- The Washington Times - Thursday, February 28, 2002

Federal Reserve Chairman Alan Greenspan said yesterday that the economy is stabilizing and probably is at the beginning of a modest recovery from one of the mildest recessions in history.
"We believe the recovery is just beginning to get under way," he told the House Financial Services Committee. But he added that significant obstacles continue to hold back the economy, including rising unemployment, high consumer debt loads, a deep recession in Japan and drooping corporate profits and investment.
"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" because consumer spending on cars, houses and other items stayed strong throughout the recession, he said.
As an example, Mr. Greenspan pointed to the record rate of existing home sales posted in January, which while "impressive," was "unsustainable" in part because consumers are servicing record levels of debt. Yesterday's report showing a 14.8 percent drop in new home sales in the same month showed the trouble consumers are having sustaining such high levels of housing performance, he said.
Low interest rates, inflation and energy prices should continue to bolster consumers, he said, but their incomes may be held back by rising unemployment, which the Fed said should crest at close to 6.25 percent this year before turning down again.
The loss of wealth in the stock market also will continue to dampen consumer spending, although Mr. Greenspan noted that the effect of stock losses as well as high debt levels has been concentrated mostly in high-income groups. The wealth of middle-class consumers is concentrated more in their homes than in stocks, and home values have increased smartly throughout the recession.
The recession has been so mild partly because of rising home wealth and consumers' increased ability to tap into that wealth through cash-out refinancings and home-equity loans. But because of the headwinds consumers continue to face, their spending must be supplemented by a revival of business investment spending, which was devastated during the recession, for the recovery to be sustained, Mr. Greenspan said.
The Fed chairman cited hopeful signs that business spending on technology is picking up, but said he expects a gradual recovery this year. A report out yesterday showing a 2.6 percent jump in orders for durable goods at factories including high-tech machinery, aircraft and other hard-hit areas was a promising development, he said.
"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," he said.
"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." The Fed projects growth will return gradually to a 2.5 percent to 3 percent pace this year.
In a controversial move, Mr. Greenspan argued against major regulations to prevent Enron-like debacles in the future. He said the changes in corporate accounting and management already sparked by the scandal have gone a long way toward correcting the problems exposed by Enron, and overall are "positive" for the economy.
"There is a significant shift toward corporations trying to be more transparent" and present their earnings "without spin," he said. "We will look back at this Enron episode as a period when we put our corporate governance back on track. …That is favorable to the economic outlook."
Mr. Greenspan is a member of a presidential commission charged with coming up with recommendations in the wake of Enron. He said that heavy new restrictions on derivatives trading, energy and securities markets would be ill-advised because those relatively open, deregulated markets play an important role in propelling economic growth and maintaining stability. They are one reason behind the resilience of the economy during the recession, he said.
Enron, like other "new economy" firms, traded in concepts rather than products. That trend fosters stability in the economy because it is not possible to overstock concepts as it is to overstock products and create an inventory bulge like the one that helped plunge the economy into recession last year, he said.
But he conceded that the trend toward selling concepts rather than projects poses some "vulnerabilities" for the economy. "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. … Trust and reputation can vanish overnight. A factory cannot."
Mr. Greenspan said he was encouraged that the energy and derivatives markets showed little reaction to Enron's collapse in the fall, suggesting that they are broad and resilient enough to weather such major failures. The "contagion" effect that Enron's problems have had on other energy firms and corporations who use similar accounting practices shows a new risk for the economy, however, he said.
In one area, Mr. Greenspan advised radical action: removing the exemption that enables corporations to avoid deducting the cost of stock options issued to compensate executives from income statements. During the 1990s, he said, 3 percent of the average gain in earnings was due to the illusion of higher income created by this exemption. Some analysts say that removing it could deflate stock prices as much as 20 percent.
Mr. Greenspan said the change is needed to better align the interests of chief executives with the long-term interests of stockholders. The stock options have acted as a powerful incentive for executives to "game the accounting system to generate short-term earnings" and then profit from the resulting jump in stock price to cash in their options..


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