Greenspan Wary of Risky Mortgages

Price Peaks Built on 'Exotic' Loans Trouble Fed Chairman

Federal Reserve Chairman Alan Greenspan yesterday expressed concern that the growing use of riskier new mortgages is helping push up home prices to "unsustainable levels" in some local markets.

Home prices in some areas of the country may fall when the market cools, but that probably would not cause serious harm to the overall U.S. economy, he told Congress's Joint Economic Committee.

The economy continues to expand at a decent if uneven pace, Greenspan said, indicating that the Fed probably will continue to raise short-term interest rates gradually to keep inflation under control

"The U.S. economy seems to be on a reasonably firm footing, and underlying inflation remains contained," he said, adding that the Fed can therefore raise rates "at a pace that is likely to be measured." Stock prices were little changed, as Greenspan did not signal heightened worries about rising prices or slowing economic growth.

But Greenspan did note some troubling aspects of the booming housing market. He highlighted the recent surge in interest-only loans, which allow borrowers to lower their monthly bills by paying only interest for the first years, and other forms of adjustable-rate mortgages.

"The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern," he said.

Nearly a fourth of the mortgage loans made this year nationally have been interest-only, according to LoanPerformance, which tracks loan originations. In the Washington area, more than a third of home buyers are using interest-only mortgages, up from about 2 percent just five years ago.

Other varieties of adjustable-rate mortgages have proliferated. There are up to 200 kinds of mortgage products on the market, all with different interest rate schedules, down payment requirements, payback terms, fees and potential penalties, said Douglas G. Duncan, chief economist of the Mortgage Bankers Association.

The "exotic" loans Greenspan mentioned probably were a reference to the "option ARM," which permits borrowers to decide themselves how much to pay, how long the loan term should be and when they can convert from a fixed rate to a variable rate, or back to a fixed rate, Duncan said.

Greenspan's comments will signal to lenders that they should examine the potential risks of foreclosure if these new kinds of loans turn sour, Duncan said. "It's an alert to the leadership of lenders to pay attention to this, and they will."

Greenspan's remarks also are a warning to consumers to be wary of buying homes in high-priced markets if the only way they can do so is with a low down payment and an interest-only loan, said Anirban Basu, chief executive of Sage Policy Group, an economics consulting firm in Baltimore. Basu predicted that in 5 to 10 years, there will be a "huge surge of foreclosures" when interest rates rise, home values level off and homeowners become unable to pay their bills.

"What the chairman is saying to people is 'be careful,' " Basu said. "This warning should be heard louder in some markets than in others."