Financial Times (website only) - October 15 1999
Greenspan urges banks to prepare for a fall By Our Summaries Staff
Stock markets around the world were sent into decline on Friday after Alan Greenspan, the chairman of the US Federal Reserve, warned banks to set aside more money as insurance against a significant downturn in the financial markets.
While stressing he was not predicting a crash in stocks, Mr Greenspan told a banking conference in Washington that sudden losses in investor confidence inevitably occurred from time to time and urged financial institutions to increase their reserves to account for that possibility.
Following Mr Greenspan's comments, the dollar weakened to about ¥105.5, from ¥107.375 at the close in New York, and to E0.92, from its Wall Street close of E0.9277. The Standard & Poor's 500 index futures were down 11.5 points to 1,278.5 by 0830 GMT, suggesting that the Dow would open about 135 points lower.
In Asia, shares in Tokyo fell 1.3 per cent while Singapore lost 1.4 per cent. European markets also opened lower with the FTSE 100 index soon losing 100 points.
Mr Greenspan did not directly address the level of US stocks, but his comments were seen as another sign that he is worried about a potential bubble in prices. In December 1996, he said central bankers should guard against "irrational exuberance" in markets, a comment which sent the Dow down 2.3 per cent the following day.
In his latest speech, Mr Greenspan said the key question was whether the recent decline in equity premiums was permanent or temporary. Equity premiums refer to the extra amounts investors are willing to pay for the risk of holding shares compared to risk-free assets such as government securities.
If it is temporary, he said, then portfolio risk managers could find they have underestimated the credit risk of individual loans based on the market value of assets and overestimated the benefits of portfolio diversification.
Mr Greenspan suggested there were logical reasons for investors to pay such high prices for stocks. For one thing, the growth of information and the speed with which it can be gathered and distributed have reduced uncertainties and risk.
But the problem is, he said, whether the decline in equity premiums reflects new, irreversible technologies or is a result of a prolonged business expansion without a period of significant adjustment.
The full market impact of Mr Greenspan's comments, however, will depend on the government's report on producer prices, due before the US markets open on Friday.
Economists estimated the September producer price index would match August's 0.5 per cent rise but forecast prices excluding food and energy costs to rise 0.4 per cent on the month, compared with a fall of 0.1 per cent in August.
Rising prices may prompt further fears of an imminent rise in US interest rates which will also hit stock prices.
The Standard & Poor's index of 500 leading stocks has risen 263 per cent since the end of 1989, including a 10 per cent decline in prices since the end of July, shortly before the first of two quarter-point increases in the overnight bank loan rate by the Federal Reserve.
The Fed's policy-setting committee meets again on November 16.
Mr Greenspan said market crashes often seem inevitable in retrospect but are very difficult to anticipate.