March 16, 2004
Greenspan Shifts View on Deficits
WASHINGTON, March 15 — Consumer debt is hitting record levels. The federal budget deficit is yawning ever larger. The trade gap? Don't even ask.
Many mainstream economists are worried about these trends, but Alan Greenspan, arguably the most powerful and influential economist in the land, is not as concerned.
In speeches and testimony, Mr. Greenspan, chairman of the Federal Reserve Board, is piecing together a theory about debt that departs from traditional views and even from fears he has himself expressed in the past.
In the 1990's, Mr. Greenspan implored President Bill Clinton to lower the budget deficit and tacitly condoned tax increases in doing so. Today, with the deficit heading toward a record of $500 billion, he warns more emphatically about the risks of raising taxes than about shortfalls over the next few years.
On Monday, the nonpartisan Congressional Budget Office published new calculations showing that the budget deficit now stems almost entirely from tax cuts and spending increases rather than from lingering effects of the economic slowdown.
Mr. Greenspan's thesis, which is not accepted by all traditional economists, is that increases in personal wealth and the growing sophistication of financial markets have allowed Americans — individually and as a nation — to borrow much more today than might have seemed manageable 20 years ago.
This view is good news for
Adjusted for inflation, the average family's debt, including a mortgage, has climbed from $54,000 in 1990 to $79,000 last year. Mortgage foreclosures, credit card delinquencies and personal bankruptcies are all at near record levels.
Mr. Greenspan's view is that household balance sheets are "in good shape," and perhaps stronger than ever, because the value of people's homes and stock portfolios have risen faster than their debts.
The Fed chairman is equally sanguine about the nation's overall borrowing from foreigners, which has soared to more than $500 billion a year and has contributed to a sharp drop in the value of the dollar. And he has also made it clear he will not try to torpedo the president's tax-cutting agenda, which could add another $2 trillion to federal borrowing over the next decade.
"History suggests that the odds are favorable that current imbalances will be defused with little disruption," he declared in a speech two weeks ago.
But a growing number of experts are worried that Mr. Greenspan is too casual. Though most economists agree that American's indebtedness is not a problem at the moment, many worry that the country has become too dependent on extraordinarily low interest rates that will inevitably creep higher in years to come.
"The fear I have is that the world is leveraged on low-interest borrowing," said Allen Sinai, chief executive of Decision Economics, an economic forecasting firm. "It's like a drug, and you get hooked on it."
According to the Federal Reserve's most recent data, household wealth bounced back after the economic slowdown and hit a record at the end of 2003.
But the main reason for that new wealth has been rising prices for real estate and stock, and those prices have climbed in large measure because interest rates are at their lowest level in more than 40 years.
If inflation rises and the Fed feels forced to raise interest rates, many economists worry that monthly debt burdens would rise at the very moment that housing prices start to decline.
"The day of reckoning is not now, but maybe five years from now," said James W. Paulsen, chief investment strategist at Wells Capital Management. "To go down Greenspan's route is like saying there is a free lunch. The fallacy is that net worth has gone up because debt went up. And that doesn't give me a good feeling."
Other analysts have begun to dispute Mr. Greenspan's benign view of rising household debt. Mark Zandi, economist at Economy.com, said many other indicators suggest that financial stress has risen significantly in the last two years.
Mortgage foreclosure rates, personal bankruptcies and credit card delinquencies have been rising steadily and are at record levels. Most of that stress has taken place in lower-income families, which is why it has not made a big impact on aggregate data about national wealth.
"These people who have heavy debt don't have stable incomes," Mr. Zandi said. "They're the ones who are getting pummeled by the loss of call-center jobs. These are the folks who rely on two incomes, the ones who don't have any assets."
Though Mr. Greenspan has not articulated a sweeping new view, his public comments on particular topics provide a mosaic of his thinking and suggest that he is groping toward his next big idea.
Mr. Greenspan's last big idea came 10 years ago, when he correctly perceived that American productivity was growing much faster than official statistics suggested and that the country could grow much more rapidly without inflation than most experts believed at the time.
