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78–399 PS 2002

CONDUCT OF MONETARY POLICY

Report of the Federal Reserve Board pursuant to

Section 2B of the Federal Reserve Act

and the State of the Economy

HEARING

BEFORE THE

COMMITTEE ON

FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

FEBRUARY 27, 2002

Printed for the use of the Committee on Financial Services

Serial No. 107–56

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

(III)

C O N T E N T S

Page

Hearing held on:

February 27, 2002 ............................................................................................ 1

Appendix:

February 27, 2002 ............................................................................................ 55

WITNESSES

WEDNESDAY, FEBRUARY 27, 2002

Greenspan, Hon. Alan, Chairman, Board of Governors, Federal Reserve

System ................................................................................................................... 5

APPENDIX

Prepared statements:

Oxley, Hon. Michael G. .................................................................................... 56

Greenspan, Hon. Alan ...................................................................................... 59

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Greenspan, Hon. Alan:

Board of Governors of the Federal Reserve System, Monetary Policy

Report to the Congress, February 27, 2002 ................................................ 77

Written response to questions from Hon. Michael G. Oxley ......................... 112

Written response to questions from Hon. Christopher Cox .......................... 128

Written response to a question from Hon. Janice Schakowsky .................... 129

Written response to questions from Hon. Ronnie Shows .............................. 131

(1)

CONDUCT OF MONETARY POLICY

WEDNESDAY, FEBRUARY 27, 2002

U.S. HOUSE OF REPRESENTATIVES,

COMMITTEE ON FINANCIAL SERVICES,

Washington, DC.

The committee met, pursuant to call, at 10:05 a.m., in room

2128, Rayburn House Office Building, Hon. Michael G. Oxley,

[chairman of the committee], presiding.

Present: Chairman Oxley; Representatives Baker, Bachus, Castle, King, Royce, Kelly, Paul, Cox, Biggert, Hart, Gillmor, Shadegg,

Miller, Cantor, Grucci, Capito, Ferguson, Rogers, Tiberi, LaFalce,

Frank, Kanjorski, Sanders, C. Maloney of New York, Carson, Sherman, Sandlin, Meeks, Lee, Mascara, Inslee, Schakowsky, Moore,

Capuano, Ford, Hinojosa, Watt, Maloney, Hooley, Gonzalez, Tubbs

Jones, Lucas KY, Shows, Israel, and Ross.

Chairman OXLEY. The hearing will come to order. Before we formally welcome Chairman Greenspan, I want to take a moment to

welcome the Committee back to our newly refurbished Committee

room. We’ve completed the bulk of our renovations to our Committee hearing rooms, which have taken a full year to accomplish.

Over the last 6 weeks, we replaced the original 40-year-old audio

system with a state-of-the-art digital sound system. The new system will enable all of us, and the audience, to hear each other

clearly for the first time. We also added some multimedia and

broadcast capabilities to the tools available to the Committee. All

of these improvements will improve the work of this Committee,

and make its proceedings even more accessible to the public.

I particularly want to thank Chairman Ney for all of his support

and hard work in helping us to complete this project. It probably

didn’t hurt to have him on the Committee either. I also want to

thank all the Members of this Committee for their strong support

in making every aspect of this Committee, including our hearing

rooms, the best on Capitol Hill.

With that said, good morning, Chairman Greenspan, and thank

you for coming here today.

The world economy has been turbulent, and you’ve had issues to

deal with that even you’ve never seen before. The economy has

benefited greatly from your leadership at the Fed. In these uncertain times, experience and steadiness at the helm with the central

bank are particularly important, so we’re all grateful for your continued service.

Before we begin today, I also wanted to say that this Committee—and the Nation—owes you its appreciation for everything

the Fed did in the days immediately following September 11th. The

2

Fed, working with financial institutions of all kinds, all over the

country, made it possible for our system to continue to work flawlessly at a time of great confusion and great peril. It is a great

story, one that not enough people know about. And we owe you,

and everyone at the Fed, our gratitude and I remember our conversation when you came back from Europe the day after the 11th

tragedy, and your experience and dedication are most appreciated.

Terrorism gave our stagnating economy a hard shove, but so far

the war has caused no lasting economic damage. In fact, our economy is rebounding from recession despite the war, and despite the

difficulties experienced by individual companies in many different

markets. This is an amazing testament to our fundamental economic strength.

We look forward to your views on what’s happening in the economy and what else can be done to speed the economic recovery.

Congress also must do its part in a number of areas. We look forward to your opinions and reactions to many of those issues.

This Committee overseas the growth engine of the economy—the

companies that provide the capital for all of our businesses to expand, and to begin. That’s why your visit here twice a year, and

that’s why we always seek your advice on things Congress can do

that will help grow the economy.

Our Committee was the most productive in Congress after September 11th. We’ve enacted bills ranging from the Patriot Act to

eliminating excess fees investors pay for operations of the SEC—

the second biggest tax cut of this Administration. We passed terrorism insurance legislation and a host of other bills. Throughout

it all, we were doing much more than responding to terrorism:

we’re trying to help the economy recover and grow.

Economic growth remains our Committee’s focus today. It’s more

important than ever for this Committee to focus on all the ways we

can remove barriers to economic growth. As you state in your testimony, ‘‘deregulation and innovation in the financial sector have

been especially important in enhancing overall economic performance.’’

Congress has made great initial strides in the 1990s. We began

to deregulate financial and product markets in Gramm-Leach-Bliley. We made sure the trading on the stock markets occurred in

decimals. We worked to help investors get more information from

companies so they can make informed decisions about their portfolios.

The result was unprecedented prosperity—and the unprecedented ability to bounce back after a recession after September 11.

But it’s no time to rest on those accomplishments. There’s a lot

more to do. Now more than ever, we need to free up capitol to seed

new businesses and expand existing businesses. We need to make

sure that the whole value of every business is reflected in its accounting and in its financial statements. We need to increase the

transparency and usefulness of financial statements to the investing public so that as much light as possible to be shed on the operations of every company.

We must continue to remove unnecessary economic and regulatory burdens on our businesses so that they can lead the economic recovery. We’re trying to do that here, both by reforming the

3

deposit insurance system and by spearheading regulatory relief for

financial institutions.

On these issues, and many others, we look forward, Mr. Chairman, to your continued advice and assistance and we appreciate

your appearance here today.

With that, let me yield to the gentleman from New York, Ranking Member, Mr. LaFalce, for an opening statement.

[The prepared statement of Hon. Michael G. Oxley can be found

on page 56 in the appendix.]

Mr. LAFALCE. Thank you very much.

Chairman Greenspan, it’s always a pleasure to have you before

us. I’d like to highlight two areas that I believe are of great importance to the economy today. The fallout from the systemic problem

known as Enron, and conditions in both our domestic and global

economy.

But first, I want to address monetary policy directly. I do not believe it is now appropriate to raise interest rates. I believe a move

to raise rates in the weeks ahead could well jeopardize our fragile

recovery in the domestic economy, and would likely have adverse

consequences for the global economy. Much of my concern about

the performance of the United States economy in the months ahead

relates to the aftermath of the stock market bubble, the collapse of

Enron, and what both have meant for the soundness of corporate

financial statements and corporate governance.

Between 1995 and 2000, you and a few others grew increasingly

concerned about the possibility of a stock market bubble. Essentially, the stock valuations did not reflect the underlying earnings

of publicly-traded companies. The concern was that the inevitable

market correction could be volatile and steep, setting off adverse

reactions in investor confidence, consumer confidence, banks’ willingness to lend, and so forth.

Then, most recently came Enron. Unfortunately, I believe Enron

is too symptomatic of a condition that has spread across corporate

America in tandem with the stock market bubble. The desire to

meet the expectations of an ever-rising market drove grossly inappropriate accounting and corporate governance practices, and exposed the shortcomings of regulation in these areas.

I warned about these shortcomings shortly after our Committee

obtained jurisdiction in January of 2001. I began calling in this

Committee, the Rules Committee, the floor of the House, for a 200

to 300 percent increase in the budget of the SEC. In June of 2000,

I sent all 600,000 of my constituents a newsletter on this subject

dealing with the protection of investments and talking about the

need to beware of Wall Street recommendations and to beware of

the numbers explaining the earnings manipulation that has been

taking place across corporate America, calling the conditions that

existed in June 2001 the tip of the iceberg and calling upon our

Committee to focus on one issue primarily: accounting.

It took Enron to give this issue the attention it deserves. Unfortunately, I believe we have to be at least as concerned about these

very same issues internationally. If the United States purportedly

has the highest corporate financial standards in the world, what

are we to make of the potential for Enrons in countries like Japan,

China, India, even the EU, all of which have well-developed finanVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
4

cial markets but may have less than adequate regulatory standards. And our Big Five accounting firms are in virtually every

major city in the world and very often the same auditors of the

largest global companies.

With an eye toward the global economy, I now want to go back

to the issue of U.S. monetary policy. It’s clear to me that U.S. monetary policy has an increasingly long reach, extending well beyond

our domestic borders. In particular, I’m concerned about the impact

of premature rate increases in the United States on the situations

in Japan and in Europe. In Japan, because they’ve had a stagnant

economy for a decade, and are the second largest economy in the

world. In Europe, because it’s going through the difficult process of

solidifying a centralized monetary policy and achieving economic

integration while also bringing in about ten new countries into the

union. I believe it’s critical that the United States be cognizant of

any policies that could impact economic conditions globally, especially in Japan and the EU.

With respect to the EU, the member countries of it are in the

midst of a grand political, social, and economic experiment not unlike the one our own founding fathers embarked on 226 years ago,

and the global economy will be the ultimate beneficiary of successful economic integration. I hope that we, in our monetary and fiscal

policy, will do all in our power to help support that endeavor. And

Dr. Greenspan, I hope in the course of this morning’s dialogue,

you’ll be able to discuss some of these issues too.

Thank you.

Chairman OXLEY. The Chair is now pleased to recognize the

gentlelady from New York, Mrs. Maloney.

Mrs. MALONEY. Thank you.

Good morning, Mr. Greenspan, and thank you for appearing before us today. After eleven interest rate cuts over the last year, we

are all hoping that the Fed will report that the country is through

the worst of the recession and that growth is ahead. While we’re

all hoping for a turnaround in the coming months, as many as two

million Americans are expected to exhaust their unemployment insurance. These families cannot wait until a rising tide lifts all

boats. The combination of the recession and the economic impact

of the World Trade Center has made the situation particularly dire

for your home State of New York, where 71 percent more people

are now on unemployment insurance than at the same time last

year.

Last quarter alone, 65,000 New Yorkers exhausted their unemployment insurance benefits. The good news is that both the Democrats and the Republicans agree that we should help these families

and pass a 13-week extension of unemployment benefits. I hope the

House will soon follow the Senate and pass a clean unemployment

extension.

I am concerned that the predictions of some of the economists—

and some of them have stated that they are concerned that positive

statements from you today could foreshadow increases in interest

rates; in fact, futures traders are betting that the Federal fund rate

will rise this summer. My concern is that the Fed may reverse direction and begin to put the brakes on the recovery before out-ofwork people benefit from the turnaround in our economy.

5

Other questions that I look forward to hearing from you today

are your views on the failure of Enron, and the crisis of confidence

it has caused in our financial markets. Also, in New York City, constituents tell me that the lack of terrorism insurance is holding

back building projects, causing a credit crunch, and stalling the

City’s overall recovery. I look forward to your comments on insurance and its impact on our economy.

Finally, since your last appearance, our Government finances have turned 180 degrees. We have shrunk a $5.6 trillion unified

surplus by $4 trillion. This is the most radical fiscal reversal in my

lifetime. New spending to fight terrorism, to protect the homeland

and to rebuild after the attacks is definitely legitimate, but I am

very much opposed to the very expensive, retroactive special interest tax breaks that are likewise proposed. One earlier version of

the budget even included a tax break for Enron. I look forward to

your testimony today, as always. Thank you for being here.

Chairman OXLEY. The gentlelady’s time has expired.

We now turn to our distinguished witness, the Chairman of the

Federal Reserve, Dr. Greenspan.

STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD

OF GOVERNORS, FEDERAL RESERVE SYSTEM.

Mr. GREENSPAN. Thank you very much, Mr. Chairman. I’ve a

rather extended statement and I will excerpt from it, but request

that the full statement be included for the record.

Chairman OXLEY. Without objection.

Mr. GREENSPAN. Since last July, when I last reported to you on

the conduct of monetary policy, the U.S. economy has gone through

a period of considerable strain, with output contracting for a time

and unemployment rising. We in the Federal Reserve System acted

vigorously to adjust monetary policy in an endeavor both to limit

the extent of the downturn and to hasten its completion. Despite

the disruptions engendered by the terrorist attacks of September

11, the typical dynamics of the business cycle have re-emerged, and

are prompting a firming in economic activity. An array of influences unique to this business cycle, however, seems likely to moderate the speed of the anticipated recovery.

One key consideration in the assessment that the economy is

close to a turning point is the behavior of inventories. Stocks in

many industries have been growing down to levels at which firms

will soon need to taper off their rate of liquidation, if they have not

already done so. Any slowing in the rate of inventory liquidation

will induce a rise in industrial production if demand for those products is stable or is falling only moderately. That rise in production

will, all other things being equal, increase household income and

spending.

But that impetus to the growth of that activity will be short-lived

unless sustained increases in final demand kick in before the positive effects of the swing from inventory liquidation dissipate.

Through much of last year’s slowdown, spending by the household

sector held up well and proved to be a major stabilizing force. As

a consequence, although household spending should continue to

trend up, the potential for significant acceleration in activity in this

sector is likely to be more limited than in past cycles.

6

Changes in household financial positions in recent years are

probably damping consumer spending, at least to a degree. Overall

household wealth relative to income has dropped from a peak multiple of about 6.3 at the end of 1999 to around 5.3 currently. Moreover, the aggregate household debt service burden, defined as the

ratio of households’ required debt payments to their disposable personal income, rose considerably in recent years, returning last year

to its previous cyclical peak of the mid-1980s.

However, increased debt burdens appear disproportionately attributable to higher income households. As a result, although repayment difficulties have already increased, particularly in the

sub-prime markets for consumer loans and mortgages, the overall

levels of debt and repayment delinquencies do not, as of now, appear to pose a major impediment to a moderate expansion of consumption spending going forward.

We have already seen significant spending restraint among the

top fifth of income earners, presumably owing to the drop in equity

prices. Moderate income households have a much larger proportion

of their assets in homes, and the continuing rise in the value of

houses has provider greater support for their net worth. Reflecting

these differences in portfolio composition, the net worth of the top

fifth of income earners has dropped far more than it did for the bottom 80 percent.

Accordingly, most of the change in consumption expenditures

that resulted from the bull stock market, and its demise, reflected

shifts in spending by upper income households. The restraining effects from the net decline in wealth during the past 2 years presumably have not, as yet, fully played out and could exert some

further damping effect on the overall growth of household spending

relative to that of income.

Perhaps most central to the outlook for consumer spending will

be developments in the labor market. The pace of layoffs quickened

last fall, especially after September 11th, and the unemployment

rate rose sharply. However, layoffs diminished noticeably in January, and initial claims for unemployment insurance have decreased

markedly, on balance, providing further evidence of an improvement in labor market conditions. Even if the economy is on the

road to recovery, the unemployment rate, in typical cyclical fashion,

may resume its increase for a time, and a soft labor market could

put something of a damper on consumer spending.

However, the extent of such restraint will depend on how much

of any rise in unemployment is the result of weakened demand for

goods and services and how much reflects strengthened productivity.

In the latter case, average real incomes of workers could rise, at

least partially offsetting losses of purchasing power that stem from

diminished levels of employment. Indeed, preliminary data suggest

that productivity has held up very well of late, and history suggests

that any depressing effect of rapid productivity growth on unemployment is only temporary.

While the balance of factors influencing consumer demand will

have important consequences for the economic outlook in coming

months, the broad contours of the present cycle have been, and will

7

continue to be, driven by the evolution of corporate profits and capital investment.

The retrenchment in capital spending over the past year-and-ahalf was central to the sharp slowing we experienced in overall activity. New orders for equipment and software hesitated in the

middle of the year 2000 and then fell abruptly as firms re-evaluated their capital investment programs. For much of the last year,

the decline in investment outlays was fierce and unrelenting.

These cutbacks in capital spending interacted with, and were reinforced by, falling profits and equity prices. Indeed, a striking feature of the current cyclical episode relative to many earlier ones

has been the virtual absence of pricing power across much of American business, as increasing globalization and deregulation have

enhanced competition. In this low inflation environment, firms

have perceived very little ability to past cost increases on to customers.

Business managers, with little opportunity to raise prices, have

moved aggressively to stabilize cash flows by trimming work forces.

