Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, September 29, 1998 : Transcript

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Meeting of the Federal Open Market Committee
September 29, 1998

A meeting of the Federal Open Market Committee was held in the offices of the Board
of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, September 29,
1998, at 9:00 a.m.

PRESENT:

Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Hoenig
Mr. Ferguson
Mr. Gramlich
Mr. Jordan
Mr. Kelley
Mr. Meyer
Ms. Minehan
Mr. Poole
Ms. Rivlin

Messrs. Boehne, McTeer, Moskow, and Stern, Alternate Members of the
Federal Open Market Committee
Messrs. Broaddus, Guynn, and Parry, Presidents of the Federal Reserve
Banks of Richmond, Atlanta, and San Francisco respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Ms. Fox, Assistant Secretary
Mr. Gillum, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Mr. Truman, Economist
Messrs. Cecchetti, Dewald, Hakkio, Lindsey, Simpson, Sniderman, and
Stockton, Associate Economists
Mr. Fisher, Manager, System Open Market Account

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Mr. Winn, Assistant to the Board, Office of Board Members, Board of
Governors 1/
Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of
Governors
Messrs. Madigan and Slifman, Associate Directors, Divisions of
Monetary Affairs and Research and Statistics respectively, Board
of Governors
Messrs. Alexander, Hooper, and Ms. Johnson, Associate Directors,
Division of International Finance, Board of Governors
Mr. Reinhart, Deputy Associate Director, Division of Monetary Affairs,
Board of Governors
Mr. Struckmeyer, Assistant Director, Division of Research and Statistics,
Board of Governors
Ms. Low, Open Market Secretariat Assistant, Division of Monetary
Affairs, Board of Governors
Messrs. Spillenkothen and Parkinson, 2/ Director, Division of
Supervision and Regulation, and Associate Director, Division of
Research and Statistics respectively, Board of Governors
Mr. Connolly, First Vice President, Federal Reserve Bank of Boston
Messrs. Eisenbeis, Goodfriend, Hunter, Kos, Lang, and Rolnick, Senior
Vice Presidents, Federal Reserve Banks of Atlanta, Richmond,
Chicago, New York, Philadelphia, and Minneapolis respectively
Messrs. Judd and Rosengren, Vice Presidents, Federal Reserve Banks of
San Francisco and Boston respectively
Ms. Yucel, Research Officer, Federal Reserve Bank of Dallas

1/ Attended portion of the meeting relating to the Committee's disclosure policies.
2/ Attended portion of the meeting relating to developments stemming from the financial
difficulties of a large hedge fund.

Transcript of the Federal Open Market Committee Meeting of
September 29, 1998

CHAIRMAN GREENSPAN. We are getting under way a bit early, but I am sure we
will use the time productively. Would somebody like to move approval of the minutes? I want
to call your attention to the addition of a reference in the minutes to our recent telephone
conference. I trust all of you have looked at it and that there is no objection to the way it is
worded.
VICE CHAIRMAN MCDONOUGH. Move approval.
CHAIRMAN GREENSPAN. Without objection.
The second item on the agenda involves a continuation of discussions we've had on
the issue of disclosure. In its memorandum, the staff winnowed down our earlier considerations,
and the options now seem fairly straightforward. There is no urgency to implement any of them,
and I think we should continue our discussions until we can reach a consensus of some sort.
This is not strictly a matter for a Committee vote. Whatever we do, including nothing, it is
important that it reflect a consensus as differentiated from a majority vote. I don't think a change
in our procedures should be made by a majority vote because once such a change is made it is
very difficult to backtrack. As a result, any change should be something with which everyone
feels reasonably comfortable. Having said that, would somebody like to respond to the
memorandum, which sets out the issues in a way that does not seem to require a staff briefing?
President Hoenig.
MR. HOENIG. Mr. Chairman, after reading the memo and participating in several
discussions of this question, my inclination is to go with Option 1. With regard to that option,
the simpler and more straightforward the language, the better. Indeed, I would simplify the

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language even further. For the symmetric alternative, I would say something like "in view of the
currently available evidence, the Committee believes that developments are equally likely to
warrant a decrease or an increase in the federal funds rate." If the decision were for a tilt, I
would have the sentence say "in view of the currently available evidence, the Committee
believes that developments are more likely to warrant a decrease/increase than an increase/
decrease in the federal funds rate." I think that wording is understandable and straightforward.
I also would like to see the minutes released even sooner than is contemplated in this
memo if that is physically possible. That's because, as I said the last time we discussed this
matter, the minutes provide context for the Committee's decision. If we are going to be more
transparent, sooner is better than later in that regard. I know there are physical limitations
involved in the production of the minutes.
In sum, my preference would be to put simpler language in the directive, release it
promptly, and then publish the minutes as soon as we can to give context to our decision.
CHAIRMAN GREENSPAN. I gather by implication that we have concluded in our
previous discussions that variations in wording to describe differing degrees of tilt have not
served us very well. As you know, in the past we have had hard tilts, medium tilts, tilted tilts,
biased tilts, and who knows what else!
MR. HOENIG. We need an interpreter to figure out what all that means. That is true
even for us, let alone the public.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Mr. Chairman, I share Tom Hoenig's views pretty much down the
line. I come to this, as I said last time, with a sense that the more information we can put out
promptly, the better. The more quickly markets react, the more the policy uncertainty premiums

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that might otherwise get built into markets are reduced. So, I would favor both announcing the
tilt immediately after each meeting and releasing the minutes sooner.
CHAIRMAN GREENSPAN. Tom, did you also say you favored releasing the tilt
immediately?
MR. HOENIG. Yes, I would be in favor of releasing it promptly after each meeting
with the simpler, clearer language.
MR. GUYNN. I think it is important as we continue this discussion to be sure that we
all have the same objectives. In my view, the first and foremost objective is to make our intent
clear. I think the staff does a really nice job on page 2 of their memo where they express their
sense of what we mean by the tilt, namely that it reflects the Committee's thinking about the
balance of risks. That is my current understanding of the primary reason for the tilt language. I
believe the secondary intent is to continue the practice of giving the Chairman the authority to
act for the Committee in extraordinary circumstances. I assume those are the two things we are
trying to accomplish.
I do not think that announcing the tilt would have a negative effect on the Committee's
discussion, although that is an issue raised in the staff memo. In fact, I would argue that it might
even strengthen the discussion in that those who favored action at a meeting when none was
taken would at least have the benefit of the tilt being announced immediately, with whatever
effect that might have on the market. I also am satisfied that Fed watchers and others who pay
attention to the tilt are smart enough to realize that circumstances may change as events unfold
after a meeting. Thus, they will not expect our next action always to be in the direction of a tilt.
I also share Tom Hoenig's view on releasing the minutes. I assume that we should be
able to publish the minutes sooner than a few days before the next meeting as suggested in the
staff memo. Since the minutes elaborate on the reasoning behind the tilt, I think the sooner we

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release them, the better we are served. I also share Tom's preference for simpler language on the
tilt, and I would incorporate the simpler language in the staff memo with the changes that Tom
suggested. I also would reword the lead sentence to indicate that the Committee seeks conditions
in reserve markets that are consistent with its mandate to foster longer-run price stability and
sustained economic growth.
Finally, I wonder whether we should consider dropping the last sentence of the
operating paragraph, which references growth in M2 and M3. That sentence may suggest that
the Committee has those aggregates as a policy objective, and I question whether it is relevant in
terms of the way we currently conduct policy. However, this may be an issue that we don't want
to open at this time.
CHAIRMAN GREENSPAN. As a central bank, we should at least recognize that M2
and M3 exist, no matter what we do with them. [Laughter]
MR. GUYNN. I accept that! Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. I am very much in agreement with Presidents Hoenig and Guynn. I
favor Option 1, prompt release after a meeting, and simpler language. I, too, tried to draft
language that would underscore the concept of risk to which both Tom and Jack seemed to be
referring. I also believe that the minutes should be released sooner than 2 or 3 days before the
next meeting, if that is at all possible.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. I basically support what the three Presidents who preceded me said
about making a prompt announcement, and I would release the operational paragraph when we
change the tilt. I have to say that I find the language in Option 2 relating to the tilt to be
somewhat preferable to that in Option 1, though both certainly are better than what we have

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today. Option 2, it seems to me, captures the essential element of asymmetry in that it refers to
the likelihood that we will move policy in one direction rather than the other, and I think that is
highly desirable. What I like about Option 1 is the reference to the long-run goals. So, some
combination of Options 1 and 2 would be my preference.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. Just to play devil's advocate, I would like to suggest that we'd be
better off not formally voting on a tilt. Therefore, we wouldn't have the decision to make on
how to release that vote. I understand that having the tilt as an option may help with consensus
building and arriving at a decision during any given meeting, but we can get the sense of where
we as a group are leaning without necessarily voting on it. We would run fewer risks of creating
embarrassing situations where we were getting ready to zig but had said at the previous meeting
that we were more likely to zag. I think there would be a greater degree of freedom for the
Committee if we did not have a formal tilt but just listened to each other and knew which way
we were leaning without having to take a vote.
CHAIRMAN GREENSPAN. Governor Rivlin.
MS. RIVLIN. I agree with Option 1 as amended by Tom Hoenig. I thought the staff
draft was a quite good breakthrough in terms of added clarity and straightforwardness, and Tom
has made it a bit better. I suspect that what will happen if we know we are announcing the tilt is
that we will be less likely to have one. We may, if there is a considerable degree of uncertainty,
take refuge in a no tilt directive, but that seems appropriate to me. The only reason for having a
tilt is that we want to send a signal about which way we are leaning. When we are sure enough
of that signal, we ought to say so. We don't need to signal ourselves; we need to signal
somebody else. So, it should be a public matter. I also think it would be desirable to get the

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minutes out sooner if we could. But the important breakthrough is straightforward language on
the tilt and announcing it immediately.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. I continue to favor immediate announcement of the tilt. I thought Tom
Hoenig and Jack Guynn presented the arguments extremely well, and I believe Tom improved
the draft language a little. I recognize that there is some danger that an immediate announcement
could reduce the use of the tilt. However, if we are disciplined, we can avoid that and honestly
communicate to the public exactly how we assess the risks going forward. That is what the tilt
does. Releasing the minutes more quickly would be a further constructive step toward
incremental transparency, and I think doing that would be a good idea.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. Mr. Chairman, I continue to believe that the more information
and the clearer the information, the better. So, I agree with the majority here. I like the language
of Option 1, and I think Tom Hoenig has improved it. With Tom's changes, that option strikes
me as a huge improvement over what we have now. I would release the directive immediately
and release the minutes as early as possible.
CHAIRMAN GREENSPAN. President Boehne.
MR. BOEHNE. I agree with the simpler language. I, too, think that Tom has
improved it, and I would go with that. While I realize that it's difficult to be against providing
more information, I continue to have some problems with immediate release of the tilt. I am for
more information as a general matter, but I believe the practical outcome of prompt release of
our decision on the tilt would be less use of it. Monetary policy does not take place in a vacuum.
It takes place in a wider social and political environment. In that environment, it is almost
always easier to lower interest rates than it is to raise them. If we are planning to raise interest

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rates, we may as well get a real bang for the buck and actually do it. If we say we might raise
them and then fail to do so, we are going to get the inevitable announcement effect and the
associated criticism for doing it. There will be a further "announcement" effect later when
nothing happens. I think we will go through that exercise a few times and conclude that it really
is not worth doing. Not acting in the direction of a tilt may also erode our credibility. The tilt
may be useful for our internal deliberations, but we would be using it less and adopting
symmetric directives more frequently. So, I have real doubts that this kind of disclosure would
actually contribute to clarity. And I therefore have misgivings about moving in the direction
where the majority opinion appears to be going.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. Thank you, Mr. Chairman. I certainly favor earlier release of the
minutes and clarifying the language with regard to the tilt or the lack thereof. Like Bob Parry, I
have a mild preference for something like Option 2, but there doesn't seem to be a huge
difference between the two versions as I read them.
I share Ed Boehne's reservations about the immediate release of the decision on the
tilt. Historically, it seems to me that it has been a very noisy signal because we frequently have
had a tilt or changed the tilt and nothing followed. That gives me some pause. I'm not sure we
are going to have the intended results from that kind of release, at least at this point in time. So,
I'm not in favor of immediate release at least for now, and I would prefer to hold off making a
decision.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. I am with what seems to be the growing majority here, but I
recognize that there are counter arguments. I'm in favor of immediately releasing the tilt mainly
because it's a question of honesty. If a consensus has emerged in the Committee that says the

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risks have moved in a certain direction and therefore policy may follow, I think it is useful to
inform the market. We are now in a posture where we do not release the tilt and we end up
having a number of people trying to interpret our speeches and our responses to questions in a
way that may not conform with our thinking. I think releasing the tilt promptly will give us a
chance to be much clearer with the market, to signal with one voice as opposed to potentially 19
voices, and to be certain that if we have reached a consensus, we will tell the market what the
consensus is.
I also would be happy to encourage the earlier release of the minutes in the sense that
they provide a fuller context for our decisions. As to the language, I have a slight preference for
Option 1 as amended by Tom Hoenig, but I can support Option 2 as well.
CHAIRMAN GREENSPAN. President Poole.
MR. POOLE. I, too, like Option 1, but I would prefer the tilt language from Option 2.
I think that the earliest possible release of the minutes, consistent with their being written clearly
and informatively, is a good idea. I would like to add that I cannot imagine a better time to
introduce these new procedures than right now, given the other things that are going on.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. Thank you, Mr. Chairman. First, I am for releasing the tilt
sentence or the entire directive paragraph promptly after the meeting and the minutes as soon as
possible thereafter. On the language of the directive paragraph, I am for Option 1. Let me point
out one difference between Option 1 and Option 2; Option 1 states the Committee's goals in the
first sentence and goes on to say what the Committee did; Option 2 reverses that order. However
we describe the tilt, I would like to preserve that aspect of Option 1. That is, I would state the
goals first and then indicate what we did.

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I agree with Bill Poole that we should adopt these changes today, although they may
make us a little less aggressive about changing the directive language. I agree with what Tom
Hoenig said, but unlike Bob McTeer, I would like to retain the tilt in the directive. One thing I
have been worried about, and I have said so in the past, is that the way we make policy could
allow us to get too rigid on the federal funds rate. If we keep the tilt, we can be a little less rigid,
and I would like to retain it for that reason.
On a last point regarding our credibility that Ed Boehne made and Gary Stern
seconded, I have been impressed since I have been here at how short people's memories are. Six
weeks is a fairly long interval in terms of monetary events, and there is a great deal of
speculation about what we are going to do today and not too much is remembered about where
we were six weeks ago. I'm not too worried about the credibility issue because if we change our
position or change our minds I think that would be viewed in the context of whether it is a good
thing to do in light of the most recent events. I don't think we would lose any credibility. So, I
am inclined to downplay that argument.
CHAIRMAN GREENSPAN. Vice Chair.
VICE CHAIRMAN MCDONOUGH. Mr. Chairman, I think it might be worth
thinking about why we do what we do before we change it. One of the realities is that by
releasing the minutes of a meeting two days after the following meeting, the decision on the tilt
at the earlier meeting may be interesting but it is no longer very important. We already have
decided either to ease or not to ease or to tighten or not to tighten at the meeting that took place
two days before. Why have we thought that use of the tilt has served our cause well? In my
view it has helped us to focus on what we want to do in terms of guiding our policy between one
meeting and the next or at least in terms of a longer-term view of where we are headed. I think
that has served us very well.

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If we decide to release the minutes earlier, which in and of itself is probably a good
idea, my analysis of the collective psychology of this group is that in fact, as Alice Rivlin
suggested, we will not do a whole lot of "tilting." The reason is that if we are going to announce
the tilt either right away or shortly before the next meeting by releasing the minutes early, we
will create a difficult conundrum for this central bank. Central bankers are supposed to be
believers in price stability. Even if we are symmetric in our approach to inflation, as I think
many of us are, in the sense that we are opposed to both inflation and deflation, the public
believes that central bankers are supposed to be inflation fighters. We have to remind them
every now and then that we are against deflation also. I can envision us sitting around this table
saying that we ought to have a directive that is biased toward tightening, and some of us would
then say that we ought to go ahead and tighten. But if we do not want to tighten at a meeting,
then it would be better not to announce after the meeting that we are thinking about doing it later.
Doing the latter would in my view make us look a little questionable in our judgment or at least
in our strength of character. On the other hand, if we are thinking of easing but are not sure we
want to ease at a given meeting, people would conclude that that is a rather reasonable thing for
central bankers to be doing. So, with an early announcement we would wind up in my view of
the real world more likely to tilt toward easing and less likely to tilt toward firming.
Even though I believe that it would be a good idea in principle to release the minutes
early, and therefore I don't feel very strongly about whether we announce the tilt or the absence
of a tilt shortly after a meeting, I think it is likely that with such an announcement the use of a tilt
would become a fairly rare phenomenon. Most of the time when we think that economic
conditions, the financial markets, and monetary conditions are such that it might be appropriate
to ease monetary policy at some point, we as good central bankers might not be entirely sure of

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the need for easing quite yet, so we would not do it. Therefore, I'm not sure what we would
accomplish by changing our procedures.
To summarize, prompt announcements make us look like believers in transparency;
that is good. They make us look like we are sharing information with the American people; that
is good. But in terms of actually serving the interests of the American people well--and I think
we have been doing a phenomenally good job in that regard, leaving collective modesty aside--I
am not sure that a change in our announcement procedures would improve our performance.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. Mr. Chairman, I tend to agree with President Boehne and also
President McDonough. It is hard to argue against transparency. Obviously, we all want to
release as much information as possible. But if we were to design this system from the start, I
cannot imagine that we would design a system that would require us to make two decisions. One
might be a decision to maintain an unchanged policy and the other a decision on whether we
want to tell the world we might be tightening or easing later. Alternatively, we might take an
action and announce shortly after the meeting whether our directive includes either of those two
tilts. It just does not seem logical to me that as a central bank we would want to do that. We
have used the tilt for other purposes, and now we are trying to design some system around that
history. We wouldn't design it this way if we were to start afresh and didn't have to take account
of its use in the past.
I believe that if we were to agree to announce the tilt at some time before the next
meeting, the practical result would be that we would use it much less. Actually, though, the
existing system seems to be working rather well. We had unusual circumstances at the August
meeting when we changed to a symmetric directive. The July minutes, released shortly after that
meeting, indicated that we had had an upward bias. In the interim, between the August meeting

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and the September meeting, the Chairman consulted with us at Jackson Hole, and he
subsequently announced that the directive no longer had an upward bias. So, I think that, on the
whole, our system for announcing our decisions has worked rather well over the years and I do
not see any need to change it at this point.
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. Thank you. With regard to the minutes, I agree with releasing them
as soon they can be prepared, even though releasing them sooner will impose some burden on
the staff and on all of us who review and approve them.
On the release of the tilt, though, I am persuaded by a number of comments today that
if we release it immediately, we will not use it. Therefore, I want to release the tilt immediately!
[Laughter] I am persuaded that over time the costs of having a tilt outweigh its benefits in terms
of consensus building. I have always thought that if we have monetary policy that operates on a
price basis, we run into problems in terms of interactions in the marketplace if we announce our
intention to change interest rates in a certain direction over time. The markets do move on that
kind of information, as opposed to the way they tend to function if we have a quantitative
approach to implementing policy.
With regard to the wording of the options, like Bob Parry and Ned Gramlich, I like the
way Option 1 begins with a statement of our objectives. Regarding the tilt sentence, though, I do
not like Option 1 because it states that "the Committee believes that developments are more
likely to warrant....etc." That immediately starts to raise questions about what developments are
involved or what indicators flashing red, yellow, or green will trigger an action. It puts undue
weight on some signal that may lead to a change in policy. Option 2 does not do that.
I agree with Governor Gramlich's comment that the federal funds rate has tended to be
too rigid, but my sense has been that the tilt frequently has been used in lieu of making a policy

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change. The tilt may serve a function in terms of building a onsensus, but if it were not
available, we would have more straight up or down votes. We would change our policy or we
would not.
CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. Mr. Chairman, when we discussed this issue earlier, I spoke at some
length against the idea of early release and I still feel the same. I would like to restate my views
briefly, if I may, even though most of my concerns already have been expressed. First of all,
please recall that the Lindsey paper that supported our earlier discussion showed that over the
past 12 years, the tilt in place at the time of each FOMC decision was in the same direction as the
decision itself only 52.7 percent of the time. In the other 47.3 percent of the time, the decision
differed from the existing tilt. Thus, the tilt has been nearly perfectly worthless as a predictor of
policy decisions. [Laughter]
In my view, this and other problems give us three reasons not to change our
announcement practices, and they provide me with a notion of what the results would be if we
did. First, this record shows that an early release over the past decade would frequently have
misled the general public, which is only concerned with deeds and not the fine nuances of
economic reasoning. As a consequence, I am convinced that with early release we would
experience a severe loss of credibility that is the lifeblood of our policy's effectiveness. Second,
early release of an asymmetry would often be the equivalent of a policy move that the
Committee had just decided not to take, and the Committee could never know as it voted what
forces it might inadvertently be setting in motion an hour or so later when the announcement was
made. Third, if an asymmetry were in place at a meeting where the issues were close, the very
existence of a publicly known 6- to 8-week old position could influence the adoption of a less
than optimal new policy.

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As a consequence of all this, I am confident that, after being burned a couple of times,
the Committee would simply cease to employ this very useful convention. That would be a
shame because the tilt legitimizes the uncertainty that is frequently present and the delay that is
frequently appropriate, and it also aids materially in building a consensus. In sum, I can see no
helpful elements to an early release regimen and many serious negative consequences.
On the rewording of the directive, truth to tell I like the existing language and I would
be a little sad to see it go. Everyone who is interested and needs to know understands it perfectly
well, and more importantly it constitutes a bit of quaint Americana that we should cherish.
[Laughter] That said, I would support a change if that is the Committee's wish, and either of the
two wording options and the suggested amendments are perfectly acceptable to me. Option 1 is
fine, but I think there is much to be said for Option 2 because of its greater continuity with the
present practice. Thank you.
CHAIRMAN GREENSPAN. One of the things that strikes me about this discussion,
and I must admit that I am on both sides of this issue, is that I switch back and forth to different
sides at different times. The reason is that we are being pressed on something that we consider
to be of value to the market, namely that more information is better than less. There also is an
ethical issue here, one relating to the integrity of this institution, that clearly is an important issue
that we need to address. Both of those considerations suggest that more is better, although we
must remember that we are not going all the way in providing information. If we went to the
fullest extent in that direction, then Henry Gonzalez's approach of live transmission of this
meeting obviously would be the most ethical and most directly available source of information to
the market, but it also would be the most useless. So, let us be careful about how we weigh the
various alternatives.

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The one thing that struck me, which has not surfaced in our discussion today, is that
our experience of the last several years has not been the same as our experience over a much
longer time frame. That is, the nature of our deliberations and the way we conduct monetary
policy are quite different when the economy is under extreme stress, when the unemployment
rate is rising, when there is a cacophony of outside comments about the need to lower interest
rates-- the sort of commentary we seldom get when the economy is strong. So, we have to be a
little cautious about proceeding further without availing ourselves of the lessons of past
experience with regard to how things may play out in a period, say, when the economy is getting
away from us on the downside and we are looking at a fairly dramatic decline in demand, rising
unemployment, and a lot of political stirring. I think it would be important for us to work
through a number of alternative scenarios in that context. If we do that, I think we're going to
find that this issue is a lot more problematical than it may currently appear. I think we ought to
do that. What our discussion did clarify, unless I misheard, was a general willingness to abandon
quaint Americanism-SEVERAL. Americana.
MR. KELLEY. Americana.
CHAIRMAN GREENSPAN. There does seem to be a fairly broad consensus about
the desirability of better and simpler language.

