[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                       CONDUCT OF MONETARY POLICY
=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 17, 2002

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-76










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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

                              ----------                              
                                                                   Page
Hearing held on:
    July 17, 2002................................................     1
Appendix
    July 17, 2002................................................    45

                                WITNESS
                        Wednesday, July 17, 2002

Greenspan, Hon. Alan, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     6

                                APPENDIX

Prepared statements:
    Gillmor, Hon. Paul E.........................................    46
    Israel, Hon. Steve...........................................    48
    Greenspan, Hon. Alan.........................................    49

              Additional Material Submitted For the Record

Greenspan, Hon. Alan:
    Monetary Policy Report to Congress, July 16, 2002............    64
    Written response to questions from Hon. Jan D. Schakowsky....   105


                       CONDUCT OF MONETARY POLICY

                              ----------                              


                        Wednesday, July 17, 2002

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to call, at 10:10 a.m., in Room 
2128, Rayburn House Office Building, Hon. Michael G. Oxley 
[chairman of the committee] presiding.
    Present: Representatives Oxley, Leach, Roukema, Bereuter, 
Baker, Castle, King, Royce, Lucas of Oklahoma, Kelly, Paul, 
Bachus, Barr, Gillmor, Cantor, Weldon, Ryun, Shays, Miller, 
Grucci, Hart, Capito, Ferguson, Rogers, Tiberi, LaFalce, Frank, 
Kanjorski, Waters, Sanders, Maloney of New York, Bentsen, 
Maloney of Connecticut, Carson, Sherman, Sandlin, Lee, Inslee, 
Schakowsky, Moore, Gonzalez, Capuano, Ford, Hinojosa, Lucas of 
Kentucky, Gutierrez, Watt, Crowley, Clay and Ross.
    The Chairman. The committee will come to order.
    Pursuant to the Chair's prior announcement, the Chair will 
recognize himself and the ranking minority member for 5 minutes 
each for opening statements and the Chair and ranking minority 
member of the Subcommittee on Domestic Monetary Policy for 3 
minutes each. All members' opening statements will be made part 
of the record.
    The Chair now recognizes himself for a brief opening 
statement.
    Chairman Greenspan, welcome back to the committee. We look 
forward to your remarks regarding the current economic 
environment.
    As you well know, the situation appears far different from 
when you were the first witness called before this new 
committee some 18 months ago. It is now apparent that, even 
then, the United States economy was sliding into a recession, a 
recession that next week's release of GDP figures should tell 
us was short, maybe only a solitary quarter's worth, but the 
results of which, nonetheless, had a real impact on American 
families and workers.
    Among the questions we all are interested in are these: 
When will the recovery start in earnest? How will we know we 
are in the recovery? What can we all do, Congress certainly, 
but everyone in this country, to encourage and speed the 
recovery? I think we also will want to hear your views on 
whether it is possible it avoid going through this time of 
adjustment again any time soon.
    Many of the committee believe that more timely and accurate 
reporting of economic data would help the business sector 
adjust to changing economic times and, therefore, avoid some of 
the gyrations the economy occasionally executes.
    In the past, you have noted how the information and 
technology revolution of the last decade can aid in this 
effort. But, primarily, Mr. Chairman, I think we would like to 
hear you talk about the mixed messages we are getting about the 
current shape of the economy.
    We have heard from many economists that the fundamentals of 
the economy are good. As a matter of fact, you mentioned that 
yesterday. Consumer spending has remained strong, and the 
dollar has settled to parity with the Euro, which one would 
expect would rapidly spur U.S. exports, while turning demand 
for comparable goods inward.
    Mr. Chairman, you mentioned a lot of these figures in your 
prepared statement, and I know you agree with me that they are 
promising. I note that you have raised your forecast of 
economic growth for the current year by a half percentage 
point, from a maximum of 3.25 to a maximum of 3.75 percent, and 
have estimated growth for the next year to be in the 4 percent 
range. Those are good numbers in any circumstance but 
especially good news right now.
    But to paraphrase a well-known and widely respected 
economic theorist, all of this plays out against a surge of 
irrational pessimism about our equity markets. Buffeted by 
reports of accounting misdeeds, the markets have plummeted, 
decreasing personal wealth and retirement incomes and dampening 
investor enthusiasm.
    We are now in what might be termed a crisis of confidence. 
Plainly, without the confidence of investors, a free market 
economy such as ours cannot remain robust. Efforts by this 
committee and more recently by the White House and Senate to 
set new standards for corporate governance will go a long way 
towards restoring that confidence. However, I think we all 
would be interested in hearing your views on what else might be 
done in that arena so that the United States economy can remain 
the envy of the world for its strength and resilience.
    The current environment brings to mind a passage in our 
recent history. A couple of decades ago, massive corporate 
restructurings caused a great deal of economic discomfort. It 
was a painful time, and many feared we would be permanently 
damaged by it. In fact, we learned that those restructurings 
left American businesses strong and lean and better suited for 
international competition than any other, and the ultimate 
result was two strong decades of growth as the rest of the 
world inexpertly took up American style restructuring.
    I wonder, Mr. Chairman, if we will not see the rest of the 
world in the next year or two embark on a reexamination of its 
own asset valuation and accounting standards and another long 
cycle in which U.S. business, again strong and lean, leads the 
way in growth.
    Of course, Mr. Chairman, there are other issues on which we 
would like to hear your opinion. Will the European financial 
services action plan create an economy that is truly 
competitive with the United States, or one that is better 
suited than ours to compete? What can be done to help Argentina 
and Brazil and other emerging markets grow their way to health? 
Do you have any early projections on the effects on the economy 
of the proposed Free Trade Agreement of the Americas? And what 
will be the shape of international trade in 5 years or a decade 
and how can U.S. businesses best prepare themselves to compete?
    Your thoughts on all these matters will be greatly 
appreciated, not only by this committee but indeed by all 
Americans.
    I thank you again for your appearance with us today; and, 
with that, I am pleased to yield to the gentleman from New 
York, Mr. LaFalce.
    Mr. LaFalce. Thank you very much, and welcome, Chairman 
Greenspan. This may be my final opportunity to address you in 
this setting, and I want you to know that it has been one of 
the great privileges of my public career to have worked with 
you these many years as Chairman of the Federal Reserve Board.
    Mr. Greenspan. Thank you very much.
    Mr. LaFalce. Chairman Greenspan, in reporting on the state 
of the economy today, I expect you will highlight recent events 
in the global economy. In particular, I would note that an 
important country in the Americas finds itself in the midst of 
a financial crisis. After struggling to meet its sovereign debt 
obligations, this country is now confronting widespread 
corruption in the business sector. Charges of inappropriate 
business dealings have reached the President and key officials 
in his government. The IMF has weighed in with criticism of the 
government's irresponsible fiscal policy and inadequate 
corporate governance standards. The head of the nation's 
central bank, while widely respected domestically and 
internationally, finds his advice on at least one important 
policy issue ignored by the President. Foreign investors have 
watched events in the country unfold with alarm and have begun 
to pull their money out, causing the currency to decline 
significantly. And yet, just a few years earlier, this country 
was envied for its miracle economy.
    Argentina? No. Brazil? No. Mexico? No.
    Of course, I am talking about the United States of America.
    For years, the United States had been the guiding light for 
an unassailable faith in free markets. Deregulation, smaller 
government and the wisdom of the marketplace had become 
watchwords that many urged other countries to follow as a 
model. In fact, we are now so accustomed to considering how 
best to deregulate, many seem unable or at least most unwilling 
to enact appropriate regulations for the private sector in the 
face of widespread and costly corporate abuses of the public's 
trust.
    Many of us in Congress have tried to put a human face on 
the toll that the corporate scandals have taken. It is not hard 
to do. Thousands of long-time employees at Enron and WorldCom 
have lost their jobs and their life savings in one fell swoop. 
But each of these individual job losses adds up to an economy-
wide problem that is no longer isolated to Houston, Texas, or 
Mississippi. Oftentimes in these monetary policy hearings we 
push you to step away from the macroeconomic issues to address 
the human side of things, but today I do believe it is 
important and useful to consider what will happen to our 
economy at large as a result of the corporate fraud 
disclosures.
    My concern is at least twofold. First, that we could be 
entering a protracted period of little or no economic growth as 
we struggle by fits and starts to restore confidence in our 
markets. And restoration of confidence is so essential for not 
only do economies move markets but today markets often move 
economies, up, down or sideways.
    Secondly, and very importantly, by mid-August, the CEOs and 
CFOs of the top 1,000 publicly traded corporations in America 
must certify to the accuracy and reliability of their 
companies' financial statements. I fear this may precipitate 
hundreds of restatements of earnings. This might well have a 
downward impact on the market and the economy.
    Mr. Chairman, I am anxious to hear your views on the impact 
corporate fraud is having on the economy and what impact it 
could have, both by mid-August and in the months ahead, 
particularly if consumers and investors continue to express 
doubt in the ability of elected officials and corporate leaders 
to respond to the problem.
    In my view, the potential ramifications are widespread. As 
I mentioned earlier, we have begun to see a depreciation in the 
dollar resulting in part from a loss of confidence amongst 
foreign investors. While a moderately weaker dollar will 
provide a substantial benefit to our exporters, a rapid decline 
in the dollar could bring with it a host of other problems and 
surely make your job significantly more difficult.
    These macroeconomic factors matter because, ultimately, 
they will affect the human side of our economy. The difference 
between economic growth of 4 percent and 1 percent is the 
difference between an economy that produces tens of thousands 
of new jobs and one that does not and the difference between an 
economy in which workers' wages grow and one in which they 
stagnate.
    Last week, in perhaps an all-too-candid moment, President 
Bush wondered out loud just how important the corporate 
scandals really are. Well, my answer, Mr. President, is that 
they are very, very important; and it is time that we all begin 
to respond to them with meaningful remedies.
    I mentioned earlier, Mr. Chairman, that your advice has 
been ignored by the President, and on that I was referring to 
your support for the expensing of stock options. I am pleased 
that Coca Cola, the Washington Post and Bank One have followed 
your and Warren Buffet's sage and prudent advice. This is just 
one of the meaningful remedies we should all be able to agree 
upon in short order, so I hope today's hearing will serve, 
amongst other things, to highlight the economic necessity and 
urgency of corporate reforms.
    I thank the Chair.
    The Chairman. The gentleman's time has expired.
    The Chair now recognizes the Chairman of the Subcommittee 
on Domestic Monetary Policy, the gentleman from New York, Mr. 
King.
    Mr. King. It is a pleasure to have you here this morning, 
especially at this particularly critical moment in our Nation's 
economic history. I notice that the Dow is up almost 200 
points, and Congressman Bereuter just cautioned me not to say 
anything that could upset that, so I will try to restrain my 
remarks.
    Mr. Chairman, I was in some ways gratified by your 
statement yesterday before the Senate about how the economy is 
fundamentally sound, that inflation appears to be under 
control, productivity is increasing, the housing industry is 
strong, and unemployment seems to be at least stable.
    At the same time, however, though, because primarily of the 
corporate scandals, there is almost a total disconnect between 
the fundamental strengths of the economy and the showing of the 
stock market; and, as Congressman LaFalce said, this has a real 
human impact. We are talking about real people--people about to 
retire, people that have their entire life savings in their 
401(k)s, looking towards their retirement years, and they are 
faced with a terrible crisis.
    So I would really again--in your testimony today, I look 
forward to if you can give us some estimate as to when you 
think we will be coming out of this, just how important it is 
that we at a very early stage pass very effective reforms and 
legislation as far as cracking down on corporate corruption and 
also to address issues such as the fact that the Euro is now at 
a parity with the dollar. Is that a threat to us or an 
opportunity? What does that auger for the future?
    Also, how much of an impact do you believe that just the 
threat of future terrorist attacks is going to have on the 
economy as far as holding it back and holding it down? How 
significant will that be?
    With all of these, Mr. Chairman, when you were talking 
about yesterday the fundamental strength of the American 
economy, I think one item you omitted was your service as 
Chairman of the Federal Reserve. I think that has done as much 
as anything to bring about the stability and strength which is 
going to bring us through this period, and I want to commend 
you for your years of service, the work you have done and also 
for coming before our committee at least twice every year, your 
constant communications with us, but, most importantly, the 
note of reassurance you send to markets both here and 
throughout the world.
    Mr. Chairman, with that I yield back the balance of my 
time.
    The Chairman. Chairman Greenspan, we are pleased to welcome 
you back to the committee.
    Mr. LaFalce. Mr. Chairman, I would like to yield Mrs. 
Maloney's 3 minutes for an opening statement in her absence to 
the distinguished gentleman from Arkansas, Mr. Ross.
    The Chairman. The gentleman is recognized for 3 minutes.
    Mr. Ross. Thank you, Mr. Chairman, and thank you ranking 
member, and good morning to you, Chairman Greenspan. I look 
forward to your testimony here this morning.
    Before I address corporate governance, I would like to 
simply stress I am confident in the long run our economic 
system will overcome its current challenges. Despite our 
immediate difficulties, I have the highest confidence in our 
system of free markets. Over time, it has proven preeminent in 
generating economic growth, jobs and rewarding innovation. We 
have been through other market declines and corporate scandals, 
including insider trading and major banking collapses during 
the 1980s. Times now demand strong leadership and meaningful 
reform.
    On Monday, the President delivered a speech in Alabama 
where he blamed our current economic problems on a hangover 
from the binge in the 1990s. I agree with the President that we 
experienced what I call a bubble in the stock market, with some 
high-tech and telecom stocks rocketing to unsustainable 
capitalizations, but I strongly disagree with his 
characterization of the decade. The 1990s were a decade of 
unparalleled prosperity. The economy experienced an unmatched 
period of growth, government surpluses, strong financial 
markets and full employment.
    The Clinton administration put us on the path to fiscal 
responsibility in 1993; and, Chairman Greenspan, you and your 
colleagues at the Fed formulated and implemented the monetary 
policies during the 1990s and deserve credit. I wonder if you 
agree with the President's characterization of the 1990s, and I 
hope you will tell the committee whether the Fed contributed to 
the excesses to which the President referred.
    Rather than blame the 1990s, it is more reasonable to point 
to the business cycle. It is unfortunate that the downturn in 
the cycle has coincided with a staggering reversal in our 
government's balance sheet resulting from the Bush tax plan. 
The White House now acknowledges a $165 billion deficit this 
year, with expected deficits through 2005.
    Rather than pointing the finger toward the past, I blame 
our current situation on the crisis of confidence brought on by 
the corrupt business practices of those in the corporate world. 
I think we have got to take the necessary steps to restore 
faith and confidence to our markets, specifically our stock 
markets.
    Despite these challenges, I am optimistic about the future, 
and I am pleased that I can have you here with us today to 
share your thoughts on the unstable economy, as I call it. We 
have got to find ways, Mr. Chairman, to restore confidence, 
what I call restore small town values to the corporate world.
    The Chairman. The gentleman's time has expired.
    Chairman Greenspan, again welcome back to the committee. 
You may proceed with your opening statement.

 STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr. Greenspan. Thank you very much, Mr. Chairman and 
Members of the Committee.
    Over the four and one-half months since I last testified 
before this Committee on monetary policy, the economy has 
continued to expand, largely along the broad contours we had 
anticipated at that time. Although the uncertainties of earlier 
this year are not yet fully resolved, the U.S. economy appears 
to have withstood a set of blows--major declines in equity 
markets, a sharp retrenchment in investment spending, and the 
tragic terrorist attacks of last September--that in previous 
business cycles almost surely would have induced a severe 
contraction. The mildness and brevity of the downturn, as I 
indicated earlier this year, are a testament to the notable 
improvement in the resilience and flexibility of the U.S. 
economy.
    But while the economy has held up remarkably well, not 
surprisingly the depressing effects of recent events linger. 
Spending will continue to adjust for some time to the declines 
that have occurred in equity prices. In recent weeks, those 
prices have fallen further on net, in part under the influence 
of growing concerns about corporate governance and business 
transparency problems that evidently accumulated during the 
earlier rapid run-up in these markets. Considerable 
uncertainties--about the progress of the adjustment of capital 
spending and the rebound in profitability, about the potential 
for additional revelations of corporate malfeasance, and about 
possible risks from global political events and terrorism--
still confront us.
    Nevertheless, the fundamentals are in place for a return to 
sustained healthy growth. Imbalances in inventories and capital 
goods appear largely to have been worked off, inflation is 
quite low and is expected to remain so, and productivity growth 
has been remarkably strong, implying considerable underlying 
support to household and business spending as well as potential 
relief from cost and price pressures.
    In considering policy actions this year, the Federal Open 
Market Committee has recognized that the accommodative stance 
of policy adopted last year in response to the substantial 
forces restraining the economy likely will not prove compatible 
over time with maximum sustainable growth and price stability. 
But, with inflation currently contained and with few signs that 
upward pressures are likely to develop any time soon, we have 
chosen to maintain that stance, pending evidence that the 
forces inhibiting economic growth are dissipating enough to 
allow the strong fundamentals to show through more fully.
    As has often been the case in the past, the behavior of 
inventories provided substantial impetus for the initial 
strengthening of the economy. However, as inventories start to 
grow more in line with sales in coming quarters, the 
contribution of inventory investment to real GDP growth should 
lessen. As a result, the strength of final demand will play its 
usual central role in determining the vigor of the expansion. 
While final demand has been increasing, the pace of forward 
momentum remains uncertain.
    Household spending held up quite well during the downturn 
and through recent months and thus served as an important 
stabilizing force for the overall economy. Spending was boosted 
by ongoing increases in incomes, which in turn were spurred by 
strong advances in productivity as well as by legislated tax 
reductions and, in recent months, by extended unemployment 
insurance benefits.
    Monetary policy also played a role by cutting short-term 
interest rates, which helped lower household borrowing costs. 
Particularly important in buoying spending were the very low 
levels of mortgage interest rates, which encouraged households 
to purchase homes, refinance debt and lower debt service 
burdens, and extract equity from homes to finance expenditures. 
Fixed mortgage rates remain at historically low levels and thus 
should continue to fuel reasonably strong housing demand and, 
through equity extraction, to support consumer spending as 
well.
    But those sources of strength probably will be tempered by 
other influences. Because consumer and residential expenditures 
did not decline during the overall downturn, there is little 
pent-up demand to be satisfied. Moreover, the declines in 
household wealth that have occurred over the past couple of 
years should continue to restrain spending in the period ahead. 
Still, despite concerns about economic prospects, equity 
valuations, terrorism and geopolitical conflicts, consumers do 
not appear to have retrenched in retail markets. Indeed, 
consumers responded strongly to the new interest rate 
incentives of motor vehicle manufacturers this month. Early 
reports indicate a significant improvement in sales over June.
    By contrast, business spending has been depressed. The 
recent economic downturn was driven, in large measure, by the 
sharp fall-off in the demand for capital goods that occurred 
when firms suddenly realized that stocks of such goods were 
excessive. Overall, the level of real business fixed investment 
plunged about 11 percent between its quarterly peak in the 
final months of 2000 and the first quarter of this year.
    With the adjustment of the capital stock to desired levels 
now evidently well advanced, business fixed investment may be 
set to improve. A recovery in this category of spending is 
likely to be gradual by historical standards and uneven across 
sectors. Still, firms should respond increasingly to the 
expected improvement in the outlook for sales and profits, low 
debt financing costs, the heightened incentives resulting from 
partial expensing tax provisions legislated earlier this year, 
and especially the productivity enhancements offered by 
continuing advances in technology.
    Indeed, despite the recent depressed level of investment 
expenditures, the productivity of the U.S. economy has 
continued to rise at a remarkably strong pace. The magnitude of 
the recent gains would not have been possible without ongoing 
benefits from the rapid pace of technological advance and from 
the heavy investment over the latter half of the 1990s in 
capital equipment incorporating such advances.
    Despite these encouraging developments regarding the 
longer-term protects prospects for the economy, financial 
markets have been notably skittish of late, and business 
managers remain decidedly cautious. In part, these attitudes 
reflects the lingering effects of the shocks that our economy 
endured in 2000 and 2001.
    Also contributing to the dispirited attitudes among many 
corporate executives is the intensely competitive business 
environment facing their firms. Increased competition, while 
producing manifold benefits for consumers and for the economy 
as a whole, clearly makes individual firms' operations more 
difficult.
    Those businesses where heightened competition has 
engendered a loss of pricing power have sought ways to raise 
profit margins by employing technology to lower costs and 
improve efficiency. In the United States, as a consequence of 
the interaction of monetary policy, globalization and cost-
reducing productivity advances, price inflation has fallen in 
recent years to its lowest level in four decades, as has the 
recent growth of nominal GDP and consolidated corporate 
revenues.
    In part because nominal corporate revenues, although no 
longer declining, are growing only tepidly, managers seem to 
remain skeptical of the evidence of an emerging upturn. Profit 
margins do appear to be coming off their lows registered late 
last year, but, unsurprisingly, the recovery in economic 
activity from a shallow decline appears less vigorous than in 
the past. The lowest sustained rates of inflation in 40 years 
imply that nominal growth in sales and profits looks 
particularly anemic. Reflecting concerns about the strengths of 
the recovery, managers continue to limit capital spending to 
only the most pressing needs.
    Given the key role of perceptions of subdued profitability 
in the current period, it is ironic that the practice of not 
expensing stock option grants, which contributed to the surge 
in earnings reported to shareholders from 1997 to 2000, has 
imparted a deceptive weakness to the growth of earnings 
reported to shareholders in recent quarters. According to 
estimates by Federal Reserve staff, the value of stock option 
grants for the S&P 500 corporations fell about 15 percent from 
2000 to 2001, and grant values have likely declined still 
further this year. Moreover, options grants are presumably 
being replaced over time by cash or other forms of 
compensation, which are expensed, contributing further to less 
robust growth in earnings reported to shareholders from its 
trough last year.
    In contrast, the measure of profits calculated by the 
Department of Commerce for the National Income and Product 
Accounts is designed to gauge the economic profitability of 
current operations. It excludes a number of one-time charges 
that appear in shareholder reports and, importantly, records 
options as an expense, albeit at the time of exercise. National 
Income and Product Account profits have increased sharply since 
the third quarter of last year, partly reflecting the dramatic 
jump in productivity and decline in unit labor costs.
    The difficulties of judging earnings trends have been 
intensified by revelations of misleading accounting practices 
at some prominent businesses. The resulting investor scepticism 
about earnings reports has not only depressed the valuation of 
equity shares, but it also has been reportedly a factor in the 
rising risk spreads on corporate debt issued by the lower rung 
of investment-grade and below-investment grade firms, further 
elevating the cost of capital for these borrowers.
    To sum up, Mr. Chairman, the U.S. economy has confronted 
very significant challenges over the past year or so. Those 
problems, however, led to only a relatively brief and mild 
downturn in economic activity, reflecting the underlying 
strengths and increased resiliency that the economy has 
achieved in recent years. The effects of the recent 
difficulties will linger for a bit longer, but as they wear off 
and absent significant further adverse shocks, the U.S. economy 
is poised to resume a pattern of sustainable growth. Our 
prospects for extending this performance over time can be 
enhanced through implementation of sound monetary, financial, 
fiscal and trade policies.
    Thank you, Mr. Chairman. I have rather extended written 
remarks and request they be included for the record. I look 
forward to your questions.
    The Chairman. Without objection, the entire statement will 
be made part of the record, Mr. Chairman.
    [The prepared statement of Alan Greenspan can be found on 
page 49 in the appendix.]
    The Chairman. The Chair would announce there is a vote on 
the floor, and it would be the wish of the Chair to recess the 
committee for 10 minutes. Then we will proceed with the 
questions for the Chairman.
    The committee stands in recess for 10 minutes.
    [Recess.]
    The Chairman. The committee will reconvene.
    Mr. Chairman, we thank you for your remarks. It is now time 
to get into the question period. The Chair will recognize 
himself for 5 minutes for that purpose.
    Mr. Chairman, during the 1990s and just until recently, 
there was a lot of talk about the wealth effect, of course we 
have changed from a Nation of savers to investors. I saw a 
recent poll the other day that some 70 percent of people 
consider themselves investors in one way or another.
    During that run-up, the wealth effect was cited as an 
example of why people felt better about themselves, felt more 
secure in their retirement.
    The obvious question is now that the, if you will, the 
bubble has burst, are you seeing the opposite effect from the 
wealth effect, and how is that affecting our overall economy?
    Mr. Greenspan. For a long period of time prior to the mid-
1990s, the ratio of net worth to household income was within a 
relatively narrow range. In the latter part of the 1990s, that 
ratio rose quite significantly as a consequence both of the 
very dramatic rise in stock prices but also in home values. As 
a consequence of that, and the various techniques which we have 
to determine what creates consumer expenditures, we concluded 
that a substantial part of the rise in consumption expenditures 
did reflect essentially the wealth effect. Either borrowing off 
increasing wealth and spending it or in essentially a sense of 
having a lot of assets, people drew down some of their liquid 
assets and spent it on goods and services.
    Now that it is reversed, we are getting essentially the 
reversal of the upside with a few major qualifications.
    First, it has not been true in the equity people have had 
in homes, and indeed, that has continued to rise. And because 
most of the evidence which we have indicates that the 
propensity to spend out of increased home wealth is much 
greater than increased stock market wealth, even though the 
aggregate value of the decline in stock market wealth since the 
peak in the early part of 2000 is far in excess of the increase 
in home equity wealth since then, it is not by any means a 
swamping of the impact on consumer expenditures from this 
dramatic decline in stock market values.
    So, yes, we have had a reversal of the wealth effect, but 
it has been very significantly tempered by the continued 
existence of growth in home equities.
    Secondly, it matters where in the income scale you are. The 
data that we have suggest very disproportionate amounts of 
equity stock wealth is in the upper 20 percent of households 
arrayed by income and that a significantly larger impact from 
home wealth is in the lower groups. So that there is a 
complexity of factors here which net has reduced consumption 
expenditures from what they otherwise would have been. But so 
long as home wealth, the value of homes and the equity we have 
in them continues to increase, that is clearly going to 
significantly temper the impact that the decline in stock 
prices has had.
    The Chairman. Let me ask you a specific question regarding 
the issue of corporate accountability and transparency. The 
bill that the House passed in April contained two provisions in 
terms of transparency. The one provision was that if a 
corporate insider was to sell his stock, that under current 
law, as you know, it would be up to potentially 40 days before 
he would have to report. The bill that passed the House would 
require that that be done in real time, essentially the second 
day from that sale, therefore providing more information to the 
stockholders when it might appear the corporate insiders were 
bailing out.
    The second provision was that, should a corporation 
discover a material change in their business, that is, they 
lost a major customer, had a major settlement, that kind of 
thing, that that, too, would have to be made available via the 
Internet in real time.
    In a general sense I think all of us support the concept of 
transparency. Do you think it is a good idea that in today's 
world in terms of the ability to transfer information that 
quickly, that those two provisions are beneficial?
    Mr. Greenspan. Well, Mr. Chairman, the only qualification I 
would make rests on the issue of whether in the process you are 
making available competitively valuable information, whether it 
is proprietary information, and I don't know the answer to 
that. But I would suggest to you that while clearly 
transparency, especially of the type you are referring to, is 
of value, it is important that what we do not do is that we 
enforce directly or indirectly the disclosure of proprietary 
information which is a valuable property right and a valuable 
asset for individual companies and, indeed, a very crucial 
element in the proper functioning of a free market system.
    The Chairman. Thank you. My time has expired. The gentleman 
from New York Mr. LaFalce.
    Mr. LaFalce. Thank you, Mr. Chairman.
    Chairman Greenspan, I would like to in my limited time 
address two questions to you. First deals with the 
certification by CEOs and CFOs of the accuracy and reliability 
of their financial statements. This is something that President 
Bush did call for in March, but as far as I understand, it was 
just a call for CEOs to do this voluntarily. There was no 
suggestion that there be legislation to require it, nor that 
the SEC promulgate regulations to require it.
    I offered amendments both within the committee and on the 
House floor, and they were voted down on a party-line vote. But 
the SEC did require it recently of the roughly top 1,000 
publicly traded corporations in America, and I expect those 
certifications to be in to the SEC by, I believe, August 14th.
    I don't know what is going to happen. I am concerned that 
it may be coupled with a significant number of earnings 
restatements. Every earning restatement I have ever seen has 
