Monday, September 26, 2005

Greenspan's Speech to the Mortgage Banker's Association

Today, Alan Greenspan addressed the MBA's ( Mortgage Banker's Association) annual convention which is held in Palm Desert, CA ( a bubble market). He addressed them via satellite.

A copy of his speech can be found here. Below are the key paragraphs. The key sentences have been made bold.

In my remarks today, I plan, in addition, to focus on one of the key factorsdriving the U.S. economy in recent years: the sharp rise in housing valuations and the associated buildup in mortgage debt. ......

Over the past decade, the market value of the stock of owner-occupied homes1 has risen annually by approximately 9 percent on average, from $8 trillion at the end of 1995 to $18 trillion at the end of June of this year. Home mortgage debt linked to these structures has risen at a somewhat faster rate.

This enormous increase in housing values and mortgage debt has been spurred by the decline in mortgage interest rates, which remain historically low. Indeed, the thirty-year fixed-rate mortgage, currently around 5-3/4 percent, is about 1/2 percentage point below its level of late spring 2004, just before the Federal Open Market Committee (FOMC) embarked on the current cycle of policy tightening. This decline in mortgage rates and other long-term interest rates in the context of a concurrent rise in the federal funds rate is without precedent in recent U.S. experience. .....

Nonetheless, it is difficult to dismiss the conclusion that a significant amount of consumption is driven by capital gains on some combination of both stocks and residences, with the latter being financed predominantly by home equity extraction.

If so, leaving aside the effect of equity prices on consumption, should mortgage interest rates rise or home affordability be further stretched, home turnover and mortgage refinancing cash-outs would decline as would equity extraction and,
presumably, consumption expenditure growth. The personal saving rate, accordingly, would rise.

Carrying the hypothesis further, imports of consumer goods would surely decline as would those imported intermediate products that support them. And one would assume that the U.S. trade and current account deficits would shrink as well, all else being equal.

How significant and disruptive such adjustments turn out to be is an open question. Nonetheless, as I have pointed out in previous commentary, their economic effect will, to a large extent, depend on the flexibility inherent in our economy. In a highly flexible economy, such as the United States, shocks should be largely absorbed by changes in prices, interest rates, and exchange rates, rather than by wrenching declines in output and employment, a more likely outcome in a less flexible economy.


As I noted earlier, we can have little doubt that the exceptionally low level of home mortgage interest rates has been a major driver of the recent surge of homebuilding and home turnover and the steep climb in home prices. Indeed, home prices have been rising sharply in many countries around the world. In the United States, signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels. It is still too early to judge whether the froth will become evident on a widening geographic scale, or whether recent indications of some easing of speculative pressures signal the onset of a moderating trend.

The housing market in the United States is quite heterogeneous, and it does not facilitate the easy diffusion of local excesses. Instead, we have a collection of local markets only loosely connected by such factors as mortgage interest rates and, over the longer term, migration and construction capacity. As a consequence, the behavior of home prices varies widely across the nation.

Speculation in homes is also largely local, especially for owner-occupied residences. For homeowners to realize accumulated capital gains on a residence--a precondition of a speculative market--they must move. Another formidable barrier to speculative activity is that home sales involve significant commissions, taxes, points, and other fees, which average in the neighborhood of 9 percent of the sales price. Where sales by owner-occupants predominate, speculative turnover of homes is difficult.


The apparent froth in housing markets may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other, more-exotic forms of adjustable-rate mortgages, are developments that bear close scrutiny. To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is adding to the pressures in the marketplace.

Over the past few years, a great deal of attention has focused on the growing range of loan choices available to mortgage borrowers. The menu, as you know, now features a long list of novel mortgage products, not only interest-only mortgages but also mortgages with forty-year amortization schedules and option ARMs, which allow for a limited amount of negative amortization. These products could be cause for some concern both because they expose borrowers to more interest-rate and house-price risk than the standard thirty-year, fixed-rate mortgage and because they are seen as vehicles that enable marginally qualified, highly leveraged borrowers to purchase homes at inflated prices. In the event of widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses.


In summary, it is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices. In addition, the LTVs for recent homebuyers appear to be lower in those states that have experienced the most explosive run-up in house prices and that, conceivably, could be at risk for the largest price reversal. That said, the situation clearly will require our ongoing scrutiny in the period ahead, lest more adverse trends emerge.

The mortgage industry is out of contol. It needs to be tamed by the Federal Reserve. Greenspan needs to tell them flat out that a negative amortization, interest only, adjustable rate mortagage for a buyer with a 550 credit score who files a no doc loan is completely unacceptable. Greenspan went light on them despite the fact the he addressed them via satellite.


  1. AG: "Speculation in homes is also largely local...."

    I strongly disagree. A national speculative infrastructure for SFR's is well in place. At my place of work, for example, people have bought houses in at least three different metro areas after being pitched by "real estate investment advisors."

  2. I believe that Brother Alan is covering himself for the period after his retirement during which he might be remembered. Beyond that, he does not care. As to whether he will be remembered at all, I think it depends on how fast and furious the real estate crash turns out to be. If it is long and slow, he will not be remembered much at all, except for his resemblance to the comedian from the first half of the 1900s -- Joe E. (or Joey) something.