However, we have not yet come together on

some of the other issues; if a vote were taken on those issues, I think there would be a majority in
favor of doing something now, but there is still a significant minority on the other side. With
regard to the wording of the directive, this is the first time that I have sensed the existence of
general agreement though there remain some small differences. I would recommend that we put
together language that reflects, as best we can judge, the consensus of this group and revisit this

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matter at a later meeting. We can then make a change, and I think we will be ready to do so in
part because we have wrestled with this issue for a long period of time.
There are two quite different disclosure issues. One is that of giving changes in the tilt
the same status as changes in the funds rate with respect to when they are announced. The
second, which as I see it may be viewed as independent of the first, is when to publish the
minutes. I have a certain sympathy for the views of the Vice Chair on the latter. I often have
wondered what we would gain by releasing the minutes a week earlier than the current schedule
if the information on the tilt was already out. I grant that if the tilt is not announced shortly after
the meeting, then moving up the publication of the minutes clearly has the effect of releasing the
tilt at that point. But if the tilt is already published, then the acceleration of the minutes strikes
me as something that probably has more potential for mischief than not. Remember that the
minutes provide a discussion of the various forces and nuances and the like, and if we were to
decide to publish them one week earlier, then why not two or three weeks earlier? There has
been general agreement within the Committee that the contingency discussions contained in the
minutes should be published only after those contingencies no longer have relevance. So, I do
think that the issues of whether we publish the tilt at the point of decisionmaking and when we
release the minutes are separable. They are not necessarily tied.
Unless I hear an objection, what I would like to do is to have Don Kohn construct a
specific, formal proposal based on today's discussion of the various wording options and Tom
Hoenig's amendment. I believe we can come to an agreement at our next meeting on that issue.
However, I do think we should continue our discussion relating to more prompt disclosures to
see if we can narrow our differences further. We have narrowed them to some extent. In that
regard, I would like to suggest that the staff review how, as they see it, changes in our practices
would play out in periods other than when we make decisions only at meetings and are getting

9/29/98

very little outside criticism. We have been in such a period for quite a while. In fact, it is almost
unprecedented because we tend to be the favorite scapegoats of a significant number of people
who live inside the Beltway. The fact that we have not been the subject of heavy criticism for a
prolonged period is quite unusual and may limit our ability to anticipate what we could face in
the down phase of a business cycle if we change our disclosure practices. I think it is essential
for us to make certain that if we decide to move toward earlier release--a decision that as I said
earlier would effectively be irreversible--we will have thought through how things would play
out and what the implications are. Unless there is an objection, I will close the discussion on this
issue at this point. Hearing none, let us go on to Peter Fisher.
MR. FISHER. Thank you, Mr. Chairman. I will be referring to the
usual package of colored charts with an FOMC cover and also to three pages
of black and white charts showing standard deviation data that I will refer to
briefly. Those two sets of charts should be in front of you. 1/
Looking at the first page of 3-month deposit rates--the current 3-month,
the 3-month forward, and the 9-month forward--you can see that the
9-month forward 3-month rate is now trading at a level of about 4.7 percent,
reflecting in my judgment a market expectation and pricing not of a single
easing of monetary policy but of a whole series of easings through early
next year. You can see that these expectations began building after the
Committee's last meeting and the contemporaneous Russian devaluation
and moratorium. They have become much more pronounced in recent
weeks.
In contrast, the forward rates in Germany and Japan have now
collapsed onto the current 3-month deposit rate, so there is no expectation of
up or down rate movements in those two countries, just sideways. I always
like to point to instances when movements in exchange rates are consistent
with changes in short-run interest rate differentials. I do not want to suggest
that the changes in the rate differentials were the only cause of the dollar's
slight weakening, but it is gratifying when we find consistency there.
At your last meeting, I suggested that market participants were on the
edge of their chairs with respect to the risk of a Chinese devaluation of the
yuan. It turns out that the Russian devaluation and moratorium of the prior

1/ Copies of the charts used by Mr. Fisher are appended to the transcript. (See Appendix)

9/29/98

day was sufficient to strain, and in some cases nearly to shatter, investor
confidence around the world, particularly in fixed income markets.
Turning to the second page, we have depicted a series of yields on fixed
income instruments. Let me work up from the bottom of the page. At the
bottom, we have the 10-year Treasury note and a Merrill Lynch high grade
agency index in yield terms. The dark blue line above the red line is the
10-year U.S. swap rate, that is, the fixed component of the "plain vanilla"
10-year fixed rate to floating rate interest rate swap. The lighter blue line is
the Ford Motor Company's 10-year bond and there is a Fannie Mae coupon
issue as well.
Moving up the page, the middle panel is on the same scale as the
bottom panel. We are looking at a jump of 150 basis points to get up to this
Merrill Lynch index of high yield securities. That index covers more than
900 companies rated BBB or lower.
The top panel is on a completely different scale in order to fit the JP
Morgan emerging market fixed-income index on the same page. One reason
for presenting this in this form, which I will come back to in a moment, is
that a widely emulated trade in the financial markets has been a spread
trade. It is based on an expectation that spreads would be narrowing
between higher yielding credits and, for example, Treasuries. You can see
here that spreads between the higher yielding issues in the top two graphs
and the Treasuries widened considerably after the Russian devaluation on
the day before the Committee's meeting in August. While some of the
yields on higher grade credits are lower in absolute terms, the spreads
themselves also have been widening. So, trades constructed even against
those credits have been under considerable stress despite the fact that their
yields in absolute terms have shifted lower.
The rush out of emerging market and higher yielding instruments in late
August obviously put significant strain not just on those who are carrying
higher yielding instruments but on those involved in trading on spreads.
The result has been an acceleration both of purchases of Treasuries and sales
of higher yield securities. It is worth noting that while the yields on higher
grade credits have come down, at least part of the explanation is an
expectation in the market that there will not be the normal pace of new
issuance. In these very volatile markets, firms that have higher grade credit
ratings like the Ford Motor Company are not going to try to price new
issues, so some of the reduction in yield is in anticipation of that supply
effect. Of course, the treasurer of Ford Motor Company is not complaining
that yields on Ford's bonds are lower, but he does face more volatile
markets. The 900 or so companies represented in the Merrill Lynch master
index of high yield securities, however, are facing both higher yields and an
inability to borrow in these very volatile markets.

9/29/98

Turning to the next page, we see another way of looking at similar data.
In the top panel, we have the 10-year swap spreads that I referred to earlier.
The panel shows the 10-year fixed leg of a fixed-floating swap against the
government bond for the same country--France, Germany, the United
Kingdom, and the United States are shown. You can see the tremendous
widening of these spreads after the Committee's last meeting.
The bottom panel, unfortunately, is poorly labeled; it should be called
"swap-spread spreads." What is depicted here is the difference between the
U.K. swap spread and the French swap spread in blue and between the U.K.
swap spread and the German swap spread in yellow. This is a trade that is
based on what a number of people have expected to occur--the long-run
convergence of the United Kingdom into the EMU. Eventually that is going
to happen and this is one way to take advantage of that expected event.
Instead of converging, however, you can see that the spreads have tripled
since late August.
Yet another way of looking at the same data is reflected in the black
and white charts that I have handed out. The point here is that the events
that have occurred recently in fixed-income markets produced a shock not
just for those who have been trading for the last year or two but also for
those whose trading goes back as far as June 1992. What we are looking at
here is the standard deviation in basis points of these spreads, as measured
over 20-day intervals, from the mean for that interval. This chart indicates
how many basis points need to be encompassed to include one standard
deviation. For the U.K. 10-year swap spread, the average 20-day standard
deviation from June 1992 through July 31 of this year was 2.6 basis points.
As you can see, the prior high for any 20-day period was an average of 9.5
basis points in 1994, while for the 20-day period through the end of August
it was 14.8 basis points. So, we had a huge explosion in the volatility of the
swap spreads in August. The same essentially can be seen on the second
page for the U.S.10-year swap spread.
CHAIRMAN GREENSPAN. This is the U.K. bank rate versus sterling?
MR. FISHER. Yes.
CHAIRMAN GREENSPAN. What maturity?
MR. FISHER. The 10-year maturity. So, we have a 10-year gilt. It is a 10-year swap
among the prime bank names, not necessarily British banks; it involves the major players in all
the markets.

CHAIRMAN GREENSPAN. But in sterling?

9/29/98

MR. FISHER. Yes, in sterling. It is that spread we are looking at as it
widens out and becomes more volatile. I don't need to go through all the
data, but you can see essentially the same for the U.S. 10-year spread and
the JP Morgan emerging market bond index. My point is to underscore that
the shock to fixed-income markets that occurred in late August was of
considerable significance to the players in the markets and in historical
terms.

Turning to the next color page--I will try not to dwell long on this--on
the left side, we have re-indexed to May 1 a total return, 10-year bond index
in blue for the United States in the top panel, Germany in the middle panel,
and Japan in the bottom. In red, we see the local equity index, in each case
also re-indexed to May 1. The obvious point here is that bonds have been a
better investment over this period than have equities. That may not have
required rocket science expertise to figure out! [Laughter]
On the right hand side, we have a measure of volatility. Here the blue
line is the At-the-Money implied volatility of options on futures of the
10-year bond contracts and the red line is the At-the-Money implied
volatility of options on the equity indices, both indexed back to May 1. So,
this is the change in the level of the implied volatilities on the futures
contracts. This shows how extraordinarily implied volatility has increased,
particularly for equities. Please forgive the lack of JGB data for June and
July in the bottom right panel. The point here is in part the extraordinary
increase in volatility in the equity markets but also how much money an
investor might have lost in late August if the investor had written a lot of
option contracts in the expectations that volatilities would be coming down.
The loss could have been an extraordinary sum of money.
CHAIRMAN GREENSPAN. Some did!
MR. FISHER. And some did.
Finally, Mr. Chairman, in the chart on the last page relating to our open
market operations, you can see that fed funds generally have traded
uneventfully since your last meeting. We did purchase $7.9 billion on an
outright basis, and we will have to make more such purchases because
reserve needs have been growing.
Finally, we had no foreign exchange operations in the period. However,
we are working on a number of issues and I would like to mention those.
One on which we are working with Board staff is that of opening accounts
for the European Central Bank on our books and trying to open a Federal
Reserve account on their books. It is not quite clear what, if anything, we
can do with our account on their books. We don't know what services they
will be offering. But in the spirit of bonhomie and camaraderie, we are
looking to open an account with the ECB. There are a number of technical

9/29/98

issues for them that are proving to be very time-consuming to work out.
With respect to their accounts with the Federal Reserve, they want to
maintain a very complex structure of 13 different accounts for the national
central banks as well as for the ECB itself and to have it all under one
umbrella. We are trying to work that out.
We also are working on a number of technical issues related to the
advent of the euro that have to do with our payment facilities and how we
operate the accounts. I am opposed, however, to undertaking any planning
at this time of changes in the investment of our reserve holdings. I would
much rather wait and see how markets develop. There may be some
diversification options for the management of our deutschemark reserves,
but I think the markets are going to be very uncertain and in any event the
operational issues are consuming our time at present.
Our holdings at the BIS, the Bundesbank, and in German government
bonds and German repos are in the wholesale markets where they will all be
converted and denominated in euros. We would have to resist rather
strongly and seek out bankers prepared to help us out if we wished to
maintain them technically in deutschemark denominations. We have not
been resisting that conversion but have been trying to work with the flow.
Ted Truman and I have sent you a memo on the status of discussions of
the swap arrangements, 2/ and we will be happy to answer any questions
about those discussions.
Mr. Chairman, as I said, we conducted no foreign exchange operations
for the System during the intermeeting period. I will need the Committee's
ratification of our domestic operations during the period, but I would be
happy to answer any questions about them.
CHAIRMAN GREENSPAN. Peter, I think we are all aware that a major trauma in
world financial markets occurred when the Russian devaluation and debt moratorium were
announced. Since the size of the Russian economy is de minimis relative to the rest of the world,
something fundamentally different was going on.
There are two, not necessarily competing, views as to what occurred. The first is that
there was a general sense that the Asian contagion around the world was moving into remission,

2 / A copy of this memorandum, dated September 28, 1998 and entitled "Update on the Federal
Reserve Swap Network," has been placed in the Committee's files.

9/29/98

though that was seen as a gradual process. That improvement was perhaps best evidenced by the
behavior of the stripped Brady spreads, which were fairly stable for a while. The realization that
contagion was still alive and well unwound a whole set of views and expectations that went back
a long way, and that shock clearly is capable of explaining the behavior of the financial markets.
The second hypothesis relates to the presumption that in all likelihood there would be
a G-7 bailout of Russia, and the implication was that if Russia was bailed out, everybody would
be bailed out. The evident failure of that to occur raised the question of whether bailouts are
back on the shelf, and the associated market disruption reflected an abrupt reassessment of risks,
which is captured in the very rapid changes that you mentioned. Of those two hypotheses, where
do you tend to lean or would you consider them not necessarily to be mutually exclusive but part
of the explanation for what occurred?
MR. FISHER. I would fall in your third category, and I'm glad you offered that
option to me. As you described it, Mr. Chairman, there was some sense of stabilization or
calming in late July when extreme movements in the Bradys and other securities seemed to
moderate. I think there was a hope at the time that the IMF program for Russia announced at
that point was going to tide Russia over. No one thought that program was going to be the last
word on Russia, but it was seen as a brief sign that things could be held together. Over-optimism
about that may have led some to double up their trades. In any event, when their confidence was
lost there resulted, through either of the channels you are suggesting, a bigger balloon to explode
or to collapse. That is, some nebulous force in the world of financial contagion was closing in or
the official sector did not have an answer. Bailout is an answer, but it is not a plausible one for
the whole world, as I think your second alternative was suggesting. It doesn't matter for
investors which of the two hypotheses you described is correct; both of them involve an extreme
loss of confidence. The market movement itself causes enough losses to concentrate the mind

9/29/98

and begin a delevering process. I must say, as a side note to this, that in a meeting in Basle
earlier this month, a number of my fellow central bankers discussed with me their view that
money does not disappear. I disagreed. When markets delever, money goes away and credit
comes in. In the macro sense, one can look at the Japanese money supply; money really is
disappearing in Japan. In a shorter-run sense, if the parties financing counterparties take away
the financing, borrower balance sheets shrink and in one sense money is disappearing.
CHAIRMAN GREENSPAN. Also, the asset values are essentially a psychological
evaluation of expected future earnings. If expectations change in the direction of weaker
earnings, wealth declines. It is not a zero sum game.
MR. FISHER. Absolutely.
CHAIRMAN GREENSPAN. Financial intermediaries can create money; they also
can "uncreate" money.
MR. FISHER. Financial wealth can be destroyed. Obviously, other people probably
have views on this very important question that you raised.
VICE CHAIRMAN MCDONOUGH. May I hazard an observation? I think one
lesson the market learned from Russia is that if there was any country the G-7 wanted to keep
from going into free fall, it was Russia because of the potential geo-political consequences. I
believe there is a general view that Russian behavior at the official level was so awful that it was
impossible for the G-7 to keep supporting such a country. That reminded people that even if the
G-7 is trying to do something, the host country has to be reasonably responsible in order to allow
the effort to go forward, much less to assure success. On top of the other things that you
suggested, Mr. Chairman, and that Peter has been discussing, I think this experience was a
reminder that even if the G-7 has its act together perfectly, it is limited by the host country's
willingness and ability to cooperate.

9/29/98

CHAIRMAN GREENSPAN. That is called sovereignty.
VICE CHAIRMAN MCDONOUGH. Yes.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. On the Russian situation, at least as regards people in the First
District, I believe their concern related more to the lack of a clear bailout in July, though I think
opinions have changed about whether that was a good or a bad thing. Obviously, people have
responded to the new stories and the rumors that the last tranche of money that the IMF put into
Russia quickly found its way out of Russia. I think they now have a better sense of the wisdom
displayed by the IMF in not putting in more money. But as far as the Boston markets were
concerned, to whatever extent they played into the general market trend, the trigger was the lack
of a Russian bailout, at least as people in our area tell me.
I know money can disappear along the lines that you talked about, but I do wonder
about some of these spread trades. Who is on the other side of them? Isn't somebody making
money on a bet that spreads will widen instead of narrowing? Do we have any sense of who or
where that might be?
MR. FISHER. I think one has to think of that in terms of the issuers or borrowers of
debt. That is, the role of the financial sector is to take on the financing requirements of people
actually building factories and the like. So, the other side may be those who issued bonds and
built factories and did so by borrowing on BBB or worse credit some time ago.
MS. MINEHAN. And they are paying off those loans now?
MR. FISHER. The borrowers made money. They borrowed at a good rate and they
built nice factories umpteen months ago. So, as I see it such borrowers involve a fair number of
those on the other side of these trades. It is not a zero sum outcome within the financial sector in
that sense.

9/29/98

MS. MINEHAN. Some of it may well be.
MR. FISHER. Yes, some people in the financial community undoubtedly are making
money on the other side.
MS. MINEHAN. These gains and losses used to be related to trade and now they
seem to be associated mostly with speculation.
MR. TRUMAN. They never involved trade! Seriously, Peter did not mention the fact
that the Federal Reserve Bank of New York is going to release its turnover survey today. If we
go back and look at the first such survey many years ago, we find almost precisely the same low
number, namely something like 10 percent or 15 percent of all the financial transactions are
traceable to real transactions. The multiplier essentially has been constant over the roughly 20
years that the Bank has been doing that survey. I don't think there has been much change, at
least on the foreign exchange side. One can assert that it is a Ponzi game, but I'm not sure it is a
bigger Ponzi game than it was 20 years ago.
MR. FISHER. Cathy, clearly there are trades where people on different sides make
money.
MS. MINEHAN. Somebody is benefiting from these lower yields.
CHAIRMAN GREENSPAN. I think it's important to understand the degree of
grossing up of the nation's balance sheet. That is, a fully consolidated balance sheet of the
United States would on the asset side have our gold stock and our net physical property accounts
plus net claims against foreigners; on the claims side all we have is equity. Grossing up by
including intermediation is a zero sum game. What is not a zero sum is the real assets. If we
have inventories of copper on the asset side of the consolidated balance sheet and the price of
copper falls, then equity on the right hand side falls. That is not a zero sum game; there has been
a real loss. The same is true if we evaluate the physical assets in terms of their market value,

9/29/98

essentially the discounted present value of expected future earnings of those physical facilities.
That number can change and that will change the equity side. That is not a zero sum game. But
all the grossing up by debt intermediation, which is a huge part of total assets and liabilities, is a
zero sum game. The only thing that is not is the market losses. But one person's market loss is
another person's market gain and that just washes out of the whole system.
MR. FISHER. Yes, I agree with your analysis, though my point to Cathy Minehan
was more limited, namely that initially we have to be careful to separate the financial sector from
those who borrow. We might call it the real sector for the moment. If we have had years and
years of IPOs and junk bond financing, the real sector has already taken its money and invested it
somehow. The financial sector is now faced with a collective writedown of the value of that
paper as the balloon is pricked. There will not be an offsetting gain within the financial sector
for every loss within the financial sector as the air comes out of the balloon.
CHAIRMAN GREENSPAN. We had some $15 trillion in equities issued in the
United States, the market value as of say last June, and we have lost $3 or $4 trillion of that
value. That is not a zero sum game. It has to appear somewhere as somebody's losses. It may
be a reduction in pension fund values or a loss by a bank that has made a loan to somebody who
owns those assets. It is going to show up somewhere, and we will not have a clue where that is
until we start to see third-quarter results. But I will tell you that it is going to start showing up in
places we do not anticipate, and the sense of nonzero sums is going to become very obvious.
MS. MINEHAN. I do not disagree with the nonzero sums. My point is that at some
level somebody has benefited from all this.
CHAIRMAN GREENSPAN. Yes, there are a lot of winners.
MS. MINEHAN. The other question I wanted to ask relates to the sharp rise in
volatilities. With regard to volatilities in the stock market, we have concluded on the basis of

9/29/98

some of the work we have been doing on mutual funds over the last two or three years that until
recently volatilities had been lower rather than higher than normal. We may be wrong about
that, but I am wondering where we are in terms of some normal level of volatility. I'm sure we
are still above such a norm, but are we as far above it as some of the recent volatility charts
show?
MR. FISHER. I'm not sure what data you are working with. I gather your study was
historical.
MS. MINEHAN. Yes, very long term. Our sense was that until very recently
volatilities, in stock markets in particular, had not been what they were, let's say, 10 years ago.
MR. FISHER. On an historical basis, working from the data in my head, I think that
is right. I have not compared the July 1 to September 15 period with other periods. What I was
showing you was implied volatility on equity and bond futures, which moved up sharply from
levels in prior months. Again, I do not know precisely what an historic comparison would show.
MS. MINEHAN. This level of volatility is not necessarily important in terms of its
immediate economic consequences, but I wanted to understand what the relationships were.
MR. TRUMAN. My impression of most of the work that has been done on this
subject over a long period of time is that volatility has not shown much trend in markets that are
well developed. Of course, we may have episodes of high volatility and that is what Peter has
pointed out. This is an episode in which we observe an extreme set of withdrawals from a large
number of markets. But that does not say anything, it seems to me, about whether we are on a
new trend.
MS. MINEHAN. I wasn't making a remark so much about trend as about what we
have been observing over the last three or four years in particular.

9/29/98

MR. TRUMAN. These things, it seems to me, give us six years worth of information
and they are all off the charts.
MR. FISHER. Dino Kos just gave me a specific reference that helps to illustrate the
point. I think the current level of implied volatility is double the historic; that is a very skewed
result. The rush to try to hedge in the options market has been making the options market, which
people rely on, very thin. So, I was focusing on that. That is a pithy point.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. I have a question for Peter Fisher or Don Kohn on a somewhat
different issue. The spread between 10-year Treasury bonds and the inflation-indexed bond has
narrowed very significantly. I think it has narrowed to a little over 1 percent. That is amazing
when we consider that the spread presumably includes the effects of expected inflation and
inflation risk. Is that due to a lack of liquidity in the inflation-indexed bond, and if it is, why
hasn't the market been selling the 10-year issue and buying the indexed bond in an effort to
reestablish a more sensible relationship?
MR. FISHER. Let me first discuss the mechanics. There clearly is a lack of supply in
relation to demand, whether it reflects a flight to quality or a closing of the spread trade. I think
a number of people in the market are now realizing that they have to shift their basic assumptions
about how to think about the Treasury curve relative to other credits. Supply is down, demand is
up, and they have to think of the Treasury curve in a different way. As I see it, they started
trading the indexed bond against an internal mental benchmark of how the normal 10-year bond
has traded over the last five years. The typical trader, I think, has a 5-year moving average of
recent experience in mind, if they are senior traders. The junior traders have a 1-year rolling
average! [Laughter] Traders started out with a presumption of how to price the inflation-indexed
bonds against their notion of a 5-year average of a normal yield curve, and there has been a

9/29/98

sudden shift in that norm, a break in behavior because of the heightened demand and reduced
supply. I think they're going to have to work that out. Don Kohn may have a more profound
answer.
CHAIRMAN GREENSPAN. There is an implicit forecast in that arbitrage of the
BLS's CPI over a long-term period. The question is whether we should treat that implicit CPI
forecast as a true reflection of the view of the inflation risk in the marketplace, assuming that the
CPI is measuring inflation accurately. It is not a supply/demand issue. If I seriously believe that
the CPI will average, say, 3 percent over the next 10 years, it would be like shooting fish in a
barrel to go buy that particular security with a 10-year maturity because it has an implicit
inflation risk of well under 2 percent. What are we to make of that?
MR. PARRY. That was my question!
MR. FISHER. I don't think you should interpret it as a good forecast. I don't think
that's what the market is doing. I think the trade you are suggesting is a very good one and
might be very profitable for you if you or anyone wants to make it at this moment. [Laughter]
MR. PARRY. When can we do that? After the end of the meeting? [Laughter]
MR. FISHER. The illiquidity of the indexed bonds is notorious. The dealers do not
like trading them.
CHAIRMAN GREENSPAN. Peter, it is not a trade! You buy it, and you put it away.
MR. FISHER. I agree with you.
MR. KOHN. I do think that the market has put a greater premium on holding liquid
assets in these very uncertain times. We can see that in the spread between Treasury securities
and federal agency securities, even the benchmark agency securities, which are extraordinarily
liquid. That spread has widened out by 15 basis points. The on-the-run, off-the-run Treasury
spreads also have widened out.

