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MONETARY POLICY AND THE STATE OF THE ECONOMY HEARING BEFORE THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED EIGHTH CONGRESS FIRST SESSION FEBRUARY 12, 2003 Printed for the use of the Committee on Financial Services Serial No. 108–1 ( U.S. GOVERNMENT PRINTING OFFICE WASHINGTON 89–078 PDF : 2003 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 HOUSE COMMITTEE ON FINANCIAL SERVICES MICHAEL G. OXLEY, Ohio, Chairman JAMES A. LEACH, Iowa DOUG BEREUTER, Nebraska RICHARD H. BAKER, Louisiana SPENCER BACHUS, Alabama MICHAEL N. CASTLE, Delaware PETER T. KING, New York EDWARD R. ROYCE, California FRANK D. LUCAS, Oklahoma ROBERT W. NEY, Ohio SUE W. KELLY, New York, Vice Chairman RON PAUL, Texas PAUL E. GILLMOR, Ohio JIM RYUN, Kansas STEVEN C. LATOURETTE, Ohio DONALD A. MANZULLO, Illinois WALTER B. JONES, JR., North Carolina DOUG OSE, California JUDY BIGGERT, Illinois MARK GREEN, Wisconsin PATRICK J. TOOMEY, Pennsylvania CHRISTOPHER SHAYS, Connecticut JOHN B. SHADEGG, Arizona VITO FOSELLA, New York GARY G. MILLER, California MELISSA A. HART, Pennsylvania SHELLEY MOORE CAPITO, West Virginia PATRICK J. TIBERI, Ohio MARK R. KENNEDY, Minnesota TOM FEENEY, Florida JEB HENSARLING, Texas SCOTT GARRETT, New Jersey TIM MURPHY, Pennsylvania GINNY BROWN-WAITE, Florida J. GRESHAM BARRETT, South Carolina KATHERINE HARRIS, Florida RICK RENZI, Arizona BARNEY FRANK, Massachusetts PAUL E. KANJORSKI, Pennsylvania MAXINE WATERS, California CAROLYN B. MALONEY, New York LUIS V. GUTIERREZ, Illinois NYDIA M. VELÁZQUEZ, New York MELVIN L. WATT, North Carolina GARY L. ACKERMAN, New York DARLENE HOOLEY, Oregon JULIA CARSON, Indiana BRAD SHERMAN, California GREGORY W. MEEKS, New York BARBARA LEE, California JAY INSLEE, Washington DENNIS MOORE, Kansas CHARLES A. GONZALEZ, Texas MICHAEL E. CAPUANO, Massachusetts HAROLD E. FORD, JR., Tennessee RUBÉN HINOJOSA, Texas KEN LUCAS, Kentucky JOSEPH CROWLEY, New York WM. LACY CLAY, Missouri STEVE ISRAEL, New York MIKE ROSS, Arkansas CAROLYN MCCARTHY, New York JOE BACA, California JIM MATHESON, Utah STEPHEN F. LYNCH, Massachusetts BRAD MILLER, North Carolina RAHM EMANUEL, Illinois DAVID SCOTT, Georgia ARTUR DAVIS, Alabama BERNARD SANDERS, Vermont Robert U. Foster, III, Staff Director (II) VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 CONTENTS Page Hearing held on: February 12, 2003 ............................................................................................ Appendix February 12, 2003 ............................................................................................ 1 45 WITNESS WEDNESDAY, FEBRUARY 12, 2003 Greenspan, Hon. Alan, Chairman, Board of Governors of the Federal Reserve System ................................................................................................................... 5 APPENDIX Prepared statements: Baca, Hon. Joe .................................................................................................. Davis, Hon. Artur ............................................................................................. Gillmor, Hon. Paul E. ....................................................................................... Hinojosa, Hon. Rubén ....................................................................................... Shadegg, Hon. John .......................................................................................... Greenspan, Hon. Alan ...................................................................................... ADDITIONAL MATERIAL SUBMITTED FOR THE 46 47 49 51 54 56 RECORD Hinojosa, Hon. Rubén: Introduction of legislation to help Mexican Nationals access the U.S. Banking System ............................................................................................ Lee, Hon. Barbara: ‘‘Who Really Gets Home Loans? Year Nine’’, Executive Summary, California Reinvestment Committee .................................................................. Maloney, Hon. Carolyn: State of New York, Office of the State Comptroller letter, January 14, 2003 ................................................................................................................ Greenspan, Hon. Alan: Monetary Policy Report to the Congress ........................................................ Written response to questions from Hon. Joe Baca ....................................... Written response to questions from Hon. Judy Biggert ................................ Written response to questions from Hon. Luis V. Guiterrez ........................ Written response to questions from Hon. Rubén Hinojosa ........................... Written response to questions from Hon. Darlene Hooley ............................ Written response to questions from Hon. Patrick J. Tiberi .......................... 72 78 84 86 120 122 124 127 133 135 (III) VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 MONETARY POLICY AND THE STATE OF THE ECONOMY Wednesday, February 12, 2003 U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. The committee met, pursuant to call, at 10 a.m., in Room 2128, Rayburn House Office Building, Hon. Michael G. Oxley [chairman of the committee] presiding. Present: Representatives Oxley, Leach, Baker, Bachus, Castle, Royce, Kelly, Paul, Gillmor, Ryun, Biggert, Shays, Shadegg, Miller of California, Hart, Capito, Kennedy, Feeney, Hensarling, Garrett of New Jersey, Murphy, Brown-Waite, Barrett of South Carolina, Harris, Renzi, Frank, Kanjorski, Waters, Sanders, Maloney, Velazquez, Watt, Hooley, Carson, Meeks, Lee, Inslee, Moore, Gonzalez, Capuano, Hinojosa, Lucas of Kentucky, Clay, Israel, Ross, McCarthy, Baca, Matheson, Lynch, Miller of North Carolina, Emanuel, Scott and Davis. The CHAIRMAN. The committee will come to order. We are pleased to welcome back the Chairman of the—distinguished Chairman of the Federal Reserve, the Honorable Alan Greenspan. Chairman Greenspan, the committee welcomes you and as always looks forward to your comments. Because of the importance of your message, it is fitting that just two years ago, you were the first witness at the committee’s first hearing in this new Congress. Mr. Chairman, notwithstanding the comments in your prepared statement about the uncertainties posed temporarily by the current situation in the Middle East, we are here to discuss how to further American economic success. For too long the United States economy has been like a starting quarterback in its rookie season. All the fundamentals are there, but we are just not getting the ball across the goal line. Looking at the replay, we are just not sure what went wrong. In an economy that saw record high productivity last year, I believe the third-quarter numbers were the highest in decades, why do we have diminished consumer confidence and so much market volatility that we can see nearly a 1,000-point swing in just a few days? That said, I think a lot of us are not just the optimists—seeing the light at the end of the tunnel. Once we resolve the situation in the Middle East, many believe that the economy will be free to grow again. I am sure we all hope that comes to pass. I appreciate your recent comments about the President’s jobs and growth plan for the economy. Many have referred to this plan as a short-term stimulus program, but I see it as a bold attempt to (1) VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 2 restructure the economy and prepare it for another long period of expansion. Recognizing your important point that any such plan must be paid for, I would like to associate myself with your view that removing the unfair and counterproductive double taxation of dividends is extremely important. Without this kind of long-term thinking, any short-term stimulus program is likely to be both expensive and ineffective in spurring an economic recovery. You are quite measured in your remarks about the effects of removing the double taxation. Mr. Chairman, I hope you are able in the period reserved for questions to elaborate on that issue. The President and I share the view that economic growth is the best way to ward off deficits, and the best way to spur growth is to keep more money in the hands of the American family. The way you do that is through lower taxes. Although I am never happy to see budget deficits, today’s forecast deficits are in terms of the GDP roughly half of what the deficits were some two decades ago. Perspective is important, I think, and I hope that you will provide it to us today. This committee will also be considering a number of measures important to reinforcing our economic infrastructure. Among them are reform of the bankruptcy laws, ensuring of certainty in the netting of derivatives contracts, reform of the bank deposit insurance system, repeal of some outmoded banking regulations, streamlining of the check processing system, some emergency authority for the Securities and Exchange Commission. These legislative efforts, which would all make the economy even more resilient as well as more efficient, are necessary and will be dealt with swiftly by the committee. Mr. Chairman, despite a number of uncertainties, our economy has continued to grow, with a 2.4 percent growth rate for last year and an expected rate of more than 3 percent in the current year. That is extraordinary. To be sure, some of the credit goes to you and your masterful handling of monetary policy. Mr. Chairman, thank you for your willingness to return to the committee at a later date to continue our discussion on these and other important matters. And thank you for working with Ranking Member Frank and myself in that regard. We will always benefit from your wisdom this morning and certainly in the future. The Chair’s time has expired, and I yield to the Ranking Member, the gentleman from Massachusetts Mr. Frank. Mr. FRANK. Mr. Chairman, I want to echo your thanks to the Chairman for agreeing to come back in April. Neither you nor I decided that this should be the second largest committee in the Congress, money being only second to highways in its lure to Members. So we couldn’t accommodate everybody, and we do want to do that. And we will be protecting all Members’ rights thanks to your and the Chairman’s cooperation. I welcome the Chairman back to what has become an interesting game. Some people when they were younger played capture the flag. The game today is capture the Fed. The question is who can hoist the Chairman to his or her flagpole in the broader debate. And I sympathize, Mr. Chairman, with your unrequested role here, but I appreciate the integrity with which you have addressed this issue in the midst of these political efforts. And essentially as I VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 3 read your testimony yesterday, you stayed true to what you have long argued, namely that deficits, and particularly ever-increasing deficits into the future, are a significant negative. We are in an interesting period in American history. I think from the intellectual standpoint, we are seeing one of the greatest examples of hypocrisy in recent times. The political party that came to power in the Congress in 1995, having signed a contract with the American people, a contract of adhesion, I am afraid, that was going to balance the budget by constitutional amendment, has now basically announced that they were only kidding, that amending the United States Constitution to balance the budget may have seemed like a useful political ploy, but, in fact, they are really not that all concerned about deficits. There is a certain bifurcation here. The President has announced a new millennium challenge plan for foreign aid, and to qualify that you can’t have a budget deficit, but deficits are okay for us. What we are talking about obviously is an ideological effort. I first thought this was hypocrisy, as I said, but I think it is clear that what we are really talking about is bait and switch. We have a political party in power that is now denigrating deficits for the purpose of getting a tax cut through, but if they are successful in getting that through and adding significantly to the deficit not just this year, but on into the future, they will then turn around and rediscover their fear of deficits and use that as a way to oppose legitimate spending on environmental concerns, unemployment compensation, extended health care and other important social needs. And the fundamental problem we face is this: This President has decided to make a contribution to economic theory which, to me, is unwelcome. That contribution is that you can pay for two wars with three tax cuts. Had the Democrats in 2000 accused the President of planning to have two wars and pay for it with three tax cuts, we would have been accused of the worst kind of unfair campaign tactics, but that is where we are. If, in fact, you go forward with two wars and pay for those two wars with three tax cuts, you then have to, A, announce that deficits are not so bad after all; and B, substantially reduce other important public programs. That is what is important. The dividend issue is a question which we should be able to consider at some point as to what is an ideal tax structure, but at this point, with another war facing us—and the President’s budget calls for a deficit of over 300 billion without the war in Iraq, so those who think the war in Iraq is going to cost us zero and that compensating Turkey and other countries isn’t going to cost us anything, we are probably talking about a $400 billion deficit this year. We are talking about a level of deficit which would have gotten us in trouble if we were in the European Union and indefinite increases into the future. So that is the context in which we operate, and I appreciate it, Mr. Chairman, as I said, what I thought was the fundamental integrity in the face of a lot of political pulling and hauling for you to restate that. There are other issues that obviously we will want to address, but I do think that the context in which we operate— and I want to close with this again, Mr. Chairman—the notion that the Nation can pay for two wars with three tax cuts, war being by VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 4 far the most expensive thing you can do and the very expensive aftermath of that war, obviously is the central factor that confronts us. And the Chairman has long believed, as have most economists, that while deficits are not instant death, they are over a long term a negative for the economy. And I very much appreciate the Chairman’s consistency in reaffirming that in the face of an awful lot of political praying that he would go the other way. The CHAIRMAN. The gentleman’s time has expired. The Chair is pleased to recognize Mrs. Biggert, the Vice Chair of the Monetary Subcommittee. Mrs. BIGGERT. Thank you, Mr. Chairman, and thank you, Chairman Greenspan, for coming before our committee this morning. This is our first hearing in this committee for the 108th Congress, and the fact that you are first, I think, speaks volumes about the great respect that we have for you and the priority we place on your stewardship of our economy. I know subcommittee Chairman King wanted to join us here today, but unfortunately, he is tied up in another committee with Secretary Powell in discussions concerning Iraq, so I appreciate the opportunity to speak as the subcommittee vice chairman. It is no secret that we now face some of the most difficult challenges in our Nation’s history. On the foreign policy front, there is the prospect of military action against Iraq; North Korea continues to behave like a reckless child in possession of a dangerous toy; and discord remains among Israelis and Palestinians, Indians and Pakistanis, and in and among other nations and groups around the world. On the domestic front, our Nation’s terror alert system remains high, deficits are mounting, economic growth is down, and the markets remain skittish. Yet when we take a close look at the fundamentals of our economy and observe how it has held up over the last 17 months, I think you’d agree that it is anything but down, dead, and buried. Last month the unemployment rate dropped to 5.7 percent, and payroll employment rose to almost 143,000, almost completely reversing December’s decline. Interest rates remain low. Manufacturing activity turned up in December. Productivity for all of 2002 grew by 4.7 percent, the strongest showing since 1950, and a big improvement over the 1.1 percent increase posted in 2001. But even so, we cannot ignore the fact that something is holding the economy back from a more vigorous rebound. And it would be unwise to not discuss the best way to spur consumers and businesses to spend and invest more, spurring growth and ultimately reining in public debt. And that is why we are here today to discuss our Nation’s fiscal future and our plan for short-term and long-term economic growth. Again, thank you Mr. Chairman for joining us. I look forward to your remarks. The CHAIRMAN. The gentlelady’s time is expired. The Chair is now pleased to recognize the Ranking Member on the Monetary Subcommittee, the gentlelady from New York Mrs. Maloney. Mrs. MALONEY. Thank you, Mr. Chairman. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 5 Good morning, Mr. Chairman, and thank you for joining the committee to offer the perspective of the Federal Reserve on the state of our economy. By practically any measure the economy has deteriorated significantly over the past 2 years. Unemployment has risen from 4.2 percent to 5.7. In New York it has reached 7.5 percent. The stock market has lost $5 trillion in value, lowering the value of ordinary Americans’ retirement savings and 401(k)s dramatically. Most dramatically, the Federal balance sheet has suffered through the single greatest about face in our Nation’s history. As an example, the administration’s first budget projected at $262 billion surplus for fiscal year 2004. The second budget estimated a deficit in 2004 of $14 billion. Now the administration is projecting a $307 billion deficit for 2004. Overall the original administration’s projection has changed by $570 billion for a single year, and the long-term picture is just as bleak. The situation is so dire that, almost in despair, OMB has stopped issuing 10-year projections altogether. Mr. Chairman, in past statements and just yesterday you have warned eloquently about the negative impact of deficits on our economy. Just last September you said, and I quote, ‘‘history suggests that an abandonment of fiscal discipline will eventually push up interest rates, crowd out capital spending, lower productivity growth, and force harder choices upon us in the future,’’ end quote. I share your concern, especially about interest rates, and fear that the administration’s new economic plan promoting deficit-expanding tax cuts will lead to increases in mortgages and credit card rates for America’s working families. Furthermore the State budgets are hurting, and the new administration’s tax proposal will make things worse. In New York the administration’s dividend tax plan will reduce State revenue and increase borrowing costs by $9 billion over the next 10 years, according to New York State comptroller Allen Hevesi. Two years ago the administration pushed through a massive tax cut which it justified with rose-colored revenue projections. Now for the first time in our history, the executive branch is proposing tax cuts and sending our Armed Forces onto the battlefield at the same time. I fear we are headed toward another round of massive deficit increases, and I look forward to your thoughts this morning. Thank you for joining us. The CHAIRMAN. Gentlelady’s time has expired. The Chair would ask unanimous consent all Members’ statements may be made part of the record. So ordered. The CHAIRMAN. Mr. Chairman, welcome back to the committee, and we look forward to your statement. STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. GREENSPAN. Mr. Chairman and Members of the committee, when I testified before this committee last July, I noted that while the growth of economic activity over the first half of the year had been spurred importantly by a swing from rapid inventory drawdown to modest inventory accumulation, that source of impetus VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 6 would surely wind down in subsequent quarters, as it did. We at the Federal Reserve recognized that a strengthening of final sales was an essential element of putting the expansion on a firm and sustainable track. To support such a strengthening, monetary policy was set to continue its accommodative stance. In the event, final sales continued to grow only modestly, and business outlays remained soft. Concerns about corporate governance, which intensified for a time, were compounded over the late summer and into the fall by growing geopolitical tensions. Equity prices weakened further, the expected volatility of equity prices rose to unusually high levels, spreads on corporate debt and credit default swaps deteriorated, and liquidity in corporate debt markets declined. The economic data and the anecdotal information suggested that firms were tightly limiting hiring and capital spending and keeping an unusually short leash on inventories. By early November, conditions in financial markets had firmed somewhat. But on November 6, with economic performance remaining subpar, the Federal Open Market Committee chose to ease the stance of monetary policy, reducing the federal funds rate 50 basis points to 1-1/4 percent. We viewed that action as insurance against the possibility that the still widespread weakness would become entrenched. In the weeks that followed, financial market conditions continued to improve, but only haltingly. Mounting concerns about geopolitical risks and energy supplies were mirrored by the worrisome surge in oil prices, continued skittishness in financial markets, and substantial uncertainty among businesses about the outlook. Partly as a result, growth of economic activity slowed markedly late in the summer and in the fourth quarter. Much of that deceleration reflected a falloff in the production of motor vehicles from the near record level that had been reached in the third quarter when low financing rates and other incentive programs sparked a jump in sales. The slowing in aggregate output also reflected aggressive attempts by businesses more generally to ensure that inventories remained under control. Thus far, those efforts have proved successful in that business inventories, with only a few exceptions, have stayed lean. Apart from the quarterly fluctuations, the economy has largely extended the broad patterns of performance that were evident at the time of my July testimony. Most notably, output has continued to expand, but only modestly. As previously, overall growth has simultaneously been supported by relatively strong spending by households and weighed down by weak expenditures by business. Importantly, the favorable underlying trends in productivity have continued. One consequence of the combination of sluggish output growth and rapid productivity gains has been that labor markets have remained quite soft. Another consequence of the strong performance of productivity has been its support of household incomes despite the softness of labor markets. Those gains in income combined with very low interest rates and reduced taxes have permitted relatively robust advances in residential construction and household expenditures. The increases in consumer outlays have been financed partly by the large extraction of built-up equity in homes. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 7 While household spending has been reasonably vigorous, we have yet to see convincing signs of the rebound in business outlays. The emergence of a sustained and broad-based pickup in capital spending will almost surely require the resumption of substantial gains in corporate profits. Of course, the path of capital investment will also depend on the resolution of the uncertainties surrounding the business outlook. The intensification of geopolitical risks makes discerning the economic path ahead especially difficult. If these uncertainties diminish considerably in the near term, we should be able to tell far better whether we are dealing with a business sector and an economy poised to grow more rapidly, our most probable expectation, or one that is still laboring under persisting strains and imbalances that have been misidentified as transitory. If, instead, contrary to our expectations, we find that despite the removal of the Iraq-related uncertainties, constraints to expansion remain, various initiatives for stimulus will doubtless move higher on the policy agenda. But as part of that process, the experience of recent years may be instructive. As I have testified before this committee in the past, the most significant lesson to be learned from recent American economic history is arguably the importance of structural flexibility and the resilience to economic shocks that it imparts. I do not claim to be able to judge the relative importance of conventional stimulus and increased economic flexibility to our ability to weather the shocks of the past few years, but the improved flexibility of our economy no doubt has played a key role. That increased flexibility has been in part the result of the ongoing success in liberalizing global trade, a quarter century of bipartisan deregulation that has significantly reduced rigidities in our markets for energy, transportation, communication, and financial services, and, of course, the dramatic gains in information technology that have markedly enhanced the ability of businesses to address festering economic imbalances before they inflict significant damage. This improved ability has been facilitated further by the increasing willingness of our workers to embrace innovation more generally. It is reasonable to surmise that not only have such measures contributed significantly to the long-term growth potential of the economy this past decade, they also have enhanced its short-term resistance to recession. That said, we have too little history to measure the extent to which increasing flexibility has boosted the economy’s potential and helped damp cyclical fluctuations in economic activity. Even so, the benefits appear sufficiently large that we should be placing special emphasis on searching for policies that will engender still greater economic flexibility and dismantling policies that contribute to unnecessary rigidity. The more flexible an economy, the greater its ability to self-correct in response to inevitable, often unanticipated, disturbances, thus reducing the size and consequences of cyclical imbalances. Enhanced flexibility has the advantage of adjustments being automatic and not having to rest on the initiatives of policymakers, which often come too late or are based on highly uncertain forecasts. Policies intended to improve the flexibility of the economy seem to fall outside the sphere of traditional monetary and fiscal policy, VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 8 but decisions on the structure of the tax system and spending programs surely influence flexibility, and thus can have major consequences for both the cyclical performance and long-run growth potential of our economy. As we approach the next decade, we need to focus attention on the necessity to make difficult choices from among programs that, on a stand-alone basis, appear very attractive. Because the baby boomers have not yet started to retire in force, and accordingly the ratio of retirees to workers is still relatively low, we are still in the midst of a demographic lull. But short of an outsized acceleration of productivity to well beyond the average pace of the past seven years or a major expansion of immigration, the aging of the population now in train will end this state of relative budget tranquility in about a decade’s time. It would be wise to address the significant pending adjustment and the associated potential for the emergence of large and possibly unsustainable deficits sooner rather than later. As the President’s just released budget put it, ‘‘The longer the delay in enacting reforms, the greater the danger and the more drastic the remedies will have to be.’’ Re-establishing budget balance will require discipline on both revenue and spending actions, but restraint on spending may prove more difficult. Tax cuts are limited by the need for the Federal Government to fund a basic level of services, for example, national defense. No such binding limit constrains spending. If spending growth were to outpace nominal GDP, maintaining budget balance would necessitate progressively higher tax rates that would eventually inhibit the growth in the revenue base on which those rates are imposed. Deficits, possibly ever widening, would be the inevitable outcome. Faster economic growth, doubtless, would make deficits far easier to contain, but faster economic growth alone is not likely to be the full solution to currently projected long-term deficits. To be sure, underlying productivity has accelerated considerably in recent years. Nevertheless, to assume that productivity can continue to accelerate to rates well above the current underlying pace would be a stretch even for our very dynamic economy. So, short of a major increase in immigration, economic growth cannot be safely counted upon to eliminate deficits and the difficult choices that will be required to restore fiscal discipline. By the same token, in setting budget priorities and policies, attention must be paid to the attendant consequences for the real economy. Achieving budget balance, for example, through actions that hinder economic growth is scarcely a measure of success. We need to develop policies that increase the real resources that will be available to meet our longer-term needs. The greater the resources available—that is the greater the output of goods and services produced by our economy—the easier it will be providing real benefits to retirees in coming decades without unduly restraining the consumption of workers. These are challenging times for all policymakers. Considerable uncertainty surrounds the economic outlook, especially for the period immediately ahead. But the economy has shown remarkable resilience in the face of the succession of substantial blows. Critical to our Nation’s performance over the past few years has been the VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 9 flexibility exhibited by our market-driven economy and its ability to generate substantial increases in productivity. Going forward, these same characteristics in concert with sound economic policies should help to foster a return to vigorous growth of the U.S. economy to the benefit of all our citizens. Mr. Chairman, I have a rather long written statement from which I have excerpted and would appreciate it being included for the record. The CHAIRMAN. Without objection. Mr. GREENSPAN. And I look forward to your questions. The CHAIRMAN. Thank you, Mr. Chairman. [The prepared statement of Hon. Alan Greenspan can be found on page 56 in the appendix.] The CHAIRMAN. And let me indicate to the Members that we will strictly adhere to the 5-minute rule so everyone can participate. The gentleman from Massachusetts. Mr. FRANK. I would ask all the Democratic Members to read a memo I put on their desk. We had some commitments in terms of order of questioning from last time, and we have the conflict with the hearing with the Secretary of State, so I hope Members—I don’t want to take up any more time—would read that memo. We have tried to accommodate. And I want to repeat: The Chairman has very graciously agreed to come back in April for an additional hearing, and any Member that doesn’t get a chance to question today will be, as far as we are concerned on this side, up first so that people will get the chance to do that in April. Thank you again, Mr. Chairman. The CHAIRMAN. And the Chair will also try to follow that on our side as well. Mr. Chairman, back when I was in college studying Economics 101, one of the issues at the Federal level was always the issue of double taxation of dividends and a lot of discussion about the fact that it was unfair, that it was a drag on the economy. As you know, the President—one of the major tenets of the President’s proposal was to eliminate the double taxation of dividends not as a shortterm stimulus, but as a long-term positive change in our Tax Code. Do you think that is a good idea, and if so, what effect, in your estimation, will it have on the economy? Mr. GREENSPAN. I do, Mr. Chairman. One of the most important experiences, I think, that we have had as analysts in the last several years, as I indicated in my prepared remarks, is the changes that we have observed in the flexibility of the economy and the resilience that that has imparted to our capability of essentially deflecting shocks and largely deflecting major pressures which would have driven us into deep recessions. Indeed, I would have suspected that the 2001 recession would have been far deeper if we did not have the flexibility that we had. And, as I have indicated in my remarks, we have to now start to move, at least in my judgment, if we are going to get increasing economic growth, to increase the flexibility and the resiliency of the system. One of the areas where we can do considerable good in that regard is to eliminate the double taxation of dividends, because the double taxation has created a bias towards debt rather than equity in our economic system. And one of the concerns that most people VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 10 looking at the longer term have is that the notion of flexibility and resilience and great debt leverage do not go hand in hand. So eliminating the double taxation will very significantly alter the way in which investments are financed over time. It won’t happen immediately, because it takes a while for the corporate sector to adjust to differing incentives, but I have no doubt it will make some very important contributions to long-term economic growth. Let me just say parenthetically, Mr. Chairman, while I do not support the elimination of the double taxation of dividends because of short-term stimulus, it does have some short-term stimulus. That is not the reason I am in favor of it. But it probably will increase the level of stock prices and the wealth effect accordingly, and there are some small income effects. But I do think that the emphasis has to be on what the long-term implications of such a policy would be. The CHAIRMAN. Mr. Chairman, as you know, this committee was deeply involved in the whole corporate scandals issue in the last Congress, culminating in legislation dealing with corporate governance and more accountability. What role, in your estimation, did the debt financing play in some of those corporate scandals, if any? Mr. GREENSPAN. Mr. Chairman, it is hard to judge without having very specific evidence, but there is no question that in many of the questionable accounting practices which were unearthed prior to the legislation which you were quite instrumental in pushing, we observed that odd forms of debt instruments were crucial to the various different schemes which were involved to, in my judgment, essentially thwart the purpose of accounting, namely, to give a clear picture of whether a corporate strategy is working or not, not to create a set of accounts to spin the stock price of the firm. The CHAIRMAN. Thank you. My time has expired. The gentlelady from California Ms. Waters. Ms. WATERS. Thank you very much, Chairman Greenspan. We thank you for your visit here today. We all await with great anticipation your creative words of wisdom. However, it appears that you have left us with more questions than answers. I am rather surprised by your rather lengthy discussion of a cash-based accounting versus accrual accounting, where you basically conclude that you do not have the tools by which to come to certain conclusions. Usually you are a lot more definitive than that, and you have always warned us about great deficits and what we should do to avoid deficits and the kind of cuts that we should make. So despite the fact that we may have the most important or the most concise ways to make these decisions, can you tell us in very simple and clear language, when you talk about fiscal discipline, do you include tax cuts along with discussion on the deficit? And will you talk about our need to cut back on this deficit and what tax cuts are doing to that, and talk about the