Sept. 27 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan said asset prices often fall after long periods of stability and ``euphoria,'' echoing warnings he's issued over the past year that investors may be too complacent about risk.

``A decline in perceived risk is often self-reinforcing in that it encourages presumptions of prolonged stability,'' Greenspan told the National Association for Business Economics in Chicago today. ``Extended periods of low concern about credit risk have invariably been followed by reversal'' in asset prices.

While the Fed chairman didn't say which asset prices concern him, the speech came just one day after he said speculators may be driving up housing prices and creating a risk because so many Americans rely on home appreciation to support spending. Earlier this year he called the rally in bond prices a ``conundrum,'' given that the Fed is raising interest rates.

``This speech is telling traders that the stability they've come so well to know is their own worst enemy,'' said Diane Swonk, chief economist at Mesirow Financial Inc. The Fed's view is ``the bond market has not priced in enough risk.''

Greenspan, 79, also may be trying to ensure the economy is in order when his 18-year career at the Fed ends, economists said. His term as chairman expires Jan. 31.

``He's thinking about legacy building at this point and the one thing he doesn't want to do is leave at the top of an immense bubble and have it burst soon after he leaves,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich. Connecticut. ``He kind of touched on it yesterday in relation to the housing market.''

`Euphoria'

The chairman today pointed to an issue he has addressed before over the past few months: the ``irony'' that economic stability produces its own risks when investors bid up assets to unsustainable levels.

``Such developments apparently reflect not only market dynamics but also the all-too-evident alternating and infectious bouts of human euphoria and distress and the instability they engender,'' Greenspan said. ``Because it is difficult to suppress growing market exuberance when the economic environment is perceived more stable, a highly flexible system needs to be in place.''

Increased flexibility has helped the U.S. weather several shocks in recent years, including the rise of energy prices, Greenspan told NABE by satellite. His comments focused on the virtues of deregulation and economic flexibility, and he did not talk about the course of the economy or interest rates in the wake of Hurricanes Katrina and Rita.

Earlier today, San Francisco Fed Bank President Janet Yellen said in London that the U.S. economy will see a ``significant dip'' resulting from the surge in fuel costs.

Popping Bubbles

Once again, Greenspan reviewed the Fed's response to the 1990s stock bubble and said that an aggressive rate increase to stop the run-up would have risked a recession. ``Whether that judgment continues to hold up through time has yet to be determined,'' he said.

That comment was a revision of his previous conclusion in January 2004, when he said: ``There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful.''

The Standard & Poor's 500 stock index the yield on the benchmark 10-year Treasury note were little changed after the speech.

Home Prices

The Fed chairman said yesterday that ``signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels.'' The median price of an existing home rose 15.8 percent for the 12 months ending August to a record $220,000, the National Association of Realtors said yesterday.

Yields on U.S. 10-year notes have fallen to 4.28 percent from 4.58 percent on June 30, 2004 when the Fed began raising rates, an event Greenspan has called ``unprecedented.''

``Greenspan in particular has been trying to nudge those rates up,'' economist Stanley said. The Fed is ``probably going to have to tighten a little bit more to get the job done.''

Greenspan made similar warnings about excessive exuberance in August to central bankers at the Jackson Hole, Wyoming, conference sponsored by the Kansas City Fed. ``History has not dealt kindly with the aftermath of protracted periods of low risk premiums,'' he said then.

Jackson Hole

Greenspan has used his public speaking engagements to warn both Congress and the public that protectionism would most likely result in lower standards of living.

``Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers,'' Greenspan said today. Even though workers are subject to more job insecurity in the U.S, ``flexible labor policies appear to promote job creation.''

The hurricanes hit at a time when energy prices and raw materials prices were already high. The consumer price index rose 3.6 percent for the year ending August, and minus food and energy the index rose 2.1 percent. Unit labor costs rose 4.2 percent in the second quarter over the year earlier period.

President George W. Bush has not named a successor to Greenspan or nominated candidates to fill two vacancies for Fed governors. The man considered most likely to succeed Greenspan, based on a poll by Stone & McCarthy Research Associates, said he agrees with Greenspan's analysis that asset prices eventually, in Bernanke's words, ``flatten out.''

``House prices are primarily reflecting strong economic fundamentals, low rates, high economic growth,'' Ben Bernanke, chairman of the White House Council of Economic Advisers, in an interview. ``But looking forward, I think it is also true that house prices can't continue to rise at double-digit rates.''

Bernanke said ``risk premiums'' in U.S. stocks ``look quite normal'' and he expects inflation to remain under control.

Bernanke, 51, received 42 percent of votes as most likely to be chosen by Bush for the chairmanship in a survey of 84 Wall Street professionals conducted Sept. 19-21 by Stone & McCarthy, an economics firm in Skillman, New Jersey.

Last Updated: September 27, 2005 17:00 EDT

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