9/29/98

CHAIRMAN GREENSPAN. I was about to say that is a good case. This is the
extreme form of that.
MR. KOHN. This is an extreme. Peter Fisher and Bob Parry are right in the sense
that at least part of that decline in the spread between nominal and real rates and the
extraordinarily low level of the spread reflect not so much expected CPIs but the extra premium
on holding very liquid, nominal, on-the-run Treasury bonds. That premium has driven those
rates below what would be sustainable levels in calmer markets, consistent with expected
inflation and expected real interest rates. I do think it is sensible or potentially reasonable to
think that at least some of this decline in the spread--and it has been a fairly steep decline of
about 1/2 point or more since the middle of August--represents a bit of a markdown of inflation
expectations as economies all over the world have weakened and commodity prices have come
down. In these circumstances, it would be sensible to have some shift in inflation expectations,
even if the whole level looks very low and may be distorted. Our interpretation of this decline
was that it reflected the extra premium people were willing to pay for the liquid, nominal
Treasuries as well as some drop in inflation expectations. It seems logical.
CHAIRMAN GREENSPAN. Anybody else? Does anybody have any questions or
comments on the memorandum on the swap network? If not, would somebody like to move
approval of Peter's domestic operations?
VICE CHAIRMAN MCDONOUGH. Move approval, Mr. Chairman.
MS. MINEHAN. Second.
CHAIRMAN GREENSPAN. Thank you, without objection. We now move on to
Ted Truman and Dave Stockton.
MR. TRUMAN. What can I say after all the talk and ink that has been
spilled on international economic and financial developments since the
Committee's August meeting? It occurred to me that the Committee's

9/29/98

"central tendency" preference might be that I should shut up and get out of
here. My so-called international friends have caused enough trouble, and
you do not need any further explanations from me about the consequences
of external developments for the U.S. economy.
On the other hand, you may have noticed that our forecast for the
external sector of the U.S. economy has weakened further, although it has
not changed all that much from the one prepared for the August meeting,
before the Russian authorities lost their game of roulette with the domestic
and international financial markets and set off a global withdrawal from
risk. That may be surprising in light of the aforementioned spilled ink. It is
clear that our external forecast would have been different without the change
in our assumption about U.S. monetary policy and the calming influence,
even before its delivery, of the Chairman's testimony last week.
In brief, four factors have influenced our outlook for net exports in
different directions: Recent trade data have strengthened our near-term
outlook. Projected slower growth abroad and in the United States reduces
both our exports and our imports, but the former is more important than the
latter. A slightly weaker dollar tends to strengthen our exports and weaken
our imports.
On the first factor, U.S. trade data for June and July were stronger than
we had anticipated, leading us to reduce slightly our estimate of the negative
contribution of net exports over the four quarters of 1998. In the June data,
imports were weaker than we expected; however, this weakness brought the
second quarter as a whole more in line with our model estimates. In both
June and July data, we were surprised that exports, particularly of
machinery, did not fall as much as we had expected. In the Greenbook
forecast, we carried some of that strength through into the remaining months
of the quarter. However, in light of the August report on shipments of
capital goods that was released late last week and suggested weakerthan-expected PDE shipments in that month, we may well have overdone
our cautious optimism. On the other hand, there may well be some
remaining residual seasonality that will boost fourth-quarter exports that we
have not taken into account in our forecast.
Turning to the second factor, our forecast for growth abroad, which was
very weak to begin with, has been revised down again--by half a percentage
point this year and three quarters of a point next year. This is the major
reason why we now are projecting no growth in real exports of goods and
services between the second quarter of this year and the fourth quarter of
next year, in contrast with the 2-1/4 percent growth in our previous forecast.
In particular, for Latin America we have reduced growth by 1-1/2 and 2
percentage points this year and next, respectively, in reaction to the reduced
access of countries in this region to credit in international capital markets

9/29/98

and to interest rates that have been elevated in defense of their currencies.
In particular, we have negative growth this year and next in Brazil and
Venezuela, negative growth this year in Chile, and negative growth next
year in Argentina. We are assuming that Brazil will adopt a program that
involves significant fiscal tightening and a depreciation of the Brazilian real
with negative short-run effects on Brazilian growth, but our base assumption
is that these adjustments will be relatively orderly and will not push the
Argentine peso off its peg.
With respect to Asia other than Japan, we have reduced slightly our
already very weak outlook. There are a few signs of a bottoming out of
economic activity in Korea--ask the U.S. steel industry--and Thailand, but
not enough to lead us to alter our basic outlook.
Turning to the industrial countries, we have not altered our basic view
of the weak outlook in Japan. We had anticipated the cut that occurred
earlier this month in the Bank of Japan's target for the overnight rate. The
official release on second-quarter growth suggested that activity was not
quite as weak as we expected, largely because of a sharper-than-anticipated
decline in real imports. We expect the third quarter to record a fourth
consecutive negative quarter, in part because of delays in the
implementation of the program of fiscal stimulus. We now anticipate that
more of the effects of that program will be felt in 1999.
We have weakened our outlook for the other foreign G-7 countries
more significantly in light of the deterioration of global financial conditions,
spillovers from Russia, Eastern Europe, and Latin America, and in the case
of Euroland, a stronger currency that has affected our outlook for Germany
in particular. This deterioration occurs despite significant changes in our
assumptions about monetary policies in these economies. In the United
Kingdom, we now assume that interest rates will decline by 125 basis points
by the end of 1999, to a level 150 basis points lower than we assumed in
August. In Canada, interest rates are assumed to decline in line with U.S.
rates, but with a longer lag and from the elevated level to which the Bank of
Canada pushed them in late August. In Euroland, we assume that short-term
rates converge to the current German level by the end of the year and remain
there through the end of the forecast period, in contrast to the assumption in
the August Greenbook of a rise of 75 basis points over the course of 1999.
We have not assumed that the outcome of the German election will affect
policy or the economy during the forecast period; it remains to be seen if we
will be right.
With respect to monetary policy in Euroland, it is clear that right now
euro-area central bankers do not want to lower interest rates below the
current German level before the European system of central banks becomes
operational on January 4, 1999. However, in considering how attitudes may
change going forward, I found it instructive to consider how the outlook for

9/29/98

growth in Euroland has changed over the past 12 month . Using our own
forecasts for the G-7 members of the Euro area as a proxy, our current
forecast for growth over the four quarters of 1998 is lower than we thought
it would be a year ago by three tenths in France, four tenths in Germany, and
one percentage point in Italy. Moreover, contrary to European protestations
that the Asian crisis has had little effect on Europe, our estimate of the
contribution of net exports is half a percentage point lower for Italy, 1-1/4
points lower in Germany, and 2-1/4 points lower in France. As the Europeans
have pointed out, they have had a positive surprise on domestic demand,
leading to caution about monetary policy easing in Frankfurt--both at the
Bundesbank and at the ECB. Nevertheless, if the euro should appreciate
against the dollar by more than the roughly 10 percent that we are projecting
from the second quarter of this year to the fourth quarter of next year, we
could well see a reduction in interest rates before we see an increase.
With respect to my third factor, U.S. economic activity, the downward
revision to U.S. growth, despite our changed assumption about U.S.
monetary policy, is the major factor behind our projection of somewhat
slower growth of imports of goods and services.
Fourth, the dollar has weakened a bit more than we expected over the
intermeeting period, primarily against the major foreign currencies. We
expect the dollar to continue to decline on average during the forecast
period, reaching roughly the same point by the end of 1999 in terms of our
real 29-currency index as we had projected in the August Greenbook. This
forecast seems reasonable with respect to the major currencies, given the
roughly parallel adjustment in our monetary policy assumptions here and
abroad. However, the slightly weaker dollar in the near term tends to
strengthen our outlook for exports and weaken our outlook for imports a bit.
The combined influence of these forces on our outlook for real net
exports is to weaken it somewhat further, but not by a huge amount.
However, the risks over the forecast period as a whole remain skewed to the
downside. Moreover, in thinking about Federal Reserve policy in this
context, the issue is not simply one of how developments in the rest of the
world will affect us. Under current circumstances, the size of the potential
linkages from Federal Reserve actions or inactions to the rest of the world
and back onto the U.S. economy appears to have been magnified.
Dave Stockton will complete our report.
MR. STOCKTON. The changes in the international environment just
sketched out by Ted Truman were important elements in the alterations that
we made to the Greenbook forecast. However, as you know, we also have
had to contend with the noticeably more negative domestic financial
conditions of the past month or so. The stock market has dropped roughly
5 percent over the intermeeting period and, as Peter Fisher noted, volatility

9/29/98

has been high. In fixed-income markets, yields on investment grade debt
have only edged down, despite the sharp drop in rates on comparable
Treasuries, and yields in the junk market have risen steeply. Moreover, our
special survey of senior loan officers revealed that large banks have shifted
from a somewhat accommodative to a more restrictive posture for business
loans in recent weeks. Clearly, there has been a pulling back in financial
markets that appears to be part of a reassessment of economic prospects and
a repricing of risk.
These developments seem likely to leave an imprint on economic
activity in coming quarters, and they would have had a more pronounced
effect on the top line of our forecast had we not altered our policy
assumptions. After your conference call last week, we decided to abandon
our assumption of an unchanged federal funds rate in favor of a decline
amounting to about 75 basis points by next spring--an assumption not far
from market expectations. By our reckoning, this path for the funds rate
will help to limit the shortfall in activity next year and to restore growth to
potential in the latter half of 2000, with the unemployment rate flattening
out at about 5-1/2 percent--roughly our estimate of the NAIRU.
With activity projected to drop from the 3 to 3-1/2 percent pace of the
past couple of years to a rate of about 1 percent in the first half of next year,
it's natural to ask, "how do we get there from here?" I should begin this
discussion by admitting that there is little in the incoming nonfinancial data
that is currently signaling the weakness that we expect to emerge by
year-end. Indeed, the information that we have received over the past
month left the starting point for this forecast very similar to that of the
August Greenbook--which is an economy that continues to show
considerable forward momentum, led by strength in domestic final demands.
In that regard, last week's reading on consumer spending for August
confirmed our view that, but for a slump in outlays for motor vehicles in
response to the GM strike and the end of the coupon incentive programs, the
growth of real PCE this quarter would have nearly matched the phenomenal
gains of the first half. And by most reports, motor vehicle sales are
rebounding smartly as supply constraints ease and manufacturers sweeten
incentives. Housing starts, though off a bit in August, remain at an
exceptionally high level, with mortgage applications for home purchases
and builder attitudes suggesting continued strength over the near term.
In the business sector, the figures on shipments of capital equipment,
which we received after the Greenbook was completed, were marginally
weaker than we had incorporated in the projection. But the underlying
growth in new orders points to reasonably healthy gains in equipment
spending in coming months--especially in the high-tech area. And, given
the low level of initial claims, businesses apparently are hiring at a brisk
pace. All in all, it's still a pretty strong picture.

9/29/98

That said, there are a few straws in the wind that hint at some downshift
in the pace of the expansion. Increases in payroll employment in July and
August, on net, fell below the gains of the first half, with pronounced
weakness evident in the factory sector. That weakness is consistent with
industrial production which, excluding motor vehicles, has been flat since
May. Reports from purchasing managers, anecdotal information, and the
slump in commodity prices seem to be pointing to a continued sluggish
manufacturing performance--a view that receives support from the recent
declines in weekly steel production. The preliminary reading on consumer
sentiment from the Michigan survey for September also slipped some, with
households citing the stock market and foreign developments as contributing
factors. The Conference Board survey, released this morning, fell to its
lowest level this year. At this point, it's simply too early to tell whether
these shreds of evidence are just statistical noise or the harbingers of
slowing activity.
Clearly, in our projection we see a number of the factors that boosted
production earlier in the year acting to restrain activity later this year and in
early 1999. One of these is nonauto inventory investment, where we think a
further reduction in the pace of accumulation will be necessary to prevent
imbalances from developing. The reduced pace of stockbuilding is expected
to lop off more than 3/4percentage point from the growth of real GDP in the
second half.
But the real action in the forecast follows from the sharp slowdown that
we are projecting for private domestic final demands. That slowdown
results not only from the waning of positive financial influences that
propelled growth previously, but their partial reversal in many cases. With
corporate earnings expected to continue sagging in coming quarters, we
anticipate that equity prices will decline still further. High and rising equity
values no doubt contributed importantly to the six percent annual rate gains
in consumption in the first half of this year. Over the next few months, this
stimulus should dissipate, and the past and prospective decline in household
net worth should begin to cut into spending. Housing starts also received a
boost from higher stock prices as well as from a strong job market and
declining mortgage interest rates. Although we expect mortgage rates to
hover around their recent lows, the drop in stock prices and the slower
income and employment growth that we are projecting should turn housing
from the considerable plus observed in 1998 to a modest negative in the first
half of next year.
We do not anticipate business fixed investment to escape this period
unscathed. A less favorable external financing environment, a slowing in
cash flow, and diminished sales expectations seem likely to leave a clear
mark on investment plans as we move into next year. These forces will be
intense in the manufacturing sector, where continued declines in export
demand and heightened import competition will slow the desired rate of

9/29/98

capacity expansion. Financing difficulties are expected to be notable for
office and other commercial construction projects. Although these
negatives result in a deceleration of fixed investment from the heady pace of
recent years, capital outlays are still expected to outpace growth in real
output. Declining relative prices and associated rapid technological changes
should continue to provide support for capital spending.
Taken together with the continued drag from the external sector, we
expect these influences to hold growth of real GDP to about 1 percent in the
first half of next year. Thereafter, the lagged effects of our assumed easing
of monetary policy, the slight decline in the real exchange value of the
dollar, and the gradual recovery in foreign economies combine to provide
some lift to real activity. Abstracting from a few highly speculative
wrinkles that we have incorporated to account for possible Year 2000
percent in the second
effects, growth in real GDP increases from about 1-3/4
percent in late 2000.
half of next year to about 2-3/4
There are, as usual, substantial risks to this forecast. We highlighted in
the Greenbook the consequences of alternative scenarios for the stock
market and for international developments, largely because we continue to
see these areas as posing the greatest risks to the forecast. This morning, I
thought I would mention a couple of other risks to the outlook.
On the upside, there simply may be more near-term momentum to the
economy than is contemplated by our projection. As I noted earlier, most of
the incoming economic indicators have remained upbeat of late. And while
we expect the economic news over the next month or so to remain fairly
bright, forward indicators will need to show a considerable softening before
too long in order to be on track for our first-half slowdown. Given the
resilience that the U.S. economy has exhibited in this expansion and, at least
until recently, the basically sound fundamentals, household and business
spending plans may prove more durable than we have projected. This
upside risk would be further amplified if the negative sentiment that has
gripped financial markets in recent weeks were to be substantially alleviated
by an easing of policy. We don't see that as the best bet, but it is a
possibility.
On the downside, there are always risks associated with negotiating a
slowdown in aggregate demand of the dimension included in our forecast.
Despite the sharp downshift in growth that we are projecting for the first
half of next year, this forecast can still be characterized as one in which the
economy achieves a "soft landing." By that I mean that in our projection
firms, by and large, foresee the softening of demand and adjust production
promptly, preventing the imbalances in inventories, in capital equipment,
and in workers that have tipped slowdowns into recessions at times in the
past.

9/29/98

Finally, I don't have much to add to our Greenbook discussion of the
outlook for wages and prices. The inflation projection and its determinants
have changed little since the last meeting, and we continue to be on the low
side of the consensus. Consumer prices are projected to pick up some next
year. After declining sharply this year, both oil and non-oil import prices
turn up in 1999, and labor markets will be tight through the middle of 2000.
Nevertheless, we believe that there will be some important factors limiting
the deterioration in inflation. Weak demand and ample capacity in the
factory sector are expected to result in further declines in capacity utilization
rates, and that should help keep a lid on goods prices.
In addition, we expect that growth in hourly compensation will soon
level out and then drift lower over the projection period. We expect this
restraint on nominal pay gains to come from both the supply and the demand
sides of the labor market. On the demand side, with profit margins under
pressure and the climate inhospitable to price increases, firms are likely to
resist outsized pay increases. Moreover, some forms of flexible pay should
decelerate. Certainly, bonuses in the financial industry are not heading for a
banner year. On the supply side, even though unemployment remains low, a
rising jobless rate may trim pay demands if latent worker insecurities
resurface. But perhaps most importantly, the drop in inflation this year and
the attendant ebbing of inflation expectations are anticipated to help
perpetuate the current low-inflation environment.
Mr. Chairman, that completes our presentation.
CHAIRMAN GREENSPAN. Thank you. Questions from my colleagues?
MR. PARRY. I have two questions. Ted, it seems to me that our international
assumptions are now fairly close to the worse case scenario that was presented to us last year in
terms of the real impact on the economy. Would it make sense to think in terms of a worse case
again, and what would be its probability? Do you have any thoughts about where the risks are in
terms of such a forecast?
MR. TRUMAN. In preparing for this meeting, I looked back at the work that we did
on a worse case scenario late last year. In one sense, we are close to the worse case, but it has
taken a different form. The sense in which we are close is essentially in that the total impact on
the U.S. economy is commensurate with it. It has taken the form, however, of the deeper
recessions and problems in Asia including Japan and no spread to Latin America. We had in our

9/29/98

worse case scenario a generalized spread to Latin America. It is a little embarrassing to say so at
this time, but this proves the less than reliable nature of forecasting. We had no growth in Asian
economies last year in our worse case scenario and also no growth in Latin America. We now
have positive growth on average in Latin America and negative growth in the Asian economies.
So, we are close to our worse case forecast, but we have a slightly different mix.
I think that outcome also points to the second part of your question about where these
foreign economies are heading. I probably should have said this in my oral presentation. Our
outlook for Latin America is quite gloomy and is much gloomier than I think anyone will see in
other forecasts. That may just be because we did ours three days ago, and most of the others you
have seen were done three weeks ago. But as was pointed out in the Greenbook, we made a
rather modest adjustment. I always find it easiest to think about current account deficits, at least
in terms of our own economy, by calibrating them on the basis of how large an adjustment in the
deficit goes with everything else that is happening in the economy. It gives me a shorthand way
of assessing how big the impact is on the United States. The answer there is that in our forecast
we only cut the current account deficits of Latin America in half from where we had them last
year. We are still assuming that the major countries in Latin America can finance $30 billion
current account deficits rather than $60 billion deficits. It is easy to envision, especially in light
of what has happened in Asia, that the number could be zero or a $30 billion surplus without any
stretch of the imagination. I think that will be the next aspect of this.
One other point about Asia is that our 1998 forecasts for China and Singapore are
about the same as they were earlier. It is the affected economies in Asia that were much weaker
than we had them before. But clearly in Latin America and, I think, in eastern Europe and
Russia--which are not as important to our economy as to the economies of Europe as I tried to

9/29/98

illustrate in my little story about our forecasts of the G-3 nati ns within Euroland--there clearly
has been a big impact.
The interesting development is our forecast. I did not go back and look at it, but I
believe our U.S. forecast for 1998 even now is probably stronger than it was a year ago.
Interestingly, our Euroland forecast is slightly weaker than we had it last September. The Euro
area has taken a very large hit on the external side. This suggests, I would think, that there is a
risk of some substantial cumulation on the downside. Now, we could talk ourselves into being
too gloomy about these things.
MR. PARRY. Sure.
MR. TRUMAN. It is useful to think about worse case scenarios, but worse case
scenarios do not always come true. Let me just end on that point.
MR. PARRY. I have a question for Dave Stockton. The assumption in the forecast is
that the saving rate remains basically constant at one half percent. That seems a little surprising
given what happens to the equity market and particularly with the coefficient that you have in
terms of net worth. I presume that what is happening is that the weakness in the equity market is
being offset by such things as lower interest rates, which stimulate consumption. Would you
say that your forecast that the saving rate will not be moving up as a result of the assumed
decline in the stock market might be a downside risk to the outlook?
MR. STOCKTON. There is some downside risk there. I think the size of the stock
market correction we have in this forecast, taken by itself, would have been expected to boost the
saving rate by at least a couple of tenths. I should point out that one of the things that keeps the
saving rate down is that we do have some offset coming from lower interest rates, and we do
have some offset coming through when income growth slows below its permanent rate. That
helps to hold up consumption a little.

9/29/98

MR. PARRY. I see.
MR. STOCKTON. But I think there is some downside risk there as you suggest.
MR. PARRY. Thank you.
CHAIRMAN GREENSPAN. President Stem.
MR. STERN. Thank you. Ted, I would like you to elaborate a little on Brazil and the
risks there because I have the sense that at least some in the international financial community
are trying to draw a line in the sand with regard to Brazil. Yet, while you said you were
expecting the Brazilian real to depreciate, you are expecting that to proceed in an orderly way.
Obviously, it is not hard to imagine something much worse happening.
MR. TRUMAN. When we do these forecasts, there is a tendency to be at least slightly
conservative. There are so many different scenarios that are possible for Brazil. We took a sort
of average of what we felt was a reasonable set of scenarios in which we assumed that the
Brazilians basically have three problems: they have a fiscal problem; they have a banking
problem; and they have a competitiveness problem. We are assuming that these problems are all
somewhat interrelated. If they address the fiscal problem that will be enough to avert a complete
loss of confidence. Although the exchange rate may have to give, it may give in a way that
either is a discrete devaluation followed by a faster rate of crawl or simply a faster rate of crawl
so that by the end of the period, the real will be at a level that by one rule of thumb appears to be
sustainable. One indicator suggests that the currency may be 15 percent overvalued. So, the real
could get down to an acceptable level without too much of an adjustment.
I'm not sure what you mean by drawing the line in the sand, unless you mean drawing
the line in the sand in terms of the exchange rate itself?
MR. STERN. Yes.

9/29/98

MR. TRUMAN. I think that is one of the problems with these situations. Brazil has
an election on Sunday, so I don't imagine that the president of Brazil is going to say they are
about to devalue. Nor do I think they want to devalue. They actually may be considering a
widening of the band. Setting a faster rate of crawl is not as much of a problem as a devaluation.
They might want to talk themselves into that, maybe correctly. It did seem likely to us as we
prepared our forecast that there would be a devaluation or some adjustment of their exchange
rate over the period. But since we did not know when it was going to come, whether it was
going to come tomorrow or next week or the week after that or in January, and whether it was
going to be discrete or gradual, we put it in as being at the desired level a year from now. We
drew a straight line between its pre- and post-devaluation levels so that it did not drift around
during the forecast period. I think there are very sizable downside risks. The worse the scenario,
the more likely obviously it could have ripple effects not just in Latin America but elsewhere.
CHAIRMAN GREENSPAN. Any further questions?
MR. HOENIG. Ted, I have a question on Europe. Some of the discussions that I have
heard in terms of whether Europe should lower its interest rates are that as they move toward
convergence, their interest rates are coming down in effect. Do you agree with that?
MR. TRUMAN. Yes, and that has been in our forecast. On that point, we have
tended to be somewhat more optimistic all along. That may not have been the case initially
when we probably had convergence at a higher level. Fairly early on, however, we had
convergence at the relatively low French and German level and the beneficial effects of that on
the Euroland economies. I don't want to minimize the actual problems that they have had.
There are two groups of countries. Italy, where the actual performance of the economy is not so
great, is lowering its interest rates. One could argue that is not so bad, but that gets everyone
involved in the fiscal fights that they are having. Then we have the other group of countries that

9/29/98

have higher interest rates because they want to pursue tighter monetary policies. The question
then is, what about France and Germany? At the moment, there is no reason for them to panic,
and I'm not sure that I necessarily would panic. In my view it is a little foolish to say that there
is no way one can imagine why they would need to lower interest rates. In some sense, our
forecast does have them lowering interest rates. It's just that by not having an increase in interest
rates associated with a boom condition in the wake of EMU, we now have them with unchanged
interest rates. The rate differential in this forecast in some sense is not that much different than it
was in the last forecast.
MR. HOENIG. Thank you.
CHAIRMAN GREENSPAN. Further questions from anyone? Who would like to
start the roundtable? President Moskow.
MR. MOSKOW. Thank you, Mr. Chairman. Since our last meeting, economic
prospects at home and abroad have changed considerably, yet much of the data that we typically
use to gauge the forces at work in our economy have changed only marginally. In some respects,
conditions in the Seventh District remain little changed since mid August. Growth in the
manufacturing sector has continued to slow though levels of activity remain high. Labor markets
are still tight and price pressures remain benign. However, the depth and the breadth of actual
and anticipated impacts of international developments in our District economy now seem greater
than they did only a few weeks ago. I think it is fair to say that many of my contacts are much
more nervous about the future than they were in August. For example, in the manufacturing
sector we increasingly hear reports of weakness even among firms with little direct international
exposure. The strength that we do see is limited primarily to housing-related industries.
Although the Chicago Purchasing Managers' composite index indicates renewed strength in
September, we believe this largely reflects a rebound from the GM strike. Furthermore, the

9/29/98

report shows little rebound in the September new orders index, pointing to future additional
slowing. This index is confidential until 9:00 a.m. tomorrow morning.
District steel manufacturers are being adversely affected by increased U.S. capacity,
significantly increased imports, and softening demand in some market segments. A major
producer of corrugated boxes reported that demand for boxes from manufacturers has declined
significantly in the last several months. Further, several members of our Advisory Council on
Agriculture, Labor, and Small Business reported that among some District manufacturers,
earnings and new orders had declined, overtime shifts were being cut back, and layoffs were
likely if export orders did not recover soon.
In contrast, contacts in the auto industry remain upbeat about U.S. sales prospects.
After averaging only 14.1 million units in July and August, light vehicle sales seem to be running
at around 14-3/4
million units in September, with Big Three projections for the fourth quarter
around 15 million units. Outside of light vehicles, the retailing picture is somewhat mixed.
Michigan retailers surveyed through early to mid-September report no deterioration in current
sales or in expectations about sales three months ahead. However, one large national retailer in
our District reports that sales of big ticket items have slowed week by week in August and
September and that the softening trend in electronics and other durable goods has worsened.
Sales of this retailer at stores located in small and mid-sized towns where they face little
competition also have softened considerably. Similarly, a large trucking firm in our District
reports that shipments to retailers are not as strong as expected for this time of the year. Another
weak spot is our ag sector, which continues to be hurt by low commodity prices, large crop
yields, and declining export demand. Sales of agricultural equipment have dropped enough to
generate plant shutdowns and layoffs at some District plants.

