Greenspan Heightens Warning on Risky Mortgages

Alan Greenspan's congressional testimony this week could be his last as Fed chairman.
Alan Greenspan's congressional testimony this week could be his last as Fed chairman. (Pablo Martinez Monsivais / Ap)
By Nell Henderson
Washington Post Staff Writer
Thursday, July 21, 2005

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

"There's potential for individual disaster there," Greenspan told the House Financial Services Committee. It was his strongest warning yet about the potential pitfalls for consumers and lenders in the nation's red-hot housing market.

Greenspan also warned 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 housing market while delivering an upbeat assessment of the overall economy in his semiannual report to Congress. Employment, retail spending and business investment have all risen in recent months, he noted.

"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.

Greenspan also made it clear that the Fed plans to continue gradually raising its benchmark short-term interest rate to keep inflation under control. He noted inflation pressures from high energy prices, businesses' increasing ability to raise prices, the improving labor market and the slowdown in growth of workers' productivity, or output per hour.

The Fed has raised its federal funds rate -- the interest rate charged on overnight loans between banks -- nine times in the past year, to 3.25 percent. Greenspan's comments prompted many analysts to predict that Fed officials will keep lifting it steadily higher in coming months, to at least 4 percent by year-end.

Greenspan's comments "dashed any hopes that the Fed would hint at a near-term change in its course" of raising rates, said Gary Bigg, an economist at Bank of America Corp.

Despite the Fed's actions, longer-term interest rates -- which are determined by financial markets -- have fallen in the past year. Mortgage rates, for example, are lower today than a year ago, helping power the housing boom.

The value of all U.S. residential real estate rose 15 percent in the first quarter from the first quarter of 2004-- faster than the growth in after-tax income, according to the latest Fed data.

Historically, the kind of rapid price appreciation seen recently "does not go on" forever, Greenspan said. Prices could decline in some real estate markets, he said.

Some borrowers assume that continued gains will enable them to pay back various types of mortgages that initially involve very low costs, he said. They include home loans that require no down payments, that initially require payment only of the interest owed and none of the loan principal, or that start with very low interest rates that can rise rapidly and steeply over time.

CONTINUED     1        >

© 2005 The Washington Post Company