Another plus Greenspan cited was the state of the equity markets. In his words, equity premiums are now at almost the highest level in American history, which means that the market is pleased with the economic outlook and the downside risk is at a minimum. It was extraordinary, he said, to see how far the markets had gone down by March of 2009, when price-to-earnings ratios were at a level where “human beings don’t allow them to go any further.” Although we’re considerably up from there, there is still the possibility of a further rise, he said. [...]
People don’t realize the significance of equity prices, and asset prices in general, for day-to-day economic activity, according to Greenspan. His research shows that equity markets are not only a leading economic indicator, but, much more important, they are fundamental creators of economic activity. Approximately 6% of the growth in GDP is funded by a rise in equity values, on average, though this varies considerably. As a result, increasing equity values can be even more important for economic growth than fiscal stimulus.
The problem with fiscal stimulus is that we measure it gross, by how much it puts into the economy, but we don’t put debits against it. The evidence is unambiguous, according to Greenspan, that rapid increases in deficits raise the expectation of taxes, engendering uncertainty in the business community and leading to significant declines in private capital investment. This lowers the impact of a fiscal stimulus by one-fourth to one-half and possibly significantly more, depending upon conditions. An equity stimulus doesn’t have this negative aspect. The data after March 2009 make clear that the equity stimulus drove the economy. Greenspan acknowledged that an equity stimulus brings with it an increase in private debt, “but not more than the system can handle.” [...]
Although the housing market is recovering – foreclosures are clearly declining, and the market is beginning to clear – Greenspan said he was reminded of 2008. At that time, half of remediated mortgages went into default again after six months. As prices have gone up and people have built up equity in their homes, that proportion has now fallen to 10%. The key to recovery is having people build up equity in their homes. As that happens, it builds up a cushion; as prices go up 10% or 15%, the underwater homes are cleared out. Remediation made no sense. If we had let the markets adjust themselves, that is, allowed the kind of selling climaxes that clean out an illiquid market and caused prices to fall to a level where the market cleared, we would have been far better off, according to Greenspan. [...]
~ Adam Jared Apt, synopsis of Alan Greenspan speech given to Boston Security Analysts Society, February 12, 2013