US 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 US 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.
"Greenspan is giving individuals ample warning that they need to take that into account," Allen Sinai, chief global economist at Decision Economics, said in an interview. "He's throwing out a yellow flag of caution.
Sinai 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.
Stock prices and house prices are factors that Fed policy-makers are increasingly needing to consider when setting interest-rate policy, Greenspan 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 the US' economic imbalances: the swollen account trade deficit, which surged to a record US$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.
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