been revised downward rather than upward. That is interesting, 
isn't it? Given the fact that accounting is an art, why is it 
that all the restatements are restatements down?
    I am just wondering if there is any contingency planning 
going on with the Federal, with the SEC, the SROs, et cetera, 
for the eventuality of what the potential impact might be.
    My second question is--I just want to get it in--is I have 
long believed I have always supported FASB when FASB said we 
ought to require the expensing of stock options. And it was 
only because of the unbelievable pressure that certain Members 
of Congress exerted upon FASB, basically threatening them with 
extinction, that they decided not to go forward with the 
expensing of options as a requirement and simply recommended 
it, the recommendation that almost no corporations in America--
I think two--complied with, until a week ago when we did get 
following your advice Coca Cola, Washington Post and Bank One.
    I would like you to explain your rationale for the 
expensing of stock options and your evaluation of the 
contribution that its absence has had upon the overvaluation, 
the bubble and the bursting of the bubble, et cetera.
    Mr. Greenspan. Well, first, Congressman, let me say that I 
have always been under the impression that one of the reasons 
the SEC moved in the direction that it did with respect to 
certification was, in fact, conversations with the 
Administration and, I would presume, as the result of the 
President's request. The initial notion of doing that is 
actually Paul O'Neill, the Secretary of the Treasury's view of 
what would be required. And when I first heard it, I thought 
that it cut right to the core of what the nature of the problem 
was. It is clear that he convinced the President, and my 
impression, but I don't know for certain, is that the SEC was 
following essentially previous conversations and I wouldn't say 
instructions from the President--obviously he doesn't do that--
but clearly influenced by the President's position.
    With respect to the issue of stock option grants, the--.
    Mr. LaFalce. The second part of that question is, you know, 
do you have any contingency plans, any expectations?
    Mr. Greenspan. Oh, of course, yes. I do believe there are 
going to be significant restatements, and I agree with you that 
the number that are going to be restated up won't take you very 
long to read. I am not terribly concerned about any impact 
because remember, what is involved here is that if we get a lot 
of restatements, and I presume we may very well, I am not sure 
that is all bad. Indeed what it is suggesting is that the issue 
which really gripped everybody for a number of years, to manage 
your earnings so that you could affect the stock price, is 
going to disappear. And indeed, I think it is very much 
disappearing.
    Mr. LaFalce. I hope you are right. I suspect you are.
    Let me just ask this, though: Do you think we should extend 
that from the top 1,000 corporations to all publicly traded 
corporations?
    Mr. Greenspan. I don't think it is necessary mainly 
because--
    Mr. LaFalce. How about desirable?
    Mr. Greenspan. Well, my main concern is that you don't want 
to overload the SEC, and the vast proportion of any of the 
issues that would come up which should concern us from the 
economy's point of view are covered pretty much by the SEC 
requirement.
    Mr. LaFalce. The economy is one thing, and a human person 
with all his or her investments is another. And if all were 
required and then did have random, this might better serve the 
public interest. That is why I think it is necessary to have 
not just the top 1,000, but all 17,000 publicly traded 
corporations have the certification.
    Mr. Greenspan. If they did it voluntarily, it would be 
fine, but I would hate to have to administer something of that 
dimension. I am fearful that the resources that inevitably 
would go in that direction would impede the much smaller group, 
which you really need to oversee in that respect.
    The Chairman. The gentleman's time has expired. The 
gentleman from Iowa Mr. Leach.
    Mr. Leach. Thank you, Mr. Chairman.
    Market economies obviously are based on confidence. And 
when you have corporate governance problems, whatever, we have 
the confidence erodes. And so the question I think many people 
in the market are asking is that if Congress moves forthrightly 
to tighten the law, if the executive demonstrates a willingness 
to serve as a referee and insists that the law be abided by, 
then is the market drop that we have seen an aberration, or is 
it simply a natural correction? Would you care to comment on 
that?
    Mr. Greenspan. It is very difficult to answer that 
question. I know that there are a lot of people who are 
focusing on it very sharply and a number of people who are paid 
very large salaries to answer that question. And I regret to 
say the answers I have heard I have not felt convincing one way 
or the other. Clearly--well, the bottom line is I really don't 
know, and that is about as much as I can say about it.
    Mr. Leach. Let my say you are paid a small salary, but the 
assumption is you know more about it than those that are paid a 
large salary. But thank you.
    Mr. Greenspan. Let me just say this: I do know what I don't 
know.
    Mr. Leach. That is what distinguishes you from Members of 
the United States Congress.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired.
    The gentleman from Massachusetts Mr. Frank.
    Mr. Frank. Mr. Chairman, I am struck by the emphasis both 
in the report, the monetary report, and your statement about 
what appears to be your concern that we are moving from surplus 
to deficit at the Federal level with the negative consequences. 
I mean, you talked a lot about and I think there was a 
consensus that one of the great things about the recent period 
was that we saw a strong growth in the economy at a time when 
the Federal Government was, in fact, moving from deficit to 
surplus, and that, in fact, that offered a basis for things 
going forward.
    Now, here's the problem. You say, and I appreciate this, 
because there has been some debate about what has caused the 
move from surplus to deficit, and I appreciate your mentioning 
there were several factors, because people try to sometimes 
talk about--they try to give a monofactor analysis, but I note 
for instance in the monetary policy report you say receipts 
have remained subdued. Individual tax payments are running well 
below last year's pace. This weakness reflects general 
macroeconomic conditions, the legislative changes in tax 
policy, and the declining stock prices. And similarly in your 
statement you say at page 13, talking about this move, the 
necessary rise in expenditures related to the war on terrorism 
and enhanced homeland security has also played a role, as have 
the tax reductions legislated last year.
    Now, in a less superheated political world, noting that 
reducing tax rates reduces revenues would not be considered a 
significant statement, but it is, and I think it is important 
and I appreciate your acknowledging that one of the 
contributing factors to the move from surplus to deficit, as 
you say both in the statement and the report, are the tax cuts 
of 2001.
    The problem we have, I think, is this: As you say, there 
have been some unanticipated results, although some of us did 
say it was a mistake to do a tax cut of that magnitude, 
assuming that you were going to have a high level of economic 
activity going forward. No one anticipated the mass murders of 
September 11th and the need to spend money. After doing the tax 
reductions in 2001, we experienced the tragedy of September 
11th, those murders, and we have committed ourselves to 
spending probably hundreds of billions of dollars over the next 
few years, as you know, increasing expenditures.
    Given that there is not a reason--and you have acknowledged 
that--you have not acknowledged because you have been a leader 
in this, you have pointed out that the move from surplus to 
deficit has very real negative consequences for the economy 
both in the ability of the Federal Reserve to help with 
monetary policy and with the economy in general.
    You acknowledge that the tax reductions of 2001 are one of 
several reasons why this is happening. We also have a consensus 
to spend much more money at the Federal level. Indeed you 
mention in the report, the monetary policy report, that outlays 
in the first 8 months of 2002 were up 14 percent particularly 
when you correct for the drop in the interest rates and the 
payment of the deficit. None of those, to my recollection, were 
over the President's objection. So outlays were up 14 percent 
in part because of September 11th. Taxes are cut. We have got 
to spend more money. We are going from surplus to deficit with 
negative macroeconomic consequences. Yes, you called for some 
spending restraints, but should a reexamination of the tax cut 
go forward?
    I guess my question would be if we had known what was going 
to happen on September 11th, and we had known what the economy 
would be doing, would it have been prudent to have reduced 
taxes by as much as we did in 2001?
    Mr. Greenspan. Well, it is turning out that the tax cut is 
a two-edged sword in that respect. One, obviously it reduces 
the surplus and adds to the deficit. It is not a very large 
part of that. It is part of it. But because it happened to turn 
out to occur just when a pickup in consumer expenditures would 
be quite helpful--.
    Mr. Frank. Let me say this, Mr. Greenspan: Yes, it was 
fortuitous that it happened at that point, more than 
fortuitous, but now we are talking about going forward where 
the great bulk of the tax cut is before us with those negative 
consequences.
    Mr. Greenspan. I understand that Congressman. The answer 
that I gave to the Senate yesterday is, I think, the 
appropriate one. In looking at our whole fiscal affairs, we are 
confronted with a major shift in the last several decades from 
budgets which we could focus on and enact within a very short 
time frame. In other words, there was very little in the way of 
very long-term commitments in the budget. What has happened to 
our budget is it has become not a 1- or even a 2-year budget 
any longer; it has become a long, 10 maybe 15-year budget. And 
my own view is that we do not put enough in the way of analysis 
of evaluating the full impact of both receipts and outlays as 
we go into the future and make determinations.
    Mr. Frank. But isn't this then imprudent--you want us to 
change that part about the budget. Maybe others will agree. But 
isn't it not imprudent to reduce revenues before you succeed in 
making those changes, or at least isn't that the consequence 
that it has a contributing consequence to the deficits?
    The Chairman. The gentleman's time has expired. You may 
respond.
    Mr. Greenspan. I think you have to look at both sides, both 
receipts and expenditures.
    The Chairman. The gentleman's time has expired.
    The gentleman from Nebraska Mr. Bereuter.
    Mr. Bereuter. Thank you, Mr. Chairman.
    Chairman Greenspan, thank you for helping us again wrestle 
with these problems. My constituents and people across America 
are really angry with corporate governments, the failures, the 
abuses there. They want people to go to prison who are guilty 
of violating the law. Their retirement accounts, their 
education accounts are devastated, and they want those prisons 
not to be just country club prisons.
    In your statement you say even a small increase in the 
likelihood of large possible criminal penalties for egregious 
behavior of CEOs can have a profoundly important affect on all 
aspects of corporate governance. And then later, just a few 
paragraphs later, you say, I recognize that I am saying that 
the state of corporate governance to a very large extent 
reflects the character of the CEO, and that that is a very 
difficult issue to address. Although we may not be able to 
change the character of corporate officers, we can change the 
behavior through incentives and penalties.
    Then you discuss the kind of responsibilities and the way 
that that governance direction would come from statutory 
direction, from Congress, or from regulation and flexibility 
and rulemaking, and then also from supervisory activities of 
nongovernmental organizations like the New York Stock Exchange.
    What are your thoughts and guidance to us about what is the 
proper role for regulation versus strict statutory action in 
the current environment that we face?
    Mr. Greenspan. Congressman, I think the principle has got 
to be based on how one evaluates what it is you are trying to 
regulate. We, for example, at the Federal Reserve are acutely 
aware that the financial system is under continuous change year 
by year as it evolves, hopefully in a positive direction. We 
accordingly don't have a fixed set of supervisory and 
regulatory standards. We are continuously revising them so that 
they match the changes that are going on in the financial 
system. It would be a mistake, for example, for what we do to 
be hard-wired into statute.
    And so then I would say the principle that I would apply 
here is whether or not what you are writing into law 
specifically is something you expect to be applicable, say, 30 
years from today. Principles should be in the law, but 
empowerment of, for example, the Securities and Exchange 
Commission is the major vehicle here to effectuate the changes 
that need to be made so that they can do it by rulemaking, but 
rulemaking which can change as the circumstances change, but it 
is rulemaking under the empowerment of legislation enacted by 
the Congress. It is a very difficult balance, but one that I 
think is very important to adhere to, and that clearly refers 
to those issues which should not be under federal regulatory 
structures one way or the other and should be in the private 
sector most effectively.
    Mr. Bereuter. Since I seem to have a minute, people look at 
a corporate leader who systematically deceived the public, the 
stockholders, investors, and they see at this moment a huge 
mansion complex being constructed in Florida, and they think, 
as I do, we ought to go after those assets. So what do you 
think about disgorgement and the need for congressional action 
on that subject?
    Mr. Greenspan. Well, that is an issue of enforcement about 
which I don't know terribly much. But, obviously fraud is 
theft. It is indistinguishable from going into a bank and 
stealing something. And our free market capitalist system 
cannot function in an environment in which fraud and 
misrepresentation are critical elements because trust is so 
essential to making that system work.
    This is something which we have to address. How we do it 
and to what extent we impose severe criminal remedies is an 
issue which I don't have any particular view on, but that it 
should be forceful and effective I have no doubt.
    Mr. Bereuter. Thank you very much.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired.
    The gentleman from Pennsylvania Mr. Kanjorski.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Greenspan, in the last several weeks consumer 
confidence has shown some shift. Of course, that was one of the 
two pillars that have been sustaining our economy over the last 
18 months: the consumption of personal items. I would therefore 
like you to address the level of personal debt and whether or 
not its high amount could impinge on the ability for consumer 
confidence to rise and consumption to continue. Then, interlace 
that answer with this discussion that we are hearing now about 
the potential of a real estate bubble. We have also had real 
estate as the second leg sustaining the economy which has been 
significantly high and to a large extent almost beyond 
understanding in a continuing growth pattern.
    Is it possible that the real estate bubble exists in the 
country as the stock market bubble existed? If the real estate 
bubble disappears--and real estate adjustments occur--and 
consumer confidence continues to go down, what do you foresee 
for the American economy over the next 18 months to 2 years?
    Mr. Greenspan. Well, first of all, Congressman, let me say 
that it is certainly the case that the surveys of consumer 
confidence have gone down, and the reasons they have gone down 
are many, but consumer spending in retail markets has not. And 
indeed our interest is actually in what people do, not what 
they say. Indeed, as I point out in my written text, at the 
same time that the indexes of consumer confidence fell, there 
has been a big surge in motor vehicle sales in the early weeks 
of July, so that I think we have to be aware that on occasion, 
as good as these measures are of consumer confidence, they 
often don't necessarily represent what people are going to do 
where we care what they are going to do as far as the economy 
is concerned.
    On the issue of debt, a goodly part of the rise in debt is 
