Alan Greenspan (the Fed Chief) suggested this week that “signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels”. Based on the fact that Greenspan always weighs his words very precisely because of the effects it has on the economy, this is not a statement to take lightly. Remember that back in the dot com craze, he also used similar carefully worded sentences to describe the stock market bubble just before it burst.
He’s also suggested that “the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices”. Again based on the carefulness of his wording, Greenspan is clearly implying that price adjustments are coming in the housing market, that prices will very likely drop! Also, in this same statement, he believes that most homeowners have sizable equity cushions to absorb the fall in prices which I don’t believe is correct. If you read further in this article from CNN Money, he also has some other statements that might suggest otherwise, which we’ll go over in this article.
Going back to Greenspan’s first comment suggesting that housing prices are in a bubble stage, this is very scary! First and most importantly because he acknowledges it. For Greenspan to suggest this is very significant, because he’s the one that sets the interest rates, because his very words can alter the economy. This man is very influencial because of his position and his knowledge and therefore careful attention must be paid to everything he says. Although he may be wrong at times, the effects of his decisions are felt worldwide.
He also states “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“. Reading between the lines as one must when listening to his statements, he’s basically saying that there are too many lending vehicles that have exceptionally high risk, as well as their increased prevalence. This is not new news to the people who come to this website, we’ve already talked about the large increase in interest only loans and their potential problems.
Christopher Low, the chief economist at FTN Financial also agrees with this interpretation with his statement: “It’s nice to know that the Fed is taking (exotic home loans) seriously. It looks like (Greenspan’s) trying … to squeeze out the speculative element in housing; they don’t want a repeat of the stock bubble”.
The only statement this week that I don’t agree with is that homeowners have a sizeable cushions to absorb the price downfalls. Firstly, we already know that a substantial amount of new homeowners are using interest only mortgages to purchase houses, which means that they have little to no equity down. We also know that many houses today are bought with 5% down. And we also know that “4/5 of the rise in mortgage debt resulted from people extracting their home equity“. What do they do with this equity? We can’t know for sure, but unless they invested it, it often used for consumer spending. For example paying off credit cards is considered consumer spending if the debt acquired on the credit card was through consumer spending in the first place. Therefore, we have just shown that a large percentage of the population has minimal cushionning.
One last thing to notice about Greenspan latest statement, he is quoted as saying “shocks should be largely absorbed by changes in prices, interest rates and exchange rates, rather than by wrenching declines in output and employment.” Again, based on his careful wording, if he is using the word “shocks” as a potential outcome, then I would seriously take head of that statement…