Monday, February 26, 2007

"We have extraordinarily low risk premiums now."

The Wall Street Journal quotes Alan Greenspan that we may have a recession later this year. To some extent the Journal is trying to make a headline. Alan Greenspan would always say that the next phase of our current cycle is a recession: that's what follows an expansion. The question is when. He warned his audience that the cycle is mature: profit margins are no longer expanding.

He found "disturbing" how low risk premia have fallen. Professor Greenspan was teaching us that when we discount risk too much we set ourselves up for a fall. When shocks occur, investors and institutions become more risk averse in reaction. This sets up the pull back in lending, investing, and spending that drives the economy down.

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