Greenspan Backs Homeowner Debt as Prices Rise and Savings Fall
March 22 (Bloomberg) -- U.S. homeowners have amassed a record $6.82 trillion of mortgage debt as real estate values jumped in the past decade, and have borrowed against their homes for spending money. Federal Reserve Chairman Alan Greenspan, the nation's guardian of financial stability, is supporting them.
``We know that increases in home values and the borrowing against home equity likely helped cushion the effects of a declining stock market during 2001 and 2002,'' Greenspan said in a Feb. 23 speech in Washington.
Some economists including Yale University's Robert Shiller say they disagree with the fed chairman, arguing that consumers shouldn't use home values to supplement spending when their hourly wages are rising at the slowest pace on record and the savings rate is a third of the last decade's average. As borrowing costs rise, mortgage payments may jump for households with adjustable-rate loans, causing delinquencies, Shiller says.
``Lenders are allowing people to borrow more against their house, but Greenspan is saying that home prices are outstripping that,'' said Shiller, a 57-year-old professor of economics at Yale, in a March 18 phone interview from Rome. His 2000 book, ``Irrational Exuberance,'' published before the 2001-2002 market slide, argued that stocks were overvalued.
The surge in house values is ``not going to continue,'' Shiller said. ``It's already slowing down in a number of cities, where we could see home price declines. There is a possibility of a real problem. I wouldn't minimize it.'' Last year's 7.5 percent jump in the median house price to $170,000 was the biggest since an 11.7 percent increase in 1980.
Housing Boom
Housing has been an engine of the U.S. economy. Sales of new and existing residences set records each of the past three years, and homebuilding accounts for 5 percent of gross domestic product. Consumer spending climbs as much as $15 for every $100 gain in home values, compared with $5 for the same rise in stock prices, according to the Mortgage Bankers Association.
The Commerce Department may report Wednesday that February new-home sales were little changed from the month before at a 1.1 million annual rate, and the National Association of Realtors may say Thursday that purchases of existing houses last month climbed 1 percent to a 6.1 million pace, based on the median estimates in Bloomberg News surveys of 45 economists.
Household debt, which has been rising for decades, is outpacing the growth in Americans' earnings. As a percentage of disposable income, household debt payments reached a record 13.3 percent in 2002 and held at 13.1 percent in the fourth quarter last year. The previous peak was 12.3 percent, just before the 1987 stock market crash.
Shiller Price Forecast
When the Fed eventually raises rates later this year or early in 2005, house sales will cool and price growth will slow because of the higher expense of financing a purchase, Shiller and other economists say.
Once the average 30-year fixed mortgage rate rises ``much beyond 6.5 percent, we'll see a strong curtailment in housing demand,'' said Celia Chen, a senior economist at Economy.com, an independent forecasting and consulting firm in West Chester, Pennsylvania, in an interview last week. The rate hasn't been that high since mid-July 2002, according to Freddie Mac, the No. 2 mortgage financier. ``The housing market as it is going right now is growing at a pace that's faster than can be sustained.''
Increases in single-family home prices will slow to 7.4 percent from January 2004 to January 2005 from 9.1 percent between November 2002 and November 2003 across 23 U.S. cities measured by Case Shiller Weiss, a housing market research firm that Shiller co-founded. Growth will slow the most in Los Angeles, Washington, D.C., and Boston, the firm forecast.
`Demand Exceeds Supply'
Lenders have created new financing, such as mortgages whose interest rates rise and fall with market yields, to reduce financing costs in the short term and help more Americans buy homes. When interest rates climb, so will monthly payments. A slowdown in the growth of homeowner equity may weigh on consumer spending, which accounts for 70 percent of the economy.
Not all economists agree with Shiller that house values are close to a peak.
``In many communities that we follow, demand still exceeds supply,'' said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis, in an interview last week. ``House prices will probably go up faster than a lot of us realize.''
Firefighter Bruno Gonzalez, his wife and three children are moving next week into a new, $1.1 million ``mini-mansion,'' as he calls it, in Pleasanton, California. The mortgage requires them to pay only interest for the first seven years. Payments on the $880,000 loan will be $3,300 a month, compared with $5,000 on a conventional 30-year fixed mortgage.
