GREENSPAN SEES ASSET PRICE DROP AFTER ‘ EUPHORIA’
‘ PRESUMPTIONS OF STABILITY’
NEW YORK •
U. S. Federal Reserve Chairman Alan Greenspan said yesterday asset prices often fall after long periods of stability and perceived low risk create “euphoria,” comments that economists read as a warning about housing and bond prices.
“ A decline in perceived risk is often self-reinforcing in that it encourages presumptions of prolonged stability,” Greenspan told the National Association for Business Economics in Chicago. “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.”
While Mr. Greenspan didn’t say which asset prices concern him most, the speech came just one day after he said speculative buying may be driving up housing prices and creating a risk because so many Americans rely on home appreciation to support spending. Economists said Mr. Greenspan is trying to ensure the economy is in order when his non-renewable term ends Jan. 31.
“He’s thinking about legacy building at this point and the one thing he doesn’t want to do is leave at the top of an immense bubble and have it burst soon after he leaves,” said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich. Conn. “He kind of touched on it yesterday in relation to the housing market.”
Increased flexibility has helped the U. S. weather several shocks in recent years, including the rise of energy prices, Mr. Greenspan told NABE by satellite. His comments focused on the virtues of deregulation and economic flexibility, and he did not talk about the course of the economy or interest rates in the wake of Hurricanes Katrina and Rita.
The yield on the benchmark 10-year treasury note was unchanged after Mr. Greenspan’s comments.
It’s “simply not realistic” to expect central banks to prevent increases in asset price bubbles such as the technology stock surge of the 1990s, Mr. Greenspan said. He pointed to an issue he has addressed before during the past few months: the “irony” that economic stability produces its own risks when markets become overpriced.
“ Such developments apparently reflect not only market dynamics but also the all- too- evident alternating and infectious bouts of human euphoria and distress and the instability they engender,” Mr. Greenspan said. “ Because it is difficult to suppress growing market exuberance when the economic environment is perceived more stable, a highly flexible system needs to be in place.”
The median price of an existing home rose 15.8% for the 12 months ending August to a record US$220,000, the National Association of Realtors said yesterday. Mr. Greenspan said yesterday that “ signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels.”
Yields on U.S. 10-year notes have fallen since June, 2004, when the Fed began raising rates, an event Mr. Greenspan has called “unprecedented.”
The Fed chairman made similar warnings about excessive exuberance in August to central bankers at the Jackson Hole, Wyo., conference sponsored by the Kansas City Fed. “History has not dealt kindly with the aftermath of protracted periods of low risk premiums,” he said then.
Mr. Greenspan has used his public speaking engagements to warn both Congress and the public that protectionism would most likely result in lower standards of living.
“Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers,” Greenspan said today. Even though workers are subject to more job insecurity in the U.S, “flexible labor policies appear to promote job creation.”
The hurricanes hit at a time when energy prices and raw materials prices were already high. The consumer price index rose 3.6% for the year ending August, and minus food and energy the index rose 2.1%. Unit labour costs rose 4.2% in the second quarter over the year earlier period.