These efforts have limited any rise in unit costs, attenuated the

pressure on profit margins, and ultimately helped to preserve the

vast majority of private sector jobs.

Part of the reduction in pricing power observed in this cycle

should be reversed as firming demand enables companies to take

back large price discounts. Though such an adjustment would tend

to elevate price levels, underlying inflationary cost pressures

should remain contained. Slack in labor markets and further increases in productivity should hold labor costs in check and result

in rising profit margins even with inflation remaining low.

Improved margins and more assured prospects for rising final demand would likely be accompanied by a decline in risk premiums

from their current elevated levels toward a more normal range.

With real rates of return on high tech equipment still attractive,

that should provide an additional spur to new investment.

The recovery in overall spending on business fixed investment is

likely to be only gradual; in particular, its growth will doubtless be

less frenetic than in 1999 and early 2000—a period during which

outlays were boosted by the dislocations of Y2K and the extraordinarily low cost of equity capital available to many firms.

Even a subdued recovery beginning soon would constitute a truly

remarkable performance for the American economy in the face of

so severe a decline in equity asset values and an unprecedented

blow from terrorists to the foundations of our market systems. For,

if the tentative indications that the contraction phase of this business cycle is drawing to a close are ultimately confirmed, we will

have experienced a significantly milder downturn than the long

history of business cycles would have led us to expect. Crucially,

the imbalances that triggered the downturn and that could have

prolonged this difficult period did not fester. The obvious questions

are what has changed in our economy in recent decades to provide

such resilience and whether such changes will persist into the future.

Doubtless, the substantial improvement in the access of business

decisionmakers to real time information has played a key role. The

large quantities of data available virtually in real time allow busiVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
8

nesses to address and resolve economic imbalances far more rapidly than in the past.

The apparent increased flexibility of the American economy arguably also reflects the extent of deregulation over the past quarter

century. Certainly, if the energy sector was still in the tight regulatory fetters of the 1970s, our flexibility today would be markedly

less. Airline, trucking, and rail deregulation has added flexibility to

the movement of people and goods across our Nation.

Both deregulation and innovation in the financial sector have

been especially important in enhancing overall economic resilience.

New financial products—including derivatives—have enabled risk

to be dispersed more effectively to those willing to, and presumably

capable of, bearing it. Shocks to the overall economic system are

accordingly less likely to create cascading credit failure. Lenders

have the opportunity to be considerably more diversified, and borrowers are far less dependent on specific institutions for funds. Financial derivatives, particularly, have grown at a phenomenal pace

over the past 15 years, evidently fulfilling a need to hedge risks

that were not readily deflected in earlier decades. Despite the concerns that these complex instruments have induced—an issue I will

address shortly—the record of their performance, especially over

the last couple of stressful years, suggests that on balance they

have contributed to the development of a far more flexible and efficient financial system.

As a consequence of increased access to real time information

and, more arguably, extensive deregulation in financial and product markets, and the unbundling of risk, imbalances are more likely to be readily contained, and cyclical episodes overall should be

less severe than would be the case otherwise.

However, the very technologies that appear to be the main cause

of our apparent increased flexibility and resiliency may also be imparting different forms of vulnerability that could intensify or be

intensified by a business cycle.

From one perspective, the ever-increasing proportion of our gross

domestic product that represents conceptual, as distinct from physical value added, may actually have lessened cyclical volatility. In

particular, the fact that concepts cannot be held as inventories

means a greater share of GDP is not subject to the type of dynamics that amplify cyclical swings. But an economy in which concepts

form an important share of valuation has its own vulnerabilities.

As the recent events surrounding Enron have highlighted, a firm

is inherently fragile if its value-added emanates more from conceptual as distinct from physical assets. A physical asset, whether an

office building or an automotive assembly plant, has the capability

of producing goods even if the reputation of the managers of such

facilities falls under a cloud. The rapidity of Enron’s decline is an

effective illustration of the vulnerability of a firm whose market

value largely rests on capitalized reputation. The physical assets of

such a firm comprise a small proportion of its asset base. Trust and

reputation can vanish overnight; a factory cannot.

The implications of such a loss of confidence for the macro economy depend importantly on how freely the conceptual capital of the

fading firm can be replaced by a competitor or a new entrant into

the industry. Even if entry is relatively free, macro economic risks

9

can emerge if problems at one particular firm tend to make investors and counterparties uncertain about firms that they see as potentially similarly situated. The difficulty of valuing firms that deal

primarily with concepts and the growing size and importance of

these firms may make our economy more susceptible to this type

of contagion.

Another more conventional determinant of stability will be the

economy’s degree of leverage, the extent to which debt, rather than

equity, is financing the level of capital. Clearly, firms find some leverage advantageous in enhancing returns on equity, and thus

moderate leverage undoubtedly boosts the capital stock and the

level of output. A sophisticated financial system, with its substantial array of instruments to unbundle risks, will tend toward a

higher degree of leverage at any given level of underlying economic

risk. But, the greater the degree of leverage in any economy, the

greater its vulnerability to unexpected shortfalls in demand and

mistakes.

Although the fears of business leverage have been mostly confined to specific sectors in recent years, concerns over potential systemic problems resulting from the vast expansion of derivatives

have reemerged with the difficulties of Enron. To be sure, firms

like Enron, and Long-Term Capital Management before it, were

major players in the derivatives markets. But their problems were

readily traceable to an old-fashioned excess of debt, however acquired, as well as to opaque accounting of that leverage and lax

counterparty scrutiny. Swaps and other derivatives throughout

their short history, including over the past 18 months, have been

remarkably free of default. Of course, there can be latent problems

in any market that expands as rapidly as these markets have. Regulators and supervisors are particularly sensitive to this possibility.

Derivatives have provided greater flexibility to our financial system. But their very complexity could leave counterparties vulnerable to significant risk that they do not currently recognize, and

hence these instruments potentially expose the overall system if

mistakes are large. In that regard, the market’s reaction to revelations about Enron provides encouragement that the force of market

discipline can be counted on over time to foster much greater transparency and increased clarity and completeness in the accounting

treatment of derivatives.

How these countervailing forces for stability evolve will surely be

a major determinant of the volatility that our economy will experience in the years ahead. Monetary policy will have to be particularly sensitive to the possibility that the resiliency our economy has

exhibited during the past 2 years signals subtle changes in the way

our system functions.

Although there are ample reasons to be cautious about the economic outlook, the recuperative powers of the United States economy, as I have tried to emphasize in my presentation this morning,

have been remarkable. When I reported on monetary policy to the

Committee last summer, few if any of us could have anticipated

events such as those to which our Nation has subsequently been

subjected. The economic consequences of those events and their

aftermath are an integral part of the many challenges that we now

collectively face. The U.S. economy has experienced a substantial

10

shock, and, no doubt, we continue to face risks in the period ahead.

But the response thus far of our citizens to these new economic

challenges provides reason for encouragement.

Thank you very much, Mr. Chairman. I look forward to your

questions.

[The prepared statement of Hon. Alan Greenspan can be found

on page 59 in the appendix.]

Chairman OXLEY. Thank you, Mr. Chairman, and it’s always

good to have you here in front of the Committee. Let me begin.

Obviously, your statements regarding Enron were timely and

probably predictable as well, and I suspect the questions will be in

that regard as well.

In light of recent market movements, in the wake of Enron, it

has been suggested by some that ultimately the market does a far

better job of deterring abuses than does Government.

What are your thoughts in that regard, and what would be some

suggestions that you would give this Committee as we work our

way through some of these difficult issues?

Mr. GREENSPAN. I think Enron, as I indicated to the Senate

Budget Committee the other day, is not a significantly negative

event to the economy and, in fact, in the long run, its emergence

may alter the way we govern corporations. That the long history

of corporate governance will continue to be a very substantial and

positive force for economic growth and productivity. I do believe

that something fundamentally different has happened in this most

recent period, and I think it’s important for us to go back and look

at the causes of it.

I would say particularly what has changed from the way I recall

corporate governance, stock prices, stock markets, security analysis, years ago, is that in earlier years there was not any really significant emphasis of the type we see today on short-term corporate

earnings. Indeed, dividends were exceptionally high. In fact, the

yield on dividends before 1950 for several years was 6 percent; it’s

now a little more than 1 percent. And if most of what you get from

a corporation is cash, you don’t worry about how it was calculated,

you just take the money and that’s it. But one with the significant

change that occurred with the propensity to buy back stock, which

only occurred in the early 1980s with rulings which somehow delimited the concerns that stock buybacks would be perceived as

price manipulation. That very act caused a very major shift from

cash dividends to stock purchase.

Two other events were very important in that context to create

the environment which ultimately led to the Enron debacle. One

was the unfortunate reversal of the FASEB ruling in the early

1990s about stock option accounting. We estimate that over the

past—or say the period 1995 to the year 2000—almost 3 full percentage points of the annual average gain in earnings resulted

from the fact that stock options, rather than cash, was used as

compensation amongst our major corporations. This undoubtedly

had an effect of accelerating the earnings outlook which in turn

had been very significantly propelled upward by the structural

change in productivity.

And so what occurred as a consequence of all of these forces was

an endeavor to try to game the accounting systemin a manner to

11

create the perception of short-term earnings growth which would

be confused with long-term earnings growth. If long-term earnings

growth were properly evaluated over this period, I don’t think we

would have had very much of the type of problems that we’ve had,

but there’s been a significant endeavor to make the data look as

though something fundamentally different is going on in corporate

America, and that has been unfortunate.

Much of that has already been reversed by the market. There is

now a very significant shift toward corporations endeavoring to be

far more transparent on what they are doing, the markets are

clearly creating price earnings premiums for corporations which

are perceived to be without spin, so to speak. And so a goodly part

of what needs to be done to restore corporate governance to where

it was in earlier years, and I must say back then it did a pretty

good job, and the vast majority of corporate governance in today’s

markets, even with Enron debacle, is of superior nature and indeed

far superior than any other place in the world, but we do need to

fix what is wrong with our system, and I would suggest that a

proper diagnosis is clearly the first step in determining what

should be done.

Chairman OXLEY. Thank you, Mr. Chairman. My time has expired.

Let me now yield now to the gentleman from New York, the

Ranking Member, Mr. LaFalce.

Mr. LAFALCE. Thank you very much, Mr. Chairman. I disagree

with you fundamentally and also with Dr. Greenspan in some of

his introductory comments. First of all, I think we’ve shown that

we cannot rely on the unfettered magic of the marketplace alone.

That with respect to publicly traded there must be significant regulation. That the SROs, the self-regulatory organizations have not

worked. They’ve not worked with respect to the securities analysts,

they’ve not worked with respect to the accounting firms. We need

a significantly enhanced role for the Securities & Exchange Commission. We need to appropriate moneys for pay parity. We need

to significantly enhance their resources to do the job, because so

many Americans today do have almost all of their wealth in the

markets. They have defined contribution plans today rather than

defined benefit plans. They’re not putting their money in banks

where you, Chairman Greenspan, have your examiners there on a

daily basis, where the State bank examiners are there on a daily

basis. They’re in the markets and we need to protect them.

I disagree with you when you say that Enron is not a significant

event. I think Enron is a most significant event. I think we can,

you know, make lemonade out of lemons to be sure but we can

never deal with the fact that four to five trillion dollars of American money has been lost in the markets, a great amount due to

the excesses, to the bubble, to the speculation, but a significant

amount due to earnings manipulation.

Now, where I do agree with you strongly is with respect to stock

options. So much of what took place was done by corporate officers

and the audit committees of boards of directors, all with stock options that were interested in one thing and one thing only. And

that was enhancing market capitalization so that they could have

12

a good return on those stock options. And we must deal with all

of those.

Now who’s we? We is Government. The marketplace will be more

vigilant now for a month, for two, maybe a year or so, but nothing

can substitute for a strong regulatory environment for our publicly

traded companies, and that’s what we must achieve. And if anybody thinks that we can achieve the end result of protection of

American investors without that, they are deluded.

Now, having said that——

Mr. GREENSPAN. Can I respond?

Mr. LAFALCE. Sure.

[Laughter.]

Mr. GREENSPAN. You are quite correct, I might add, in saying

that we need more resources for the Securities & Exchange Commission, especially on the pay parity issue, which I think is long

overdue. I did not say, nor do I believe that there are not adjustments that are required and indeed ought to be made and I would

start off with the way we account for stock options, I would account

for a number of other issues as to the way we have corporate governance, because significant things have happened in the recent

decades which require adjustment.

I want to emphasize, however, that the overall level of corporate

governance has served us well over recent decades including the

current period by the vast majority of corporations who see their,

management sees their self-interest as coincident with those of

shareholders. I don’t want to get into the economics of this, but if

we could make that tie locked in some manner or another, we will

maximize the allocation of capital in this economy.

There has been a severance, in my judgment, of the interests of

the chief executive officer in many corporations from those of the

shareholders, and that should be pulled together. Stock options

help but not if they are functioning in the manner in which they

currently are.

Mr. LAFALCE. Dr. Greenspan, if I could just get one question.

Could you comment on the conduct of United States monetary policy within the global context, given the fact that there is now one

monetary policymaker in Europe that they are achieving integration with, while at the same time expanding, that Japan has been

in the doldrums for a decade or so and the interplay that goes on

in your decisionmaking between the domestic and the global economy.

Mr. GREENSPAN. Well, Congressman, as you well know, our mandate is to maximize long-term sustainable economic growth in the

United States. I mean, we consider foreign conditions only to the

extent statutorily as they impact on us, and obviously as they increasingly do so, we become far more interested in what’s going on

in the world and respond to it. And indeed, we have. In other

words, a considerable part of our analysis of what’s been going on

in the American economy in recent years has had a very high level

of international interrelationship and fallout in certain respects. So

we do evaluate the European economy, the Japanese economy, East

Asia, Latin America, at a fairly extensive level to make certain that

our policy, which is implemented here and focused on the American

13

system is not going to be deflected by events that we perceive are

occurring more abroad.

Chairman OXLEY. The gentleman’s time has expired. The Chair

is now pleased to recognize the gentleman from New York, Mr.

King.

Mr. KING. Thank you, Mr. Chairman. Good morning, Mr. Greenspan. It’s always a pleasure to have you here. Let me just at the

outset, as a New Yorker and as an American commend you for the

critical role you and the Fed played in providing the liquidity that

was so important after September 11th. It was very reassuring and

I want to thank you for that.

I’m going to focus my questions on the question of interest rates.

And this in a way is a follow-up to what Mr. LaFalce was talking

about with the Japanese economy being in the doldrums. I would

ask you if you could just make some comments on how low interest

rates can go before the cutting of the interest rates loses its impact.

Now Japan has had low interest rates for a number of years and

it appears that has had no impact as far as rebuilding the economy. If you could tell us how close you think we are to that level

where perhaps it can’t go any lower.

Second, in that regard, even though the rates have gone down,

the discount rate has gone down, the long-term rates have not gone

down. How essential do you believe the reduction of long-term rates

are to the long-term growth of the economy?

Mr. GREENSPAN. Well, Congressman, I would not view the Japanese experience as a general experience with respect to how low interest rates could or could not go. The problem in Japan, as I’ve

indicated on many occasions, is that they have only one major form

of financial intermediation, which is their banking system, and

their banking system, as you know, is in very serious difficulty, so

that the ability of monetary policy to function, in my judgment, is

impaired in a manner which makes it very difficult to read what

basically the level of rates and the level of economic activity are

doing. I think it’s very difficult and one should not generalize from

the Japanese experience.

The issue of long-term rates is quite an important one because,

while undoubtedly short-term rates do have significant impacts on

the American economy, far more it relates to longer-term rates.

Longer term rates are a function essentially of, one, inflation expectations, and the underlying real rate itself. And what we have observed in this economy is that long-term rates did come down quite

materially at the tail end of the year 2000, but have essentially

stabilized, as I think you pointed out, for the last year or so. But

they have stabilized their relatively low historic rate and indeed

one can observe what’s occurring in the housing market to basically

see the impact of what mortgage rates have done.

So it’s a complex issue but at the moment I think that we do not

see any really significant inflation premiums embodied in longterm rates and that frankly is a good sign.

Mr. KING. One follow up question, Chairman Greenspan, is regarding the Argentine and Japanese economies. How significant do

you think their doldrums are going to have on our prospects for

long-term growth?

14

Mr. GREENSPAN. Well, as difficult as the problems in Argentina

are, and they’re really having considerable structural problems,

and we only hope that they can correct them as quickly as possible,

they have not had a contagion effect where one would ordinarily

have expected them to have an effect, specifically in Brazil where

markets are doing reasonably well and especially in Mexico, which

has done quite well. So in Latin America, it’s important that Argentina stabilize as quickly as they are capable of doing, but fortunately, there’s not been significant fallout.

