Foreseeable dangers

If the stock market crashes in the next couple of months, Donald Coal will be able to say "I told you so" thanks to his list of five factors that could lead to a financial storm. Of particular interest is the most plausible threat:

Alan Greenspan is headed for retirement, and he wants to go out as the man who slew the speculative excesses that threaten the U.S. economy -- notably the housing bubble. In all past periods of sustained Fed tightening, long-term interest rates rose. Most importantly, the yield on the 10-year treasury note, which is the basis for home mortgage loan yields, always rose, and that cooled out -- or sometimes killed -- the housing market, along with other kinds of asset speculation. Not this time.

In what Greenspan calls "a conundrum," 10-year yields have actually fallen since he began raising the Fed funds rate from its surreal low level of one per cent to the current 3.5 per cent. In percentage terms, that's the most dramatic Fed tightening ever, but money is still loose, speculation is still robust, and house prices remain, as he puts it, "frothy" in at least some parts of the country. (Greenspan resists using the term "bubble," because he has never identified a bubble until after it burst, even Nasdaq at 5,000.)

When he was a private economist, Greenspan was known as a poor forecaster. Perhaps that record encourages him to proclaim the impossibility of identifying asset price excesses. Still, he keeps raising interest rates by .25 per cent at every meeting. The gap between his rate and the 10-year yield is now a relatively tiny .8 per cent, aiming toward almost zero by year-end. Flat or inverted yield curves (in which short-term interest rates are as high, or higher than, long-term rates) usually produce recessions. They even more usually produce stock market sell-offs.

Of course, there's no easy way out of the problem for Greenspan: while holding the Fed rate down would avoid the inverted yield curve, that would also help to encourage more spending and expand what Greenspan surely knows to be a housing bubble. Unfortunately, it was bad policy choices over the past four years that made the situation what it is now - and like it or not, Greenspan's legacy will likely be as the man who could (and should) have prevented both the reckless Bush tax cut and the current bubble. It seems the best he can do now is to try to shift some of the blame.

For the rest of us, meanwhile, now might be a great time to let some investments go on vacation.