Greenspan points to market ‘fear’

Analysis

Current financial turmoil is identical to that seen in earlier stock market crashes, Alan Greenspan has warned.

The ex-Federal Reserve boss compared today’s situation to the crash of 1987 and the fallout from the near-demise of Long-Term Capital Management in 1998. Anxiety over a global credit squeeze triggered by the US housing slump was driven by “fear”, he said in a speech. “The human race has never found a way to confront bubbles,” he said, alluding to booms suddenly grinding to a halt.

According to the Wall Street Journal, Greenspan drew parallels in a speech in Washington with US financial panics down the years, driven either by a collapse in confidence in banks or land speculation turning sour. The current turbulence is being driven by banks’ unwillingness to lend until the full extent of their exposure to the troubled sub-prime mortgage market becomes clear, a situation which threatens to hurt the US economy and spread to other countries. The Federal Reserve has said sub-prime losses could total $100 billion and is under pressure to cut interest rates later this month to make borrowing cheaper for banks and consumers. “The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998 and what we saw in the stock market crash of 1987," Greenspan said. The remarks were made at a meeting in Washington organized by the academic journal Brookings Papers on Economic Activity.

1987 saw the largest one-day peacetime fall in the US stock market, when more than 20% was wiped off the value of the Dow Jones index of leading companies. The collapse was triggered by the widespread fear that the US economy was set to slow after a period of feverish expansion, in which borrowed money, some of it high-risk, was used to fund huge takeovers. The financial problems of Long-Term Capital Management, which caused consternation in the global derivatives market, were triggered by the Asian financial crisis of 1997, which spread to Russia and Brazil a year later. Stock markets in the US recovered relatively quickly after both upheavals.

Greenspan, who now advises a number of hedge funds and other financial institutions, said the nervousness, which typically gripped markets when a period of “euphoric” expansion ended was extremely powerful. “The expansion phase of the economy is quite different and fear as a driver, which is going on today, is far more potent than euphoria,” he said. (bbc.co.uk)

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