Greenspan Says Asset Prices Often Fall After Eras of `Euphoria’

09/27/2005

Sept. 27 (Bloomberg)—Federal Reserve Chairman Alan Greenspan said long eras of economic stability and low risk often give rise to ``human euphoria’’ and that is later followed by declines in asset prices.

``A decline in perceived risk is often self-reinforcing in that it encourages presumptions of prolonged stability,’’ Greenspan said in the text of his remarks via satellite the National Association for Business Economics meeting 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.’’

Greenspan did not address the near-term course of interest rates in his speech, which focused on the virtues of deregulation and economic flexibility. Increased flexibility in the U.S. economy has helped it weather several shocks in recent years, including the rise of energy prices, he said.

The chairman pointed to an issue he has addressed before over the past few months: the ``irony’’ that economic stability produces its own risks when markets become overpriced. It’s not realistic to expect central banks to prevent increases in asset price bubbles such as the technology stock surge of the 1990s, he said.

``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,’’ 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 Fed chairman wasn’t specific about whether he was referring to some regional home prices or bond prices, two markets he has referred to as being abnormally priced in recent months.

Yields on U.S. 10-year notes have fallen since June 2004 when the Fed began a series of 11 rate hikes, an event Greenspan has called ``unprecedented.’’ The median price of an existing home rose 15.8 percent for the 12 months ending August, the National Association of Realtors said yesterday, to a record $220,000. The Fed chairman said yesterday ``signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels.