- The Washington Times - Tuesday, March 4, 2003

"Last year was surely one of the most memorable years ever experienced by the home mortgage market," said U.S. Federal Reserve Chairman Alan Greenspan in a speech Tuesday. And we might add that 1999 was one of the most memorable years for the U.S. stock market.

Greenspan's speech Tuesday morning has a troubling head-in-the-sand quality to it. He celebrates the positive impact on the U.S. economy of rising house prices in 2002, denies that these housing price increases are likely to do any medium-term harm and then says the boom is over — without dwelling on what its end might do to the economy.

The numbers Greenspan gives illustrate the scale of the impact of rising house prices on the U.S. economy. As with the stock market boom — which increased household net worth by around $17 trillion in the second half of the 1990s — the numbers are huge.

According to Greenspan, no less than $1.75 trillion in mortgage debt was refinanced in 2002. That is a sum equivalent to 16.8 percent of U.S. gross domestic product in 2002. No wonder the real estate and mortgage financing industry is one of the few in the United States to have added jobs last year.

Of this sum households "'cashed out' almost $200 billion of accumulated home equity," Greenspan tells us. How important a sum is this in the context of the U.S. economy? Think of the mammoth Bush stimulus plan of close to $700 billion — over 10 years. In one year, home equity refinancing has offered almost three years' worth of the sum involved in the new stimulus plan.

For what was this money used? About half of the amount, Fed studies suggest, would go into consumer spending. Greenspan also tells us that "approximately $70 billion was apparently applied to repayment of home-equity loans, and a significant part was employed to reduce higher-cost credit card debt." Thus, American homeowners have been able to use cheap mortgage debt to reduce other debt payments, and thereby sustain their spending. That is all to the good, but it is not a process that can continue.

The obtaining of cash from mortgage refinancing was, moreover, not the only element in the keep-the-economy-alive house price boom. "An even greater support to the economy," in Greenspan's words, was "the extraction of home equity associated with a record 6.4 million existing home sales, including condos, at record prices" — in other words, the capital gains to those (fortunate) people who sold property at the current oh-so-high prices, gains paid for, of course, by the soaring debt taken out by the (unfortunate) purchasers.

The Fed estimates that mortgage originations for existing home purchase "topped $600 billion," so that, subtracting the homesellers' repayments of remaining debt on outstanding mortgages, the Fed judges that there was "a net increase of approximately $350 billion in debt on the homes that turned over last year." Sellers got that money, and spent a good part of it, Greenspan says.

And there is a third leg to the money from housing boom. Home equity financing — loans for purposes other than house buying but backed by property equity — amounted to approximately $130 billion, "also a record," Greenspan tells us.

Putting the three elements together, Greenspan said the Fed calculates that "the amount of previously built-up equity extracted from owner-occupied homes last year, net of fees and taxes, totaled $700 billion … or more than 10 percent of estimated equity at the beginning of the year."

This sum is enormous, as large as Bush's 10-year stimulus plan — and all of it entering the economy in one year.

All this should raise a question in our mind as to what will happen to domestic demand in the United States when house prices cease to go up and up. Greenspan gives the danger a brief mention, in a typically Greenspanesque, non-ringing phrase. A slowdown in the housing boom will have the effect of "possibly notably lessening support to household purchases of goods and services."

And calm down is what Greenspan thinks the house boom is beginning to do — which may be in part why housing stocks slumped Tuesday. "With home price increases now subsiding, and mortgage interest rates no longer declining at last year's impressive pace, some slowdown in the rate of mortgage debt expansion is to be expected," Greenspan says.

But could it be worse than that? Might house prices, like stock prices, fall, leaving those who have bought while the market is high nursing a loss? Greenspan says that it is "possible" that home prices might fall "as they did in a couple of quarters in 1990" but essentially dismisses that the house price boom carries much danger, claiming that "Any analogy to stock market pricing behavior and bubbles is a rather large stretch."

He justifies his view with arguments that themselves seem to be stretched. There is no national housing market in the United States, he says, but many local ones, which is of course true, but does that matter? He points, too, to the high transaction costs in the housing market which "discourage the type of buying and selling frenzy that often characterizes bubbles in financial markets." Yet a frenzy is just what appears to have occurred in the housing market, which has now recorded three years of activity at record high levels.

The chief danger seen by Greenspan is, then, that the level of activity in the housing market will decline, "leading to a lower level of realized capital gains on homes." He does not contemplate the possibility of capital losses. We would.

What Greenspan ignores is that the house price boom which has been fomented by ultra-low interest rates is just another example of the asset price inflation that affected the stock market in the second half of the 1990s. The boom is also all the more dangerous because it is occurring in a weak economy for which it is the chief support. House prices are becoming more and more out of line.

Fortunes were made in the stock market, and the fortunate extracted them and turned them into cash. The unfortunate bought at the top and realized losses. The same process will take place in the housing market.

The excess capacity built up when the U.S. stock market was booming and the drag from it now that the market has burst explain why the US economy is frail today. The house price boom has helped to offset that frailty. But because it, too, is something false, another episode of wealth generated by inflation, its medium-term impact will be negative.

There is a symmetry to booms and busts. As house prices have spiraled up Americans have sold assets for much more than they paid for them. As house prices come down, Americans will find the opposite.

The house price boom is troubling. As house prices fall in nominal or real terms for some years, another strongly negative influence will weigh on the U.S. economy. An excess of cheap money medicine from Greenspan in the past two years makes the economy more vulnerable to a prolonged slump. America's imbalances are getting worse, not better.

And as more Americans own homes than stocks, the house price boom could do more harm than the boom and bust of the stock market.

Greenspan has let a second bout of asset price inflation build on his watch. Don't expect him to be the first to recognize it.


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