RAY SUAREZ: News that consumer prices soared last month made official what many Americans are already feeling: Consumers are paying more for everything, from gasoline to food to transportation.
The inflation numbers come amid ongoing economic anxiety, fueled in part by a turbulent stock market, rising unemployment, and slow growth, the failure of California bank IndyMac, and an emergency government plan to rescue mortgage giants Fannie Mae and Freddie Mac.
There were glimmers of good news today. Despite fears of continued mortgage-related losses at financial firms, the stock market went up; for a second day, oil prices fell; and the government reported that industrial output, measuring production at factories, mines and utilities, unexpectedly rose 0.5 percent last month.
For some analysis, we’re joined by Roger Altman, who served as deputy secretary of the treasury in the Clinton administration. He’s now CEO of Evercore Partners, an advisory and investment firm.
And Michael Boskin, he chaired George Herbert Walker Bush’s Council of Economic Advisers. He’s now a professor of economics at Stanford University and a senior fellow at the Hoover Institution.
Roger Altman, let me start with you. If you had to put together a diagnosis for this economy, what are the signs that you see? How would you assess the health of the economy?
ROGER ALTMAN, Evercore Partners: Ray, by any objective standard, it’s poor. Huge sectors of the economy, housing, the financial sector, autos, to name three, are in terrible shape.
And the question now is whether the disease which has infected the financial sector will spread into the rest of the economy. I suspect that it will, because consumers will be scared or are scared by bank failures like IndyMac and all of the publicity over that, and fears of other failures, and by events like the Fed-Treasury rescue over the weekend of Fannie Mae and Freddie Mac.
Those, of course, don’t inspire confidence. Quite the opposite. And while we have had over the past couple of quarters essentially no growth, 0 percent to 1 percent real growth in GDP, my guess is that we may well see negative numbers, meaning contraction, before the end of the year.
Rising inflation, low confidence
RAY SUAREZ: And, professor Boskin, you heard Roger Altman use words like "terrible" and "diseased." Do you share his outlook?
MICHAEL BOSKIN, Stanford University: Well, the economy is certainly not in good shape. It's struggling. I would describe it as in a mini-stagflation, in the sense that we've got very sluggish growth while we're witnessing increasing inflation to levels that are unacceptable.
Even the core inflation rate stripped of the rapidly rising food and energy prices has been going up above the Fed's 2 percent target range.
So this is a serious problem for the economy, for American families, for consumers whose budgets are being strapped. I would add high energy prices to the list, Roger mentioned.
I would say that there seems to be a bit of a pickup in the quarter that just ended. We did somewhat better than Roger might have left an impression of. He was talking about the previous couple of quarters. We don't have data yet for the last quarter.
But that may have been temporary because of the rebate checks. We'll see. I do agree that, as we head toward the end of the year and beginning of next year, the prognosis is for a soft economy and for rising inflation.
The Fed has tried to get -- hoped that a period of sub-par growth would get inflation under control. That hasn't happened yet, and that's a big bet Bernanke is making right now.
RAY SUAREZ: Well, in two days of testimony, Professor, Chairman Bernanke told senators and representatives that inflation was basically his number-one concern. With so many fires burning in so many places, should it be?
MICHAEL BOSKIN: Well, I think if the central bank is not worried about inflation, who will be? The problem is, once inflation gets started, starts rising and gets built into inflation expectations, that feeds back on inflation and we get a process going that takes a long time to unwind, and it would become much more painful in the future to unwind it, as we experienced in the 1970s, that horrible inflation, when Paul Volcker finally had to raise interest rates to 16 percent to get the 13 percent inflation down.
We had the worst recession since World War II in the early '80s as a byproduct of that disinflation. We certainly don't want to get back into that situation.
I think Chairman Bernanke and his colleagues at the Fed would like to head that off, so he's keeping a diligent eye and he's using a lot of other tools at the moment. You can argue whether those are being targeted precisely enough or are being too general and what impact they're having, but he's a lot of the lender of last resort tools to try to put out some fires the financial sector.
Interest rates may begin to rise
RAY SUAREZ: Roger Altman, today the president of the Federal Reserve in Kansas City, Thomas Hoenig, threatened that interest rates might have to start rising, even with low growth or no growth, because inflation is so dangerous. Do you agree with that strategy?
ROGER ALTMAN: Well, I agree with Michael that the central mission of the Fed always is inflation restraint. And, of course, Chairman Bernanke has to make that priority number one for him and other members of the Federal Reserve system, like the Kansas City governor, the same.
But if one had to choose -- and it's an excruciating situation we're in here between a weak economy and rising inflation, if one had to choose, I don't think that rising inflation at this moment is the bigger of the two challenges.