mortgage debt, but that mortgage debt has not been going up 
faster than the rise in the market value of homes. Indeed it 
has been going up less, and that actual new equity is still 
increasing. So a goodly part of the rise in debt is merely a 
reflection of the significant rise in home ownership and the 
rise in the market value of homes, which to a large extent is a 
function of, one, the low interest rates; two, the shortage of 
buildable land; and three, and importantly, the incredible rise 
in immigration. A third of the rise in the household formation 
is from immigration, and that has been a major factor holding 
the price level of homes up.
    We have looked at the bubble question, and we have 
concluded that it is most unlikely mainly because, we have a 
very diverse real estate market throughout the country. You 
have so many different areas which don't arbitrage one another 
as do stock prices, and the transaction costs in homes is very 
high. You cannot readily sell a home without a fairly large 
cost, and perhaps, even more importantly, you have to move, so 
that the type of underlying conditions that creates bubbles is 
very difficult to initiate in the housing market. It is 
actually easier in England where they have had bubbles because 
it is a smaller geographical area. But we see no evidence that 
a national bubble in home values which would then collapse and 
create the type of problems you correctly identify is likely to 
happen. Indeed, I might say the evidence of the last few months 
is that the acceleration in prices which we saw earlier is 
beginning to phase down so that it is not an issue on the table 
at the moment. It is theoretically a concern. We do watch it. 
If it changes, obviously we would try to conceive of actions we 
could take to change it, but that is not an issue that we think 
needs to be addressed by policy at this stage.
    The Chairman. The gentleman's time has expired.
    The gentlelady from New Jersey Mrs. Roukema.
    Mrs. Roukema. Thank you. I thought that Mr. King was going 
to be next. But in any case--well, in any case I do want to 
congratulate and extend my congratulations to you, Mr. 
Chairman, because of your wisdom and knowledge on these 
subjects. We always look forward to your leadership. It has 
been excellent.
    There have been a couple of questions here. As I understand 
it, you do support the question of expensing of stock options, 
and that is supportable. And that is certainly in the Senate 
bill, but not adequately covered in our bill here. But let me 
ask you how that relates as--I heard your answer to Mr. 
Bereuter on that subject, but how that relates with what you 
had stressed in your testimony about the transparency issue. 
Now, the question is, I think you said, do not force directly 
or indirectly proprietary information. How does that work out? 
How does that transparency work out, whether it is stock 
options or whatever, in real terms, and how do we deal with the 
SEC and be sure that they are empowered as regulators under 
this new legislation?
    Mr. Greenspan. Congresswoman, I think that the issue that 
has been really with us for half a century or more is the 
trade-off of transparency in the regulatory process and the 
need to maintain proprietary information. Clearly the IRS has 
got a very major issue there. But it is also true in all 
regulation. We have at the Fed, for example, information which 
we do not divulge publicly and cannot because it is 
proprietary, and if it were divulged, it would undercut the 
competitive position of individual institutions.
    So I think it is something which is really done reasonably 
well in this country. Over the years we have managed to know 
where the dividing line is, and while there are on occasion 
clearly egregious breaches of that, it is not the standard 
practice. I am not concerned that as we move into other areas 
that are involved in legislation both from this Committee and 
from the Senate Committee that we will not--address that issue 
at an appropriate time.
    Mrs. Roukema. Is it presently addressed, or does it have to 
evolve through the conference, this consideration?
    Mr. Greenspan. I don't know the detail of the specific 
statutes and the empowerments you give, for example, to the SEC 
and others. So I really can't answer that, but I believe that 
as the staffers write up final legislation, that will address 
those issues, and I have got every confidence that it will be 
addressed.
    Mrs. Roukema. Certainly will be tracking that and hoping 
that we will be addressing those issues of tracking it through 
with both bills.
    I thank you, Mr. Chairman, and I do again congratulate you 
for your wisdom and your leadership. Thank you.
    The Chairman. The gentlelady's time has expired.
    The gentleman from Vermont Mr. Sanders.
    Mr. Sanders. Thank you, Mr. Chairman, and nice to you see 
you again, Mr. Greenspan.
    I think, as usual, you and I look at the world a little bit 
differently. And my line of questions are two: I am going to 
talk about the crisis and confidence; and I want to talk about 
our trade policy and how that relates to the ostensibly strong 
foundations of the economy which you have talked about.
    It seems to me when the average American looks out in the 
world, he or she has every right to have a crisis of confidence 
in the ruling class of this country, the people who control our 
economy, and to a large degree through their campaign 
contributions control what goes on in the White House and in 
the Congress. It is not just Enron and WorldCom and Xerox. The 
fact is that over the last 5 years 1,000 corporations have 
restated their earnings, and you have just indicated to us that 
you think more may come. In other words, these leaders, these 
country club executives, have lied to their investors and to 
the American people.
    But it goes beyond financial misstatements. Many of these 
companies cheat on their taxes, they bulldoze the IRS because 
they have 10 well-paid accountants trying to take advantage of 
every loophole, while the middle class pays their taxes. Many 
of these companies are now running to Bermuda to disown their 
obligations to the American taxpayer at all. We are looking at 
profitable corporations which have surpluses in their pension 
funds, cutting back on the pensions of workers who have worked 
for those companies for 20 or 30 years, and, while profitable, 
cut back on their health care benefits of their retirees. We 
are looking at these companies who denounce the Federal 
Government every day, but then they run to Washington for their 
corporate welfare, largest corporations in America who are 
taking their jobs abroad. They line up here and get their 
corporate welfare. And meanwhile in order to cover their 
behinds, they contribute hundreds and hundreds of millions of 
dollars to both political parties, so they are not held 
accountable.I want you to talk about that in a moment.
    The second issue I would like you to talk about is trade. 
You are an advocate of free trade. You have told the American 
working people how great it is. Let's open up all the markets.
    Today we have a $426 billion trade deficit, including an $8 
billion trade deficit with China. Over the last 4 years we have 
lost over 2 million factory jobs, representing 10 percent of 
the manufacturing work force in my own State alone. We haven't 
been as low in manufacturing as 33 years ago. This is going on 
all over the country.
    So I want you to tell American workers why deregulation and 
free trade is so great when we have lost millions of decent-
paying jobs while American companies are selling out working 
families and moving to China and to Mexico. And I want you to 
tell us how a $426 billion trade deficit suggests a potentially 
strong economy.
    Those are my two questions: crisis of confidence and the 
wonderful trade policies that we have.
    Mr. Greenspan. First of all, I am not going to obviously 
have time to address all the issues that you raised, but let me 
just say that one, the issue of restatement of earnings is not 
an issue of lying. And the reason it is not is that there are 
quite legitimate differences with respect to how a number of 
different items are treated. There are difficult questions with 
respect to how one judges what the particular average rate of 
return, for example, on defined benefit pension plans will be, 
and that will have a significant effect on what the earnings 
estimate--.
    Mr. Sanders. Were WorldCom and Enron lying?
    Mr. Greenspan. Let me finish. We are no longer dealing 
with, as we used to maybe a century and a half ago, a situation 
where bookkeeping was essentially a measure of the cash that 
came in and the cash that went out, and the difference was your 
profit. Today we have got very complex problems of forecasting 
what happens to balance sheets and what the values of those 
balance sheets are. And there is quite a legitimate difference 
of opinion among very skilled and professional accountants as 
to how you handle these various things. And they are 
essentially based on forecasts, different people's forecasts. 
So if you restate your earnings, it doesn't necessarily mean at 
all that you lied, it means that you misjudged. And that is a 
different issue.
    On the question of trade, I have argued, and I think the 
evidence is really very impressive, that the dramatic increase 
in globalization during the post-World War II period has been a 
major factor in rising living standards throughout the world 
for those countries engaged in trade, and especially for the 
United States. The number you quoted is the current account 
deficit. That is not the trade deficit and is not in and of 
itself a measure of anything bad, because what that means is 
that that much money is coming into the United States on the 
part of those who want to invest here.
    Mr. Sanders. Do you think the loss of 10 percent of our 
manufacturing base in the last 4 years is not bad?
    The Chairman. The gentleman's time has expired. The 
chairman may respond.
    Mr. Greenspan. First of all, the production level of 
manufacturing remains high. We have got fewer people in 
manufacturing because productivity is so good. But they have 
shifted to other jobs.
    Mr. Sanders. Lower-paying jobs.
    Mr. Greenspan. No, the real average income of the American 
worker has been rising for several years at a fairly--.
    Mr. Sanders. It has substantially--.
    The Chairman. The gentleman's time has expired. The 
gentleman from Delaware, Mr. Castle.
    Mr. Castle. Thank you, Mr. Chairman.
    Going back if we can, Chairman Greenspan, to some of the 
earlier issues on the corporate aspects of all of this, in your 
report, which is I think relatively optimistic and talks about 
sustainable growth, you indicate that things are perhaps not as 
bad as the stock market is. And you have--a wise man earlier 
said something about irrational exuberance a few years ago, and 
we seem to have gone to some sort of rational pessimism, may be 
on our way to irrational pessimism, and I am trying to figure 
out why.
    My judgment is the whole corporate behavior has become a 
very significant issue in how people look at the stock market, 
the uncertainty which is there; not the corporate production, 
but what they are doing in the corporations. And like a lot of 
other members here, we hear this at home, but we are just 
personally concerned, too, about the whole issue of corporate 
malfeasance, which we have heard about right at that table a 
few times; the greed which exists; the issue of stock options, 
which I would like to come back to; the accounting and 
auditors; the analyst recommendations, which I would like to 
come back to, which to me are all roiling these markets, are 
really having a huge input.
    It is because the average investors who ultimately make up 
the mutual funds and ultimately are very important in terms of 
the future of the economy and capitalism of this country, just 
don't quite understand what is happening. They are looking to 
us for some direction and action. And, frankly, they are 
probably looking to those who have the bully pulpit, and the 
President is another, and a few others in this country, to try 
to help straighten this out. I think we need to bring some 
certainty to it.
    And that is why I want to come back to stock options. Mr. 
LaFalce talked about this a little bit also as well. We can't 
have Warren Buffet on every corporate board in the country. 
That would be a nice thing if we could, by the way, but we 
can't. So therefore I don't think all of them are going to 
convert to some sort of expensing of stock options. But I am 
really concerned about this. Stock options right now appear as 
footnotes. They are nonentries. They are not expensed at all, 
which you, I think, have stated repeatedly is probably not a 
very good way to do it.
    On the other hand, to allow the corporations to do it on 
their own, with still lack of clarity as to what we are looking 
at, bothers me too. I don't have a problem with stock options 
per se, but I have a real problem with the accountability of 
what is happening with them. It just seems to me that somebody, 
maybe it is not Congress, maybe it is FASB, maybe it is 
somebody else, but somebody needs to look at a methodology for 
the use of stock options. I realize there are different kinds 
of stock options, different years of issuance and that kind of 
thing. But somebody needs, in my judgment, to do this if we are 
going to have a concrete understanding of what is happening 
corporately out there.
    I just like--I know where your views have been on that, but 
it just bothers me that we are going to leave it up to the 
corporations.
    Mr. Greenspan. Well, first of all, I think that the 
evidence is becoming increasingly overwhelming that both the 
economic and the accounting principles that we apply 
necessitate the expensing at the point of stock option grant 
and evaluating it in a manner which effectively reflects market 
values. I will go into the issue if somebody wants me to, but 
it is something which was sort of vague 5, 10 years ago. It is 
no longer vague. There has been a very major debate going on, 
and the evidence as best I can judge is dramatically clear that 
expensing is the right way, and I will be glad to debate that.
    Mr. Castle. To me it is extraordinarily real. It really 
does impact earnings.
    Mr. Greenspan. It affects earnings. The question is what 
you really want to do is get the correct earnings; that is, you 
want to know whether you are using more real resources to 
produce output or less real resources. And the only way to do 
it is a proper accounting.
    My impression, and obviously I don't know this, is that if 
you leave it to FASB and you don't interfere with what they are 
going to do, they will get it right. If in fact it turns out 
that they do not, and Congress or the SEC wants to revisit the 
issue, then it would be an appropriate time to do it. I don't 
think that one need worry about that at this stage.
    Mr. Castle. I just think we need firm guidance. Hopefully 
it will happen that way.
    Mr. Greenspan. What I do think is going to happen is that--
we have already seen Coca Cola and the Washington Post Company, 
but there are a very large number of companies whose actual 
stock option grants are relatively small--they, in my judgment, 
are all going to start to expense. For example, the Coca Cola 
stock price went up, not down, after they announced it. And I 
think that is going to be the general experience.
    The early event is going to be a major move on the part of 
those in which it doesn't matter very much, and then the 
market's pressure will start to move on everybody, even if FASB 
doesn't do anything. But I do believe that FASB will, and my 
own impression is that it is probably unnecessary at this stage 
for the Congress to be involved in that technical an issue 
which can be handled and should be handled in the normal 
private sector, by normal private sector means, with SEC 
oversight.
    The Chairman. The gentleman's time has expired. The 
gentlelady from New York, Mrs. Maloney.
    Mrs. Maloney of New York. Thank you, Mr. Chairman. Earlier 
today during your opening statement, the New York delegation 
was meeting with the FEMA director to discuss recovery efforts. 
And I do want to thank you for the work of the New York Federal 
Reserve, which produced a study of the economic effects of the 
tragedy on our city, which I asked to you produce at your last 
appearance before this body. Thank you.
    Mr. Chairman, yesterday you mentioned infectious greed as 
one of the underlying problems facing our economy, corporate 
America, and the markets. I don't disagree that greed is 
playing a role in the mounting scandals, but I am not convinced 
that this is such a new phenomenon. Certainly the desire to 
accumulate personal wealth is not a new motivation for business 
people, and we have been through corporate scandals before, 
including insider trading and major S&L banking collapses 
