Greenspan cautions against overconfidence in investments

JACKSON, Wyo. -- Federal Reserve chairman Alan Greenspan on Friday cautioned Americans against thinking the value of their homes and other investments will only go higher, saying "history has not dealt kindly" with that kind of optimism.

Greenspan also said that bloated trade and budget deficits threaten the long-term health of the U.S. economy.

His warnings, made at a high-profile economic policy conference, came as the Fed chief and prominent economists pondered his 18 years at the central bank and the legacy he will leave. He is expected to step down in five months.

Rising house and stock prices have made many people feel more wealthy and have helped to support consumer spending, a key ingredient of the economy's good health.

Greenspan, however, said people shouldn't count on that paper wealth, which can evaporate if economic conditions deteriorate rapidly.

"What they perceive as newly abundant liquidity can readily disappear," he said. "Any onset of increased investor caution" could cause home and stock prices to drop, he noted.

A long spell of low interest rates and low risks for investors has especially encouraged investment in homes. Greenspan worried about what would happen if that climate were to change.

"History has not dealt kindly with the aftermath of protracted periods of low-risk premiums," he said.

Low interest rates have powered the booming housing market. Home sales have hit record highs four years in a row, and house prices are surging. In previous speeches, Greenspan has warned of "froth" and "speculative fervor" gripping some local housing markets.

If house prices were to fall suddenly or if interest rates were to rise rapidly, some local housing markets, homeowners and lenders could get clobbered.

Allen Sinai, chief global economist at Decision Economics, and others believe Greenspan was strengthening his warning about the booming housing market. But they didn't think he was signaling a new concern about the development of a national housing price bubble. Instead, they said, he seemed to be stressing his oft-stated worries about bubbles in local housing markets.

"He's staying with the position he had before. There are local bubbles but no national bubble," Allan Meltzer, a Carnegie-Mellon University professor, said in an interview.

On Wall Street, the Dow Jones industrials lost 53.34 points to close at 10,397.29.

Stock prices and house prices are factors that Fed policy-makers are increasingly needing to consider when setting interest-rate policy, Greenspan said. "Our forecasts and, hence, policy are becoming increasingly driven by asset price changes," he said.

During the high-flying stock market days of the 1990s, the Fed chief in December 1996 famously questioned whether Wall Street investors were engaging in "irrational exuberance." Despite the warning, stocks continued to soar. In 2000, the stock market bubble began to rupture and wiped out trillions of dollars in paper wealth.

Maintaining economic flexibility is especially important, Greenspan said, to deal with what he called some of America's economic imbalances: the swollen account trade deficit, which surged to a record $668 billion last year, and the housing boom.

"Developing protectionism regarding trade and our reluctance to place fiscal policy on a more sustainable path are threatening what may well be our most valued policy asset: the increased flexibility of our economy, which has fostered our extraordinary resilience to shocks," he said.

Teamsters President James Hoffa took issue with Greenspan's comments that trade protectionism is a threat to the economy.

"I think Alan Greenspan is wrong," Hoffa said in an interview with The Associated Press in Washington. "Teamsters unions and machinists have seen thousands and thousands of jobs go overseas that are never coming back" due to "unwise trade agreements."

Job loss, Greenspan said, should be addressed "through education and training, not by restraining the competitive forces that are so essential to overall rising standards of living of the great majority of our population."

Greenspan said that "fear of change" is behind stalled international trade negotiations and the hesitancy of Congress and the White House to "face up to the difficult choices that will be required to resolve our looming fiscal problems."

In the past, Greenspan has urgently called on policy-makers to shore up Social Security, saying a big wave of baby boomers starting to retire in 2008 will put massive strains on the system and if not fixed can imperil the overall economy.

Greenspan's remarks were to a conference, sponsored by the Federal Reserve Bank of Kansas City, called "The Greenspan Era: Lessons for the Future."

"The Greenspan era gets extraordinarily high marks," said John Taylor, professor at Stanford University. Those thoughts were echoed by many others attending the conference.

Greenspan's appearance at the annual two-day conference, which is attended by Fed policy-makers, economists, academics and central bank officials from around the world, is expected to be his last as Fed chairman.