tax cuts that we made in 2001 and the tax cuts in the new stimulus package? Mr. GREENSPAN. Congresswoman, I testified before the House Budget Committee in September and very strongly recommended that the PAYGO and discretionary cap rules, which, in my judgment, were really quite extraordinarily effective in restraining deficits over the years, be reinstated. As you know, they expired in the VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 11 House on September 30 and will be expiring in the Senate sometime in the spring. Those rules effectively limit the capacity to cut taxes without also having either offsetting revenues or cuts in nondiscretionary spending. It also stipulates that expenditure programs are—require the offsets in the other direction. I do not deny, especially in most recent years when the surpluses arrived, that there was a lot of game-playing with that system, and the reason was that it was originally put in place to constrain deficits. When the surpluses arose, it seemed to everybody that they no longer made any sense, and they were widely evaded and effectively disbanded. I think this is a very bad mistake, and before any actions are taken with respect to the appropriations for the next fiscal year, I certainly trust that these rules, that is, the discretionary caps and PAYGO rules, will be re-established, because what that will do is enforce the necessity to really put forward only the major priorities which this Congress has into legislation, because it is fairly evident that if one merely looks at an array, as I said in my remarks, of free-standing projects, they all look good. They wouldn’t have made it, in a sense, to the semifinals if they weren’t extraordinarily good projects. The only problem is that there is an aggregate amount of fiscal capacity in any economy, and we are very clearly straining the capacity of the system owing to the inexorable retirement of a very significant part of our population starting at the end of this decade and carrying on, as you know, beyond that. So, without getting into any of the individual programs, because that is a very crucial and important choice that the Congress must make for the American people, I do say to you that looking at it from the point of view of an economist, looking at what we can afford and what we can’t afford, there are limits, and you have to choose what we do within those limits. And while I didn’t expect it to be as effective as it was in the years in which it was effective, PAYGO and discretionary caps really did work. The CHAIRMAN. The gentlelady’s time has expired. The gentleman from Alabama Mr. Bachus. Mr. BACHUS. Chairman Greenspan, I want to focus on one issue that is not discussed a lot, but which I think is very important, and that is the Fair Credit Reporting Act. The preemption provisions will be expiring at the end of this year. Fair Credit Reporting Act gives us a national credit reporting system with uniform standards. Would you comment on the importance of maintaining a national credit reporting system, the advantages of that, how important you think it is that we reauthorize the Fair Credit Reporting Act? What may be some of the detriment if we don’t? Today I think it gives us great flexibility, and we are able to assess credit risk well, and I think it is very beneficial to have this national system for consumers and also for our financial institutions, and obviously will let you comment. Mr. GREENSPAN. Well, Congressman, 100 years ago when we just had small banks dealing with customers, you knew what the credit quality of your loans was. You knew the families to whom you were lending, you knew the businesses, and you didn’t need a data bank. But as we became ever larger and far more complex, and as our financial system, especially that which relates to consumer credit, VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 12 became huge in the post-World War II period, there was no other way to handle a fair evaluation of the credit standing of individual borrowers unless it was in one way or another more automated. And we needed to build up some means of history that would essentially enable us to, as bankers say, make judgments without knowing the person personally and not having in front of them a great deal of information, especially because you may not have any way of doing that. These data systems are essential, in my judgment, to enable consumers to have access to credit. In other words, it is not that long ago when going into a bank and trying to get a consumer loan was just never conceived as an appropriate thing to do. They didn’t make consumer loans. That has changed, and it has had a dramatic impact on consumers and households and access to credit in this country at reasonable rates. That system cannot function without data, without credit histories of individual borrowers, and I should certainly hope that it is maintained. Mr. BACHUS. It is very important that we reauthorize the Fair Credit Reporting Act to our economy? Mr. GREENSPAN. Yes. Mr. BACHUS. Thank you. Let me just close by saying I have read your prepared remarks, the ones you have delivered here today. Let me sort of capsulize maybe one thing I got out of that, and that is that we must reform Medicare and Social Security and do it sooner as opposed to later, and that is of critical importance to our economy and to our financial stability. Mr. GREENSPAN. When you look beyond the next few years, what strikes you is how significant the retirement of the baby boomers is to our fiscal system. The number of beneficiaries for both Social Security or OASDI and Medicare and Medicaid are really quite startling. The problems with Social Security, as difficult as they are, and they are difficult, are nonetheless capable of being resolved because the Social Security system has the characteristics of a private defined benefit plan, and we can judge within some range what types of claims on federal resources are required. Medicare is a wholly different type of institution. Because of the extraordinary gains in technology, the fact that medical care per se is, as economists say, highly inelastic, meaning that you demand it without respect to price, where we have a subsidized third-party payment system, that leaves the estimates of what the size of medical expenditures are in general and Medicare in particular, very difficult to judge, but it is almost open-ended. And this is why I am very much concerned about having PAYGO in place, because we are going to have to address these systems in a manner which will fit them into the overall resources of the system. That problem, incidentally, exists with or without the President’s economic program. In other words, the change in the fiscal state subsequent to, say, 2010 or perhaps 2012, is such that the rate of debt-to-GDP, a measure of the sustainability of our fiscal affairs, goes up quite abruptly, and as, in fact, the President reports in his budget, and indeed so does the Congressional Budget Office, that those rises are unsustainable. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 13 Something has to be adjusted in order to bring the real resources available for our total fiscal affairs in line, and in my judgment, it is none too soon to start that process, to make it phased-in in a manner which doesn’t create abrupt problems for either those contributing to Social Security or Medicare trust funds and those receiving the benefits. The CHAIRMAN. The gentleman’s time has expired. And the gentlelady from California, Ms. Lee. Ms. LEE. Thank you, Mr. Chairman. I want to thank you and Ranking Member Mr. Frank, and also welcome Mr. Greenspan and say how timely as always your appearance is. Let me call your attention to a report which was recently issued by the California Reinvestment Committee. This is their ninth annual report as it relates to home lending mortgage practices in California. It concluded that California’s most active banks have failed to meet the quality benchmark in each and every instance; secondly, the financial institutions are clearly ailing in their efforts to average California’s African American and Latino households; thirdly, that the race and neighborhood of home loan applicants seem to be a factor in how much they will pay for their loan; and finally, the final conclusion was that bank holding companies are profiting from their failure to ensure that borrowers get the best loan product for which they qualify from their own family of companies. What I wanted to ask you is what would be some of your recommendations to address these very glaring discriminatory outcomes and practices, and how do you think the Federal Reserve can weigh in, if you can or not, because, of course, accumulation of equity in one’s home is the primary means of wealth accumulation for the majority of Americans. That is the American dream. Mr. GREENSPAN. I agree with that, Congresswoman. I think it has been quite a remarkable track record that we have had in this country in expanding home ownership and home equity. And there is no question that if home equity had not existed, we would not have been able to have had the extraordinary degree of extraction of equity that has occurred in recent years and what has accordingly supported the economy, more exactly supported consumption, when business investment was doing so poorly. So clearly it has been housing and mortgage availability which has been a very critical factor in sustaining the economy, which is obviously of crucial importance to the Federal Reserve. The problems in California are difficult in part because prices are much higher in California, as I recall, than elsewhere, and that makes it quite difficult for first home buyers and minorities to get into home ownership as readily as one would like. And I think what is required in this respect is to find ways in which to enhance the capability of everyone. There is very little doubt that even though home ownership rates for minorities are still well below those of whites, the gap is, in fact, closing, and we ought to make all sorts of efforts that we can to continue that progress, because as you point out, living in a home and accumulating equity is the way one moves up from the lower-income scales into the middle-income scales. And it strikes VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 14 me that whatever can be done should be done to press that forward, as I have said many times in the past. But the Federal Reserve has only limited capabilities in that regard. We can and do obviously affect mortgage interest rates, and that is a major factor which I think has been quite important in expanding that capability. We will look and I hope we will find other areas which might be helpful, because our general view is that the greater the home ownership in this country, the better. Ms. LEE. Thank you. Mr. Chairman, I would like to ask unanimous consent to insert into the record the executive summary of this report by the California Reinvestment Committee. The CHAIRMAN. No objection. [The following information can be found on page 78 in the appendix.] Ms. LEE. Do I have 1 more second? The CHAIRMAN. You have 38 seconds. Ms. LEE. Let me just ask you with regard to the elimination of tax on dividends, would you not agree that this dividend exemption could make the low-income housing tax credit, which does give investors a real dollar-for-dollar reduction in taxes and in return, you know, for their investment in housing and other tax matters—you know, for that matter, doesn’t that make it less attractive to investors if, in fact, this tax on dividends is enacted, because the lowincome housing tax credit we know is—has about run out? Mr. GREENSPAN. There are lots of impacts of this issue of eliminating the taxation on dividends. The most important thing, however, to keep in mind is that by improving the flexibility of the economy, it almost surely increases the aggregate level of economic activity, of incomes, and probably does contribute to rising incomes all across the income scale when you increase the economy. And generally in the United States, while there are very obvious differences by income group, the data do show that everyone benefits. And in my judgment, the elimination of the double taxation of dividends will be helpful to everybody. Will it have negative effects in certain parts of the market? For example, state and local governors and mayors have been concerned about the cost of credit of municipal bonds that may actually rise relatively speaking, and there are other people raising similar issues. In my judgment, looking at the whole context, there is no question that this particular program will be, net, of benefit to virtually everyone in the economy over the long run, and that is one of the reasons I strongly support it. The CHAIRMAN. The gentlelady’s time has expired. The gentleman from Louisiana, Mr. Baker. Mr. BAKER. Thank you, Mr. Chairman. Chairman Greenspan, welcome. I always enjoy having your perspectives presented to the committee. And for the record, I am not raising a subject that you would be surprised by, although it was raised yesterday in questions in the Senate proceedings relative to mortgage-backed securities, MBS. And I studied your response, and there was an aspect of your answer relative to interest rate risk that caught my eye. I share those views, and I want to give you a little background for my principle question. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 15 The concern over interest rate risk and GSEs is something that I have had continual concern about, and it was first sort of publicly quantifiable in the last quarter of 2002 with the difficulty in managing the negative duration gap numbers. As a consequence of that, I have a related concern to the growth in the number of institutions and the notional amount per institution of GSE securities held by those institutions to meet their Tier 1 capital requirements. It would appear to me that, given the obvious now quantified difficulty in rebalancing asset liability portfolio balance in an interest rate environment, which fortunately has been very stable and moving in the right direction, I might add, if we are to return to an environment where we have a rapid increase in rates, which we all hope does not happen, should there be careful assessment given by the committee to establishing some limit on the amount of GSE securities held by insured financial depositories in order to minimize adverse systemic consequences in an interest rate environment which none of us want to see occur? As you well know, today there is no such limit despite loan limits on borrowers and all other credit questions, despite limits on the prohibitions on holding triple A rated corporate securities. These appear to be traded without limit, and I am worried about the consequences of the scope today that now appears to exist in many of the insured institutions’ portfolios. Mr. GREENSPAN. Congressman, we are obviously aware of the issue that you are raising. Remember that, at bottom, supervision and regulation in general looks at the safety and soundness of every institution. And while there are various different legal limits and the like, any time there is a concentration of anything, it gets our attention. And the reason basically is that the history of commercial bank defaults, and, in fact, defaults of other institutions, has been too heavily peppered with institutions with concentrations of something. And the trouble is that you could never in advance list all the things that people can think up to get too much of in their balance sheets. So it is far better to leave it, as far as I can see, in general, to the underlying process that we currently have. But it may be that there are discussions within our staff which I am not aware of that I would just like to quickly double check. Mr. BAKER. Well, my question really went to the validity of a significant study on the matter, because it appears that the number of institutions and the amount held per institution continues to go up because the number of attractive alternatives for bank investment are fairly limited. Mr. GREENSPAN. I think that is correct. But I was curious to know whether or not we in fact had done something internally which I had not seen yet. Mr. BAKER. Terrific. I may follow this up with some correspondence on the matter at a later time. Mr. GREENSPAN. Why don’t you do that, and we will try to be responsive. Mr. BAKER. Thank you very much. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Kentucky. Mr. LUCAS OF KENTUCKY. Thank you. