Since Henry was quoting me from over on pkt
I might as well follow up on this. First of all, I have
heard nobody claim that Laurence Meyer is a fan
of the Taylor Rule. As near as I can tell, its biggest
fan on the Board is Edward Gramlich who gave a
talk to the Eastern Economic Association about
two years ago praising it to the skies (appeared
as a paper in the Eastern Economic Journal in
early 1999). Meyer is well known as the leading
hardliner on the Board despite being a Clinton
appointee. Just goes to show that the FRB can
be like the Supreme Court in that regard.
Also, I hear from my sources at the FRB that
indeed in recent years Greenspan has actually
been a leading "dove" on the FRB, especially
in contrast to Meyer and some of the Reserve
Bank presidents, especially Jerry Jordan of the
Cleveland Fed and Al Broaddus of the Richmond
Fed. If anything, the Taylor Rule probably looks
like the de facto middle road between the doves
led by Greenspan (who refuses to openly follow
the Taylor Rule) and the hawks led by Meyer,
Jordan, and Broaddus.
Barkley Rosser
-----Original Message-----
From: Yoshie Furuhashi <[EMAIL PROTECTED]>
To: [EMAIL PROTECTED] <[EMAIL PROTECTED]>
Date: Friday, November 24, 2000 11:51 PM
Subject: [PEN-L:4946] Re: Anxious Krugman: "The Bond Market Warning Us of
TurbulenceAhead"
>Jim D.:
>
>>>What worries me is this: The bond market is warning us of
>>>turbulence ahead. That would be O.K. if the world's largest
>>>economy were being run by experienced, open-minded officials like
>>>the ones who got us through the last crisis. But who will actually
>>>be in charge? If it turns out to be knee-jerk conservatives who
>>>are opposed to any government intervention in markets, you'll be
>>>amazed at how badly things can go wrong. *****
>>
>>wow! the economics elite is scared.
>
>I posted the same Krugman Op-Ed to Lou's list, and I got the
>following from Henry:
>
>***** Date: Fri, 24 Nov 2000 20:26:19 -0500
>From: "Henry C.K. Liu" <[EMAIL PROTECTED]>
>To: [EMAIL PROTECTED]
>Subject: Re: Anxious Krugman: "The Bond Market Warning Us of
>Turbulence Ahead"(was Re: NY Times: clueless on Argentina)
>
>Krugman is on target that the US ecnomy is heading for a credit
>crisis. This is particularly true for the communication sector.
>
>US investors looking for guidance are starting to heed recent
>distress signals in the bond market - a storm for the United States
>capital markets that may be tougher to recover from than the debacle
>in the autumn of 1998. Then, a crisis was precipitated by the demise
>of one giant hedge fund, Long-Term Capital Management, while HK had
>to make a massive incursion into the equity market. But after the
>Federal Reserve Board lowered interest rates, recovery came swiftly
>to the US stock market and the US economy was relatively unscathed.
>This time around, the turbulence will be set off by many troubled
>companies buckling under the weight of excessive debt lent to them at
>the height of New Economy euphoria.
>
>As worried investors continue to shun corporate bonds as they turn
>away from risk, companies will find it impossible to further raise
>the capital that leads to new job creation and continued economic
>growth. And since much of the economic growth in this nation over
>the past few years came from the big money spent by companies that
>had raised cash in the anything-goes bond market, the economy could
>slow quite sharply as the money spigots go dry. Greenspan's soft
>landing is turning into a hard one, and what is worse, the attempt to
>engineer a soft ending has used up the entire runway. As more and
>more companies go under, their woes could turn a soft economic
>landing into a crash. And the longest American expansion on record
>could come abruptly to an ugly end. Even if Greenspan can manage a
>soft landing, corporate fixed expenses have built up during this
>nine-year period of prosperity and will be hard to roll back, so that
>a minor shortfall in revenues will cause a major shortfall in profits.
>
>The bond market's condition has implications for interest rate policy
>as well. Before the Fed can cut rates, it must weigh the decline in
>credit quality against the need to get the market moving again. The
>corporate debt market has grown enormously in recent years, expanding
>to accommodate the burgeoning capital needs of hundreds of companies.
>Although most investors focus on the stock market, the corporate bond
>market dwarfs it in size. So far this year, companies have raised
>only $146 billion from new stock issues, compared with $935 billion
>in the corporate bond market. The peak of corporate issuance came in
>1998 when $1.2 trillion worth of bonds came to market, up from $433
>billion raised in 1995.
>
>Just last Tuesday, ICG Communications, a telecommunications and
>internet service provider in Englewood, Colo., filed for bankruptcy.
>Its stock had traded as high as $39 last March, with $2.2 billion in
>long-term bonds on its balance sheet before the bankruptcy. On May
>17, GST Telecommunications, a Vancouver voice and data services
>provider, declared bankruptcy. Although Time Warner bought its
>assets, it paid only 70 percent of the book value of the company's
>plant, property and equipment. That left just 50 cents on the dollar
>for bondholders.