during the 1980s. Greed certainly played a role in these 
episodes, which were resolved after government responded by 
punishing criminals and putting in place new financial service 
reforms. Times now demand a strong leadership from government 
and meaningful reform.
    Yesterday the Senate unanimously approved the Sarbanes 
accounting legislation. I hope that this body will do the same.
    This Monday in Alabama, the President went so far as to 
blame our current economic problems on, quote, "a hangover and 
binge," end quote, in the 1990s. I agree with the President 
that we experienced a bubble in the stock market as some high-
tech and telecom stocks rocketed to unsustainable 
capitalizations, but I strongly disagree with his 
characterization of this decade. In my view, the 1990s were a 
decade of unparalleled prosperity, the longest and the best in 
my lifetime. The economy experienced an unmatched period of 
growth, government surpluses, strong financial markets, and 
full employment.
    The Clinton administration, along with Bob Rubin and 
others, put us on the path to fiscal responsibility in 1993. 
And Chairman Greenspan, you and your colleagues at the Fed 
formulated and implemented the monetary policies during the 
1990s and accordingly deserve credit.
    I wonder if you agree with the President's characterization 
of the 1990s? To me it was a period of well-thought-out 
policies that reduced the deficit, balanced the budget, and 
made meaningful investments in education and health care for 
the American people. Do you agree with the President's 
characterization of the 1990s?
    Mr. Greenspan. Well, I am not sure that I read what he said 
the way you are, Congresswoman. I think the issue he is raising 
is the fact that there are certain aspects of the 1990s which 
were characterized by the fact that huge values in the stock 
market began to impact the way the economy functions and 
created certain distortions which, as you point out, in the 
past unwound.
    Greed is not an issue of business, it is an issue of human 
beings. And as I tried to point out in my prepared remarks, 
what occurred was the dramatic increase in the market 
capitalization of equities which, regrettably in part resulted 
because of the failure to expense stock options, created 
distortions and a bubble which eventually must burst, and it 
did. And that has, as I pointed out in my remarks, lingering 
effects which take time to work their way through.
    My own judgment is that the issue of corporate malfeasance 
being driven by endeavors, as I put it, to harvest part of that 
huge increase in market capitalizations is over. There is none 
of it left to do the types of things people were doing. And we 
will see the lingering effects of that in the restatements of 
earnings that we talked about earlier, and we will see that in 
some of the impacts of the declining level of stock prices on 
consumer expenditures, as I mentioned in my prepared remarks.
    But I didn't read the President's remark as stipulating 
that the 1990s were not a decade of rapid growth and 
productivity, of major improvements in standards of living and 
great technological advances. Indeed, the dot-coms which went 
under, went under because they did not have value added. But a 
lot of them are still around. They have produced major advances 
in technology and improved our standards of living. So I 
think--.
    Mrs. Maloney of New York. And I am sure you would agree--
    The Chairman. Time of the gentlelady has expired. The 
gentleman from New York Mr. King.
    Mr. King. Thank you, Mr. Chairman.
    Chairman Greenspan, if I could follow up on your latest 
answer on the question of corporate corruption, the fact of 
whether or not it is working its way out of the system. I would 
ask you two questions; one on that issue. We have seen other 
countries where the issue of crony capitalism has been so 
embedded that it takes an economy years to recover from it. You 
seem to believe that the corruption in this country, as serious 
as it may be in the corporations, is not that entrenched, and 
that specific legislation with severe penalties will eliminate 
it or at least remove it considerably.
    How can you be that confident that the corruption has not 
entrenched itself and is not so deep-rooted that it could take 
many years for it to recover?
    Secondly, if I could, just as a follow up question, the 
whole issue of the Euro versus the dollar, as what you see the 
impact of the parity now between the Euro and the dollar. Is 
that a threat, is it a challenge, how is that going to work, 
you know, play itself out in years to come as far as an impact 
on our economy?
    Mr. Greenspan. The reason I am reasonably sure about the 
fact that the malfeasance that we have observed and documented 
in very great detail has not cut to the core of the system is 
that fact that we have got a remarkably efficient and 
productive economy. You cannot reconcile this dramatic increase 
in productivity which we have been seeing in recent years, in 
fact concurrently, with a goodly part of the type of corporate 
malfeasance which is concerning us. It has had an effect. It 
has an effect on the margins and it would have an effect if it 
were carried forward and continued indefinitely.
    But that is not going to happen, because I think a goodly 
part of the tinder, the huge capital gains tinder which created 
a goodly part of the attraction to do things which people 
ordinarily wouldn't do, that is gone. And as far as I can see, 
the underlying structure of the economy, its underlying 
efficiency, has not been materially impacted. If it were, we 
wouldn't see the type of productivity numbers, the type of 
efficiencies that have emerged in recent years. So we are very 
fortunate in that regard.
    It could have been different, but the evidence does not 
suggest that the malfeasance really cut to the core of the 
system. It did create a very significant problem with respect 
to that part of corporate governance which relates to the 
allocation of gains, or financial gains between shareholders on 
the one hand and corporate managers on the other. And that, in 
my judgment, very much needs to be addressed. Fortunately, that 
has not had a major impact on the underlying efficiency of the 
corporate system, and in that regard, that part of corporate 
governance has with all of its difficulties apparently 
continued to work well.
    Mr. King. I asked the question about the Euro and the 
dollar, the parity.
    Mr. Greenspan. As I mentioned in the Senate yesterday, the 
particular ratio, which is what an exchange rate is, when it is 
set is arbitrary. It could just as easily be half the number or 
20 times the number. So the particular question of the 1.00 
issue is an arbitrary issue which has no economic or financial 
significance. The change in the ratio clearly does matter, 
obviously. That affects the relative purchasing power of 
currencies. But the absolute number that is used to measure 
that is an arbitrary choice, and needs to be.
    Mr. King. How about the question of the Euro being 
strengthened and the dollar being weakened? What impact do you 
see that having?
    Mr. Greenspan. Well, as I said in my prepared remarks, 
issues of that nature are left to be discussed by the Secretary 
of the Treasury in this government. We have found that it is 
far better that there be a single voice on those issues in 
international finance. I would like to adhere to that.
    Mr. King. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The 
gentleman from Texas, Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Chairman Greenspan, it is always good to see you here. In 
reading your testimony, you lay out a prognosis that you expect 
to see economic growth, fairly significant or fairly good 
economic growth through the remainder of this year and into the 
next year. But you also talk about a number of considerable 
uncertainties. And if you read through your testimony, one 
could argue that it lacks any exuberance at all, which is of 
course your trademark, but one could argue that perhaps it is 
even a little more tampered down than normal.
    And you talk about a number of issues, the fact that--you 
talk about considerable uncertainties. You talk about business 
investment being questionable, final demand uncertain, business 
investment gradual by historical standards and uneven, no surge 
in household spending. Adverse publicity regarding accounting 
practices would affect the actions of managers; which, from 
what I have seen in my sector, in the energy sector, shoring up 
of balance sheets rather than engaging in new capital 
investment.
    You raise concerns about fiscal policy that Mr. Frank also 
talked about yesterday. We had the President's budget director 
before the Budget Committee, and he at the end of the day more 
or less said, yes, we are in a unified or in an on-budget 
deficit for the next decade, without question, and the prospect 
of paying down all public debt and curtailing your open market 
activities are no longer a concern.
    And my question to you--well--and on top of that, we have 
seen a dramatic outflow of foreign investment in U.S. equities 
over the last month or so, somewhere between 30 or $40 billion, 
I think, in one article that I read. The dollar, which I 
realize you don't want to comment on, has declined relative to 
other currencies.
    So let me ask you this, a concern that I have. I have two 
questions for you. One is you can paint, obviously, a picture 
that we are going to have good economic growth and ultimately 
things will come back into fore and business demand and 
aggregate demand will increase. But on the other hand, is there 
a possibility that we see a further decline in the dollar, a 
further outflow of foreign investment, a rise in the Federal 
budget deficit for long-term costs like homeland security and 
the like, and a bear market in the U.S. equity markets that 
could result in a down period for the U.S. economy? Not 
necessarily a double dip, but should we be concerned that 
ultimately interest rates will have to come up to defend the 
dollar and that that tampers down investments?
    The second thing I would ask, a little bit unrelated, is 
the House and Senate will soon go to conference on the Oxley 
and Sarbanes bills. One of the key differences between those 
bills is the structure of a new oversight entity for the 
auditing industry. In your testimony, you talk about the 
breakdown in the bulwarks of those who we relied on, including 
auditors, in corporate investment practices. There is a 
difference as to whether or not this new entity ought to be 
separate and apart or at least on a par with the Securities and 
Exchange Commission or it should be a subset and under the 
auspices of the SEC. And would you be willing to give us your 
guidance, as one who has spent a great deal of time in 
regulatory financial regulatory affairs, as to what sort of 
structure we might look for to oversee public accounting?
    Mr. Greenspan. With respect to the first question, I think 
the problem we have is that the economy did not go down very 
much, and therefore, the usual characterization of a recovery, 
one which is surging and often growing at a 5- to 7 percent 
annual rate, is not there, and should not be there, can't be 
there. Because we didn't go down, we can't go up. So what we 
have is an economy that will tend to increasingly move from 
being somewhat below potential growth up to potential growth as 
the lingering effects of the shocks we have seen over the last 
couple of years begin to dissipate.
    That is what the evidence suggests to us is by far the most 
probable outcome that we perceive. And the pieces seem to be 
falling into place day by day. We are not getting a big surge 
in anything, we are not getting a surge in consumer spending, 
in capital spending, we are not getting a surge in the economy, 
but we don't expect to see that.
    Are there problems in the economy? There are always 
uncertainties. But as best we can judge, the outline of the 
forces that we thought would drive the economy earlier this 
year, indeed when I was testifying before you in February, 
pretty much have come about in the way we expected them, and at 
this moment we are still on path.
    Yesterday, for example, the Federal Reserve issued its 
estimate of the June industrial production index, which was up 
quite significantly, and as I mentioned earlier we are seeing 
in the retail markets, especially motor vehicles, clearly 
evidence that the consumer has not retrenched in any material 
way.
    So, I would say overall, there are always elements within a 
complex economy such as ours which suggest that things are not 
going straight up, and indeed they are not, and I hope they all 
do not, because if we are ever in a period of that, we are 
usually out of balance.
    So, I just would repeat what I have been saying in the last 
couple of days, namely, that we are poised for a reasonably 
good expansion. It will not be an expansion of the order of 
magnitude that we have seen coming out of past recessions.
    The Chairman. The gentleman's time has expired. If the 
Chairman would respond to the second question from the 
gentleman from Texas regarding the Independent Oversight Board, 
if he chooses to?
    Mr. Greenspan. I have seen in general discussions of the 
various different ways of coming at these issues. I don't know 
enough about the consequences of both to really give you a 
thoughtful judgment. There are others who are more 
knowledgeable than I.
    My general view is that the approach of both Houses is 
coming to grips with the nature of the problem, but on the 
specific value of one approach versus the other, I am not 
sufficiently knowledgeable about to give you anything useful 
with respect to resolving some of these questions.
    The Chairman. The gentleman from Alabama, Mr. Bachus.
    Mr. Bachus. Thank you. Chairman Greenspan, I reviewed your 
testimony from yesterday. You talked at length about the 
importance of capital investment to maintaining a strong 
economy, to maintaining business viability, to maintaining high 
productivity.
    Now, my question relates to how do we spur that investment?
    The Fed has lowered the Fed funds rate 11 times this year. 
It is at an astonishing 1.75 percent. Yet during this time, 
long-term rates, like the 10-year T bill, have stayed fairly 
stable and fairly high.
    How can the Fed, or what can the Fed do to push down long-
term rates to free up business capital, because that is how 
most capital is financed, is longer term rates?
    Mr. Greenspan. It is certainly the case that long-term 
rates in below investment grade issues have moved up during 
this period as the risks have moved up. But investment grade, 
and specifically A and AA rates and mortgage rates, which are 
very important, have come down. So it is a mixed case.
    I don't think it is the issue of debt or long-term 
interests rates which are inhibiting capital investment. It is 
the perceived issue of subdued profitability.
    The way I look at this economy is profitability is 
gradually being restored and margins are gradually opening up. 
As that process continues, and indeed as we see it in, as I 
mentioned in my prepared remarks, those types of profit 
estimates which endeavor to exclude all of the one-shot 
charges, one-time charges, the profitability of American 
business is improving. As that continues, it will impact on the 
propensity to invest, whereas now, as I mentioned in my 
prepared remarks, capital investment seems to be at a level 
that meets only the most basic needs. That will inevitably 
change as we begin to see profitability moving up, as we begin 
to see the longer-term outlook emerge more clearly.
    So, our projection is for these markets to open up and 
improve, and it is just a question of time.
    Mr. Bachus. Let me ask you another question. You are the 
chairman of a top Federal regulator, so you, obviously, 
appreciate how regulators affect it.
    The Securities Exchange Commission is the top Federal 
regulator of accountants, of publicly traded companies, of 
security markets. First of all, I am sure you are aware that 
they have two vacancies on the five-member board, and two 
people are serving as recess appointees. I saw where Laura 
Unger, former board member, recently said serving as a recess 
appointee is like serving with one arm tied behind you.
    Would you be concerned, if you were chairman of the SEC, 
with having 40 percent of your board unfilled and another 40 
percent serving as recess appointees? Does that compromise 
their ability?
    Mr. Greenspan. Oh, I think it inhibits your ability to 
function as best you can, certainly.
    Mr. Bachus. So it is a major problem in addressing some of 
the problems we have had recently?
    Mr. Greenspan. I would certainly agree that the sooner that 
can be resolved, the better.
    Mr. Bachus. And you consider it critical that those 
vacancies be filled?
