Fed chief: Market must be watched closely

By Alice Ann Love The Associated Press August 27, 1999 9:59 a.m. CDT

WASHINGTON (AP) -- Federal Reserve Chairman Alan Greenspan said today that the nation's central bank must pay closer attention than ever before to what happens on Wall Street because more Americans are investing in stocks.

"As the value of assets and liabilities have risen relative to income, we have been confronted with the potential for our economies to exhibit larger and perhaps more abrupt responses to changes in factors affecting the balance sheets of households and businesses," Greenspan said.

His remarks were in a speech to be delivered today at the Fed's annual retreat, in Wyoming's Grand Tetons. The text was distributed in Washington.

There has been a debate in economic circles over whether financial markets should be taken into consideration when the Fed sets interest rate policy. Since the central bank's primary response is to keep inflation in check, some argue, it needs to focus on price changes in the real economy, looking at such things as whether commodity prices or wages are rising too quickly.

Greenspan, however, in today's speech, said that given the larger percentage of household wealth that is now accounted for by investments, the central bank needs to watch more closely what happens on Wall Street.

"Central bankers, in particular, are going to have to be able to ascertain how changes in the balance sheets of economic actors influence real economic activity and, hence, affect appropriate economic policies," Greenspan said.

Greenspan has expressed concern about the high-flying stock market before. In December 1996 he caused a sharp, brief selloff in markets around the world by wondering aloud whether investors were in the grip of "irrational exuberance."

At the time of that speech, the Dow Jones industrial average was hovering around 6,500. At midmorning today the index was at 11,175, even after Thursday's selloff dropped it below the record set Wednesdsay.

Greenspan returned to that theme in a more technical way today, discussing what he called "waves of optimism and pessimism" that are currently affecting stock prices.

He made a number of observations about various factors that make it difficult for investors to judge the true value of any given stock in today's economy. He said one problem was the "rapid shift in the composition of gross domestic product toward idea-based" technology, including such things as computer software.

Other factors he cited as giving investors problems in determining stock values included how a company accounts for its expenses on its balance sheet. Greenspan said a recent internal Fed study found that undervaluing the cost of stock options granted to employees resulted in overstatement of profits by one to two percentage points over the last five years.

Greenspan said another difficulty that economic forecasters face in judging how much weight to give to the stock market is the uncertainty of knowing how investors will react to unforeseen and unusual events.

On this point, he cited the turbulence created a year ago in financial markets around the world when Russia unexpectedly defaulted on billions of dollars in foreign debt.

"That episode of investor fright has largely dissipated," Greenspan said. "But left unanswered is the question of why such episodes erupt in the first place."

Despite all the sophisticated economic models that forecasters now have at their disposal, he said, it still is virtually impossible to predict when a financial market becomes overvalued and a crash is imminent.

"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," he said.

But even with this difficulty, Greenspan said, central bankers still must invest more efforts in determining the links between stock-market values and the real economy. He specifically said that further study is needed on something economists call the "wealth effect," the link between rising investment holdings and consumer spending.

"We no longer have the luxury to look primarily to the flow of goods and services, as conventionally estimated, when evaluating the macroeconomic environment in which monetary policy must function,"

-- mr. j (mr. j@whynot.com), August 27, 1999

Answers

"Despite all the sophisticated economic models that forecasters now have at their disposal, [Greenspan] said, it still is virtually impossible to predict when a financial market becomes overvalued and a crash is imminent."

* * *

YIKES!!! I think the BIG Gee just sent out the word to anyone with eyes to see and ears to hear. Time to bail!

-- M.C. Hicks (mhicks@greenwich.com), August 27, 1999.

Translation: Time honored/proven fundamental value investing means zip to current fund manager/cabdriver investment gurus....no thanks to Mr. Greenspan.

-- Charles R. (chuck_roast@trans.net), August 27, 1999.

History will show that the average ignorant public investor was poorly served by Mr. Greenspan's unforgivably late acknowledgement of these obvious facts. Of course, the Fed doesn't give a rat's about what happens to the mooches who've been providing the champagne and caviar through the sweat of their brow. After all, the hordes of greedy little mooches thought they were going to get rich without working. Ha! Serves 'em right! says the Fed.

Here's a word you'll here a lot in the next few years, "unwinding." Know it, because you're gonna live it.

-- Puddintame (achillesg@hotmail.com), August 27, 1999.

Hey Puddintame,

Greenspan was one of the first to talk of "irrational exuberance" in the stock market, and that was a 40% rise ago.

You may not like the Fed or fractional reserve banking, but I would not be quick to blame Greenspan for the current stock market bubble.

There is an article in the current Atlantic Monthly which can't understand why the Dow isn't at 36,000 right now. They cite lower uncertainty and more information available to investors who now understand how much less risky the stock market is now.

Yeah...and now that the Cold War is over, the world is a safer place.

-- nothere nothere (notherethere@hotmail.com), August 27, 1999.

Nothere, you're right, of course, about the irrational exuberance comment. He has somewhat talked about the bubble, but it's my perception that at the same time he was tailoring interest rates to protect LTCM and their ilk on Wall Street. Now I could be 180 degrees wrong on that, but my perception is that he was complaining about the heat while he was stoking the fire.

