Upswing will be a dicey time for Greenspan

Can the Fed wizard raise rates without bursting the housing bubble?
KNIGHT RIDDER NEWSPAPERS
WASHINGTON -- As the U.S. economy picks up, Alan Greenspan's much-vaunted reputation is on the line again.
The chairman of the Federal Reserve nursed the economy through recession and two wars by dropping interest rates to extremely low levels. Now he faces the tricky task of raising rates without undermining the recovery by suddenly popping what some analysts believe are bubbles in the housing and bond markets.
Inflation is the wild card. The economy grew at a healthy 4.2 percent annual clip in the first three months of the year, the Commerce Department reported Thursday. But inflation accelerated. Prices, excluding the volatile food and energy sectors, rose at a 2 percent annual rate, up from 1.2 percent in the previous three months.
Greenspan is betting that inflation will stay low enough to allow the Fed to nudge up interest rates gradually. That would soften the impact on the economy. Higher inflation, though, could force his hand. Then the Fed would have to jack up rates sharply and quickly, and that could send the economy reeling.
Complications
Either way, higher rates will cause some pain. Home construction is sure to slow. Interest on credit card debt and adjustable rate mortgages will rise. Poor countries will face higher interest payments on debt.
Bond market investors also stand to lose. Higher interest rates would drive down the value of the bonds in their portfolio. Other investors can get higher returns with new bonds, so they're not willing to pay as much for the old bonds.
"If you've gotten used to very low rates and dependent on them, it's going to be painful," said Peter Hooper, a former Fed economist and the chief U.S. economist at Deutsche Bank in New York.
Greenspan hopes to minimize that pain as well as the chance of a broader financial and economic crisis. But he also has to keep inflation at bay.
"This is a very delicate operation," said former Fed governor Lyle Gramley, a Washington-based consultant to Schwab Soundview Capital Markets.
What's next
The Fed's interest-rate-setting committee, which Greenspan chairs, isn't expected to raise rates when it meets Tuesday. But the latest inflation news will weigh on the minds of Fed officials as they debate whether to raise rates this summer or wait until later in the year or until 2005.
Some critics blame Greenspan for causing the 2001 recession by failing to head off the late 1990s stock market bubble with earlier interest rate increases. Now, they contend, low interest rates have created a housing and consumer-borrowing boom that is poised to collapse, possibly damaging some banks or investment houses in the process.
"They have kept interest rates so low for so long that they can't raise them without the house of cards collapsing," said Peter Schiff, president of Euro Pacific Capital, a money manager in Newport Beach, Calif.
Greenspan has argued that the Fed could only have pricked the stock market bubble by raising rates so high that it would have thrown the economy into recession.