    Mr. Greenspan. Well, I don't want to use the word 
"critical." I mean, the SEC functions because it has a very 
effective staff, and most of the operations that occur, that 
are important in the SEC, are staff-driven. So it is not as 
though they are undercut from being an effective regulator. But 
if you don't have the Commission effectively in place, it means 
a lot of things you ordinarily should be able to do, you are 
not able to do.
    Mr. Bachus. You are aware with the Federal Reserve, if you 
don't have a certain number of members, actually certain 
actions can't be taken and certain actions can be thrown out 
legally. In fact, the Federal court recently did that.
    Mr. Greenspan. Absolutely.
    Mr. Bachus. I appreciate your testimony. I appreciate the 
job you have done. I saw all the compliments in the Senate 
yesterday, and it was very touching. They said you raised the 
market 200 points. I noticed right after you left it fell back 
down. So we may want you to just continue to talk all day.
    The Chairman. The gentleman's time has expired. The 
gentleman from Texas, Mr. Gonzales.
    Mr. Gonzalez. Thank you very much, Mr. Chairman. Again, 
welcome, Chairman Greenspan. It is good to see you. I have a 
couple of simple questions. It is really about timelines and 
the importance of Congress acting.
    We have already indicated that we have a reporting period 
pursuant to Chairman Pitt's request for the affirmation of the 
financial statements, and I guess that is August 15, and we 
anticipate, we are just anticipating, that there may be some 
restatements and that people will attribute that or will 
attribute reasons that may not be accurate. It could be a 
change in regulation, it could be interpretation, and not 
necessarily that someone was cooking the books, trying to 
misrepresent facts and figures. But, nevertheless, I think that 
we need to prepare ourselves for that.
    Coupled with ongoing investigations of other large 
corporations.
    I would venture to guess that it is incumbent on Congress 
to act quickly--we will be in recess in August when this 
happens. So could do you see that there is some value in acting 
quickly before we recess for August when it comes to the 
corporate governance legislation that is pending and going to 
conference? That is the first question.
    The second one has to do with options. I think you pointed 
out the pitfalls and the negatives associated with options. But 
in our discussions, especially with individuals representing 
the high-tech industries and the importance that options play 
in that particular industry, we are not talking about Coca-
Cola, we are not talking about Bank One, we are not talking 
about Boeing, but I don't see any of the high-tech industries 
rushing in and agreeing with you on the expensing of options.
    Can you go ahead and tell me what the benefits are 
associated with options, and what can we do to still retain the 
benefits that options provide these corporations?
    Thank you.
    Mr. Greenspan. With respect to your first question, 
Congressman, I don't perceive a need for Congress to move 
expeditiously in this regard. The reason is that, as I 
indicated in my prepared remarks, and indeed in testimony 
yesterday before the Senate, the frenzy that has occurred--the 
frenetic activities in corporations endeavoring to manage their 
earnings to meet various different goals, to drive their stock 
price--that is largely over, and indeed it will be over 
shortly.
    We will get some restatements. I hope we get restatements. 
indeed, because a lot of people began to think that the name of 
corporate governance was how do you manage earnings to satisfy 
stock prices.
    Now, that is nonsense. That is not what corporate 
governance is all about.
    I think that is over. And indeed, if I were convinced that 
you didn't need to do anything ever, then I would say Congress 
can just go home and forget about it. The trouble, 
unfortunately, is that the shock of what has happened will keep 
malfeasance down for a while, but human nature being what it is 
and memories fade, it will be back, and it is important that at 
that time appropriate legislation be in place to inhibit 
activities that we would perceive to be inappropriate.
    But I do think it needs to happen in a manner which is 
deliberative, rather than rushed, because there is nothing that 
anyone is going to do out there that you need to stop people 
from doing. Most of them are so traumatized at this point that 
the thought of doing anything other than preserve cash is not 
something which is first on their agenda.
    If you wait too long, you probably lose the window of 
opportunity, but I don't think there is a need to move forward 
especially before the August recess, but I think you do have to 
move before everybody loses interest in the subject.
    With respect to the issue of stock options, there is no 
question that a number of the high-tech companies could not 
have made it without issuing stock options in lieu of cash, 
because they didn't have cash.
    The argument has got nothing to do with whether you issue 
stock options; it is whether you account for them. In other 
words, a very significant number of dot-com companies reported 
earnings which really did not exist. What they effectively did 
is that they used a very significant amount of labor resources 
to produce new goods and services, but didn't count them as any 
cost, so you get an artificial view that there is profit, 
meaning that you produced more than you used up than in fact 
was the case.
    I have no argument against new high-tech companies giving 
stock options. Indeed, it is a very useful and very beneficial 
mechanism to get people engaged in a company. I am only arguing 
that when you do it, you represent the earnings of the company 
correctly, and indeed don't try to fool the people whom you are 
giving stock options to, that the company is worth a lot more 
than it is.
    So, it is more a question of proper reporting, not in the 
issue of whether or not you should issue stock options.
    Expensing stock options says nothing about whether they are 
desirable to do or whether you can legally do them. On the 
contrary, they are desirable to do, they do have benefits, but 
the income ought to be recorded appropriately so that people 
know how valuable the company is.
    Mr. Gonzalez. Thank you very much.
    Mr. King. [Presiding.] The gentleman from California, Mr. 
Royce.
    Mr. Royce. Chairman Greenspan, welcome. Last week in this 
committee, we had testifying here on the $308 billion 
restatement of earnings at WorldCom, an individual named Jack 
Grubman. He is a securities analyst at the underwriting firm of 
Salomon Smith Barney. He is also one of the individuals who 
helped hype that company's market capitalization to over $190 
billion, which I think is about 600 times what it is today.
    In his testimony, in response to our questions, he admitted 
that no one could sit here on Wall Street today and deny to 
anybody on this committee that banking is not a consideration 
in the compensation of analysts at a full-service firm.
    I think he was the best paid on Wall Street, and I think 
his compensation was in the neighborhood of $20 million a year.
    There used to be this firewall between security analysis 
and investment banking within firms in order to protect 
investors from the inherent conflict of interest that could 
arise when employees of a given firm simultaneously raised 
capital for companies and then go out and advise investors. I 
think his testimony really makes clear that today analysts are 
promoting deals at sales road shows is basically an adjunct of 
their firm's investment banking in order to make up for the 
loss leader, which is the securities research, at the 
underwriting firm.
    Now, the New York Stock Exchange has written new rules that 
are supposed to be in place by November, and those rules are 
supposed to bar analyst compensation tied to investment banking 
deals, they are supposed to make it difficult for analysts to 
discuss specific stocks on the air, to require the monitoring 
of communications between researchers and deal makers, and to 
require disclosure of the firm's ratios of buy, hold and sell 
ratings to the public.
    I don't know that that is possible. It seems to me that the 
only way to fix this, if you really want to return to what used 
to be called that ``Chinese wall'', is to forbid analysts from 
any involvement in investment banking deals whatsoever.
    I was going to ask you for your opinion of the potential 
for mingling of securities research and investment banking, the 
potential that that creates a conflict of interest where these 
particular stocks are hyped, where that gives rise to 
irrational exuberance in certain stocks or certain sectors of 
the market, and my question is, do these regulations by the New 
York Stock Exchange effectively address this situation? And if 
not, how can this problem be more effectively addressed by us 
in Congress, since we are going into conference right now on 
CARTA legislation.
    I thank you very much for your thoughts on that.
    Mr. Greenspan. Congressman, first of all, I would like to 
state that the market value of research is based on its 
credibility. Over the years it has become quite apparent that 
there is an upward bias in security analysts' forecasts of 
earnings that estimated over the last 15 years as averaging 
about 5 percent per and up. In other words, it is a fairly 
significant--.
    Mr. Royce. It is compounding.
    Mr. Greenspan. It is a fairly significant change. It is not 
so much that what you are getting are analysts who are fudging 
the numbers, but there is a tendency on the part of brokerage 
firms to hire people who are optimistic. So you get that sort 
of built-in bias, even though everyone is telling it exactly 
the way it is. So that the question really is can you regulate 
that?
    I think not. I think the New York Stock Exchange's endeavor 
to do it is the best that probably can be done. But there has 
been a major loss in the market value of stock market research, 
if I can put it in a business sense. It is to everybody's 
interest who is endeavoring to get involved in that activity to 
try to give the perception that, indeed, there is a Chinese 
wall; not only is there a Chinese wall, but there is objective 
valuation.
    As you know, a number of the firms which do this no longer 
put in buy recommendations. They merely grade various different 
companies, A, B, C, D, E, F, or whatever, and leave it at that. 
I think what is going to happen here are changes which will get 
us back to where research is going to be useful. I am very 
doubtful that there is legislation that can do that. This is 
too technically a difficult issue to legislate, and I would 
leave it to the private sector to handle it.
    My judgment is that they will do as good a job as can be 
done, but I say at the end of the day, the presumption that you 
are going to get what you really would want in this respect, 
independent security analysts working only for the purpose of 
doing forecasts of earnings, selling it as a commercial 
product, it will not happen, because the market apparently is 
not there.
    The only place it exists is within a number of large 
institutional investors who hire specific analysts to do that, 
and they do it right.
    Mr. Royce. Well, there are some independent research firms 
out there, Charles Schwab and so forth. I wonder if the market 
will evolve in that direction?
    Mr. Greenspan. There are a few. I certainly hope so. If the 
demand is there, it will. I doubt very much any legislative 
vehicle on the part of the Congress can actually expedite or 
improve on that process.
    Mr. King. The time of the gentleman has expired.
    The Chair recognizes the gentleman from Massachusetts, Mr. 
Capuano.
    Mr. Capuano. Thank you, Mr. Chairman.
    Mr. Chairman, since we started this morning, the market 
started out at up 208 at 10 o'clock. It is now up only 77, so 
every word we say is apparently losing somebody some money. So 
I will try to keep this very boring and try not to excite 
anybody.
    But I do have similar questions that I have asked you in 
the past. I read the policy report and I read the numbers and I 
know what the Fed does and I know that what you do is all 
macroeconomic, and I appreciate that, and I don't think there 
is anybody better at it than you.
    But from my level, the impact of macro on micro is 
critical. For instance, you mentioned earlier that equity has 
increased quicker than mortgage debt, and I appreciate. It has 
in my home as well. My home is worth a lot more today than I 
bought it for. But the problem is I cannot access that equity, 
because I could not pay the monthly mortgage on accessing it. 
So therefore, though the equity is there, my personal level, 
that is great, it makes me look good on paper, I can't touch 
that money. No bank in their right mind would give me the 
mortgage that my house is worth. So that is the micro part of 
it. The macro part is it is this and looks good, but the micro 
part is nobody can get to it.
    Again, I would encourage you and others who look at these 
things to really look at how it impacts individual investors 
and individual people, because it is really critical. It is the 
same thing with the unemployment rate and other issues that are 
in these reports on a regular basis.
    That goes to one of the questions I want to ask you. I 
really only have two questions, and I hope both are boring. One 
of them, I have heard you very clearly on the stock options. I 
could not agree with you more. I totally agree with you, and it 
actually came as a little displeasure that others don't. So be 
it.
    There is also another item that strikes me as something 
that inflates the bottom line of corporations, and I think some 
of the transparency is there, but again, similar to stock 
options, I think some of the access to the wealth is not there, 
and that is when it comes to the reporting of investment 
increases in pension funds.
    Many corporations, you know better than I do, when the 
pension funds that they have related to for their employees, 
when they invest in something and that investment goes up, they 
report that investment increase as profit. Now, my guess is 
that some of the best and more independent analysts could weed 
through that, but my guess is that my mother could not. That 
being the case, I think that is problematic.
    I would ask if you think that my analysis is, again, not 
point for point correct, but on board, and, if so, would you 
share that concern, or are you comfortable with the current 
situation?
    Mr. Greenspan. Well, I think we have to separate defined 
contribution plans, which clearly belong to the individual who 
has shares in them, and defined benefit pension plans, which 
are essentially an obligation on the part of the corporation to 
make a fixed payment, a fixed annuity to the employee at the 
point of retirement.
    There is a legal obligation which the corporation has to 
meet that. The existence of the pension fund does not, in any 
way, change that obligation. So what happens is that 
corporations, in order to make certain that they can meet their 
legal obligations, will build up a pension fund to a size which 
enables them to pay off retirement benefits as they occur.
    Periodically what does happen is that they become 
overfunded. That is, either the stock market went up or they 
inadvertently put in more than they actually need, and under 
certain conditions, that is capable of being drawn out and the 
entries are reversed, and it does show up in corporate profits 
in some form or another.
    But I think the important issue here is that the pension 
fund in no way affects the obligation, as I understand it, of 
the individual corporation. If the fund went down and they lost 
a great deal of money, they are still obligated to pay the 
pension.
    Mr. Capuano. In some pension funds I would agree with you. 
Again, I would ask you to look at that in some point of the 
future and let us know, let me know, whether you are satisfied 
with current reporting requirements relative to pension fund 
items.
    The only other question I have for you, I was just reading 
some news clips this morning--.
    Mr. King. The gentleman's time has expired.
    Mr. Capuano. May I just ask this last one question, two 
seconds. Since 1998, apparently 77 percent of the mergers and 
acquisitions that have occurred in this country have occurred 
by the acquisition by foreign companies of American companies. 
I am just wondering if you are comfortable with that trend?
    Mr. Greenspan. Well, that is another way of looking at the 
fact that foreigners view investment in the United States as 
superior to investment anywhere else in the world. One of the 
reasons why we have had such a huge increase of funds flowing 
into the United States, some of which are so-called direct 
investment, is that people perceive that this is the best place 
