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.
More specifically, the perception also results from the Fed's decisions to slash interest rates in response to a series of economic shocks over the last seven years -- thereby pumping cheap money and, some say, overconfidence into the markets. The shocks include the 1998 bond market turmoil sparked by a hedge fund's huge losses; the 2001 recession and terrorist attacks; and the fear in 2003 that falling inflation might turn into deflation, a harmful drop in the overall price level.
The Fed has been raising short-term rates gradually over the past year. Nevertheless, critics argue it should move more aggressively today and in the months ahead to curb various excesses they see:
* The surge of money into hedge funds, the lightly regulated and often heavily leveraged private investment funds for wealthy investors willing to take greater risks in search of greater returns. The amount under hedge fund management has grown to more than $1 trillion this spring from nearly $200 billion at the end of 1995, according to Hedge Fund Research Inc., a Chicago-based research firm.
* Soaring home prices. The value of all U.S. household real estate rose 15 percent in the first three months of the year from a year earlier -- faster than the growth in after-tax income, according to the latest Fed data.
* Real estate speculation. The National Association of Realtors estimates that 23 percent of U.S. homes purchased last year were for investment. Another 13 percent were second homes. About 23 percent of home buyers nationwide are using interest-only loans, according to LoanPerformance, a company that tracks loan originations. Interest-only and other types of adjustable-rate mortgage loans allow borrowers to pay no principal and sometimes little interest for an extended time while gambling that home prices will keep rising.
* The low interest rates paid on many types of debt issued by developing countries and shaky companies. One measure of risk in financial markets is the difference, or "spread," between the rates paid on such debt and the yields on ultra-safe U.S. Treasury securities. Such spreads have been tight this year, hitting lows not seen since before the Asian financial crisis of 1997 and 1998.
Fed officials share a concern about these developments but attribute them largely to a combination of Fed policy and complex global trends that have pushed down inflation and long-term interest rates worldwide for many years. This has helped stabilize the U.S. economy, resulting in milder, less frequent recessions.
People may be taking more financial risks because they reasonably expect the economic waters to remain calm, Greenspan suggested in his February report to Congress:
"In the United States, only five quarters in the past 20 years exhibited declines in [economic output] and those declines were small. Thus, it is not altogether unexpected or irrational that participants in the world marketplace would project more of the same going forward."
He added, however, "history cautions that people experiencing long periods of relative stability are prone to excess. We must thus remain vigilant against complacency."
Greenspan also said recently that the nation's housing boom is an unintended but acceptable side effect of the Fed's efforts to support the economy through difficult times. He and other Fed officials reject suggestions that they overreacted in cutting interest rates following the bursting of the stock market bubble in 2001.
"As best we can judge . . . the positive effects of the policy far exceeded the negative ones," Greenspan told Congress's Joint Economic Committee earlier this month. "And while it's too soon to judge the final conclusions of how all this comes out, I think that given the same facts under the same conditions, we would have implemented the same policy."
By June 2003, Fed officials had slashed their benchmark short-term rate to a four-decade low of 1 percent. They held it there for a year, encouraging consumers to keep spending. The cuts worked, helping keep the recession short and mild, supporting an initially weak recovery and preventing deflation. By last June, the economy no longer needed the stimulus of low rates, and the Fed started moving its benchmark short-term rate upward.
Over the past year, the Fed has raised the federal funds rate, the overnight rate charged between banks, to 3 percent in a series of eight hikes of one-quarter percentage point each. Fed officials are likely to move it up again at their meeting today, to 3.25 percent, and to keep pushing it higher in coming months to keep inflation contained.
Fed officials also are likely to repeat, as they have for more than a year, that they probably will keep raising the rate at a "measured" pace. While they emphasize that they could slow or pick up the pace as necessary, investors have come to think "measured" means no more than a quarter-percentage-point increase per scheduled meeting.
Many economists believe the Fed's strategy over the past year has succeeded, enabling financial markets to adjust gradually to rising interest rates with none of the turmoil of 1994-95, when the Fed raised rates higher and faster, contributing to Orange County, Calif.'s bankruptcy, Mexico's currency crisis and the demise of investment bank Kidder Peabody & Co.
"Let's give the Fed credit, they've done a phenomenal job," said Mickey Levy, chief economist for Bank of America Corp. "The economy is sound fundamentally and inflation is low."
However, the fed funds rate remains relatively low for an economy expanding briskly. Too low for critics like Morgan Stanley chief economist Stephen S. Roach, who argued recently that the Fed may have to raise the rate as high as 5.5 percent to wring out "the excesses that now exist."
And AEI's Makin said the Fed should shake the markets out of complacency by dropping its forecast of "measured" rate increases.
Fed board member Donald L. Kohn noted recently that some observers "think our words have removed too much uncertainty from markets, encouraging people to take financial positions that they will regret eventually." But he disagreed, saying, "I believe the performance of the economy, rather than our words, has shaped expectations beyond the very near term."
Kohn added a warning: "Market participants should understand the nature of the chances they are taking. . . . We central bankers are by nature a gloomy lot, trained to focus on what could go wrong; avoiding really bad outcomes helps to shape our policy, and a dose of central banker-like risk assessment is also good advice for investors."