Hearing of the Senate Banking, Housing and Urban Affairs Committee - Semi-Annual Monetary Policy Report by the Federal Reserve

Federal News Service

HEADLINE: HEARING OF THE SENATE BANKING, HOUSING AND URBAN AFFAIRS COMMITTEE

SUBJECT: SEMI-ANNUAL MONETARY POLICY REPORT BY THE FEDERAL RESERVE

CHAIRED BY: SENATOR RICHARD SHELBY (R-AL)

WITNESS: ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS, THE FEDERAL RESERVE

LOCATION: 216 HART SENATE OFFICE BUILDING, WASHINGTON, D.C.

BODY:
SEN. CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman. I'd ask that my full statement be submitted for the record.

SEN. SHELBY: Without objection, so ordered.

SEN. SCHUMER: The only observation I'd make is there are two wings to sort of our economic policy here; there's fiscal policy and monetary policy. The thing you're here to report on and the thing you're in charge of, monetary policy, I think you're doing a superb job. I think the quarter-inch sort of steps that you've made is just about perfect for our situation.

But I do worry about our fiscal policy. And sometimes, as you well know-much of the time lower interest rates is better for the economy than lower taxes. And those will be the line of my questions.

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SEN. CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman.

And thank you, Mr. Chairman, as well.

You know, hearing the summary of your statement and your answers to questions, I guess if I had to summarize it, I'd say the recovery's sustainable. That sort of seems to be the tone. The disparity I think some of us face as we go around our states and our country is there doesn't seem to be a tremendous amount of confidence about that.

You can look at two measures. One, consumer confidence has been relatively flat.

You know, we have the oil prices, which you mentioned. And for the higher-income people, since we've talked a lot about it, disparities, the stock market has actually gone down since the good numbers have started going up.

And I guess the question I have, the first question I have, is why do you think that is? Does it have an effect on the economy? You mentioned terrorism in your statement. Obviously, that's something that's out there, it's hard to quantify. Do disparate incomes create that? Does the deficit help, you know, create lower confidence? And how much effect, if this lower confidence, confidence that is not as optimistic-doesn't seem that average folks, the consumer end, whether it's higher end or lower end, seem to have that kind of confidence. Businesses seem to have a little more confidence these days, but even they are saying that profitability, which was enormously high in the last few quarters, is going to decline some. Could you just talk a little bit about this phenomena, which is sort of confusing in certain ways? Particularly the stock market. I'm sort of puzzled how the stock market's gone-Dow Jones has gone down 400 points as all these numbers are good.

MR. GREENSPAN: Senator --

SEN. SCHUMER: I'm not asking you to pick any stocks, believe me. (Chuckles.)

MR. GREENSPAN: No. (Laughs.)

This is not atypical of a recovery. If you go back historically and read the records of the time, when you know that subsequently things got extraordinarily positive, people are glum. So you've got to put it in context, and the context of today's environment, for example the June figures and the soft patch we're going through, I don't recall a recovery in which there weren't several soft patches. It's the way the markets work.

There is something different here in the sense that, as you pointed out, that the level of confidence is less. And the way we know that, or the way I would suggest is a strong indication of it, is we have for the first time in a quarter-century, or more than that I think, the aggregate of capital investment and inventory investment running less than cash flow. The typical pattern is that businesses, when they are confident or expanding, they are borrowing and the economy expands way beyond-or I should say capital investment way beyond cash flow.

You look at the debt markets, corporate debt markets, and they are barely moving. In fact, I think in June the preliminary estimate is that corporate debt on balance declined; in other words, repayments were greater than new extensions because cash flow is so high. And I think the reasons for that are largely the aftermath of the terrorism, and I still think there are concerns out there. The corporate scandals have created a really serious issue of caution on the part of business who are terribly fearful of doing things which are perceived to be inappropriate, so that there is this sense of general lack of charging ahead which clearly was the case in the latter part of the 1990s.

SEN. SCHUMER: Right.

MR. GREENSPAN: And it's likely that the mere aftermath of the 1990s themselves had some effect. But it doesn't appear to be enough to hold back the gradual broadening that we perceive to be going on. Some things go down, some things go up, but the markets and the economy continues to grow.

The stock market doesn't always respond to good news positively, and in fact, in most instances where the perception is that a rising economy or a booming economy will somehow create increased interest rates in the context, where long-term or short-term profitability no longer has the upside to move as fast as it has, markets will go down under those conditions. So I would say that the weakness in the stock market is perfectly typical type of pattern that one sees over the years, and more generally, that the way this economy is behaving, with its obvious idiosyncratic characteristics, as all recoveries have, is nothing that we perceive at the Fed as particularly surprising.

SEN. SCHUMER: One more question if I might, Mr. Chairman.

SEN. SHELBY: Go ahead.

