Washington, Oct. 14 (Bloomberg) -- Federal Reserve Chairman
Alan Greenspan said surging stock prices have increased risks for
investors and lenders, and financial institutions should boost
their reserves to weather market panics.
Losses will ``inevitably emerge from time to time when
investors suffer a loss of confidence,' as they did a year ago
after Russia defaulted on its bank debt, Greenspan said in an
evening speech to a conference sponsored by the Office of the
Comptroller of the Currency.
While Greenspan didn't directly address the level of U.S.
stocks, Standard and Poor's 500 stock index futures slumped after
the Fed chairman's text was released at 7 p.m. in Washington. The
index fell more than 13 points in trading on the Chicago
Mercantile Exchange.
This isn't the first time Greenspan raised questions about
stocks. On Dec. 5, 1996, he said central bankers must guard
against ``irrational exuberance' in markets. That comment, also
delivered in an evening speech, sent the Dow Jones Industrial
Average skidding as much as 2.3 percent at the start of trading
the next morning. By the end of the day, though, the index
recovered about two-thirds of the decline.
The Dow index is also more than 60 percent higher today than
it was when Greenspan issued that 1996 warning.
``We wouldn't sell on this,' said Doug Johanson, a
portfolio manager at IMS Capital Management in Portland, Oregon.
which oversees $60 million. ``He's saying what he's said 10 times
-- that the high price of equities worries him.'
Like Fire Insurance
Greenspan said he said ``the key question' is whether the
recent decline in so-called equity premiums -- a measure of the
return investors are willing to accept for common stocks compared
to holding risk-free assets like Treasury securities -- is
permanent or temporary.
``If it proves temporary, portfolio risk managers could find
that they are underestimating the credit risk of individual loans
based on the market value of assets and overestimating the
benefits of portfolio diversification,' he said.
As a consequence, Greenspan said banks and other financial
institutions must ``set aside somewhat higher contingency
resources -- reserves or capital' to cover potential losses, he
said.
Maintaining such funds may seem like a less than optimal use
of money, but ``so do fire insurance premiums,' Greenspan said.
The Standard & Poor's index of 500 stocks is also 263
percent higher than it was on the last trading day of 1989.
That's even after a decline of almost 10 percent in the index
since it set a record in July, shortly after the first of two
quarter-point increases in the overnight bank loan rate by
Greenspan's Federal Reserve.
Inflation Fears
The yield on the 30-year Treasury bond has also risen more
than a full percentage point since early February on concerns
that the Fed will need to continually raise interest rates to
slow the economy as a way of keeping inflation in check.
A government report tomorrow could intensify investor
concerns about inflation. It is expected to show that prices paid
to U.S. producers rose in September for a third straight month,
pushed up by higher oil and tobacco costs.
Even after the recent decline in stocks, investors still
must pay the equivalent of 30 times the earnings of the average
S&P 500 stock today. While that's down from this decade's high
p/e of 35 in April, it's well above the average of 21.6 for all
of the 1990s.
Greenspan suggested there are logical reasons investors are
willing to pay so much for stocks. For one thing, the growing
wealth of information and the speed in which information is
gathered and distributed have ``reduced uncertainties' and risk
of relying on equities.
Tulip Bulbs
``That equity premiums have generally declined during the
past decade is not in dispute,' Greenspan said. ``What is at
issue is how much of the decline reflects new, irreversible
technologies, and what part is a consequence of a prolonged
business expansion without a significant period of adjustment.'
Greenspan said ``panic reactions in the market are
characterized by dramatic shifts in behavior that are intended to
minimize short-term losses.'
This happens time and time again throughout history, he
said. ``Whether Dutch tulip bulbs or Russian equities, the market
price patterns remain much the same,' he said.
Central bankers are no more adept than investors at
predicting when panics set in, Greenspan said. ``Collapsing
confidence is generally described as a bursting bubble, an event
incontrovertibly evident only in retrospect,' he said. ``To
anticipate a bubble about to burst requires the forecast of a
plunge in the prices of assets previously set by the judgments of
millions of investors, many of whom are highly knowledgeable
about the prospects for the specific investments that make up our
broad price indexes of stocks and other assets.'
Pricking Bubbles
In a speech in Columbia, Missouri earlier this week, Fed
Governor Laurence Meyer said investors sometimes push the values
of stocks and real estate above justifiable levels, but central
bankers shouldn't aim to prick such bubbles.
Instead, Fed policy-makers should focus on holding down
inflation and maintaining full employment, Meyer told a seminar
at the University of Missouri at Columbia, quoting the work of
researchers he said is ``worth considering.'
Such an approach will ``mitigate the adverse consequences of
equity market bubbles,' he said, citing the conclusions of an
economic study discussed at a recent conference sponsored by the
Federal Reserve Bank of Kansas City.
Central bankers are reaching a consensus, Meyer said, that
they should set monetary policy using a ``flexible inflation
target.' He defined such a goal as ``price stability plus a
cushion' to allow for errors in the measurement of inflation.
In practice, such inflation targets should probably be above
zero to prevent deflationary periods that would be destabilizing,
Meyer said.
¸1999 Bloomberg L.P.
regards |