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 16 Mr. Chairman, we have a long history as the American people of being real patriots in a time of war. In my view, the old adage of guns and butter still prevails in the larger sense. I think our American people would be willing to make some sacrifices in deference to the war. Given your knowledge of the economy, what would be a reasonable economic sacrifice or other sacrifice for our people to make at this particular troubling time? Mr. GREENSPAN. Congressman, that question came up in the Senate in a somewhat different form yesterday. Usually when we have been confronted with guns-and-butter-type issues, the ratio of defense expenditures to the GDP has been elevated, and indeed there were limited resources available to do both. And it is well known that in the Vietnam War, mistakes significant mistakes, were made in not recognizing that we were in fact trying to do too much. Fortunately, or unfortunately, depending on one’s point of view, the level of defense expenditures to GDP is really quite low at this stage. In fact, only two years ago it was the lowest since before World War II. So we do have a $10 trillion plus economy and about $400 billion in defense expenditures, which by no means is a small amount, but it is not at this stage pressuring on other resources. So the question is, should we artificially do something? And I think not. I agree with you, I think the American people are remarkable in that respect, and their willingness to sacrifice for the Nation is what has really made us great, and there will be occasions when those issues will re-arise. I do not think, however, that in today’s environment that there is any trade-off here that makes any realistic sense. We used to talk about tax surcharges or various other things in order to finance abnormal expenditures. But that doesn’t exist as yet because the scale of our economy has become so large that even as significant an effort as we are embarked upon in the Middle East doesn’t put the type of strain which, for example, the Korean War put on our economy and later Vietnam. Mr. LUCAS OF KENTUCKY. With these record deficits as far as the eye can see, as one of my colleagues said the other day, which was pretty thought provoking, we are sending our young men and women to war, and then if and when this is over—and when it is over, I should say, they are going to come home and their kids and their grandchildren can pick up and pay the debt. It is kind of like double jeopardy. Mr. GREENSPAN. Actually, it turns out that we do not really have a fiscal problem of moment until we get beyond the end of this decade largely because the underlying growth rate and the structure of interest rates at this stage keep deficits even under the President’s program beyond these next two years in areas where the rate of debt-to-GDP does not move up in any way which suggests we are in an unstable system. But when you get beyond this decade, when you get into 2011, 2012, the ratio of debt-to-GDP begins to rise in a very worrisome manner. And as I said in my prepared remarks, because we know that with almost as high a degree of certainty as we can know anything in the area of finance, that it would be far better, as indeed the President’s budget suggests, for us to prepare well in advance and phase-in in a manner which does VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 17 not require significant discontinuities, because all of a sudden we are retiring a large part of our population from productive endeavors into retirement. The CHAIRMAN. The gentleman’s time has expired. Could we—I am just trying—could we reset the clock here, the shot clock? The gentleman from the first State, Mr. Castle. Mr. CASTLE. It takes me a long time to shoot here. Thank you, Mr. Chairman. It is always a pleasure to see you. You have already answered the questions about dividend exclusion, and I think I understand where you are coming from, that it makes a great deal of sense but as stimulus from doing it now, this deficit issues, et cetera, that kind of thing. You may not know the answer to this first question, maybe we can go over it quickly. But if you change the taxation on dividends to a finite number, $1,000, $3,000, something of that nature, I mean, as soon as I saw that Bill Gates was going to get, what, over $95 million of Microsoft dividends, I thought that was in trouble as a tax cut. But what if you changed it to a smaller number? Does that—would that still have the effect of having corporations—enough pressure on corporations to change the dividend policies to improve the corporate aspects of this? Or does it have to be a full exclusion, in your judgment? If you have given any thought to that. Mr. GREENSPAN. I must say to you, I would much prefer it be done fully, because it makes the issue clear and it lets the markets function in an effective way. I think you diminish the effect of the power of what the elimination of the double taxation does by doing it by capping, for example. Capping usually undercuts the economic effect far more than the presumed equity effect that it is employed to address tends to do. So I must say that you diminish the effect. Mr. CASTLE. And your preference on the corporate—deducting on the corporate level versus the individual? Mr. GREENSPAN. I would prefer that the deduction be at the corporate level, because it immediately impacts the trade-off between debt and equity. But over the long run I don’t think it really very much matters, because if you put the tax credit—or you put the deduction at the investor level, it will not take very long before the pressure to increase dividend payments, and which this is all about, will occur. So whether it happens directly at the corporate level or through pressure coming from investors is more a matter of time than end result. Mr. CASTLE. Let me turn to housing for a minute. As you know, that is the one part of the economy that has held up, and I am sure you have studied that to a great degree, or you can call it a housing bubble. My first question is, and for those of us fortunate to own the houses but also got into the stock market a little bit late on tech stocks and essentially lost our shirts, this is a matter of some comfort. But there is a lot of discussion now by the pundits out there that we are going to—that the bubble is about to burst and we are going to have a housing problem. I was wondering if you have any thoughts about that, and if you have any thoughts and what would trigger that. I assume higher interest rates are one of the things that could trigger that. But what are your thoughts VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 18 about the next few months, even few years, as far as the housing circumstances are concerned? Mr. GREENSPAN. Well, Congressman, one of the things which is really quite impressive is that when you measure the level of new construction additions of housing units, or housing starts, including mobile home shipments, which are not all that small, what you find is that it barely is in excess of the aggregate increase in occupied households or dwellings or of household formation. What that says is that after making adjustment for change in vacancies, you get an implicit demolition or reduction or replacement of the housing stock. And what is really fascinating is how small that number is, which suggests that we don’t have a demand for housing which could all of a sudden slip because, with immigration as it is, having a fairly important impact on the number of new households, net, which are formed and that number not being all that far from the number of new homes that we create, we are effectively not building up a glut of excess housing. And under those conditions, one would presume, even though we have been having some fairly strong gains in home prices, it is our conclusion, without getting into the details of some of the internals of the market place, that it is unlikely that we are confronting a housing bubble. Certainly the analogy to stock market bubbles is inappropriate. Remember, one crucial thing is that if you sell your house, you have to move. And if you sell your house, there is also a very large transaction cost. That in and of itself prevents the type of speculative housing demand which leads to bubbles and contractions. So while it is not inconceivable—I mean, there are conditions under which that can happen, it has happened in other countries, and it has happened in small geographic areas, but we have such a broad expanse in our country that you cannot arbitrage housing demand in Portland, Maine with Portland, Oregon. And that matters. It is not like the stock market, where there is a single market and everybody is trading with everybody else. The housing market is a highly fragmentized metropolitan area-type market. Mr. CASTLE. Thank you, Mr. Chairman. Based on that, I will take my house off the market. I am just kidding, Mr. Chairman. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Kansas, Mr. Moore. Mr. MOORE. Thank you, Mr. Chairman. Mr. Chairman, thank you for being here. Two years ago, we had a $5.6 trillion surplus, and there was discussion around Washington about the dangers of paying down the debt too soon. We don’t have that problem anymore. Isn’t that correct? That is really a concern we have now, is paying down the debt too soon. Mr. GREENSPAN. We do not. Mr. MOORE. Okay. A lot of what we say in the discussion that is here, I think as much as we would like to believe this is science, a lot of this is kind of art, isn’t it, trying to figure out what is going to happen in the future, making educated guesses? Mr. GREENSPAN. If you are talking about the economy in general—— Mr. MOORE. Yes, sir. Mr. GREENSPAN. ——and the decisions we make? Mr. MOORE. Yes, sir. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 19 Mr. GREENSPAN. Yes. In fact, the one thing that we know with a great deal of certainty is that the future is of necessity unknown. There are very few things we know for certain, like inventories cannot go below zero. We know basically with some degree of certainty what the number of people will be in the population, say, 20 years of age and over, because they are already born and our experience with immigration and death rates is reasonably well contained, so we can make reasonably good forecasts. When you are dealing with the broader issues, on what the level of economic growth is going to be, what prices are going to be, what markets are going to be, we are looking at a very complex system. And it can only be handled conceptually if we abstract from that complex system and create models which are much simpler but which we presume will somehow reflect the broader forces in the economy. And the reason why there are differences amongst economists on forecasting is that this process of abstracting for what is the appropriate model to represent what is going on is, as you put it, I think, a state of art, something like that. Mr. MOORE. You have been here several times in the 4 years I have been in Congress, and you have stated consistently, Mr. Greenspan, that one of your concerns was deficits and the growing national debt, which is now approaching $6.4 trillion. And I think you have been extremely consistent about that, and in fact today you were consistent again, mentioning your concern about deficits. I understand things aren’t black and white here and there is a lot of gray area in the middle and that we need to try to sometimes negotiate our way through that gray area and find some compromises, but I think one of the facts that we can state here is, the President has projected for next year, fiscal year 2004 and for the next year after that $300-plus billion deficits and deficits beyond that as well for a while. And I think the other fact that we can certainly state is, as I understand it, the projected interest payment on the national debt for next year is about $174 billion, which is a lot of money by anybody’s standards. And I guess my concern is, and you have said here, that in the short run, in the short next few years maybe we are okay. But you have raised a red flag, I think, about what happens beyond 2011, 2012, when the boomers start to retire. How do we reconcile all of this, this $174 billion debt and what I call a debt tax? Because we have to pay it every year as long as we have a national debt. And I don’t see that national debt shrinking, and in fact I think it is increasing. So how do we get ready and maneuver our way into this 2011, 2012, and be able to take care of that when we are proposing more tax cuts and some more spending? I belong to the Blue Dog Coalition, and we try to be consistent like you have, and saying one of the things we need to practice is fiscal responsibility. Mr. GREENSPAN. I would say there are two things that have to be done. One is to put in place a process which enforces the decision making into making choices. The—— Mr. MOORE. May I interrupt just one minute? Because I would like you to answer this, too, and this is my last question and I will let you just finish then. You mention in your testimony the permanent tax cuts and what that might do to future deficits and debt. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 20 And I would like you, if you would, just to touch on that as well, and I am sorry to interrupt you. Mr. GREENSPAN. The first thing is to get a process in place which has two aspects to it. One is the PAYGO and discretionary caps which we have done over the last decade or so quite successfully. Second, which would be helpful, is to add an accrual system to our budgetary accounts, which will enable us to be able to anticipate exactly how our obligations are spinning out into cash requirements. But having done that, all that does for us is tell us what various alternative sets of choices there are. There is a limit to what revenue resources are available which are tied to the GDP. We have done extraordinarily well in that regard in that we have had a major acceleration in productivity, and that has raised the tax base quite considerably, which has enabled very substantial expansion of expenditures which I don’t think has been terribly helpful, but the productivity has been crucial. We can accelerate further, but it is not as though we are back in 1990, when the productivity rate was 1 percent, well below the historical average, and then we moved it up quite appreciably in the latter part of the 1990s, and currently. So our leverage to go higher is limited, and therefore we do have, even under the most optimistic of assumptions, a limit to what our resources are. We do not, I might just say parenthetically, have the capability of a country which is not at the cutting edge of technology all of a sudden obtaining all sorts of technology and having its productivity growth rate rise sharply, its tax base rise sharply, and have a great fiscal capability. We are at the cutting edge, and history tells us that there are limits to how far we can go, and we must stretch them. In other words, that is the reason I think flexibility is so important. But this is where the issue of permanent comes in. As a matter of principle, you cannot have permanent anything, either tax levels or spending programs, because it is quite conceivable that if you have either tax rates or entitlements, it is quite possible that the net of those effects may be a larger drain on our real resources than we actually have available. Therefore, I have concluded—and I indicated in my prepared remarks—that we do need triggers or sunset legislation to enable us to adjust in the event that we find that programs previously put in place, either a tax structure or an expenditure program, which combined is in excess of our capability. So we need far superior fiscal mechanisms far beyond what we used to deal with 40 years ago when everything—virtually everything—was discretionary and all you had to do was make annual appropriations and that was adequate. We now have gravitated to the point where two-thirds of our system is essentially nondiscretionary and on automatic pilot, and we have to make certain that the fiscal vehicle doesn’t run off the road because it is a new ballgame. We cannot deal with it the way we did in previous years. The CHAIRMAN. The gentleman’s time has expired. The gentleman from California, Mr. Royce. Mr. ROYCE. Thank you, Chairman Oxley. Chairman Greenspan, welcome. I wanted to ask you about some testimony you made in the Senate last year in April. You said be- VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 21 fore the Senate Banking Committee that while deposit insurance contributes to overall short-term financial stability and protection of small depositors, it also induces higher risk-taking, resulting in a misallocation of resources and larger long-term financial imbalances that increase the need for government supervision to protect the taxpayers’ interests. You concluded by saying: Any reforms to deposit insurance should be aimed primarily at protecting the interest of the economy overall and not just the profits or market shares of particular businesses, and that it is unlikely that increased coverage, even by indexing, would add measurably to the stability of the banking system today. I want to ask if your underlying position of skepticism toward the necessity and net benefit of increasing deposit insurance coverage levels has changed drastically, or do you still view an increase in these levels as a solution in search of a specific problem which would warrant creating the resource misallocations and long-term imbalances that you see as inevitably stemming from their increase? In other words, do you believe that large increases in municipal and retirement account coverage are warranted? Mr. GREENSPAN. All I will say to you, Congressman, is I stand by the testimony that I gave last year, and I have seen nothing of which I am aware to alter the evaluation that we have had with respect to it. Mr. ROYCE. Well, I thank you for that answer, Chairman Greenspan. And I thank you, Mr. Chairman. The CHAIRMAN. Does the gentleman yield back? The gentleman yields back. Mr. ROYCE. I yield back the balance of my time. The CHAIRMAN. The gentleman from Texas, Mr. Hinojosa. Mr. HINOJOSA. Thank you, Mr. Chairman. Thank you Chairman Greenspan for coming to visit with us. I am not certain whether or not you are familiar with matricular consulars. The matricular consular is a water-sealed photo identification card issued by the Mexican government to Mexican nationals that complete an application form in person at any of the 47 Mexican consulate offices in the United States and submit a certified copy of a birth certificate, present an official picture I.D. issued by any Mexican or U.S. authority, and show proof of residence in the consular’s district by presenting a phone, rent, or power bill. Are you familiar with these matricula consulars? Mr. GREENSPAN. I have read it in the newspapers, but that is the extent of my knowledge. Mr. HINOJOSA. I come from an area that is trying to increase trade with Mexico. We have millions of Mexican nationals who are working in the United States and need to have the opportunity to open a bank account. At least a third of them do not have a bank account, and many of those individuals are trying to send money back to their families and pay exorbitant amounts to have that done. All this to say that they need a healthy and intelligent alternative to payday lenders, wire transfer services, and check cashers in general. And the question is, should matricula consulars be considered valid forms of ID for the purposes of opening a bank ac- VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 22 count. This committee certainly has jurisdiction on that and would like to have your thoughts on it. Mr. GREENSPAN. Well, Congressman, I don’t know enough about the pros and cons of various different alternatives. But I certainly will, if you would like, look into it. Mr. HINOJOSA. May I send something to you in writing and see if maybe you and your staff could look into it? Because I think we need to think out of the box. I think that we need to make it easy for individuals, particularly Mexican nationals with matricular consulars, to be able to open up bank accounts instead of leaving money in places at home where it can be stolen, or to violence because they are forced to carry such large sums of money with them. I would like to include for the record legislation and a press release on matricula consulars. Mr. GREENSPAN. Well, why don’t you send us a series of questions, and we will try to respond expeditiously to them. Mr. HINOJOSA. I would be happy to do that. And a last question. As you know, there was some debate last year in this committee as to whether financial institutions, specifically credit unions, should be allowed to be privately insured. And over the past couple of years we have seen an increasing number of credit unions drop their Federal insurance and opt for private insurance. With the strength of all of the Federal insured systems such as the Bank Insurance Fund, the Savings Association Insurance Fund, and the National Credit Unions Share Insurance Fund, is this something that we should be concerned with at this time? Mr. GREENSPAN. Well, I haven’t been aware that the private insurance has taken hold, because, as you recall, our experience over the years with private insurance has not been very impressive. And one of the reasons is that deposit insurance is a very unusual sort of insurance which is very difficult for a private insurer to successfully market without exorbitantly high insurance premiums. And in the past, various different types of insurers found that out to their dismay and bankruptcy, I might say. I am not aware of the extent to which it has re-emerged in credit unions, but I certainly will be glad to look at it and again respond to you quickly. Mr. HINOJOSA. Anything we can do to protect the depositors as Congressmen is very important to me, and I would love to get your thoughts on what we should be doing in this committee to improve that, and I thank you for your response. And thank you, Mr. Chairman. