How Alan Helped Ben

Greenspan sounded an alarm the Fed couldn't. Bernanke owes his predecessor a thank-you note

What does Federal Reserve Board Chairman Ben S. Bernanke think of his illustrious predecessor now? For weeks, Bernanke has been reassuring Washington and Wall Street that the economy is healthy and inflation pressures are diminishing. Yet Alan Greenspan comes along and helps ignite a global market firestorm by talking about the risks of recession in America. Is Bernanke feeling dissed by a living legend?

I doubt it. Of course, I don't know for sure, and neither Greenspan nor Bernanke is talking about their relationship. Yet I bet Bernanke is mouthing a silent thank-you to his predecessor. Greenspan just made Bernanke's job a bit easier.

The reason lies with a four-letter word: risk. Pension funds, hedge funds, private equity pools, and other investors are scouring the globe seeking higher returns. A tidal wave of foreign investment has poured into Brazil, China, India, and Russia. But it isn't just emerging-market giants that have attracted money. Vietnam's stock market is one of the fastest-growing in the world, up 52% year to date. Bernanke and the other Fed governors have crisscrossed the country openly worrying about excessive risk taking and investor complacency, to no avail.

The Messenger Matters

Maybe investors will pay more attention to Greenspan. In the speech where he talked about recession, he also said: "We have extraordinarily low risk premiums now. Risk is no longer perceived as major risk, at least as it was in years past, and that, I must say, I find disturbing."

The Fed has wrestled for years with how to react when it seems an asset-price bubble is emerging. In 1996, Greenspan fretted about "irrational exuberance" in the stock market, but his jawboning had little impact. Stocks soared into record territory until crashing in 2000. Greenspan was criticized for not hiking interest rates to burst the bubble.

This time around, investor enthusiasm for assets is global, and the danger is that risks are being systematically underestimated. Yet Bernanke is in a tight spot. If he hikes interest rates, he risks turning an implosion in the subprime mortgage market into a housing market collapse. The economy wouldn't be far behind. It's a far better tactic for a legend well-schooled in the risks of bubbles to sound the alarm.

Certainly everyone has a better appreciation of capital market risk after the events of this week. We'll find out in the weeks ahead whether jawboning works this time around.

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