`Walk Away Millionaires'
Since they won't be paying any principal, they are betting on rising prices to increase their equity. The value of the family's previous home in Castro Valley, California, soared to $745,000 from $375,000 in just over five years.
``We know in the long run the house will appreciate so much that we're going to walk away without having to pay the principal down, really,'' Gonzalez said Wednesday in a telephone interview. While the home purchase is ``a stretch'' for the family's $155,000 annual income, Gonzalez said, ``we're going to walk away millionaires.''
As he campaigns for re-election in November, President George W. Bush is highlighting a record homeownership rate of 68.6 percent as a barometer of economic health. His Democratic rival, Massachusetts Senator John Kerry, has been emphasizing the economy's loss of 2.3 million jobs since Bush took office.
Bush vs Kerry
``We want more people owning their own home,'' Bush said during a visit last Monday to Ardmore, Pennsylvania.
Kerry didn't respond himself. Andrew Cuomo, a Kerry adviser and former Housing and Urban Development secretary under President Bill Clinton, told reporters in a conference call last Monday that he was speaking for the campaign. He said bankruptcies and foreclosures are at record highs, and Bush's budget plan calls for cuts in federal housing assistance.
In Europe, U.K. house-price growth in the three months through February held close to the highest in a year, the Royal Institution of Chartered Surveyors said last Tuesday, suggesting two increases in interest rates haven't cooled the market.
The Bank of England raised its benchmark lending rate in November 2003 and February this year, citing concern that house- price growth was ``unsustainable.'' Stephen Nickell, a member of the central bank's rate-setting committee, said March 8 in a panel discussion in London that the bank's prediction of house- price inflation slowing to zero within two years carries ``high uncertainty.''
ARMs, Refinancings
In the U.S., adjustable-rate mortgages will account for 29 percent of all home-loan originations this year, up from 19 percent in 2003, according to Fannie Mae, the largest U.S. housing financier. In some cases, consumers are taking out mortgages along with so-called ``piggyback'' home-equity loans to avoid making a down payment.
Interest rates close to the lowest on record encouraged $2.5 trillion in refinancings last year, up 75 percent from 2002, according to the Mortgage Bankers Association. A dip in Treasury yields during the week ended March 12 pushed the group's gauge of refinancing to the highest since last July.
The flurry of refinancings has led homeowners to expect more, said James Paulsen, who oversees $120 billion as chief investment officer of Wells Capital Management in Minneapolis, in a March 2 interview.
``You have a consumer group that is budgeting in periodic refinancings,'' Paulsen said. ``If you stop having those, that's going to have a huge impact.''
Rising Assets
Rising home prices contributed to a 12 percent jump in household net worth last year to a record $44.4 trillion in the fourth quarter, according to the Fed.
That helped convince Greenspan that Americans can continue to accumulate debt. If households run into trouble, they can use their home equity to get out of it, the argument goes. The 78- year-old central banker also has said that rising real estate values are supported in many markets by a shortage of land and by immigration.
``Without an examination of what is happening to both assets and liabilities, it is difficult to ascertain the true burden of debt service,'' Greenspan told the Credit Union National Association Feb. 23 in Washington. ``Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress.''
Greater Risk
Richard DeKaser, chief economist at National City Corp. in Cleveland, agrees with Greenspan that without taking assets into account, debt ratios don't accurately measure Americans' ability to make good on their financial obligations.
``If a person has collateral, they're more secure,'' DeKaser said Wednesday in an interview. ``You can always liquidate those resources.''
An increase in interest rates and a slowing in house-value gains will put consumers at greater risk, say economists including Roberto Rigobon at the Massachusetts Institute of Technology. With the Fed's benchmark overnight lending rate at 1 percent, the lowest since July 1958, mortgage rates have held close to the record low for more than a year. The 30-year fixed rate averaged 5.38 percent last week, according to Freddie Mac.
Trading in federal funds futures suggests traders are betting the Fed will start raising rates in the fourth quarter. The yield on the U.S. Treasury's 10-year note will climb to 5 percent in the first three months of next year, according to the median forecast of 63 economists surveyed by Bloomberg News from Feb. 27 to March 8. The 4 percent note maturing in February 2014 fell Friday to 101 27/32, pushing its yield up 2 basis points to 3.77 percent.
