mr. Greenspan. I would agree completely with your remarks,
Congressman.
Mr. LaFalce. Thank you.
Chairman Oxley. Mr. Chairman, we appreciate your appearance
here today. And as always, most enjoyable. And your knowledge
is exceeded only by your patience and good will. And we look
forward to seeing you in July.
The hearing now stands adjourned.
[Whereupon, at 1:50 p.m. the hearing was adjourned.]
A P P E N D I X
February 27, 2002
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