>
>Bond investors appetite for risk has shrunk markedly. The total
>amount of money raised in high-yield bonds this year will probably be
>around half the $99.7 billion raised in 1999. In October, only seven
>high-yield bond issues came to market, raising a total of $1.63
>billion. In October 1999, 17 high-yield bond issues raised $3.3
>billion from investors. Such bonds now yield 13.34 percent, up from
>the 10.3 percent demanded by investors in September 1998, when
>Long-Term Capital Management was sinking and the capital markets
>stood still. And high-yield bonds are trading at yields that are
>almost 9 percentage points higher than comparable Treasury
>securities. Today's high yields and high spreads suggest that
>investors realize that many companies issuing high-yield debt
>confront much greater risks than they faced two years ago. That is
>because in the crisis of 1998, even though one big participant was
>teetering, the overall balance sheets of most issuers remained
>healthy. Then, the underlying credit fundamentals of high-yield
>companies were better than they are now. A recent report on heavy
>debt among telecommunications companies argues that the market's
>current problems are tied to declining credit quality of underlying
>issuers that have continued to add leverage in the face of falling
>growth rates.
>
>Last year, 89 companies with debt that was rated defaulted on $24.2
>billion in securities; so far this year, 85 companies have defaulted
>on almost $24.7 billion of debt. In 1991, when the country was in a
>recession, 65 companies defaulted on $19.8 billion of debt. Adding
>to the unease over the higher default figures of today, companies are
>defaulting on their bonds more quickly than they have historically.
>84 of the 152 bonds that defaulted this year were issued in 1997 and
>1998. That's 55 percent, which is very significant. For most of the
>1990's, high-yield issuers have defaulted in four years on average,
>not the two to three years that is becoming common. What these
>companies are running into is an unaccommodating market just when
>they need to refinance. Between 1991 and 1997, lenders holding
>unsecured debt -- those that stand well back in the creditors' line
>-- got back on average 40 cents on the dollar invested. But, in the
>past three years, unsecured lenders have received 23 percent less on
>average, or 31 cents on the dollar, because defaulters are so
>overextended. Credit ratings of once high-quality corporations seems
>to have collapsed overnight. Investors fear that the woes of such
>blue chips may signal a looming recession.
>
>The high-yield bond market, where companies of questionable credit
>strength go for money to fund their operations, has grown from $213
>billion 10 years ago to $508 billion today -- far beyond the growth
>of the economy. Naturally, as the market ballooned, so did the
>risks. Besides the dot coms, an economic backbone sector like
>telecommunications, most of the money needed for expansion has been
>raised in the high-yield bond market. Telecommunications bonds made
>up an astonishing 18.6 percent of the market on Sept. 30. The next
>industry group, cable television, had just 8.63 percent. The telecom
>area is venture capital masquerading as high-yield with only future
>earnings to point to. Now, those earnings are in doubt.
>
>Capital spending by telecom companies has never been done before in
>an unregulated, free-market environment. This is significant because
>regulated industries can bank on guaranteed income from consumers
>that can be used to pay interest on the debt amassed to build the
>projects. But given the intense price competition in
>telecommunications, lucrative cash flows from customers are no sure
>thing. That makes many of these bonds precarious indeed.
>
>The precipitous decline of technology stocks in recent months is also
>contributing to the high-yield bond market's woes. That is because
>investors who were willing to lend to speculative companies took some
>comfort in their holdings as long as these companies' stocks -- and
>overall market value -- were riding high. Many of these companies
>have continued to add debt at a consistent pace, but their market
>values have stopped growing or are growing at a slower pace. As a
>result, the market leverage of the companies has grown rapidly and so
>has their probability of default.
>
>Other indebtedness that is not easily identified is growing at many
>corporations. These less visible forms of debt include so-called
>vendor financing, increasingly popular at technology companies, and
>syndicated lending by banks to new companies. Last month, Lucent
>warned investors that it was increasing its expenses to cover bad
>debts from its customer financing. The news sent Lucent's stock
>reeling, and it dropped 32 percent in a single day.
>
>Syndicated lending by banks is also largely hidden from investors'
>views. FDIC found classified credits, loans that are defined as
>substandard, doubtful or lost, increased by almost 70 percent this
>year over 1999. As the high-yield market has grown in recent years,
>the number of brokerage firms and banks willing to trade the
>securities has declined. Some of the decline stems from mergers in
>the financial services industry, but even the firms that still stand
>ready to facilitate their customers' purchases and bond sales have
>sharply reduced the amount of money they are willing to offer for
>this business. Since 1998, the capital that firms were willing to
>commit to make secondary markets in high-yield bonds has been slashed
>by at least 50 percent.
>
>Unlike 1990 when financial institutions held most of under water
>securities; today, the risks in the market are more widely spread
>among financial institutions, insurance companies, sophisticated
>investors like those who put money in hedge funds and individual
>buyers of high-yielding mutual funds.
