WASHINGTON -- In his second appearance before Congress in as many days, Federal Reserve Chairman Alan Greenspan warned anew that the stock market is headed for a fall.
The difficulty, he acknowledged, is predicting when. The other unknown is whether middle-class Americans, who now own trillions of dollars of stock through IRA and 401(k) accounts and mutual funds, will run scared or use the downturn as a buying opportunity.
"Ultimately, yes, I think that history tells us there will be a correction of some significant dimension. What it doesn't help you on very much is when," Greenspan told a House Banking subcommittee Wednesday. "Indeed, history is strewn with periodic contractions of significant dimensions."
His comments were the latest in a series of cautions, stretching back to his December 1996 musings about "irrational exuberance." The market retreated after that comment but soon rebounded.
The Dow Jones industrial average, in fact, increased 45 percent between then and last Friday when it closed at a record 9,338. Nervousness over weak corporate earnings has driven the market down this week, and the average slipped an additional 61 points to close at 9,129 Wednesday.
On the whole, investors appear to be assuming that "low inflation and stronger productivity growth will allow the extraordinary growth of profits to be extended into the distant future," Greenspan said in testimony accompanying the Fed's midyear report to Congress.
These rising expectations of earnings growth have "driven stock prices sharply higher ... to levels that will be difficult to sustain" unless the cycle of low inflation and increased productivity continues, he said.
The stock run-up has added $12.5 trillion to U.S. households' net worth since the end of 1994.
Rep. Joseph P. Kennedy III, D-Mass., questioned whether a significant drop in stock prices would stampede investors who haven't experienced a declining market into pulling out entirely, thus exacerbating the decline.
Greenspan said he doubted that would happen.
"Most of the evidence of recent years is that people who have built up 401(k)s ... have been the ones who have been buying on the declines and, indeed, have turned out to be prescient and wealthier," he said.
Ultimately, though, any attempt to forecast investor behavior after a correction "is probably futile," he said.
The real danger, he said, is to investors who have allowed their growing portfolios to encourage them to take on excessive debt, which "all of a sudden becomes unserviceable" if stock prices fall significantly.
Investors weren't the only group whose optimism Greenspan challenged. Members of Congress, eyeing projected budget surpluses as a source of tax cuts or spending increases, should recognize that recent revenue growth has been fueled by soaring stock values, which in turn have increased capital gains tax collections, he said.
The Clinton administration this year is projecting the first budget surplus since 1969. According to the Treasury Department, the surplus in June -- a month when quarterly tax payments were due -- totaled $51.1 billion. For the first nine months of fiscal 1998, it totaled $67.1 billion.
But Greenspan noted that Japan's government experienced a surge of revenue in the late 1980s, when its stock market was booming, and then a sharp drop when Japanese stocks started falling in 1990.
"While we haven't seen the other side of a stock market decline, and hence its potential impact on revenue, it's instructive to observe that the Japanese had a quite similar phenomenon," he said.