Not a Safe Bet
``Given that debt over personal income is so high, increasing interest rates could be more damaging than expected,'' said MIT's Rigobon, who as a research fellow for the National Bureau for Economic Research has published studies on how low interest rates have spurred investment shifts. The bureau determines when recessions start and end. ``Real estate isn't a safe bet.''
Testifying before a congressional committee in July 1997, Greenspan remarked that consumer debt loads were then near historic highs, while credit card delinquencies and personal bankruptcies had jumped over the previous 12 months. ``These circumstances may make both borrowers and lenders a bit more cautious, damping spending,'' the Fed chairman said.
``The rise in debt represses the limits to how fast the economy can grow in the future,'' said Allan H. Meltzer, Carnegie Mellon University professor of political economy, in an interview Wednesday. He wrote the book, ``A History of the Federal Reserve, 1913-1951.''
Role of Demographics
``No matter what theory the Fed has, you can only mortgage your asset once,'' Meltzer said. ``If you did it yesterday, you can't do it tomorrow. Clearly, it limits the amount you can get from future expansion.''
Greenspan has also underscored the role demographics are playing in demand for housing. Before Congress in February 2003, Greenspan said the level of new home construction was ``barely in excess'' of the increase in occupied homes as immigration added to population. ``We don't have a demand for housing which could all of a sudden slip,'' he said.
The U.S. population may expand 9.2 percent to 319.9 million by 2014, according to Census Bureau projections. The number of U.S. households is expected to grow by 1.2 million each year, according to a report from Harvard University's Joint Center for Housing Studies, in Cambridge, Massachusetts.
Rental Vacancies
The growth in mortgage debt is being ``driven by demographics,'' Fannie Mae Chief Executive Franklin Raines said in an interview last May. ``We're going to have 13 to 15 million new households by the end of this decade. And they're going to have to live somewhere.''
If demographics were the driving force behind the demand surge in housing in recent years, ``that would be showing up equally in the housing market and the rental market,'' said Dean Baker, an economist at the Center for Economic Policy Research in Washington, in an interview last Wednesday. ``It's not even close. Rental prices are weakening.''
Rental rates for apartments in the downtown areas of major cities have declined since the third quarter of 2001, according to the National Real Estate Index. The national rental vacancy rate has reached 10.2 percent, the highest since the Census Bureau started recording the statistics.
``It's a very strange approach the Fed is taking,'' Baker said. ``If it wasn't their job in the late 1990s to warn people about the stock market bubble, why is it their responsibility now to tell people to invest in their homes and even to take out adjustable rate mortgages? They're trying to keep this going as long as they can.''
To contact the reporter on this story:
Will Edwards in Atlanta wiedwards@bloomberg.net.To contact the editor on this story:
Kevin Miller in Washington kmiller@bloomberg.net.
More News:
3-22-04 College grads lose big in this economy
3-22-04 Creative mortgages fuel home sales
3-22-04 Debtors, beware of credit-counseling firms
3-22-04 Debt protection plans are all the rage
3-22-04 Energy costs not hurting economy yet
3-22-04 Experts Say Filing Taxes Early Produces No Major Benefits
3-22-04 Feds Predict Higher Gasoline Prices
3-22-04 Home-office deduction has pitfalls
3-22-04 Poll Shows Texans Less Gloomy about Economy
3-22-04 Probe: No Laws Broken in O'Neill Book
3-22-04 San Diego-Area Fire Relief Donations
3-22-04 Stocks Sink Amid Fears of Global Violence
3-22-04 Treasuries Firm as Stocks Slip
3-22-04 U.S. housing department pulls back mortgage rule
3-22-04 Weak US jobs scene lifts mortgage industry hiring
Great Mortgage Articles:
Homeowner's Insurance | Debt Overload | Credit Cards | Successful Remodeling | Managing Mortgages | Refinancing Loans | Home Improvement | Moving Tips | Homeownership Mishaps | Best Appraisals | Clean Your Credit | Real Estate InvestmentsApply Online | About Us | Contact Us | Free Mortgage Quotes | Our Programs | Home Equity Loans
Second Mortgages | Refinance Mortgage | FAQ | Colleagues