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Texas, Mr. Paul. Mr. PAUL. Thank you. Welcome, Chairman Greenspan. I have a question relating to the speech that you gave at the Economic Club in New York in December, because you introduced your speech with three paragraphs dealing with gold and monetary policy. And you made some very pertinent points about gold, indicating that from the year 1800 to 1929, the price levels were essentially stable under gold. And after we got rid of the gold restraint on the monetary authorities, prices have essentially increased by over tenfold since that time. But you follow that by indicating that inflation, when it was out of control VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 23 in 1979, monetary policy changed direction and they were able to take care of inflation, more or less conquer inflation, and that now you are more or less not concerned about inflation, that your concern really is about deflation. And it was interesting that you brought up the subject of gold, of course, and there is a lot of speculation as to exactly why you did this and what this means. But my question deals with whether or not we should forget about inflation, whether or not this has been dead and buried. Federal Reserve credit for the last 3 months has gone up at the rate of over 28 percent. Inflation is a monetary event, so therefore we have monetary inflation. The median CPI is almost going up at twice the rate as the CPI, close to 4 percent. The Commodity Research Bureau Index is going up, in the last 15 months over 35 percent. Gold is up 36 percent over 18 months or 15 months. Oil is up 60 percent. So we have a lot of inflation. And we have medical care costs skyrocketing, housing costs going up, the cost of education going up, the cost of energy going up. And to assume that we shouldn’t be concerned about inflation, all we can do now is print money. I would suggest that this is what we have been doing for 3 years, the monetary authorities. You have lowered the discount rate 12 times, and there is still no signs of good economic growth. So when will you express a concern about an inflationary recession? Because that to me seems like our greatest threat, because that has existed before. We even had a taste of it in the 1970s. We called it stagflation. So I would like you to comment on that as well as follow up on your comments on just why you might have brought up the subject of gold at the New York speech. Mr. GREENSPAN. First of all, we have not lessened our concerns about inflation. Indeed, our general presumption is that we seek stable prices, and stable prices mean no inflation nor deflation. The reason I raised the issue of gold is the fact that the general wisdom during the period subsequent to the 1930s was that as we moved to an essentially fiat money standard, that there was no anchor to the general price level. And indeed, what we subsequently observed is, as you point out, a very marked increase in general price levels, indeed, around the world as we removed ourselves from commodity standards, and specifically gold. I had always thought that the fiat money system was chronically and inevitably an inflation vehicle, and indeed, said so repeatedly. I have been quite surprised, and I must say pleased, by the fact that central bankers have been able to effectively simulate many of the characteristics of the gold standard by constraining the degree of finance in a manner which effectively has brought down general price levels. The individual price levels to which you allude are certainly correct. I might say the gold and the oil issue are clearly war-related and not fundamental, but we still are looking at the broadest measures of average inflation, and the best statistics that we have still indicate very low inflation with no evidence of an acceleration. That does not mean, however, that we believe that inflation is somehow inconceivable any time in the future. We will maintain a considerable vigilance on the issue of inflation, and are looking all the time for evidence of an emergence of inflation, which at this VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 24 particular time we do not see. But that does not mean that we believe inflation is dead and that we need not be concerned about it. We will continue to monitor the financial system as best we can to make certain that we keep prices stable. They are stable now, and we hope to be able to continue that indefinitely into the future. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Missouri, Mr. Clay. Mr. CLAY. Thank you, Mr. Chairman. Mr. Greenspan, thank you for being here. I am somewhat confused by the reports that I read and would like some clarification. You have opposed budget deficits that are to continue for the long term, and you have had an equal distaste for surpluses that you thought would compete in the private markets. You supported the Bush 2001 tax cut, believing that it would control budget surpluses that would continue for years. Maybe the tax cut worked better than expected. We no longer have projected surpluses; all we have now is deficits. The tax cut contributed greatly to this adverse situation with the budget deficits. Presently, without any budget surpluses in sight, we have another tax cut proposed that will push deficits even higher and extend them for untold numbers of years. My question is, will you state your position on the proposed $1.4 trillion Bush tax cut and inform the committee on its ramifications on the deficit and the national debt? Mr. GREENSPAN. Well, I have not commented on any of the proposals in general except those which are specifically economic issues, and I have stipulated that I would have hoped that back in September we would have had a PAYGO system continuing and that it would be continuing today. And I would view any proposal that occurs with respect to either taxes or expenditures be first applied through the PAYGO system. We have been talking about taxes all along, and nobody has mentioned spending. There is an awful lot in the way of spending initiatives out there which, if we had PAYGO rules, would require that they go through the same process to maintain budget neutrality as best we can. So as far as I am concerned, from the point of view of the central bank, which is interested in the total financial system and is very crucially interested in the level of federal debt and the degree to which it preempts private debt issuance, that is a major issue which is directly in areas which we find important for monetary policy. The question of how you regulate taxes versus expenditures and what expenditures you are having to put forth is something which, as I mentioned before, is, in my judgment, one of the crucial roles of the Congress, because it is the only mechanism that we have which enables the will of the people and their priorities to be constructed in our various budgetary forms. The President makes recommendations insofar as he can infer what he thinks is the best for the American people. It is the Congress which disposes with the obvious final resolution of the decisionmaking by whether the President signs or vetoes a bill, which you can then override. So that, to me, is a process which we just ought to think about because we are abandoning that. Mr. CLAY. Well, what do you think about the reversal in fortunes of the U.S. budget as far as us two years ago having a $5.5 trillion VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 25 projected surplus and now looking at a projected deficit that grows every day? Mr. GREENSPAN. Well, one of the reasons that I was in favor of a tax cut two years ago was to prevent the accumulation of private assets by the Federal Government, which I think is a very bad idea and still think it is a very bad idea. Remember, at that time there were a number of tax cuts on the table. It wasn’t just the President’s tax cut. The issue here is if the President’s tax cut didn’t pass, another very significant tax cut would have passed, which I would have thought would have been fine, because it was needed to take the surplus off the table, and I think clearly that happened. What also happened was a major, 50 percent, decline in stock prices which had the effect of very markedly reducing revenues beyond what the Congressional Budget Office had projected when they made that $5.6 trillion surplus projection. They recognized that there were risks in those longer-term forecasts. But in the event it came out to the extreme end of probabilities, it was very unexpected by both the CBO and OMB analysts. The CHAIRMAN. The gentleman’s time has expired. The gentlelady from Illinois, Mrs. Biggert. Mrs. BIGGERT. Thank you, Mr. Chairman. Chairman Greenspan, I know that the Fed is very involved with the ongoing Basel negotiations for new risk based capital standards. And as you know, Chairman Oxley and Ranking Member Frank are particularly concerned with the proposed new capital standards for operational risks, and we are going to be looking into this issue in depth in future hearings. And I don’t want to ask you to comment specifically on the operational risks section of the rules, but could you please describe to us how the Federal Reserve and other bank regulators are factoring into their Basel positions such factors as the impact of the rules on U.S. banks of all sizes and on the U.S. economy? Mr. GREENSPAN. I can’t comment on exactly how other regulatory authorities will address the Basel II implications. But from the point of view of the United States, for the vast majority of American banks, Basel II is irrelevant. It is a specific set of rules which endeavors to address the fact that we are getting ever-increasingly large global types of international institutions employing very sophisticated risk evaluation techniques and models. The vast majority of American banks, as you know, are small, are not involved in any of this, and Basel I will, for all practical purposes, continue to be the operative rules for those banks. Even those banks, if they so choose, can apply effectively for regulation under the Basel II procedures, which essentially endeavor to capture the usefulness of these new risk evaluation models, which improve immeasurably the capability of large institutions to contain risk. But in so doing, what the supervision must then turn to is a much more sophisticated approach in evaluating how the risk models are constructed, what the nature of supervision is, and what the nature of disclosure is of these various different types of institutions. But I want to emphasize we are dealing with a handful of American institutions, and unless and until individual, smaller banks VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 26 wish to do the same thing—which they can legally do—it doesn’t apply to them. In one sense, you have to remember that a small commercial bank has very considerable control over its risk management systems. It knows every borrower, as I mentioned before, it knows the history. It is able to get a far more sophisticated evaluation of any individual loan than a very large commercial bank using these mathematical techniques to make a judgment on a loan. I would much prefer to have the small bank appraisal, because you are really looking at the core of what is being done. Because that is not feasible with a very large institution, you have to fall back on more automated types of risk evaluation procedures, which is what they are doing. But there is no way that in any individual loan the quality of judgment that is made on whether that is a good loan or a bad loan can be done better mechanically in the way that these risk management systems do than a small banker fully familiar with the credit history of a particular borrower and knowing what his business is all about can do. Ms. BIGGERT. So you don’t think that a medium-sized bank or a small bank will think that these big banks are getting so much benefit that they either need to consolidate with another bank or that they would need to just voluntarily opt-in to doing the same thing? Mr. GREENSPAN. I think not. I mean, if indeed you could formalize a credit evaluation through the mathematical techniques which we now have available, which is superior to the capability of an individual banker in a small town making a judgment on the loan, then, yes, I would agree with what you are saying. But that is not what the issue is. The CHAIRMAN. The gentlelady’s time has expired. The gentleman from Massachusetts, Mr. Frank. Mr. FRANK. Mr. Greenspan, on the proposal for a tax cut now of $674 billion for the next period, the current tax cut before us, am I correct your position is that it should not be adopted outside of the PAYGO rules, specifically unless you were in the situation where it would take 60 votes in the Senate? Is that a correct understanding of your position? Mr. GREENSPAN. I would say that I am somewhat distressed that the PAYGO rules were allowed to expire. Mr. FRANK. So you would not have us adopt a major piece of either the budget or anything else, including a tax cut, until we have reinstated PAYGO? Mr. GREENSPAN. Tax cut or expenditure program. I would prefer that that had continued and hopefully would put in place before—— Mr. FRANK. It would take 60 votes. So we should not do either expenditure or tax cut decisions this year until they get back to a 60-vote rule in the Senate? Mr. GREENSPAN. Well, the 60-vote rule still occurs I think through April, as I recall. Mr. FRANK. Well, but you—— Mr. Greenspan. Yes, the statement that you—— Mr. FRANK. Don’t be the Senate Parliamentarian. Be the Chairman of the Fed. In principle, what do you think? VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 27 Mr. GREENSPAN. The answer is yes. Mr. FRANK. Good. Now, that would mean then that any new significant expenditure or new significant tax cut would have to be offset, correct? Mr. GREENSPAN. Yes, unless obviously emergency issues come up or other various forms of exemption under the procedures that have been involved. Mr. FRANK. Now, the question I have is this about the $674 billion. You said that the tax cut in 2001 seemed reasonable to you at that level. And what then happened was the economy, picking the stock market, went to the low end of everybody’s projection. Is that what you said? Mr. GREENSPAN. That is correct. Mr. FRANK. If you were back in 2001 and you knew that the tax—that the projections were to go to the low end, would that have affected the judgment? I mean, it is not anybody’s fault. But would that have affected the judgment? Mr. GREENSPAN. I frankly don’t know. Mr. FRANK. All right. But then let me ask you this question. Having said that clearly the projection of the revenues went to the low end, the tax cut cost us more than we thought it was going to in some ways, doesn’t that argue against a further large tax cut now? I mean, having miscalculated doesn’t mean we are going to miscalculate again, but if the fiscal picture is considerably worse than people reasonably could have thought it would be, where is the argument for now a further tax cut? Mr. GREENSPAN. Not necessarily. Because the types of tax cuts we are talking about—let me stay with the double taxation of dividends. Mr. FRANK. No. I want the whole package. Mr. GREENSPAN. I will come to the whole—— Mr. FRANK. I only have 5 minutes. Come on. Mr. GREENSPAN. I understand that. The principle I am trying to raise is that you need to make judgments when you are looking at long-term tax and spending policy; what, for example, the elements of the tax policy do to the GDP and therefore the revenue-raising capacity of the economy. They are not all equal. And I happen to think that the types of programs which have been brought forth which are in the President’s program are of the type of—— Mr. FRANK. I am disappointed. I want to be very serious here. Mr. GREENSPAN. Why are you disappointed? I have—— Mr. FRANK. Because I think what has happened is this. I think when you restated yesterday, quite honestly, your long-held positions on the deficit, and when you disagreed with those who poohpoohed deficits, that got presented in this morning’s papers as being critical of the proposal that the President put forward. And my strong impression today is that you are seeking now to find the maximum points of agreement to diminish the impression created that your longstanding positions would be somewhat negative. You will have a chance to answer. I just want to throw in one—— Mr. GREENSPAN. But may I respond to that? Mr. FRANK. I just want to finish. Let me finish the question. Mr. GREENSPAN. Sure. