Even if he's not widely credited for it, Alan Greenspan has been successful recently in sustaining strength in housing, boosting stock and Treasury market prices, and weakening the dollar.

But acknowledging that Greenspan is getting what he wants is not the same as condoning his actions. Many observers worry Greenspan's short-term successes are going to cause major long-term headaches. Although the chairman is hoping rapid money-supply growth -- M2 has risen at an annualized rate of 13.4% in the last eight weeks -- will continue to fuel higher asset prices, critics contend this overly accommodative monetary policy threatens to unleash dangerous speculation in equities, reminiscent of the late 1990s, as well as grossly inflated Treasury and housing markets.

Broadly speaking, Greenspan is betting strength in the housing market -- and more recently stocks -- will spur consumer spending to keep the economy afloat until business expenditures revive. Despite a 42-year-low in the fed funds rate, corporate executives remain reluctant to spend because the 1990s spending boom generated poor returns and created overcapacity that remains onerous today. (Yes, many executives also are distracted by new accounting regulations and other oversight issues.)

"Do you really need more capital spending when capacity utilization rates are so low?" wondered John Lonski, senior economist at Moody's Investors Service. "You have to be patient and work your way out of this sluggish state."

Ahh, but we live in impatient times. In this world of instant gratification ( yes, Dad, you were right), investors, policymakers and certainly politicians are loathe to contemplate slogging through years of sluggish growth. Trouble is, many economists believe Greenspan is prescribing the wrong medicine for what ails the economy.

A Lender and a Borrower Be

By keeping the fed funds rate at 1.25% since November 2002, and threatening to ease more, Greenspan has pushed Treasury yields to levels unseen since the 1950s and spurred record mortgage and refinancing activity. Concurrently, the Fed has encouraged rabid lending activity by giving banks a veritable license to print money via the so-called carry trade, whereby institutions borrow at the rock-bottom fed funds rate and lend at higher rates along the yield curve.

With debt being the drug and the Fed being the pusher, Paul Kasriel, chief U.S. economist at Northern Trust, compared American households and business to heroin addicts. "If you give a heroin addict a fix, he'll function better in the short run then if he went cold turkey," Kasriel said. "But if you keep giving him fixes, ultimately he's going to die."

On the corporate side, $70 billion of debt was issued in May, while an additional $14.1 billion was raised through convertible bond offerings, according to Morgan Stanley. Total outstanding credit market debt totaled $32 trillion at the end of 2002 vs. $13 trillion in 1990, according to Doug Noland, financial markets strategist at David Tice & Associates in Dallas.

In the household sector, refinancing activity has lowered borrowing costs and helped Americans replace "bad debt" with good. Still, households' total liabilities relative to total assets were a record 18.3% in the fourth quarter and personal bankruptcies were at an all-time high as of March 31, Kasriel noted.

To his many critics, it is as if Greenspan has facilitated a migration from one bubble in equities to another in housing, with a Treasury bubble thrown in for good measure. The equity bubble, of course, ended with one of the worst bear markets in American history. Some foresee the risk of repeats in housing and fixed income, with perhaps even more devastating effects to the real economy.

"Indeed, never has a financial system been more vulnerable to higher interest rates, emanating from the highly over-borrowed consumer and corporate sectors, as well as the egregiously exposed financial and 'speculator' arenas," Noland recently wrote. "And there is absolutely no escape."

On a less draconian note, Lonski fears ever-lower mortgage rates could trigger a true housing bubble, much as the Fed's aggressive easing in 1998 spurred wild speculation in equities.

Although there are currently pockets of insanity in housing, Lonski referred to even more excessive speculation and overbuilding, akin to what occurred in the 1980s. That cycle ended, in part, because of the stock market crash in 1987. Notably, the Fed today is pursuing policies consistent with a weaker dollar, a major trigger of the '87 crash. Skeptics worry that weakness in the greenback will turn into a rout, prompting the Fed to tighten monetary policy. Higher rates will curtail economic growth and have devastating consequences for both housing and Treasuries.

"Rates will turn fast and end refinancing activity," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson in Chicago. "It can be vicious when an easing cycle comes to an end."

Wesbury recalled the bond market's heavy losses in 1994, after the Fed abruptly ended an easing campaign and started tightening. The bond market is "in the same can of worms today," he said, suggesting the Fed is "too easy" today and "you can't play that game forever."

Should rates rise and/or home prices fall dramatically, for whatever reason, homeowners will be unable to extract equity via refinancings. Also, many homeowners may find themselves "upside down" on their mortgages, meaning they'll owe more than their homes are worth and delinquencies may rise. Given commercial banks' exposure to mortgage debt -- of all stripes -- any trouble in the housing sector will have serious repercussions for the financial sector; ominously, mortgage foreclosures hit a 30-year high in the fourth quarter, as reported previously.

Furthermore, no matter how low mortgage rates fall, it's going to be hard for most Americans to make their mortgage payments if they're out of work.

Laboring Over Jobs

Labor markets will be the center of attention Friday. The May jobs report is expected to show nonfarm payrolls falling by 30,000, while the unemployment rate rises to 6.1% from 6%, according to Briefing.com. Greenspan's description of the labor market as "exceptionally weak" on Tuesday provides ample cover for the Fed to ease again at its policy meeting on June 24-25, if not sooner, if the jobs report proves much weaker than expected (Payrolls fell by a less-than-feared 17,000 and the unemployment rate was 6.1%, as expected. Stocks rallied early Friday in reaction and Treasury prices fell as expectations for a 50-basis point Fed ease this month diminshed.).

"A weak-enough reading on May employment might very well tilt the odds overwhelmingly in favor of another rate cut," Lonski agreed. "Beyond that, I don't see a compelling reason indicating another rate cut is required."

In addition to the "record-smashing" pace of mortgage applications, the Institute for Supply Management reported higher-than-expected surveys for both manufacturing and services this week, the economist noted. Meanwhile, equities have rallied sharply, corporate bond spreads have narrowed and the dollar has fallen markedly in the past year. In addition, Moody's index of industrial metals is up 12.5% year to date and "not warning of deflation at all," he continued. Notably, that index excludes crude prices, which are hovering around $30 per barrel, a level few associate with deflationary pressures.

So if deflation really isn't a threat, why do Greenspan & Co. keep talking about it? In fairness, many believe the risks are real, citing deflationary pressures emanating most prominently from Japan and China, and more recently Germany. By their own admission, Fed officials have never dealt with deflation in the real world, so it's best for them to be overly aggressive in preventing its onset.

However, some believe the Fed waited too long to address the deflation threat and "the delay has weakened the system and potentially imperiled the economy to such an extent that it will be far more vulnerable to extraneous shocks," as Dave Hunter, chief market strategist at Kelley & Christensen, warned. "I think history will record that his recent shift to a more accommodative policy" -- meaning faster monetary growth and not just lower rates -- "was 'too little, too late.'"

In other words, Greenspan emerging victorious isn't guaranteed, even if he's ahead of the game right now.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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