-- Puddintame (achillesg@hotmail.com), August 27, 1999.

Gee, even at this late-late date, Greenspan NEVER EVEN MENTIONED the three letter Y word. (Well, 2 letters 1 numeral.) Must not be important to the stock market and the economy after all....

-- King of Spain (madrid@aol.com), August 27, 1999.

for the last 3 years greenspan has been warning the public with his irrational exhuberance and bubble speaches and the result was that the market keeps on going higher and higher. I still belive it is the seperation of the Joe Public to make his retirement now or ork till he is 100 years old. Greenspan cannot possible mention Y2K ( even thought) he did say in of his speeches that nex year there will be a slow down) if he would mention y2k he would himself start the bursting of the bubble and that is not his job.

-- rena (wsch 117360@aol.com), August 27, 1999.

Can someone please translate this for me? I'm not kidding! If you know what the hell he is saying, can you please explain it to me!

Thank you! (god, I hate making myself vulnerable)

"As the value of assets and liabilities have risen relative to income, we have been confronted with the potential for our economies to exhibit larger and perhaps more abrupt responses to changes in factors affecting the balance sheets of households and businesses," Greenspan said.

-- Dave Butts (dciinc@aol.com), August 27, 1999.

Has anyone ever heard of the magic number - 11,600? Seems I read in another forum months ago a post by a Canadian analyst who predicted, based on a numerical formula that the market cannot hold past 11,600. Are we not very close to this?

:)April

-- April (Alwzapril@home.com), August 27, 1999.

Well, let's see if we can read Mr. G's mind:

"As the value of assets and liabilities have risen relative to income,

The majority of households are relying on ever-increasing value of real estate and stocks/equities, not on income, to offset all that debt they've racking up...

we have been confronted with the potential...

We're seeing a big ol' weather system on the radar...

for our economies to exhibit larger and perhaps more abrupt responses to changes in factors...

and when that storm hits, lots of things will move very quickly and in a very big way...

affecting the balance sheets of households and businesses,"

hitting everyone right in the pocketbook...

Greenspan said.

I'm not doing these speeches, for my health, OK? Listen up!

Summary:

Batten down the hatches, we're headed into a squall.

-- Mac (sneak@lurk.hid), August 27, 1999.

Thwack!

Thwack!

-- Mac (sneak@lurk.hid), August 27, 1999.

Dave,

It means that we're playing with stock market numbers that hardly seem real any more, but scary anyhow. When your market holdings were half your yearly income, or two times your yearly income, or whatever, it still seemed real. You kept some in the bank, you played with some, you had your feet on the ground.

Now you have folks with a million bucks of Monopoly money, manufactured by stock inflation in a bubble, and they slop it around like a puppy that hasn't learned to eat Pablum without standing in the bowl. It's not real anymore. Get a whim, cash it out, throw it from one fund to another like promissory ping pong. It's like the federal budget - a billion here, a billion there ...

[But holy cow, Martha, this is twenty years' income! What do we do if the market drops? Well, Joe, haul it out before someone else does, because without that, we're paupers.]

It's not real because it's too big to be real, but it's scary because it's all we have. Alan is saying that greed and fear are really close to being equal. And we're all vulnerable.

-- bw (home@puget.sound), August 27, 1999.

"Blast it, Spock, Ah'm a mind-reader, not a Webmaster!"

"Obviously, Doctor."

-- Mac (sneak@lurk.hid), August 27, 1999.

Puddintame,

It is true that Greenspan was 100% behind the bailout of Long Term Capital, and I agree that this was an inflationary mistake. Ever since October of 1987, he has seen himself as a preventor of collapsing capital markets. He's been trying to talk the markets down without collapsing them for a good 3 years now.

It won't work until Y2K fears hit the markets with greater uncertainty in the next few months and the interest rate spreads widen some more. My guess would be October.

Rena,

Greenspan testified to Congress about Y2K over a year ago in an unofficial capacity during one of his official visits. He admitted to making the mistake himself and underlined the seriousness of the issue. Since then he has backed the banking industry's claim that they are fully compliant. I think he is afraid of cash withdrawals, and for good reason.

Dave,

How's this?

"As the value of assets and liabilities have risen relative to income,"

As the prices of stocks and the size of the debts that households own (including mortgages and credit card debt) rise faster than those households' wages and other income,

" we have been confronted with the potential for our economies to exhibit larger and perhaps more abrupt responses"

the stock market and other financial markets not only have been more volatile in the last year, but are now even more vulnerable to large price swings than they were before due

" to changes in factors affecting the balance sheets of households and businesses," Greenspan said.

to normal bad things like recessions which unemploy lots of people and bankrupt businesses.

What he's really saying, and I agree with him fully, is that if we even get a mild recession in the near future, the stock market in the U.S. (and probably elsewhere) is going to collapse, and quickly.

-- nothere nothere (notherethere@hotmail.com), August 27, 1999.

Dave,

Strong but vulnerable men are my favourite.

G'span's saying that individuals and businesses are now way over- leveraged on credit, so the domestic economy is seriously vulnerable to market shifts.

It's not you--G'span's quite the *stylist*.

-- PH (ag3@interlog.com), August 27, 1999.