9/29/98

On balance then, I see our District's expansion continuing at a slower pace than I
reported in August, though with little easing of the tight labor markets we have had for some
time. Competitive pressures still limit the ability of firms to raise prices. Among our business
contacts I also see greater uncertainty about the future and some declines in confidence.
Turning to the national economy, at our last meeting I thought that the risks, though
close to balanced, remained greater on the upside. Since then, however, virtually all the news
has suggested a weakening in the prospects for real economic growth and less risk of a
significant increase in inflation. International financial instability has begun to have significant
effects on the economies of Latin America, as has just been mentioned, which likely will reduce
the demand for our exports even further. The continued decline in U.S. equity prices appears to
be showing through to consumer confidence, which threatens growth in consumer spending.
Despite the decline in Treasury interest rates, financial turbulence seems to be threatening the
access of at least some firms to capital, and that may take much of the steam out of the great
burst of investment spending we have had in this expansion.
Our projections do not show as sharp a deceleration in growth as in the Greenbook,
but we do see a period of growth somewhat below potential next year. To be sure, with labor
markets still very tight, the threat of increased inflation has not disappeared. Indeed, we still
expect some pickup in core inflation next year, but the balance of risks has shifted noticeably
toward the downside.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Mr. Chairman, solid overall economic growth continued in the Twelfth
District in recent months, although the pace slowed from earlier in the year. Between June and
August, District payrolls expanded by 2.3 percent at an annual rate, down from the 3 percent
pace of the first half of the year. Construction and services as well as finance, insurance, and

9/29/98

real estate continued to grow rapidly in recent months. However, the District's manufacturing
sector has not fared as well. Reduced export demand and a more general slowdown in high-tech
manufacturing have led to a significant weakening overall in manufacturing. District
manufacturing employment has contracted slightly so far this year after rising 3.7 percent in
1997. The deceleration in manufacturing has been concentrated in California, with
manufacturing employment falling 1/2 percent so far this year. While many sectors of
California's manufacturing have slowed in 1998, producers of high-tech products have been
particularly hard hit. However, employment growth in high-tech software and business services
remains strong.
Turning to the nation, the outlook for economic activity has deteriorated since we met
in August largely because of a continued decline in our stock market and a worsening outlook for
growth in the rest of the world. Under the assumptions of an unchanged federal funds rate and
no further change in the stock market, we have lowered our forecast for real GDP growth for the
remainder of this year and 1999 by 1/2 percentage point to only 1-1/2 percent. I actually see risks
on both sides of this forecast. On the upside, the economy has consistently outperformed most
forecasts for the past three years. On the downside, of course, the stock market is still
overvalued according to most models. In addition, it is possible that the expected economic
performance of the rest of the world could be even worse than we all have been forecasting and,
of course, we cannot rule out future shocks in financial markets. Real GDP growth in the
neighborhood of our forecast, we believe, would help to ease tight labor markets, and this would
reduce the risk of higher inflation in the future. Under our forecast, upward pressures from labor
markets would moderate over the next couple of years. Moreover, any pressures from this
source most likely would be offset by diminished inflation expectations, the higher dollar, ample
industrial capacity, falling commodity prices, somewhat higher trend productivity growth, and

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negative speed effects as the economy slows. As a consequence, our forecast shows inflation as
measured by the core CPI falling from 2-1/4 percent this year to about 2 percent in 1999, and then
going below 2 percent in 2000. Overall, since we met in August the risks of higher inflation
have receded, while the downside risks for the real economy have increased noticeably.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. Thank you, Mr. Chairman. Not a lot has changed in New England
during the intermeeting period. The regional economy continues to expand nicely, with
respectable job growth vis-a-vis the nation's and very low unemployment rates. Labor markets
remain very tight despite August job losses in three of our states and anecdotes abound about the
difficulty of finding qualified workers even at the entry level. However, signs of potential
weakness have grown as well. Manufacturing jobs declined in four out of the last five months,
though there has been some small year-over-year growth in this job category in contrast to the
nation as a whole. Regional merchandise exports declined in the second quarter, though not as
steeply as in the first quarter. The largest falloff occurred in exports to South Korea. Exports to
Japan, Taiwan, and Singapore were also below year-ago levels as were exports to the United
Kingdom and the Netherlands, but exports from our region to France and Germany were
considerably higher.
Uncertainty about the future is greater than earlier this year. Manufacturers see
problems now and in the near future while retailers are less concerned about the near term but
see downside risks six months off. Volatility in the financial markets has affected regional
commercial real estate trends. The greater Boston commercial real estate market remains strong,
with rents of about $30 per square foot, adding together markets inside the city and suburban
markets closely related to Boston. However, downtown Class A space is now priced above $40
a square foot and vacancy rates are below 4 percent. But as REIT financing has moved from

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equity to debt markets, as investors have demanded higher yields on paper backed by
commercial real estate, and as banks have tightened lending standards, new and existing real
estate deals have come under increased pressure. In greater Boston and some areas of
Connecticut, about half of 20 recent office building deals are being renegotiated. Financing has
not totally dried up, but it has become more expensive as lenders raise their rates to match the
demand for increased yields in bond and syndication markets.
Since the period of market volatility in mid-August, I have been regularly canvassing
the CEOs of the region's major banks, one of our insurance companies, and a major mutual fund
to determine first-hand how they see their own business risks and the risks facing markets more
generally. These conversations have served to underline three themes that seem interesting to
me. First, despite worldwide market volatility, flight to quality, and disclosures of losses,
settlements in global markets have been largely unaffected. The CEO of one major global
custodian, which settles in more than 50 countries daily, indicated that he believes the changes in
settlement practices brought about by the events of October 1987 have enabled markets around
the world to withstand this period of instability, at least so far. The only problem that his firm
has experienced is related to settlements involving Malaysian securities. With the imposition of
currency controls in Malaysia, there were distinctions drawn between residents and nonresidents.
Those have prompted the introduction of rather complicated administrative measures. But that
is something his firm is well capable of handling.
Second, the CEO of the region's one major global bank commented on the recent
widening of spreads and what he sees as a rather significant drying up of liquidity in all markets,
the same phenomenon we have seen in our tables and charts on spreads. In that bank's view, the
widening of spreads has been exacerbated at least to some extent by some of the supervisory
letters on credit standards. Those letters have been interpreted as a warning about REITs or

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cautioning about REITs and what the bank sees as an unexplained downgrading by the OCC of
shared national credits. Finally, the bank is especially concerned about market turmoil in Brazil
and Latin America more generally. This bank traditionally has benefited from a flight to quality
during periods of financial turmoil in Latin America and regards their own positions as more or
less devaluation proof, but their concerns are heightened nonetheless.
Finally, while all those contacted believe the current market retrenchment is overdone,
they also believe that spreads were far too narrow previously. So, in some sense they regard the
financial market conditions as in part a return to more normal spreads in the markets, though
there clearly is a concern that the attendant deleveraging will have a near-term contractionary
effect. Those organizations that are publicly held have seen a sharp deterioration in the value of
their stocks in the market, though they admit that the four to five times earnings reflected in
previous market valuations probably was a bit high. Moreover, institutions that have a track
record of growing by acquisition see a time of potential opportunity, with the prices of smaller
banking and financial institutions becoming more realistic. Clearly, even the ill winds of global
financial insecurity may blow some good fortune to those who are positioned to recognize it.
On the national scene, we have little to quarrel with in the Greenbook's forecast for
1998 and early 1999. However, we and other forecasters are not as pessimistic as the Greenbook
about the full year 1999. We see a bit higher growth, lower unemployment, and a small pickup
in inflation even without the easing of monetary policy embodied in the Greenbook forecast.
These differences result from several factors. We have not built in a further drop in stock market
prices from current levels. Our estimate of the economy's potential is somewhat lower, resulting
in more pressure from tight labor markets. Our assessment is that given profit pressures, wage
increases will begin to show through more directly into prices. However, this estimate is fraught
with risk, and I must say that we are very humble about our ability to forecast inflation trends in

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particular. I am not at all sure that we fully accounted for either the contractionary effects of the
current credit squeeze or the feedback effects of low inflation on future prices. Also, I must
admit to finding the pessimistic international scenario at the end of the Greenbook more
reflective of my personal assessment of a likely external outcome. Thus, I think the risk to the
Bank's forecast and possibly to the Greenbook's as well is decidedly on the downside despite
relatively upbeat domestic conditions currently.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. The Eleventh District economy continues to perform at a healthy
level, although it is retreating from the strong growth we saw earlier in the year. District
employment picked up slightly in the first two months of the third quarter after a weak second
quarter. The pickup is masking a tale of two economies: a strong service sector and a softening
goods sector.
Southeast Asia effects continue to accumulate, especially in the energy and
semiconductor industries. Low oil and product prices are harming the energy industry. Lower
demand from Asia has worsened the excess supply problems in the oil market, keeping prices
below $15 per barrel for much of the summer. Drilling has declined dramatically, especially for
oil. Our directors report that wells are being shut in and rigs stacked. Not many new pickup
trucks are being bought in West Texas these days! We haven't seen too many layoffs yet
because companies are reluctant to part with the skilled workers they worked hard to recruit in a
very tight labor market. However, if oil prices stay at or below $15 too long, we will begin to
see the layoffs accelerating. Our directors in the energy industry expect the supply overhang to
continue and oil prices to remain weak for the foreseeable future. Petrochemicals felt the fallout
from the Asian crisis early, and the inability to export to Asia has placed substantial downward
pressure on chemical prices all year in spite of strong domestic demand.

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The semiconductor industry continues to feel the effects of Asia. Some semiconductor
plants are closed in our area, and we continue to hear intermittent layoff announcements. All
segments of the semiconductor business show declines except for digital switch signal
processors, which have seen 5 percent growth year over year. However, some people in the
semiconductor industry feel that it may be at or near the bottom of its recession right now. Most
regional high-tech firms were battered in the stock market decline. Some smaller Austin firms
have put off going public because of the gyrations in the stock market and have scaled back their
expansion plans.
Texas exports have felt the pains of a weak Asia and a strong dollar. Exports have
been falling throughout the year, but the decline accelerated in July. The current Beigebook also
suggests continued weakness in exports of petrochemicals, primary metals, liner board and other
commodity paper, plastics, and semiconductors.
The construction industry has been one of the bright spots in our District, propelling
our high employment growth. But it, too, is showing some signs of softening lately. Singlefamily housing has been the hottest sector, but we are seeing a slowing in sales of new homes.
Housing inventories are still slim, though. On the office side, industry contacts are wondering
whether the market has reached its peak. They note that although absorption remains good, rents
are not rising as rapidly as earlier. Financing has dried up recently for a variety of commercial
projects. REITs and insurance companies have scaled back their operations, citing the stock
market slump and the flattening of the yield curve. Contacts tell us that some banks are not
lending because of tougher lending standards even though they have the money.
Our most recent Beigebook report shows that the price picture has turned deflationary
in several sectors. Weak international demand has continued to add to growing supplies and
falling prices. We see price declines in gasoline, petrochemicals, oil and gas services,

9/29/98

semiconductors, computers, primary metals, paper and paper products, and softwood lumber.
Although wage pressures remain prevalent, they are not being passed forward to consumers
because low input costs are offsetting any increases in wage costs.
On the national and international fronts, the risks have risen sharply in emerging
market economies, and the exposure of the United States to these risks has increased. The
United States is increasingly vulnerable to the effects of trade deterioration because the stock
market is no longer driving U.S. consumption and investment. The real economy shows
continued moderate growth, but the downside risks are increasing. Manufacturing is showing
increasing signs of weakness in the face of falling foreign demand and increasing competition
from imports. The manufacturing sector has lost 53,000 jobs per month so far in the third
quarter. Employment growth in the payroll survey slowed slightly in July and August.
Employment growth in the household survey is much weaker. There are signs that consumer and
business spending will weaken from here on out. Consumer confidence has fallen off. The most
recent Purchasing Managers' survey painted a weakening picture for manufacturing. Export
orders were the main source of weakness. The Michigan survey of future business conditions
has deteriorated markedly since the spring. The attitudes expressed by our boards of directors
were very consistent with the survey's depressed outlook. The El Paso board was especially
gloomy, reflecting a region hit by lower oil prices, drought, and a softening outlook for Mexico.
On the financial side, the stock market is down roughly 15 percent since the record
highs posted in July. The yield curve is now inverted. These indicators are telling us that real
economic weakness lies ahead. While most risks are on the downside, there are some upside
risks as well. Medical and housing costs are on the rise, and M2 growth has accelerated and is
well above FOMC bounds for the year. However, the downside risks far outweigh the upside
risks primarily because of the international problems. A monetary policy that is effectively tight

9/29/98

is detrimental to both domestic and global economies. The risks of Asian contagion are real.
Low commodity prices and a strong dollar continue to batter the Latin American economies.
Asian contagion to Brazil is the most worrisome for us in part because it has the potential to spill
over to the rest of Latin America including Mexico. Recent history suggests that small or
moderate devaluations, as was discussed earlier for Brazil, are very difficult to implement these
days.
I concluded my statement at the last meeting by saying that in terms of the global
context and our position in the world, I thought it was time to get ahead of the curve by easing
monetary policy. I still think so, although it's probably too late to get ahead of the curve.
[Laughter] Much additional damage has been done in the world's financial system during the
last six weeks. I'm afraid history will blame us for too little too late. I hope we deal with both of
those issues today and not just one--the too little as well as the too late. To paraphrase a quote
coming out of Washington last January in another context, "we need sooner rather than later, and
we need more rather than less."
CHAIRMAN GREENSPAN. President Boehne.
MR. BOEHNE. The Philadelphia District economy, while still operating at high
levels, is showing some early warning signs of deterioration. Business people have become
more uncertain and in some cases apprehensive. This anxiety began in manufacturing and is
now spilling over to other businesses as well. The outlook now is significantly more guarded
compared to several months ago. However, measured deterioration and actual business
conditions today are still mostly concentrated in manufacturing. Other sectors report more a
fraying around the edges. Retailing and construction are still holding up. Bankers report less
loan demand and still acute competition, and lending terms remain looser than one might expect
in this environment, especially among smaller and medium-size banks. Inflation is a word that

9/29/98

is hardly used in the District. Labor markets are still tight, although the squeeze on earnings and
less demand for exports are prompting a few layoffs and talk of more layoffs around the District.
Turning to the nation, the risks clearly have shifted to the downside. Global financial
stresses are closing in on the American economy and are likely to continue to do so for some
time. With the Treasury yield curve now completely below the federal funds rate and the real
fed funds rate rising, there is a persuasive case for a decrease in the fed funds rate. I believe,
however, that we have not fallen behind the curve and that we are still in a position to be
preemptive. While it is important to move today, we also do not want to convey a sense of panic
or that things are getting away from us. I think that what easing we do should be deliberate.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Thank you, Mr. Chairman. In one sense, it is difficult to find much of
significance that has changed in the Sixth District since the July and August meetings. Our
District's economy continues to expand at a moderate pace, but with signs of some modest
slowing. Indications of some slowing showed up in the manufacturing survey where production
slumped in August and fewer respondents indicated that they expect new orders or production to
rise in coming months. Single-family home sales in our area are slightly weaker than this time a
year ago, and the multifamily sector now seems to have passed its peak. Our commercial real
estate sector remains quite healthy, but for the first time in this cycle our examiners report that
some caution is being exercised by commercial real estate developers, largely attributed to a
pullback by the REITs as sources of financing.
As a couple of other members already have indicated, perhaps the most noticeable
development over the intermeeting period has been a decided shift in confidence and growing
unease about the future; I see that among almost all my business contacts. The spread of world
problems to Latin America, which is much more important economically to our region than is

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Asia, clearly has heightened concerns. We still can find only pockets of activity that have been
affected thus far by international crises. Hardest hit have been pulp and paper forest products
and the energy sector. Echoing Bob McTeer's comments, the lower oil and gas prices have
discouraged drilling. The Louisiana rig count declined to 170 in August, down from 184 in July
and a little over 200 a year ago. Some producers are telling us that they are now shutting down
production to wait for higher prices; they argue that oil is worth more in the ground right now.
International trade winds are helping some and hurting others in our District. A Mississippi
chicken producer reports that the collapse of the Russian financial markets has devastated
poultry exports and disrupted shipments of 70,000 to 80,000 tons of frozen chickens; these will
now be dumped on the domestic market with commensurate implications for domestic poultry
prices. Ironically on the positive side, tobacco products are doing well. Cigarette demand
abroad apparently is holding strong despite weakening economies. The Brown and Williamson
Tobacco Company is planning a $500 million expansion in Macon, Georgia and indicates that
nearly half of that production will be supported by foreign demand.
Looking forward, we expect more of the same in our District's economy. We
anticipate a modest deceleration in the rate of growth, albeit from a relatively high base. One
sector of our economy that may be vulnerable is tourism. While it has been quite strong and is
not yet showing any significant falloff in future bookings, visitors from South America are an
important part of that business and problems in that region are likely to begin to show through.
We still are not seeing significant signs of price pressures. Our manufacturing survey indexes
for prices of materials remain negative for the fifth month in a row, but we now are picking up
more incidents of escalating wage costs due to continued tightness in labor markets. Whereas
wage increases were in the 0 to 4 percent range earlier, our contacts now report them to be in the

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4+ percent area for many companies. However, there is no inication that the higher wages are
being passed on in the form of higher prices.
On the national front, we see a relatively strong domestic economy over the near
term, and the prospects are for only moderate but clear downward revisions in our third-quarter
forecast. We are now projecting third-quarter GDP growth in the 1.8 percent range. We think
that the fundamentals have changed only marginally on the domestic side but that the risks are
now slightly to the downside on net. Of course our chief concern, as it is for others, is the risk to
continued growth due to turmoil in international markets and how much developments in those
markets will feed back to the domestic economy. Compared to our previous read, affected
countries appear to be in worse condition and are less poised for a turnaround than previously
expected. We are getting increasing evidence from surveys of expectations, declines in
corporate earnings, and the pullback in confidence that the risks from the international sector
have increased and are now posing a significant downside risk to GDP growth going forward.
The main question marks are how these developments will ultimately affect consumer spending,
inventory accumulation, and business investment, all of which have been sources of strength
over the past year. At this juncture, the outlook for a slowdown is still prospective rather than
reflecting strong evidence that some slowing is currently in hand. Nevertheless, I believe the
risks clearly have shifted since our last meeting and are now asymmetric to the downside in my
view. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. Thank you, Mr. Chairman. As far as the District economy is
concerned, general conditions remain favorable, although I think it's fair to say that the trends
are a little more mixed than was the case earlier in the year. Attitudes have not changed
dramatically, but I do think there is a little more caution and a little more concern now than there

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was earlier. On the positive side, labor markets remain very tight. The unemployment rate in the
state of Minnesota has dropped to a new record low, and this must be the third or fourth record
monthly low established this year. Housing activity and nonresidential construction activity in
general remain strong. Auto sales are healthy. The weaknesses are in agriculture, where I think
the problems are well recognized and are quite severe in at least parts of the District, in parts of
the manufacturing economy, and in mining activity. Trade issues, especially with Canada, have
become a matter of concern, and several of the governors in the District are taking actions at
least to show the flag with regard to trade.
As far as the national economy is concerned, I started by assuming that the national
economy would grow at trend, which is not too different from the model forecast. Then, I asked
myself where the risks lie. Like others, I concluded that the risks at this juncture are mostly on
the downside relative to trend growth. I don't know exactly how I would parcel that out on a
quarter-by-quarter basis, but that is what I concluded. Having said that, I think we have to be
careful not to get carried away with the downside risks. I am not at all sanguine, but I think it is
worth reminding ourselves that there has been a lot of discussion around this table in recent
months, indeed in recent years, that the equity markets have been overvalued. The implication
was that those prices had to come down. Indeed they have! In some sense, we are getting what
we expected or what we hoped. I think there has been a similar discussion that quality spreads
were far too narrow. They have now widened out. Again, that seems to be something that we
expected would happen and hoped would happen in the context of a necessity for domestic
demand to slow to a pace more consistent with the growth of aggregate supply. We were
concerned about the excessive availability of credit. Those conditions seem to be changing.
Again, that is something that we anticipated and to some extent hoped for. In my view, what we
are seeing here to a great degree is developments that we either expected or hoped for, and while,

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as I said, I think the risks are on the downside, I believe we should be careful not to lose sight of
the fact that these developments were anticipated, at least in part. What I conclude from all this
is that it is very hard to see any inflationary momentum building in the current environment. So,
I think we are in for further periods of modest inflation.
CHAIRMAN GREENSPAN. Why don't we take a break at this point. President Jordan
will have the floor when we come back.
[Coffee break]
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. Thank you. We had a joint meeting in September of our three boards
of directors. What was notable about the meeting was that about half of the group said that there
had been a change in confidence and the other half said there was none. At earlier meetings,
virtually no one had said that there was any concern on the downside. So, this was a marked
mood change on the part of many of the directors, while others from their local vantage
points--their local city or economy--saw no break from earlier trends.
In construction, commercial real estate continues to be very strong throughout the
District. We get more reports of overbuilding in the upper price range of the housing sector.
Our contacts say that projects are falling through or are behind schedule because of labor
shortages; certain construction skills are just not available. Cost estimates of some proposed new
projects, especially warehouses and hotels, have come in so high that institutional investors are
no longer willing to provide permanent financing because the implied yields are so low. In
contrast to that concern about low yields, the Cleveland Browns franchise was sold for $530
million plus stadium cost overruns that are estimated to run between $35 and $50 million. One
of the investor groups backed out, saying that above about $350 million they no longer saw any
current yield. But a spokesperson for the NFL said in the New York Times that even though

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some are concerned about a very low or nonexistent current yield, the owners can count on
capital asset appreciation! Builders report that local banks are still willing to provide 100
percent construction financing without pre-arranged takeouts in the form of permanent financing
because of their knowledge of the projects and the builders. But our contacts believe that
institutional investors are backing away, especially out-of-area investors. One banker
commented that the young developers in the region believe that they are bulletproof.
Probably the worst situation in the District is that of the steel industry. Steel is being
impacted very severely by imports. While domestic consumption is going to be at record levels
this year, we are told that imports were up 43 percent in July. The steel companies are now
telling us that there will be consolidations, permanent plant closings, and companies taken over
by foreign investors, probably the British, because the domestic companies are in so much
difficulty.
One theme that came out of meetings with advisory council members and others
around the District is investor caution. We get reports that the fear factor is pervasive. We hear
claims of a daily buildup in cash on the sidelines; investors are parking cash because of
uncertainty and are waiting for it to subside. We hear nothing about what will dissipate the fear,
when it may happen, and what will be done with all the cash that is parked on the sidelines
waiting for the green lights to come on again.
Labor markets continue to be extremely tight. Turnover is rising and finding qualified
replacements is taking longer and longer. One of the banks that hires throughout the region and
in several other states said that a year ago starting tellers were earning $7 an hour; they are now
earning $10. The bank expects their nonexempt pay to be up 4-3/4
to 5 percent this year versus 4
percent in 1997. They also reported, like some others, that mortgage lending is at record
volumes.

