Greenspan sees peril in cheap mortgages

`Dramatic increase' in interest-only loans helps create housing `froth,' he says

Overall, economy called best in history

June 10, 2005|By Joel Havemann | Joel Havemann,LOS ANGELES TIMES

WASHINGTON - Federal Reserve Chairman Alan Greenspan warned yesterday that new, liberal kinds of mortgages were helping to drive up home prices and fueling the danger of a sharp price decline.

Greenspan said low-interest-rate mortgages also were contributing to what he termed "froth in some local markets." He said he continued to be bewildered by the decline in mortgage rates and other long-term interest rates even as the Fed is beginning the second year of its campaign to raise short-term rates.

But on the whole, Greenspan, who is regarded by the public as more responsible for the nation's economy than anyone except possibly President Bush, told the congressional Joint Economic Committee that the economy was humming along.

"You can't get around the fact that this is the most extraordinarily successful economy in history," he said.

Nothing that Greenspan said led analysts to believe that the Fed would soon abandon its course of raising short-term interest rates by one-quarter of a percentage point at each of its policy-making Federal Open Market Committee's eight regular meetings a year.

The federal funds rate - the rate that governs overnight loans between banks - was at 1 percent, a historically low rate designed to boost economic growth, when the Fed began its campaign last June. Now it is at 3 percent and rising.

In fact, Greenspan quoted from the Open Market Committee's statement after its May meeting, in which it said it believed it could raise rates at a "measured" pace without upsetting the rebound from the 2001 recession.

"We're still in the middle innings of the Fed tightening," said Mark Zandi, chief economist at the consulting company Economy.com. "He's sticking to the script that he laid out." Zandi predicted that the Fed would not pause before pushing short-term rates up another percentage point, to 4 percent.

Some committee Democrats took issue with Greenspan's upbeat tone.

"I am concerned about what continues to be a disappointing economic recovery for the typical American worker," said Sen. Jack Reed of Rhode Island.

Wages are stagnant even as corporate profits are soaring, Reed said, and with energy and health costs rising, that is "squeezing the take-home pay of workers."

Greenspan responded that "there is no question that this standard of living is unmatched, and it's unmatched for everybody. Everybody has got a car, and the cars that people have today are so superior to what they were 50 years ago it's unimaginable."

Greenspan acknowledged some concern about the housing sector, which he said was overheating in some local markets. The National Association of Realtors estimated Wednesday that sales of existing homes would approach 7 million this year, topping last year's record of 6.78 million.

Second homes bought for investment or vacation purposes can be sold quickly because the owners do not live in them, and they account for much of the acceleration in home sales, Greenspan said.

He also blamed the rise on the "dramatic increase" in interest-only loans - in which the borrower does not begin paying off any of the principal for several years - and "relatively exotic forms of adjustable-rate mortgages."

In addition to home sales, homeowners have been refinancing at lower mortgage interest rates and using the proceeds for current consumption. A sudden drop in home prices could leave them with mortgages greater than the resale value of their home.

Greenspan called the decline in mortgage and other long-term interest rates "among the biggest surprises of the past year." While short-term rates have risen by 2 percentage points in 12 months, he said, the rate on 10-year Treasury notes has declined by 0.8 percentage points.

Yesterday mortgage giant Freddie Mac reported that rates on 30-year, fixed-rate mortgages averaged 5.56 percent this week, the lowest since they averaged 5.52 percent the week of April 1, 2004.

"It's the fastest decline that we have seen ... in many decades," he said. "So something unusual is clearly at play here."

One factor, Greenspan suggested, is the entry into the global labor market of "educated, low-cost employment pools in China, India and the former Soviet Union." These workers may be taking jobs away from Americans, but Greenspan said they were also exerting downward pressure on prices - including interest rates - around the world.

The Los Angeles Times is a Tribune Publishing newspaper.

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