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 28 Mr. FRANK. And then I am through. You keep talking, and this is part of the problem. You say, well, we have no problem until 2010 or 2011, and then we have a problem. I mean, that is probably what you are saying. But the world is not divided into two separate wholes. 2008 leads to 2009 and 2010 and 2011. In other words, you are saying Social Security and Medicare will be serious problems for us 10 years from now, but it is irrelevant if we increase deficits between now and then. The more we increase deficits between now and then, the more people who, out of a conservative ideology, want to put pressure to reduce Social Security and Medicare will be able to argue. And I am afraid that is the position I infer from you. Mr. GREENSPAN. No. The issue basically is this, that if you are going to start with a question of having an aggregate capacity, a revenue capacity in which to fit tax cuts and expenditure increases, then you are dealing with an issue of making choices amongst various different elements if the total of all of the programs you are dealing with exceed, as they always do, the aggregate amount of revenue capacity in the system. What I am saying to you is this: The way you formulated what is attributed to me is incomplete. I am not saying that—let me finish. Mr. FRANK. Incomplete, but not incorrect. Mr. GREENSPAN. Well, let me state it, and I don’t know whether or not it is incorrect. I am stating to you the following: I am saying you cannot get an effectively full evaluation of whether you should be cutting taxes or making expenditure programs without knowing the impact of that on the revenue base. I don’t know what the impact is, but I am basically saying that to make a full judgment about any particular proposal, you need to have a judgment one way or the other of the extent to which it affects the tax base. And, as I said earlier this morning, in my judgment; the elimination of the double taxation of dividends will have a significant although admittedly indeterminate impact on the flexibility of this economy, its growth rate, and therefore its degree of revenue. Not including that in your evaluation of making a judgment of how to balance various elements of taxes and spending I do think is incomplete. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Texas, Mr. Hensarling. Mr. HENSARLING. Thank you, Mr. Chairman. And Chairman Greenspan, thank you for your testimony today. As part of your testimony, your prepared remarks, I believe you said that if spending growth were to outpace nominal GDP, maintaining budget balance would necessitate progressively higher tax rates that would eventually inhibit the growth in the revenue base on which those rates are imposed. My question, Mr. Chairman, is, isn’t that the recent history of our country if you look back 5, 10, 15 or 20 years, that indeed the growth of government has outpaced the growth in GDP? And if that is true, and this trend continues unabated, given that the average American family has a 40 percent tax burden, almost at its historic high between its local, State, and Federal component, I am curious about your opinion on what the long-term impact will be on our economy and on family income. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 29 Mr. GREENSPAN. Well, Congressman, we are fortunate in the sense that currently the level of debt to the public is at a reasonably low level historically. That is, we came down quite considerably from higher levels and we are now in the low-to mid-30 percent of debt to the public as a percent of the GDP. So we are in the position where the debt load as represented by the amount of debt plus interest—interest being low because interest rates are low—is a great burden on the American public relative to what it has been in previous periods. So it is not—it is not a progression of increasing percents of government expenditures to GDP, because in fact the trend has been largely flat. As I stipulated in my prepared remarks, there has been a big shift from discretionary spending to nondiscretionary spending, but the numbers have stayed in the area of 18, 20 percent, 21 percent on occasion. So the evidence is that we have not been having government expenditures growing faster than the GDP. It is true that we have had nondefense expenditures growing faster than the GDP and especially nondefense discretionary. But overall the decline in defense expenditures has opened up a much larger capacity for the use of federal revenues for nondefense purposes than we have had in the past. Mr. HENSARLING. You spoke in your testimony about the desirability of certain budget constraints such as the PAYGO rule sunset provisions. In the President’s economic growth package that he has proposed as part of that package is the goal of restraining the growth of government spending to no more than the growth in family income. Let us use for the moment—let us have an overactive imagination and believe that this Congress could actually achieve that goal of restraining government spending to the growth in family income. Do you have a thought of what the long-term impact on the economy would be if we could achieve that budget discipline? Mr. GREENSPAN. Well, strangely enough, we actually have done that in the sense of the aggregate expenditure because, as I just mentioned before, of the very dramatic decline in defense expenditures, going back say 50 years, we have been able to keep aggregate Federal Government expenditures constant relative to incomes. However, that is going to change. It is inevitably going to change because of the fact, as I mentioned before, with defense as low as it gets, it can’t go any lower. And with the retirees after 2010 or 2012, we have a very substantial projected increase in nondefense expenditures. Mr. HENSARLING. As we see different policies to promote economic growth and obviously a rollback in marginal rates as part of the President’s program, we can debate what might happen in the future, but if we look to the past, hasn’t the history of our Nation been, in the 1980s, the 1960s and 1920s, that indeed when we roll back these rates that Government revenue and GDP revenue grew? Mr. GREENSPAN. Would you repeat that again? I didn’t quite get it. Mr. HENSARLING. Isn’t the history of our Nation when we roll back marginal rates, as we did in the 1980s, in the 1960s and the 1920s, that revenues to the government actually increased and that GDP grew? VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 30 Mr. GREENSPAN. Let us put it this way. It depends on the conditions. It is very rare that you can reduce a tax rate and end up with more revenue. It happens on occasion, but it is not the general case, and I don’t think you could argue that in the aggregate sense in any of those particular episodes that it invariably happened. But it is certainly the case that if you have various taxes which inhibit growth and inhibit capital, it is quite possible that reducing those could create a rise in the tax base greater than the cut in taxes and therefore you would get more revenues. That is not the general case, and I think each case has got to be evaluated on its own. The CHAIRMAN. Gentleman’s time has expired. The gentleman from Pennsylvania, Mr. Kanjorski. Mr. KANJORSKI. Thank you, Mr. Chairman. Mr. Chairman, the President in his State of the Union Address just several days ago said we will not pass along our problems to other Congresses, other Presidents or other generations, and that was in the very early part of his speech. And quite frankly, when I heard him say that, I became quite pleased with his intentions as reflected by that statement. But then as he went on to develop his plan for America in his State of the Union Address, and particularly with his tax policies, it seems to me that the President is saying something very interesting. He is saying that the Congress should reduce this double taxation on dividends. And I for one can understand why people would support reduction of any taxes that are possible. And if these are economically retarding-type of taxes to our economy, as your recent answer seemed to indicate, that these are the types of things we can reform or tailor to stimulate the economy long-term but with the intention of not doing away with the revenue source and get out of balance with the budget considerations. But the President’s budget reflects the fact that, yes, he wants to make this reduction in dividend taxes and make it up in no other side so that we just basically increase the deficit accordingly. And for a relatively long period of time, certainly as long as the budget projects, the budget will be in deficit and major deficit. And that brings to my mind—I don’t know how long the President can continue to serve, but I think only 6 more years, and I do not see a balanced budget in his projections within those 6 years. This Congress only serves for 2 years, and clearly the President recognizes there will be major deficits for the remaining 2 years. And as we look at a minimum of $300 billion deficit and I think closer probably to $500 billion if you consider the fact that we are taking all of the Social Security overpayment and misdirecting it to operational expenses and not accounting for the expenses of the war, which will be at least $50 billion to $100 billion, I think we can realistically conclude that at the end of this coming year and next year we will be in excess of $500 billion of real deficit. And then our Congress will be over and we will be halfway, or at the end of the President’s first term. If he doesn’t go on to a second term, there will be a new President and passing that tremendous debt increase on to next generations. So I have concluded in my own mind, and I am wondering what your conclusion is—wasn’t the State of the Union Address and this statement by the President of his policy a rather disingenuous view to put to the American people that you can have this tax cut now, VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 31 and as Mr. Frank said, we can fight two wars and give you the third tax cut and there aren’t any long-term economic consequences to the economy as a whole and to the fiscal responsibility of the action of the Federal Government as a whole over the next decade or two? What is your position on that? Mr. GREENSPAN. Congressman, it depends on what the President does next because there is an extraordinarily accurate, in my view, evaluation of the long-term budget outlook in the President’s budget, and there is the issue of the sustainability of the budget in the budget document with a fairly sophisticated analysis. So I read the combination of the President’s State of the Union plus what is in the President’s budget as that there are new policies to come which effectively reconcile the issue that you are concerned about. That is the way I would read it. Mr. KANJORSKI. Well, you said that we can get control of the fiscal responsibility of the country and the budgetary positions by either not cutting revenue or counterbalancing a loss revenue in the dividend reduction or we can cut spending, and I would tend to think that the emphasis of the President’s budget is cutting the expenditure side. But don’t you think it is both politically and intellectually disingenuous for this administration and the majority of this Congress to fail now to tell the American people the consequences of cutting these expenditures in order to eventually get to a balanced budget? How can he say we are going to spend more money on education, on health, on the military and all these other expenditures and not be honest telling the American people so that they have a decision process to make? If they want to do away with the double taxation of dividends, they have to be willing to give up the solution of the health problems, the education problems, the military problems of this country. Mr. GREENSPAN. I can’t speak for the President and won’t. My impression, basically, is that many of these issues are discussed in some detail in the budget. And I presume that when you see that sort of thing in budgets, it is usually indicating what the thrust of an administration’s fiscal policy is. And I would assume that he will make it clear as the time goes on. I have no way of knowing what specifically in each case the particular programs direct to, but he does—there is no doubt in my mind, reading through the budget in full detail, that there is full awareness of all of the various concerns that you raise in the budget document itself. Mrs. KELLY. [Presiding.] Mr. Garrett? Mr. GARRETT. Thank you, and I appreciate the opportunity to be with you and ask you a couple of questions today and I will just have two short ones along the lines with regard to the issues on the deficit. We had the opportunity this past week to have some administration officials come before the Budget Committee, and I think they were saying things generally along the line you were when concerns were raised as we look forward on the deficit. And one of the responses we had was similar to what you mentioned just about 5 minutes ago with the comment that things have to be put into perspective as far as the deficit as a percentage of the GDP. But the question that followed on that was, then why was there as much of a concern just 6 or 7 years ago back in the mid1990s on the deficit if as a percentage of the GDP the deficit was VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 32 around at the 2.5 percent level at the same time back then? What is the difference in the factors? Since we are staying constant, as you said, as a percentage, why we should be more concerned back then than we are now? Mr. GREENSPAN. The crucial issue really gets down to simple arithmetic. If you have debt as a ratio to GDP, say, in the mid-30 percent, which is where it is now, and you have average interest rates as a process, you will find that arithmetically if the ratio of the deficit to the GDP is about 2 percent, that is equivalent to the ratio of debt-to-GDP being constant. As you can see, if the budget is in balance and GDP is rising and the debt by definition is not changing, the ratio of debt-to-GDP will go down. Put it another way, for the debt-to-GDP ratio to be stable, it would be consistent with a modest deficit as a percent of the GDP. So the question isn’t whether or not in the past we were concerned or not concerned. There were many times in the past when we weren’t concerned when we should have been concerned. It is really a question of moving forward in time. If you take the President’s program as it stands, you have modest deficits after the next two years, which are consistent with a level of debt-to-GDP, which is not significantly different from where it is now. But as we go beyond the turn of the decade, expenditures rise quite significantly and the ratio of debt-to-GDP begins to move up. And when that begins to happen, you have an unstable system with consequences which are difficult to judge, and it is that period which has to be addressed. And one of the reasons I have said it is none too soon to start thinking about the path of how we get there is that it is a fairly significant change that occurs as the baby boomers retire. Mr. GARRETT. Thank you very much, and the other portion of the question is the spending side, which I guess you alluded to a couple of minutes ago. You were saying we have sort of bottomed out on the defense side and then leaving a smaller percentage as far as the discretionary side, and we are within the 4 percent figure that we mentioned over here. Mr. GREENSPAN. What I am basically saying is the fact that over the past 50 years the ratio of expenditures-to-GDP has been constant, has masked a trend towards nondefense expenditures as a percent of GDP which has actually been rising quite significantly. And the problem was, even without September 11, we probably would have found that the ratio of spending-to-GDP was going to start to rise, not a great deal, but at least start to rise. And the trend is changing because the defense budget has gone from a fairly significant percent of GDP down to 3 or 4 percent. Mr. GARRETT. Where we should be concerned is on the mandatory side, especially in light of the administration’s proposal where we are significantly adding on to that portion of the budget? Mr. GREENSPAN. Yes, we should be concerned about anything which is mandatory. Mr. GARRETT. Thank you. Mrs. KELLY. Mr. Sanders? Mr. SANDERS. Thank you, Madam Chairman, and thank you very much, Chairman Greenspan, and I look forward to working with VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 33 you as the ranking Member of the Financial Institution Subcommittee. Mr. Greenspan, I always enjoy your presentation, because frankly I wonder what world you live in. It is not a world in which you engage with working people who are struggling harder than ever to keep their heads above water, with workers who have lost their jobs, with elderly people who can’t afford prescription drugs. And maybe, and I say this respectfully, you might want to stop going to all the black tie dinners and hanging out with the CEOs and come and talk to the middle class working families of this country, because I think if you do that you are going to find that your world view and your economic approach is dead wrong and has caused devastating impacts for millions of people. Mr. Greenspan, you have been pushing for years for unfettered free trade, for energy deregulation, which has given us Enron, for huge tax breaks for the richest people in this country. You have opposed any increase in the minimum wage, and in fact the last time you were here you told us you didn’t even believe in a minimum wage. Your policies call for massive cutbacks in government programs, such as Social