in the world to invest. So what they are doing is that they are 
buying existing companies. We are creating new ones and we keep 
selling them to foreigners.
    So it is, in a sense, a measure of what people perceive 
that this country is capable of doing.
    Mr. King. The gentlewoman from New York, Mrs. Kelley.
    Mrs. Kelly. Thank you.
    Mr. Greenspan, in reading your testimony at yesterday's 
hearing in the Senate, you observed that you felt that the most 
important part of the legislation that we would do here would 
be to raise the penalties for malfeasance. Tell me, do you 
think that increasing the ability for individuals to sue 
corporations for inaccuracies in their statements is a proper 
goal for this kinds of legislation?
    Mr. Greenspan. I think not. I don't see that that has any 
particular economic advantage. The issue is a technical one and 
a complex one and should be really under the aegis of the 
Securities and Exchange Commission, and they should be taking 
the actions which are required to redress the inaccuracies, 
mistakes, malfeasance and the like.
    I don't see any particular benefit in resolving the types 
of problems we are confronted with by increasing the ability of 
people to sue. I mean, we have an existing structure. I think 
that the major expansion that will occur has got to be in the 
ability of the empowerment of the SEC to do these various 
different things. I don't think you gain anything by increasing 
the ability to sue the company. Because remember that it is 
shareholders suing other shareholders. That is what it is.
    Mrs. Kelly. Thank you. There has been a tremendous attempt 
to politicize this issue, and I would be interested in seeing 
what you feel about the potential for Congress to overreach and 
possibly do more harm than good in some respects with this 
legislation that we are looking at, and, if so, would you be 
willing to outline some of the areas where you feel there is a 
need for us to proceed with great caution?
    Mr. Greenspan. I am not sufficiently knowledgeable about 
the details of either the bill that has been passed in this 
House versus the one that was passed on Monday in the Senate. 
They both address the problems that I think need to be 
addressed. They have technical differences and these are a lot 
of changes, but I can't argue that I am sufficiently 
knowledgeable about the impact of a lot of those things, so 
that my comments I don't think are very worthwhile in that 
regard.
    Mrs. Kelly. One final question, sir. I understand that 
today the news came out that construction on new homes dipped 
by 3.6 percent. Although apparently the permits for future 
projects have gained, this could represent a blip perhaps in 
the housing market, and if we experience a loss in value of 
housing, how readily will that translate into harm to our 
economy, and does this give the Board pause in any 
consideration of raising interest rates?
    Mr. Greenspan. First of all, I think the data that came out 
today were pretty much in line with what our forecasts were. 
Indeed, almost exactly in line with it. There is no evidence 
that one can see that the fairly significant strength in the 
housing market is, in any way, impeded. Indeed, as you point 
out, permits, which are in a certain sense as important as the 
housing starts data in evaluating the market, were firmer.
    Mrs. Kelly. My question was whether or not the Board would 
be looking at raising interest rates?
    Mr. Greenspan. I know what your question was.
    Mrs. Kelly. And you didn't answer.
    Mr. Greenspan. I was hoping the chairman might find that 
the time ran out. I tried to address that as best I could 
within my prepared remarks, Congresswoman.
    Mrs. Kelly. Thank you. I yield back.
    Mr. King. I remind all members that Chairman Greenspan has 
to leave by 1 o'clock today, so I ask them to stay within the 5 
minute limit.
    The gentleman from New York, Mr. Crowley.
    Mr. Crowley. Thank you for the time. Thank you, Mr. 
Greenspan. Good to see again. Thank you for coming before the 
committee again. I have a couple of quick questions.
    One question deals with an issue I asked the last time I 
had an opportunity to ask a question of you, and it dealt with 
consumer confidence. We have seen a little over a decade of 
tremendous growth, high double digit earnings, percentage 
earnings in the last decade, tens of millions of people who 
have known nothing but growth have all of a sudden had a bucket 
of ice cold water dumped on their heads. Many of them are in 
the middle of their careers, maybe a little over 12 years in 
their careers, and they are halfway through, getting ready, set 
their retirement at 40 years of age, and now realize they have 
a little more work to do in their lives in all likelihood.
    What are your thoughts about how to restore the confidence, 
not only of those folks who are directly engaged in the market 
and it is their livelihood directly, but for those tens of 
millions of investors who now, I think, have gotten the real 
jolt, not having lived through maybe more difficult times, and 
looking to someone like yourself, who, in all likelihood, not 
knowing exactly how old you are, has probably lived through 
more difficult times.
    What advice do you have for those people who work directly 
within the market, and for those tens of millions of people, 
blue collar men and women who never have been invested before, 
who have become invested?
    On the issue of the development of tax havens, corporate 
tax havens as well, I would like to know what your position is. 
The Democratic members of the Appropriations Committee, 
approved a provision that would prohibit government contracts 
from being issued to companies that have reincorporated 
overseas, specifically, to avoid paying their full taxes. It is 
my understanding that that language is coming under attack now, 
and the administration is also attacking that, the attempt to 
close that loophole.
    We have seen a great deal of fleecing going on here in the 
States with American companies, and some of those companies are 
attempting to go offshore to avoid paying taxes. I wonder what 
your thoughts are on that attempt to avoid to pay corporate tax 
in lieu of the fact that we have gone from a $5 trillion 
surplus in just under 2 years of seeing no end to the massive 
deficits in just less and year and a half maybe during this 
administration.
    Then lastly, you mentioned stock options before. Do you 
believe that it should be imposed by market or by government in 
terms of the accounting of those options?
    I will leave it to you.
    Mr. Greenspan. Well, Congressman, I have indicated that I 
would far prefer that the issue of accounting principles be 
privately determined. I don't think anybody believes that you 
can legislate the principles of accounting, and that would 
obviously include how one handles such technical questions of 
various different types of stock options and various different 
types of forms of compensation.
    On the issue of the difficulties that a lot of people are 
going through--and indeed they are, and as you correctly point 
out, I have been looking at ups and downs for a very long 
period of time and I prefer the ups--we do have, however, in 
this country increasing evidence that the flexibility and 
resiliency of the economy that has emerged in the 1990s largely 
as a result of the technology advances, but also of increasing 
deregulation of various areas in our economy which were 
creating bottlenecks in the flexible movement of markets and 
prices and people and capital, and that has apparently had a 
very important positive effect on the longer term, and we are 
indeed seeing almost on a day-by-day basis its repercussions.
    As I said earlier, the longer-term outlook for this economy 
is really very, very impressive. When we do our short-term 
forecasts, we essentially move into our longer-term outlook, so 
to speak. What that is, in effect, telling us as we do it is 
that things are gradually improving. And while we are all 
seeing the downside of stock prices and the various 
difficulties that emerge as a consequence, it is a two-way 
street, and that street will change. It always has. There is 
nothing fundamental in the economy that appears to be a longer-
term deterioration. When we had that sort of valuation, you had 
a much more deep-seated set of problems than we have today.
    So I think that the longer term is, if anything, better 
than I have seen it in a very long period of time, and while 
that might not be something which can console people who have 
been through some very rough times in the financial markets 
recently, it is an issue that suggests that in the long term, 
this will pass.
    Mr. Crowley. The tax havens?
    Mr. Greenspan. I think you have to be very careful. This is 
a very tricky issue, and it is a tricky issue because when you 
impose taxes in this country which do not exist elsewhere, 
there will be a tendency for people to try to move where the 
tax burden is least. If you are going to have a free market 
system, you have to have freedom of movement. I think without 
having looked at the detail of this problem more than at a 
level necessary to come to a real judgement, I do know enough 
to know that it is not always as simple as it looks; if you 
start to change the tax code at the border, you have 
consequences which, as far as the economy is concerned, I think 
you have to be careful about.
    So, I can't give you any specific advice on how to handle 
this particular problem. It is just that it is very easy to try 
to block people from taking actions. I am not sure that that 
helps in the long run. I am not sure that that advice is 
helpful, but that is the best I can do.
    Mr. King. The gentleman's time has expired.
    The gentleman from Texas, Dr. Paul.
    Dr. Paul. Thank you, Mr. Chairman. Welcome, Chairman 
Greenspan. I have listened carefully to your testimony, but I 
get the sense I may be listening to the chairman of the board 
of Central Economic Planning rather than the Chairman of a 
Board that has been entrusted with protecting the value of the 
dollar.
    I have, for quite a few years now, expressed concern about 
the value of the dollar, which I think we neglect here in the 
Congress, here in the committee, and I do not think that the 
Federal Reserve has done a good job in protecting the value of 
the dollar. It seems that maybe others are coming around to 
this viewpoint, because I see that the head of the IMF Mr. 
Koehler, has expressed a concern and made a suggestion that all 
the central bankers of the world need to lay plans for the near 
future to possibly prop up the dollar. So others have this same 
concern.
    You have in your testimony expressed concern about the 
greed factor on Wall Street, which obviously is there, and you 
implied that this has come out from the excessive 
capitalization, excessive valuations, which may be true. But I 
think where you have come up short is in failing to explain why 
we have financial bubbles. I think if you have fiat money and 
excessive credit, you create financial bubbles, and you also 
undermine the value of the dollar, and now we are facing that 
consequence.
    We see the disintegration of some of these markets. At the 
same time, we have potential real depreciation of the value of 
our dollar. We have pursued rampant inflation of the money 
supply since you have been chairman of the Federal Reserve. We 
have literally created $4.7 trillion worth of new money in M-3. 
Even in this last year with this tremendous burst of inflation 
of the money supply, it has gone up, since last January, over 
$1 trillion. You can't have anything but lower value of that 
unit of account if you keep printing and creating new money.
    Now, I would like to bring us back to sound money, and I 
would want to quote an eminent economist by the name of Alan 
Greenspan who gives me some credibility on what I am interested 
in. A time ago you said, ``in the absence of the gold standard, 
there is no way to protect savings from confiscation through 
inflation. There is no safe store of value without gold. This 
is the shabby secret of the welfare state that tirades against 
gold. Deficit spending is simply a scheme for the hidden 
confiscation of wealth. Gold stands in the way of this 
insidious process. It stands as a protector of property 
rights.''
    But gold always has always had to be undermined if fiat 
money is to work, and there has to be an illusion of trust for 
paper money to work. I think this has been happening for 
thousands of years. At one time the kings clipped coins, then 
they debased the metals, then we learned how to print money. 
Even as recently as the 1960s, for us to perpetuate a myth 
about our monetary system, we dumped two-thirds of our gold, 
500 million ounces of gold, on to the market at $35 an ounce, 
in order to try to convince people to trust the money.
    Even today, there is a fair amount of trading by central 
banks in gold, the dumping of hundreds of tons of gold, loaning 
of gold, for the sole purpose of making sure this indicator of 
gold does not discredit the paper money, and I think there is a 
definite concerted effort to do that.
    My questions are twofold relating to gold. One, I have been 
trying desperately to find out the total amount of gold either 
dumped and sold on the markets by all the central banks of the 
world, or loaned by the central banks of the world. This is in 
hundreds and hundreds of tons. But those figures are not 
available to me. Maybe you can help me find this.
    I think it would be important to know since all central 
banks still deal with and hold gold, whether they are dumping 
or loaning or buying, for that matter. But along this line, I 
have a bill that would say that our government, our Treasury, 
could not deal in gold and could not be involved in the gold 
market, unless the Congress knows about it.
    That, to me, seems like such a reasonable approach and a 
reasonable request, but they say they don't use it, so 
therefore, we don't need the bill. If they are not trading in 
gold, what would be the harm in the Congress knowing about 
handling and dealing with this asset, gold?
    Mr. Greenspan. Well, first of all, neither we nor the 
Treasury trades gold. My impression is that were we to do so, 
we would announce it. It is certainly the case that others do. 
There are data published monthly or quarterly which show the 
reported gold holdings in central banks throughout the world, 
so you do know who holds what.
    The actual trading data, I don't think is available, 
although the London Gold Exchange does show what its volume 
numbers are, and periodically individual central banks do 
indicate when they are planning to sell gold, but they all 
report what they own. So it may well be the case that you can't 
find specific transactions, I think, but you can find the net 
results of those transactions, and they are published. But as 
far as the United States is concerned, we don't do it.
    The Chairman. [presiding.] The gentleman's time has 
expired. The gentleman from California, Mr. Sherman, is 
recognized.
    Mr. Sherman. Thank you. It is good for you to be back 
again. As before, I may have some questions I will ask you to 
submit answers to in writing, because my questions exceed the 
amount of time. I was looking back at our February exchange, 
and I noted that I said that I was amazed that the dollar still 
sells for more than the Euro. I am amazed that the dollar is 
not selling for a lot less than the Euro, given our incredibly 
high and continuing trade deficit. But perhaps we are headed 
toward a glide path. I would ask you a question about that, but 
I am not sure that you want to comment.
    First, I want to thank you for the incredible wisdom of 
holding off on any new regulations allowing commercial banks 
into the real estate-brokerage business. I hope I am confident 
that that wisdom will continue well into next year.
    I also want to thank you for not echoing the comments of 
others. Others have said that home prices today show irrational 
exuberance, and I note that that was not your conclusion.
    One thing that concerns me is that the whole world is way 
faster, especially in getting information. We used to wait for 
a weekly magazine. Now we log on to the Web. But in one area, 
it hasn't gotten any faster. You still get only annual audited 
financial statements. Putting aside whether the audits do us 
any good and we are striving to create audits worthy of the 
name, would it make sense for us to have semi-annual audits of 
our 1,000 largest companies? I don't know if you would like to 
respond.
    Mr. Greenspan. I think that the internal audit system is 
almost universally overseen by outside auditors, and in a 
sense, the quarterly statements that come out, whether audited 
or not, are within a set of guidelines. So I am not sure you 
pick up very much except additional expense in doing that.
    If there are individual companies or industries where, say, 
