Reading Greenspan


Alan Greenspan, says Nick Souleles, chooses his words very carefully.

Which is precisely why Souleles, associate professor of finance at the Wharton School, admits he was surprised when Greenspan, during testimony before the Senate Banking Committee last month, more or less admitted he had no explanation for the unusual U.S. interest rate climate, setting off a frenzy of speculation in the process.

“ He admitted the behavior of the bond market was a ‘conundrum,’ a puzzle,” Souleles says. “Which is a strong word coming from the head of the Fed.”

Greenspan, who has served as Fed chairman for 17 years, raised more than a few eyebrows when he told lawmakers on February 16 he saw the nation’s interest rate situation—interest rates have remained low in recent months, despite Fed actions that should have sent them higher—as a “conundrum.” He also suggested the situation could be an “aberration.”

The comments set off fierce speculation in the financial world, and Souleles thinks he knows why—comments of that nature, from the chairman of the Fed, don’t hit the papers all that often. The use of the word “aberration,” especially, was interesting, says Souleles.

“ That’s a strong word,” Souleles says. “It’s stronger than saying, ‘puzzling.’ He’s implicitly suggesting it’s a possibility that it’s a short-term low—that not only should rates be higher, but that they will be higher.”

Greenspan and the Fed do not directly control long-term interest rates, which are the rates that help determine, for instance, how much homebuyers pay in their monthly mortgage payments. But the Fed does control short-term borrowing rates for banks, and raising or lowering those short-term rates can nudge long-term rates in the direction it deems appropriate.

For months now, it’s been clear the Fed wants long-term rates higher—and has, therefore, steadily raised short-term rates from a low of 1 percent to the current 2.5 percent. Still, despite those increases, long-term rates remain stubborn.

Several explanations have been offered for the situation—some point to similarly low rates in Europe, and others blame a lack of borrowing from large businesses—and Greenspan discussed those in his testimony.

But, says Souleles, Greenspan then added he didn’t think those explanations were adequate—and this, says Souleles, is what is most interesting.

“ The bottom line is that he’s saying ‘I don’t think these stories are enough,’” Souleles says. “He offered a pretty sophisticated analysis, but in the end—and this is my interpretation of it—he’s saying he’s not convinced these explanations are quantitatively enough.”

Greenspan’s message, it appears, was effective. And though Souleles says he could not speculate whether Greenspan intended his remarks to have an immediate impact on the rate climate, that’s exactly what happened. Since his testimony, long-term rates have crept upward—once again illustrating the power the chairman’s carefully chosen words can have.

“ Those rates rose after the speech,” Souleles says. “And they’ve risen quite a fair bit, too.”

Originally published on March 17, 2005