Japan has been essentially stable for a decade now. Growth has

been effectively zero. And it’s difficult to read exactly how changes

in the Japanese economy impact the rest of the world. Clearly to

the extent that they are the second largest economy in the world,

they do affect us, and clearly what is going on in Japan is negative

to the United States outlook. But I do not perceive it as a major

factor containing a recovery in the United States which we believe

is just beginning to get underway.

Mr. KING. Thank you, Chairman Greenspan, Mr. Chairman.

Chairman OXLEY. The gentleman’s time has expired.

The gentlelady from New York, Mrs. Maloney.

Mrs. MALONEY. Thank you, Mr. Chairman.

Mr. Chairman, I want to likewise thank you for moving quickly

and dropping interest rates 50 basis points in the very uncertain

environment the day the financial markets opened shortly after

September 11th. As New York works to recover from the terrorist

attack, it’s critical that we have an accurate assessment of the economic damage to our city, State and the private sector.

After having contacted CBO and many other agencies, no single

Federal entity is compiling an in-depth analysis of the economic

impact on New York and costs to its institutions. I know the New

York Federal Reserve has a very large and accomplished research

staff and I would like to appeal to you, and will do so separately,

to President McDonough, for just such a well-researched economic

analysis. New York really needs your help. Could you help us with

this?

Mr. GREENSPAN. Well, Congresswoman, I agree with you that the

Federal Reserve economic staff is first rate and a considerable part

of what they do is a continuous evaluation of the Second District,

obviously New York City being a very major part of that district.

But I will communicate to them, and I assume you will speak to

President McDonough, and my impression is that they probably are

fairly far along in examining the type of issues that you think are

important to be examined.

Mrs. MALONEY. That would be extremely helpful. As a Representative from New York, I am spending a great deal of my time

on the recovery effort. One of the areas that I am hearing tremendous concern from my constituents is the lack of availability of terrorism insurance, the escalating cost of insurance. Many building

projects and proposals have not been funded and turned down by

the banks as being too risky, and there appears to be a credit

crunch that is stalling the recovery of New York City and New

York State. I would like to hear your comments on the fallout from

the lack of insurance, terrorism insurance, and do you think a FedVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
15

eral reinsurance program is necessary? Could you share your

thoughts?

Mr. GREENSPAN. Well, we have obviously spent a good deal of

time on exactly that issue, because it’s a crucial aspect of a fairly

large segment of the economy. The difficulty that one has when

dealing with terrorism insurance is that it is exceptionally difficult

for an insurer or even a reinsurer to have any sense whatever of

what the probability distribution of a terrorist event is and, more

importantly, what is its magnitude. In all insurance, you have to

have some general knowledge of what the parameters of what

could happen are, or you cannot set premiums. In this case, it is

virtually impossible to do so and a number of people have argued

I think somewhat effectively that what may be necessary here is

for the Congress to stipulate that in the event of a terrorist attack

clearly defined as a terrorist attack, that the Federal Government,

with some deductible, would cover the cost of that.

The problem that you have with trying to do it before the event

is it’s almost impossible to know precisely how to construct a response to it, but if individuals know that after the fact that it will,

in fact, be covered one may hope that you can construct a means

by which there can be some form of reinsurance to remove the

types of problems that we see. This is an issue which I think there

is considerable dispute on, because we don’t know what the nature

of what it is we are facing. But I’m one who thinks that we ought

to be addressing this not solely because of its impact on the economy, but there is a very difficult problem of how one handles

things over which one is not responsible. The issue of home security is now, in fact, indistinguishable from our national defense

budgets, and much of that has the same basis of taxation for financing.

Mrs. MALONEY. Thank you very much. And I ask unanimous consent to add additional questions to the record. Thank you.

Chairman OXLEY. Without objection.

The Chair now is pleased to recognize the gentleman from Alabama, the Chairman of the Financial Institutions Subcommittee,

Mr. Bachus.

Mr. BACHUS. Thank you, Mr. Chairman.

Chairman Greenspan, first of all I welcome your written testimony on Enron. You’re on the President’s working group and I

think what you said here is very valid as to what happened at

Enron.

My question is—I’m not going to ask you for a prediction—I’m

going to ask you for what’s happening real time. I know you have

folks at the Fed who look over data. You spend a lot of time focusing on productivity. My question is a simple one. You talked about

through the last decade a surge in productivity. Real time, are we

continuing to see an increase in productivity, or is it slackening, is

it constant, or is it declining?

Mr. GREENSPAN. Well, Congressman, the data that now appear

to be in real time, as you put it, probably are exaggerating the underlying trend in productivity, if for no other reason than the numbers look just too large to be credible. We’re going to have another

upward revision in the fourth quarter’s productivity numbers, and

if you take a look at the first quarter, we already have a good deal

16

of data in on both the numerator and denominator of output per

hour. And at this particular stage, unless average hours worked

rises very sharply in the February-March period, for which we

don’t as yet have data, and/or payroll numbers rise significantly,

we’re going to have a very large increase in the first quarter. So

while I doubt very much if they will be representative of the true

underlying trend, the do nonetheless confirm that the long-term

trend of productivity has managed to sustain itself through these

very difficult times of say the second quarter of the year 2000 to

date. That doesn’t necessarily mean it will continue, but since you

didn’t ask me for a forecast——

Mr. BACHUS. No, that’s right.

Mr. GREENSPAN. And I think the real time data are really quite

impressive.

Mr. BACHUS. Thank you very much, appreciate that. I’m going to

yield the balance of my time to the gentlelady from Pennsylvania,

Ms. Hart.

Ms. HART. Thank you, Mr. Bachus. I have a question actually regarding interest rates. They’ve obviously been quite helpful to some

businesses we’ve heard. However, in my district there are some

smaller and medium-sized businesses that now are having serious

trouble getting access to credit caused by the new pressure on loan

portfolios. Do you have evidence of the tightening of that kind of

credit, particularly available to kind of the main street-type businesses? And if so, do you expect that to have a negative impact on

our efforts to pull out of the recession?

Mr. GREENSPAN. Congresswoman, the evidence there is mixed.

We are observing certain tightening in some of the banks of a modest type. We’ve not yet seen, or I don’t know whether you could say

not yet, but we do not see the general pressure on small business

as reported by the National Federation of Independent Business.

They have a fairly extensive survey of their members, of credit conditions available to them, and their series have not indicated any

really serious concerns. But it’s highly unlikely, in a period such

as we’ve been running through, that there wouldn’t be some difficulties. Indeed, if somebody told me there were none, I would say

the data are wrong. So there clearly are such events.

Hopefully, if the economy continues to show the signs that it has

been exhibiting of late, some of that pressure will be removed, and

I would hope that the opening up of profit margins and improved

balance sheets would bring a number of especially smaller enterprises up to a level where credit availability is no longer a difficulty

for them.

Ms. HART. Is there an action regarding that that you think the

Fed could take or should take that would be appropriate that

would help them?

Mr. GREENSPAN. I don’t think that there’s anything that we, the

Federal Reserve, can do and at the moment frankly I don’t think

anything really needs to be done because, unless I’m mistaken and

this whole change in the economic environment is a false dawn,

then things should improve.

Ms. HART. Thank you. Also there was a report released yesterday. This is dealing with the steel issue and all the bankruptcies

we’ve had in the steel industry. American University released a reVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
17

port that if the Administration didn’t act strongly regarding the

201 and either implementing a tariff rate of maybe 40 percent or

so, that about 325,000 American steel jobs would be lost in the

coming months.

Mr. GREENSPAN. How many?

Ms. HART. About 325,000.

Mr. GREENSPAN. There aren’t 325,000.

Ms. HART. I think it’s steel producing jobs around that industry.

Mr. GREENSPAN. I see.

Ms. HART. Anyway, there already are a significant number of

bankruptcies. There are many more companies, especially in the

area that I represent, and I think a lot of the areas in the midwest

and in the east, that would lose a lot more jobs. And the bankruptcies are also affecting office suppliers and others.

What effect do you think that would also have on the economy

in general? Do you think it’s large enough to affect it in general?

And do you think it would slow our pulling out of the recession as

well?

Mr. GREENSPAN. Now, as you know, the President has to make

a judgment before March 6th on the 201. It’s a difficult decision for

lots of obvious reasons. But I think the important issue which is

on the table is not only the impact that it has on, one, jobs, and

the 600,000 retirees in the steel industry, who have as we call significant legacy costs, but it’s also an issue of what a marked increase in steel import prices would do to the costs of steel using

industries, of which the numbers are quite significantly larger than

the roughly 150,000, 175,000 who work directly in the steel industry.

In my judgment, far more important than that, because neither

of those two issues are big as far as the domestic economy is concerned, is the implication for our international trade posture. And

here the whole question of the importance of international trade

and how we handle it is critical to, in my judgment, the next number of years, because even though I raise the issue of the flexibility

and resiliency of our economy being the major reason for the fact

that we didn’t go into a severe contraction in this most recent period, but what I didn’t mention but which is also the case is a very

substantial part of the economic growth that we’ve experienced in

the post-World War II period occurs as a consequence of the opening up of international markets for which the United States has

been the largest recipient of growth as far as I can evaluate. So I

think the President’s got a very difficult set of choices before him,

and I wish him well.

[Laughter.]

Chairman OXLEY. The gentleman’s time has expired.

Ms. HART. Thank you Mr. Bachus, thank you, Mr. Chairman.

Chairman OXLEY. The gentleman from Massachusetts, Mr.

Frank.

Mr. FRANK. This illustrates the dilemma, the colloquy you just

had, which is this. You and many others believe, and I share that

to some extent, that the increased open trade regime is helpful to

the economy. One of the major obstacles is precisely the resistance

engendered by the only 175,000 people who may lose their jobs.

18

They tend not to think of themselves as ‘‘only.’’ Well, from the

macro standpoint, they’re only; for them, they’re it.

And I am afraid that we may be exacerbating that. I read the

Administration’s analytical perspectives on the budget and they, in

their analysis on page 24, come back to something we’ve discussed

before, the NAIRU, the non-accelerating inflation rate of unemployment and give it a much higher rate than I think experience has

shown. And their projection is that given everything they want to

do, this is their optimistic projection. If the Administration gets all

that it wants in the budget, unemployment will level off at 4.9 percent for the next decade and stay at 4.9 percent. It’s about 25 percent higher than we had managed to get it during the growth.

Here’s what troubles me.

You say, and I hope you’re right and I’m inclined to agree that

the productivity gains that we have been having are not going

away. It’s the productivity gains in part that helped us get the unemployment rate lower consistent with low inflation. If in fact,

you’re accurate, I hope you’re going to tell me you don’t agree with

this, because if you’re going to go to a 4.9 percent best case unemployment, we’re talking about 4.9 percent after the recession and

full recovery. If that’s as low as we can get it, if, in fact, the Administration is correct, and I don’t believe they are, that there’s an economic rule that says we can’t go below 4.9 percent for any considerable period lest we trigger inflation. Then not only is that going to

be socially a problem but it’s going to exacerbate precisely the resistance to the kind of trade regime you want to see. So I’d be interested in your comment.

Do you agree with them. I know you’ve been skeptical about the

whole concept of NAIRU but is it, in fact, the case that we’re going

to have 4.9 percent unemployment best case, going out, 25 percent

higher than we’ve been able to get to?

Mr. GREENSPAN. I don’t consider the fact that there’s a 50,000,

100,000, 175,000 jobs at stake an irrelevant consideration. Indeed,

it’s much less than that because, as you know, half the industry

is minimills, and they’re not in the same difficulties that the socalled traditional coke operated and blast-furnace steel type of operation is in.

But my own judgment is that we should focus very significantly

on making certain that those, who through no fault of their own

lose their jobs because of the opening up of international markets,

that we make certain that they are appropriately compensated and

taken care of by any number of programs which one can conceive

of.

Mr. FRANK. All right, let me just ask in the written part. I want

to get to some other questions. I’d be interested if you would give

me a list of the ways of compensating people who are getting hurt

this way that the Federal Reserve would think was a good idea.

And the problem of course is that we’re in a budgetary situation

in which some of those things are being cut and not expanded, but

I’d be interested in the programs you supported.

Mr. GREENSPAN. Let me put it this way. In this regard, I’m

speaking for myself, not the Federal Reserve.

Mr. FRANK. Well, I’ll take a few personally. It’s OK, the rest are

on their own. I’ll ask for that from you personally. But do you think

19

4.9 percent, though—let’s get back to the macro question—do you

think 4.9 percent is as good as we can do for the next 10 years unemployment?

Mr. GREENSPAN. No, Congressman. I have not changed my view

on that since we discussed it last. And I have serious questions

about the concept itself, because I don’t believe it’s a stable number

and I don’t believe that one can categorize.

Mr. FRANK. Well, I appreciate that and I think having the Administration’s official projection be that again, this is assuming

that they get everything they want in terms of policy, we’re going

to be at 4.9 percent. That’s very discouraging so I hope the next

time you and Mr. Hubbard are talking, you might bring that up.

Let me ask you another question about long-term interest rates.

In the written report we got, on page 23, it talks about the failure

of long-term rates to continue to drop, although, as you said,

they’ve dropped some, and the report says, ‘‘they may also have

been held up last year by an increased likelihood of Federal budget

deficits and investors’ optimism about future economic prospects.’’

Now that’s another issue. Some have argued that the budget deficit

is irrelevant or has only very slight relevance to long-term interest

rates. Would you elaborate on that?

Mr. GREENSPAN. I’ve always argued that there is a relationship

and indeed I think the markets respond as though there is a relationship, and I think quite properly so.

Mr. FRANK. Well if the markets respond that way, then there is

obviously.

Mr. GREENSPAN. Of course.

Mr. FRANK. So you think there is a—you’re unusually reticent.

I hope it’s not simply the reluctance to disagree with the Administration that gives us the shortest answer I’ve ever heard you give

on an important issue.

[Laughter.]

Mr. FRANK. Would you elaborate a little more? Do you believe

that the switch in the Federal fiscal situation from expected surplus to expected deficit has had an impact in keeping long-term interest rates from dropping as much as they otherwise might?

Mr. GREENSPAN. No. As I’ve commented and testified previously,

I do believe that the extent to which interest rates have not come

down as much as they ordinarily would have in a period say such

as this is partly the result of a change in the long-term fiscal policy.

Mr. FRANK. That’s two things to talk to Mr. Hubbard about.

Chairman OXLEY. The gentleman from Louisiana, Mr. Baker.

Mr. GREENSPAN. I agree with most of what he says, however.

Mr. FRANK. Well, the Republicans can ask you that, Mr. Greenspan.

Chairman OXLEY. Call on Mr. Baker.

Mr. BAKER. Thank you, Mr. Chairman.

Chairman Greenspan, welcome. I wanted to return to what I believe is the underlying economic perspective of the statement this

morning which is essentially that an information-based economy

must have access to accurate free flow of information in order for

it to function properly. Even with the free flow of such accurate information, that would not predetermine the advisability of some

20

particular capital investment decision, but real time accurate information enables proper balancing of equities to minimize potential

market distortions which have resulted from the release of misleading data. Thus, any revision of a rule, regulation, or statute

that provides for additional transparency, responsibility for disclosure of material facts, even more forward-looking statement responsibility should, to the contrary opinion of some, minimize, not

enhance, market volatilities.

As I understand your statement, reputational capital or the belief that a non-marketed idea has significant value, underscores the

need for meaningful corporate disclosure. Additionally, it is appropriate I think for careful review of all corporate governance standards, given the fact that reputation has driven many investment

decisions. Some have suggesting that Government regulation can

move faster than the markets to preclude unwarranted activity. I

don’t believe that is well-founded. Certainly smart investment individuals know that Rule 10.b[5] exists and fraudulent conduct can

take you directly to jail without going anywhere else first.

And for those who choose to distort and misrepresent, Government can provide for consequences of that inappropriate behavior,

but we cannot preclude such behavior. However, real time disclosure of accurate information to the markets provides a much more

difficult problem for those who choose to pursue ill advised course,

and that is an inability to secure the capital in the first place to

engage in an ill advised investment practice. Therefore, my question goes to the advisability of the Committee’s future work, not

only to examine but to modify where justified disclosure requirements, the nature of the disclosures to be made, the timing of the

disclosures, to define more clearly the responsibilities of corporate

executives and members of the board, not only to disclose material

facts but to ensure the independence of the audit team in reporting

of the accurate financial condition of the corporation.

Such a system should ensure that markets, and by that I mean

every investor, has a platform to make a decision from which real

information leads to sound investment strategies, not always success but the best possible strategy one can devise from his own perspective.

Looking backward, Rule FAS–133, for example, on the treatment

of derivatives reporting, even the fair disclosure regulation I would

suggest has not resulted in the type of disclosure regimes which I

think enable competent investment decisions to be made. And we

should be encouraging real time material fact disclosure, forwardlooking statements in order to ensure that information flows precedent to the decision being made. Can you comment?

