Published On: Thu, Jul 24th, 2014

Former Fed Chief Greenspan Concerned About Bubbles

Former Federal Reserve Chairman Alan Greenspan

Former Federal Reserve Chief Alan Greenspan noted signs of economic recovery, but warned of “false dawns, ” bubbles of overvaluation and the burden of government deficits.

When asked about Fed Chair Janet Yellen’s controversial comments about overvalued sectors in the stock market, which include social media and biotech, Greenspan validated the notion that it is appropriate for a Fed Chief to make general observations about the stock market.  He told Marketwatch:

You can’t get around the fact that asset values have a major impact on economic activity, and no central bank can be oblivious to what is happening, not only in credit markets, which is, of course, the Fed’s fundamental mandate, but in asset markets, as well. As a central banker, in addition to evaluating stock prices, you have to cover commercial-real-estate markets, commodity markets and the price of owner-occupied homes, as well. Without asset-market surveillance, you do not have an integrated view of how the economy works. How to respond to asset-price change is a legitimate issue. But not to monitor it, I think, is clearly a mistake.

Allen Greenspan, who was Chairman of the U.S. Central bank between 1987-2006 discussed many of the financial crises in recent history in term of bubbles of overvaluation, whether the bubble was represented by the dotcom crisis of 2001 or the housing bubble, which popped in 2008. The reason why the latter had a more severe  and lasting impact than the former downturn was the amount of debt involved in the form of bad mortgages. Greenspan explained:

In a collapse in stock prices with no debt, unleveraged holders get the full impact of the equity loss, but there is no serial contagion. That was not the case in the housing bubble or the highly leveraged stock market of 1929.

Given the severity of the most recent crisis, Greenspan is concerned about the effect the end of the government’s quantitative easing will have on the economy. He noted how stocks swooned when there was even a discussion of tapering bond-buying. However, he did point to economic improvement, but warned of a “false dawn.”

Fear has diminished somewhat, but the shortfall in GDP from its potential is still predominately in these very long-lived assets that are discounted heavily. There is definite evidence the economy is picking up. The financial system is finally beginning to lend. But, what we don’t know is whether, when the recovery gets underway, it is going to run into another false dawn … At root, the problem is government deficits suppressing the national savings rate. Until we come to grips with that, it is going to be difficult to get the economy moving in a sustainable way.

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