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Greenspan Sees Signs Of Reversal

Federal Reserve Chairman Alan Greenspan said Thursday he sees "significant signs" that investors are becoming less fearful, which could reduce pressure on the Fed to ease rates again.

In a speech delivered by video to the Securities Industry Association's annual meeting, Greenspan spoke very little about the U.S. economy or the prospects for another interest rate cut at the Nov. 17 meeting of the Federal Open Market Committee.

As he has done several times over the past year, Greenspan analyzed the current global economic crisis and described measures he believes must be taken to adapt financial institutions to a world where capital and information flow faster and freer than ever before.

In September, Greenspan said investors had reacted to the global crisis by not only fleeing to less risky investments, which he considered a rational response, but also by seeking only totally liquid investments, which he considered motivated by fear. Greenspan noted that the spread between riskless government securities and nearly riskless corporation bonds had widened, indicating that investors were demanding a liquidity premium.

Soon afterward, the Fed cut interest rates twice in three weeks in an effort to prevent a serious credit crunch that could send the U.S. economy into a slowdown or recession.

"It is, of course, plausible that the current episode of investor fright will dissipate, and yield spreads and liquidity premiums will soon fall into more normal ranges," Greenspan said Thursday. "Indeed we are already seeing some significant signs of some reversals."

Greenspan said a major cause of the economic turmoil was ineffective financial institutions in many developing nations that were unable to cope with massive flows of capital. By contrast, institutions in the United States and Japan were easily able to adapt to "last month's unprecedented three-day weakening in the dollar, relative to the yen," he said.

"Open economies ... rarely experience exchange rate problems that destabilize those economies to the degree we have seen in Asia," Greenspan said. "Problems have arisen in recent years when an economy without a history of sound finance endeavored to 'rent it,' so to speak, by locking its currency into one of the stable currencies."

"There is no shortcut to sound fundamentals," he said.

Greenspan said the private sector will assume more of the responsibility of financial oversight. "As the financial system becomes ever more sensitive to change, consideration needs to be given to discourage excess leverage by financial intermediaries worldwide," he said.

Written By Rex Nutting, Washington Bureau Chief, CBS MarketWatch

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