Mr. GREENSPAN. Yes. Congressman, I generally agree with the

whole thrust of your remarks. Let me just say this, that it’s a very

complex issue and clearly as we move toward an increasingly conceptual environment, the values that are relevant to producing future income flows and hence the market value of a firm, depend

very much on, as I said in my prepared remarks, ideas which you

cannot physically feel.

Mr. BAKER. Let me interrupt on that. Particularly on that point,

a report that indicates the historical position of the corporation,

which is 90 days old does not indicate where an idea-driven corVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
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poration is going in the next 30 days, and the reporting system

itself leads to some misrepresentation in the investor’s mind.

Mr. GREENSPAN. I think that is a very relevant consideration. I

would say that in periods in the past when most wealth was visible, in other words, you had automotive plants, petrochemical feedstock operations, steel mills, there was real assets which one could

evaluate and you couldn’t spin what your open hearth furnace capacity was, it was real.

In today’s environment, it is very important that the form of disclosure essentially fit the nature of the value creation process.

Mr. BAKER. And that the disclosure is complete so there’s not offbalance-sheet obligations which do not reflect the true financial

condition of the corporation.

Mr. GREENSPAN. I would say, however, that it is important to remember that no matter what you do, unless you changes the incentives to game the GAAP accounting system, it will be gamed.

Mr. BAKER. Well, if an executive has a no-cost——

Chairman OXLEY. The gentleman’s time has expired.

Mr. BAKER. Just three seconds. If an executive has a no-cost option, can run up the stock price, capture that, and then do a restatement of earnings 6 months later, the shareholder takes the

loss, the executive doesn’t, and I think that’s something we need

to look at.

Mr. GREENSPAN. Agreed.

Chairman OXLEY. The gentleman from Pennsylvania, Mr. Kanjorski.

Mr. KANJORSKI. Thank you, Mr. Chairman.

Mr. Chairman, following up on Mrs. Maloney’s question on terrorism insurance, we are going to have a hearing later on this

afternoon on that very issue to see what the risk is to the economy.

But, I would like to find out whether or not the Federal Reserve

has gathered any evidence to demonstrate that this lack of coverage has caused any drag on the economy, or what the potential

future of the economy is, and most of all, how you see the potential

risk and exposure of our banks? Has there been any use of the failure to acquire terrorism insurance as a default mechanism in some

of our financial institutions?

Mr. GREENSPAN. Congressman, we haven’t seen any impact of

that nature on the banks. Indeed, much of the problem is it’s presumed that banks won’t lend unless a particular borrower has

forms of insurance which previously they did not need. So the problem is not threats to the banking system, the problem basically is

whether or not the types of real estate activity which occurred in

the past very readily is being held up. Whether construction’s being

held up, whether, in fact, there’s a significant impact on the economy.

To date, in an aggregative sense, it does not appear to be the

case. We are still struggling to get enough adequate data to make

judgments but clearly there have been effects. What we do not

know is what the aggregate size of those effects are because we

largely are dealing with anecdotal rather than macro economic

data systems. Hopefully at some point, we’ll be able to get considerably more information but at this stage, I think it’s actually too

early to make a judgment of that type.

22

Mr. KANJORSKI. But could I assume, though, that you feel that

the Congress should take action and provide some sort of backstop?

Mr. GREENSPAN. I personally do, yes.

Mr. KANJORSKI. Now, moving to an entirely different matter, the

Federal Reserve and the Treasury Department have had under

consideration a proposal that would allow national banks and financial holding companies to engage in real estate management

and brokerage. The proposal has attracted considerable opposition

here on the Hill. As you know, in passing the Gramm-Leach-Bliley

Act, Congress did not intend for banks to engage in commerce. But

this proposal, in my estimation, would subvert congressional intent. What is the status of this ill-conceived regulation? Could we

get a report?

Mr. GREENSPAN. Well, Congressman, as you point out, there has

been considerable discussion on this issue, and the consequence of

that is an extraordinary amount of comment that we have been

getting as a consequence of our request for comment on various different types of rulings. The result is we have a lot of processing to

do so we will work through it. And obviously since we have to coordinate with the Treasury Department, we will move as quickly

sa we can, but at the moment it’s going to be, in my judgment, a

while just effectively dealing with the processing of comments that

we have so far today.

Mr. KANJORSKI. Thank you, Mr. Chairman. I yield back my time.

Chairman OXLEY. The gentleman yields back.

The Chair now recognizes the gentleman from the First State,

Mr. Castle.

Mr. CASTLE. Thank you, Mr. Chairman.

Chairman Greenspan, let me preview a question I’m not going to

ask you but I’d like to submit in writing to you. I mean I know

you’ve probably heard it before but it relates to the creation of

money and the selling of money by the United States the Bureau

of Engraving and Printing and the Mint which, as you know, are

done fundamentally differently, and it seems to me that the BEP’s

methodology is clear, more transparent in terms of what they’re

doing and also accounts for the dollars in a better sense. The Mint

I think the way they do it has a lot of obfuscation to it that perhaps there’s some controls on the Mint which are not totally in

place, not that they’re doing anything wrong with it, and obviously

it doesn’t score income for Congress and the 50-state quarter program which I was involved with is going to produce now $5 to $10

billion in so-called profits and that’s something I think we need to

look at. I’ll submit in writing.

My question I want to ask you, questions I want to ask you today

relate to the economy, if you will. A year ago, your outlook report

delivered here predicted, and I quote: ‘‘Stronger economic additions

to emerge as the year progresses’’ with the economy growing at a

rate of 2 percent to 2.5 percent. The report also said, and I quote

again: ‘‘an end to the profitable investment opportunities in the

technology area does not yet seem to be in sight.’’ I guess that was

a longer term than a year statement, since households and businesses are still in the process of putting recent innovations in

place. Even without the 9/11 attacks, it does not appear that the

23

economy would have achieved the results, the 2 percent to 2.5 percent results.

To what do you attribute this under performance?

Mr. GREENSPAN. Well, Congressman, I’m not sure that that

statement is accurate.

Mr. CASTLE. You believe it was 2 to 2.5 percent?

Mr. GREENSPAN. Well, no. I think it was less but not all that

much less. As we were going into the month of August, the economy was clearly gathering some stability and as we’ve seen what’s

happened in the last few months, I’m sure we would not have made

the actual, the Federal Market Committee’s forecast would have

fallen short, but I’m not sure it would have fallen short by a particularly large among.

Mr. CASTLE. So you’re saying without September 11th, we would

have come close, even though we might not have achieved it?

Mr. GREENSPAN. Clearly, without September the 11th, the third

quarter would likely have been no change or maybe a small plus

or very small minus, and the fourth quarter would probably have

done better. Now whether or not that would have added up to the

figures that we have, I don’t know, but I think that the quality of

the forecast, if I may differentiate from the numbers, was not all

that far off in my judgment.

Mr. CASTLE. Well, let me extrapolate all that and carry it to the

future which is what I guess we’re all more concerned about right

now. Economic indicators demonstrate that we’re coming out of the

recession, at least some of them do that I’ve seen, if we’re not out

already on a technical basis. I would like to factor into that what

the economic impact of the long term war on terrorism may be,

which I think it is going to be, and also the Enron effect, which

appears to be reduced capital markets of a substantial nature and

other corporate uncertainty which is going on out there. Will these

eventually trigger a recession, going back into a recession? If so,

what steps should we be taking in Congress to prevent or mitigate

this?

Mr. GREENSPAN. Congressman, I think not. Indeed, as I said earlier, I think after the fact, we’ll look back on this Enron episode as

a period when we put our corporate governance back on track,

which would not have happened without it, in my judgment, not

fully. That is favorable to the long-term outlook. If it were going

to have a significant impact on the economy in the short run, we’d

already be seeing it, and we are not. And I don’t deny that there

may be other Enrons out there which we just have not, have not

been exposed, it’s conceivable to me, but it cannot be a large issue.

It’s almost too late for it to have had delayed effects which would

be material. If they were going to occur, much of what we would

have seen, much of what occurred would have likely occurred earlier rather than later.

Mr. CASTLE. I don’t mean to get in an argument with you about

this; you know much more than I do, or split hairs, but it does

seem to me that some of these effects could be long-term.

Mr. GREENSPAN. Oh, yes.

Mr. CASTLE. Much longer term than we seen so far in terms of

the accounting aspect of it, the effect on the corporations, capital

markets, just a whole variety of changes which are going to occur.

24

Mr. GREENSPAN. Congressman, I don’t deny that. I’m just basically saying that the order of magnitude is not material for the

long term outlook.

Chairman OXLEY. The gentleman’s time has expired.

Mr. GREENSPAN. It will affect, there’s no question that there will

be long-term effects of Enron and I think that’s good, not bad.

Chairman OXLEY. The gentleman’s time has expired.

The gentleman from Vermont, Mr. Sanders.

Mr. SANDERS. Thank you very much, Mr. Chairman, and it’s nice

to see you again, Mr. Greenspan.

Mr. GREENSPAN. Thank you.

Mr. SANDERS. Mr. Greenspan, as the Nation’s chief economist, I

would like to tap your expertise. Over the years, I think, as you

know, you and I have disagreed on some major economic issues. As

I recall the last time you were here, you informed us, to my amazement, that you actually believe in the abolition of the minimum

wage at a time when many of us think we should substantially

raise the minimum wage.

I also have a very difficult time in recognizing the kind of rosy

economy that you are portraying, and that is not the economy that

I see in Vermont and not the economy I think that exists in many

areas of this country. The reality is, as you know, the tens of millions of Americans today are working longer hours for lower wages.

Twenty-five or 30 years ago, when you and I were a little bit

younger, the norm was that in the middle class one breadwinner,

one person could earn enough money to take care of the family, and

today for the middle class that is very much the exception to the

rule. The statistics are amazing about how many two-worker families there are because of the decline in real wages. With a $400 billion trade deficit, some folks my colleagues talked about steel, but

it’s not just steel. We have lost millions of decent-paying manufacturing jobs to China, Mexico, and elsewhere and they are often

being replaced by part time temporary jobs in the service economy

which have no benefits, which are low wage. We have 44 million

Americans who have no health insurance, millions of senior citizens can’t afford their prescription drugs. One end of the country

to the other, there’s a housing crisis. Middle class families are paying 50 to 60 percent of their incomes for housing. Families are

going in debt to pay for college. The childcare situation is a national disgrace. So I don’t quite see the economy that you are talking about for the working families of this country.

But, in fact, the issue that I wanted you to comment on had to

deal with a front page story that appeared in the Wall Street Journal on Monday. And that dealt with the growth of economic oligarchies in this country, and the reality that a small handful of

corporate executives have enormous power today over the U.S.

economy, and perhaps never before in our history have so few people had so much power over the American economy as is the case

today.

The Wall Street Journal gave some examples, and let me give

some others. Twenty years ago, there were thousands of small

cable TV companies; today a pending deal would leave three companies in control of two-thirds of the market. We used to have

many defense contractors selling defense products to the GovernVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
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ment. Today there are five. We used to have many, or at least

eight, Baby Bell telephone companies; today there are four. In

terms of the media, fewer and fewer giant media corporations control television, radio, newspapers, and magazines. Oil, in the wake

of oil company mergers, five companies control more than two-fifths

of domestic production. Agribusiness five firms now account for

over 80 percent of the beef packing market. Six firms account for

75 percent of pork packing. Airline competition is almost non-existent in many parts of this country.

So my question to you is has the Government been too lax in

terms of enforcing antitrust regulations. Have we allowed fewer

and fewer corporate executives to have huge amounts of economic

power by controlling industry after industry. Is it morally right

that CEOs of large corporations now make over 500 times what

their workers make, and seem to make more money to the degree

that they lay off American workers. Do you have any concern about

any of these issues?

Mr. GREENSPAN. Well, Congressman, let me just say there are a

few qualifications I would make to the data that you cite. First, to

be sure, there has been a very considerable consolidation of defense

procurement activities because the defense budget, as a percent of

the GDP, is very much smaller than it was in periods past, so

when you have a declining industry, you’d expect that to happen.

Mr. SANDERS. Several hundred billion dollars is not insignificant.

Mr. GREENSPAN. Several hundred billion dollars is a good deal

less than the—remember we’re talking about the relationship within the economy—so that if you go back 20, 30 years, the proportion

of the economy which represented defense was much larger and

you can afford—or put it this way; there was enough business for

a much larger number of companies to function.

Mr. SANDERS. But it’s not just defense, Mr. Greenspan.

Mr. GREENSPAN. No, I understand that. Let me go down to—I

mean, to be sure, there’s been a consolidation in the oil industry,

but remember that a very significant change has occurred in the

last generation or so when most of the oil, a very significant part

of the oil-producing properties have effectively been taken over by

host countries, especially in the Middle East, so that the nature of

the international oil companies have changed.

Now I’m not going to say what is in the media. The media is a

very significantly controlled operation and that really gets down to

what Government policy should or should not be. But we have an

extraordinarily competitive economy today. It’s more competitive

than I ever recall it and indeed the international aspects of the

competition is one of the reasons why I think, contrary to the remarks that you made, that the standard of living of this country

is higher than it’s ever been on average, and two——

Mr. SANDERS. I would respectfully disagree with you. I think the

facts do not speak to what you say.

Chairman OXLEY. The gentleman’s time has expired. Does the

Chairman wish to continue?

Mr. GREENSPAN. I just basically wish to stipulate that we have

an extraordinary standard of living. I don’t deny that there are, as

there always will be, significant parts of our population which are

basically in difficulty in one form or another with respect to the

26

economy. I think we ought to work as hard as we can to alleviate

that but I don’t think it changes the fact that the economy is doing

extraordinarily well in an historic context, that all of the data that

most economists would adhere to believe the standard of living is

higher than ever before on average. And if you wish to dispute that

then to be sure we do have a very significant disagreement as we

always do.

Chairman OXLEY. The gentleman’s time has expired.

The pivoting from one corner of the philosophical divide to another, I now recognize the gentleman from Texas, Mr. Paul.

[Laughter.]

Mr. PAUL. Thank you, Mr. Chairman.

Welcome, Chairman Greenspan. I wanted to start by referring to

a speech you gave in January at the American Numismatic Society

where you spoke profoundly about monetary policy and said that

central bankers have had relative success over the past decades,

and it raises hopes that the fiat monetary system can be managed

in a responsible way. So I think you’re still at the point of hoping

that this system will work. I maintain that the jury is still out on

whether or not fiat money will work over the long-term.

And then you followed it up by saying, in case it didn’t work, and

I don’t know whether you had tongue-in-cheek or not about this,

but you said that we might have to go back to sea shells and oxen

as our medium of exchange.

And then you reassured everybody that the discount window

would have an adequate supply of oxen. Chairman Oxley, if we get

to this point, which I suspect we will someday, I ask you that we

have hearings to debate the issue of what medium of exchange we

have before the Fed starts using oxen as a medium of exchange.

Chairman OXLEY. Are you referring to the Chairman here?

Mr. PAUL. Yes, I hope that you will at least consider that. But

I think it is an important point and I want to relate that to the

Enron issue, because in many ways, I think the system that you

have been asked to manage is similar to being asked to manage an

Enron system. Because Congress is notoriously in favor of deficit

spending, we’re currently expanding the national debt at $250 billion a year, and we have nearly a $6 trillion debt.

Now we create that debt by buying votes. We spend a lot of

money. Then the Federal Reserve comes in and they buy that debt

in order to maintain the interest rate that they think is the right

interest rate. And they take that and use it as an asset. You put

it in the bank. You call this debt that we created an asset, and you

use it as collateral for our Federal Reserve notes. So that’s a pretty

good scheme, and I think in the moral terms, as well as the economic terms, it’s very similar to how Enron operates. I’m not convinced the system works very well because a lot of people here

praise you for the adequate amount of liquidity and that’s what inflation is: create more money, lower interest rates. Every time you

ask for liquidity, and every time you ask for lower interest rates,

you’re asking for inflation of the money supply. I think that what

we fail to do is to ask about the cost. Do we ever concern ourselves

about the people who have had two-thirds of their income removed

because they happened to be savers and living off interest? We

gouge them with inflation, the loss of purchasing power, and taxes.

27

A lot of people in this country have suffered from this particular

system.

Now the analogy I would like to draw is something you said in

your testimony on page 13, and you have mentioned several times

now that Enron may be a good lesson, and I think it is. And I’m

not for more of this regulation by SEC. I think you’re correct that

derivatives provide a market tool that is worthwhile, but you also

said the Enron decline is an effective illustration of the vulnerability of a firm whose market value largely rests on capitalized

reputation, with very little on no physical assets. That’s exactly

what our monetary system is all about, and that’s why I believe the

dollar is vulnerable. We in Congress do not have a responsibility

to run Enron. Some other government has the responsibility to deal

with fraud. We have a responsibility to the dollar, and I think

that’s what we fail so often to address around here.

