Federal Reserve Chairman Alan Greenspan yesterday said he sees a housing price bubble in “certain areas” and suspects prices are vulnerable to declines, but they will not collapse in any way that threatens the economy.
“I think we’re running into certain problems in certain localized areas. We do have characteristics of bubbles in certain areas, but not, as best I can judge, nationwide,” he told the House Financial Services Committee. “I don’t expect that we will run into anything resembling a collapsing bubble. I do believe that it is conceivable we will get some reduction in overall prices, as we’ve had in the past, but that is not a particular problem.”
Mr. Greenspan was responding to a question from Rep. Scott Garrett, a New Jersey Republican who said he is buying a house in Washington, one of several dozen urban areas on the East and West coasts that economists suspect may be experiencing housing bubbles.
Washington home prices surged on average by 27 percent last year, twice the national rate. In Northern Virginia and many other parts of the region, home values have doubled since 2000 ” a boon to homeowners and housing investors but a bane to those trying to buy into the market.
“The bubble is about to burst as soon as I buy my house down here,” Mr. Garrett complained to the Fed chairman.
Mr. Greenspan said homeowners have accumulated considerable wealth because of the rapid run-up in the value of their homes in recent years, and many have been tapping into that wealth through home sales, cash-out refinancings and home-equity loans.
The Fed estimates that home values have doubled from $8 trillion to $16 trillion since 1996, outpacing the rapid growth of mortgage debt, which also has doubled from $3.5 trillion to $7 trillion in that time.
“Remember that there’s a very significant buffer in home equities at this stage,” he said, referring to the $9 trillion difference between home values and outstanding mortgage debt.
Since most homebuyers have put down deposits of 20 percent, they have that much of a cushion against a potential drop in their home values, he said. Even when homebuyers have obtained loans of as much as 100 percent of a house’s cost, he said, the rapid gains in value in many cases has provided them with a buffer against decline.
But the Fed chairman conceded that any drop in home values ” which could affect as much as one-fifth of the population, according to private estimates ” could put a damper on consumer spending and economic growth. Consumer spending since 2000 has been fed by the “wealth effect” created by rising home values.
“Some reversal in that [wealth] is not out of the question. If that were to occur, households would probably perceive the need to save more out of current income; the personal saving rate would accordingly rise, and consumer spending would slow.”
Mr. Greenspan indicated that the Fed would like to see consumer spending out of household wealth slow some, since it has been a major factor driving down the personal savings rate to a meager 1 percent last year from a historic average around 7 percent. The Fed’s campaign to raise interest rates in the last year thus has been aimed in part at cooling the overheated housing market.
However, home sales have continued at record levels. Mr. Greenspan said the Fed’s intentions have been thwarted by an unusual decline in long-term interest rates, in defiance of the Fed’s steps to raise short-term rates by 1.5 percentage points.
“Other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields,” he said. Yet “30-year fixed-rate mortgage rates have dropped to a level only a little higher than the record lows touched in 2003.”
Many analysts attribute this “conundrum” to heavy buying of U.S. Treasury bonds and mortgage-backed securities by foreign central banks and overseas investors, he said, but the explanations have not been convincing. The unexplained drop in mortgage rates “may be a short-term aberration.”
Mr. Greenspan also told Congress to slow the growth of mortgage lenders Fannie Mae and Freddie Mac, which have a combined $1.55 trillion loan portfolio.
“Going forward, enabling these institutions to increase in size, we are placing the total financial system of the future at substantial risk,” he said.
Most of the House questioners yesterday, like their counterparts on the Senate Banking, Housing and Urban Affairs Committee on Wednesday, focused on the heated topic of Social Security reform.
Mr. Greenspan repeated his support for creating a new system of private accounts to fully fund Social Security’s obligations to retirees in the years ahead.
He said such a system would have an advantage over the current one because it would ensure that money supposedly set aside for retirement is actually saved for that purpose. Today, payroll taxes that the government doesn’t use to pay retirement benefits are immediately spent on other items. About $1.5 trillion in Social Security funds have been spent that way.
Another reason Mr. Greenspan said the private accounts would be desirable is they would enable many low-income workers to enjoy the benefits of building wealth for the first time.
They “will create … a sense of increased wealth on the part of the middle- and lower-income classes of this society who … struggle with very little capital,” he said. “For the last 25 years we have had … an ever-increasing concentration of income and wealth in this country … that is not conducive to the democratic process. … It’s crucial to our stability that people all have a stake in this system.”