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Our retail sales have been very strong. Retailers say that sales and profits for the third
and fourth quarters will be at record levels and that retailers that source from Asia are doing
especially well. They are not as optimistic about 1999 but extremely optimistic about the way
this year will finish. In contrast to what somebody else said, sales of home furnishings have
been very strong, probably reflecting the housing industry. Telecommunications also are very
strong.
We decided to check on a couple of developments in parts of the service sector that
had not otherwise been reported. One was what is happening to hotel rates, but after the staff
memo on the Watergate, I guess I don't need to report on that! We contacted major theme and
amusement parks in the region. I myself as part of our research effort spent a weekend looking
at those roller coasters at Cedar Point! They boast about having more and bigger roller coasters
than anywhere else in the world. They and other theme parks in the Pittsburgh and Cincinnati
areas boosted ticket prices this year by 6.5 percent to 6.7 percent, yet attendance also was up in
excess of 6 percent at all of them, giving them double-digit revenue gains this year. One big
park said that they will boost ticket prices 10 percent further in January and February next year.
To deal with the labor shortages, one of the parks reported hiring 500 foreign students this
summer.
Another bit of evidence as to the psychology in our area is that caution apparently did
not hit Kentucky because the thoroughbred horse auction was the best ever. Average prices were
up 35 percent from last year. More yearlings were sold for over $1 million than in any year since
1980. In two days alone in September 56 yearlings were sold for over $1/2 million each. Most
of those horses will be sent to Europe and Asia.
Turning to the national economy, I can save some time by saying that I agree with
Gary Stern that a lot of the changes--the break from the past that we have seen--were essential.

9/29/98

We have known for a couple of years perhaps that there were certain unsustainable trends at
work. As some sage once said, unsustainable things have a habit of ending. We may not like the
way they ended, but it was essential for that to happen. The difficulty now is how to deal with
the attendant shocks to confidence. We have a long history of responding to domestic events
such as Nixon's wage and price controls and the stock market crash of 1987 and to international
events such as financial crises and military actions--including among the latter the Suez, the Bay
of Pigs, and the Gulf War in the early part of this decade. When these things happen, there tends
to be a rush to liquidity and a rush to quality. The yield curve steepens at the short end and
people seek to invest in better grade assets. The central bank had to respond to such
developments in order to avoid an inadvertent contraction of central bank money. But in this
environment, we have to be very, very careful about how much of a response we make because
the developments in question tend to be reversed. The response has to be limited and
proportional to the problem because of the unavoidable necessity of taking out an injection of
liquidity as confidence starts to rebuild. We do not want to err on the other side. We have had a
number of episodes in the past where we responded to surprises and overstayed our response.
The cost of then taking corrective action in terms of contracting central bank money and raising
interest rates had some unfortunate effects. Thank you.
CHAIRMAN GREENSPAN. President Hoenig.
MR. HOENIG. Mr. Chairman, if you were to ask how the Tenth District is doing
today, you would get two answers. If you looked at any metropolitan area, you would see that its
economy is still very strong, with tight labor markets and unemployment rates that are extremely
low. When you looked at retail sales, you would find that they remain very strong. If you
looked at housing, you would find it strong overall. You also would hear a lot about changes in
attitudes in the sense that while business conditions are strong, people are much less confident

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about the future. We are seeing some of the effects of Asia in our manufacturing sector, in
health products for example, and we have anecdotal indications that at least some firms are
backing off on plans to invest in plant and equipment as they look to the future. But, currently,
the metropolitan area economies are still in very good shape in our District.
In the rural areas and in the energy sector, we get a completely different answer.
Contacts in the energy industry, as you already heard for some other Districts, are very
pessimistic about the outlook for oil. Natural gas, which is more predominant in our region, is a
question mark; its prospects depend on how the winter goes. Contacts in the agricultural sector
are very pessimistic. I know you have heard some of the statistics, but I would note that we
normally export about 40 percent of our agricultural products to Asia. So demand is down.
CHAIRMAN GREENSPAN. Is the 40 percent for the Tenth District or nationwide?
MR. HOENIG. Nationwide, but I would say that percentage is not too far off the
mark for the Tenth District as well. We are having some bumper crops this year, 20 percent
increases in some areas. That is on top of earlier increases. So, prices obviously are down. Our
banks are saying that their loan portfolios currently are in satisfactory condition, but they
anticipate loan problems going forward. They already are contacting us and others about what
the attitudes of examiners are going to be with regard to carrying over loans and so forth. So,
there is a fair degree of bearishness in that sector of the economy and concern especially among
banks in the rural areas. However, we need to put that in the context of the District as a whole,
which still appears to be generally sound.
On the national economy, I think the most likely outcome next year is for real GDP
growth to slow to below trend and for inflation to remain moderate. I am concerned about
further downside risks to the domestic economy. Therefore, I believe a slight easing of policy

9/29/98

would be appropriate at this time. But I, like Ed Boehne, would be cautious and deliberate in
adjusting policy at this time. I don't think we would be behind the curve after a small move.
I want to add a couple of points relating to policy. First, while I see growth moving
down toward or below the economy's long-term potential, I am not as pessimistic as the
Greenbook at this time. I think that is why I also am cautious about how deliberate we are in
adjusting policy. Second, I believe there are significant downside risks to the outlook, as I
mentioned. These stem from the fact that there are significant slowdowns in the economies of
Latin America and Canada that could cause our own economy to grow more slowly. We need to
keep that in mind. In that context, inflation should remain moderate in the near term, and a
number of factors should help to keep it in line for the foreseeable future. I would not, however,
recommend a more significant easing. I am mindful of the fact that our record in forecasting
growth slowdowns has not been overly accurate in recent years, and therefore I think we should
be cautious. As others have mentioned, M2 is growing strongly. So, I think a deliberate ease in
policy would benefit the economy, and I would go cautiously forward with it. Thank you, Mr.
Chairman.
CHAIRMAN GREENSPAN. Vice Chair.
VICE CHAIRMAN MCDONOUGH. Thank you, Mr. Chairman. The Second
District economy has slowed somewhat during the third quarter, with continuing job losses in the
manufacturing and government sectors. Not surprisingly, the anecdotal evidence is considerably
weaker than the data. There is real concern throughout the District about the growth prospects
both for the Second District economy and that of the nation. This lesser degree of optimism or
beginning of pessimism is not reflected only in the financial sector, where it is quite
understandable, but around the District as a whole. Needless to say, some major firms in the
financial sector have announced rather significant losses that have important implications for the

9/29/98

tax revenues of state and local governments in our District. The firms in the securities industry
and the banks that compete with them are very concerned about their profit prospects in the
fourth quarter because of their sharply reduced deal flows.
Our national forecast is somewhat more optimistic than that of the Greenbook, in part
because we do not have quite as strong a wealth effect. But our sensitivity analysis to our own
forecast has a downside alternative that produces an outcome that is quite close to the
comparable alternative in the Greenbook. Like everybody else, we see the main source of the
weakness as stemming from the effects of international weakness on the performance of the
American economy.
Let me speak briefly on how I interpret the very wide credit spreads that have
emerged. I don't spend a whole lot of time worrying about the level of prices in the equity
markets because I think the credit markets are really more important for the economy as a whole.
The spreads in the credit markets were certainly unnaturally tight earlier this year, but the
correction has carried these spreads well beyond a return to normalcy. The current spreads are
very wide indeed, and they indicate in my view that we have to be concerned on the downside
that risk aversion will become unduly great. The result could be that not only would the credit
markets be essentially unavailable to firms that normally deal with banks, but the banks
themselves might in this environment become sufficiently risk averse that we could get a credit
crunch. I am not forecasting that, but I see it as a serious downside risk that we have to be
concerned about. I think we have to be extremely attentive, especially in the Reserve Banks with
our proximity to the banks in our Districts, to whether that is happening or not. There is no
question that in the securities firms and banks with which I am familiar, the executive vice
president in charge of marketing has been put in the closet and the executive vice president in

9/29/98

charge of credit is now in front taking charge. That is a good development as long as it does not
get into the risk aversion area to a point where a credit crunch could follow.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. At least for the time being, overall economic activity in our
District remains at a very high level. Revenue growth in the broad service-producing sector
slowed in August but picked up again in September. There was a noticeable rise in retail activity
essentially across the board in September. As in many other Districts, residential construction
and new home sales are still quite strong throughout our region. More generally, our contacts
indicate that there has been no perceptible easing in the extraordinarily tight labor market
conditions we have experienced for many months. Workers with even minimal job skills are
hard to find in many areas. Skilled construction workers are especially scarce. We had a
meeting of our Small Business and Agriculture Advisory Council last week and they were
particularly direct in describing the tight labor market conditions in their respective industries
and areas.
That said, we are now seeing for the first time some unmistakable signs of softening in
the region's manufacturing sector. Manufacturing is important in our region. A special note: A
couple of components on our monthly manufacturing survey, namely new orders and planned
capital spending, slowed quite sharply in August and September. A number of manufacturers, as
in other parts of the country, had been telling us about reduced exports and increased competition
from imports. One especially high profile example of a change in sentiment in the
manufacturing sector was the announcement a couple of weeks ago by Motorola that they are
going to suspend construction on a new $3 billion chip plant that was being erected near
Richmond. That is a big blow to our local community. They did not announce any time frame
for resuming construction. In my view, manufacturers in our region now clearly have the sense

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that they have bigger problems and that these problems may last longer than they had thought
previously.
Turning to the national economy, I would like to add a note of caution, and I guess I
am underlining some of the things that Gary Stern, Jerry Jordan, Tom Hoenig, and others have
said. It is certainly true that the overall national picture has changed quite radically in many
ways over the last couple of months. As we all know, the Russian devaluation and default,
doubts about the effectiveness of the IMF, and perhaps to some extent a perceived world
leadership deficit have produced a quantum jump in risk in world financial markets. I think that
has been a seminal event. One can see it in the data, as Bill McDonough said, and it is quite
dramatic. The Salomon Brothers spread on Brady bonds over U.S. Treasuries, for example,
increased by fully 5-1/2 percentage points between the end of July and the end of August. That is
not much less than the cumulative increase in that spread over the much longer period when we
were tightening policy back in 1994 and 1995. This increased financial risk is significantly
complicating adjustment problems in the world economy, and in the United States it probably
accounts for a good part of the decline in stock prices and the apparently tighter conditions in
loan and other credit markets.
I certainly agree that these shocks will likely take some of the steam out of domestic
U.S. demand. That is probably a good thing. But it is still unclear to me how sharp the ultimate
slowing is going to be. Even with a 75 basis point decline in the funds rate built into the
forecast, the Greenbook expects the real GDP growth rate to fall to only 1 percent in the first half
of next year and then to rise only1/2 point to 11/2 percent in the second half. However, there still
is no really hard evidence as I see it that the U.S. economic expansion either is or will soon slow
in a major way. It may happen. Certainly, the downside risks are greater than they were, but it
may not happen. Labor markets are still tight. Wages are rising. Consumer confidence is down

9/29/98

from its peak, but it could pop back up in the wake of any easing action we may take. Also, the
rate of growth of M2 over the last 18 months or so, as far as I am concerned, still constitutes an
inflation risk in the outlook. The most recent M2 surge probably does reflect a flight to liquidity,
but the rapid M2 growth in the earlier months of this year and late last year did not. This latest
bulge could well reflect in part the prospective policy easing that is now apparent in fed funds
futures rates.
If we ease policy now, as assumed in the Greenbook, in reaction to events that many
in the United States regard as largely a foreign problem, we run at least some risk in my view of
creating a perception at some point that our longer-term price stability objective has changed or
at least that we are being distracted. There is a risk that we may in fact be distracted to some
extent from our long-term price stability goal. I think that risk is heightened by the tightness in
labor markets and the general strength of the economy.
The good news at this stage, of course, is that markets have already priced in much of
the policy easing that is assumed in the projections. As yet, bond rates have not risen; they show
no increase due to heightened inflation expectations. For now at least, I think we still have our
credibility and it is holding up well. But I do hope we will watch closely as we go forward for
any evidence of eroding public confidence in our commitment to price stability if we follow the
policy strategy that is laid out in the Greenbook.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. Thank you, Mr. Chairman. For much of this year, as others have
said, we have been waiting for a financial upset to hit our shores, and it looks as though that is
about to happen. While many of us have migrated to a view of noticeably weaker growth, and I
am among them, I think it's important to reiterate two realities that others have brought out.
First, of course, this weakness is a forecast. Domestic weakness is not yet here. In fact, labor

9/29/98

markets, as others have said, remain tight. Anecdotal evidence suggests that the demand for
workers is still strong in some sectors. GDP is likely to grow at or above trend for this quarter
and the next. The boost to GDP is the result of two things: the first, obviously, is the return of
the GM workers and the second is the continued strength of some interest-sensitive sectors of the
economy. PCEjumped as consumers purchased more automobiles. Orders for durable goods
indicate continued increases in shipments and spending, albeit at lower rates than in the first half.
Retail sales reports are strong and anecdotal evidence indicates no slowing yet in housing or
housing-related durable goods. I think I heard a little of that around the table. There clearly
remain some risks of higher inflation, though I will agree with others that they have gone down
significantly.
On the negative side, employment growth is down further and the likely impact of
international financial turmoil has become much clearer. For me the important source of
potential weakness from the foreign side is not necessarily in the traded goods sector even
though that will continue to be a source of drag on domestic economic activity. What is more
worrisome in my view is the transmission of financial weakness abroad to our financial markets
and the resulting impact on the investment behavior of U.S. businesses. I guess it should not be
a surprise that weakness will emanate from the investment activities of firms after a period when
growth has been heavily driven by business investment spending. Importantly for me, a lot of
this investment spending from corporations has been maintained during this period by both cash
flow and leverage. We have not talked much about it in this room, but I believe that nonfinancial
corporate debt grew at an annual rate of about 12 percent in the first half of this year. The
difference between capital spending and internally generated funds, what many call the financing
gap, is I believe at its highest level since the recession of 1982. This approach to corporate
investment, which includes both cash flow and leverage, makes such investment particularly

9/29/98

vulnerable to changes in financial conditions, psychology, and profit prospects, all of which we
have experienced recently.
I agree with Vice Chair McDonough that the vehicle for this weakness is not purely
stock market effects where we in fact had expected some deterioration. Of greater importance to
me is the fact that it is more broadly centered in credit markets. We have heard from the staff
that the syndicated loan market appears to have become less accommodating, and that is causing
some banks to pull back to some extent from lending. I am concerned that if that reduced
willingness to lend is combined with significant increases in the cost of capital from the stock
market, we will face a real risk of serious capital-raising constraints. Like Vice Chair
McDonough, I am not predicting a credit crunch, but I am mindful that it is not out of the realm
of possibility. It also seems likely that a slowdown in credit-driven business investment will lead
to slower growth in job incomes and wealth-driven consumption. Thus far this year
consumption has surprised us on the upside, driven by tight labor markets and by high equity
values. It seems, though, that both of these factors have begun to unravel or will shortly do so.
Equity markets already have done so. Labor markets will adjust gradually over time.
For me the final question is what the reaction of this Committee should be. As others
have indicated, the international side seems unlikely to settle sufficiently or sufficiently quickly
to alter the scenario. No other major economic power seems capable of engendering the growth
of demand that we need to maintain near-term trend growth in our country. But like President
Boehne and others, I believe that any monetary policy adjustment that comes out of our meeting
today should be done very judiciously. There are some elements of strength in the economy.
The downside risks are still quite high, but we could again be surprised on the upside. I for one
do not think we are yet behind the curve. Thank you.
CHAIRMAN GREENSPAN. Governor Gramlich.

9/29/98

MR. GRAMLICH. Thank you, Mr. Chairman. Coming late in this discussion, there
is not too much to say that has not been said many times already. That is the good news. I
would point out that there has been a quite important change in the general comments of the
Reserve Bank presidents in the past several meetings, though maybe not a sea change. My own
forecast, such as it is, is fairly close to the Greenbook; I am roughly in agreement with the
Greenbook scenario. While it is true that more is influencing the slowdown than the stock
market, I think there is an important point to be made about the stock market that has not been
brought out today. That is, if we look at forecasts of earnings by the so-called stock market
analysts, they would still be on the high side by all measures. What seems to happen in the way
these forecasts are put together is that as disappointing numbers come in, as they have recently,
the current quarter is downgraded but not the future quarters. There is still a lot of that going on.
I think the Greenbook is on solid ground in anticipating a further decline in stock prices and a
feedback on the real economy through the consumption wealth effect.
One concept that we have not talked about much this morning is NAIRU. I think that
if we are coming out in the direction of an easing move, as it seems to me most people are, we
should at least go through a mental test on why we are doing so when we have an unemployment
rate that is sitting at 4-1/2 percent. Many of you have addressed the fact that you see very little
evidence of accelerating inflation. On the TIP premium that we talked about earlier, my view is
that while liquidity preferences and transaction costs may account for some of the TIP premium,
I think there is some information there as well, namely that it reflects a general downgrading of
inflation worries. So, with regard to the NAIRU, I guess the story on inflation would be a
combination of things. On the one hand, those who think the NAIRU is 5-1/2 percent or
thereabouts may be a little off on that estimate. The other aspect, however, is that even in the
Greenbook forecast there is projected to be a rise in the unemployment rate.

9/29/98

All of this together adds up to a recommendation on my part for easing as we have
previously discussed. I think the main question is whether to ease a lot or a little. The
arguments are actually nicely made in the Bluebook, and I will not repeat them. I will just say
that where I come out on that issue is that I am for cautious ease. One reason is that I believe we
are still ahead of the curve in terms of managing the real economy. I don't think there is a sense
in which, if we just look at the real economy, we can be described as being too late or behind the
curve. Dave Stockton pointed out that there still are upside risks and we should keep those in
mind. I think that Al Broaddus made a good point when he said that if we go too far at this
meeting, it might look as if we have become distracted from what should be our fundamental
goal of dealing with inflation. We certainly would not want to send out that message. The last
point, which others have made, is that a big move at this point might be misinterpreted as a
degree of panic on our part. It would be at a minimum very un-Fed-like, and we certainly would
not want that. [Laughter]
CHAIRMAN GREENSPAN. Governor Rivlin.
MS. RIVLIN. Let me start with the world situation. Like many others, I find the
world economy both sad and scary. The saddest part is that so many millions of people in
developing countries in Asia and Latin America are being thrown into desperate circumstances
just at the point when they were beginning to have hope for the long-run future. Many of them
have not been in the modern world all that long. They left villages and in many cases their home
countries in search of jobs in modernizing economies. Now they are being thrown back into
insecurity and a struggle for bare necessities with no idea if or when the economic opportunities
for them will reopen. I stress that because I think we sometimes tend to sit around this table and
act as though all the losers were investors and high flyers. They definitely are not.

9/29/98

The scary part is that those of us who believe strongly and rightly in the power of
capitalism to improve peoples' lives do not know where the current downslide will end or what
we can do that will effectively stop its spreading contagion. We already knew, of course, that
when large amounts of capital are moving freely in search of higher returns that investors can be
victims of their own excessive optimism and then get caught in a wave of excessive pessimism.
We also knew that capital flows were far greater than ever before, that world markets were more
interlinked, and that financial movements were more rapid in an age of instant global
communications. But I don't think we knew how big an impact that might have. We knew that
very clever self-assured people were placing huge bets with other peoples' money on
relationships that they could only guess about, that sooner or later some of them would guess
wrong, and that the consequences could be serious. But now that the exuberance has turned to
pessimism and risk aversion and so many of the weaknesses in the world's financial structure
have been revealed--some we knew about and some we are just learning about--the economic
policymakers in industrial countries are struggling to figure out how best to manage the crisis
and where and how to build firebreaks in hopes of containing the meltdown so the rebuilding can
begin.
That is a very difficult job, but it is not our job around this table. The job of this
Committee is a much narrower one. It is to keep the U.S. economy growing at a healthy rate, not
only for the well being of Americans themselves but so we can play as strong a role as possible
in bringing the rest of the world back to economic health. For the last couple of years, indeed
the whole time I have been part of this group, we have been primarily worried that the United
States was growing at an unsustainably high rate. Now many of the signs point to slowdown,
although it is striking that the anecdotes about the domestic economy are a lot more negative
than the real statistics so far. Nevertheless, the risks have shifted, and clearly one risk to worry

9/29/98

about is that if the United States slides into stagnation or even recession--although that is not
likely to happen soon--we will further exacerbate the world crisis.
I don't think we have a hard choice today. We need to take a small step in the
direction of monetary ease. We need to stand ready to take more steps if necessary, but I
certainly agree with those who feel that rushing quickly ahead would gain us little and probably
would be, as Ned Gramlich said, an un-Fed-like thing to do.
CHAIRMAN GREENSPAN. President Poole.
MR. POOLE. Conditions in the Eighth District, as we have heard around the table
with regard to other Districts, are largely unchanged in the real economy. I think it's fair to say
that the mood is less buoyant than it was earlier. The financial market upsets, again in terms of
the real economy, have been I think largely a spectator sport so far, although one that is much
less fun than watching Mark McGuire. I want to reemphasize the point that Bill McDonough
made. The stock market decline is a very typical decline; its size is nothing abnormal, but the
spreads that we have seen open up in lower quality credits indicate a very abnormal state of
affairs. The spreads were too narrow before, but they are now much too wide. If those spreads
remain that wide, they will be an indication of a very serious drawing back in the very near
future. So, I interpret the conditions in my own District and the stories that we hear as simply
reflecting the fact that the financial market upsets have not yet registered in the lending and
spending activities that affect the real economy. The stock market declines should make us feel
good in a sense, but I will confess that every decline, especially the big declines, give me a very
uneasy feeling. Every recovery that we have had in these volatile markets has made me breathe
a little easier. As I see it, the situation is quite uncertain right now.
The variance of the outlook has certainly increased. The soft landing scenario is
something of a central tendency, with a fairly wide range of perfectly plausible outcomes on

9/29/98

either side. It may be the best bet down the middle, but there is some significant probability on
both sides. That suggests we may have a lot of business ahead of us as the information comes in.
If we get the soft landing, then I would suppose that the spreads will have to narrow because
everything will seem to be coming out all right and the financial markets should settle down.
That obviously is what we want. Clearly, we will continue to see adverse effects coming from
abroad. The recessionary trends abroad are affecting U.S. exports and the import-competing
industries; steel is a good example. Those effects are very real and to some extent we are going
to end up with an economy that is going in two directions, with some domestic activities very
clearly impacted by the foreign sector. But the external sector is not by any means the largest
segment of the national economy. If the home-grown industries--the service industries,
construction, housing, domestic investment--can all remain solid, we are going to come out all
right on a national average basis, although the hurting industries will to continue to hurt until
conditions improve abroad.
With regard to the outlook, it seems to me that we have something of a race between
two forces here. Interest rates on low risk credits have declined. Borrowers who are very well
situated, such as homeowners who can put down substantial equity, are going to have their
activities stimulated by this environment. On the other hand, the more risky borrowers are going
to be held back. They are going to have projects cancelled. So, we have a race between these
two forces that will determine exactly how the economy comes out over the next quarter or two.
Of course, that will then determine whether the economy tips over into a genuine recession or
whether it in fact ends up with a soft landing. So, I certainly agree that the balance of risks has
tipped very decidedly over into the negative side. I think that the flight to quality does explain
recent rapid money growth, but I want to emphasize that the dramatically increased spreads in
the financial markets are highly abnormal. They just do not represent business as usual.

9/29/98

CHAIRMAN GREENSPAN. Thank you. Governor Kelley.
MR. KELLEY. Mr. Chairman, events are moving quite rapidly. It was only last July
that the Committee began to get concerned about the emerging bifurcation being introduced by
an ongoing very strong domestic economy interacting with a deteriorating international situation.
In less than 90 days, policy risks have shifted dramatically to the downside. If the Committee
should respond to this situation this morning by easing policy, I will support that decision but not
without considerable hesitation and misgivings. While growth in overall economic activity
clearly has been slowing recently, our domestic economy remains remarkably robust. Though
decelerating from earlier this year, final sales remain strong; labor compensation is rising; new
jobs continue to be created; consumer sentiment remains high; long-term credit is available at
rates not seen in decades to support housing and motor vehicle sales; and the stock market has
slipped but it has not collapsed. If this beat goes on for long, the slippage in capital spending
could soon reverse and an up-cycle in inventory spending could once again emerge.
It may well be that we will experience no more than the moderate slowing of the
expansion that we have long expected and for which we fervently have hoped. The odds have
become lower that this is all the weakness that will occur yet it is highly questionable in my view
that slower economic growth alone would call for an immediate reduction in interest rates. Of
course, far more is involved as this situation plays out against a background of ailing world
economies, fragile financial markets that could turn very ugly very quickly, and a continued
quiescent inflation rate in the United States. I am concerned that we are now at risk of falling
behind the curve. It would seem on balance that we have an opportunity here to take out a
modest and relatively inexpensive--in terms of risk--insurance policy, and I believe we should do
so. Consideration of actions stronger than that should await the unfolding of future events.
Thank you.