Security, Medicare, Medicaid, veterans needs, affordable housing and education. In my view, your policies have been one of the reasons why the middle class in this country is being decimated, why more and more Americans are being pauperized and why the gap between the rich and poor is growing wider. In my view, you owe millions of Americans who have lost their jobs or who today are working longer hours for low wages an apology, and it is high time you rethought your extreme right wing ideology. In your position, you are supposed to represent all Americans and not just the wealthy and the CEOs of large corporations. Mr. Greenspan, let me introduce you to some reality. Since January, 2001, 1.7 million jobs have been lost and we have 8.5 million Americans today who are unemployed. In 2001, 1.3 million Americans slipped below the official poverty line. Over the last few years, trillions of dollars have been lost on the stock market and millions of workers today in this country have got to work beyond the time they originally planned to retire. In the last 2 years the U.S. has had the highest rate of bankruptcy cases in history. In 2001, the number of Americans without health insurance rose by 1.4 million, and that number continues to rise. Today as a result of the policies being proposed by the Bush administration, it is likely that millions of workers are going to see a significant reduction in the pensions that they had been promised by their employers. Now you in your testimony talked about expanding, quote-unquote, the liberalized global economy, which you call an ongoing success. This year we are going to have a $400 billion trade deficit, including a $100 billion trade deficit with China. In the last 2 years we have lost 2 million decent paying manufacturing jobs. At 16.5 million manufacturing jobs, we are at the lowest ebb position we have been in in 40 years, and you tell us that that is an ongoing success. If we have more successes like that, we are not going to have any manufacturing jobs in America. Mr. Greenspan, as you know, we have the most unfair distribution of wealth and income of any industrialized country. The richest 1 percent of the population own more wealth than the bottom VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 34 90 percent, and yet you here today tell us that you think it is a good idea to provide more tax breaks to the wealthiest people by doing away with the tax on dividends. The fact is that under that proposal people earning more than a million dollars would get an average tax break of $27,000 a year while those making less than $75,000 will get an average break of $42. Why do you advocate tax breaks for the richest people when we already have the greatest gap between the rich and poor of any industrialized country? And what particularly disturbed me about your testimony is that at a time when millions of elderly people today cannot afford prescription drugs, can’t afford to heat their homes, you are advocating by monkeying with the CPI major cuts not only for our seniors but for our veterans. Mrs. KELLY. Mr. Sanders, your time is up. Mr. SANDERS. Can you respond why you want to cut back on your Social Security? Mrs. KELLY. Mr. Sanders, your time is up. Mr. SANDERS. I would like the same time. Mrs. KELLY. Mr. Sanders, we have been working with the 5minute rule. Everyone knew about that. Mr. Greenspan, if you would like to answer that question. Mr. GREENSPAN. I don’t wish to cut back on Social Security, I just merely wish to enforce the law. The law stipulates that the cost-of-living adjustment is what should be applied to all tax and certain social insurance programs. I am stipulating, as I did in my remarks, that the new chain-weighted Consumer Price Index is a far superior means of measuring the cost of living. Mr. SANDERS. Because it would cut back? Mr. GREENSPAN. Do you wish—— Mrs. KELLY. Mr. Sanders, please do not interrupt Mr. Greenspan. Mr. GREENSPAN. If you wish to increase Social Security, you can do so through statute. I am merely raising a technical question of trying to adjust to how the statute that you have passed is best administered. Mrs. KELLY. Mr. Murphy. Mr. MURPHY. Thank you, Madam Chairman, and thank you, Chairman Greenspan. First a question on check truncation issues. The committee intends to consider legislation this year to modernize the check processing system. As you know, legislation known as Check 21 is based upon a proposal the Federal Reserve originally submitted to Congress in December 2001. Can you share with the committee your perspective on the legislation and what savings in operational efficiencies do you expect to flow from its enhancement? Mr. GREENSPAN. Congressman, we strongly support check truncation because we think it would very significantly improve the process of payments within our financial system. You may recall that we had some fairly significant problems right after September 11 as a consequence of air traffic problems and the ability to move checks through the system in an adequate manner. Had we had check truncation at that time, it would have made it a far easier problem to resolve. We think it is a significant advance in our pay- VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 35 ment system and we hope that the Congress would address that issue as expeditiously as you can. Mr. MURPHY. Thank you. Another category has to do with the impact of the economy upon the States. A number of States are facing fiscal problems and talking among themselves about cutbacks in services and spending as well as raising taxes. What are your views on these fiscal problems of the States and how do you see that impacting the economy as a whole? Mr. GREENSPAN. Well, as many people have noted, the substantial deficits in the general reserve of states are quite significant. And with the exception of Vermont, as I recall, all states are required to maintain a balanced budget, which means essentially that a substantial amount of either expenditure cuts or tax increases are taking place within the states so that by the end of the fiscal year, June 30 in most cases, the law has been adhered to. The question of endeavoring to be of assistance to the States has to recognize that any aid that can come from the Federal Government would have to come not for the current fiscal year because there is no way to get monies that quickly, but for subsequent years. And so the question is some of the states by the actions they will be taking in this fiscal year will, with very stringent changes, have successfully solved their problem so that when you go to fiscal 2004 and beyond they may no longer have a problem which would need to be addressed with federal funds. Doubtless some states, even if they bring their general fund to balance in the current fiscal year, nonetheless have problems in 2004 and beyond, in which case then the question of federal transfers to those states is on the table. And again, we are looking at a PAYGO issue, and I think appropriately so. So it is not an issue which can be readily resolved, as I see it, currently, because so much will have already taken place before the first dollar can be transferred to the states, and by then it probably would be too late unless they wished to reverse tax increases or programs they have canceled. Mr. MURPHY. One final quick question. Some have said that if we do a dividend tax cut that it would make States’ bonds look less attractive and might have some impact upon raising those interest rates. Could you comment about what your thoughts are about that? Mr. GREENSPAN. I think that is probably accurate. The size is difficult to judge. As I said in a similar question in the Senate yesterday, it raises a very interesting question as to whether or not the double taxation of dividends has effectively been subsidizing municipal finance in the sense of giving them a fairly improved status in the financial markets, in which case you would argue the elimination is taking away the subsidy. The other side is that if we are trying to maintain the state and local financial systems, the elimination of the double taxation does have an impact of a negative sort. I am not sure it is very large, but I don’t know because I have never seen an actual realistic evaluation to know how significant it is. I think it is correct that it has some effect, but whether it is minor or significant I frankly do not know. Mrs. KELLY. Mrs. Maloney. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 36 Mrs. MALONEY. Thank you, Madam Chairwoman, and thank you, Chairman Greenspan, for your testimony today. I would like to follow up on the gentleman’s question on the impact of the administration’s economic plan on the States. And I have an analysis that New York State Comptroller Alan Hevesi has done on the impact and I request permission to place it into the record. Mrs. KELLY. So moved. [The following information can be found on page 84 in the appendix.] Mrs. MALONEY. In his analysis he describes the administration’s dividend plan more or less as the gift that keeps on taking, and he estimates or believes that it will reduce New York State tax revenue and increase borrowing costs in New York State alone by $551 million this year and by $9 billion over the next 10 years. He estimates that the impact on New York City will be $160 million in 2003 and $3.3 billion over the next 10 years. In your statement earlier, you mentioned that some of these States would solve their problems this year, but clearly the only way they can solve these problems is to cut back on programs that are particularly important to lower income people in a bad economy or increase taxes. And nationally in his estimates he put forward in his letter to the New York delegation, he estimates that the cumulative State deficits are now between $60 billion and $85 billion. And my question is, do you think the impact of the administration’s plan on State budgets both from the revenue side and on the borrowing costs, because tax favored municipal bonds could lose some of their appeal, this is really going to place a tremendous burden on our States in a time when they are confronting tremendous challenges? Mr. GREENSPAN. Congresswoman, unless I am mistaken, the reason why the loss of revenues occurs in the states is because they use adjusted federal gross income as the base to apply the state income tax rate. It strikes me that perhaps what some of the states may want to do is alter that. In other words, what is occurring in the process is a reduction in state taxes because there is a lesser amount of income which occurs because it is tax free. So it may very well be that the solution to this is for the states to recognize that they don’t wish to cut taxes and they can alter the rates accordingly or alter the employment of the adjusted gross income that is applied on the federal form in a manner which doesn’t get this flow-over effect. And I would suspect that a number of states are going to do that. Mrs. MALONEY. Well, they can, but still overall as the Comptroller points out, it is a tremendous impact on State budgets when they are facing huge budget gaps. Getting back to the deficits that are galloping forth, are you concerned that the increases in the deficits will push up interest rates and increase mortgage, car and credit card rates for working families? Mr. GREENSPAN. I am, Congresswoman. I think that what has been an extraordinarily important prop to this economy through its very stressful two or three years has been low mortgage interest rates, which have not only maintained the fairly pronounced level of residential construction, but have also, in conjunction with the VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 37 rise in the prices of homes, facilitated a fairly substantial extraction of equity from homes, which has been the means of financing the fairly large part of consumer expenditures over the years. Clearly if mortgage interest rates were to move up in any material way I think we would find that that would have a marked impact on, obviously, house turnover, which is a major factor in extraction of equity, and clearly on refinancings and the cash-outs which are associated with them. So, yes, I am concerned about long-term interest rates specifically, but mortgage rates in particular, rising. Mrs. MALONEY. And we seem to be going in that direction. Mrs. KELLY. Excuse me, but your time is up, Mrs. Maloney. It appears to be my turn to ask questions, Mr. Greenspan, so I am going to ask you a question that says—tells you I am reintroducing my business checking legislation in this Congress and I expect the House is going to pass that fairly quickly. I take it that the Fed is still behind in supporting my legislation? Mr. GREENSPAN. We certainly are. Mrs. KELLY. It is my understanding that one of the issues that has held up the legislation in the Senate was the intent of some of the Members to add language to the bill to give State chartered industrial loan companies the ability to also pay interest on demand accounts. We hear arguments that these institutions are well regulated by the State and Federal Deposit Insurance Corporation. There has been a great deal of debate on this point, but I want to get it on the record. Mr. Chairman, why should we oppose efforts to allow the industrial loan companies to pay interest on NOW accounts held by the businesses? Mr. GREENSPAN. Basically because if you make that shift, they become full commercial banks, and because of their exemption under the Bank Holding Company Act they can be purchased by commercial enterprises. Now it has been my impression that the purpose of Gramm-Leach-Bliley was to limit the extent of the mixing of banking and commerce and to draw a line in a specific way, which has been very difficult. At the moment we don’t have that problem with industrial loan companies who are doing reasonably well, but we would have if that amendment came into place and it would significantly alter the intention of Gramm-Leach-Bliley. So it has been our impression that it is not appropriate for the legislation going forward. Mrs. KELLY. I want to make sure that I am clear about this. If an industrial loan company in a State like Utah is given the ability to pay interest on NOW accounts that are held by businesses in the State of Utah, why does the Fed oppose the State’s intent? Mr. GREENSPAN. Why don’t I ask our General Counsel to—why don’t you come up here—give you a legal—make sure he gets it right. This is Virgil Mattingly, our General Counsel. Mrs. KELLY. Excuse me. Sir, would you please just give us your name for the record? Mr. MATTINGLY. My name is Virgil Mattingly. I am General Counsel to the Federal Reserve, and I think the Chairman has accurately answered the question. Right now the only federal restriction on industrial loan companies is on their ability to offer ac- VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 38 counts that function as demand deposits to commercial entities. If they were to be given the authority to offer business NOWs or checking accounts to corporations, they would have all of the powers of an insured bank. In other words, they would be a substitute for an insured bank. Industrial loan companies have an exemption from the Bank Holding Company Act, which means they can be acquired by commercial entities, and several in Utah are owned by commercial entities. And as the Chairman indicated, the mixing of banking and commerce would be inconsistent with the GrammLeach-Bliley Act, which was recently passed by a previous Congress. Mrs. KELLY. Thank you very much. Mr. Greenspan, I was interested in reading your testimony in front of the Senate yesterday, especially the line where you said the ability of economists to assess the effects of tax and spending programs is hindered by an incomplete understanding of the forces influencing the economy. Nice statement. And in light of what Mr. Sanders said, I would like to invite you to come and take a look at what the forces of the economy have done to New York. New York State has not completely recovered from 9/11. I know that you know where my district is. I know you have come to my district. I invite you back so you can take a look and perhaps meet with some of the people. I hope you will answer in the affirmative, but I am not going to put you on the spot and force you to answer that question now. With that I yield the rest of my time and call on Mr. Inslee. Mr. INSLEE. Thank you. Mr. Chairman, I always enjoy your presentation for different reasons than my friend Bernie Sanders, and the reason I enjoy it is because you have been consistent through time and through administrations in reminding us of the importance of fiscal discipline and pointing out the dangers to the United States economy, in jobs, in interest rates of these deficits. And I want to tell you that your continued reminding of us is very consistent with what people are telling me back home. I represent a district just north of Seattle, and I have to tell you what I hear on the streets and in the grocery stores right now. People believe that there is a certain madness that has descended on Washington, D.C., and they are very, very angry, and what they are angry about is that they have seen us work through these deficits during the 1990s that they were continually concerned about, saw us make some progress on that, and now seen us have a $7 trillion swing from projections of surpluses in February to now these big multi-billion dollar deficits, and they are mad about it for three reasons. One, they understand the baby boom phenomenon. They understand this intrinsic gut level belief that we should be saving for the future when the baby boomers retire. Two, they understand what you have said, they like low interest rates and they understand it doesn’t do any good to have big tax cuts or big spending if it results in higher interest rates on their homes and their cars. And three, they are starting to hear about the debt tax. They are starting to hear about the fact that 12 or 14 percent of all the money they pay in income taxes go to service the Federal debt. They don’t like it. They think that is waste, fraud and abuse. So they really appreciate the message you have of fiscal discipline and responsibility. VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 