September 27, 2005
Exuberance leads to asset drops:Greenspan
By Tim Ahmann
WASHINGTON (Reuters) - Asset bubbles fueled by "market
exuberance" invariably burst and policy-makers cannot safely
pierce them, Federal Reserve Chairman Alan Greenspan said on
Tuesday in what some economists took as a warning to bond
market and housing speculators.
In a speech in which he once again defended the Fed's
decision not to deflate the late-1990s stock market bubble,
Greenspan said a successful monetary policy can be a victim of
its own success -- by reducing economic volatility that in turn
fosters greater risk-taking.
He warned that protracted bouts of big risk-taking by
investors are always followed by asset-price declines, and he
said maintaining the U.S. economy's flexibility was essential
to helping it weather the inevitable blows.
"History cautions that extended periods of low concern
about credit risk have invariably been followed by reversal,
with an attendant fall in the prices of risky assets," he told
an economics conference in Chicago via satellite.
"Because it is difficult to suppress growing market
exuberance when the economic environment is perceived as more
stable, a highly flexible system needs to be in place to
rebalance an economy in which psychology and asset prices could
change rapidly," he said.
Prices for both U.S. stocks and government bonds rose a bit
after his remarks as traders showed relief he had not signaled
higher-than-expected interest rates ahead.
The Fed chief, who steps down at the end of January after
more than 18 years, said the U.S. economy's ability in recent
decades to weather a series of shocks -- including the latest
run-up in energy prices -- offered evidence of its increased
"That greater tendency toward self-correction has made the
cyclical stability of the economy less dependent on the actions
of macroeconomic policymakers, whose responses often have come
too late or have been misguided," he said."
"It is important to remember that most adjustment of a
market imbalance is well under way before the imbalance becomes
widely identified as a problem," Greenspan added.
The comments reminded observers of Greenspan's now famous
warning to stock market investors in a 1996 speech not to get
caught up in "irrational exuberance."
EXHAUSTING THE BOOM
Some economists have criticized Greenspan for failing to
stem the stocks bubble in the 1990s. He also faces criticism
for an ultra-low interest rate policy in recent years that some
argue has fueled speculation in housing.
As he has in the past, Greenspan defended the Fed's
decision to wait for the "eventual exhaustion of the forces of
boom" in the 1990s, saying acting aggressively to deflate the
stock market could have led to a "significant recession."
"Whether that judgment continues to hold up through time
has yet to be determined," he said.
He raised the prospect the economy's greater flexibility in
recent years could mean a better economic performance.
"If we have attained a degree of flexibility that can
mitigate most significant shocks -- a proposition as yet not
fully tested -- the performance of the economy will be improved
and the job of macroeconomic policy-makers will be made much
simpler," he said.
Some analysts said the speech appeared in part a "victory
lap," but one in which Greenspan seemed concerned about the
potential for market stress once he leaves office.
"As outgoing Fed chairman, he's clearly concerned about the
asset cycle and the prospect the low concern on credit risk is
going to be associated with a decline in asset prices down the
track," said Alan Ruskin, research director at 4Cast Inc.
Greenspan did not refer specifically to the low risk
premiums evident in the U.S. bond market -- a topic he and
other Fed officials have addressed in recent speeches.
Those low risk premiums have kept long-term interest rates
down, helping underpin swift housing price gains.
In a speech on Monday, Greenspan restated his view that
"froth" was evident in some local housing markets, but said it
was not yet clear if those speculative conditions would reach
across the nation as a whole.
On Tuesday, he said "fostering an environment of maximum
competition" was the best way to ensure economic flexibility.
In that regard, he said it was important to ward off
misguided efforts to try to protect jobs through trade
protectionism and other competition-inhibiting policies.
"Protectionism in all its guises, both domestic and
international, does not contribute to the welfare of American
workers," Greenspan said. "At best, it is a short-term fix at a
cost of lower standards of living for the nation as a whole."