9/29/98

CHAIRMAN GREENSPAN. Finally, Governor Meyer.
MR. MEYER. Thank you, Mr. Chairman. What has changed between the last
meeting and today that could justify an easing? That clearly is the question of the day. The
answer is not the initial conditions, in terms of very tight labor markets, nor the near-term pace
of the expansion. Second-half GDP growth still looks to be close to trend, at least to my estimate
of trend. That is, of course, a significant slowdown relative to the rate of growth in the first half,
but it is in line with earlier expectations and it will leave labor markets still very tight at the end
of this year. Nor do I see anything in the most recent data relating to the strength of the
expansion to justify a change in policy. The forecast? Well, that's a different story and that is
my point. Any policy action today must be based squarely on and be defended in terms of the
forecast for 1999, specifically on the change in that forecast justified by recent developments.
The staff did an excellent job of identifying and quantifying the effects of three recent
developments.
The first is the downward revision to foreign growth due importantly to a downward
revision in growth prospects for Latin America. The second is the sharper-than-anticipated
decline in equity prices that suggests a downward revision to consumer spending and quite likely
to business fixed investment and residential construction as well. The third is a widening of risk
spreads and a generally reduced appetite for risk that might well have an incrementally adverse
effect on spending. Taking the direct impacts of the first two, adding a smidgen for the difficult
to quantify latter factor, and then applying an appropriate multiplier gets me to something in the
range of a 3/4 percentage point downward revision to my growth forecast for 1999, albeit from a
somewhat higher initial forecast than that in the last Greenbook.
The change in the forecast can perhaps best be understood by differentiating what I
call phase two of the global turmoil from phase one. I date phase two from the Russian

9/29/98

moratorium and devaluation and the increased pressure on Latin American economies that
immediately followed. Interestingly, phase two does not appear to have an especially adverse
effect in terms of its incremental effect on net exports, certainly when compared to the effect of
the crises among developing Asian economies and the deterioration of the Japanese economy
during phase one. However, whereas phase one was accompanied by offsetting positive shocks
in the form of lower U.S. interest rates stemming from safe-haven capital flows and lower oil
prices, phase two in contrast is accompanied by the reinforcing adverse effects of a decline in
equity prices and an increase in risk spreads as well as by a coincidental increase in oil prices due
to supply cutbacks. A second likely difference is that whereas phase one was accompanied by an
unexpected and largely unexplained surge in private domestic demand, phase two will likely be
accompanied by a spontaneous unwinding of that exceptional strength.
I have emphasized previously the distinction between central tendencies and
asymmetric risks in the current forecast, and I believe this aspect of the outlook is also relevant
to the policy decision. I have to admit that when I hear someone say that the risks in their
forecast are asymmetric, my first inclination is to encourage them to rethink that forecast and
return when they have managed to produce one where the risks are symmetric. I believe our
staff has followed this philosophy more than most forecasters. They assume, for example, a
break in Brazil's exchange rate regime and a fairly sharp adjustment in growth in Latin America,
and they have a further decline in the stock market on top of the recent correction. Nevertheless,
when there are potentially important one-sided discontinuities in the outlook, as I believe there
are today, risks can legitimately be asymmetric. As a result, there could be an important
difference between the modal forecast--the best guess and the most likely outcome--and the
mean of the probability distribution of outcomes. Both are relevant to the policy decision.

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On balance because my previous forecast for 1999 was not as pessimistic as that in the
August Greenbook, I end up with a somewhat higher growth forecast for 1999, even allowing for
a similar downward revision to growth. But I do expect growth to be decidedly below trend next
year. Given my expectation of somewhat faster growth than in the Greenbook and therefore a
slightly lower path for the unemployment rate, I anticipate a bit higher inflation than is projected
in the Greenbook. However, I agree the weaker growth now in prospect and the projected rising
path of the unemployment rate should restrain inflation going forward. The policy question, of
course, is whether the projected slowdown crosses the line from benign to undesirable. I will
save that assessment for my policy statement.
CHAIRMAN GREENSPAN. Thank you very much. Let's now move on to Don
Kohn.
MR. KOHN. At your conference call last week, most of you seemed to
favor easing policy at this meeting. I will briefly review the case for an
easing action before discussing the factors bearing on how large the cut in
the federal funds rate should be.
The case for easing does not rest on incoming data about the economy.
As many of you have noted, the information that has become available since
your last meeting indicates that the economy continues to expand at a pace
around the growth rate of its potential. That has kept the unemployment
rate flat at a very low level, and inflation has edged higher on a 12-month
basis, at least as measured by the core CPI. Thus, a standard, backwardlooking Taylor rule that called for a 5-1/2 percent federal funds rate in August
would continue to do so today.
Rather, the case for easing relies on projections that have been marked
down by developments overseas and in U.S. financial markets. Most
significantly, the sea change in investors' perceptions of risk and their
apparent heightened unwillingness to take those risks has continued to
spread globally, hitting the Americas with greater intensity. Financial
conditions have become more restrictive throughout the hemisphere,
especially in our important export markets in Latin America and Canada
where the authorities have had to tighten monetary policy to defend their
currencies.

9/29/98

While Committee members may have had stronger economic forecasts
than the staff, it is likely that most of your projections also have been
reduced noticeably by these events. In that case, if you considered the
federal funds rate to be at an appropriate level in August, it probably should
be lower now. Even if Committee members had not marked down their
forecasts of the most probable outcome for economic growth by very
much--or only by enough to become more comfortable with the inflation
outlook--the lower tail of the distribution undoubtedly has gotten a good bit
fatter. In that regard, the Committee might see these as the appropriate
circumstances in which to take some risks on the side of trying to ensure
that U.S. economic growth comes close to being as robust as possible,
consistent with continued low inflation. Prolonged sluggish expansion in
the United States would seriously undermine recovery prospects in the rest
of the world and eventually feed back on our own economy.
Much of the benefits of an easing move was realized for financial
markets when expectations came to embody action today. That process
helped to level out risk spreads in some domestic markets and to reduce
spreads on Brady and other dollar-denominated sovereign bonds on
international capital markets. It probably also has helped to halt the drop in
equity prices after their sharp fall in August. Failing to follow up by
actually easing could undo much of that.
To be sure, it is important not to be, or to be seen as, attempting to
support particular values in capital markets. A good part of the market
adjustment, at least in the United States, probably has reflected appropriate
reassessments of business risks and prospects. And in some markets, such
as that for U.S. equities, the reappraisal may not be complete. But the
Federal Reserve can try to keep the real economy on an even keel as
financial market adjustments are made, and the Committee may see that
objective as now requiring some reduction in a real federal funds rate that
had been kept at an unusually high level in part because of financial market
exuberance.
A cautious approach to easing, characterized by a 25 basis point
reduction in the federal funds rate, might be justified by the situation now
prevailing in the economy. With the unemployment rate well below most
estimates of its sustainable level, the Committee has long been of the view
that economic growth needed to slow substantially from the pace of the last
few years--most likely to below trend--just to keep inflation from
accelerating. As yet, there are few signs that the economy already is
slowing enough to begin to relieve labor market pressures, much less that it
is decelerating so sharply as clearly to require monetary policy easing.
Inflation risks associated with the tight labor market are heightened by the
possibility that some of the factors damping price increases in recent years
may already be reversing--the dollar is falling against currencies of other
industrial countries, health care costs are rising faster, and oil prices have

9/29/98

begun to firm. Whether inflation expectations will remain subdued as these
influences turn around is an important uncertainty in the outlook.
Caution in not moving the federal funds rate by very much also may be
seen as consistent with basing the action primarily on projections rather
than actual data, particularly since it is difficult to be confident about the
effects of a change in the federal funds rate in the current highly skittish
financial market environment. To be sure, a series of tightenings in 1994
was initiated largely on the basis of projections, but the Committee waited
until it was sure the economy was strong, and much of the subsequent
policy firmings occurred against the background of surprisingly robust
growth and early signs of rising inflation pressures. The analogous strategy
at this time might be to begin with a small action and build on it should
further developments in either the financial markets or the economy indicate
that the shock to spending was in fact turning out to be substantial.
Lastly, holding the action to 25 basis points may have some appeal if
the Committee thought both that the act of easing in any amount would
itself usefully reassure financial markets, households, and businesses that
the Federal Reserve recognized and was responding to potential problems
and that in total not much easing would ultimately be necessary to support
adequate economic expansion. In these circumstances, a relatively modest
action now would be desirable so that one or more further easings could be
undertaken in response to changing conditions without risking excessive
stimulus to growth and a potential intensification of inflation pressures.
Reducing the federal funds rate by 50 basis points might be appropriate
if the Committee instead saw the situation as one that required, or was
highly likely eventually to require, substantial policy easing. In the staff
forecast, a decrease in the federal funds rate of 75 basis points is needed to
keep the economy from dropping below the level of its potential in the year
2000. Absent such policy easing, the added restraint on aggregate demand
that emerged in the period between the August and the September
Greenbook projections would reduce the growth of the economy by almost
one percentage point next year.
While the most likely outcome is that credit conditions will end up only
moderately less accommodative, recent financial market developments
suggest that the odds may have increased of a significant further tightening
in credit availability with associated downside risks to the economy.
Questions about the financial soundness of a number of financial firms have
intensified in the wake of the near failure of Long-Term Capital
Management. Were this process to continue, or the settling down in the
market that the staff has anticipated fail to occur, the result could be greater
disruptions than in the staff forecast in the access of households and
businesses to credit, in part as intermediaries incurred higher costs and
turned more cautious in their lending to conserve capital. The longer

9/29/98

volatility and uncertainty persist in financial markets, perhaps the higher are
the risks that they will feed back on business and household confidence and
spending plans.
An easing of 50 basis points, if accompanied by a sense that the Federal
Reserve would then be on hold for a while, would reduce one source of
volatility in markets for a short time--that is, guessing about immediate
Federal Reserve action and parsing statements of Federal Reserve officials
for the probabilities of such action. Because markets would be somewhat
surprised by a full 50 basis point reduction today, there might be an adverse
initial reaction in the prices of riskier assets should participants infer that
the Federal Reserve saw the situation as difficult enough to take a
somewhat unusual action. Over time, however, market participants could
find reassuring your willingness to act forcefully.
Because a 50 basis point easing at this meeting is not fully built into the
structure of interest rates, it would provide some added help to emerging
market economies running tight monetary policies to defend their
currencies. The associated drop in the exchange value of the dollar might
even nudge the monetary authorities in the United Kingdom, continental
Europe, and Canada to ease their policies. It would be of no help to
Japan--since the added demand in the United States for Japanese exports
arising from higher income here would be offset by the effects of a higher
yen--unless it induced the Bank of Japan to use the remaining 25 basis
points between its policy rate and zero!
Presumably, an easing of 50 basis points would be associated with
adoption of an unbiased directive. A smaller decline of 25 basis points
might be associated with either a symmetrical directive or one that was
asymmetrical toward easing. The latter would connote that the Committee
wanted to remain especially sensitive to the potential need to ease further,
perhaps because it still saw a relatively greater potential for surprises--in
foreign economies and domestic financial markets and in the spending plans
of businesses and households in reaction to ongoing developments--that
would imply considerable further restraint on demand in the United States.
CHAIRMAN GREENSPAN. Questions for Don? If not, let me proceed.
A number of you have argued, quite persuasively in my view, that there are only
limited hard data that suggest any loss of momentum in the current expansion. I can find only
two statistics that point to some weakening, although I am sure there are more. One is a
significant drop in the production of steel ingots in the last two weeks.
MS. RIVLIN. Only you would know that!

9/29/98

CHAIRMAN GREENSPAN. Well, I hesitated to mention it because it is such a small
item. Second, the latest data indicate a fairly dramatic decline in construction awards for
nonresidential building. Beyond that, we do not find significant weakening in equipment orders.
Retail sales are not terrific, but obviously they are not doing too badly. Motor vehicles, which
are a crucial factor, are softening a little but hardly enough to take note. Actually, the ratio of
used car prices to new car prices, which has not been a bad short-term indicator, has turned up a
little. Homebuilding may be off a bit, but it is still quite elevated by any objective measure. So,
as we look across the board, it is very hard to find any indicators of significant softening. To be
sure, the labor market is exceptionally tight, although we have had a modest increase in insured
unemployment. It popped up with the GM strike and did not reverse fully after the strike was
settled. I might add that the low level of initial claims relative to insured unemployment
probably reflects declines in both hires and layoffs in relation to the number of employed
workers. That is showing up, incidentally, in the household data as well. A more relevant
indication of a weakening labor market would be an upturn in the level of insured
unemployment. That level has risen a little but scarcely enough to argue that we are seeing a
significant development.
The crucial development, which has been mentioned numerous times around this
table, is that we are observing an important shift in attitudes toward risk. The reason is that one
can generalize and explain the business cycle, perhaps in an overly simplistic way, as reflecting
shifting views toward risk. When there is a general sense of declining risk, there is a tendency to
reach out into the future. That is another way of saying that the cyclically sensitive areas of the
economy--capital investment, construction, consumer durables--all accelerate as the result of
efforts to invest in the future. The downside of the cycle occurs when there is a widespread
perception of rising risks.

9/29/98

We would certainly expect to see a change in psychology before any significant
erosion in the real variables of the economy became apparent. Such a change in psychology
clearly is what we are observing. The opening up of risk spreads is a very significant indication
of increased risk aversion. As we know, that means in effect that commitments are being pulled
back. We see in the balance sheet data that are now emerging and that Governor Ferguson was
referencing a fairly pronounced weakening of cash flows in the business sector coupled with an
ever-increasing difficulty of raising capital externally.
If we have a contraction in both internal and external sources of funds, the question
then arises as to how the momentum will be maintained in the capital goods markets, a sector of
the economy that has been an important factor in the significant expansion of economic activity
in recent years. So, what we should be looking for, and indeed what is implicit in the Greenbook
forecast, is a process by which the combination of increased risk aversion in the market,
reflecting changed attitudes toward the future, and the effects of higher perceived risks on the
balance sheets of business firms all point in a single direction. That is, they suggest a decline in
capital investment. From the perspective of the way our models operate, the reason would be
that the cost of capital has gone up. In terms of what actually is happening in the real world, the
reason is basically that people are pulling back, and those who are not pulling back are finding it
difficult to finance their activities either internally or externally.
I was mentioning in a short conversation during our coffee break that I suspect that if
we had September capital appropriations data for corporations, we would see a fairly significant
decline. That would be the first hard evidence in the forward data. We do not see any general
weakness in the order books thus far. We do in steel where imports have caused steel industry
orders to collapse, but that is a specialized industry effect and we do not yet have indications of

9/29/98

any overall contraction in orders for equipment. But if we are at all correct in evaluating how the
system is functioning, that should be on the fairly near-term horizon.
I believe that the stock market decline has had a very profound effect, and indeed one
can argue that a goodly part of the increased risk aversion is itself a consequence of the collapse
in stock market values. As best I can judge, that collapse is not all that much a result of a
contraction in earnings expectations, at least on the part of security analysts. It clearly is far
more the result of rising discount factors against those earnings in the sense of a rise in equity
premiums, as least as we measure them. What that indicates is a foreshortening of forward time
preferences or, looked at another way, an increase in risk aversion. So, in one sense
differentiating equity markets and the credit markets is not something that is very meaningful
because both very much reflect the same underlying process of pulling back.
As I indicated earlier, the approximately $3 trillion capital loss in the aggregate value
of equities in the United States, most of which are held by U.S. residents, just cannot be
occurring without considerable breakage of crockery somewhere. A stock market decline of the
magnitude we have experienced probably was far less significant 20 or 30 years ago than it is
today. This is largely because the aggregate size of stock holdings relative to income is so much
higher now and so many more people have equity investments that the effects of stock market
declines on economic choices is almost surely higher. Clearly, our exposure to stock market
developments is much greater than it is in Europe.
In any event, I think that what we are observing is a development that is occurring at
the fulcrum of a turn, for want of a better expression, in the psychology of anticipatory
evaluations that will be reflected at some point in hard numbers relating to the performance of
the economy itself. I think, however, that it is a mistake to expect the latter to happen very
quickly. The economy's momentum in 1997 and the first quarter of 1998 and the big surge in

9/29/98

stock market values in the first half of this year are all working their way through the income and
product accounts. I would be very surprised to see that momentum disappear in the near term. I
do anticipate a significant decline in capital appropriations, new orders, and contract awards.
But these take time to work their way into actual purchases of capital goods and spending on
projects that are under way. Therefore, a presumption that we are going to see a significant
effect on capital expenditures before 1999 is probably unrealistic.
Nonetheless, it would be wrong to say that the change in psychology is all ephemeral
just because we have not seen it in the hard data yet. In the forecast process, we have to look at
people's value judgments. It is the change in value judgments that alters the real world. We
have evidence that those value judgments are changing in a very significant way, and that is no
longer a forecast. As a consequence, we are likely to see this process continue and perhaps
accelerate.
I thought the evidence of fairly widespread tightening in the senior loan officers
survey was quite startling in terms of its discontinuity with bank lending practices in the previous
survey. We picked up indications of that at our meeting with the Federal Advisory Council
several weeks ago, well before the latest loan officers' survey was conducted. What was
extraordinary is how depressed that group was. None of them was saying that their loans were
declining. None of them was saying that their local economies were experiencing a major
contraction. But the essential conclusion is that the risks really are perceived as having increased
in a way that I had not seen earlier, and that conclusion is now being solidified in the senior loan
officers' survey, which is far broader and more detailed.
What we are seeing in our financial markets is essentially a mirror image of financial
developments abroad, including a remarkable similarity in timing. The concurrence between
developments here as measured by domestic yield spreads and the dramatic events abroad as

9/29/98

measured by the weighted Brady stripped spreads indicates that we are not currently observing a
lead/lag phenomenon. In effect, the same contagion that has so gripped the rest of the world is
spilling over to our economy. We are becoming infected. This is evidenced by a widening of
domestic yield spreads.
I come out of all of this with a set of conclusions or probabilistic evaluations that
suggest to me that the Greenbook is essentially on the right path. But I do think that we have to
be careful to recognize that yield spreads that can become dramatically adverse also can work
their way back toward previous norms. We have seen several spikes in the international stripped
Brady data that have involved reversals. To be sure, this one is a much more deeply seated one,
and it has spilled over to the United States. However, we cannot presume that the process of
deterioration is 100 percent irrevocable. That defies history. The probability of a substantial
reversal at this stage is, I think, less than 50/50, but it is by no means zero. Therefore, those who
have urged a degree of caution in moving the funds rate lower, in keeping with the tentative
decision during our telephone conference last week to move at this meeting, have the best case as
far as I am concerned.
Accordingly, I would suggest a reduction of 25 basis points in the federal funds rate
and not 50 basis points. I think that there is a better argument for a tilt toward ease in that the
latter has somewhat greater support in terms of the historical experience. Nonetheless, it is
conceivable that we may end up viewing this action not as the first in a series of moves but as an
insurance premium, as Governor Kelley pointed out. If that outcome is felt to be more likely,
then the argument for symmetry is more compelling. I'm not sure the tilt is all that critical at this
stage because I think events are going to drive us far more than our predispositions at this
meeting. I would be less inclined to base our future actions on whatever we conclude at this
stage than I would on what I might see in a newspaper, say, two weeks from today that reported

9/29/98

on significant developments over the next couple of weeks. So, I don't think that the tilt is going
to matter all that much. The reason is that in my view this economy is either going to weaken
further as a consequence of the very significant shift toward greater risk aversion and very large
capital losses in our equity markets or it is going to stabilize. Brazil may suddenly look better;
Latin America more generally may look better; we may get a further decline in the Brady yield
spreads, which we have seen in the last few days; junk issues may suddenly look a lot less
uninteresting in the American market. In other words, we cannot rule out the possibility that at
some point the economic outlook may look far more like the August Greenbook projections and
what we discussed at the August meeting than it has in the last few weeks. My own impression
is that economic conditions are eroding at this point. I do not believe we are behind the curve
because I think recent economic developments are to a very large extent what we were
anticipating. It is not as though there is a shock element involved.
You may remember that in Jackson Hole a number of us got together and expressed
the hope that we would be able to wait until today's meeting to take whatever action was
consistent with developments in our domestic economy. We did not want to be seen as rushed
into action by events external to the United States and associated market forces. We felt that
having to move earlier than today would clearly be seen as evidence of a central bank that was
scurrying to catch up. We have succeeded in staying on schedule, if I may use that term, and
hopefully we will continue to do so.
Accordingly, I am putting on the table a proposal to reduce the federal funds rate
immediately by 25 basis points and a recommendation that we move to asymmetry toward ease.
I would add that my preference for a tilt in that direction is a lot less strong than what I see as the
desirability of a clear action to move the rate down by 25 basis points. Vice Chairman.

9/29/98

VICE CHAIRMAN MCDONOUGH. Mr. Chairman, I agree with your proposal to
cut the fed funds rate by 25 basis points. Being the resident theologian on the meaning of "tilt," I
would say that a tilt in the direction of further ease is more reflective of what the Committee
thinks is likely to happen and where the risks are located. So, I, rather more strongly than you,
prefer an asymmetric directive.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. Mr. Chairman, I agree with your recommendation for a 25 basis
point cut. I would be more comfortable with a symmetric directive at this point simply because I
think we still are not, as you point out, seeing real evidence of a slowing domestic expansion. If
the reality of a rate cut, as opposed to its promise, results in calmer markets--and Don Kohn
suggested that they have calmed a little in recent days--we may see a shorter rather than a longer
period of market turmoil and a return to an economic situation resembling the one that we had in
August. At that point, the domestic economy was still displaying a good deal of strength, and we
had some concerns on the upside as well as the downside. So, I would be significantly in favor
of a symmetric directive, given that I am not entirely convinced that the economy is headed
down an irrevocably slippery slope. I say that despite the fact that the market turmoil is
significant and the overreaction in credit markets has been much greater than we anticipated at
the August meeting.
CHAIRMAN GREENSPAN. Governor Rivlin.
MS. RIVLIN. Mr. Chairman, I too agree with your recommendation of a 25 basis
point reduction. In my view, a larger move is unnecessary, and it likely would be interpreted as
evidence that the Fed must really be worried. I don't think we want to convey that impression. I
would also concur with the proposed downward tilt in the directive despite the discussion that we
had at the beginning of our meeting this morning. If we were going to announce our decision on

9/29/98

the tilt today, I might be more inclined toward a symmetric directive. I would worry that the
reaction to asymmetry might be to question why we didn't reduce the rate by 50 basis points if
we are that concerned.
MR. KELLEY. Aha! [Laughter]
CHAIRMAN GREENSPAN. I'm sorry, but where do you come out given that we
decided not to announce our decision on the tilt today?
MS. RIVLIN. Since we decided not to publish the tilt today, I come out in favor of a
25 basis point reduction and asymmetry toward easing.
CHAIRMAN GREENSPAN. Thank you. Governor Kelley.
MR. KELLEY. Mr. Chairman, I support your 25 basis point move, and I prefer
symmetry for two reasons. First, that is what the facts of the situation call for in my judgment.
Secondly, lowering the fed funds rate could well "spook" this market if such a move is combined
with an asymmetric directive. The market might see the Committee as badly frightened rather
than responsibly concerned. This could induce the very sequence of adverse events that policy is
intended to discourage in the first place. Should evolving conditions so warrant, we can just as
well move policy further from a symmetric directive.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. Mr. Chairman, I support your recommendation of a 25 basis point cut
in the target federal funds rate. As I noted earlier, an easing has to be justified as a preemptive
response to a significant change in the forecast. In regard to that forecast, we have changes that
involve some combination of a lower central tendency for growth next year and wider downside
risks. The question we face in reaching this decision is the location of the threshold where such
a projected slowdown crosses the line from being benign to becoming unacceptable. There is no
question in my mind that a slowdown of the dimension projected by the staff meets that test. It is

9/29/98

a closer call from the standpoint of my less pessimistic forecast, but taking into account my sense
of asymmetric downside risks, I believe an easing is clearly justified today. An easing can be
viewed as either a step toward filling an expected hole in growth in 1999 and/or providing
insurance against a bad draw from the unpleasantly fat tail of the probability distribution of
outcomes. An easing also can be justified in terms of the minimax framework I previously
suggested in relation to our March 1997 tightening. We should look at each of our options, in
this case no change or an easing, and ask what would be the worst possible outcome under each
option. Then, we should select the option that yields the least-worst outcome. As I balance these
risks today, I am convinced that the greater danger comes from an unacceptably sharp decline in
growth and that an easing is therefore justified.
The next question is the size of the move. It is useful to make a provisional judgment
about the path of the funds rate in relation to the forecast. The path of the funds rate should be
set so as to partially offset the projected slowing in growth in 1999. The objective is to leave
growth below trend next year so as to reverse in part the prevailing tightness of the labor market
and also to avoid overshooting in the year 2000 as foreign growth begins to recover. The
magnitude and timing of the rate cuts in the Greenbook look about right based on the above
considerations relative to the Greenbook forecast. Since my forecast is less pessimistic, I would
not want to move more aggressively than the funds rate path assumed in the Greenbook. I also
agree with your recommendation of an asymmetric posture toward further easing. In my view,
such a posture better reflects where we are, assuming that we implement a 25 basis point move
today. I would favor that posture whether or not we were to announce it today.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. I would like to review briefly where I am coming from, Mr.
Chairman. Despite the rising turbulence in the international economy over the last year or so, I

9/29/98

have been primarily focused on the upside risks until recently. I am still focused on them at least
to some extent. Until recently, I have felt that the effects of the foreign shocks were primarily
two-sided in terms of their implications for GDP growth. The drag on GDP growth from
reduced net exports was offset to a considerable degree in my view by lower interest rates due to
the flight to quality and by downward pressure on domestic prices occasioned by the stronger
dollar and lower commodity prices. With that offset in place, I tended to look through the
international problems to the domestic economy where I saw very rapid growth in M2 and a high
level of economic activity. That for me translated into an inflation risk. That situation clearly
has changed dramatically. The huge increase in perceived risk in financial markets, if it persists,
may well short-circuit the earlier, mainly favorable, impact of foreign developments on U.S.
financial conditions. In this new environment, we no longer have that offset. Bob McTeer will
be happy to know that I am no longer in favor of tightening monetary policy.
While the downside risk in the domestic outlook clearly is greater than it was, that
alone would not be enough to persuade me that we need to ease monetary policy, at least not
quite yet. I see a continuation of very strong conditions in the economy and not much evidence
that they are going to weaken significantly in the near future. If there is a case for easing now,
from my standpoint it would be to signal that we are not indifferent to the growing risks in world
financial markets and that we are prepared to be flexible going forward as emerging
developments may require. In my view, 25 basis points is a sufficient signal to get that message
across. I think a 50 basis point reduction would go well beyond what is necessary.
As far as the symmetry of the directive is concerned, since I think a1/4 point reduction
is going to put us a little ahead of the curve--I may be the only person in the room who feels that
way but I do feel that way--I would prefer a symmetric directive.
CHAIRMAN GREENSPAN. President Jordan.