In addition, you said that Enron provides encouragement that

the force of market discipline can be counted on over time to foster

a much greater transparency. That’s exactly what the market does

with money. If you look at the rapid and the sudden devaluations

of the fiat currencies around the world, such as what happened to

us in 1979 and 1980, that was the market coming in and forcing

vulnerability and transparency on us. Now gold gives you a hint as

to what’s happening. Gold has sent a mild message in this past

year. In spite of the fact that central banks and others continually

sell and loan out gold and push the price of gold down, there is a

message there.

So I would ask you, can you see any corollary whatsoever on

what you’re asked to do in running our monetary system to that

which Enron was involved in?

Mr. GREENSPAN. I hope there are fundamental differences. First,

dealing with essentially a fiat currency, what it is that we are

doing is that the currency is granted value by fiat of the sovereign,

as it is said in the textbooks. The issue there is that in years past,

there has been considerable evidence that fiat currencies have been

mismanaged in general, and that inflation has been too often the

result. What I was mentioning in the speech that you were referring to is the fact there is some evidence that we’re learning that

lesson, learning how to manage a fiat currency. I’ve always had

some considerable skepticism about whether that in the long run

can succeed, but I must say to you that the evidence of recent decades is that it has been succeeding. Whether that continues is a

forecast which I can’t really project on.

The Enron situation is essentially one in which there was an endeavor to imply that earnings were much greater than they really

were, that increasing debt was hidden. I can think of no reason to

have done what they did with their off-balance sheet transactions

other than to obscure the extent of the debt they had, and what

essentially was squandered in that process was the reputational

capital which they had succeeded in achieving over a period of

time. And I don’t perceive that anything that we are doing as a

Central Bank involves anything related to that. I hope that where

we need to be transparent and indicate what we are doing we do

so, and we do so except in those areas where it, as I mentioned to

28

you previously, inhibits the ability to actually function as a Central

Bank.

But as I say in summary, I hope your analogy is inappropriate.

Mr. PAUL. I guess we’ll all keep hoping.

Chairman OXLEY. The gentleman from California, Mr. Sherman.

Mr. SHERMAN. Thank you.

Thank you, Chairman Greenspan, for an outstanding presentation. As before, I’ve got far more questions than the 5 minutes

allotted so, as in the past, I’d like to start off with some questions

that I hope that you and the Fed Staff would respond to for the

record.

We met here a year ago. Of course, you come every 6 months,

but a year ago is the last time I’d had a chance to ask you a question, and we dealt with the incredible deficit and I’d coin the term

‘‘trade debt,’’ that is to say, the trade deficit building up year after

year, the transfer of assets abroad, and I’m still amazed that the

dollar sells for more than the euro, and that we hope that this

trade debt and deficit reach a soft landing. I don’t know anyone

who could have predicted a decade ago that the country could run

a trade deficit as long and as large as we have and still have such

a strong currency.

I’d like to restate the concern that I expressed to you in this

room a year ago, and echo the comments of Mr. Kanjorski that real

estate brokerage was never designed to be something included in

the grant of powers to national banks and financial institutions.

Not only is it bad public policy, but I think that if the bank regulators go down that road, it will undercut your relationship with

Congress. We were in this room for literally hundreds of hours over

half-a-dozen or more years trying to paint a picture for ourselves

as to what financial reform would mean and under particular statutory text.

None of us in this room ever put forth the idea that the bill we

passed would open this huge industry to those insured financial institutions. And I noted that you have not acted precipitously in this

area. You indicated that you’re going to wait for a chance to respond to all the incoming comment and if what it takes to avoid

precipitous action is additional incoming comment that needs response, I’m sure that can be arranged.

First, as to economic stimulus, there’s two ways to do it, monetary and fiscal. The monetary has immediate effect. You could meet

in the next day. The interest rates are lower. It may not have an

immediate impact. Fiscal takes months, it seems, for the IRS to

even get the checks out to even have an effect, let alone an impact.

Yet it’s odd that this country is now thinking in terms of fiscal

stimulus and monetary sedative, for want of a word to express the

opposite of stimulus. First, let me urge you to consider cutting interest rates one more time instead of increasing them.

But second, putting aside your well-known preference for lower

total Federal expenditures, and assuming those expenditures are

going to remain the same, does it make any sense for Congress to

be thinking of fiscal stimulus while the Fed is at least rumored to

be considering monetary sedative?

Mr. GREENSPAN. The problem with fiscal policy, as economists

have begun to realize over the decades is that it’s very difficult to

29

implement in a timely manner largely because our capacity to forecast in a specific timeframe itself is limited.

Nonetheless, as I indicated over the last year or two, if it turns

out that you can fortuitously time a tax cut in a period of economic

weakness, it obviously does do some good. I do think that the tax

cuts of last year in the middle of the year did show up as increased

expenditures in July and August. That’s not the way they were

constructed in that timing, but they turned out to be actually quite

effective as best I could judge.

But the broader question still remains whether it is possible to

implement an effective fiscal policy with the inevitable time lags

that are involved. I’m skeptical myself that it is feasible.

Mr. SHERMAN. Do we need stimulus at this time, let alone is

there any evidence that we need stimulus 6 months from now, or

a year from now?

Mr. GREENSPAN. Well, the question really rests on whether the

level of final sales will kick in, as I put it in my prepared remarks,

prior to when the obvious significant positive thrust coming from

a reduction in inventory liquidation dissipates. It’s too soon to

make that judgment at this particular point. So one can argue that

if one believes that it might not, that as an insurance policy, you

might want some fiscal stimulus.

My own impression is that it’s probably not necessary, as I indicated in previous testimony. But there is a credible argument for

it as an insurance policy for those who believe that the economy

may be at risk of not being able to follow through after we get the

inventory turnaround.

Chairman OXLEY. The gentleman’s time has expired.

Mr. SHERMAN. If I could have just ten seconds, though.

Chairman OXLEY. The gentleman from California, Mr. Cox.

Mr. COX. I’d yield ten seconds to my colleague.

Mr. SHERMAN. I just want to point out that the cheaper insurance policy is for you to cut interest rates which would have the

stimulus effect if that was determined to be needed without increasing the national debt. I thank the gentleman.

Mr. COX. Mr. Chairman, welcome. As you point out in your testimony, the proper functioning of our markets depends upon investor

confidence. And the Enron debacle, which is in major part an accounting scandal, has eroded public confidence in, among other

things, financial reports generally. It has put a glaring light on the

role of directors, particularly members of the audit committee. It

has cast into doubt the adequacy of the entire accounting profession.

To address these problems you, regulators, Congress, the SROs

and the private sector know that we have got to take every responsible step to increase auditor independence, to strengthen the role

of the audit committee, of an independent audit committee, to fortify the accounting profession to attract highly skilled, intelligent

people of integrity. And yet if we survey the lay of the land today,

we know that the market forces, the trends, the incentives are all

running in the opposite direction.

At a time when we need the very best people to serve on boards,

the risk to such service is greater than ever. We can ask ourselves

based on very real experience of late, who would want to volunteer

30

for service on an audit committee of any large enterprise today?

Whereas, 30 years ago, many top graduates of the Nation’s business schools headed for the accounting profession. That’s no longer

the case, and Enron has almost certainly made the problem worse.

The question I’d like to put to you is what we as Congress can

do and what the private sector can do, what regulators and SROs

can do to address the problem of auditor compensation while still—

or not while still, but while actually increasing auditor independence? And what can we do to encourage people of character and

reputation to risk those irreplaceable assets to serve on the boards

and the audit Committees of the Nation’s businesses?

Mr. GREENSPAN. Congressman, this is an issue which the President’s Working Group is deeply involved in at this particular stage.

One of the things that I think is becoming evident is that the

change in corporate governance which has occurred over the generations where you very rarely now have shareholder control in a

limited number of hands so that effectively the directors are appointed and work for the shareholders and the CEO is appointed

and works for the directors.

The fact that such a substantial amount of shareholding is now

for investment and not for control has effectively switched the locus

of control from shareholders to the CEO. And if the CEO endeavors

to run the company wholly in the interests of shareholders, then

there’s no loss in the structure of corporate governance. And it’s in

our judgment that what we have to start to do is to try to find

those areas where the CEO’s self-interest has diverged from that

of shareholders and try to find means and incentives which would

restore what, I think, was the case 20 or 30 years ago before shortterm earnings expectations became such a critical issue in what individual corporate managements were able to do.

My own judgment is that you have to be careful about trying to

presume that directors are really, truly independent. I’ve served on

innumerable boards in the private sector, and there is an asymmetry of information between an insider in a corporation and an

outside director which will never be breached, which will never be

brought together, I should say.

The result of that is that it is crucially important that the incentives require that the CEO behave in a certain manner or be

incentivized in a certain manner. I’ve served on too many audit

committees to know that even though I would consider myself independent, I would consider myself knowledgeable, I did not know

what questions to ask the chief financial officer during meetings to

find out what it is that conceivably is going wrong in the corporation, and he wasn’t about to tell me.

So that there is a very difficult problem that one confronts, and

the mere presumption that you somehow make a bunch of people

independent and have an independent audit committee, it won’t

work that simply because if you make everybody on the board independent, what’s going to happen is you’re going to have competing

power centers within a corporation. And in my judgment, corporate

governance will suffer as a consequence.

Mr. COX. Mr. Greenspan, I wonder also if—you’re making the

case for the complexity of the problem. I wonder if you could address the concern which is no matter how we address corporate

31

governance issues remains, and that is how you attract quality people. Because I think the accounting profession has taken a hit. I

think that the ranks of boards and audit committees are going to

take a hit. And we’ve got to have good people in these positions if

we’re going to lick these problems.

Chairman OXLEY. If I could interfere just briefly. We have a vote

on the floor. Make that the last question. The Chairman could respond and then we’ll take a break for the vote.

Mr. GREENSPAN. Why don’t I answer it later then, if that’s the

case?

Mr. COX. Well, I’m happy to put the question to you now and

hear your response and not put any further questions so that we

can that wrap it up, Mr. Chairman.

Chairman OXLEY. Yes. If the Chairman would like to respond.

Mr. GREENSPAN. Which specific question did you want to ask

quickly?

Mr. COX. The burden of my question is, we are seeing increasing

risk to the individuals who we want to be even more responsible

than they have been in the past, and we’ve got to attract persons

of training and integrity to these positions. What structurally can

you recommend to the Congress that we might do to fortify the accounting profession and the ranks of our directors?

Mr. GREENSPAN. It’s my impression on the basis of experience

I’ve had in an innumerable number of boards on which I have

served that if you get a chief executive officer who looks toward his

outside auditor as somebody to tell him what he is doing wrong

rather than somebody who should try to acquiesce in a particular

set of accounting principles, he will change the whole nature of the

relationship between directors, CEOs, and he will certainly create

the type of independence of the audit function that will attract

numbers of people back into the accounting profession and create

the type of directors who will be most effectively helpful to the

CEO and to the shareholders in getting appropriate corporate governance.

Chairman OXLEY. The gentleman’s time has expired. The Chair

would declare a recess of the hearing for the vote, and we will reconvene in 10 minutes.

[Recess.]

Chairman OXLEY. The hearing will come to order. And the Chair

now recognizes the gentleman from Pennsylvania, Mr. Mascara.

Mr. MASCARA. Thank you, Mr. Chairman.

I’d like to revisit the steel crisis issue, Mr. Chairman. I come

from Southwestern Pennsylvania where steel and coal used to be

king. And as we all know, there is an apparent steel crisis. The

steelworkers will be here tomorrow at a rally to stand up for steel

and I certainly will visit with them.

First of all, I happen to believe that the steel crisis is a microcosm of our failed trade policies. And I don’t want to get into that,

because that’s a long story. But, I respectfully disagree with you in

an earlier comment to a question about what effect tariffs would

have on steel, and that perhaps prices would increase as a result

of even as high as 40 percent. The President, on March the 6th,

will make a decision about the percentage of increase on steel tariffs.

32

I don’t believe that I’ve seen any decrease in the cost of automobiles, appliances as a result of the consumer consumption or the

domestic steel users in this country of that cheap steel passing that

profit on or any part of it to the people who buy automobiles and

appliances. That’s one point I want to make. And I’m wondering

whether you have any feel for what the President—I’m not asking

you to guess the President—but what the President should do in

regards to the March 6th decision that he has to make?

On Sunday, I was on KDKA television in Pittsburgh with the

CEO of Weirton Steel that employs 3,500 steelworkers. He said

that 20 percent would be of no help and that eventually the steel

industry would die on the vine, that companies continue to go into

Chapter 11. In fact, Wheeling-Pittsburgh Steel plant in my district

is now in Chapter 11. And I was wondering whether you had any

feel where that number should go from 40 percent down, given that

20 percent won’t work.

Mr. GREENSPAN. Well, first of all, I’m not clear as to what you

mean if you put a tariff on that the price will not go up. If it

doesn’t go up then it has no impact on the domestic steel price that

the traditional steel operations are still under severe pressure because their margins are not going to change. I’m not sure if a tariff

doesn’t increase the domestic price its impact on domestic profitability and employment is zero.

Mr. MASCARA. What I said, Mr. Chairman, is that the savings

that the domestic users of steel to make their products with, that

savings has not been passed on to the consumers.

Mr. GREENSPAN. Well, if it hasn’t, then the profits of the steelusing industry must have risen significantly and there’s no evidence of that happening, Congressman.

Mr. MASCARA. Well, I don’t have those facts here. But there is

a concern that the steel industry will cease to exist. Have you considered the national security impact? Bethlehem Steel, which is one

of the only producers of the steel that’s used in ships and tanks,

is also in Chapter 11 now. And do you feel that if the steel industry

does, in fact, cease to exist in this country—and those kinds of

talks are going on currently—what will we do in the event that we

need to produce that kind of steel? Would we have to depend on

foreign production of that type of steel?

Mr. GREENSPAN. Are you talking about defense?

Mr. MASCARA. Yes.

Mr. GREENSPAN. You’re talking about steel plate and the like?

Mr. MASCARA. Yes.

Mr. GREENSPAN. Well, first of all, I don’t believe that it’s credible

to presume that the steel industry will no longer exist, because half

of the mills, as you know, are electric arc furnace, steel scrap consumers and while they’re under some pressure because of the obvious weakness in steel prices, they’re doing reasonably well. And

there’s no evidence of which I am aware would suggest that they’re

going out of business.

The crucial issue that really is involved with the notion of the

traditional steel industry is there are certain types of steel which

cannot be made effectively in a scrap furnace. In other words, the

chemical control that you have of the scrap makes it difficult to creVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
33

ate the type of steel which for example you need in an automobile

for forming purposes and the like.

And so that there is a need in the country for a certain what I

would call ore-originated steel, because you can essentially control

the metallurgy in an appropriate manner. But that’s not a very

large number. And indeed, as you know, there’s a good deal of slab

imports which are made from ore and which are rolled into a type

of cold-rolled sheet which the automobile manufacturers need.

As far as steel for defense, the amounts that we need are extraordinarily small. And I’m not convinced, at least from what I understand it, that with the appropriate amount of pellets within say

a scrap mix that a goodly part of the actual heavy steel that we

need is not available.

But in any event, I mean there’s certainly not going to be a disappearance of the traditional steel industry. I do agree with you

that it’s under severe difficulty and as one who is old enough to

have visited the old Homestead Works when they were really extraordinarily effective and productive, I know what it means for

that type of industrial structure to fade.

Mr. MASCARA. My time has expired. But apparently we disagree

on some issues as it relates to the stability of steel industry. There

are hundreds of thousands of retired steelworkers who now may

lose their health care and pensions. I think the President ought to

do something and do it very quickly. Thank you, Mr. Chairman.

Chairman OXLEY. The gentleman’s time has expired.

The gentlelady from New York, Mrs. Kelly.

Mrs. KELLY. Thank you, Mr. Chairman.

Mr. Greenspan, you’ve been here a long time and so I really want

to make this fast. But I noticed something that I wanted to ask you

about. We saw in the news this morning the Commerce Department said that durable goods rose by 2.6 percent in January and

they rose in December by .9 percent. But in your testimony on page

4, you said, as a consequence, although household spending should

continue to trend up, the potential for significant acceleration in activity in that sector—this sector is likely to be more limited than

in past cycles.

That seems to be somewhat in conflict with the numbers, and I

wanted to know if you believe that this is a trend in durable goods

and one that’s likely to continue. I wonder if you’d address that for

me.

Mr. GREENSPAN. I would say looking at the data that we saw

today, clearly it’s encouraging that the markets are coming back.

