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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Fed Chief’s Warning Spooks Markets Greenspan Calls Wall Street’s ‘Excessive Optimism’ Unhealthy

Martin Crutsinger Associated Press

Federal Reserve Chairman Alan Greenspan took his sharpest aim yet at the raging bull market Wednesday, warning of “excessive optimism” on Wall Street and reminding investors the Fed could launch a pre-emptive strike against inflation.

The comments roiled financial markets, sending stock and bond prices plunging. The Dow Jones industrial average was off more than 120 points in afternoon trading but trimmed those loses to close down 55 points.

In delivering his semiannual report to Congress on monetary policy, Greenspan used blunter and more detailed language to describe the central bank’s worries than he had in a Dec. 5 speech.

At that time, he first raised concerns that investors might be in the grips of “irrational exuberance.” Markets plunged around the world, but the impact was short-lived and the Dow soon began setting new records, crossing the 7,000-point level in recent weeks.

In his new testimony, Greenspan pointedly mentioned that the Fed was closely monitoring financial markets and the overall economy and stood ready to raise interest rates to fight pending price pressures.

“This is a rather blunt warning that if the stock market continues to roar ahead, it is threatening to become a source of economic instability,” said Lyle Gramley, economic consultant at the Mortgage Bankers Association and a former Fed board member.

American investors, including those saving for retirement, have been pouring money into the stock market, helping to fuel the rapid increases in stock prices in recent years.

In his appearance before the Senate Banking Committee, Greenspan warned that U.S. investors may have grown complacent about the risks.

“We have had 15 years of economic expansion interrupted by only one recession - and that was six years ago,” Greenspan said. “As the memory of such past events fades, it naturally seems less sensible to keep up one’s guard against an adverse event in the future.”

Greenspan said that rapidly rising prices for stocks and bonds can contribute to overall inflationary pressures in an economy. He also warned that speculative bubbles always burst and that when asset prices do fall it could trigger a recession.

“History demonstrates that participants in financial markets are susceptible to waves of optimism,” he said. “Excessive optimism sows the seeds of its own reversal in the form of imbalances that tend to grow over time.”

MEMO: This sidebar appeared with the story: WHAT GREENSPAN SAID “The Federal Reserve must not acquiesce in an upcreep in inflation, for acceding to higher inflation would countenance an insidious weakening of our chances for sustaining long-run economic growth.” “We cannot rule out a situation in which a pre-emptive policy tightening may become appropriate before any sign of actual inflation becomes evident.”

This sidebar appeared with the story: WHAT GREENSPAN SAID “The Federal Reserve must not acquiesce in an upcreep in inflation, for acceding to higher inflation would countenance an insidious weakening of our chances for sustaining long-run economic growth.” “We cannot rule out a situation in which a pre-emptive policy tightening may become appropriate before any sign of actual inflation becomes evident.”