9/29/98

MR. JORDAN. Thank you. My position is not a 1ot different from that just expressed
by Al Broaddus. I had been hoping for quite some time for the emergence of investor caution.
Rational optimism is desirable, but investor sentiment was well beyond anything that I would
have called rational optimism. Having both lenders and other investors be a little more reasoned
in weighing risks is certainly desirable, but we got there too fast. It went too far, and we now are
dealing with a crisis of confidence. We do not want to see a seizing up in financial markets,
domestic or foreign. Foreign financial markets have seized up to a large extent. So, I am hoping
that this uncertainty will dissipate rapidly and that we can turn back to a situation that is more
reflective of the fundamentals. I think that any action that we take will be more symbolic--a
message that may have a political component--than needed in a fundamental sense. I hope that
turns out to be the case. For that reason, I think it is desirable to do the minimum that we can get
away with. To do otherwise would be to ignore to our peril the rapid acceleration that we have
seen in all of the money, reserve, and credit aggregates. We have to be careful about that.
As far as the symmetry is concerned, I always prefer symmetric directives. But I do
not feel strongly enough about asymmetry or symmetry that I would dissent from an asymmetric
directive.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Mr. Chairman, I support a 1/4 point reduction in the funds rate. I also
think the current situation may require more than one 25 basis point cut in the funds rate in the
future, and therefore I would prefer a directive with asymmetry toward ease.
CHAIRMAN GREENSPAN. President Hoenig.
MR. HOENIG. Mr. Chairman, I also support a 25 basis point reduction. As to the tilt,
I would much prefer no tilt for a couple of reasons. Number one, I don't think the facts today
warrant it. Number two, I think you are correct in your observation that events will drive what

9/29/98

we do next, and changing circumstances may well require a discussion at a telephone conference
before a decision is made.
CHAIRMAN GREENSPAN. President Boehne.
MR. BOEHNE. A 25 basis point reduction captures my feeling. I think it is the right
measure of response at this point. As far as the tilt is concerned, I'm almost indifferent about it.
I believe that we are going to be so driven by events that the tilt is likely to have no substantive
influence on what we do. If we had a different disclosure policy and there were an
announcement effect, I think it would be worth spending more time on this question, but I am
happy to go along with your recommendation.
CHAIRMAN GREENSPAN. President Poole.
MR. POOLE. I support the proposed cut of 25 basis points. I have a preference for
symmetry, but I don't believe the issue is very important. In the long run what we do is what
determines the outcome, although I believe that what we say can be extremely important in the
short run. So, we need to be clear about our direction and our purpose. We have to emphasize
that our intention is to focus on the U.S. economy not because we are unconcerned with what is
going on abroad but because we have only one policy instrument. At best, we can serve one
policy objective and that should be to achieve price stability or maintain low inflation in the
United States. That is a very important message that we need to repeat continuously. Market
expectations are very important in terms of how monetary policy exerts its effects in the short
run. We have seen a large decline in interest rates in recent months. That is not just good luck.
It is not just an accident. It is a consequence of the market's understanding of the Federal
Reserve's objectives and what its policy is going to be in the long run. That decline in interest
rates could not have occurred if the market did not believe that the incoming data were consistent
with low inflation and that we would in time act to bring interest rates down as required to keep

9/29/98

the economy in'the neighborhood of full employment. So, I think that the consistent message
that we send about the importance that we attach to our long-run objective of price stability is
essential to having built in stabilizing effects from market fluctuations in rates.
I would like to comment briefly on the discount rate. In the long run, I would like to
see the discount rate closer to the federal funds rate, but I think that this is not the time to make
any such adjustment. I hope that the Board will accept a 1/4 percentage point cut in the discount
rate so that the change in the federal funds rate at this time will be viewed as perfectly normal
and will not send any possibly confusing messages to the market.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. Mr. Chairman, I support your recommendation for a 25 basis point
reduction in the fed funds rate. In my opinion, going beyond that clearly would be seen as an
overreaction and some would view it as panic on our part. It is important for us to keep in mind
that we are basing this policy action on projections, as you said, and we have to be somewhat
humble about our record on projections.
On the tilt in the directive, I am almost indifferent. If we follow the logic of how we
have been using symmetry, I would have a slight preference for asymmetry since I am assuming
that there is a better than 50 percent probability that we will have to lower rates again. I hope I
am wrong about that, but that is my assessment of the outlook at this point.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. Thank you, Mr. Chairman. I endorse your recommendation for a
decrease of 25 basis points in the federal funds target rate. As I said in my earlier statement, I
think we are acting somewhat preemptively, and while I believe we should take action at this
point, we should not overreact.

9/29/98

With respect to your policy recommendation for moving to asymmetry, I endorse that

as well. Like President Moskow, I feel that further cuts are slightly more likely than not, and I
think it is important to signal that at least internally. Therefore, I would move to asymmetry.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. I also support both proposals. Given all that we have discussed, I
believe some rate cut is important, and I think 25 basis points is about right. I am not
embarrassed about basing this policy move on the forecast. I think the forecast has it about right.
We may find that we have to do more than 25 basis points, and therefore I would also support
asymmetry toward easing.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. I, too, support the recommendation for a 1/4percentage point reduction
in the fed funds rate. It seems to me that that is the prudent thing to do given the risks as I
perceive them. I view such a policy adjustment mainly as on the margin of our effort to insulate
the domestic economy from the series of negative developments that has engulfed the world in
recent months.
As far as symmetry and asymmetry are concerned, as I have commented before, I have
a long-standing preference for symmetry most of the time. This is one of those times, mainly for
the reasons you cited, Mr. Chairman. I think events will determine what happens and I do not
feel that asymmetry buys us very much in this setting.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. Mr. Chairman, I think I have done my colleagues a real service today
in suggesting that we may be behind the curve. I gave them all a chance to say we were not, and
an opportunity to vote to ease monetary policy while still sounding hawkish! [Laughter] Just to
clarify my views on that--

9/29/98

CHAIRMAN GREENSPAN. I don't think you need to! [Laughter]
MR. MCTEER. I'm willing to quit! I do not believe we are behind the curve on the
real economy. On the other hand, I do think that had we lowered the fed funds target by1/4
percentage point prior to the Jackson Hole conference, we might have avoided some of the
financial market turmoil that we have seen since then. But starting from here and now, I would
just point out that at 5-1/4percent the federal funds target rate will still be above 30-year bond
rates. The yield curve will remain inverted. As the earnings reports for the third quarter come in
below current expectations, I think that having a lower interest rate at that point and a lower
discount factor would help cushion some of the further stock market deterioration. If you wanted
to approve a larger reduction and make it look mild and involving all deliberate speed, you could
put periods rather than exclamation points in the announcement! But I realize that I'm not going
to win this argument, so I defer to your better judgment, Mr. Chairman, and that of all my
colleagues on that.
I don't care much about the tilt either, but going back to my earlier comment, our
discussion today does illustrate how convenient it would be not to have to vote on the tilt and
therefore not to have to announce a decision on the tilt. We would still know how we feel
without having to take the risk of publicizing it.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Mr. Chairman, I agree with the proposed 25 basis point easing move
and I would prefer no tilt for the reasons that you articulated with regard to that choice and that
Gary Stern reinforced in his comments. Thank you.
CHAIRMAN GREENSPAN. There is unanimity for a 25 basis point reduction and
the smallest of majorities for asymmetry. So, will you read the directive accordingly.

9/29/98

MR. BERNARD. I will be reading from page 14 of the Bluebook: "In the
implementation of policy for the immediate future, the Committee seeks conditions in reserve
markets consistent with decreasing the federal funds rate to an average of around 5-1/4
percent. In
the context of the Committee's long-run objectives for price stability and sustainable economic
growth, and giving careful consideration to economic, financial, and monetary developments, a
slightly higher federal funds rate might or a somewhat lower federal funds rate would be
acceptable in the intermeeting period. The contemplated reserve conditions are expected to be
consistent with some moderation in the growth in M2 and M3 over coming months."
CHAIRMAN GREENSPAN. Call the roll.
MR. BERNARD.
Chairman Greenspan
Vice Chairman McDonough
Governor Ferguson
Governor Gramlich
President Hoenig
President Jordan
Governor Kelley
Governor Meyer
President Minehan
President Poole
Governor Rivlin

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

CHAIRMAN GREENSPAN. Our next meeting will be on Tuesday, November 17.
We will now go into a short recess for lunch. When we resume our meeting, Bill McDonough
will report on what has been going on with Long-Term Capital Management.
[Recess]
CHAIRMAN GREENSPAN. I have the draft of a press release, which I will ask Don
Kohn to read.

9/29/98

MR. KOHN. It reads as follows: "The Federal Open Market Committee decided
today to ease the stance of monetary policy slightly, expecting the federal funds rate to decline 1/4
percentage point to around 5-1/4 percent. The action was taken to cushion the effects on
prospective economic growth in the United States of increasing weakness in foreign economies
and of less accommodative financial conditions domestically. The recent changes in the global
economy and adjustments in U.S. financial markets mean that a slightly lower federal funds rate
should now be consistent with keeping inflation low and sustaining economic growth going
forward.
The discount rate remains unchanged at 5 percent."
MS. MINEHAN. Sounds good.
CHAIRMAN GREENSPAN. Vice Chair, do you wish to comment?
VICE CHAIRMAN MCDONOUGH. Yes, Mr. Chairman. I want to give the
Committee members some background about the involvement of the Federal Reserve Bank of
New York in helping a number of private sector financial institutions arrive at a decision to inject
capital into Long-Term Capital Portfolio (LTCP). Long-Term Capital Management (LTCM), a
hedge fund management company established in 1994, created a set of funds that collectively are
called Long-Term Capital Portfolio. The founder was John Meriwether. His senior colleagues
are David Mullins, formerly of this Board, and two Nobel Prize winning economists/
mathematicians, Bob Merton and Myron Scholes, plus some others, most of whom were
recruited from Salomon Brothers where Meriwether had worked before.
They were quite successful in 1994 and very successful in 1995 and 1996. In each of
those two years they returned to their investors over 40 percent of their initial investments after
the deduction of very considerable fees by the management company. All their investors were
either firms or high net worth individuals who invested a minimum of $10 million. During this

9/29/98

period, the fund's performance exhibited a very low level of volatility. They were consistently
successful, and, not surprisingly, they apparently began to believe very firmly in their ability to
continue to be successful. They did not take essentially one-sided bets on transactions. Rather,
they were speculating on spreads of the kind that Peter Fisher described earlier, and over time
they also went into spreads on equities as well as fixed-income instruments. In 1997, they were
somewhat less successful. If I remember correctly, they had a return of about 17 percent. At the
end of the year, they decided that market opportunities were not as great as in previous years and
that they could not profitably use as much capital as they had previously, so they returned about
$2.8 billion to their investors. The year 1998 has been considerably less successful; by the end
of August, they had lost 52 percent of the capital that they had at the start of the year. During
August, LTCM officials approached some very prestigious financial firms in New York to see if
additional investors could be brought in. On Wednesday, September 2, Meriwether sent a letter
to the investors of LTCP. Knowledge of that letter became quite widely spread. Meriwether
reported the losses, but he also expressed a great deal of confidence. He said in his letter that he
thought there were investment opportunities and he encouraged his existing investors to invest
more. At the same time, as I mentioned, he was seeking new investors, both directly and
through some securities firms.
Meriwether and Mullins informed me on September 15 that they had to raise a
significant amount of additional capital--about $1 to $1-1/2 billion--in order to support the risk
positions of LTCP and have the staying power that they needed. Two days later, they informed
our Bank that they had been unsuccessful in that regard. That is, they were not able to raise the
money directly or through the securities firms they were using.
You may remember that the markets were very turbulent on September 18. In such
situations I make an effort, as did all my predecessors in this job, to talk to the heads of the major

9/29/98

banks and securities firms in New York. My purpose is to get a feel for two things--what they
think is going on in the markets and how their own firm is doing. Early in the day I had heard
from Messrs. Meriwether and Mullins who told me that their losses were continuing. I thanked
them for the information. It was fascinating to me that every head of the 8 to 10 firms that I
talked to subsequently during the day brought up the problems of LTCM/P independently of
anything that I said. They gave particular emphasis to what in their view would be the very
serious problems that a failure of that firm would create in financial markets. They were not
talking particularly about the problems that such a failure would cause for their own firms but
rather about the problems that it would cause for the financial markets in general.
The reason those problems could arise is that LTCM, because of its previous success,
was able to take positions with its counterparties in the market that essentially involved creditors
lending to them with no initial margin. That is, if LTCP were financing a position of 100, their
creditors would lend them 100. So, LTCP did not have any limitation on the size of its positions
based on the need for an initial margin. The result was that the firm's positions in a variety of
instruments around the world were very large. What my contacts were talking about was the
effect that the failure of the firm would have on world markets if all these positions had to be
dumped on the markets. People who thought they had an offsetting position with LTCP would
suddenly find that they did not have one. They would find themselves with big open positions
that they had to worry about.
Late in the day on September 18, a major securities firm that had been very involved
in trying to find equity investors for LTCP informed me that they had asked LTCM if they, the
securities firm, could share with the Federal Reserve their knowledge of the positions and
condition of Long-Term Capital Portfolio. Long-Term Capital Management said that they would
rather explain their situation to us directly. I agreed on Saturday, September 19, that Peter Fisher

9/29/98

would lead a group of people to visit the firm in Greenwich on Sunday. To make a long story
somewhat shorter, he and his group, which included Dino Kos and some others, were joined by
Mr. Gensler of the U.S. Treasury. At that point I was in an awkward position because, wearing
my supervisor hat, I had to go to London to give a speech and hold a press conference. The
nature of my position is such that if I did not make my scheduled speech at a time when rumors
were circulating in New York about a number of securities firms--not just LTCP--market
participants might conclude that a firm was about to fail. That was not a signal that I wanted to
give.
Fortunately, my distinguished colleague, Mr. Fisher, could remain in New York and
set up a team. He did a lot of the dealing with LTCM. He and I engaged in lengthy discussions,
and we shared the view that the collapse of Long-Term Capital Portfolio would create chaotic
financial markets around the world and that nobody could make a good estimate of what the
likely damage would be. By this time we knew that view was shared by Goldman Sachs, Merrill
Lynch, JP Morgan, and shortly after, UBS. To go back to some conversations that we had earlier
today, it was our view that the effect of the firm's failure would be to depress equity markets and
to create widening spreads in fixed-income markets. What the downside effect of that would be
on many economies, including that of the United States, could not be easily ascertained. It also
became clear that even though LTCM had been working with at least the four firms that I
mentioned, they had not been able to establish enough of an identity of interests to make it
possible for the private investors to get the interested parties together. These were deemed by
this time to be approximately 17 financial institutions around the world that had very large
counterparty positions with LTCP.
We essentially saw only two likely scenarios since we were convinced that the private
sector group could not get itself in a room to work out a possible solution. Either there would be

9/29/98

a failure of LTCP or the Federal Reserve Bank of New York would play its traditional role in
this type of situation. We knew that our intervention would put the prestige of the Bank on the
line; put the Federal Reserve, of which it is a part, in the morning newspaper; and put the
personal reputation and prestige of the President of the Bank who made the decision on the line.
As I saw it, our intervention was preferable to letting the firm collapse in the belief that we were
good at damage control. So, I made the decision that we had to play that role, working through
Peter Fisher for a good portion of its implementation.
Peter held a series of meetings, but the climactic meeting occurred last Wednesday at
which 15 firms were represented. I began the meeting by explaining that if it was possible for
the private sector firms to reach a decision in their interest--one that was freely arrived at by
them because there would be no public money involved--that would be in the best interests of
markets in general and of the people who depend on markets. At the end of the day, the private
sector firms reached a conclusion after a very long struggle. We stayed out of the fray, but it
was perfectly clear in light of the fact that we were present--I was in the room; Peter was in the
room; the chairman of the New York Stock Exchange was in the room--that we had an interest in
their coming to a conclusion. The conclusion reached, including all the terms and the conditions,
was theirs, not ours. It was not suggested by us; it was not guided by us.
In a subsequent series of meetings, the details were finally worked out with some
difficulty. Late in the afternoon on Friday, I was asked by the person presiding over the private
sector group if the Federal Reserve Bank of New York would "authorize a meeting of the
seniors," that is, the people who had been in our board room on Wednesday, or invite them to the
meeting, or attend the meeting, or ask Peter Fisher to attend the meeting. I said "None of the
above. We got you folks to a point where you could all be in the room and where you could find
it possible to arrive at a decision. But if there still are difficulties in your closing the deal, you

9/29/98

have to resolve them." The problem with our convening the meeting and sitting there glowering
at people to induce them to reach an agreement is that if they were not able to solve the problem,
then it would be our deal. The Federal Reserve would be excessively, inappropriately, and
unwisely involved.
So, the involvement of the Federal Reserve Bank of New York was essentially to
bring the parties together because we agreed with the heads of four of the major securities firms
in the world that a failure of LTCP would bring chaotic market conditions, with immeasurable
and essentially inestimable damage to economies around the world. That was a sufficiently great
danger that we believed we should use the premises and the good offices of the Federal Reserve
Bank of New York to bring people together so they would have an opportunity to reach a
conclusion.
Peter Fisher can answer any number of questions you might have on the details, but
my summary is essentially the story regarding the Federal Reserve's involvement. We put the
name of the Federal Reserve Bank of New York on the line, and of course it is part of the
Federal Reserve System. I put on the line my personal prestige of being in that business most of
my life and therefore being considered by the other participants in the room as having a
knowledge of these things. I believe we did the right thing, but I certainly understand why others
could say we went a little too close to the edge or we went over the edge. Thank you, Mr.
Chairman.
CHAIRMAN GREENSPAN. Bill, did those in the room think that their own firms
would benefit from an agreement, or were they looking solely at the macroeconomic effects of
being good citizens?
VICE CHAIRMAN MCDONOUGH. They were looking at both in my view. There
was a good deal of concern about the macroeconomic effects. There also was a belief or

9/29/98

assumption that if the LTCP collapsed, spreads would widen put, it would be very difficult to
mark positions to market, and there could be some chaos for a week or two where it would be
very difficult for markets to function. During that period, certainly, the mark-to-market losses
for the firms would be moving in all directions. Therefore, there is no question in my view that
they thought they would be better off if there were a solution. They get paid for making that
kind of judgment in the interest of their shareholders. There also was quite a lot of discussion,
which sounded rather sincere, that they as the "seniors" of the financial services business in New
York had a responsibility to the financial system. But were they also strongly motivated by the
best interests of their firm? Without question.
CHAIRMAN GREENSPAN. Could you go back and tell us what you know about the
position of our bank examiners regarding the practices, which I think you described as less than
optimal, that were followed by the institutional lenders to LTCP?
VICE CHAIRMAN MCDONOUGH. Richard Spillenkothen might be able to pick
this up better. A staff group from the Board of Governors and the New York Reserve Bank
made a number of visits last December to the major banks, both national banks and state member
banks, and put out a memorandum on the subject in April.
MR. SPILLENKOTHEN. I should probably point out that this was not an on-site
examination. Our staffs met with the managements of these institutions. I think they came away
with a feeling that, generally speaking, the banks were saying the right things in terms of the
kinds of risk management processes they had in place. The bankers talked a lot about how their
involvement with hedge funds was becoming a bigger part of their overall business activities,
and they noted that they actually had staff who managed their relationships with the big hedge
funds because of the nature of the business. I gathered that the bankers were indicating that they

9/29/98

had the policies and procedures in place to deal in a fairly effective way with the risks that
generally were involved.
In terms of this situation, I think that the issues either then or going forward are
threefold. One is the extent to which the banks actually are applying these risk management
policies in the course of their activities. That application of policies has to be looked at in the
context of the examination process. We indicated in the memorandum, as Bill McDonough
mentioned, that this was an area that we needed to continue to focus on in the course of the
examination process. Secondly, in terms of the issues here, I think the robustness with which the
banks applied their own policies was adversely affected by their perception of the reputation of
the people who ran LTCM/P. The final point is that in terms of lessons learned, a lot of the focus
here has to be on collateral and collateral management. One thing that this experience has
underscored--and actually we have known this for some time--is that collateral is only one aspect
of the overall control of credit risk, but it is not a replacement for the banks' analysis of the
overall creditworthiness of the borrower.
At this point, we think the banks had the right policies and procedures in place. The
question is how effectively the banks were implementing those policies and procedures. We
have people visiting the three major state member banks today, and tomorrow they will be at
Salomon, to talk about the overall exposure of these institutions to hedge funds, their exposure to
LTCM, the extent to which they actually are following the policies that they said they had in
place, and whether they treated LTCM differently from other hedge funds for whatever reasons.
I think the basic answer is that we were reasonably comfortable that they had the policies in
place, but the question is how effectively the banks were actually implementing them in the case
of this particular institution. We still have to look into that.

9/29/98

CHAIRMAN GREENSPAN. When we conduct our examinations, I know that we
check to see whether bank policies are being implemented, but how did we do that with respect
to, say, Morgan and LTCM? Did we actually evaluate the loan portfolio that represented
Morgan's claims against LTCM/P to see whether, in fact, Morgan abided by the principles that
you just outlined?
MR. SPILLENKOTHEN. We typically do some transactions testing to see if banks
are carrying out their policies with respect to counterparties. Actually, the Bankers Trust and
Morgan exams are now under way. Just before I came to this meeting, I looked at the previous
examination, and there was no mention of LTCM in it. But that firm grew rapidly, and the banks
may have had a fairly modest amount of exposure at the time of the previous examination. At
this point, I cannot say whether we looked at the particular relationship you mentioned, but we
do look at and test to see whether a bank's policies are being implemented. We do not do that
for every counterparty by any means. We do a spot check.
VICE CHAIRMAN MCDONOUGH. Rich, it could well be that, with the rapid
growth of LTCP and the increasing involvement of banks in dealing with hedge funds, the banks
may not even have been dealing with LTCP at the time of the previous exam.
MR. SPILLENKOTHEN. Yes, that previous exam probably would have been as of
the middle of 1997. That exam would have been over a year old. That's a question we have to
go back and take a look at.
CHAIRMAN GREENSPAN. Where we are most vulnerable is with regard to the
adequacy of our examinations.

