Greenspan Upbeat on Economy, Warns on Housing Market

Federal Reserve Chairman Alan Greenspan said today that certain types of increasingly popular, risky home mortgages could prove "disastrous" for some borrowers betting on ever-rising house prices.

"There's potential for individual disaster there," Greenspan said on Capitol Hill, issuing his strongest warnings yet about the potential pitfalls for consumers and lenders in the nation's red-hot housing market.

Historically, the kind of rapid price appreciation seen recently "does not go on" forever, Greenspan said during a hearing of the House Financial Services Committee.

However some borrowers are assuming such continued gains will enable them to pay back various mortgages that initially involve very low costs, he said. They include home loans that require no down payment, that initially require payment only of the interest owed, or that start with very low interest rates that can rise rapidly and steeply over time.

Those mortgages have surged in popularity over the last year, enabling individuals and families to buy houses they could not otherwise afford, and helping to further pump up prices, he said. But some borrowers could find it difficult to make the required loan payments if interest rates rise sharply or their incomes fall. And if prices flatten or decline, a borrower might be unable to sell a house for enough to pay off such a loan.

Greenspan said such loans account for only a small fraction of all the mortgages outstanding, and therefore do not pose a threat to the overall economy.

But, he added, these mortgages in "individual cases, could prove disastrous."

The Fed chairman went on to warn lenders to "fully appreciate the risk that some households may have trouble meeting monthly payments as interest rates and the macroeconomic climate change."

Greenspan discussed the risks in the housing market while delivering an upbeat assessment of the overall economy in his semi-annual report to Congress on behalf of the Fed.

"The U.S. economy has remained on a firm footing, and inflation continues to be well contained. Moreover, the prospects are favorable for a continuation of those trends," he said.

Stock prices rose after he spoke, with many investors cheered as well by his comments reaffirming the Fed's belief that it can probably continue raising short-term interest rates at a gradual, or "measured," pace.

Although the Fed has raised its key short-term rate nine times over the last year to 3.25 percent, mortgage rates are lower today than a year ago, helping fuel the recent boom in home building and home prices.

The value of all U.S. residential real estate rose 15 percent in the first three months of the year from a year earlier -- faster than the growth in after-tax income, according to the latest Fed data.

Greenspan said it is difficult to know whether homes are overvalued on average nationally. But he repeated that "there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels." And he added that some regional markets appear to be charged "with speculative fervor."

The National Association of Realtors estimates that 23 percent of U.S. homes purchased last year were for investment. Another 13 percent were second homes.

Meanwhile, almost one of every four new home loans are interest-only loans, according to LoanPerformance, a company that tracks loan originations.

Greenspan said the increased use "of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages are developments of particular concern."

Fed officials see these riskier mortgages as "the tip of an iceberg we're concerned will get larger," he said.

Greenpan's testimony today and tomorrow, when he is scheduled to deliver the identical report to the Senate Banking Committee, may be his last on behalf of the Fed. He has indicated that he intends to step down as chairman when his board term expires at the end of January, after 18 years on the job. However, he could stay on in the position until a successor is confirmed.