Corzine Says High Consumer Rates Reflect a Return to Deficits

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10/04 00:01 Corzine Says High Consumer Rates Reflect a Return to Deficits By William Roberts

Washington, Oct. 4 (Bloomberg) -- Senator Jon Corzine of New Jersey, the former co-chairman of Goldman, Sachs & Co., says the interest rates American consumers and businesses are paying are higher than they should be because of growing concern in the bond market that the federal budget surplus will be replaced soon by years of deficits.

The Federal Reserve has lowered the cost of borrowing between banks nine times in as many months to a 39-year low of 2.5 percent. Yet interest rates in the $3 trillion U.S. government bond market, which determines the cost of 30-year mortgages as well as long-term corporate bonds, haven't declined even a tenth as much since January.

That's the free-market penalty for a government, responding to an economic slump even before the Sept. 11 terrorist attacks, that cuts taxes too much and spends too much, said the 54-year-old Corzine, a Democrat and former bond trader who moved to Capitol Hill from Wall Street in 1999.

``We're talking about short-run stimulus and spending programs with no real long-term fiscal discipline,'' Corzine said in an interview, that have the potential to saddle the U.S. with the kind of annual budget deficits that prevailed for almost four decades, from 1961 to 1997, he said.

Boosting Economy

Congressional leaders and President George W. Bush are weighing a combination of business and individual tax cuts, coupled with public-works spending, to boost the economy. Lawmakers say they want the legislation to transfer enough revenue -- between $30 billion and $100 billion -- from the government to the private sector to provide an economic boost.

As a result, the gap between short- and long-term bond yields isn't likely to narrow much, Corzine said.

The spread between two-year Treasury notes and the 30-year bond widened to 2 3/4 percentage points on Sept. 20, a seven-year high, from less than a half-point on Jan. 1. The change is a reflection of a disappearing budget surplus and the chance that investors will be asked to buy more debt, Corzine said.

When terrorists destroyed the World Trade Center in New York and damaged the Pentagon in Washington, they killed as many as 5,700 people and probably tipped the U.S. economy into a recession. Many economists who had expected a slowdown to end in the third quarter now see a recession lasting through December.

Make It Temporary

What Congress should do is suspend future installments of Bush's $1.35 trillion, nine-year tax cut, focus on temporary spending ``that can go away'' and business investment incentives ``that could have multiple impacts,'' including the creation of more jobs, Corzine said.

Republicans reject any notion of repealing Bush's tax cut. Senator Phil Gramm of Texas, for one, says Corzine is wrong about long-term interest rates being too high.

``Mortgage interest rates are six and a quarter percent,'' said Gramm, former chairman of the Senate Banking Committee. ``That's extraordinary.''

That is true of mortgages that are tied to short-term interest rates, such as yields on U.S. Treasury bills. Some of these are even lower than 6 percent.

The traditional, 30-year fixed-rate mortgage, prized by many American homeowners because it has no risk of being reset every few years, averaged 6.82 percent this month, still above the 30- year low in October 1998, when the Fed cut its benchmark rate a quarter-point to 5 percent.

Greenspan's View

As recently as July 24, in testimony to Congress, Fed Chairman Alan Greenspan, who earlier in year endorsed the Bush tax cut, said investors sensed that the government would be selling more Treasury notes and bonds in the years ahead than anticipated. ``The failure of long-term rates to come down more than they have is largely a supply issue,'' Greenspan said.

Gramm said he wants ``to move in exactly the opposite direction'' to Corzine by making Bush's tax cut permanent and adding a reduction in the capital-gains tax.

For some bond market strategists, that means a greater risk of federal red ink as the government attempts to rescue the economy.

``If they are going to have stimulus, they are going to have go into more deficits,'' said Jeff Junior, director of fixed- income sales at Josephthal & Co. in New York. ``There's a good chance they are going to issue more debt, and increasing supply will hurt the bond market.''

Michael Maurer, a fixed-income strategist at A.G. Edwards & Sons in St. Louis, said the stimulus bill being written by Congress and the president ``could easily push them into deficit territory.''

`No More Buybacks'

``You are going to be looking at increased supply and no more buybacks'' of debt by the Treasury, Maurer said. ``I think you will see higher rates with the greater supply.''

With the exception of a brief peak in 1994, when the economic conditions were different, spreads between short and long rates last widened so much, so fast -- swinging three percentage points in nine months -- when the economy was in the depths of the 1990- 91 recession.

The spread then continued to widen into 1992, when the U.S. ran a deficit of $290 billion, the biggest ever.

``Any fiscal stimulus would be good for the economy. The question is at what cost,'' said Michael Cheah, who helps manage $1.5 billion in bonds at SunAmerica Asset Management.

``A lot depends on what kind of fiscal stimulus we get and how big a package,'' Cheah said. If Wall Street ``sees a hastily prepared package that doesn't go to good use, that will scare the market.''

Building Goldman

Corzine, a native of Illinois and a graduate of the University of Illinois and the University of Chicago, joined Goldman in 1975. He became co-head of the firm's bond department in 1985 and helped make it one of the five dealers in U.S. government securities. By the early 1990s, trading and underwriting bonds accounted for almost half of the firm's revenue.

Corzine, who reported personal assets worth more than $352 million on his Senate financial disclosure last June, helped orchestrate the partnership's initial public offering, in which he received 4.4 million shares in May 1999. Corzine quit Goldman that same month, after some partners chafed at his management style during the transition to a public company and after losses sustained from the bond market shakeout that followed the collapse of Long-Term Capital Management, a hedge fund.

The senator first called attention to the yield spread between the Treasury's 30-year bonds and two-year notes in May, when it widened to 2 percentage points. ``That was more a function, in my view, of the nature of the president's tax proposals,'' he said.

In Rubin's Footsteps

As the Fed has pushed its benchmark overnight bank lending rate down this year, the yield on two-year Treasury notes has declined by about 2 1/4 percentage points. At the same time, the yield on 10-year Treasury notes, to which many mortgage and business loans are tied, has fallen only a half percentage point.

In calling for long-term fiscal discipline, Corzine is picking up within the Democratic Party where Robert Rubin, former Secretary of the U.S. Treasury and co-chairman of Goldman Sachs, left off.

Rubin was the chief architect of former President Bill Clinton's policies that Democrats say led to budget surpluses, a shrinking U.S. debt, low interest rates and low inflation. Rubin contends the longest expansion in U.S. history, which began its 10th year in April, was partly the consequence of the Clinton administration's fiscal policies.

Rubin argued repeatedly when he was Treasury Secretary that driving long-term interest rates down and keeping them low was a more effective way to prolong an economic expansion than a corporate tax cut.

During the budget battle earlier this year, Corzine stood up in the weekly Democratic caucus meetings and argued that Republicans and Bush were vulnerable. Long-term interest rates were staying high because investors fretted that Bush's tax cut might turn the surplus into deficits, Corzine said.

Corzine's views soon were shared by Tom Daschle, the South Dakota Democrat and majority leader in the Senate, and by Senate Budget Committee Chairman Kent Conrad, a North Dakota Democrat.

``Senator Corzine is a person to whom I turn frequently for his analysis of the economic circumstances,'' Daschle said this month.

If you don't make any money, you don't pay taxes and there are gobs of corporations with negative earnings and unemployment continues to skyrocket. I guarantee deficit spending for 2002. The budget surplus (which was social security excess) is gone.

-- Guy Daley (guydaley1@netzero.net), October 04, 2001


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