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The Honolulu Advertiser
Posted on: Tuesday, September 27, 2005

Fed chairman warns of shaky mortgages

By Joel Havemann
Los Angeles Times

WASHINGTON — Federal Reserve Chairman Alan Greenspan yesterday warned home buyers to be wary of exotic mortgages that allow them to hold down monthly payments or defer principal payments in the early years.

If the red-hot housing market cooled off, Greenspan said, "These borrowers, and the institutions that service them, could be exposed to significant losses."

Greenspan's warning came as sales of previously occupied homes rebounded to a near-record height and their prices reached a new peak, according to a report released yesterday.

While the central bank chief criticized the growing use of "interest only" mortgages and other risky loans that allow buyers to afford expensive homes through lower initial payments, he took comfort from a Fed estimate that most homeowners held mortgages equaling less than 90 percent of their homes' value.

"The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices," he said in a speech beamed by satellite from Washington to an American Bankers Association convention in Palm Desert, Calif.

Mark Zandi, president of Economy.com, said Greenspan had two messages.

"He said housing has turned increasingly speculative, and a correction in the market is coming," Zandi said. "But he also said that the correction won't affect the great bulk of homeowners."

Greenspan's remarks indicated to analysts that the Fed was not through with its campaign of raising interest rates. He suggested a degree of frustration that the Fed had raised its benchmark short-term interest rate from 1 percent to 3.75 percent during the past 15 months, and yet the rate on 30-year mortgages actually had dropped half a point to 5.75 percent.

"Implicitly," Zandi said, he is saying, " 'I can keep raising rates, and most homeowners won't suffer."'

Low interest rates on mortgages, in turn, have lifted home values, prompting a binge of refinancing and home equity loans. Greenspan estimated that homeowners had used about half the proceeds either for personal consumption or for repayment of credit-card debt.

One result has been a nosedive in the personal savings rate, to minus 0.6 percent of disposable income in July.

"So many Americans are consuming by using their home equity," said Alan Skrainka, chief market strategist at the investment company Edward Jones. "If you can't afford a standard mortgage, you probably shouldn't be buying a home."

Greenspan delivered his speech hours after the National Association of Realtors reported that sales of existing homes had shot up to an annual rate of 7.29 million in August, a level 7.8 percent higher than a year earlier and higher than any month except June's 7.35 million.

"Apparently," Greenspan said, "a substantial part of the acceleration in turnover reflects the purchase of second homes — mainly for investment or vacation purposes." He said second homes accounted for 14 percent of all sales at the end of last year, double the level in 2000.

The median sales price in August was $220,000, or 15.8 percent higher than in the same month last year. That was the greatest 12-month increase since 1979. The rise was steepest in the West, where it was 20.1 percent.

Greenspan scolded the providers of "novel mortgage products," including some requiring no down payment and others allowing 40-year repayment schedules. A fall in home prices or rising mortgage rates could increase the risks of defaults on these and other risky loans.

But he also said that, so far, rapidly rising home prices had lifted some risky mortgages into the "safe" category.