Greenspan Warns, Stocks Rally

Greenspan, however, spent a large part of his speech justifying why the Fed had not burst the tech bubble in the 1990s, emphasizing that it was not the role of monetary policy to control asset prices:

"By the late 1990s, it appeared to us that very aggressive action would have been required to counteract the euphoria that developed in the wake of extraordinary gains in productivity growth spawned by technological change. In short, we would have needed to risk precipitating a significant recession, with unknown consequences. The alternative was to wait for the eventual exhaustion of the forces of boom. We concluded that the latter course was by far the safer. Whether that judgment continues to hold up through time has yet to be determined."

Noteworthy on its face, those comments about the tech bubble take on heightened significance given that Greenspan has intensified warnings about asset prices recently, most notably housing. Greenspan's comments came after the Census Bureau reported that sales of new homes fell 9.9% in August from 1.373 million in July. Economists expected a rate of 1.350 million new homes to be sold.

Major homebuilders fell in reaction, with Toll Brothers (TOL Quote) losing 1.6% and KB Home (KBH Quote) shedding 1.9%. Lennar (LEN Quote) was relatively strong after reporting better-than-expected earnings and strong guidance late Monday but still slid 0.1%.

Psychology vs. Sentiment

Signs of cooling in the housing market have multiplied over the past month and a half. Even as sales of existing homes roared past expectations in August (as reported Monday ) the data showed an increasing buildup in inventories, which could put further downward pressure on home prices going forward.

In a previous speech Monday, Greenspan said that even if a downward trend in home prices were to continue, most homeowners would be cushioned by the equitiy in their homes.

If that's true, that would be reassuring for the outlook of consumption, especially after Tuesday's news of a post-Katrina plunge in consumer confidence in September. The Conference Board's consumer confidence index fell to 86.6 in September from 105.5 in August, reaching a two-year low. This is also the third largest one-month drop in the index's history, which began in 1985.

According to Charlie Kenny, president of consumer psychology consulting firm Right Brain People, the emotional comfort associated with the values of homes is a far better indicator of consumption patterns than sentiment surveys.