earnings fluctuate a great deal or there is great complexity, 
maybe. But I am not sure what the advantages would be, frankly.
    Mr. Sherman. So you don't see a major difference in 
investor reliability between a reviewed financial statement and 
an audited financial statement?
    Mr. Greenspan. I would say our recent history answers that 
question, unfortunately.
    Mr. Sherman. Turning to stock options, one of the basic 
fundamental premises of an accounting system is comparability. 
We used to be able to compare Coke with Pepsi. We still can as 
consumers, but as investors, we no longer can. I know you are 
opposed to having the government write financial statements, 
but perhaps you could comment on the incredible timidity of the 
Financial Accounting Standards Board, that long ago issued a 
statement saying the right thing to do is to expense stock 
options. But, oh, gee, we are not going to make you do it.
    I wonder whether some government board or some other entity 
might come up with a better approach to knowing what the right 
thing is, but actually requiring it, and I would join you in 
saying just because stock options should be expensed, doesn't 
mean they are bad. Right now a company recognizes an expense 
when they pay for employee health care or coffee or salaries, 
and we are all in favor of salaries and health care, and they 
are expensed when they are given to employees, and obviously 
stock options should be as well.
    But what do you think of an accounting standards board that 
knows what the right thing to do is, but doesn't do it, and do 
you think that this voluntary approach by Coke, while a good 
step, doesn't just confuse the whole comparability issue?
    Mr. Greenspan. No, I have been in business forecasting for 
a long time to know when I see a trend. I see one. We will 
have, as best I can judge, expensing of stock options fairly 
generally within a reasonable period of time.
    If I am wrong on that, I will acknowledge that I was wrong 
and that maybe additional actions are required. But I doubt it. 
I think if you leave it to the FASB at this particular point, 
my impression is that it will come out right.
    The Chairman. The gentleman's time has expired. The 
gentleman from New York, Mr. Grucci.
    Mr. Sherman. I will submit additional questions in writing.
    The Chairman. Without objection.
    Mr. Grucci. Over the course of the last several weeks or 
so, the last couple of months, consumers have lost and 
investors have lost their confidence in the market, but they 
certainly haven't lost their confidence in the economy. The 
economy seems to be solid. As you reported here today, it seems 
to be moving in the right direction. But they have lost their 
support for the cornerstone of our economy, which is our stock 
market. It is just absolutely shameful that the acts of a few 
have tainted the many.
    I would like to know your thoughts regarding your talk 
about strengthening the actions taken against those who would 
use their influence, use their power, use their position to 
hide, to shade, to jade the truth. At the same time, making 
personal gains for themselves.
    What would your thoughts be about having a standard or 
statute similar to that of RICO that if indeed someone was 
found to be guilty of something of that magnitude, not only 
would they be facing a jail term, but they would also be the 
facing the possibility of being stripped clean of all of their 
assets, having those assets converted back into cash and given 
back to the people whose children's education funds were lost 
and their retirement funds lost people who watched their entire 
life savings being wiped out.
    Do you think that would be a strong deterrent to prevent 
the future actions of some of these corporate executives?
    Mr. Greenspan. Congressman, as I indicated in my prepared 
remarks, I think actually a relatively small shift in emphasis 
will have a very large impact. I don't know enough about the 
criminal justice system to give any real views as to what works 
and what doesn't work and what is appropriate or not. All I am 
aware of is that the incentive structure was distorted and 
needs to be redressed. I think that can be done within a 
relatively modest set of changes. But then, again, I can't say 
for sure, because, as I said, I am not sufficiently familiar-- 
I am not a lawyer, I am certainly not a criminal lawyer--to 
know exactly what type of inhibitions are required to achieve 
certain types of results.
    Mr. Grucci. Nor am I a lawyer, sir. But it would seem to me 
if I stood the risk of losing everything, it might give me a 
moment of pause before I cooked the books a little.
    A second thought I had that I would like your opinion on, 
you have certainly expressed your support for expensing stock 
options. By doing so, do you see that having a chilling effect 
on the market in the sense that once you reevaluate the 
company, people would take a moment of pause to see how that 
all shakes out? In doing so, would that have a negative effect 
on the investors in the market, and if you do think it does, 
for how long do you think it might?
    Mr. Greenspan. My general impression is no, because I think 
it is pretty apparent that reality is not changing. It is just 
the way books are kept. The most recent experience has really 
indicated that the confidence that investors have had in the 
books, if I may put it that way, has deteriorated to a 
significant extent, so that by definition, if you don't have 
confidence in the number you are looking at, if you change it, 
you are not going to have very much confidence in that either.
    So I think as we move toward a much better structure of 
reporting, which truly endeavors to measure what is really 
profitable as distinct from sort of fictional bookkeeping 
profit, the better off we are.
    It is far more important to get back to reality, to get 
back to sound bookkeeping, as quickly as we can, and the net 
effect on the markets and the market values is going to be, on 
net, positive not negative.
    Mr. Grucci. Lastly, along that same thought, what would 
happen to the value of the company? Would it be overburdened if 
the options were never exercised? Would the company be unfairly 
burdened?
    Mr. Greenspan. You mean if it had options which were 
vested, but not exercised?
    Mr. Grucci. Yes, correct.
    Mr. Greenspan. Not really. We are talking about basically a 
relationship between new shareholders and existing 
shareholders. You know, the aggregate amount of the market 
value of the firm doesn't change when you trade the stock. So 
really, the question of whether you have vested options which 
are exercised or not doesn't have a material effect. It has an 
impact on the potential value of the existing shares because 
those shares would be diluted.
    Whether you exercise or not probably doesn't really matter 
at the end of the day.
    The Chairman. The gentleman's time has expired. The Chair 
would like to inquire of the Chairman, I understand you have to 
leave by 1, is that correct?
    Mr. Greenspan. I do indeed.
    The Chairman. If we could do a couple minutes for the 
members, if the Chairman would--.
    Mr. Greenspan. Then obviously I will be glad to answer 
whatever questions in writing.
    The Chairman. I think that would be more fair, if we can 
try to divvy up the time.
    The gentleman from Tennessee for 2 minutes.
    Mr. Ford. Thank you, Mr. Chairman.
    Welcome. A couple of questions, Chairman Greenspan, and I 
will try to be very quick. One, the last time you were here, a 
year and a half ago, I asked a question regarding the 
challenges that so many of our States are facing, 45 to 50 of 
them now, are facing with these budget shortfalls.
    Your remarks yesterday before the Senate Banking Committee 
suggested that the fundamentals are in place for this economy, 
it may take a little longer, the recovery or the growth may not 
be as robust as we enjoyed during the nineties.
    My question is, the fiscal challenges facing the States, 
what kind of contractionary impact, if at all, will it have on 
the national economy? If I might be so bold, your response last 
time suggested not much. You talked about elasticity and 
inelasticity of revenue streams for States versus the Federal 
Government. My question at that time was motivated by these 
remarkable projections, surplus projections.
    My, my, my, how a year and a half can change things. We 
talked about retiring this debt. It doesn't look like we are 
going to do it as quickly as we once did. That is my first 
question, sir.
    The second, third and fourth deal with, I know you 
indicated corporate government reform is not something in your 
estimation that needs to be done before the August recess, or I 
should say it is not urgent. But, as you know, there are a few 
differences between what we passed here in the House and what 
the Senate passed.
    I would love to give you a chance to respond to the first 
question and just give you the three areas where I think the 
differences are the most significant; one being leveling the 
playing field and the kind of ensuring the independence of 
analyst advice, forcing them to disclose ownership of stocks 
that they cover as well as business relationships that may 
exist with companies. Two, these auditor committees, ensuring 
that in many ways--or the independence of outside auditors. In 
a lot of ways--as you know, both bills prohibit auditors from 
performing internal audit work, as well as consulting on the 
formation of financial systems designs. But the Senate bill 
goes further and allows audit committees of corporate boards to 
have to sign off on any other type of non-audit work.
    I am curious to know your thoughts on that. I will wait for 
the last one if I have more time.
    The Chairman. The gentleman doesn't have any time. The 
Chairman may respond.
    Mr. Greenspan. I will be glad to respond to that in 
writing.
    [The following information was subsequently submitted by 
Chairman Greenspan.]
        [You have raised three questions. In your first 
        question about the fiscal challenges facing State 
        governments, as you have noted, in most States (and 
        some localities) revenue collections have fallen short 
        of policymakers' expectations for at least a year. So 
        far, the response in State budgets has been a fairly 
        small slowing in spending and some relatively minor tax 
        increases, as has been typical in past cyclical 
        downturns. As a result, the overall balance of State 
        and local budgets has declined, which tends to have an 
        expansionary effect on aggregate demand.
        Regarding your question about the appropriateness of 
        independent analyst advice, I believe that stronger 
        regulatory oversight, combined with market discipline, 
        is working to improve the information content of 
        analyst reports and recommendations. In May, the SEC 
        approved new regulations that had been proposed jointly 
        by the National Association of Securities Dealers and 
        the New York Stock Exchange. These regulations mandate 
        increased disclosure of potential conflicts of interest 
        and prohibit compensation practices believed to impair 
        the objectivity of analysts' advice. In addition, 
        brokerage firms must include in research reports the 
        distribution of their ``buy,'' ``sell,'' and ``hold'' 
        ratings, so that investors can see whether the firm is 
        typically optimistic. Even before these rules received 
        SEC approval, many brokerage firms had adopted key 
        features of the proposed rules in response to market 
        pressure. In light of these positive developments, the 
        Sarbanes-Oxley Act--appropriately, in my view--leaves 
        the oversight of analysts in the hands of the SEC.
        Regarding your question about independence of outside 
        auditors, enhancing the independence of outside 
        auditors is an important and necessary part of the 
        corporate reform agenda. This key issue was addressed 
        by the Sarbanes-Oxley Act, which prohibits an outside 
        auditor from providing eight specified non-audit 
        services, For an outside auditor to provide other non-
        audit services, advance approval by the company's audit 
        committee is now required. In coming months, the SEC 
        will be writing regulations to implement these 
        provisions of the Sarbanes-Oxley Act.]
    The Chairman. I thank the gentleman. We want to move on. 
The gentleman from Louisiana, Mr. Baker.
    Mr. Ford. You are going to abbreviate everyone's time?
    The Chairman. Yes.
    Mr. Baker. Thank you, Mr. Chairman. Rarely is a there a 
singular cause for any identifiable problem, especially in 
complex financial markets, but in the words of quarterly 
earnings reports and expectations, you either beat the street 
or you die, and that is little incentive for corporate 
management to look toward long-term corporate value growth.
    To some extent, the development of and release of pro forma 
returns I think are intended to diffuse the volatility 
resulting from quarterly reports.
    In response to Chairman Oxley earlier today as to the 
effects of potential real time material fact disclosure, you 
expect some concern about the protection of proprietary 
information, which I share. However, if you were to take the 
elements of the quarterly earnings contents and require that 
model to be utilized on a day-to-day requirement by management, 
it would seem to me that moving that reporting system to an 
hour or daily basis as opposed to waiting for the 90-day 
volatility would eliminate the potential for the broad swings 
we see now in the marketplace.
    Other than possible tax incentives or holding periods for 
ownership of stock, are there any other mechanisms or manners 
in which you think the committee could act to incentivize long-
term corporate management building of value?
    Mr. Greenspan. I have thought about that, and I really 
would like to respond to the extent that I can after I give it 
some more thought, because it is a very tricky and very 
important question, if I may.
    Mr. Baker. You have another 30 seconds. Thank you, Mr. 
Chairman.
    [The following information was subsequently submitted by 
Chairman Greenspan.]
        [Regarding your question about long-term incentives for 
        corporate management, stock options and other forms of 
        equity-based compensation, if properly constructed and 
        accounted for, can be effective tools to strengthen the 
        incentives of corporate management to build the long-
        term value of the firm. There are two issues to be 
        addressed. First, the failure to expense stock options 
        has distorted reported earnings and weakened the link 
        between a firm's true condition and its ability to 
        raise investment capital. This link is crucial for 
        channeling our economy's limited supply of investment 
        capital to its most productive uses. Second, stock 
        options, as currently structured, are typically based 
        on the absolute, not relative, performance of the 
        firm's stock. In periods when stock prices are rising 
        across the economy, absolute-performance options will 
        reward managers whose companies are merely keeping pace 
        with, or indeed are even lagging somewhat behind, the 
        overall market. Relative-performance options would 
        provide a stronger incentive, by only rewarding those 
        managers whose actions result in their stock 
        outperforming a benchmark stock index.
        In recent weeks, a number of companies have announced 
        that they will voluntarily expense the cost of their 
        employee stock options, and the Financial Accounting 
        Standards Board is currently considering changes to 
        disclosure requirements for option expenses. Given 
        these developments, I believe that legislative action 
        in this area would be inappropriate at this time.]
    The Chairman. The Chair would indicate that under an 
arrangement with Chairman Greenspan, he had to leave at 1 
o'clock. Let me say to the members who have been so patient 
that the Chair would note the presence of those members and 
would recognize them first when the next appearance by Chairman 
Greenspan. That is about as fair as I can be. We will take 
names, and we will appreciate the participation of the members 
at that time.
    Chairman Greenspan, once again, thank you very much for 
appearing before us today. Some of our members may have 
additional questions. The committee record will remain open for 
30 days so that members may submit additional questions.
    Without objection, the committee stands adjourned.
    [Whereupon, at 1:00 p.m., the committee was adjourned.]
                            A P P E N D I X



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