SEN. SCHUMER: Although I'd just make the comment I made at my opening statement-sometimes, maybe for the stock market and maybe for the economy, you know, lower interest rates are better than lower taxes. That's a debate on the fiscal side that we've been having here, although it effects you. And I take it you wouldn't disagree with that necessarily as long as I --

MR. GREENSPAN: I can conceive of situations in which you could be accurate.

SEN. SCHUMER: Yes. How about now? (Laughter.)

Here's my other question. (Laughs). This is a little bit off the topic, but I wanted to ask you this before. Last week we had a very interesting hearing that the chairman led on hedge funds, and it was an interesting discussion. And I, for one, haven't made up my mind on this thing. You know, I have sort of a bent that regulation, if it's not heavy-handed, has been good for the markets. People complain about it, but it works, and it's led people's view that our markets are on the level.

And the proposal made by Chairman Donaldson, who I know is your friend and whom I know you disagree with on this issue-he made a pretty good argument in saying, first of all, that 40 to 50 percent of the funds register now, and there doesn't seem to be too many complaints; in fact, they voluntarily register; that he thought registration might increase because pension funds and other types of funds that are dealing with consumers and others might feel better with the registration.

He mentioned that the financial cost was quite low. I think he said it would cost about $45,000, $50,000 to do the registration, which for a large pension fund is a drop in the bucket, particularly given their profitability. And he seemed to feel that the act of registering would not inhibit-would not create any kind of systemic risk-sorry, you said the systemic risk. But he felt that the act of registering would not get in the way of any kind of thing that a hedge fund wanted to do in terms of its entrepreneurial zest, activity, risk-taking, et cetera.

Could you just-you know, because I am wrestling with this issue, and I think some of us on the committee are. Could you give us your views on this, particularly on the aspect of does required registration cause-oh, one other point he mentioned which made a difference to me, since hedge funds are based in New York, and I try to make sure businesses come to New York, don't run away-that you wouldn't have people go overseas. I had heard from some hedge funds, "Well, we'll just go overseas." He said it doesn't matter, if they have U.S. investors, they'd still have to be through the same-you know, they'd meet the same legal requirements and have to register anyway.

Could you comment on the issue in general, and specifically your view about how required registration would affect the entrepreneurial zeal and zest risk-taking of the hedge funds?

MR. GREENSPAN: Senator, I actually was writing down a few comments on this particular issue, not knowing whether-where I would use it, just to get my own thoughts. It will take a couple of minutes for me to read. Let me read it to you, if you don't mind.

SEN. SCHUMER: That'd be great. That'd be great.

MR. GREENSPAN: If I-with the chairman's acceptance.

Hedge funds have become major contributors to the flexibility of our financial system-an issue which I raised earlier-a development that proved essential to our ability to absorb so many economic shocks in recent years. Hedge funds seek out the abnormal rates of profit often found where markets are otherwise inefficient. Taking positions in volume, as hedge funds do, tends to eliminate the abnormal profits and the inefficiencies by aligning prices across markets, and provides liquidity to markets. Successful or not, when those profit opportunities are perceived to be eliminated, individual funds move on to address other inefficiencies.

But these above-normal profits have attracted a large number of new entrants seeking to exploit a possibly narrowing field of inefficiencies.

Not surprising, the rate of return in this activity reportedly declining. I would not be surprised if, with time, many of the new entrants exited, some presumably following large losses.

Chairman Donaldson-who, as you mentioned-who's been a very good friend of mine for 45 years-I think, is certainly right in wanting to eliminate fraud by hedge funds and other financial institutions. Fraud undermines markets and the efficient functioning of our economy.

My problem with the SEC's current initiative is that the initiative cannot accomplish what it seeks to accomplish. Fraud and market manipulation will be very difficult to detect from the information provided by registration under the 1940 act.

Fraud is almost always uncovered through complaints of counterparties or by accident, such as the uncovering millions of dollars of new U.S. currency in Federal Reserve wrappings in Iraq. This is certainly true-namely, that the uncovering of fraud through counterparties-is certainly true in regulated banking, as we experience it and, I assume, among regulated broker-dealers as well. Even should SEC's proposed risk evaluation surveillance of hedge funds detect possible trading irregularities-which I doubt, frankly-those irregularities will likely be idiosyncratic and of mainly historic interest, because by the time of detection hedge funds would have long since moved on to different strategies.

Should the existing proposal fail in achieving its goal, pressure will become irresistible to expand SEC's regulatory reach in an endeavor to accomplish what it set out to do.

Hedge fund arbitrageurs are required to move flexibly and expeditiously if they are to succeed. If placed under increasing restrictions, many will leave the industry, to the significant detriment of our economy.

SEN. SCHUMER: So in other words, if I might-and I think-I appreciate your statement. As I said, I'm grappling with this issue and haven't made up my mind. But you're saying registration in itself wouldn't be detrimental-it might not accomplish what its advocates say-but could lead to other things that would become detrimental. Is that a fair summation?

MR. GREENSPAN: That is correct.

SEN. SCHUMER: Without the erudition that you have. (Soft laughter.)

Thank you, Mr. Chairman.