Thursday, June 9, 2005

Federal Reserve Chairman Alan Greenspan yesterday gave his clearest warning yet that housing bubbles pose dangers in some areas and are being fed by unusually low interest rasand risky lending practices that are raising the level of concern at the central bank.

In light of the “unsustainable level” of prices in some local markets, Mr. Greenspan suggested in remarks to the Joint Economic Committee that the Fed and other bank regulators soon may move to curb questionable mortgage loans by national banks.

An explosion of interest-only loans and “exotic” adjustable-rate mortgages in the last year are of “particular concern,” he said, because they suggest “the apparent froth in housing markets may have spilled over into mortgage markets.”

The majority of home-purchase loans in the last year in Washington and around the country were in the forms described by Mr. Greenspan. They were designed to minimize initial monthly mortgage payments so buyers can qualify to buy increasingly expensive homes.

Under the terms of the loans, however, the payments usually explode after two or three years, when principal is added or interest rates are increased, posing significant financial strains and risks for borrowers and lenders alike.

“To be sure, these financing vehicles have their appropriate uses,” Mr. Greenspan said. “But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace.”

Mr. Greenspan said the apparent bubbles in some of the nation’s hottest real-estate markets — generally thought to be those on the East and West coasts — owe much to an enigmatic drop in long-term interest rates that has defied the Fed’s efforts to raise rates in the past year.

“There can be little doubt that exceptionally low interest rates on 10-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of home building and home turnover, and especially in the steep climb in home prices,” he said.

Mr. Greenspan offered no new explanation for the “very surprising” rate decline, but said it appears to be primarily “international” in origin — that is, due to economic weakness or surplus savings abroad — though U.S. home buyers are among the primary beneficiaries.

“Something unusual is clearly at play here,” he said. “We have concluded it is not a U.S. phenomenon.”

Another development adding to the boom in the housing market is the widespread purchase of second homes and investment properties by baby boomers who are in their peak earning years, he said. Various surveys show a quarter to a third of recent home purchases were for nonprimary residences.

“Speculative activity may have had a greater role in generating the recent price increases than it has customarily had in the past,” he said. “Transactions in second homes, of course, are not restrained by the same forces that restrict the purchases or sales of primary residences — an individual can sell without having to move.”

Mr. Greenspan stressed that he does not think the bubble extends nationwide or poses a danger for the overall economy. Housing markets are local or regional by nature, and speculation is discouraged by high closing costs averaging 10 percent of a home’s price, he said.

Nationwide banking and the widespread securitization of mortgages, which passes on the risks of default to investors, have made the banking system more immune to problems caused by local real-estate bubbles in the past, he said.

And despite the overstretched financial condition of many buyers, as well as widespread debt leveraging by homeowners to tap into their housing wealth in the past five years, the surge in prices has left an ample cushion to protect most homeowners from steep losses, should prices fall, he said.

“Although we certainly cannot rule out home-price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications,” he said.

“Despite some of the risks that I have highlighted, the U.S. economy seems to be on a reasonably firm footing, and underlying inflation remains contained.”

On another issue, Mr. Greenspan said the choppy pattern of U.S. economic growth in the past year appears to derive from the ups and downs of oil prices, which surged to record levels in the fall and then receded in the winter before surging again to record levels in the spring.

Oil prices have stayed higher much longer than in the past, primarily for “political” reasons, he said. Most of the world’s remaining oil reserves are in countries that control access to and even prohibit development of the oil by Western oil companies, he said.

These countries, for political reasons ranging from nationalistic pride in Mexico to hostility toward the United States in Venezuela, are not increasing supplies at the rate that otherwise would occur given current high market prices, he said.

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