Alan Greenspan, who was Gerald Ford's chief economic adviser and presently is an unofficial adviser to the Reagan administration, is normally a pretty calm fellow. His thorough and cautious analysis has earned him a close following and deep respect, even among Democrats who disagree with him on policy.
Last week, Greenspan felt constrained to deliver a truly frightening warning on the potential impact of sustained high interest rates, especially on the nation's thrift institutions -- savings and loan associations and mutual savings banks.
"A time bomb is ticking away in the financial system," Greenspan warned. "It will eventually blow up if we do not defuse successfully the underlying inflationary pressure in our economy and thereby rid ourselves of the high inflation premiums embodied in nominal interest rates."
That statement was part of carefully framed testimony before the Joint Economic Committee. But on a day when multiple economic hearings were being held on Capitol Hill, Greenspan's words unfortunately got lost in the shuffle in almost all news accounts.
The point Greenspan was making -- and it helps to explain much of the frantic effort of the Reagan administration to cut government spending -- is that the United States "cannot for any length of time successfully function above or even at current levels of interest rates."
Office of Management and Budget Director David Stockman told the Senate Appropriations Committee that we "simply can't go through very many more years like 1980 in which we saw first boom then bust -- the interest rate rising to 20 percent, collapse, and then go all the way back up.
"This caused dislocation for everyone from the car dealer to (other businessmen and home buyers). It becomes increasingly more stable, more volatile, and the problems only accumulate."
Greenspan pointed out that the U.S. financial system has been built around the assumption that any inflation would be temporary, soon to be succeeded by a noninflationary period. Thus, even after the first OPEC-induced price shock in 1973-1974, long-term government bonds rarely yielded more than 8 1/2 percent. A rate as low as that, in effect, reflected the expectation that over the long run (say 10 to 20 years) the inflation rate would be no worse than 6 percent.
Today, long-term government bonds yield about 13 percent, which means that the markets are now saying that the long-term inflation rate is more like 10 percent.
The former expectation that prices would be stable provided the underpinning for the U.S. home-building industry, itself one of the pillars of the long postwar boom. With prices predictable and stable, the thrift institutions were able to underwrite housing construction with low long-term mortgages, while acquiring the cash they loaned out by paying even lower short-term interest on passbook savings. Lenders could make money on 6 percent mortgages if they came in across the counter at only 4 percent.
Clearly, savers were subsidizing homeowners, and that unfair element in the savers-owners relationship had to change -- and is changing as the savings institutions have to pay more competitive rates of interest. But with the unprecedented explosion in interest rates, the S&Ls today earn an average of only about 9 percent from their mortgage portfolios, or barely half of what they must pay for some -- not all -- of the funds acquired. Greenspan estimates that the S&Ls hold about $100 billion, or 21 percent of their total liabilities, in 5 1/4 percent passbook accounts, without which they'd really be in the soup.
They couldn't function at all if it weren't for federal help, including heavy direct lending by the Federal Home Loan Bank Board. And the S&Ls can unload certain nonmortgage assets to pay off some of their high-cost certificates of deposit.
"But obviously," Greenspan says, "this cannot go on for very long under the existing interest-rate structure. At some point, when interest income will no longer consistently meet interest cost requirements, the whole thrift institution system will undergo a massive crisis."
But don't panic. Don't run to withdraw your savings. The "crisis" doesn't mean that the S&Ls are about to go under or that any saver will lose any money. What it does mean is that somewhere down the road, some of these institutions may have to be bailed out by the FHLBB in cooperation with the Federal Reserve.
If the government should have to come to the rescue of the thrift institutions, Greenspan says, that action (in effect a huge government borrowing to keep the institutions whole) would be a brand-new acceleration of inflation, perhaps doubling the present underlying 10 percent rate to 20 percent. And you can figure out where interest rates would go.
Clearly, that kind of economic disaster can't be allowed to happen. Already, the interest cost on the national debt for the current fiscal year (1981) is estimated at a staggering $65 billion, up $13 billion in a single year. By fiscal 1982, it could easily be as much as $95 billion, according to Stockman. That's more damage to the federal budget from high interest rates, as he said, than even a wasteful Congress could manage in a short period.