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Federal Reserve's First Monetary Policy Report, Hearing Before The FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 1991 HEARINGS BEFORE THE COMMITTEE ON BANKING, HOUSING, AND UEBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED SECOND CONGRESS FIRST SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978 AND THE CONDITION OF THE BANKING INDUSTRY AND ITS BROADER ECONOMIC IMPLICATIONS FEBRUARY 20 AND 21, 1991 Printed for the use of the Committee on Banking, Housing, and Urban Affairs U.S. GOVERNMENT PRINTING OFFICE WASHINGTON : 1991 For sale by the Superintendent of Documents, Congressional Sales Office U.S. Government Printing Office, Washington, DC 20402 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS DONALD W. BIEGLE, JR., Michigan, Chairman ALAN CRANSTON, California JAKE GARN, Utah PAUL S. SARBANES, Maryland JOHN HEINZ, Pennsylvania CHRISTOPHER J. DODD, Connecticut ALFONSE M. D'AMATO, New York ALAN J. DIXON, Illinois PHIL GRAMM, Texas JIM SASSER, Tennessee CHRISTOPHER S. BOND, Missouri TERRY SANFORD, North Carolina CONNIE MACK, Florida RICHARD C. SHELBY, Alabama WILLIAM V. ROTH, JR., Delaware BOB GRAHAM, Florida PETE V. DOMENICI, New Mexico TIMOTHY E. WTRTH, Colorado NANCY LANDON KASSEBAUM, Kansas JOHN F. KERRY, Massachusetts RICHARD H. BRYAN, Nevada STEVEN B- HARRIS, Staff Director and Chief Counsel W. LAMAR SMITH, Republican Staff Director and Economist PATRICK J. LAWLER, Chief Economist (ID Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS WEDNESDAY, FEBRUARY 20, 1991 Page Opening statement of Chairman Riegle 1 Opening statements of: Senator Garn 2 Senator Dixon 4 Senator D'Amato 4 Senator Heinz 6 Senator Gramm 9 Senator Mack 10 Senator Sanford 10 Senator Roth 12 Senator Graham 37 WITNESS Alan Greenspan, Chairman, Board of Governors, Federal Reserve System, Washington, DC 12 Prepared statement 18 Economic and monetary policy developments in 1990 and early 1991... 20 The behavior of money and credit in 1990 and early 1991 25 Economic prospects in 1991 and monetary policy plans and objectives. 28 Risks to the economic outlook 31 Regulatory initiatives 33 Response to written questions of: Senator Riegle 69 Additional response to questions during the hearing 79 Senator Sanford 84 Witness discussion: Lowering of interest rates 38 Flexibility to change when appropriate 39 Comprehensive banking legislation 39 Loan availability 41 Capital gains tax 43 Public and private debt 47 Fed is constantly confronted with new issues 49 Possible changes to restore depressed real estate market 51 GATT negotiations 51 Impact of war on the economy 52 Bottoming out of the economy 55 Impact of real estate downturn and the recession 58 Fed slow to respond to potential recession 59 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Wall Street Journal, Feb. 8, 1991, article entitled "There Is No Credit Crunch" by Allan H. Meltzer THURSDAY, FEBRUARY 21, 1991 Opening statement of Chairman Riegle 91 Opening statements of: Senator Garn 92 Senator D'Amato 106 Senator Sasser 130 (in) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis IV WITNESSES Page Carole S. Berger, senior vice president, C.J. Lawrence, Inc., New York, NY 93 Prepared statement it 98 Summary and conclusion 98 Credit cycle 99 Real estate 100 Commercial credit cycle 101 Consumer credit cycle 103 Longer-term outlook 103 Response to written questions of Senator Riegle 152 William Weiant, managing director, the First Boston Corp., Boston, MA 109 Prepared statement 115 Factors leading to current problem 115 Condition of banking industry today 115 Response to written questions of Senator Riegle 179 James Grant, editor, Grant's Interest Rate Observer, New York, NY 117 Prepared statement 120 Panel discussion: Too-big-to-fail 123 Role of banks in their intermediary function 125 Getting our priorities in order 128 Banks of the future and Federal deposit insurance 131 Banking charter 132 Cost savings for multistate financial institutions 135 Can Congress help restore the real estate market? 