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July 16, 2002

Wisdom from the Fed Oracle

Fed Chairman Alan Greenspan testified before Congress (see testimony) and his main argument was that the fundamentals of the economy are not dire, but that the robust consumer spending through the recession means that there is no pentup demand that would encourage an economic surge even if the economy ticks upward.

But one the more interesting points Greenspan made was his analysis that, having overplayed profitability during the bubble, people may be making the same mistake for the same reason in reverse-- namely stock options:

it is ironic that the practice of not expensing stock-option grants, which contributed to the surge in earnings reported to shareholders from 1997 to 2000, has imparted a deceptive weakness to the growth of earnings reported to shareholders in recent quarters. As stock market gains turned to losses a couple of years ago, the willingness of employees to accept stock options in lieu of cash or other forms of compensation apparently diminished. According to estimates by Federal Reserve staff, the value of stock option grants for the S&P 500 corporations fell about 15 percent from 2000 to 2001, and grant values have likely declined still further this year. Moreover, options grants are presumably being replaced over time by cash or other forms of compensation, which are expensed, contributing further to less robust growth in earnings reported to shareholders from its trough last year.
So if Greenspan is right, we are now seeing irrational bearishness to match the irrational exuberance of past years.

Posted by Nathan at July 16, 2002 11:49 AM

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