By Steven K. Beckner
Market News International - Although Federal Reserve Chairman Alan Greenspan did not directly talk about what he and his Fed policymakers will do with interest rates when they meet next week, his comments left the door open to further rate cuts of some size.
Greenspan had little to say directly about the economy in his prepared testimony before the Senate Banking Committee, but it was revealing nonetheless.
The Fed Chairman said the United States is going through a period of weak economic performance and said the "softening economy" has hurt borrowers in the retail, manufacturing and other sectors. He said the California utilities have come under "particular pressure."
As a result, Greenspan said, there has been a "deterioration of loan quality."
Greenspan said weaker loan quality will "require that both bank management and supervisors remain particularly alert to developments." But his comments should not be interpreted as seeking to discourage bank lending. Quite the contrary.
Greenspan sent a message that banks should continue to make loans to deserving borrowers. During the slowdown, he lamented, "new loan applications that earlier would have been judged creditworthy ... are nonetheless rejected, when in retrospect it will doubtless be those loans that would have been the most profitable to the bank."
"Such policies are demonstrably not in the best interest of banks' shareholders or the economy," Greenspan continued. "They lead to an unnecessary degree of cyclical volatility in earnings and, as such, to a reduced long-term capitalized value of the bank."
"More importantly, such policies contribute to increased economic instability."
These comments come against a backdrop of contracting commercial and industrial loans and tightening loan terms and standards, not to mention weaker demand for credit among some firms. Greenspan's comments suggest he sees little relief on the horizon for that important aspect of financial conditions.
That, in turn, would seem to imply a fairly gloomy outlook for any near-term revival of business expansion.
The Fed can cut rates and improve banks' margins, but if the banks don't (or can't) lend, those infamous "lags" with which monetary policy impacts the economy can be "long and variable" indeed.
Dovetailing with those comments was what Greenspan had to say about inflation in answers to questions following his formal presentation. In responding to a question on that subject, he revealed much more about his assessment of economic conditions than about inflation pressures.
As always, Greenspan gave the committee his requisite reassurance that "we have to be very careful about any evidences of emerging inflationary instability" and added "we certainly hope to be able to see sufficiently far in advance to fend of any emergence of inflationary forces." But for now, he said, core inflation, as measured by the personal consumption expenditures deflator, excluding food and energy, has been "relatively stable," he said.
Greenspan's more important point was that neither rising labor nor energy costs are being passed through to the prices consumers pay "in any material way." Rather, higher costs are "squeezing profit margins."
Although he did not say so Wednesday, in the recent past, Greenspan has expressed concern that squeezed profits are discouraging business investment spending.
Consumer spending has also been a big Fed concern, and Greenspan said lay-offs are bound to weaken consumers' confidence and potentially, their spending.
In an exchange with Sen. Charles Schumer (D-NY), Greenspan observed that "the issue of lay-offs has got to be a factor in determining the propensity of people to spend money ... ." He observed that "we've had a significant pickup in initial claims" and added that mounting lay-offs are "doubtless impacting to a certain extent on consumer confidence."
So far, he said actual "consumer expenditures have held their own" but when Schumer said continued lay-offs will begin to discourage spending, Greenspan agreed. "That's been our history, Senator, and I think that it is clearly an issue which ... we at the Federal Reserve watch very closely," he replied.
Greenspan made clear he was quite concerned about the upward trend in jobless claims. Though down in the latest week, the 4-week moving average of claims rose to its highest level since August 1992 at 424,500. Referencing those numbers, Greenspan said "the rate of layoffs has gone up."
And when Schumer asked whether "we ought to start worrying a little more about" the upward trend in lay-offs and its potential impact on consumer spending than a few months ago, Greenspan told him, "I agree with that, that's a correct view."
That's as close as you'll get to a rate cutting signal as you'll usually get from the Fed Chairman this close to an FOMC meeting, and it could be read as a 50-basis-point signal.
In a May 31 "Insight," Market News International reported that there were conditions under which the Fed might cut the federal funds rate by 50 basis points for the sixth time this year. Since then, various Fed officials have voiced a preference for a more incremental 25 basis point cut, but arguably the economic and financial conditions to override that preference have been realized.