Alarm Bell is Sounded by the Fed's Chairman

Here, Mr. Greenspan is issuing a warning that the housing bubble is about to burst.
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Greenspan cautions investors

By JEANNINE AVERSA

Tuesday, September 27, 2005 Posted at 3:09 PM EDT

Associated Press

WASHINGTON — Federal Reserve Chairman Alan Greenspan issued a fresh warning on Tuesday that investors shouldn't be lulled into a false sense of security by the economy's long stretch of low interest rates.

“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,” Mr. Greenspan said in a speech delivered via satellite to a meeting of the National Association for Business Economics in Chicago.

Mr. Greenspan, in Tuesday's speech, didn't specify what risky assets he was referring to. But the Fed chief has been sounding an alarm for months — including an emphatic warning on Monday — about the perils to home owners and lenders using risky and exotic types of mortgages.

In his remarks Tuesday, Mr. Greenspan repeated worries he has expressed in the past — that a rise in interest rates may spell trouble for some investors who are counting on rates to stay low for an extended period of time.

“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,” he said.

The country enjoyed some of the lowest mortgage rates in more than four decades, when the Federal Reserve ratcheted down a key interest it controlled to the lowest level in 46-years. However, since June 2004, the Fed has been raising rates gradually to keep inflation in check.

This Fed campaign is beginning to have an impact on long-term interest rates set by financial markets. While long-term rates — such as those on mortgages — are still considered low, analysts do believe that they will move higher in coming months.

Low mortgage rates powered home sales to record highs four years in a row and are on track to set a new record this year. The hot housing market has sent home prices skyrocketing.

Mr. Greenspan said it is “difficult to suppress growing market exuberance when the economic environment is perceived as more stable.”

The economy, he said, has shown incredible resilience in the face of major shocks, including the bursting of the stock market bubble in 2000 that wiped out trillions of dollars in paper wealth and the Sept. 11, 2001, terror attacks.

Even now, coping with steep rises in oil and natural gas prices over the last two years, the economy thus far has weathered “reasonably well” this situation, Mr. Greenspan said.

Mr. Greenspan devoted part of his speech to an extensive defence of the Fed's failure to deflate the stock market bubble of the 1990s. He again stated his belief that it would have required the Fed to push interest rates so high it could have triggered a serious recession.

He acknowledged, however, that the Fed was troubled as stock prices soared.

“We at the Fed were uncomfortable with a stock market that appeared as early as 1996 to disconnect from its moorings,” he said.

Despite this concern, he and other Fed policy-makers believed that “we would have needed to risk precipitating a significant recession, with unknown consequences,” to have any impact on the roaring stock market at that time.

Mr. Greenspan on Monday offered his most extensive thoughts thus far on the housing market with a two-pronged message. He issued a fresh warning about risky mortgages, saying in the event of a widespread cooling in the housing market certain borrowers and lenders “could be exposed to significant losses.”

At the same time, Mr. Greenspan said most homeowners are in a fairly good position to weather a shock if prices drop.

“The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices,” he told a bankers conference in California.

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