But they went down in an awfully extended way and they were

under really severe pressure. So I think that it’s going to take a

while to be sure that we’re getting the type of response that we’re

going to ultimately need.

There are a number of elements in the capital goods markets

which are still quite weak. And indeed, some of the anecdotal stuff

especially. And in the telecommunications area, for example, orders

are not showing very much. They did improve in this morning’s

numbers and that was encouraging. But all I would say to you is

that, yes, the durable goods orders were somewhat better than I

would have expected this morning. That if they continue that way,

then I think things will clearly improve.

34

But it’s too soon to make those types of judgments. We need a

good deal more time to see that this recovery is integrating, is taking shape in an integrated form.

Ms. KELLY. So you don’t feel that the numbers over the past—

I know the projects in December had projected zero growth or negative, and we got a .9 percent. And here we are in January with a

2.6 percent. You’re saying you don’t feel that that yet, that that’s

enough to make a trend?

Mr. GREENSPAN. No. I think it’s certainly enough to indicate that

the hypothesis that we’re coming out of what has been a period of

significant stress that the probability is improving. It’s nonetheless

still early in the sequence.

Ms. KELLY. Let me just throw something else in that equation.

According to the National Association of Realtors, existing home

sales for January set a monthly record. They topped out a $6 million mark for the first time.

On page 5 of your testimony, you say in recent months, low mortgage interest rates and favorable weather have provided considerable support to homebuilding. Moreover, attractive mortgage rates

have bolstered the sales of existing homes and the extraction of

capital gains embedded in home equity that those sales engender.

With all that said, do you feel that this is a trend in the new

home sales and you think that’s a sustainable trend for the near

future or do you think that trend may slow down?

Mr. GREENSPAN. You mean $6 million annual rate figure? That’s

clearly not going to be sustained. I mean, there’s just no evidence

that we’re off on a different track. Because remember that existing

home sales are essentially a rate of turnover of the existing single

family housing stock plus condominiums. And historically, that

ratio doesn’t change all that much. It’s a gradual change in households, and the turnover is related very largely to demographic

forces as well as the obvious economic forces which I cited.

So if you’re asking me do I think the $6 million number will stay

up there, I think unlikely. But nonetheless, it’s still impressive.

Ms. KELLY. Would you say that you feel that the trend toward

increasing home sales would continue whether it hits that mark or

not?

Mr. GREENSPAN. Well, I think the trend of existing home sales

has been relatively flat at a reasonably high level for quite a long

period of time. And if we can even maintain that, I think we’re

doing well.

Ms. KELLY. Thank you very much. My time is up. Thank you,

Mr. Chairman.

Chairman OXLEY. The gentlelady’s time has expired.

The gentleman from Washington, Mr. Inslee.

Mr. INSLEE. Thank you.

Mr. Chairman, we’ve all been talking about the concerns about

Enron and the prospect of other Enrons out there, of other organizations that would overstate revenues and understate costs. And I

know of at least one other large organization that’s exactly in that

position of deceiving essentially their shareholders in that regard.

You’re smiling. You see where I’m going with this. Which is the

United States Federal Government.

35

And it’s my belief that our deceit of our shareholders sort of

makes Enron look like small potatoes, considering the phony accounting that we indulge in that I believe is leading us to chronic

deficits over the next decade unless something happens. And let me

just list three of those that I believe that are phony bookkeeping

that disguises the fact that we’re going to have these chronic deficits. We’re already over $100 billion this year, as you know.

You know, we tell the American people that tax exemptions that

are now in the Code aren’t going to be renewed when the Administration makes their projections. We all know that’s not true.

They’re going to be renewed. Everybody in this town knows it, including the folks in the White House.

We know that the AMT eventually is going to be fixed, has to

be fixed, because so many millions of Americans will be subject to

it. Everybody in this town knows that, and yet we don’t tell the

American people that. We base projections on that phony statement.

We know there’s going to be relief for Medicare of some of the

cuts that have damaged health care in this country, and everybody

in this town knows that this is going to happen.

Now assuming that’s true, looking at the numbers, we’re in for,

at least in my view, long-term deficits somewhat approaching the

history of the 1980s, which was a movie we saw once before, of big

tax cuts, big defense buildup, and unrestrained domestic spending.

And I guess my question to you is, if we end up back in that pickle

because of our Enron-like activities at the Federal level, what impact do you think could that have on the U.S. economy in the next

decade?

Mr. GREENSPAN. Well, obviously, if we resort to a significant

amount of deficit spending, the question essentially is how is it financed? And it’s financed basically by extracting capital from the

private sector. And to the extent that you do that, obviously, the

capital assets which are produced are generally less productive in

producing economic goods than is the case when the Government’s

drain on resources is neutral or zero even or slightly in surplus so

that it’s merely a simple question of how it’s financed and what the

implications of that are, and history tells us that it’s not very helpful.

Mr. INSLEE. I think there’s another downside, too, and let me

just ask you about this. And that is that essentially the Administration is financing this budget deficit by raiding Social Security.

And of course, Congress and the Administration has told Americans for the last couple of years that raiding Social Security was

no longer going to be countenanced in this town, and that’s exactly

what we’re doing.

And now, because of these faulty, phony numbers that we’re posing about, we’re going to be again raiding Social Security for the

next decade to finance this deficit. I’ve heard it expressed that that

in itself is a problem when you talk about Americans’ confidence.

And I can tell you that people right now, because of that seriously

question whether Social Security is going to be there for them.

I was meeting with a group of young people in their early

twenties. They honestly don’t believe Social Security is going to be

there for them. And one of the reasons they do is because of this

36

budget that the majority—and I’m not a part of that here—as past

will put us back in these deficits.

So I guess is that a factor that we should consider when we look

at what people are doing in their personal investment decisions?

Mr. GREENSPAN. Well, first of all Congressman, remember that

the types of accounts which are kept both at OMB and CBO are

reflective of the laws passed by the Congress. In other words, if the

statute stipulates that a certain law is to end as of a certain date,

it, meaning OMB—well, it’s basically CBO, because OMB can assume that and extend it if it wants, but CBO cannot. In other

words, it’s not making the laws, it’s merely registering what the accounts imply under existing statute.

So I would think that if you want to alter that, you’re going to

have to change the statute or change the rules on which you request CBO to give you the types of data which they do.

With regard to the issue of Social Security, if the Social Security

trust fund goes to zero, the chances that benefits will be curtailed

in my judgment is zero. And the reason for that is I see no credible

scenario in which the Congress would fail to adhere to the benefits

as now appear in law. So I don’t think it’s a credible issue to be

concerned about what is happening to the Social Security trust

fund if the issue is whether benefits will be continued. Because I’ve

been around this town long enough to know that that’s not the way

it works and I think if you’re talking about making certain we keep

the books balanced, I would also suggest that we try to resolve the

issues that are real and I don’t think it’s a real issue, nor do I

think the American people have to be concerned about their benefits disappearing if the fund disappears.

Now what I think younger people are concerned about is the rate

of return that they’re getting in benefits from the numbers that

they put in the fund is much lower than, for example, my generation. I mean, if you look at what I put in and what I got out or

what I would have gotten out if I retired at 65, is an extraordinary

rate of return. And Social Security was remarkably popular for my

generation. I don’t think it is for the younger generation. But, because of the fact that they’re not perceived as getting back an adequate return.

Chairman OXLEY. The gentleman’s time has expired.

Mr. INSLEE. Thank you, Mr. Chairman.

Chairman OXLEY. Mr. Chairman, we’re glad you didn’t retire at

65. The gentlelady from Illinois.

Mrs. BIGGERT. Thank you, Mr. Chairman. And thank you, Mr.

Chairman for staying this long to allow us to ask questions.

As you’re aware, the electronic transfer of value was not interrupted by the tragedy of September 11th, but as I understand it,

for a period after September 11th, many of the banks really didn’t

know what their true financial position was because it was impossible to move the checks and payments around the country, particularly because of the airlines not flying and for various other

reasons.

But is the Fed doing anything to ensure that the payments

mechanism really is going toward or using the technology such as

electronification of paper checks to facilitate the stability of that

system?

37

Mr. GREENSPAN. We are, Congresswoman. We were sort of taken

aback by the extent to which the amount of telephonic exchange

and data processing exchange which presumably was supposed to

be back up in the lower Manhattan area during the period subsequent to September the 11th, we had assumed that a goodly part

of that backup would work. The trouble, unfortunately, is a lot of

the backup went over the same cable lines that the original systems went and were quite useless for a while. And as you point

out, we had a very significant amount of float in the system as a

consequence of the airlines effectively stopping and not delivering.

We have a proposal, I believe it’s up to the Hill now, on truncation of checks and the effect of implementation of a significant

amount of electronic processing to move the checks through the

system in a much more facile way.

Mrs. BIGGERT. Do you think that Congress needs to pass such a

bill on check truncation? Or can the Federal Reserve do it through

their rules and regulations?

Mr. GREENSPAN. No. I think we need legislation.

Mrs. BIGGERT. Thank you. Let me turn for a minute to trade. I

don’t think we’ve talked too much about that. What effect would a

free trade area of the Americas have on the U.S. economy? And can

we afford to wait for the time that it seems to be taking to get that

through?

Mr. GREENSPAN. Well, I think the evidence increasingly is persuasive that the greater the amount of cross-border trade, the higher the standards of living everywhere. And to the extent that we

can facilitate the emergence of greater trade irrespective of where,

provided that the individual trade groups do not themselves become protectionist, then it’s all to the good. And all I can say, Congresswoman, is I trust that we will move forward expanding trade

and gain the benefits and recognize that the problems that that invariably creates for a number of our industries which are under severe competitive pressures, that we recognize that we should find

ways to assuage those problems.

Mrs. BIGGERT. Is there any difference between bilateral trade

agreements or multilateral? Should we be looking if we can’t get

the free trade area, start with bilateral?

Mr. GREENSPAN. Well, no. I would say that the greater the number of players, if I may put it that way, the better. So multilateral

and indeed global is by far the best. Bilateral trade is helpful but

only as a fallback position, because it is better than no trade but

certainly not as good as global trade.

Mrs. BIGGERT. Thank you. Thank you, Mr. Chairman.

Chairman OXLEY. The gentleman from Kansas, Mr. Moore.

Mr. MOORE. Thank you, Mr. Chairman.

And Chairman Greenspan, I very much appreciate your being

with us again today. Secretary Paul O’Neill recently requested that

Congress increase the statutory limit on the public debt from $5.9

trillion to $6.65 trillion, about three-quarters of a trillion dollars.

I guess my question is, and I don’t know if there’s any good answer

to this, are we opening up the checkbook so to speak if we increase

it by three-quarters of a trillion dollars, say, as opposed to $250 billion? Do you have any thoughts about that?

38

Mr. GREENSPAN. Well, first of all, I think that I’m not a great

proponent of this type of legislation to begin with, because I think

that the Congress enacts tax structure and it enacts appropriations, and the difference between those two is the change in the

debt.

To then have to reauthorize a different level of debt is very much

like trying to restructure arithmetic. I mean, you’ve already done

it. And it’s not really appropriate to then put on a debt ceiling and

then find yourself with contrary law. Because clearly, you cannot

simultaneously have your tax legislation, your appropriations and

your debt ceiling, they may not be in agreement, in which case

some law is being violated, and I think that is inappropriate.

Mr. MOORE. Is there any benefit, though, to such a check and

saying we’re going to have a public discussion about this before we

increase the public debt any more?

Mr. GREENSPAN. Well, first of all, I should hope one does that in

the appropriations discussions.

Mr. MOORE. Certainly.

Mr. GREENSPAN. I mean, that’s where theoretically it occurs. The

problem I have with the specific legislation is that if you’re going

to do it, and as I say, that’s not what I would do, I would put it

on the debt to the public, which is truly the difference between receipts and outlays in the unified budget. The inclusion of the twoodd-trillion dollars—a little more than two trillion dollars—in

intragovernmental holdings in my judgment serves no useful purpose, and that as a consequence of that, even granting, I mean,

even granting that a debt ceiling might be usable, that’s not the

one I would use.

Mr. MOORE. Chairman Greenspan, you talked about the importance of confidence of people in the economy and how that affects

the economy. And I wonder, is there a relationship between fiscal

surpluses and/or debts and long-term interest rates? And I’ve heard

some people in the past, for example, say—and maybe this is too

simplistic, and you can tell me if it is—that if we’re able to pay

down $100 billion or $300 billion or a half a trillion dollars in debt,

that it would beneficially affect interest, long-term interest rates.

Mr. GREENSPAN. I think that’s right. And indeed, just remember,

it’s other things equal.

Mr. MOORE. Yes, sir.

Mr. GREENSPAN. I think the evidence pretty much is conclusive

on that, although I must tell you that there’s a very considerable

degree of differences amongst economists. And clearly, I don’t want

to get into the details of it, but you will find people who don’t agree

with that. And I think everyone agrees that under extreme circumstances where, in fact, you have huge deficits and inflation is

being engendered that long-term interest rates go up and indeed,

in those types of economies, you cannot sell long-term debt. No one

will buy it.

But there is a legitimate dispute as to what the relationship is

between surpluses and deficits when those are in a relatively narrow range, is it conceivable that the changes are very modest? And

the answer is yes, it is conceivable, and that may indeed be the

case.

39

Mr. MOORE. One of the Members said that they were happy that

you hadn’t retired when you were 65, and I was listening to NPR

this morning. They were talking about the possibility of your departure prior to the expiration of your term. And I for one hope you

stay.

Mr. GREENSPAN. Thank you very much.

Chairman OXLEY. The gentleman’s time has expired.

The gentleman from California, Mr. Royce.

Mr. ROYCE. Thank you, Mr. Chairman.

Welcome, Chairman Greenspan. What I wanted to ask you about

specifically were some of the incentives that are currently in place

for management. Incentives, especially in terms of the evolution of

compensation packages with stock options, which at times in some

firms have management pushing for very aggressive accounting

methodologies, and then at the same time have management deciding who is going to do the audit and then trying to influence the

outcome of that audit.

And it seems to me that one of the questions would be can we

change the structure in some way so that either the audit committee is truly independent and truly picking the auditor, the auditor responding to the audit committee rather than to management,

and do you do that by setting up some special regulatory structure

where the audit committee reports separately? Or do you do that

by maybe requiring audit insurance perhaps rather than the mandate of an outside audit, have the insurer have the vested interest

for transparency in the accounting? Or do you look at these public

companies that are on the New York Stock Exchange or the

Nasdaq and say, all right, give the Exchange the responsibility of

picking the auditor?

Any of these approaches might make the audit truly representative, even in these cases like Enron’s, because it would change the

incentive structure. Either that or change the incentives for management’s compensation, which would be another way to approach

the same problem and have management act in the interest of the

shareholders.

But could you maybe respond to those concepts and whether you

think they’re viable?

Mr. GREENSPAN. Yes. Well, I do agree that how a firm is audited

and by whom is quite important. The issue that I think is crucial

here is that if properly constructed and I would say the structure

of corporate governance, that it’s interest of the CEO to see that

you have an effective external audit, remembering that it’s an

audit of the internal auditing system, you certainly want an auditor who knows your business, knows your company and consequently the reason why it’s important to at least have the corporation either choose or acquiesce in a specific choice of an auditor

is that it is quite credible to get somebody who doesn’t have a clue

as to what, in fact, he’s auditing.

And the experience of the auditing profession is under such conditions you find that embezzlements occur far more readily in the

early years of a new audit system than they do later on. So you

have to be careful about unintended consequences of alternating a

system which has evolved over the years.

40

The President’s Working Group has been instructed to look into

this issue in some considerable detail, and we are in the process

of doing that.

My general impression personally, having looked at a whole series of ways of coming at this, that because under the vast majority

of corporate relationships with outside auditors, the outside auditor

not only is a good independent auditor but also is very helpful to

the CEO in overseeing how his own internal system works and suggesting to him what he can do to improve the internal workings of

the system. And it’s my judgment, having seen this function for

decades, it’s best when you have a good relationship between the

auditor and the CEO.

If, however, it turns out, as I fear regrettably seems to have been

the case in the Enron situation, that a number of internal strategies thought up by internal auditors were agreed to by the external

auditor only to find later on that it had to be reversed. Now that

is very unfortunate circumstance and probably regrettably as a

consequence of incentives not being appropriately positioned.

I reemphasize as I’ve said to your colleagues in earlier questioning, if you can somehow find a way to create a set of incentives

for the chief executive officer to function solely in the interests of

the long-term values of the shareholders, then the whole issues of

independent directors, independent auditors and good corporate

governance system comes into play.

