Federal Reserve Chairman Alan Greenspan, in likely one of his last Capitol Hill appearances, yesterday warned that the red-hot housing market poses risks to the economy and that home prices likely will fall in local markets where a “speculative fervor” has taken hold.
Many home buyers and investors appear to think — unrealistically — that today’s extraordinarily low mortgage rates and double-digit gains in home prices will continue indefinitely, he said.
Those who take out risky mortgages such as interest-only loans with the idea that such euphoric conditions will continue could be stung by a rapid rise in rates or collapse in home prices, he said.
“We certainly cannot rule out declines in home prices, especially in some local markets,” he said. “If declines were to occur, they likely would be accompanied by some economic stress,” though he expressed hope that damage to the overall economy would be minimal.
“The significant rise in purchases of homes for investment since 2001” is one of the most potent signs of a housing bubble, said Mr. Greenspan, who is expected to retire in January. It “seems to have charged some regional markets with speculative fervor.”
The Fed chairman’s increasingly strident warnings this year about the pitfalls of unsustainable home sales and price gains have led some analysts to predict the Fed will keep raising interest rates until it sees a cooling of the housing market.
Mr. Greenspan stressed that the overstretched state of the housing market in large part was due to an unprecedented drop in long-term mortgage rates, even as the Fed was raising short-term rates in the past year.
He said the yields on 10-year Treasury notes, which determine the rates on 30-year mortgages, are a half percentage point lower than they were before the Fed started raising rates.
He warned that the future behavior of long-term rates — which after an extraordinary period of quiescence could rise suddenly on a pickup in inflation or worldwide growth and investment — would be critical not only to the fortunes of the housing market but also to the economy as a whole.
The extraordinary decline in bond yields worldwide in recent years is due partly to excessive savings outside the United States, particularly in Asian countries like China and Japan, where savings rates are much higher than in the United States.
In addition, spending on capital projects by businesses — which typically absorb savings during an economic expansion — has been lower than usual, perhaps because businesses grew cautious after being burned by the bursting stock market bubble in 2000, he said.
Another reason interest rates have fallen despite the Fed’s efforts, he said, is a perception in financial markets that inflation risks have shrunk with the entry of billions more workers and consumers into world markets since the fall of the Soviet Union and the rise of developing countries like China and India.
While prices have declined steadily amid stiff competition for production jobs worldwide, he warned against complacency.
Escalating energy prices have raised inflation substantially in the past year and could continue to put pressure on prices, he said, while labor costs in the U.S. also appear poised to accelerate.
“History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress,” he said. “Such perceptions, many observers believe, are contributing to the boom in home prices.”
While Mr. Greenspan’s remarks hinted at more rate increases aimed at cooling the housing market, he stressed that the Fed’s strategy of raising rates gradually by a quarter percentage point every six weeks was designed to avoid precipitating a housing crisis.
The Fed also wants to avoid disruptive moves because high energy prices continue to crimp consumer spirits and discretionary spending and put a damper on economic vitality.
“It is a shock. We do estimate a three-quarter-percentage-point loss in real growth this year as a consequence of these prices,” which are likely to remain high “for years to come,” he said.
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