Fed chief assails exotic lending

Greenspan again warns of risky mortgages that could lead to big losses

September 27, 2005|By Joel Havemann

WASHINGTON — Federal Reserve Chairman Alan Greenspan warned homebuyers yesterday to be wary of exoticmortgages that allow them to hold down monthly payments or defer principal payments in the early years.

If the red-hot housing market cooled off, Greenspan said, "These borrowers, and the institutions that service them, could be exposed to significant losses." His warning came as sales of previously owned homes rebounded to a near-record height and their prices reached a new peak, according to a report from the National Association of Realtors yesterday.

While the central bank chief criticized the growing use of "interest only" mortgages and other risky loans that allow buyers to afford expensive homes through lower initial payments, he took comfort from a Fed estimate that most homeowners held mortgages equaling less than 90 percent of their homes' value.

"The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices," he said in a speech beamed by satellite from Washington to an American Bankers Association convention in Palm Desert, Calif.

Mark M. Zandi, president of Economy.com, said Greenspan had two messages.

"He said housing has turned increasingly speculative, and a correction in the market is coming," Zandi said. "But he also said that the correction won't affect the great bulk of homeowners."

Greenspan's remarks indicated to analysts that the Fed was not through with its campaign of raising interest rates.

Zandi suggested a degree of frustration that the Fed had raised its benchmark short-term interest rate from 1 percent to 3.75 percent over the last 15 months, and yet the rate on 30-year mortgages actually had dropped half a point to 5.75 percent.

"Implicitly," Zandi said, he is saying, "`I can keep raising rates, and most homeowners won't suffer.'"

Low-interest rates on mortgages, in turn, have lifted home values, prompting a binge of refinancing and home-equity loans. Greenspan estimated that homeowners had used about half the proceeds either for personal consumption or for repayment of credit-card debt.

Decline in savings

One result has been a decline in the personal savings rate, to minus 0.6 percent of disposable income in July.

"So many Americans are consuming by using their home equity," said Alan Skrainka, chief market strategist at the investment company Edward Jones. "If you can't afford a standard mortgage, you probably shouldn't be buying a home."

Greenspan delivered his speech hours after the National Association of Realtors said sales of existing homes rose 2 percent in August to a seasonally adjusted annual rate of 7.29 million units, second only to the all-time high pace of 7.35 million units in June.

"Apparently," Greenspan said, "a substantial part of the acceleration in turnover reflects the purchase of second homes - mainly for investment or vacation purposes."

He said second homes accounted for 14 percent of all sales at the end of last year, double the level in 2000.

Second homes

The quicker turnover of second homes - such as for investment or vacation purposes - appears to be feeding the surge in house prices, Greenspan said.

"Speculative activity may have had a greater role in generating the recent price increases than it customarily had had in the past," he said.

"In the event of a widespread cooling in house prices, these borrowers and the institutions that service them could be exposed to significant losses," Greenspan said.

Any retraction in sales or refinancing raises the risk of an "adjustment" in overall spending. How much is an "open question," he said.

The National Association of Realtors said the median sales price in August was $220,000, or 15.8 percent higher than in August 2004. That was the greatest 12-month increase since 1979. The rise was steepest in the West, where it was 20.1 percent.

Greenspan scolded the providers of "novel mortgage products," including some requiring no down payment and others allowing 40-year repayment schedules.

A fall in home prices or rising mortgage rates could increase the risks of defaults on these and other risky loans. But Greenspan also said that, so far, rapidly rising home prices had lifted some risky mortgages into the "safe" category.

Joel Havemann writes for The Los Angeles Times. Wire services contributed to this report.

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