Mr. ROYCE. As part of that, just to follow up, would part of that

potentially be looking at the way in which proxy votes are manipulated by management and vesting more direct power in the shareholders by making changes or recommending changes in the system where management can’t corral basically proxy votes in order

to——

Mr. GREENSPAN. Well, that obviously is the type of thing which

I think is an appropriate issue for evaluation. The way, regrettably,

the system works today is that the vast, vast majority of votes by

shareholders are either 99-to-1, 98-to-2 if it’s 95-to-5, it’s perceived

to be a disaster for management.

Now what that clearly tells you is that the slate of directors, the

various issues presented to shareholders for authorization, largely

comes from the CEO. And unless and until you change the incentives for the CEO to do things in a different way, the issue of gaming the system, gaming the GATT rules, endeavoring to make it appear as though short-term earnings growth reflects longer-term

earnings growth, so long as there are incentives for management

and specifically the CEO to do that, I don’t care what else you do,

it will not work.

Chairman OXLEY. The gentleman’s time has expired.

Mr. ROYCE. Thank you, Chairman Greenspan.

Chairman OXLEY. The gentleman from Massachusetts, Mr.

Capuano.

Mr. CAPUANO. Thank you, Mr. Chairman.

Chairman Greenspan, thank you for that last clarification. You

just answered one of the questions I was going to ask you. I don’t

think your answer earlier was as clear as the answer you just gave

in differentiating short-term interests from long-term interests. I

think you just did it, and I appreciate that clarification.

41

One of the questions I do want to ask you, though, is have you

had an opportunity to review the CBO report that came out roughly about a month or two ago that looked at the economic stimulus

proposals that are currently floating around Capitol Hill?

Mr. GREENSPAN. I’m aware of it, but I must say to you, Congressman, I did not look at it in detail.

Mr. CAPUANO. Fair enough.

Mr. GREENSPAN. I’m familiar with the general procedures.

Mr. CAPUANO. OK. At some point, since you’re not familiar, in

general their conclusions were that the proposals currently floating

around will not sufficiently or accurately stimulate the economy in

a short-term basis. I would appreciate it if you and your staff could

review that report and comment on it to see if you would agree

with their conclusions or not, if that’s an appropriate request to

make of you.

Mr. GREENSPAN. Well, what I’d like to point out, however, is remember that the agreed procedures in which they make those evaluations are what economists call a static model in which feedback

effects are not counted. Everybody who works in this field knows

that that’s a very major shortcoming of this procedure. But, because there’s such dissent as to what to do with respect to the

feedbacks, there’s sort of a fallback position that we all agree, at

least that’s the first approximation.

So I think you have to be a little careful about making judgments

as to what the economic effects of particular proposals are with a

static model. We’ll be glad to take a look at that and respond to

it, obviously, but I just wanted to clarify that the ability of those

models to forecast even in a dynamic sense has not been impressive. And therefore, their ability to project the economic consequences of a program are somewhat marginal.

Mr. CAPUANO. I understand that, and I respect their limitations,

but that’s why I’m asking you to take a look at it so we can have

somebody else with a different view take a look at it.

I guess the thing I always ask you when you come by relates to

productivity and a little bit on unemployment. I’d like to start with

the unemployment rate. The numbers in the report, not your statement, but the report that accompanies it, cites a 5.6 percent rate

in January. Do you know whether that report—I had read earlier

that that number did not include 900,000 unemployed people who

had been taken off the rolls because they had stopped seeking employment. Is that an accurate belief or an inaccurate belief?

Mr. GREENSPAN. Well, it is certainly the case that the unemployment rate is measured by the number of people who are seeking

jobs in a certain actively defined way and that the ratio of those

who are employed plus unemployed by that definition is the labor

force. And the unemployment rate is the ratio of the unemployment

to the total.

To the extent that people withdraw from the labor force—either

go back to school or are discouraged workers or have any of a number of reasons not to be seeking a job, according to the definition—

they do not appear in the unemployment data.

Mr. CAPUANO. The reason that it concerns me obviously is

900,000 is a big number and any number in addition to that is a

big number. But also as the unemployment rate, whatever level it

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is, once it levels off, those people, many of them will try to get back

into the workforce, therefore extending the length of time that the

unemployment rate is high. That’s why I wanted to get a clarification.

Mr. GREENSPAN. Let me just say one quick question about the

900,000. That’s a sample statistic, and my suspicion is that it’s exaggerated, because we only have a 50, 60 thousand sample of

households. But the issue you’re raising is a valid one.

Mr. CAPUANO. And I guess I’m going to make a comment that

I’ve made to several members of the Administration. That when I

read unemployment rates, I hate reading percentages alone, and I

would ask that in the future as you talk about them, you talk

about absolute numbers. Even a 5.6 percent unemployment rate is

8.1 million Americans, which is larger than the workforce, the total

workforce of all but three States, which is larger than the combined

workforce of 16 States. It’s a huge number of individuals, and I just

think that out of respect to them and to get a real handle on what

a percentage really means, that absolute numbers should be at

least in a footnote someplace.

Mr. GREENSPAN. They actually are reported in some detail in the

reports themselves.

Mr. CAPUANO. OK. I didn’t see them here.

Chairman OXLEY. The gentleman’s time has expired.

Mr. CAPUANO. Thank you, Mr. Chairman.

Chairman OXLEY. The gentlelady from California, Ms. Lee.

Ms. LEE. Thank you, Mr. Chairman.

Good to see you. Let me ask you a couple of things about CRA

ratings. but first let me just preface this by saying that we all on

both sides of the aisle agree that home ownership is key to the accumulation of wealth, to acquiring equity so that working men and

women, working families, minorities, can send their children to college, can start a small business. Equity in one’s home is really the

primary way that the majority of Americans ever see any wealth

in terms of accumulation.

One of the areas which many of us have been concerned about

is the disparity in home ownership in the minority community. I

believe nationally it’s about 47 percent, as compared to white home

ownership at about 72 percent. So we’ve been in touch with you

with regard to the lending practices of some of the banks in California which have received very outstanding or highly satisfactory

CRA ratings yet have a very poor record or minority lending.

Let me just give you an example of what I’m talking about.

Citibank, for example, less than 2 percent of its California conventional home loans were made to African Americans, also for

Latinos. Yet it received an outstanding on the lending test. Bank

United made less than 1 percent of their homeowner loans to African Americans but also received an outstanding in terms of their

CRA ratings. Chase Manhattan received a high satisfactory CRA

rating, and I could go on and on. And I thank you for providing

the basic raw data for us to compile this analysis which was actually put together by the Greenlining Institute.

So what I’m asking you today, Mr. Chairman, is how do you reconcile these great CRA ratings with the poor lending practices of

these institutions and what do you think we can do about it? I acVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
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tually wrote to you February 20th and made some suggestions in

terms of follow-meeting and to really begin to sort this through.

But I’d like to get your take on this.

Mr. GREENSPAN. Let me just say, I just signed off on a response

to you and you’ll probably be getting it this afternoon. Let me just

say briefly that there are a number of issues that we take into consideration by law on CRA rating. More generally, it’s got to do with

making certain that the individual institution have appropriate

credit availability for the total community and that there are a

number of other issues involved other than mortgage loans.

Second, as I think we may have discussed with you at another

time, it’s important in looking at the issue of mortgage extensions

to look not only at the bank itself but its subsidiaries, because

many banking organizations do a goodly part of their mortgage

lending through subsidiaries rather than through the bank itself.

And these numbers which you are citing refer to as I recall conventional mortgages only. And you’ll find that FHA and VA, which is

a fairly significant amount of the lending, show very significantly

different figures from the ones that you cited.

Now I don’t know what those data will show, because we have

not compiled them. But I do suggest to you that before you reach

conclusions on this issue that it’s probably worthwhile to look at it

in the broader sense. There are a number of other technical issues

which are involved in our CRA ratings which I try to outline in the

letter we’re sending up to you and I hope it’s a satisfactory response. If not, come back and I’ll try to respond again.

Ms. LEE. Thank you, Mr. Chairman. I appreciate that. And let

me just, while I still have a couple of seconds left, I would like to

just ask you with regard to the issue of housing production as a

viable economic stimulus initiative or plan. Housing production creates jobs. Yet we haven’t been able to find the resources to establish a massive affordable housing production strategy.

I’ve introduced a bill with my colleague Congressman Sanders to call for a $15 billion Federal investment in affordable housing production. How do you see this right now in terms of the recession?

And does a housing production program make sense in terms of job

creation?

Mr. GREENSPAN. Well, Congresswoman, as I mentioned previously, residential building has been holding up remarkably well

through this period of contraction. And by all historical standards,

it’s reasonably high at this stage. And as you know, even though

you point out the differentials between minority and non-minority

home ownership, both are rising significantly.

You may recall when I was in San Francisco I think I quoted a

number of those statistics, and the rise in minority home ownership, the black and Hispanic, is really quite impressive. I mean, I

grant you it’s still not where I would like to see it. I think that the

more people who own homes, the greater their interest in the community in which they function and the more effective they are as

citizens. So that’s clearly a desire over and beyond the economics

that are involved.

But so far as home residential construction is concerned, it’s

doing reasonably well. And you have to ask yourself in allocating

funds as to whether, in fact, that’s the most appropriate and effecVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
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tive use of the funds you’re referring to rather than some other priority, and that’s a judgment that the Congress has to make.

Ms. LEE. Thank you very much.

Mr. GREENSPAN. You’re welcome.

Chairman OXLEY. The gentlelady’s time has expired.

The gentlelady from Illinois, Ms. Schakowsky.

Ms. SCHAKOWSKY. Thank you Mr. Chairman.

And Chairman Greenspan, I appreciate your spending so much

time with us this morning and that I have the opportunity to ask

a few questions. I’m going to ask them all, and if you have time

to respond to all of them, fine. Maybe otherwise in writing later,

I hope you will.

Last year, you stated some support for a large tax cut, and that

support I think was based at least in part about some concerns

that you had about too quickly paying down the public debt. I’m

assuming that those concerns have changed somewhat, and I wanted to ask you if you have a different view on the wisdom of those

large tax cuts, particularly those that go to the very wealthiest of

Americans.

Second, on the economic stimulus package, the one that passed

the House and others that have been recommended by the leadership emphasize major tax cuts it seems to me over investment.

That is, speeding up the tax cuts that were passed, giving new

ones, largely to corporations, some to very profitable corporations.

The one that passed the House would have given a rebate of $254

million to Enron. I wondered if you had comments on the thrust

of the economic stimulus package, the one that passed and the ones

that are being considered in the House.

Third, on the issue of predatory lending, which has been very

dear to my heart, I know that the Fed and other regulators have

suggested that Congress should act. We haven’t acted yet in any

way. I’m wondering if you feel that we still should take some steps

to deal with that problem.

And finally, I can’t stay away from Enron too far. Your Board of

Governors disclosed that Ken Lay at some point last October during a period when the company was looking for some help from

senior Government officials did make a call to you. I was wondering what he said in that call and what your response was.

Those are my questions.

Mr. GREENSPAN. First of all, the issue that I was concerned

about a year ago reflected the notion that if you believe the CBO

data that we would create far too rapid a decline in the debt outstanding which would require an accumulation of assets by the

Federal Government which I thought was very bad policy.

In the event taxes were cut, spending was increased and that

problem was, if you want to put it that way, taken care of. So I

no longer have that problem. But it was the tax cuts and the

spending increases which obviously obviated further action. So, yes,

it is no longer a concern of mine.

Second, on the economic stimulus proposals, as I said previously,

it’ really comes down to a judgment as to whether you think that

the emerging stabilization that has now occurred after the significant weakness in the economy is a prelude to a self-adjusting recovery after the rate of inventory liquidation dissipates. If you beVerDate 11-MAY-2000 10:43 Jul 26, 2002 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 C:\DOCS\78399.TXT HBANK1 PsN: HBANK1
45

lieve that there is not enough potential final demand, then one

could argue for some form of stimulus program. I’ve argued that

it’s probably not necessary. The economy is very likely to recover

without it. And that would be my judgment. But it is a credible argument to stay that stimulus might be helpful in this particular

context.

Ms. SCHAKOWSKY. And the stimulus being, as I said, heavily

weighted toward tax cuts rather than investment?

Mr. GREENSPAN. I’m sorry. Tax cuts instead of investment?

Ms. SCHAKOWSKY. Instead of, for example, housing, school construction, and so forth.

Mr. GREENSPAN. That’s a judgment that the Congress has got to

make. I’m not certain that, without getting into the full detail you

can very easily determine——

Ms. SCHAKOWSKY. Well, I guess the question is, though, whether

or not you believe that tax cuts, speeding up the current tax cuts

or giving more corporate tax cuts is viable as an economic stimulus.

Mr. GREENSPAN. If you’re asking me would it stimulate the economy, the answer is probably yes.

On the issue of predatory lending, as you know, we have just recently come out with a ruling related to that and the Congress has

it under consideration, and it’s a disputable issue. Because there’s

sort of a fairly strong argument that subprime lending as a general

issue is not a bad thing under certain conditions. When carried to

what we call predatory levels, it is. And a lot of people have difficulty differentiating what is and is not predatory in the subprime

categories. And I think that’s one of the reasons why it’s getting

difficult to come to conclusions on this issue.

Chairman OXLEY. The gentlelady’s time has expired.

The gentleman from Tennessee.

Mr. GREENSPAN. I’ll answer the others for you.

Mr. FORD. Thank you, Mr. Chairman, Mr. Oxley and Chairman

Greenspan. In fairness to my good friend Ms. Schakowsky, what

you may call ‘‘spending’’ we call ‘‘investment’’ up here, so I think

that’s what she might have been referring to, Mr. Chairman.

I have two quick questions. Last year before the Committee, at

least one of your trips to the Committee, you advocated the idea

of a trigger mechanism where tax cuts would be delayed if the fiscal situation worsened, obviously meaning if our projections or expectations of revenues did not meet the grandiose projections made

by some of my colleagues.

In your testimony last year, I think you specifically said you supported a trigger mechanism largely because of the uncertainties

that one has with respect to 10-year budget forecast are very high.

Two parts to the question. In retrospect, with the dramatic reduction or deterioration of projected revenues that we’ve experienced,

do you think a trigger mechanism would have been helpful? And

two, there’s been considerable talk here from some of my colleagues

on the other side of the Hill in the Senate and here regarding efforts to revisit the tax cut and that parts of the tax cut and even

to revoke parts of it that have not gone into effect yet.

President Bush has eloquently and forcefully suggested that he

would not support such an idea and has even equated a revisiting

the tax cut with actually raising taxes. I’d be curious to get your

46

thoughts on both strands of that question, Mr. Chairman. And I,

too, am glad you didn’t decide to retire once you reached the eligible age.

Mr. GREENSPAN. Thank you. First of all the trigger I was referring to was a trigger on both taxes and spending initiatives. And

the reason for that is that the Federal budgetary process which 15,

20, 30 years ago never really got beyond 1 or 2 years out, largely

because the vast proportion of it was discretionary and the Congress could very readily reverse or sunset any type of program it

wanted with ease. That’s increasingly less credible as the greater

proportion of spending outlays become what we used to call

uncontrollables, entitlement programs of some form or another.

Under those conditions, you have no choice but to make longterm forecasts, because even if you don’t make a forecast, there is

an implicit forecast in the actions you’re taking in the Congress. So

it’s better to have a bad forecast than none at all. But those forecasts, as you point out, are bad. And hence, it’s far superior to have

some form of mechanism which recognizes the fact that if they are

really very far off that the actions which were promulgated on

them will not take place. So I still believe that that process should

still exist.

I have no particular comments on the issue of what one would

do or not do about existing programs. But the point that the President is making with respect of changing the existing tax structure

now, say, reversing, implying some form of tax increase is correct

in the sense that there are some parts of the economy where people

are making judgments about the future, making current investments about which are go-no go investments, depending on what

the presumed tax structure is in the future.

So if you change rates, if, for example, you had a tax cut pending

and you go back to neutral, that effectively creates an effective tax

increase for somebody who is making an investment.

Mr. FORD. I understand that. But I guess obviously a lot of

things have changed since we passed that tax cut, and as you indicated, the fiscal situation irrespective of what occurred on September 11th has changed things dramatically. And I would imagine

as you chair a Board that has consistently lowered short-term rates

for a period of time, you are in the business of adjusting. So as

much as I appreciate your point, I’m a little confused by it.

I know my time is running and I’d love to maybe get a longer

answer from you, Mr. Chairman, on that. But the last time you

were before the Committee I raised it, the last time I had an opportunity to address some of my thoughts to you before the Committee, my State of Tennessee, where I’m from, and other States

were experiencing enormous budget shortfalls, and we see now that

many other States are faced with the same crisis. The National

Governors Association met last week here. I don’t know if you had

an opportunity to address them. I know some of my colleagues and

Members of the Administration had that opportunity.

