- The Washington Times - Monday, September 26, 2005

Speculative buying of vacation and investment homes is at unprecedented levels and may be driving the surge in home prices, which hit another record last month, Federal Reserve Chairman Alan Greenspan said yesterday.

The housing boom, which has pushed home values up to $18 trillion nationwide from $8 trillion in 1995, also accounts for much of the strength in consumer spending, as homeowners tap into their rising home equity to finance purchases from plasma televisions to second homes, Mr. Greenspan told the American Bankers Association.

“One of the key factors driving the U.S. economy in recent years [is] the sharp rise in housing valuations and the associated buildup in mortgage debt,” he said.

The National Association of Realtors yesterday reported that the average home price nationwide rocketed 15.8 percent in the past year to a record $220,000, the biggest jump since 1979, while sales of existing homes remained at near-record levels.

The Fed is concerned about harm to over-leveraged homeowners and to the economy when the housing market cools — which may precipitate drops in home prices in some markets where speculation has driven prices to “frothy” levels, Mr. Greenspan said.

Many buyers today are stretching their resources to the limit to buy homes at “inflated” prices, he said, creating a dangerous situation in which a downdraft in housing prices could cause a debt crisis for consumers and massive losses for the banks that financed them.

Those most at risk are homeowners who have financed with interest-only loans and “exotic” instruments such as “option ARMs” or adjustable-rate mortgages that allow homeowners to avoid paying principal on their loans, Mr. Greenspan said.

“These products could be cause for some concern both because they expose borrowers to more interest-rate and house-price risk than the standard 30-year, fixed-rate mortgage, and because they are seen as vehicles that enable marginally qualified, highly leveraged borrowers to purchase homes at inflated prices,” he said.

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

But the Fed has determined that fewer than 5 percent of homeowners are in potentially over-leveraged positions, with loans equal to 90 percent or more of their property value, although that is partly because rapid appreciation has lifted many recent home buyers out of that risky category, he said.

“The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices,” even in overheated markets such as California, he said.

Meanwhile, consumers are putting their equity to good use with cash-out financings. Mr. Greenspan noted that he recently co-authored a study that found that 80 percent of the recent record rise in mortgage debt has been spent on “discretionary” purchases.

Although home equity loans traditionally were used to finance remodeling projects or other big-ticket investments with long-term value, they increasingly are financing purchases such as clothing and restaurant meals that used to be put on credit cards, he said.

Between a quarter and a third of home equity loans and cash-out refinancings are used that way, according to Mr. Greenspan’s study, while an additional quarter of the loans are used to refinance credit-card debt.

In this way, consumers have turned their home equity into a powerful spending machine and supplement to incomes that has enabled them to keep spending even as their wages were barely growing.

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