Backstopping the Economy Too Well?

Some Experts Worry Greenspan's Success Bequeaths Risky Overconfidence

In financial markets, they call it "the Greenspan put" -- a belief that if stock or bond prices fall too much, the Federal Reserve will help prop them up with quick interest rate cuts to pump more cash into the system.

For many home buyers, it's the sense that house prices will keep going higher in a U.S. economy blessed with healthy growth, low interest rates and tame inflation -- thanks in part to Fed policies under Chairman Alan Greenspan.

For many lenders, it's the assumption that borrowers in the stable, vibrant Greenspan Economy will have no trouble repaying increasingly risky home mortgage and home-equity loans.

But according to some Fed observers, this confidence is a worrisome legacy after Greenspan's nearly 18 years helping to steer the economy through a variety of storms. As Greenspan prepares to step down early next year, they say, he leaves behind a widespread perception that people can take bigger financial risks because the chairman can and will save them if their bets go sour.

Greenspan does not lay claim to such powers. He and other Fed officials have expressed concern about increasingly risky financial behavior, stepping up their warnings about exotic investment strategies, real estate speculation and loose lending practices.

The chairman even felt compelled to state recently that he cannot foresee the future and prevent all bad things from happening.

"The economic and financial world is changing in ways that we still do not fully comprehend," Greenspan told a bankers' conference in Beijing. "Policymakers accordingly cannot always count on an ability to anticipate potentially adverse developments sufficiently in advance to effectively address them."

Now you tell us.

"The essential Greenspan legacy . . . is the idea that the Fed will allow nothing to go really wrong," said James Grant, publisher of Grant's Interest Rate Observer, a biweekly analysis of financial markets.

In financial dealings, a "put" is a contract that ensures an investor will get no less than a certain price for an asset, such as a stock or a bond. It puts a floor under falling prices and insures against greater losses.

Investors have come to perceive the Fed's policies of recent years as "free insurance for aggressive risk-taking," said John H. Makin, an economist at the American Enterprise Institute. "Who doubts that a sharp drop in the market for housing or in the stock market would cause Fed [credit] tightening to stop or even to be reversed?"

The idea of "the Greenspan put" stems in part from the chairman's success in helping to steady financial markets through the stock market crash of 1987, the recession of 1990-91 and international financial crises of the 1990s.