One of the things that they declared, Mr. Chairman, was that

the current, quoting, the current fiscal crisis for States compounded

by unsustainable growth in the Medicaid program is creating a situation in which States are faced with either making massive cuts

in programs or being forced to raise taxes significantly.

47

My question last time dealt with I couldn’t understand for the

life of me how you could reconcile the idea of growing exploding

surplus projections with the reality of States facing budget shortfalls. And I guess my question is, as those of us at the Federal level

try to boost the economy, and you tried to address some of these

questions here, while maintaining some fiscal discipline, what will

be the effect of the budget problems off the 50 States and will any

drastic spending cuts or even tax increases at the State level offset

our efforts here at the Federal level? And for that matter, offset the

Herculean efforts that your organization has engaged in over the

last year.

Mr. GREENSPAN. Well, as I think I may have answered last year,

one of the reasons why we had this extraordinary Federal surplus

and difficulties in the State areas is that there were a significant

amount of tax cuts that occurred within the States to essentially

remove considerable surpluses that were emerging. And so when

the situation turned around, you would expect, as indeed has happened, States are in far greater difficulty than even the Federal

budget system is.

But as you point out, Congressman, from the point of view of

looking at the economy overall, you consolidate the Federal and the

State and local systems so that clearly cuts in spending in State

and local authority or an increase in taxes has the same effect essentially as that which would occur at the Federal level.

Mr. FORD. Mr. Chairman, I know my time is up, but just one last

point. You mentioned how there may be those who are depending

on the tax cut that was passed and the idea that tax cuts will kick

in. I just can’t imagine that too many of my friends, at least the

ones I’ve spoken to, and I don’t know a lot of friends with big estates, but the or two I do know, they’ve indicated they’ve not made

any dramatic changes in their estate planning as a result of what

we passed last year. So as much as I appreciate that comment, I

can’t imagine——

Mr. GREENSPAN. I wasn’t referring to the estate taxes. I was referring to individual income taxes.

Mr. FORD. Right, fair enough. Fair enough. Thank you for letting

me go over my time. Thank you, Mr. Chairman.

Chairman OXLEY. The gentleman’s time has expired.

The gentleman from Texas, Mr. Hinojosa.

Mr. HINOJOSA. Thank you, Mr. Chairman.

Chairman Greenspan, could you give us an idea of how the decline in long-term rate would impact the household incomes and

possibly what effect it would have on individuals like the one you

were just talking about in making decisions to make investments,

whether they be in their investment portfolio of securities or businessmen wanting to invest in say equipment and machinery in

their factories?

Mr. GREENSPAN. Congressman, in our type of economy, long-term

interest rates play a fairly significant role. Most of us deal with it

wholly from the mortgage market only and that clearly what the

interest rate is on these 30-year fixed rate mortgages has a fairly

significant impact on what your monthly payment is and does, has

a major effect on how one behaves.

48

They are also relevant where you are involved in investing in

plant and equipment, as you point out, because to the extent that

you’re borrowing money over the long run, that has very major effect on the potential profitability of that investment and clearly,

lower interest rates imply that the profitability under any existing

state of technology will be higher for corporations who borrow

money to finance it.

So it’s generally a very important element within the economy.

And one of the reasons why we are so focused on keeping inflation

expectations down is inflation expectations are a critical factor in

the determination of long-term interest rates. And if inflation expectations go up, it tends to inhibit a lot of economic activity in this

country.

Chairman OXLEY. The gentleman’s time has expired.

The gentlelady from Indiana, the very patient lady, is now recognized.

Ms. CARSON. Thank you very much, Mr. Chairman.

And thank you very much, Mr. Chairman, for your patience. I’m

going to ask you this question because you are perceived—and correctly so—to know everything, and that is a compliment. It is not

a put-down at all, and we appreciate very much that you’re here

today.

Indiana has a spiraling rate of foreclosures, housing, home foreclosures among its citizens. Could you tell me why that is?

Mr. GREENSPAN. Well, I think the foreclosure rate generally, and

more importantly, the bankruptcy rate for individuals has been

going up recently, in large part because the economy is weak, the

unemployment rate has gone up and there’s been obviously specific

difficulties. I don’t know the situation specifically in Indiana, but

there’s no reason to believe that that is dramatically different.

I should say that the foreclosure rate, while it is up, is not up

a great deal as I recall at the national level, and it varies by

whether it’s FHA, VA, conventional. And as a consequence of that,

it’s very hard to generalize. But the basic reason is that the economy has been weak.

Ms. CARSON. Do you see, Mr. Chairman, one quick other question, any reversal of that trend, given all of these people that are

going to be propelled into homelessness, if you will? These are

homeowners. People that were taxpayers. People that were longtime employees and now they’re losing their place of abode. Do you

see any reversal of the trends that has precipitated that chronic

situation among so many people?

Mr. GREENSPAN. I think so, Congresswoman. The evidence that

we’re seeing nationwide is that we seem to have stabilized. A lot

of the weakness that we saw earlier seems to be dissipating. And

while I’ve argued that it’s too soon to say that we’re on our way

back and moving at a reasonable pace, nonetheless, there are signs

that those types of improvements are taking place. And if they do,

that will be by far the most effective program to address the particular concerns that you have in that regard.

Ms. CARSON. How are they beginning to reverse? And I don’t

want to hold you. But what signs do you see related to what?

Mr. GREENSPAN. Well, what we see, for example, is that the gross

domestic product, which was negative during the third quarter and

49

appeared to be going into the fourth quarter as a significant negative, at the end turned out to be a small positive. And for the first

quarter, the numbers do at this moment appear to be positive as

well. So we are beginning to see the forces which engendered the

rise of unemployment starting to simmer down, and while we’re not

to the point where I think you can essentially say that we’re over

the hump with respect to unemployment, we’re approaching it.

Chairman OXLEY. The gentlelady yields back. The Chair now recognizes the gentleman from New York, Mr. LaFalce.

Mr. LAFALCE. Chairman Greenspan, in my introductory remarks

I asked some largely global questions which we didn’t have an opportunity to get into. Now I’d like to get into some more local and

specific questions.

You and I, I’m sure, are equally concerned about unfair and deceptive practices within the field of financial services. It’s my understanding that some 25 years or so ago, a law was passed that

delegated responsibility to the Federal Reserve Board to promulgate regulations articulating what an unfair and deceptive practice

is. Correct me if I’ve been misinformed. But it’s my understanding

that we haven’t seen regulations in the past 25 years from the Federal Reserve Board.

I’ve also been advised that the Comptroller of the Currency recently brought a lawsuit saying that we could operate under the

aegis of the law itself absent regulations, and that was challenged

in the courts by the financial institutions. The initial lower court

holding was that indeed the Comptroller was correct. I don’t know

the status of that case on appeal. But could either you or Mr. Mattingly advise me as to what the status of that is?

Mr. GREENSPAN. I would say you would be much better advised

by Mr. Mattingly.

[Laughter.]

Mr. LAFALCE. Virgil?

Chairman OXLEY. Would the gentleman identify himself for the

record, please?

Mr. MATTINGLY. Virgil Mattingly. I’m the General Counsel of the

Federal Reserve.

Chairman OXLEY. Thank you.

Mr. MATTINGLY. The Comptroller has taken that position, the

one you articulated in several cases, and so far, my understanding

is he’s been upheld on that.

Mr. LAFALCE. OK. But can we go to the first issue, Virgil? And

that’s what’s taken 25 years to articulate those regs?

Mr. MATTINGLY. The Board wasn’t required to issue regs. It was

given the authority to identify practices for banks that would be

unfair and deceptive. And I think the Board has done that my

recollection is once, only once.

Mr. LAFALCE. Only once in 25 years. But it’s also my understanding that there’s an expectation that the Federal Reserve will

promulgate regulations. As a matter of fact, that was the gravamen

of the argument that was used against the Comptroller, and the

Comptroller—nobody seems to dispute that. I mean, 25 years and

one example. It seems to me you could be a bit more aggressive.

[Laughter.]

50

Mr. MATTINGLY. Well, that may be so. But as you are well aware,

during that 25 years, Congress itself has passed a lot of laws that

have applied to banks.

Mr. LAFALCE. But the unfair and deceptive practices have not

been dealt with adequately. You need to become much more aggressive on this. And I would like to have a meeting with Chairman

Greenspan and you and the other member of the Federal Reserve

Board who is responsible for this issue in order to discuss the possibility of a much more aggressive Federal Reserve Board on this

issue.

Mr. MATTINGLY. Certainly.

Mr. LAFALCE. Thank you.

Chairman OXLEY. The gentleman yields back. Let me if I can,

Mr. Chairman, use the prerogative of the Chair to ask a few questions as we wrap up here. And you’ve been very gracious with your

time and we most appreciate it.

Recently, Secretary of the Treasury O’Neill suggested that CEOs

of public companies be required to personally certify financial

statements and such CEOs be held personally liable for such certifications, thereby avoiding or not having the protection of insurance. Do you have any opinion on that proposal?

Mr. GREENSPAN. The general proposal is to switch the onus of decisionmaking with respect to a whole series of corporate governance

questions which we’ve been discussing today to the CEO. I fully

support that. I think having served on many boards, indeed, Paul

O’Neill and I served on the Alcoa Board together, there’s no question in my mind that unless you get the CEO effectively saying not

we have met every GAAP requirement and therefore we have no

liability further that he has to be able to say that irrespective of

any particular GAAP regulation the accounts which we have appropriately certify what this company is all about.

Now the question, getting down to the issue of penalties to induce the CEO to make sure that that is done, gets to the question

in his mind on the degree of D&O insurance, director and officer

liability insurance. And that there’s no doubt in my mind that

there’s no doubt in my mind that if you created some inability to

get fully liability insurance under certain circumstances, it might

be helpful. Although the law as I understand it now stipulates that

deceptive certifications do not cover you under a particular insurance requirement.

My general view is I think that Secretary O’Neill is definitely

going in the right direction on this. There is a question that has

arisen with respect to if you construct an issue of increased liability

on the part of the CEO that you will engender a huge new flood

of lawsuits which clearly will not be to the interests of either the

company, the country and I do suspect it’s something we ought to

try to avoid. So there are possibilities of doing what the Secretary

wants to do, but to delimit the way in which the individual CEO’s

liability is adjudicated.

Chairman OXLEY. Along those lines, some folks have suggested

that corporate governance issues should be dealt with at the Federal level as opposed to the traditional State level. Do you have any

comments in that regard?

51

Mr. GREENSPAN. I really don’t. I’m aware of the arguments. I

don’t feel myself sufficiently in control of the facts to make a judgment at this stage.

Chairman OXLEY. That hasn’t deterred others from making those

same suggestions.

[Laughter.]

Chairman OXLEY. But I’ll pass on that. Let me ask you a couple

of questions on derivatives since they have been mentioned a number of times in several different areas. In the year 2000, Congress

passed the Commodity Futures Modernization Act which exempted

or excluded many types of derivatives transactions from the Commodity Exchange Act. Some have recently questioned this decision

certainly in the wake of Enron. Is this still sound policy or is it in

need of discussion?

Mr. GREENSPAN. I think not, Mr. Chairman. I think that the legislation that you passed in the year 2000 strikes me as appropriate

and still valid.

Chairman OXLEY. And why would you say that in light of a great

deal of criticism that has come from a number of quarters that at

least part of the reason for the Enron collapse was this, quote, ‘‘deregulatory move’’ by the Congress in 2000?

Mr. GREENSPAN. That’s not impression of what happened. I

mean, what I sense happened is that they ran into losses which

they basically endeavored to obscure. And there’s nothing that they

did which just could not have been done in 20 different ways, had

nothing to do with derivatives except that derivatives happened to

be one of the vehicles that were involved, but the issue that I’m

aware of had nothing to do with the legislation that you passed in

the year 2000.

There is a question as to whether the specific issue of exempting

over-the-counter energy derivatives from the Commodity Exchange

Act. And the argument there is that somehow that Enron was not

controlled and it should have been. But what that issue is is in the

law that regulation of transactions between professionals is wholly

inappropriate in that specific regard. And I see nothing that’s

changed from the discussions we all had when that particular Act

was under review.

Chairman OXLEY. Mr. Chairman, some would say that in the

case of Enron that the Enron collapse really began when the price

of commodities, particularly oil and gas, declined. And as a matter

of fact, you can look at some rather startling charts that indicate

that Enron’s stock went up almost equally with the commodity

prices and then plunged at the same rate. Is that a valid trigger

for the Enron collapse, or is there some other theory out there

that’s just as credible?

Mr. GREENSPAN. Well, as far as I can see, there are two issues

involved. One is the underlying earning power that Enron engendered. And I would presume that since they were very heavily in

the issue of energy that the higher the price at any fixed margin,

the higher would be their earnings. But I think the evidence will

probably show when we finally know what all of the evidence is

that the triggering point had nothing whatever to do with that. It

had to do with the loss of I guess I would call it reputation capital.

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That is, as I indicated earlier on, Enron is a classic case of a company whose market value is very significantly dependent on the

reputation of the firm. And when it became apparent that the data

that they were putting forth as representing their earnings figures

were indeed false and had to be recalculated, they lost a very large

part of their reputational value and indeed, it was that that ultimately did them in. Had they, for example, recognized the losses

that they actually had in these affiliates early on, I have no doubt

it would have hit their stock some, but it would have had a negligible impact relative to what actually happened.

It was a very expensive business mistake which they made. I do

not think that had they a correct set of accounts that they’d still

be in business. Their stock price would be lower. Their stock price

would be lower because basically, energy prices are lower, and

their margins presumably wouldn’t have changed, so their earnings

would have been less viable. But they would not be in Chapter 11.

Chairman OXLEY. One of the former officers stated publicly that

he thought that the Enron situation was a classic run on the bank

and that seems to be what you are referring to. However, I guess

there are some differences as to what triggered that run on the

bank. Your estimation is that it was this reputational capital that

was depleted rapidly, which goes to the whole question of public

confidence and the like in the system.

Mr. GREENSPAN. As I said in my prepared remarks, Mr. Chairman, a company whose assets are substantially physical, real, and

I used the example of an automobile assembly plant, could conceivably have the reputation of its management sullied considerably or

come under a cloud and yet the company would still have sufficient

physical assets to engender incomes which would give it a considerable capital value. But that was not the case of Enron. Their actual

real assets—pipelines and various energy-related assets—were a

relatively small part of the market value of the firm.

Chairman OXLEY. And finally, I couldn’t let this pass by, and

that is a question on netting. You and I have had these discussions

numerous times. And as you know, the netting provisions are currently in the bankruptcy bill that’s in the Conference Committee.

Mr. LaFalce and I are both conferees, and as you know, Mr.

Toomey of our Committee has introduced legislation also in that regard. I know you haven’t changed your mind on this, but I’m wondering if you could help us and help the listening public understand the importance of enacting netting legislation this year.

Mr. GREENSPAN. Mr. Chairman, as I indicated in my prepared

remarks and later, I think that the extraordinary expansion of derivatives has been a major factor in creating an increased degree

of flexibility and resiliency in our system and that they are a very

effective tool that used for good is exceptionally effective and used

for ill can be just the same. It’s neutral with respect to that.

But, because it’s such a valuable potential tool, it’s important

that it function as efficiently as possible. The legal uncertainty that

still exists on certain types of derivatives which did not appear in

the original act which gave legal certainty to netting are a cloud

over these markets which, if we can dissipate sooner rather than

later, would be very helpful. There is no downside of which I am

aware of in passing this legislation. And as you know, it was in the

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bankruptcy legislation there solely for the purpose of trying to integrate something which I presume has fairly broad support in a bill

which had some conflicts associated with it.

So I would just merely argue that unless I am mistaken about

this issue of there being no downside, there’s an awful lot of upside

to its enactment.

Chairman OXLEY. Thank you. Let me yield to my friend from

New York.

Mr. LAFALCE. I thank the Chair for yielding. Chairman Greenspan, I couldn’t agree with you more on the issue of netting. And

I don’t think there’s a controversy about that issue but there is

great controversy about the bankruptcy bill. Now in the previous

Congress, we separated the netting bill from bankruptcy and

passed it independently.

In light of the Enron, Global Crossing and other debacles, don’t

you think it is advisable to separate the netting bill from the banking conference, pass it separately in the House and separately in

the Senate and send it to the President for his signature as soon

as possible?

Mr. GREENSPAN. I would agree completely with your remarks,

Congressman.

Mr. LAFALCE. Thank you.

Chairman OXLEY. Mr. Chairman, we appreciate your appearance

here today. And as always, most enjoyable. And your knowledge is

exceeded only by your patience and good will. And we look forward

to seeing you in July.

The hearing now stands adjourned.

[Whereupon, at 1:50 p.m. the hearing was adjourned.]

(55)

A P P E N D I X

February 27, 2002

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