Jeff,
"He was sending information to the big boys"????
Oh really?
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. |
