Alan Greenspan, Henry Paulson on the Economy

Federal Reserve Chairman Alan Greenspan. Courtesy WashingtonSpeakers.com

By Ken Holman
Overland Group

Meet the Press Moderator David Gregory met with former Federal Reserve Chairman Alan Greenspan and former Treasury Secretary Henry Paulson to discuss unemployment, housing, the economy and deficit spending.

On Friday, the New York Times had the headline, “Jobless Rate Falls to 9.7 percent, Giving Hope Worst Is Over.” Gregory asked Greenspan, “Does this jobs report signal a turnaround?”

Greenspan stated that the reduction in unemployment did not signal a turnaround, since the turnaround occurred last summer. It did signal that the economy is moving, but not in an “aggressive manner.”

Greenspan said the recession is over, bottoming back in the middle of last year. While it doesn’t have strong momentum, the fourth quarter was robust due to inventory buildup, he said.

“We shot all of our ammunition (in the fourth quarter) so it’s going to be a slow, trudging thing,” Greenspan said.

The issue is innovation, according to Greenspan.

“Innovation, by definition, is not forecastable. So we don’t know where the jobs are coming from,” Greenspan said. “We don’t know how this market is exactly in terms of dynamics ... But we know this process is underway and have every reason to believe it will continue.”

Greenspan suggested that unemployment rates would hover at the 9 to 10 percent for a good part of the rest of the year. Although unemployment will spike downward as temporary census workers are hired this summer.

Nearly 8.4 million jobs have been lost since December 2007. Paulson said that although the economy is clearly recovering, jobs will not return until there is certainty in the fiscal and financial regulatory form action in Washington.

“I think we have to start with the focus of economic activity. Jobs are created by having something to do. You can’t create jobs before economic activity occurs, therefore we could argue that what would be most effective is cutting taxes on small business,” Greenspan said. “Small business is the big creator of jobs, but they won’t hire anybody if they don’t have any business. So you have to act in a manner that creates the types of economic activity which drives ever-increasing demand for labor.”

Paulson thinks the focus should be on temporary incentives for businesses to hire. A stable economy and recovering markets will bring confidence to small business owners. And hiring will begin.

A New York Times article, “No Aid or Rebound in Sight, More Homeowners Just Walk Away,” was quoted by Gregory during Sunday’s Meet the Press.

“The number of Americans who owed more than their homes were worth was virtually nil when the real estate collapse began in mid-2006, but by the third quarter of 2009, as estimated 4.5 million homeowners had reached the critical threshold, with their home’s value dropping below 75 percent of the mortgage balance,” the article stated.

“‘We’re now at the point of maximum vulnerability,’ said Sam Khater, a senior economist with First American CoreLogic, the firm that conducted the recent research. ‘People’s emotional attachment to their property is melting into the air,’” the New York Times article continued.

Greenspan and Paulson said many of the experts didn’t see the housing crisis coming. Housing prices and mortgages have generally been deemed to be safe investments. So the recent declines in housing prices really destroy wealth across the country.

When homes are worth less than mortgages, behaviors tend to change. Before the housing crisis, everyone that had a mortgage would generally claw, fight or do whatever it took to make the mortgage payment and avoid default. This is no longer the case.

“I am very much concerned if home prices decline from here. I don’t think they are going to. They seem to be bottoming out,” Greenspan said. “During 2005 and 2006, there were 8 million home purchases with the conventional 20 percent down payment. That down payment is now gone.

“We have this very large block of homeowners who are tilting down into that underwater territory. Fortunately, the evidence suggests that the vast majority of these types of homeowners with conventional home mortgages do continue to pay even though the value of the home is below the market price [mortgage balance].”

The result would be a large block of homes thrown on the market as people start foreclose on their homes.

In regard to deficit reduction, Paulson said, “The deficit,” which is expected to be $1.56 trillion in 2010, “is the most serious challenge that we as a nation face. All these other economic issues are minor compared to that. It is a generational issue. There is no way we are going to deal with the deficit without reforming the entitlement programs, i.e., Medicare, Medicaid, and Social Security. ... It is very difficult to get Congress to act on anything this big and difficult and controversial if there is not an immediate crisis.”
Greenspan suggested that the United States cannot remain the world’s biggest power as long as it is also the world’s biggest borrower.

“Not indefinitely. There is no doubt that if the United States continues down this road we are going to find that our ability to borrow is going to get restrained,” Greenspan said.

“We have, throughout our history, always maintained a capital cushion between our capacity to borrow on the one hand and our level of debt on the other,” Greenspan continued. “That is beginning to shrink.

“If we get to the point where we are having difficulty selling our Treasury security issues, then interest rates begin to move and our ability to move internationally to be the major currency, the major economy, the major economic power in the world is significantly diminished. History tells us that great powers, when they have gotten into very significant fiscal problems, have ceased to be great powers.”

Paulson and Greenspan agreed that taxes would have to go up and spending would have to be reduced for the deficit to come down. Paulson, however, did not advocate eliminating the Bush tax cuts. He said the elimination of the Bush tax cuts, which are slated to expire at the end of this fiscal year, would result in a harmful tax increase.

Congress, on the other hand, appears to want to continue to bury their proverbial head in the sand when it comes to resolving these tough issues.

Greenspan said he was disappointed in the Senate’s approach at resolving these issues. They agreed to form a commission to look into these matters, but then voted 97 to nothing to exclude social security reforms from the deliberations.

Greenspan said that we have gotten to the point where spending is untouchable.

“I have no doubt that we are going to have to raise taxes to close this huge deficit. But we cannot do it wholly on the tax side.”