136 Money leaving the banking system 136 Severe recession and bank failures 138 Competing internationally 142 Consortium of United States banks 144 Asset allocation 146 Economic system laden with debt 148 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 1991 WEDNESDAY, FEBRUARY 20, 1991 U.S. SENATE, COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, Washington, DC. The committee met, pursuant to notice, at 10:03 a.m., in room SD-538 of the Senate Dirksen Office Building, Senator Donald W. Riegle, Jr. (chairman of the committee) presiding. OPENING STATEMENT OF CHAIRMAN RIEGLE The CHAIRMAN. The committee will come to order. Let me welcome all those in attendance this morning. We're pleased to welcome, in particularly the Chairman of the Federal Reserve Board, Alan Greenspan, before the committee today. He is here to testify on the Fed's semiannual report on monetary policy which was released this morning. In analyzing that report and looking at the economic situation generally, there are a number of very difficult and important prob- lems that face us today and affect monetary policy. Certainly, the economy has gone into a tailspin since the last report that was made here under these same circumstances. We're now in the midst of a recession in which such indicators as housing starts and auto sales have already fallen to levels that approximate those of the 1982 recession. And this very morning, data has come out that show that housing starts have fallen another 13 percent to a rate a little better than half of that of a year ago. Commercial real estate markets are in very tough circumstances, as was testified to by members of the RTC just within the last 2 weeks and, of course, Chairman Greenspan was here as part of that Board. Now in response, the Fed has cut bank reserve requirements and has lowered its key interest rate target by 2 percentage points since last summer. But the decline in interest rates the banks actu- ally charge their customers has been much smaller. And in fact, banks' willingness to lend even at those rates has diminished be- cause of capital and other regulatory concerns affecting the bank- ing system. How one measures this credit crunch and how we go about ad- justing the monetary policy to account for it are matters that we have discussed before. This committee appreciates the difficulty of understanding precisely what may be in that mix of circumstance that the Fed is endeavoring to evaluate and respond to. (1) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis In addition to that, of course there are the uncertainties attach- ing to the war in the Persian Gulf and how that may be affecting spending decisions by households and companies. I think this recession is also unique with regard to the enormous debt burdens that are carried by consumers and businesses. Many have speculated that we should expect an unusual number of bank- ruptcies in this recession and, in fact, there is news this morning in The Washington Post of just the bankruptcy patterns here in the metropolitan area and the fact that they're up quite substantially, as they are in a number of areas across the country. This committee is also very much concerned about pressures that have accumulated within the banking system and the fact that the pressures there clearly appear to be contributing to the credit crunch, and that, in turn, makes the economy less able to respond to the recession even when interest rates are lowered. Now, with respect to the issue of inflation, we have not heard a lot of talk about inflation because the focus has been on other prob- lems, particularly the recession and the war. But it's important to note that inflation last year was the highest that we have seen in 8 years, even abstracting from the recent rise in energy prices. This morning's data indicates that the core CPI Consumer Price Index, excluding food and energy which tend to be more volatile, was up 8/10ths of 1 percent. Now that's a single month's data and you can't hang your hat entirely on 1 month's data. But it does seem to indicate, based on the inflationary pressure that we've al- ready seen for last year, that there are pressures there that are a matter of concern. Finally, there are two things most on my mind that I hope the Chairman will respond to today. First, in light of these kinds of fac- tors and elements that are in the economic puzzle at the present time, how much monetary policy latitude does the Fed have? How much latitude is there to change interest rates to really be able to interdict the path of the economy in a material way? Said another way—how much can we expect the Fed by itself, through adjustments in monetary policy, to somehow create a won- derfully better outcome in the economy that we would all like to see? The second thing that I hope you'll comment on directly is that while you have lowered the Federal funds rate and attempted in other ways to ease credit for banks, the prime rate has really not come down very much. I think it ought to have come down more, but that's a personal opinion. The prime rate has fallen only to 9 percent. I think we need to understand better why it is that we're not seeing a corresponding reduction in interest rates offered by banks in response to lower borrowing rates that the Fed has provided to the banking system, presumably to help bring consumer rates down to a lower level that could help lift the economy.
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