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June 06, 2005

Alan Greenspan Is Worried

Edmund Andrews reports:

Greenspan Says Low Rates Tempt Investors to Risk More - New York Times: Alan Greenspan, chairman of the Federal Reserve, warned Monday night that the baffling persistence of low long-term interest rates was driving investors to hunt for higher returns by plowing money into hedge funds that will not be able to deliver on their promises. Speaking to a conference of central bankers in Beijing, Mr. Greenspan reiterated that he is perplexed that long-term Treasury bond rates are lower today than they were a year ago, when the Federal Reserve began systematically raising short-term rates. The persistence of cheap money is 'clearly without recent precedent' and defies simple explanation, Mr. Greenspan said.

Mr. Greenspan warned that low rates are driving investors to seek higher returns by taking on higher financial risks - particularly in hedge funds and private equity funds that hold out the prospect of higher profits through sophisticated trading strategies. He took particular aim at packages of debt known as collateralized debt obligations, which have been one of the fastest- growing businesses on Wall Street. Mr. Greenspan raised worries about the proliferation of hedge funds based on arcane but not fully tested trading strategies. 'I have no doubt that many of the new hedge fund entrepreneurs are embracing a strategy of pinpointing temporary market inefficiencies, the exploitation of which is expected to yield above-average rates of return,' Mr. Greenspan said. But, he cautioned, 'most of the low-hanging fruit of readily available profits' has already been picked.

Normally, long-term rates climb when the Fed raises short-term rates. But rates on 10-year Treasury bonds, which directly affect rates for mortgages and corporate bonds, have declined nearly one percentage point, to less than 4 percent, since the Fed began raising rates in June 2004.

Posted by DeLong at June 6, 2005 09:26 PM