But after having reduced the federal funds rate on overnight loans to just 1 percent, the lowest level in 46 years, Mr. Greenspan has presided over an explosion in home buying, mortgage refinancing and consumer spending fed by cheap money.
Mortgage debt soared by more than one-third from $4.9 trillion in 2000 to $6.8 trillion in 2003. And though many people borrowed against their houses to pay down more expensive debt from credit cards, nonmortgage consumer credit climbed by $300 billion, or about 15 percent.
In a Feb. 23 speech to the Credit Union National Association, Mr. Greenspan made it clear that consumer borrowing cannot keep that pace indefinitely. But he said the rise in debt had been matched by a rise in real estate values and stock portfolios.
"The surge in mortgage refinancings likely improved rather than worsened the financial condition of the average homeowner," he said. Though bankruptcy rates had climbed sharply, he continued, these were "not a reliable measure" of household financial health.
Mr. Greenspan went on to note that household debt burdens had been rising for the last half-century as banks and other lenders extended credit to wider segments of the population.
That leads to Mr. Greenspan's broader idea: that financial institutions have steadily expanded credit by developing complex new instruments like credit swaps to hedge their risks.
Back in June 2001, the Fed chairman praised the use of new risk-scoring techniques to expand "subprime" lending to people with poor credit histories.
"Such lending is favorable both to borrowers and lenders," he said in a speech to bankers that year. People with poor credit gained access to loans that would otherwise be unavailable, he said, while lenders obtained "the opportunity for higher returns."
In numerous speeches, Mr. Greenspan has argued that advanced new hedging techniques helped financial institutions survive huge loan losses to telecommunications companies after the stock market bubble collapsed.
Telecommunications companies raised $1 trillion between 1998 and 2001, only to lose hundreds of billions when technology spending collapsed.
"Unlike in previous periods of large financial distress, no major financial institution defaulted," Mr. Greenspan told a conference sponsored by the British Treasury in January. Novel tools for hedging risk, he concluded, had created a "far more flexible, efficient, and hence resilient financial system than existed just a quarter-century ago."
Mr. Greenspan has voiced similar thoughts about the United States' huge current account deficit, which reached a record $541 billion in 2003.
Like many economists, Mr. Greenspan has described the deficit as unsustainably high and said it would have to come down. The most common way for that to happen is for the dollar to drop in value, which would make imports more expensive and exports cheaper.
But he has also suggested that the country may be able to borrow more because investors have become far less wedded to their home countries. This declining "home bias," Mr. Greenspan said in a speech this month, "has enabled the United States to incur and finance a much larger current account deficit than would have been feasible in earlier decades."
Many economists say Mr. Greenspan is correct about basic changes in the world.
"There is really nothing unusual in what he is saying, and I happen to agree with him," said Janet L. Yellin, a former Fed governor who teaches economics at the University of California at Berkeley.
But others say they are increasingly uneasy. If foreign lenders lose their appetite for American securities, the dollar will fall and interest rates are likely to rise. If interest rates rise, and Fed officials have made it clear today's rates are unsustainably low, household debt payments are likely to rise and real estate values could decline.
"It really strains the imagination to believe that household balances are in that great shape," said David Rosenberg, a senior economist at Merrill Lynch. "If you look at debt on a cash-flow basis, servicing the debt is not a great problem. But under a different interest rate scenario, the servicing costs become less manageable."
But J. Bradford DeLong, a longtime Fed watcher at the University of California at Berkeley, cautioned that Mr. Greenspan had been right at times when many others were wrong.
"I think he's wrong, but he's got a better track record than I have," Mr. DeLong said.
Correction: March 17, 2004, Wednesday
A front-page headline yesterday about the views of Alan Greenspan, the Federal Reserve chairman, on debt levels in the United States characterized his position on budget deficits incorrectly. While Mr. Greenspan has urged Congress to avoid tax increases as a way of reducing such shortfalls, he continues to oppose budget deficits. He has not shifted his view.