What do you think Mr. Greenspan?

Yesterday, Federal Reserve Chairman Alan Greenspan appeared before the House Financial Services Committee.  His prepared remarks were identical to those he gave the Senate Finance Committee the day before, but his responses to members’ questions were particularly candid and enlightening.  Here are some of the highlights of his remarks on topics that most directly affect long-term investors.

On theU.S.Economy:

According to Mr. Greenspan, “theU.S.economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well anchored.”  The evidence broadly supports the view that economic fundamentals have steadied.”  He sent stock and bond prices down though when he said that, adjusted for inflation, the 2.5% federal funds rate remains “fairly low” implying more rate hikes were on the way and that the “measured” term used to describe future rate changes was not going to be used in “perpetuity.”  Rate increases will likely continue and may at times be higher than the .25% of recent months.

On the Global Economy:

“I think that one of the key aspects of the American economy is its increasing integration into a global system.  Barriers to cross-border trade are coming down all over the place.  The issue of communications has shrunk the distance that’s involved.  I should say communication plus transportation has shrunk the distance between peoples around the globe.  And what we’re finding is, in the same context [of say] 150 years ago, we gradually went from local markets to national markets [and now we are going] from national markets now to global markets.  And we are exceptionally competitive in that regard in the sense that of all the industrial nations in the world, few have gained from globalization as much as we.  We have an exceptionally flexible economic system” due to “bipartisan deregulation since the 1970s of a whole series of different industries.  The information technology has created an incredible capability to develop new financial instruments and to develop basically the types of things which enable a system to adjust around the world.  And I think the major focus that we have to maintain is to keep that degree of resilience and flexibility, which means eschew issues of protectionism, regulation and anything which rigidifies the market’s adjustments process which has served us so well in the last decade or so.

On Taxes:

When asked if he supported making permanent all of the taxes that have been cut thus far Greenspan responded; “I can’t say all of them.  I still support the partial elimination of the double taxation of dividends, but I do it in the context of a full PAYGO system, which I trust the Congress will initiate.”  He went on the say that he viewed the dividend tax cuts were important to economic growth, but that the “overriding consideration is to make certain that our deficits don’t run away because that will destabilize the whole system.”

Greenspan says he’s willing to consider tax increases after all.  He usually stresses a preference for spending cuts.  His willingness to consider them indicates a growing uneasiness with President George Bush’s fiscal policies, according to Barry Bosworth of the Brookings Institute.  “You’re going to have to increase taxes or reduce spending somewhere if we’re going to keep the deficit under control,” Greenspan said.  He said that he would support making the 10-year tax cuts enacted during Bush’s first term permanent on a “pay-go” basis, which requires Congress to offset spending increases or tax cuts with new revenues.  Back in 2001 Greenspan likely gave momentum to the Bush tax cuts when he said “it is far better” that “surpluses be lowered by tax reductions than by spending increases.”  He said yesterday that those reductions helped lift the economy out of the recession that began in March 2001 and ended in November of that year.  He didn’t say the economy now needed a similar boost.

On Personal Retirement Accounts:

Mr. Greenspan said he was in “complete agreement with the president” and an “important part of the answer is personal accounts.”  “From its creation, Social Security was never envisioned as the sole answer to an individual’s retirement needs, but as a supplement.  However, now, two-thirds of its recipients rely on Social Security for at least half or more of their retirement income.  That isn’t good for them, and it isn’t good for the country, in my view.”

On U.S. Savings

“What we really have to do is to get people to consume less of their income. That’s what savings is.  My suspicion is that the 1% savings rate, which is what we have been at for the last year, is probably going to be a low point and we will start to rise from here.  But that’s been my expectation for a number of years and I can’t honestly wish to guarantee it because it is a tricky issue to forecast.”

Overseas buying of U.S. Treasury Securities:

“We concluded that the effect of foreign borrowing of U.S. Treasury instruments has lowered long-term interest rates a modest amount. Therefore, if they were to choose to stop buying or sell, it would raise interest rates, but again, by a modest amount.”

On Housing Prices:

I think we’re running into certain problems in certain localized areas.  We do have characteristics of bubbles in certain areas but not, as best I can judge, nationwide.  And I don’t expect that we will run into anything resembling a collapsing bubble.  I do believe that it is conceivable that we will get some reduction in overall prices, as we’ve had in the past, but that is not a particular problem.”


On Fannie Mae and Freddie Mac:

Greenspan called on Congress to curtail the growth of Fannie Mae and Freddie Mac which have a combined $1.55 trillion loan portfolio to avoid financial instability.  Congress, reacting to accounting errors at the two government-chartered enterprises is considering creating a tougher regulator with authority to alter capital standards and reject new lines of business.  The companies, which sell bonds and use the proceeds to buy mortgage loans from banks, have more than $1.7 trillion of debt, a level exceeding either France or the U.K. Their mortgage holdings have grown from a total of $136 billion in 1990.  The purpose of the organizations is to provide liquidity and stability to theU.S.residential mortgage market in good and bad economic times.”

All in all, Mr. Greenspan seemed pretty upbeat on the state of the economy.  As usual he focused his emphasis on issues of fiscal responsibility and restraint in the government budgeting process as well as the new issue of overhauling the Social Security System.  What seemed different than prior testimony was his rising concern of building deficits.  We will keep a close eye on how the government plans to solve this issue.