Last week I wrote about how Greenspan mischaracterized mortgage debt to create the false impression that the U.S. economy is well prepared to withstand rising interest rates. An article in today’s Financial Times supports my criticism by reporting that over 80% of sub-prime mortgages use floating-rates, the majority of which are extremely short maturities. However, in that critique, I let pass similar Greenspan misstatements concerning corporate balance sheets.
In his prepared congressional testimony, Greenspan stated that with respect to business debt, “The protracted period of low interest rates has facilitated a restructuring of business balance sheets. Businesses have been able to fund longer-term debt at highly favorable interest rates and, by extending the maturity of their liabilities, have rendered net earnings and capital values less exposed to destabilizing interest.” He further stated, “Lastly, very large fractions of the total outstanding obligations of businesses are long-term, fixed-rate debt. As a result, rising market interest rates will not have much immediate direct effect on business burdens.”
Today, an article in The Wall Street Journal reveals that corporate issuance of floating rate debt has for the first time surpassed the issuance of fixed-rate debt, and estimates about half of all the outstanding U.S. corporate debt to be floating-rate. Incredibly, though this article completely contradicts Greenspan, it makes no mention of Greenspan himself, or his testimony, proving that no matter how much Greenspan lies, the mainstream press will look the other way, even when reporting evidence which directly contradicts him.
To believe that Greenspan was unaware of this data is absurd. Therefore, there is no conclusion other than that he deliberately mischaracterized the financial vulnerability of corporate America, as he did with respect to households and their mortgage debt. These deliberate misstatements, together with his rather suspicious omission of the Federal Government’s complete dependence on short-term financing of the national debt, clearly reveal that Greenspan’s testimony was one of calculated deception.
Rather than having used this period of artificially low interest rates to improve their balance sheets as Greenspan falsely testified, businesses, households, and government have instead squandered that opportunity, choosing short-term expedience over long-term responsibility. Collectively, all three have indulged the present at the expense of the future.
For corporations, heavy utilization of floating-rate debt has enabled current earnings to be higher than would have been the case had their borrowings been funded by fixed-rate debt. Of course, higher current earnings are at the expense of lower future earnings. When interest rates move higher, those businesses will be deprived of the long-term benefit of fixed-rate debt. Also, lower current interest expense frees up current cash flow, financing greater capital spending than would otherwise have been possible. Again, these benefits are only temporary, and will be more than offset by reduced future capital expenditures. Finally, this temporary reduction in interest expense has artificially boosted corporate earnings and therefore stock prices. Higher stock prices, through the wealth effect, and increased capital spending, have provided an ephemeral boost to the economy. Rising interest rates will ultimately cause these causalities to work in reverse.
Households have relied on ARM’s to temporarily lower their mortgage payments, freeing up income to fund other discretionary purchases, which has provided a transitory boost to the economy. Also, the proliferation of ARM’s, which have kept housing “affordable,” has been one of the chief enablers of rising housing prices and the home equity extractions such price increases collateralize. These extractions, and the wealth-effect of higher housing equity, have also provided props to the U.S. economy which will ultimately topple under the weight of higher interest rates.
The Federal Government benefits dramatically from its reliance on short-term debt, because it temporarily reduces the cost of servicing the national debt. These lower interest payments make the current budget deficit appear smaller. However, the current savings comes at the expense of higher future deficits, as interest rates ultimately rise. Artificially suppressing the current budget deficit has allowed government non-interest spending to be higher, and taxes to be lower, than would have otherwise been the case, which have also acted as temporary props to the U.S. economy.
The facts that all segments of the U.S. economy are now addicted to low interest rates, and that the economy itself is completely vulnerable to higher interest rates, should be uncontestable. It is this very vulnerability that is the real explanation for Greenspan’s having kept interest rates so low for so long, and is the only reason for his current measured pace in raising them. However, because Greenspan does not want to officially admit the obvious, he continues to hide his true motivations. He is proving the old adage that if one repeats a lie loud enough and often enough, eventually people will believe it. However, eventually Greenspan will become so entangled in his own web of lies, he will have no choice but to speak the truth. Unfortunately, such a personally epiphany will come too late for the millions of Americans who put their trust in his rhetoric, and their life savings in U.S. currency.
Since there is no way to avoid the inevitable, Greenspan’s only policy tools now are deceit, and to delay the credit crunch for as long as possible. But since this technique only succeeds at the expense of exacerbating the problems, one wonders about his true motivation. Is this pure politics, with Greenspan’s goal the re-election of George Bush? Such a tactic would call into question the very legitimacy of the Fed itself, which at its very essence is supposed to be independent of political influence. Or is it simply a game Greenspan is playing for himself? Perhaps he is trying to set his own personal record, such as “Biggest financial bubble blown by a central banker,” or simply his wanting to see just how long he can keep the con going? Or perhaps his ego is so great that he believes he can keep it going indefinitely simply by the power of his own will. Whatever game Greenspan is truly playing, one thing is clear, the whole world, particularly America, and especially Greenspan himself, will be the losers.