Fed chief - Scandals delaying recovery

WASHINGTON -- The U.S. economy is poised to return to healthy growth, but the startling stream of accounting scandals that has rocked Americans' faith in corporate leaders could weaken the recovery, Federal Reserve chairman Alan Greenspan told Congress on Tuesday.

Those accounting problems already have contributed to a slide in the stock market, he said. That threatens to cause consumers to spend less and businesses, whose profits took a hit during the slump, to become even more reluctant to make big commitments in capital investment, a necessary ingredient to the economy's full recovery.

"Considerable uncertainties -- about the progress of the adjustment of capital spending and the rebound in profitability; about the potential for additional revelations of corporate malfeasance; and about possible risks from global political events and terrorism still confront us," Greenspan said in testimony to the Senate Banking Committee.

Against that backdrop and given that inflation has remained low and isn't a risk to the economy, Fed policy-makers have opted to hold short-term interest rates at 40-year lows at each of their four meetings this year.

Growing numbers of economists believe the Fed will keep rates unchanged through the rest of the year. Some said Greenspan's Tuesday remarks reinforced that view.

"I think the Fed will stay on the sidelines," predicted Mark Zandi, chief economist at Economy.com. "He duly recognized the threat posed by the sliding stock market."

By keeping interest rates low, the Fed might motivate consumers to keep spending and businesses to step up investment, both of which would bolster economic growth.

Even as he acknowledged risks facing the economy, Greenspan struck a more upbeat and reassuring tone than he had earlier this year.

"The fundamentals are in place for a return to sustained healthy growth," he said, delivering his semiannual report on the economy to Congress.

But Greenspan's soothing comments provided only temporary solace to investors. The Dow Jones industrial average, which had been off 232 points earlier in the day, trimmed losses to close down 166.08 points at 8,473.11. It was the Dow's seventh consecutive losing session.

Greenspan and his Fed colleagues expect the economy this year to grow between 3.5 percent and 3.75 percent when measured from the fourth quarter of 2001. That compares with a 2.5 percent to 3 percent forecast in February.

"The effects of the recent difficulties will linger for a bit longer, but as they wear off, and absent significant further adverse shocks, the U.S. economy is poised to resume a pattern of sustainable growth," Greenspan predicted.

Good consumer spending

Thus far, consumers, whose spending accounts for two-thirds of all economic activity, have been holding up despite the spotty recovery and the sour stock market, Greenspan said. Weak stocks have yet to crimp consumer spending because of offsetting boosts from low interest rates, solid appreciation in home values and extra cash from refinancing.

In contrast, business spending has remained weak, he said. It was deep cuts in capital spending that helped push the economy into recession last year.

"Financial markets have been notably skittish of late, and business managers remain decidedly cautious," the Fed chairman said.

To restore investor trust shaken by the accounting scandals, Greenspan said chief executives must be held accountable to report accurately on the financial conditions of their companies and should be penalized for not doing so.

"Manifestations of lax corporate governance, in my judgment, are largely a symptom of a failed CEO," Greenspan said, in some of his harshest comments to date on the scandals.

During questioning, Greenspan said elements in a Senate bill passed Monday to combat corporate fraud were "moving in the right direction and will be helpful." He called the legislation's stiffer penalties the "most important part of the bill."

'An infectious greed'

Greenspan said checks and balances on corporate governance that worked well in the past might have been hurt by the go-go mentality of the 1990s that "arguably engendered an outsized increase in opportunities for avarice. An infectious greed seemed to grip much of our business community."

The Fed chief repeated his support for companies to treat lucrative stock options for top executives as business expenses. He indicated that decision should be left to the private sector, not be forced by Congress.

Recent announcements by Coca-Cola Co. and others suggest that companies are moving in that direction on their own, he said.

"Greenspan clearly recognizes that the stock market is responding to accounting shenanigans," said Wells Fargo's chief economist, Sung Won Sohn. "He was pretty upbeat about economic fundamentals but at same time injected caution that the stock market setback could have a dampening effect on the economy, especially on business spending."

Fed policy-makers' forecast is for the nation's unemployment rate, now at 5.9 percent, could edge up to as high as 6 percent this year. That's an improvement from the Fed's earlier forecast and significantly below the 7.8 percent jobless rate hit in the last recession, in 1990-91.

Inflation was forecast to be moderate this year, with consumer prices as measured by a price gauge tied to the gross domestic product to increase by about 1.5 percent to 1.75 percent, little changed from an earlier estimate.