Concerns Raised as Home Sales, Prices Rise Again

A sign advertises a Seattle home. Sales of existing homes in August rose 2 percent, hitting the second-highest level on record.
A sign advertises a Seattle home. Sales of existing homes in August rose 2 percent, hitting the second-highest level on record. (By Kevin P. Casey -- Bloomberg News)
By Nell Henderson
Washington Post Staff Writer
Tuesday, September 27, 2005

U.S. home sales and prices surged again last month, an industry group reported yesterday, as Federal Reserve Chairman Alan Greenspan warned that the growing use of riskier new mortgages could result in "significant losses" for lenders and borrowers if the market cools.

And some cooling is likely, Greenspan suggested in remarks delivered via satellite to the American Bankers Association convention in Palm Desert, Calif., repeating his view that "home prices seem to have risen to unsustainable levels" in certain local markets.

Greenspan's concerns -- expressed in his strongest language yet on the subject -- were echoed by another bank regulator, U.S. Comptroller of the Currency John C. Dugan, who also addressed the bankers' convention.

The median sale price of a previously owned home rose to $220,000 in August, up 15.8 percent from the same month last year -- the fastest 12-month pace in 26 years, the National Association of Realtors said yesterday.

Sales of previously owned homes -- which include single-family homes, townhouses and condominium units -- rose 2 percent in August to a seasonally adjusted annual rate of 7.29 million units, the second-highest level on record, exceeded only by June's pace of 7.35 million units, the group said. Previously owned homes account for more than 80 percent of monthly sales.

One driver behind price appreciation, Greenspan said, is the popularity of new types of mortgages that enable many borrowers to buy houses at prices they could otherwise not afford -- and that may be hard for some borrowers to repay if interest rates rise and home prices stabilize or fall. He mentioned as examples interest-only mortgages, 40-year mortgages and "option ARMS" -- adjustable-rate mortgages that permit borrowers to decide how much to pay, how long the loan term should be, and when they can convert between a fixed rate and a variable rate.

"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," Greenspan said.

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

More than one of every five new mortgage loans made in the first half of this year were interest-only, according to LoanPerformance, a firm that tracks loan originations. In the Washington area, more than a third of new mortgages were interest-only, up from about 2 percent five years ago.

Dugan reinforced Greenspan's message to the banking industry, expressing concern that "looser underwriting standards and the more widespread penetration of riskier mortgage products have raised questions about how these loans will fare in the event of a rise in interest rates or a softening in house prices."

The Fed, the Office of the Comptroller of the Currency and other bank regulators are studying these practices and "expect to issue appropriate guidance" to lenders later this fall, Dugan said.

The regulatory agencies urged lenders in May to tighten their standards for home-equity loans, for example by requiring more documentation from borrowers and more closely monitoring borrowers' financial health over the life of the loan. The agencies do not write the standards but issued the suggestion as "guidance," warning that some borrowers may have trouble repaying their loans.

Low mortgage rates are another major cause of rapid home price appreciation, Greenspan said.

The Fed raised its benchmark short-term interest rate last week, the 11th consecutive hike since June 2004, and indicated it will keep moving the rate higher in coming months to keep inflation under control. In the past, long-term rates such as mortgage rates have gone up when the Fed's benchmark rate rose. But long-term rates, which are determined by global financial markets, have fallen over the past 15 months -- an occurrence "without precedent in recent U.S. experience," Greenspan noted.

The national average rate for a 30-year fixed-rate mortgage last week was 5.8 percent, barely up from a year before, when it was 5.7 percent, according to Freddie Mac, the mortgage finance company. Before the Fed started raising rates in June 2004, the rate was above 6 percent.

Many economists, including those at Freddie Mac, predict that mortgage rates eventually will rise and the housing market will cool as the Fed keeps bumping its rate higher.

Other analysts, however, predict home sales and prices will keep climbing for a while. David A. Lereah, chief economist for the Realtors association, said that with a growing U.S. population and tight housing inventory, "we'll continue to see above-normal home price appreciation for the foreseeable future."

Hurricane Katrina, which destroyed thousands of homes when it struck the Gulf Coast on Aug. 29, had no measurable effect on the association's August sales and price figures. But association President Al Mansell said the storm will affect the numbers this month and for a while, as sales are disrupted in the hardest-hit areas and spike elsewhere as displaced residents buy new homes.

Katrina has already caused prices to jump for lumber, cement and many other building materials, noted Gary Bigg, an economist with Bank of America Corp. "As a result, new-home prices are expected to increase sharply. This will likely induce a shift in demand to existing homes, causing existing-home prices to remain elevated."

© 2005 The Washington Post Company