Briefing.com At The Jackson Hole Fed Conference
30-Aug-99 06:00 ET
Media coverage of the markets is pathetic. That's where this story begins. On Friday,
Greenspan spoke in Jackson Hole, Wyoming. Invoking local's privilege, I attended that
speech. And I can tell you that what went on at the Fed conference bears absolutely no
resemblance to what was reported by business media on Friday. Here's a look at how
the media went wrong and at what Greenspan really said.
The Media Misses The Point
The failing of the media was the result of an all too typical reaction to news. Here's
where it starts: a handful of reporters have access to the Greenspan speech before it is
released. In the time that precedes the official release time of the speech to the public,
these reporters must read the speech and determine the crucial excerpts that warrant
headlines.
The problem is that reporters' incentives do not favor accurate reporting; they favor
reporting that has the greatest potential to move markets. If your newswire moves
markets, it's a must-have. If it doesn't, it isn't. That helps to explain the misleading
Greenspan headlines seen on Friday.
The rest of the day followed the usual pattern for the media. Once the markets react
negatively to the headlines, it becomes a game similar to telephone, in which a bunch of
reporters who have never laid an eye on the actual speech compete to see how far they
can veer from the truth. CNBC reported at day's end that Greenspan said that equity
prices were "inexplicable," a word that didn't even appear in the speech.
And finally, there was Alan Abelson, who must have quickly skimmed the speech
before deciding to claim that Greenspan "indicated that even earnings have been hoked
up, in some instances by capitalizing expenses." Had he been paying attention, Abelson
might have noticed that Greenspan actually argued that earnings have been understated
because many capital outlays have been expensed -- precisely the opposite of what
Abelson claimed. But then Abelson's been wrong for a decade, why change now?
What Really Went Down
Enough media diatribe; suffice it to say that you should always read these speeches for
yourself if you want the truth. Let's move on to that truth, as it wasn't something that was
discussed on Friday. The first point that must be made is that the decision to talk about
asset prices was not Greenspan's, it was the subject of the conference and it only made
sense that in his introductory remarks he would address this issue.
Greenspan's speech starts with the obvious: since asset holdings have risen relative to
income, asset prices are more important to the economy than in the past and the Fed
should therefore increase its effort to understand them. With this obvious point made,
Greenspan attempts to explain the reason for current equity market valuations.
In his analysis, the Chairman focussed first on the difficulty in defining corporate profits
and later on the risk factors that determine how people discount future outcomes.
Profits Over or Understated?
Let's start with corporate profits, which is where many reporters such as Alan Abelson
clearly became confused. Greenspan argued that there several factors that led to both
understatements and overstatements of profits. Leading the list of factors that led to
understatement was the treatment of many capital outlays as expenses. His primary
example was software, which most companies have considered an expense even though
it clearly has long term benefits and is more appropriately considered a capital outlay.
Greenspan noted that in an increasingly idea-based economy, the problem of expensing
capital outlays was growing quite large, and corporate profits have therefore been
significantly understated.
On the side of profit overstatement, Greenspan noted the increasing use of stock
options as a means of compensation. While not complaining about using stock options
for this purpose, he did note that options were not properly accounted for, and that this
factor has overstated profits by 1 to 2 percentage points per year over the past few
years.
After reviewing the factors suggesting understatement and overstatement of corporate
profits, Greenspan concludes that "it is reasonable to surmise that undercapitalized
expenses have been rising sufficiently faster than reported earnings to have more than
offset the factors that have temporarily augmented reported earnings." That's a pretty
clear statement, but apparently Abelson was too busy playing with his thesaurus to read
that far.
More To It Than Profits
Even though profits probably have been understated in recent years, Greenspan
concluded that this understatement cannot, by itself, explain the entire rise in equity
market valuation. The rest of the increase reflects changes in perceived risk. These
changes can be rational responses to longer business cycles created by better inventory
management, or an increased confidence in long term price stability, or they can be
irrational -- the herd mentality that has created many past asset price bubbles.
There is no question that Greenspan allows for the possibility that current equity market
valuations are irrational and that if they are, the bubble will someday pop. For the
market, there are only two questions: first, is Greenspan right, and second, will he do
anything about it?
The first question has been asked since December 1996, when Greenspan first raised
the issue of irrational exuberance. That equity prices have been rising ever since
indicates that investors, rightly or wrongly, continue to bet against Greenspan. There
was no new information presented in the Jackson Hole speech to suggest that the
market is wrong and Greenspan is right (in fact, the understatement of corporate profits
that Greenspan mentioned is a new argument which favors the market).
The Fed Does Not Pop Bubbles
The second question is easy: Greenspan will not make any attempt to drive down asset
prices. There was a clear theme running through the first two panels of the conference:
virtually everyone in attendance thought it was obvious that central banks could not
determine if an equity market rally was a bubble, and even if they could it wasn't clear
that anything should be done about it. Panel member Rudi Dornbusch began his speech
by suggesting that the question before the panel was whether or not the Fed should
target lower equity prices, and specifically lower prices for Internet stocks. His remark
drew laughter from everyone including Greenspan precisely because it was accepted
that targeting equity prices was ludicrous.
We'll conclude by noting that Greenspan himself made it abundantly clear that the Fed
would not act to rein in equities. At the end of the second panel, Greenspan rose from
the audience to respond to a point made by the IMF's Michael Mussa, who questioned
whether it made sense for the Fed to respond only to crashes in stock prices and not to
extraordinary increases. Greenspan responded by noting that it was not the direction of
stock prices that determined whether the Fed would act, it was the speed of the change
in prices.
Greenspan argued that the Fed does not react to rising equity prices because prices
never rise with the violence that they fall, and if they ever did the Fed probably would
react. It was the markets that were asymmetric with regard to sharp price movements,
not the Fed that was asymmetric in reacting to them, according to Greenspan. Implicit in
this remark was the fact that the Fed does not react to rising equity prices.
Preposterous
The Fed of course will react to changes in the real economy which might well be
precipitated by changes in stock prices, but Greenspan made it clear that the Fed would
not react directly to stock prices. That's not the message you heard from the media on
Friday, but then few in the media even took the time to read the speech. I was there, I
heard it, I read it. And I can tell you that central bankers treat the proposition that they
should attempt to rein in stock prices as preposterous. |