I think the economy is headed into a weaker period for the second half of the year. And there's a great deal of fear, particularly in the financial sector, but now, as I said earlier, spreading a bit more broadly.
And the greater challenge is to avoid a steeper fall in the economy, rather than at this moment worry more about inflation. Again, the Fed has to do that; that's what we want them to do.
But from a broader point of view, of the two challenges, I don't think inflation is No. 1.
RAY SUAREZ: What about the banking sector? Over the last few days, some banks have taken punishing losses on the value of their stock. There was the failure of the California thrift. And there is said to be some real worries on Wall Street about a new spate of failures. Go ahead.
ROGER ALTMAN: Ray, the banking sector is in worse shape than at any point since the 1930s. We've never seen such large losses so fast. After all, the credit market collapse began only a year ago right now.
We've never seen such levels of capital need on the part of all of the large lenders. And we've never seen such questions about their fundamental stability as we have right now.
And today's welcome rally notwithstanding, almost all financial observers would say that the condition of our banking system and our financial sector more broadly is more serious and a greater threat than it's been at any time, as I said, since the 1930s. This is a really perilous moment.
RAY SUAREZ: Professor Boskin, the worst shape since the 1930s?
MICHAEL BOSKIN: Well, I think...
ROGER ALTMAN: No, since the '30s.
MICHAEL BOSKIN: I think that we've been through other serious challenges to our economy and our banking system, in the early 1980s, when Mexico defaulted on its debt, and we had the third-world bank -- debt crisis for banks, the money market banks, the big major banks whose names we all know in New York were technically insolvent, if they were mark to market. We had the S&L problems in the early '90s.
So we've been through other serious things. I do agree this is very serious. There are sands in the gears of the financial system, and that is very likely to continue to be a big headwind for the economy, for production, output and employment.
Effect of Mae, Mac on perception
RAY SUAREZ: Today, professor, the Fed chairman said that Freddie Mac and Fannie Mae are going to make it, that they are not in danger of collapse. Should that help them right their ship? Are they going to have a few calmer days coming, because of that reassurance?
MICHAEL BOSKIN: Well, one would hope so. I think that one would expect, for example, the Treasury to have had a plan, because of the well-known status of these government-sponsored enterprises, that they had this implicit guarantee, which might have to be made explicit, because of the special status they have.
And so one would expect the Treasury and the Fed to have had a plan just in case, but when news of that got out, I agree with Roger, it caused a lot of concern. Why would they be doing this now? But I think people have calmed down some, given the reassurances in the last day or two.
I do believe that we have a long-run issue with regard to Freddie and Fannie, which is they grew too big, their mission grew, they were insufficiently capitalized. Many people have warned about that in the last couple of administrations, I think the last couple of Federal Reserve chairmen.
And I think that they're right. We need to capitalize them and not have them grow precipitously. But in the short term, we do have to make sure that we don't precipitate a crisis and a crisis of confidence that spreads.
So we need to bridge from the current next couple of quarters, getting them through this, to a different type of Freddie and Fannie out into the future.
RAY SUAREZ: Roger Altman, do you share professor Boskin's desire to see a reconfigured Freddie and Fannie? And do you share the chairman's optimism that they're going to make it?
ROGER ALTMAN: Well, the chairman's optimism -- and I have great respect for him -- is self-evident without being said. Fannie and Freddie have always been backed by the federal government. Financial markets have always traded their securities on that assumption.
And even late last week, when the fears over them and the concerns had risen to unprecedented proportions, they were still borrowing right above the Treasury's own borrowing costs, because markets knew that, from the point of view of their debts, they're backed by the federal government.
So the chairman saying they're going to make it is a good thing to say. And if any of us were he, we'd say the same thing.
But it's self-evident that that's the case, because they are backed, always have been, and must be. So there's never been any question about whether the debts of Freddie or Fannie are money good, never been any question.
I agree with Michael on the long term. Fannie and Freddie should be slimmed down. They should be converted, so to speak, into yield-related or yield-focused organizations, as we say in Wall Street, not growth stocks as they were. That was rather a foolish period.
And it will take quite a while for them to shrink themselves, but they can ultimately emerge as safer and sounder and more focused organizations, given enough time.
And what's really happened here is that the Fed and the Treasury have unsheathed such big weapons with their weekend rescue that the hope is -- and I believe there's a good chance -- that they'll never have to be used.
RAY SUAREZ: Well, I have to leave it there, but thank you, Roger Altman and Michael Boskin. Good to talk to you.
MICHAEL BOSKIN: Good to talk to you, Ray.
Good to see you, Roger.