>
>Even if Mr. Greenspan cuts interest rates in coming months, it may
>not help this situation. The cost of debt capital for high-yield
>telecom companies is 15.6 percent; if the Fed eases by 200 basis
>points, it wouldn't substantially lower their costs. Furthermore,
>since the huge growth in capital spending that has fueled economic
>growth in the United States was largely funded by high- yield bonds,
>when the market freezes, it cuts off access to capital. When a big
>growth engine stalls, the economy could get hit hard.
>
>In the past four years, debt at a group of seven high-grade
>telecommunications companies, including AT&T, Verizon and SBC,
>exploded from $93 billion, to $210 billion, an annualized rate of
>almost 23 percent. At lesser-quality telecom and media services
>companies, like Global Crossing, Nextel Communications and PSI Net,
>high-yield corporate debt and convertible bond issuance ballooned to
>$275 billion, a compounded annual rate of 60 percent, in the period.
>To put this binge into perspective, the entire value of high-yield
>debt issued between 1983 and 1990, the heyday of junk-bonds, was $160
>billion.
>
>These companies' capital structures now are simply too indebted for
>their cash flows to cover interest payments. The investment thesis
>for many of these firms was that, as they were nimbler and faster
>than the incumbents, they would quickly raise capital, build out
>networks with the latest technologies and then sell the completed
>networks to the large investment-grade telecom companies which needed
>the new assets. Now, however, even the big companies are strapped
>for cash and are not in a buying mood. This puts immense pressure on
>the speculative companies whose debt levels exceed the value of the
>plant and equipment they have sunk in their networks. For example,
>PSI Net has $4.6 billion in debt and preferred stock, more than
>double its $2 billion in net plant and equipment. Its interest
>expense and preferred stock dividends for the past 12 months totaled
>$400 million, compared to revenues of $1.04 billion. The company's
>net operating cash flow was a negative $241 million in the past 12
>months. PSI Net's stock reflects these difficult economics; it has
>crashed from $60.94 a share last March to $1.63. The company's bonds
>are fetching less than 40 cents on the dollar. But other speculative
>companies' stocks are still trading at fairly fancy premiums, even
>though their debts exceed the value of their hard assets. This
>suggests that those companies are bound to feel further pain.
>
>As to Bush Economic Team:
>
>Lawrence Lindsey, a former volunteer for George McGovern, the 1972
>Democratic presidential nominee, now holds a position within the
>George W. Bush campaign that is likely to make him Assistant to the
>President for Economic Policy. Lindsey, having turned conservative,
>now argues the supply-side line that the current government and
>philosophical structure of the leading nations of the world has been
>designed to battle past challenges, most notably the Cold War. He
>asserts that nations can effectively confront new economic and
>financial crises only by unleashing the power of democratic
>capitalism to establish innovative global economic arrangements, i.e.
>be a submissive colony of the US global system. He proposes what many
>in the Third World have identified as neo-imperialism and
>neo-colonialism as a natural law disguised in the form of
>neo-liberalism, just as the British economists since Amith did with
>classical economics theory during the British Empire. Lindsey was a
>member of the board of governors of the Federal Reserve System from
>1991 to 1997, a policy advisor to President Bush, and a member of
>President Reagan's Council of Economic Advisers. Lindsey's new book,
>Economic Puppetmasters: Lessons from the Halls of Power, focuses on
>the constraints that neo-liberal economics places on modern
>decision-makers. Lindsey claims that decision-makers may never be
>the masters of the systems over which they hold sway, no matter how
>much they delude themselves and the public into believing that they
>are. More typically, they are the system's servants, constrained by
>the prejudices of existing theory, by the information flow that has
>developed in the bureaucracies they oversee, and by the constraints
>that other decision-making forces impose on them. Thus one of its
>principal lessons is how a knowledge of these constraints--an
>understanding of the neo-liberal economics of the modern world--is an
>extremely important tool of government today. Even powerful leaders
>are very tightly constrained by institutions and history, that
>strings are being pulled elsewhere by the "unseen hands" of the
>market system, and that the high politicians spend most of their time
>frantically trying to pretend that they are leading the parade. In
>other words, nations and their governments might as well surrender to
>US financial hegemony, which is the product of natural laws of
>neo-liberal economics.
>
>John Taylor might soon be appointed to the Fed Board of Governors.
>His is the author of The Taylor Rule: if inflation is one percentage
>point above the Fed's gaol, rates should rise by 1.5 percentage
>points. And if an economy's total output id one percentage point
>below its full capacity, rates should fall by half a percentage
>point. Governor Laurence H. Meyer is a supporter of the Taylor Rule
>
>It is a not-widely-known fact that there are currently two vacancies
>on the Board. Senator Phil Gramm blocked approval of two appointees
>by Clinton in order to allow appointments by his fellow Texan, young
>Bush. Taylor has been an adviser to Bush. Robert Novak claims in
>today's Washington Post that Greenspan is secretly for Gore and that
>Bush will undermine him in revenge for his perceived tanking of Bush
>sr. in 1992 with tight monetary policy. Also, Larry Lindsey is a
>supply-sider. Might be some interesting things coming up soon....
>
>Henry C.K. Liu *****
>
>Yoshie
>
>