39 But I want to ask, the reason they are angry is they think a madness is descending because others have fallen off the fiscal discipline wagon here, and others have changed their tune. I want to read a quote from John Snow, November 13, 1995. It says a balanced Federal budget is the best choice to ensure a bright future for the Nation’s economy. That was then. Now we hear representatives of the administration, a quote from Mitch Daniels, January this year, said we have returned to an era of deficits, but we ought not to hyperventilate about this issue. If Mr. Daniels was here I would tell him people are breathing hard, not hyperventilating, and they are very angry about this. And I guess the question I have is, is there any economic justification for people who for decades have been telling America that they believe in balanced budgets, for decades telling us we had to have fiscal responsibility, for years been hectoring members of the other political party about this issue, is there any economic reason that has changed those fundamental characteristics of Federal deficits? Mr. GREENSPAN. Congressman, there is a big dispute on the question of the extent to which various different types of tax cuts engender their own revenue increases. The extreme form, as you know, is the argument that if you cut taxes, the level of revenues will not change, and there are certain circumstances in which you can demonstrate that that is the case. That has been broadly generalized in many respects and it is a question of fact. It is not an issue of whether or not one has some ideological view of the way the world works. It is either true or false, and so it is a factual question. And the trouble is that it is difficult to basically corral all of the facts to make definitive cases in which all individuals agree. In recent years, there has been considerable evaluation and thinking on this particular question, and I think a number of people have changed their view or moved from views of the fact that there were no tax programs which could significantly improve revenues. You cut taxes, revenues go down. Some people have revised their views on that issue, and that is the reason you are getting the results that you are getting. Mr. INSLEE. Have you—I hear what you are saying, but I want to make sure I understand. What I understand you are telling the Congress is that whatever you do, if you are going to cut taxes, whatever you are going to do on spending, it is a negative for the U.S. Economy to run long-term Federal deficits? Is that a basic statement that you believe in? Mr. GREENSPAN. That is correct. Mr. INSLEE. And do I hear you saying to us—— Mrs. KELLY. Excuse me, Mr. Inslee, your time is up. Mr. INSLEE. It is a great question for April. Mrs. KELLY. Mr. Kennedy. Mr. KENNEDY. Thank you, Mr. Chairman, in trying to characterize the world that you live in, I think the gentleman from Vermont—an outline, that he lives in a bitterly partisan world and I applaud your patience in enduring that shrill attack. In the world that I have lived in, in my time period prior to coming to Congress here, I was in the common sense job creation world. And as a former chief financial officer, I have had the opportunity to struggle with that and understand and applaud your bringing up the fact VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 40 that the Tax Code really gives too much of an incentive to debt versus equity and also applaud the fact that you acknowledge that removing this double taxation on dividends would give us a better balance that would make our economy more flexible to attack, less likely to have a financial structure of a business, cause layoffs and other things that are harmful to businesses. So I acknowledge and agree with your statements on that. I would also like to say, though, as a former chief financial officer and a CPA that has lived in this job creating world, I also agree with what you are saying on accrual accounting. We in government don’t allow major businesses to practice cash accounting. We require them to do accrual accounting. We don’t allow any businesses to intermingle their pension funds with their operating businesses like we have done for years. And as you outlined very well in your testimony, the need to look at our world on an accrual basis, my first question to you is what can we do? Who would we ask to do what to get to more of an accrual view of the world? Mr. GREENSPAN. Since the Congressional Budget Office is a creature of the Congress, you could request of them that they develop effective accrual accounting systems. As I say in my prepared remarks, on the outlay side we are pretty much there. We do know the accrued benefits for Social Security and I think probably can calculate it for Medicare and many of the other programs that you related. We have more difficulty on the deferred tax side because what we do know is there is a very large block of retirement accounts out there which become taxable on withdrawal, and hence those are appropriately measurable as deferred assets of the Federal Government. And clearly, if we have changes in the accrued benefits and the accrued revenues, we obviously have constructed an accrual system which in combination with the cash system enables us to understand how various appropriations and authorizations made for eventual spending by the Congress spin out through the cash accounts and how they affect the debt to the public and what the level of contingent debt is, net, to the public over and above the little under $4 trillion in debt to the public which now exists. Mr. KENNEDY. And I strongly agree with our need to do that approach, and you outline the difficulty in forecasting the revenue. Part of that difficulty is a reliance on capital gains tax, which are highly variable depending on which way the market is going. And the reason we face a deficit today is, as you mentioned, the dramatic falloff in evaluation. If we addressed also the capital gains tax, wouldn’t that not only be a very positive thing for our economy but really allow us to have a more predictable and more dependable view of revenues for the long-term future? Mr. GREENSPAN. I am sorry, do what with the capital gains? Mr. KENNEDY. Either reduce it, eliminate it and not to have such a heavy reliance on it in our future revenue streams. Mr. GREENSPAN. I commented many times in the past, Congressman, that I think the capital gains tax is a very poor means of raising revenues. It imposes costs on capital which are far larger than the equity revenue effects, which, in my judgment, are the sole purpose of doing that. I would much prefer that we did not tax capital VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 41 in the way that we did. I think it is counterproductive to aggregate economic growth. Mr. KENNEDY. And my last question is if we looked out into the future and we address these long-term needs to reform and make sure that we have a balance on our long-term entitlement pass, would we see a positive impact in our economy today for addressing those here and now as opposed to letting them fester for another decade? Mr. GREENSPAN. To the extent that the market perceives that those long-term changes were real, are going to happen, then clearly they would be discounted in the prices of securities today. Mr. KENNEDY. Thank you. Mrs. KELLY. Mr. Watt? Mr. WATT. Thank you, Mr. Chairman, for being here. I just have two very quick questions, which hopefully won’t take my full time, and I apologize if they have been asked while I was out of the room. On pages 7 and on the following pages of your written testimony, you spend quite a bit of time talking about some of your concerns about our whole budget process and the way we account, which is a continuation of the discussion you were just having with my colleague. First of all, I just want to be clear, do you have a position on dynamic scoring? And if so, what is it? Mr. GREENSPAN. In principle, Congressman, dynamic scoring is the way in which we should be estimating the impact of revenues and expenditure programs. It is theoretically doable, but it is very difficult to get general agreement on the type of model that is required to estimate the secondary effects over and above so-called static scoring. If we could get the general agreement on how dynamic scoring would be done with respect to various different types of programs, then it would be useful because the Congress would know what the various costs of various programs are in which everyone would agree that those are the data. But as I have testified before, it is very difficult to get a model which everybody agrees is the ideal model, meaning the one in the context of earlier remarks. Abstraction is a very complex reality. Mr. WATT. So if they accepted your model, you would have supported it? If they didn’t accept your model, you probably wouldn’t support that? Mr. GREENSPAN. Congressman, I trust they wouldn’t accept my model because I know how flaky any model is, mine included. I fall back to what I would call a less desirable means of evaluating programs, which is so-called static scoring. I would like to see us be able to develop dynamic scoring. It is conceptually superior as a means of doing it. I just don’t see how we are going to do it, but I hope we can try. Mr. WATT. Second question, on page 14 of your written testimony, you say something that I am having a little trouble understanding. You say, ‘‘So short of a major increase in immigration, economic growth cannot be safely counted upon to eliminate deficits.’’ the reverse of that is will—the implication is a dramatic increase in immigration might have some positive impact on growth. Can you just tell me what you mean by that so I will have a clear understanding of it? VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 42 Mr. GREENSPAN. It is precisely what you just indicated. The level of immigration in this country, which is a third to a half of our increase in households, has been a major factor in the increase in the population, the increase in the labor force, the increase of employment. And aggregate economic output is basically output per person times the number of people, and if you accelerate immigration, you will expand the labor force and increase the GDP, increase aggregate wages and salaries, increase contributions to social insurance, increase individual income tax payments, and in a sense the whole revenue base goes up accordingly. Mr. WATT. Well, I could go on and on with that, but I won’t deal with that. I appreciate it. Those are the two questions that I wanted clarification on. I appreciate your response, and I yield back the balance of my time. Mrs. KELLY. I would remind the people in the committee who are remaining Mr. Greenspan must leave at 1 o’clock, so we are going to try to get everybody in. But you must keep your questions succinct and the answers short. With that, Mr. Shays. Mr. SHAYS. Thank you, Mr. Greenspan. Thank you for being here and thank you for your service to our country. I would like to ask you some questions on derivatives and on the GSEs. For the last several Congresses, we have attempted to pass bankruptcy reform legislation, and included in those efforts were provisions to improve the netting out process of certain financial contracts. Could you please describe your views on these netting provisions and what level of importance would you attach to them? Mr. GREENSPAN. We have had very considerable success in developing a sophisticated financial system in recent years, which has been a major factor in American economic growth. A not insignificant part of that has been derivatives, which in earlier legislation were able to be netted out in a manner in which bankruptcy courts could essentially make a determination of who owed what to whom under various different circumstances. Because of changes that have occurred in recent years, this needs to be addressed again, and it is terribly important that individuals are able to net out various differing derivative obligations owed to them or owed by them in a manner which could facilitate a much less risky bankruptcy procedure. So in my judgment, it is crucially important that the changes that we have been discussing about netting be moved through as expeditiously as possible either tied to the bankruptcy laws or essentially as a free-standing piece of legislation. It is important largely because the ability to net out clarifies a very significant element of uncertainty in who owes what to whom under various different stressful conditions. Mr. SHAYS. Thank you. When you were before the Senate Banking Committee you made reference to GSEs as legally private corporations that should be handled the way private corporations are handled. As you are aware, there is legislation to repeal the GSEs’ exemption from this Nation’s securities laws and subject them to the SEC disclosure standards imposed on every other publicly-traded company. Now I know you can’t endorse legislation, but would you basically say that GSEs should be handled the way private corporations are handled in general? VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 43 Mr. GREENSPAN. Yes, I would. Mr. SHAYS. Just one last question, should there be two-tier treatment for capital gains or would you prefer to just see one-tier treatment; in other words, short-term gain versus long-term gain? Mr. GREENSPAN. It is a complex question. I said previously my view of the capital gains taxes is it is counterproductive. Mr. SHAYS. If we are going to have this counterproductive tax though, would you prefer—— Mr. GREENSPAN. I prefer short-term and long-term gains being separated. Mr. SHAYS. Be separate. Mr. GREENSPAN. Yes. Mr. SHAYS. I yield back the balance of my time. Mrs. KELLY. Mr. Meeks? Mr. MEEKS. Thank you, Madam Chair. Mr. Chairman, let me just follow up on Congressman Watt, because I was also intrigued by the statement on page 14. Conversely, you know, the administration has put into effect the policy to sharply curtail or maybe even to discourage because of protecting our borders, et cetera, immigration. So would you say that by us now curtailing immigration, that that is a factor, whether it be significant or otherwise, in our slowing economy? Mr. GREENSPAN. Well, obviously the less immigration we have, the less employment, the less GDP. And I might say that the fact that so many people are pounding on our doors to get into this country is a very significant vote of confidence in what type of economic society we have created here. And my view is that immigration throughout our history has been a very important part of the dynamism and the growth that we have had in this country. And my view is that limits should be less than they are. Mr. MEEKS. Let me ask another question, and I am going to try to be brief. I hope I can squeeze somebody else in, so I will just have this one question. Right now oil prices are starting to again go through the roof, and they are rising dramatically. And of course concerns about when we go to war with Iraq, it just seems that that is inevitable. The political instability in Venezuela, again, that is driving oil prices crazy. If the war hypothetically were to last, say, a year, how much of an inflationary effect would it have on our economy, and would the Feds see the need to increase the Fed fund rate to fight the inflation? Mr. GREENSPAN. Well, Congressman, it depends very much on what happens both to Venezuela and to Iraqi crude oil production. As you know, the Venezuelan production has been cut to a third. It is rising now, but it is still well below where it was. And both of these countries’ capacity are about three million barrels a day. If there is a substantial shortfall which is not made up by the other Gulf states, for example, Saudi Arabia being the obvious important one, then we are up against problems of making judgments as to how much leeway there is between aggregate capacity worldwide on crude oil production and what consumption is. Fortunately, in the period immediately ahead, worldwide consumption is in the seasonal decline. Starting in April, May, and June, you get a much lower level of oil consumption, which means that if we had a shutdown, its effect on price would be modest. But VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 44 if it went on, as you point out, for a year, it could be troublesome in how it was handled. Mr. MEEKS. I yield back. Ms. KELLY. Thank you. Mr. GREENSPAN. I should say, I find it unlikely. A year under any scenario seems to me far beyond anything I could conceive of. So the more likely scenario is a much shorter one, obviously. Ms. KELLY. Thank you. Mr. Chairman, we are very pleased and we do thank you for your willingness to come here and be with us today. We have run out of time. The Chair notes that some Members may have additional questions, and they may wish to submit those in writing. So without objection, the hearing record will remain open for ten days for Members to submit written questions to these witnesses and to place their responses in the record. Chairman Greenspan, you are excused with the committee’s great thanks and appreciation for your time. And—— Mr. FRANK. I would—— Ms. KELLY. Mr. Frank? Mr. FRANK. Madam Chair, I do note that we do all want to get together and do this again sometime. Ms. KELLY. This hearing is adjourned. [Whereupon, at 1:01 p.m., the committee was adjourned.] VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 APPENDIX February 12, 2003 (45) VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00049 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 46 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00050 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 47 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00051 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 48 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00052 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 49 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00053 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 50 VerDate 11-MAY-2000 12:39 Sep 12, 2003 Jkt 000000 PO 00000 Frm 00054 Fmt 6601 Sfmt 6601 C:\DOCS\89078.TXT HBANK1 PsN: HBANK1 51 VerDate 11-MAY-2000 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@FedFRASER