Posted on 07/24/2002 1:12:59 PM PDT by shrinkermd
NEW YORK, July 24 (Reuters) - The Federal Reserve should consider cutting interest rates soon to cushion the impact of negative financial market developments on the economy, prominent Wall Street economist Henry Kaufman said on Wednesday.
"The Federal Reserve should be considering lowering interest rates soon," Kaufman said. "The Federal Reserve should lower margin requirements on stocks. The administration should propose a reduction of the capital gains tax, corporate tax and some modest reduction in individual taxes in order to cushion this down-drag from the financial side," he said.
Corporations are facing difficulties raising money, Kaufman said, and the way developments in financial markets are unfolding right now, chances are close to 50 percent that the economy will experience a double dip, revisiting the recessionary environment it encountered in 2001.
Before establishing his own investment management and economic and financial consulting firm in 1988, Kaufman spent 26 years at bond powerhouse Salomon Brothers Inc. as managing director, a member of the executive committee and leading the firm's four research departments.
Kaufman's announcement in August 1982 -- after the United States had endured in the early 1980s one of its most severe economic recessions in decades -- that a significant interest rate decline was ahead caused a massive rally in both the bond and the stock markets on August 17, 1982. The Dow Jones Industrial Average jumped 4.9 percent. Long-term Treasury bond prices jumped $40 (per $1,000 of face value), and most short-term interest rates tumbled by more than half a point.
Kaufman's comments came after Goldman Sachs & Co. chief economist William Dudley said on Tuesday that the chance of a Fed easing had become more likely than a tightening over the next six months.
"That is because the stock market weakness is likely to have negative feedback effects on the real economy, dampening growth," he said.
However, Dudley said an easing would come quickly only if there were "systemic problems" in the U.S. financial system separate from the harm caused by the equity market decline.
But Kaufman seemed to say that some of those systemic problems seemed to be at hand. On one hand, he said, ample liquidity is available to households who want consumer loans and for households that want mortgage financing.
But he said liquidity has been "significantly constrained" for corporations.
"The high-yield market is virtually closed," Kaufman said. "The IPO market is pretty well closed. Commercial paper outstanding is contracting and is being paid off by forcing issuers into the banking system. Banks generally are becoming cautious in the extension of credit and market makers are holding down their position taking," he said.
"Dealing with these many financial constraints is going to impinge and impinge and impinge on economic activity," Kaufman said.
Conceding that his is now a minority view, Kaufman said the majority of private economists as well as the Federal Reserve and the administration take an "extraordinarily bifurcated" view of the relationship between the financial markets and the economy. A majority point to the rise in industrial production, the good level of housing activity, the good level of consumer spending, and low inflation and call the economy "fundamentally sound," he said.
But Kaufman said this view fails to take into account the "significant contractionary force that is bearing down on the economy from the bad financial developments.
"The mind-set of the monetary authorities and of the administration is not focused on how to deal with these financial contractionary forces," he said.
"The view is that everything will be all right, that the so-called fundamental strength of the economy will prevail," Kaufman said. "My view is that it can't, and that there are no policy initiatives there to deal with this overwhelming negative force coming from the financial side."
Kaufman said financial markets are currently flushing out into the open "many of the excesses of the last decade or so."
Those excesses, he said, involved the shortsightedness of corporate chief executive officers and the failure of many boards of directors to really exercise their authority.
"It involved the biased views of Wall Street analysts and the unwillingness of the supervisory authorities to really deal with the excesses that have been fomenting for some time," Kaufman said. "It involves lending institutions not performing adequate due diligence. That's the backdrop all contributing to this problem."
The double taxation of dividends has resulted in an over reliance on bank debt and bonds. Smaller and profitable corporations would do better with dividend paying stock including cumulative preferred than bonds provided the dividends were not taxed twice. Making dividends an expense to corporations and taxable to the person paid is not only fair but IMHO politically feasible.
Then, they should obviate the 1 million dollar tax deductible rule for executive pay passed by Clinton's 1993 tax bill. This has been the genesis of most of the "options problems" that Congress is trying to control by making them an expense. Some Boards of Directors think (Correctly IMHO) that there are those who are worth more than a million a year; hence, they find other ways to pay them --stock options.
Third, rather than try to get a capital gains tax through the "politics of envy" which invariably kill it, let us just pick a day and begin indexing capital gains for all such matters from then forward. Hard to disagree with this and a lot easier to pass, but it would take Congress out of the equation.
In the meantime, let us hope the Federal Reserve focuses on inflation, deflation, interest rates and avoids the creation of bubbles tring to solve all the financial systems real and imagined ills.
I would think so, but who knows. There is so much manipulation by the central bankers, general rules don't seem to apply, or if they do, they apply only over long periods of time.
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