Reiterating a credit-quality warning, Federal Reserve Board Chairman Alan Greenspan said Tuesday that bankers have not tightened underwriting standards enough.
"We find the issue somewhat discomforting," Mr. Greenspan told the Senate Banking Committee. "In our judgment, practices are looser than they need to be."
The strong economy may be deluding some bankers into believing low loan- loss rates will continue indefinitely, he said.
"It is remarkable how few losses there are and how few loans are delinquent," he said. "It is that process that is causing people to let down their guard."
Mr. Greenspan said banks, reacting to fierce competition, have been forced to cut lending rates. As a result, they already have booked loans that likely will go bad during the next economic slump.
"We don't know how much, but we do know that if history is any guide now is the time to be circumspect," he said.
Asked about record high bankruptcy rates, the Fed chairman urged Congress to enact reforms but declined to support any specific plan. The House approved a bankruptcy reform bill in June that would require more debtors to repay unsecured credit, and the Senate is expected to vote next week on a similar bill.
Mr. Greenspan said credit card lenders are not responsible for the record 1.3 million consumer bankruptcy filings last year. "Credit card debt, while growing substantially, is still relatively small," he said. "Mortgage debt, by comparison, is huge."
The Fed chairman was on Capitol Hill for his semiannual report to Congress on the economy, known as the Humphrey-Hawkins report. He is to make a similar report to the House Banking Committee today.
During 90 minutes of testimony, Mr. Greenspan generally praised the economy and indicated there was little chance the central bank would raise interest rates.
"The Federal Open Market Committee believes that the conditions for continued growth with low inflation are in place here in the United States," he said.
Mr. Greenspan warned, however, that the Fed is prepared to raise rates preemptively if evidence of inflation appears. "Should pressures on labor resources begin to show through more impressively in cost increases, policy action may be needed to counter any associated tendency for prices to accelerate before it undermines this extraordinary recovery," he said.
Sung Won Sohn, chief economist at Norwest Corp., Minneapolis, was disappointed by Mr. Greenspan's remarks. "We had hoped a softening economy would lead to cuts in interest rates," he said.
Mr. Greenspan also tried to temper both the equity and credit markets. "Expectations of earnings growth over the longer term have been undergoing continual upward revision by security analysts since early 1995," he said. "These rising expectations have, in turn, driven stock prices sharply higher and credit spreads lower, perhaps in both cases to levels that will be difficult to sustain unless the virtuous cycle continues."
Carl Tannenbaum, senior vice president and economist at LaSalle National Bank, Chicago, a unit of ABN Amro North America, said the comment is similar to Mr. Greenspan's "irrational exuberance" warning in December 1996.
"That was his way of bringing attention back around to the stock market," Mr. Tannenbaum said. "He is saying we need to be very cautious about making sure that asset prices are related to the fundamentals."
The Fed chairman also urged Japanese banks to liquidate real estate seized through foreclosure rather than keeping the assets on their books. "Allowing the problem to fester as long as it has was a major mistake and is going to make it a lot harder to resolve," he said.