We rarely come up against a situation where we say this is awful, the institution is falling

9/29/98

apart, and we did not spot the deterioration. For example, when we looked into the Japanese
operation in New York in which the embezzlement occurred-SEVERAL. Daiwa.
CHAIRMAN GREENSPAN. Daiwa, yes. What Daiwa exposed is how complex
these situations are and how few troops we have to look into them.

if we had to meet the standards that people think exist, we would have five
times as many examiners

We would examine them

to death, and they would not have any breathing room.

What we need at this stage is some sense of whether we are examining very
specifically what actually happened in the LTCM situation. When I was in the private sector, I
remember looking at the details of particular loans that were shown to bank directors. I was on
the loan committee of one of these major banking institutions, and we actually went through the
loan portfolio major client by major client. The bank's senior loan officers would provide a
basic review. They would take the loan portfolio and point to the vulnerabilities and strengths of
the borrowers and give their evaluations of the risks that were involved. The review was quite
thorough. I knew that I was getting a bit of a snow job--the type of thing where mistakes never
are made and everything is perfect. But even adjusting for that, the examination was at a level
that would not have allowed this LTCP problem to happen. But it did happen and a number of
extraordinarily effective counterparties were involved. The question is why it happened in this

9/29/98

case. Is it just that the lenders were dazzled by the people at LTCM and did not take a close
look?
VICE CHAIRMAN MCDONOUGH. I think there was in place a credit management
system that appeared to make a great deal of sense.
CHAIRMAN GREENSPAN. Whose? LTCM's?
VICE CHAIRMAN MCDONOUGH. No, the lenders, including the institution with
which you were once associated. One may question the notion that at least for some lenders
there was no initial margin requirement. Beyond that issue, it should be emphasized that the
lenders had very good collateral management systems so that if the LTCP began to lose on a
position, it would need to put added collateral in place. What we have to get our hands around
conceptually is whether there was something that we missed that could have provided us with
some notion of just how big the overall position of LTCP had become. I don't know how we
could have done that. We do not regulate that firm. But given the number of institutions they
dealt with around the world, was there a way that should have enabled us to be more aware of
their overall position? One is inclined to say, "you bet." But exactly how we could have done
that I am not so sure.
CHAIRMAN GREENSPAN. Somebody mentioned to me that Bankers Trust had an
August balance sheet for LTCM. Is that true?
VICE CHAIRMAN MCDONOUGH. Yes, but the balance sheet is a relatively small
piece of the whole action because so much of the latter is off-balance-sheet.
MR. FISHER. I don't think they had an August balance sheet on September 1.
VICE CHAIRMAN MCDONOUGH. They may have one now.
MR. FISHER. They may have had one during the weekend, eight days ago. I don't
think anyone had seen one before the weekend of September 19 and 20.

9/29/98

CHAIRMAN GREENSPAN. It is one thing for one bank to have failed to appreciate
what was happening to LTCP, but this list of institutions is just mind boggling.
VICE CHAIRMAN MCDONOUGH. This tells us that there was something in the
way that the financial services institutions as a group were dealing with at least this firm that
allowed a position to be built up that was very dangerous.
CHAIRMAN GREENSPAN. What type of collateral would ordinarily be required on
this type of loan?
MR. FISHER. Let me try to answer your line of inquiry, Mr. Chairman, with a
hypothesis. I want to be very clear that this is just a hypothesis. On August 31, the firm has a
$125 billion balance sheet against $2.8 billion of capital, which they have lost. Essentially, $125
billion of assets are out under repo. There are no assets in the firm. One kind of transaction they
are doing with their counterparties is a repo transaction.
CHAIRMAN GREENSPAN. Involving U.S. Treasuries?
MR. FISHER. U.S. Treasuries, Danish government bonds, BBB credits--you name it.
CHAIRMAN GREENSPAN. There are not a lot of triple Bs outstanding.
MR. FISHER. There is a fair amount of government credit in these assets, but there
are a lot of other assets also. Swap agreements are their instrument of choice, and that is how
they got to a $1.45 trillion off-balance-sheet position on August 31. By the time we were
looking at that position during the weekend eight days ago, the firm clearly had lost a lot of
capital. Other firms that looked at their position in greater detail than we were able to thought
the off-balance-sheet had shrunk to around one trillion dollars by the third week of September.
The balance sheet leverage ratio was 55 to 1 by the time we looked. The off-balance-sheet
leverage was 100 to 1 or 200 to 1--I don't know how to calculate it. Let me try to explain by
way of a hypothesis.

9/29/98

A counterparty looking at LTCP and contemplating secured financings involving repo
transactions and a lot of total-rate-of-return swaps and other swap transactions might decide not
to take any initial margin. The counterparty would consider itself secure because it had taken
five years of data and seen what the daily and two-day price moves can be. It would be
managing its risk exposure on the basis of the same five years of data that the experts at LTCM
were using and had concluded that not all the correlations would go to one. Both counterparties
would be using risk management systems--this is now a hypothesis--where they have become
increasingly comfortable with zero initial margin because the daily cash flow is enough to let
them think they only have a 1-day move to consider. That is, when they look at five years of
data and a potential 1-day move on that basis, they conclude that they can handle that 1-day risk.
On the basis of that same five years of data, the partners inside LTCM have persuaded
themselves that the correlations will never go to one between Japanese, German, and U.S.
government bonds. They are making the assumption that they will have a globally diversified
portfolio. That in part is how the counterparties also get comfortable with zero initial margin.
But from the System's point of view, zero initial margin permits an essentially unlimited amount
of leverage. There is no constraint other than exhaustion on the part of counterparties.
VICE CHAIRMAN MCDONOUGH. The biblical justice in this situation is that the
principals of LTCM apparently believed so firmly that this system would continue to work that
they appear to have borrowed rather heavily to increase their own risk positions in their firm.
So, there is a general and spreading belief that we may have some extraordinarily elegant people
in private bankruptcy court in the fairly near future.
MS. RIVLIN. How many more LTCMs are there?
VICE CHAIRMAN MCDONOUGH. We do not know of any other hedge fund that
would be remotely of the size of LTCM/P. If John Meriwether can do it, there certainly would

9/29/98

have to be other smart individuals with computers who could engage in the same sort of activity.
So, there have to be little versions of LTCM/P. Most of the other very well known hedge funds
operate much more in the direction of one-way bets. They can lose $2 billion in Russia, and one
can say that is a shame. Well, it is a shame for them but not of much concern for anybody else.
MR. MEYER. As we get under way with our F-6 study of systemic risk, I think this is
an important episode for us to study. We are trying to decide what is systemic risk and what is
not--where we can draw the line. I think we need some further analysis of this episode to help us
decide whether this was an appropriate involvement of the Federal Reserve. There will always
be a matter of judgment involved, but this certainly was a close call. We need to think about
that. Secondly, we have the supervisory issue. I think we are going to be called on to explain
whether or not our examinations and other sources of information provided us with what we
needed to know.
There also is an issue that I would be remiss not to at least mention, namely that of
overseeing how these lending and investment decisions get made. Rather well along in this
process, I was getting telephone calls from reporters who knew more about LTCM than I did. I
don't think that was the way it should have been.
CHAIRMAN GREENSPAN. Let me go back. Can you explain to me how, if
everybody is 100 percent collateralized--not 110 but 100 percent--we can end up with these huge
losses for lenders?
VICE CHAIRMAN MCDONOUGH. The lenders continue to be collateralized as the
firm starts to lose money but only so long as the firm has capital to continue to provide added
collateral to make up for the losses. As the losses continue to mount, the firm at some point-CHAIRMAN GREENSPAN. But, are we looking at losses in the value of the
collateral or is collateral being withdrawn? If I am a bank lender and I lend $200 million to a

9/29/98

hedge fund, ordinarily I would be over-collateralized. I would hold more than $200 million in,
say, U.S. Treasury bills.
VICE CHAIRMAN MCDONOUGH. Remember, on day one there was no initial
margin.
CHAIRMAN GREENSPAN. I am talking about my position as a bank lending to
LTCM.
VICE CHAIRMAN MCDONOUGH. You made the loan but since there was no
initial margin, there was no collateral.
MR. TRUMAN. There is collateral but no margin.
MR. FISHER. If I lend $100 to LTCP they give me an asset worth $100. If the
market value of that asset goes up 5 percent today, I give them back $5 dollars; if it goes down 5
percent tomorrow they give me $5 dollars.
CHAIRMAN GREENSPAN. That is a 100 percent collateralized mark-to-market
position.
MR. FISHER. Right.
CHAIRMAN GREENSPAN. Now, in order for me as a bank to lose in this situation,
I either have to find that the collateral I have is not legally available under certain circumstances
or its market value has declined. Which was it in this case?
MR. FISHER. It was the latter. The collateral lost market value.
CHAIRMAN GREENSPAN. So, the collateral lost value and LTCP did not have the
resources to make up for the loss.
VICE CHAIRMAN MCDONOUGH. That's right.
MR. FISHER. I want to be clear, Mr. Chairman. We are talking about a balance sheet
of $125 billion and an off-balance-sheet of $1.4 trillion. Now, we know the total was not all

9/29/98

collateralized at 100 cents on the dollar. It was only the balance sheet financing that was fully
collateralized.
CHAIRMAN GREENSPAN. Let's leave the derivatives out.
MR. FISHER. I realize it is notional, but we do not know how to scale the notionals.
MR. TRUMAN. The off-balance-sheet presumably goes the same way as the balance
sheet.
CHAIRMAN GREENSPAN. There are two ways of coming at this. There are certain
transactions between counterparties in derivatives where net positions are fully collateralized or
up to X percent and in some cases there is no collateral at all. Straight lending usually is fully
collateralized. I don't know what bankers are going to write off on these losses, but what I'm
trying to get at is where the losses to the banks are coming from. Are we looking at
uncollateralized derivative positions that went against LTCP and in favor of a bank, which
theoretically has a net position of $20 million but discovers that it really has a $20 million credit
problem? In other words, where are the losses coming from as best we can see?
MR. SPILLENKOTHEN. Initially, these transactions in derivatives were in a sense
unsecured. Once the exposure reached a certain point, then the lender, the bank, had the right to
demand collateral to cover that. That is, when the mark-to-market position and the current
exposure built up to a certain point, then the banks asked for the collateral. According to the
numbers we have now, it appears that the mark-to-market positions of these big institutions are
largely covered by collateral. So, it does not seem that there is much loss in their current
mark-to-market positions and other derivatives positions. One of the problems is the potential
future exposure. I am going to say this in English. If markets keep moving away from them in
the wrong direction, their future exposure could be very large and they might not have the
collateral at that point in time to cover that exposure.

9/29/98

CHAIRMAN GREENSPAN. That is a different issue. As far as bookkeeping is
concerned, banks do not book those anticipatory losses unless some real commitments are
involved. What I am trying to focus on is where the losses are coming from.
MR. FISHER. Let me try to work through some of the sources of the losses that were
discussed. Long-Term Capital Management did an analysis of its top 17 counterparties on just
12 trades. These represented a very small percent of the hundreds of trades that they had on their
books, but they were their big trades. For example, 2 of these 12 had losses of $1/2 billion over
a period of 30 days; there were some offsets involving very complicated transactions. The
scenario that LTCM worked out attempted to take into account negative movements in each of
the asset markets. That is, if the market moved against the position in the direction where
liquidation was likely to occur, there would be an acceleration of the losses. But neither the
people at LTCM nor I nor others who looked at this thought a meltdown scenario was involved.
The losses actually were the result of discrete bad days in each of these markets. They had
generated a counterparty loss of $2.8 billion that was spread among the top 17 lenders. That was
at a time when the net asset value of the collateral was about $1 billion or $1 billion plus, so
there were $1-1/2 billion or so of losses to be shared among the top counterparties. I think a
number of us who eyeballed that analysis thought that it was one thing to focus on just the trades
in question; but if all the trades of those firms were included, this direct loss could rise to $3 to
$5 billion. That was a number that the other firms that were actively looking at the numbers also
thought was a plausible forecast of a liquidation scenario involving just the top 17 lenders.
VICE CHAIRMAN MCDONOUGH. I suggest that what would be valuable for the
Committee, for all of us, would be to make certain assumptions about market developments and
then see what the bookkeeping effects would be. How does firm X suffer a loss because of its
relationship with LTCP? This gets us into very sophisticated accounting and complex analyses

9/29/98

of losses. I think we are all trying to make estimates on the fly, but that is not going to give a
very accurate description of how it really works.
CHAIRMAN GREENSPAN. What I think we are going to need for our testimony on
Thursday is a general summary of what we do as examiners, how often we do it, and why banks
with a huge amount of experience in lending got caught in this kind of thing. We need an
answer. The answer is not that it should not have happened. Part of banking involves losing
money. Banks never make a loan that they do not expect to be repaid. In that sense, every loss
is an error. The issue is to define the error.
VICE CHAIRMAN MCDONOUGH. I agree that we are going to need that
information for our testimony, which is being prepared by some of the people who are sitting at
the end of this table.
CHAIRMAN GREENSPAN. If we indicate what we are doing to find the answers,
that is fine. This to me is where the issue of the responsiveness of the Federal Reserve is going
to be.

VICE CHAIRMAN MCDONOUGH. I assume that one of the things we will want to
talk about is the fact that we had staff, other than those who were conducting examinations, who
were meeting with the management people to examine the nature of their dealing with hedge
funds. In their report, the staff mentioned LTCM/P as one of the customers of some of the
institutions. What did we learn there? What might we have learned in addition? It is not as if
we were asleep. I think that as we write the testimony, which already is in process, we will have

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a story. The only fully convincing story is that the problem did not happen, and we know that is
not the case. [Laughter]
CHAIRMAN GREENSPAN. All I care about is that we produce accurate testimony.
MS. RIVLIN. I agree.
MR. FISHER. I would like to offer one final perspective on the numbers that I
discussed. One of the surprises for people who went to look at LTCP's position, myself
included, was the tremendous size of their equity and equity volatility positions. People knew
they were dabbling in that sector of the markets, but everyone including a lot of the press had
thought of LTCP as a fixed-income shop. Some of the firms who looked at LTCP's position in
more detail than I, who had the weekend to investigate, felt that the preponderance of the
exposure, if one uses the $3 to $5 billion number, that needed to be stabilized was the equity
position and the equity volatility position. That's in trades with LTCP in total-rate-of-return
swaps. A lesser part of the losses was in the fixed-income financing area. So, the bigger risk
was this huge equity volatility position that LTCP had taken on.
VICE CHAIRMAN MCDONOUGH. One of the things that we have to be able to
say to Congress is whether the state-chartered banks that we supervise participated in the equity
piece or not. I do not know the answer at this point.
CHAIRMAN GREENSPAN. Have we developed a series of questions for the
testimony that we are asking ourselves? I think that would be very useful. In other words, in the
testimony we should identify the questions to which we do not yet know the answer.
VICE CHAIRMAN MCDONOUGH. We will say what we know, and then we will
say what we do not know and are trying to find out.
CHAIRMAN GREENSPAN. It has to be a full report on what we know and do not

know.

9/29/98

MR. FERGUSON. Two questions come to my mind. One relates to reports that some
of the institutions were not just lenders but also investors. Those, I presume, mainly have been
investment banks. Do we think there also are some section 20s or others that may have been
involved?
VICE CHAIRMAN MCDONOUGH. There was a foreign bank, UBS, that was a
large investor and its investment accounted for a good chunk of the loss that the bank announced
last Thursday.
CHAIRMAN GREENSPAN. Did they participate through an American affiliate or
directly from Switzerland?
VICE CHAIRMAN MCDONOUGH. We think it was Switzerland, but that is again a
fact that we have to establish. It also has now been reported in the press that some senior officers
of the securities firms, we think not of the banks, were involved as individuals either through a
retained earnings fund for senior executives at their institutions or directly as investors in
Long-Term Capital Management.
MR. FERGUSON. My other question is one that I also ask to make sure that we will
have an answer. It involves an issue that is similar to the one that Larry Meyer was raising.
Does this experience in any sense bring into question the approach we are taking with respect to
risk-based supervision? To some extent, it involves what we do and when we do it. We need to
figure out how that approach might have to be adjusted based on this experience.
VICE CHAIRMAN MCDONOUGH. This tells you that the move toward risk-based
supervision is the right way to be going.
MS. RIVLIN. If you do it right! [Laughter]
VICE CHAIRMAN MCDONOUGH. We should try to get enough facts to make sure
that they are doing what they say they are doing. That is what is needed to give an intelligent

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answer to the question. If I sound a little anxious, it is because the people who should be writing
the testimony are here involved in this discussion, including me. Much as I want to share all of
this with you, we have to be sitting down before Mr. Leach at 10:00 a.m. on Thursday morning.
There's a lot of work to be done before then.
CHAIRMAN GREENSPAN. I would like to ask one quick factual question of our
legal counsel. Virgil, you raised an issue with respect to whether in fact a particular group of
new investors in LTCM were investing in violation of the 5 percent equity cap. What have you
concluded, if anything, on that question?
MR. MATTINGLY. I do not know what has happened, but I suspect that fund has
gotten rid of everything over 5 percent.
CHAIRMAN GREENSPAN. So, it is in compliance with the Bank Holding Company
Act?
MR. MATTINGLY. Nobody has told us, but I read in the paper that they have been
dumping equities, so I assume that they are trying to get down below 5 percent.
CHAIRMAN GREENSPAN. Ah! That explains it!
MR. MATTINGLY. Mr. Chairman, some of the banks can take an equity position in
LTCM in satisfaction of a previously contracted debt, but some of the foreign banks may have
reached the 5 percent limit of the Bank Holding Company Act.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. Just to follow up on Alice's question, tell me again how we know
that there are not a lot more large hedge funds like LTCP out there, accidents waiting to happen.
VICE CHAIRMAN MCDONOUGH. How do we know? We do not know.
MR. GRAMLICH. We do not know!

9/29/98

VICE CHAIRMAN MCDONOUGH. We have our usual antennae out. That is how
we learned from a variety of sources that LTCM/P was getting into trouble. We can surmise on
the basis of what has happened to spreads that, although they may get worse, anybody who had
an opportunity to get into trouble certainly had a tremendous opportunity. If nothing else, one
would think that the rumor mill would have brought to our attention that firm X was having
difficulties. We hear all kinds of rumors in the financial markets, but we have not heard of a
hedge fund that would appear to be remotely of the size and macroeconomic risk potential of a
LTCM/P.
MR. FISHER. It was something of a signature for this firm to insist that if a
counterparty wanted to deal with them, there would be no initial margin. Not many other firms
have gotten away with that.
MR. GRAMLICH. It goes to your bedazzlement effect.
MS. MINEHAN. I might mention something that we found out that came as a bit of a
surprise, namely that some of the loans made by some of the large lenders were participated out.
So, we see shares in banks in our District of both collateralized and uncollateralized lines to
LTCM/P.
VICE CHAIRMAN MCDONOUGH. I think there were two major credit lines, one of
which was drawn down. It was a $900 million line of which slightly under $500 million was
drawn down and participated out. I think, however, that most of the transactions we have been
talking about here involve counterparties rather than syndications.
MS. MINEHAN. I realize that but there were at least two syndicated pools.
VICE CHAIRMAN MCDONOUGH. Yes, one to the management company and one
to the partnership.

9/29/98

MS. MINEHAN. I was wondering whether any of this showed up in the review of
shared national credits last year.
MR. SPILLENKOTHEN. As I recall, the credit was $700 million. It was $500
million initially, but it subsequently was increased.
MR. PARRY. Did this program produce a default of any loan?
MR. SPILLENKOTHEN. No.
MR. PARRY. Then how can the investments be a part of DPC [debt previously
contracted], Virgil?
MR. MATTINGLY. They were anticipating that the market would move and that
they would lose their position. The DPC exemption does not require an actual default. The
exemption is also available in anticipation of a default.
MR. STERN. Another form of collateral!
MR. SPILLENKOTHEN. It looks as though their current positions are covered by
collateral, but the issue is potential future exposure in these markets. I have to pin these numbers
down, but from the numbers I've seen, it looks as though they did a pretty good job of getting
collateral to cover their mark-to-market positions. But the potential future exposures seem rather
large, and if they were to materialize under these market conditions one has to wonder where any
collateral would come from in the future. That is part of the problem.
MR. PARKINSON. I would like to draw an analogy. As you may know, we use the
VAR model to measure market risk. The danger is that this analysis does not cover potential
losses in extremely volatile situations. In those markets we have to do stress testing to uncover
what exposures are there. The same distinction is important here, and I think it lies at the heart
of the problem. LTCM is using a VAR-type model, the same basic technology as our VAR, to
measure potential future exposure. But that model estimates exposure in normal markets on the

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basis of one-day movements, perhaps at a 95 percent confidence level. It does not deal with the
kind of markets we are seeing today. The latter are extremely volatile and currently very illiquid.
For example, Peter Fisher talked about equity option positions. Now, suppose investors have to
close those positions out and try to replace them by going into the market. There is no liquidity
whatsoever in that market. It is completely illiquid. I think this emphasis on initial margin
actually is misplaced. The reason is that if investors had decided to collect initial margin, they
would have collected enough margin to cover their estimate of potential future exposure. By
hypothesis, they seriously underestimated that exposure, so they would be still left with a serious
shortfall in their margin.
MR. FISHER. All this relates to the question of how this financing got to be so big
and nobody realized it was happening.
CHAIRMAN GREENSPAN. What technically happens in that kind of model is that
if we are resting on the last five years of experience during which the structure of the markets is
essentially stable, that is, there were no severe contractions or even expansions, the covariances
that we are going to pick up out of that five years are correct covariances for that population and
that environment. What we were dealing with in the Russian situation, if we look at the data,
was something that clearly was not a simple, steady state. In that environment, the coefficients
in an econometric model either collapse to zero or to one. If we took the covariance matrix that
would be implicit in that environment, it would give wholly different risk parameters than we
would get in a system in which we are taking five years of special experience and saying the
losses were never more than "x" on a daily basis. So what? That begs the question of what will
happen in the future.
MS. RIVLIN. That is what stress testing is all about.
CHAIRMAN GREENSPAN. Yes, exactly.

9/29/98

VICE CHAIRMAN MCDONOUGH. We have to be very careful because as
horrendous as this experience was, if we assume that the normal market is that the Russians are
going to default once a week, the cost of capital would go so high that nobody would ever invest
in anything.
CHAIRMAN GREENSPAN. That is the whole point. These are very special cases.
In fact, as some of my colleagues know, my favorite speech is one where I discuss separating the
risks that confront the monetary authority from the risks that the commercial banks have to face.
I have always argued that the commercial banks are responsible for 99.95 percent of the risks
with their own capital. The rest are these 50-year events, which the central bank will handle.
The trouble is that this is what this event clearly was.
VICE CHAIRMAN MCDONOUGH. That is why this central banker was happy to
call a meeting but wanted to make it absolutely clear that our money was not going to be made
available.
CHAIRMAN GREENSPAN. That was very wise. Al Broaddus.
MR. BROADDUS. I didn't have a question, just a 15-second comment in the context
of this Committee's broader responsibility. Bill, I would not second-guess your decision for a
minute. It is the most natural thing in the world to respond to a request for our good offices in a
situation like this. But this kind of action does create expectations with respect to what we might
do going forward that in turn create expectations about monetary policy. So, this issue clearly is
an FOMC matter in my view, and I appreciate it being brought to this Committee. The problem,
of course, is that there is no time for the FOMC to deliberate a situation like this on a case-bycase basis.
CHAIRMAN GREENSPAN. It is not something a committee can do.

9/29/98

MR. BROADDUS. Right. Against that background, it might be constructive for us to
have a discussion at some point in which we would explicitly address the tradeoff and how we
balance the need to intervene in a crisis.
CHAIRMAN GREENSPAN. That is Larry Meyer's committee, I presume.
MR. BROADDUS. Well, if we could do that, it would give us some sense of how we
as a group view the tradeoff. So I think that would be helpful.
VICE CHAIRMAN MCDONOUGH. In one respect the Fed is a bank supervisor; in
another the Fed as the central bank has some degree of responsibility for financial stability. I
think that implies a broader discussion.
MR. BROADDUS. It is the latter context that I had in mind.
MR. MEYER. Our committee will certainly be engaging in a broader dialogue with
all of you as we think about this.
VICE CHAIRMAN MCDONOUGH. It sounds as if we have exhausted this
interesting subject for now or at least it has exhausted me.
CHAIRMAN GREENSPAN. Unless you get up and run, you will find that you are
mistaken. [Laughter] In all seriousness, does anybody have any quick additional issues to raise?
SPEAKER(?). Let's run quickly!
CHAIRMAN GREENSPAN. The meeting is adjourned. Thank you all very much.
END OF MEETING