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Alan Greenspan on the Roots of the Mortgage Crisis
By JLP | December 13, 2007
This is from Alan Greenspan’s opinion piece, The Roots of the Mortgage Crisis (free), that was in yesterday’s Wall Street Journal (emphasis mine):
I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1% rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages and may have contributed to the rise in U.S. home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.
Demand in those days was driven by the expectation of rising prices–the dynamic that fuels most asset-price bubbles. If low adjustable-rate financing had not been available, most of the demand would have been financed with fixed rate, long-term mortgages. In fact, home prices continued to rise for two years subsequent to the peak of ARM originations (seasonally adjusted).
Interesting. I think the impact on demand for homes financed with ARMs WAS major. Especially, the option ARMs that allowed people to pay only the interest portion of their payment. I think that’s the ONLY WAY many people could afford the payments in the first place. Of course, that’s my opinion and I don’t have any date to back it up. In theory though, it makes a lot of sense.
I do agree with him that demand was driven by expectations of higher prices. People felt pressured to GET IN NOW or prices would be much higher later! I also think that contributed to many of the exotic mortgages people were using because they assumed they could just refinance at a later date.
Greenspan then went on to say:
In mid-2004, as the economy firmed, the Federal Reserve started to reverse the easy monetary policy. I had expected, as a bonus, a consequent increase in long-term interest rates, which might have helped to dampen the then mounting U.S. housing price surge. It did not happen. We had presumed long-term rates, including mortgage rates, would rise, as had been the case at the beginnings of five previous monetary policy tightening episodes, dating back to 1980. But after an initial surge in the spring of 2004, long-term rates fell back and, despite progressive Federal Reserve tightening through 2005, long-term rates barely moved.
I thought this was because mortgage rates were tied to the 10-year note, not short-term rates. I could be wrong. I’m not an economist but I remember reading that somewhere. If that’s the case, it makes sense that mortgage rates wouldn’t necessarily rise because short-term rates were increased.
When will this crisis end? Here’s what Greenspan says:
The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.
I have a feeling that this isn’t going to happen until the government stops trying to prop things up by issuing moratoriums on ARM resets. Eventually people are going to have to pay for their houses or they’ll have to give them up.
Topics: Housing Market |
December 13th, 2007 at 1:17 pm
It seems revisionist history is all the rage these days. I’m not surprised to hear Greenspan chime in and deny involvement in the mortgage mess.
Having been an insurance agent in the days or the ARM boom (I sold homeowners policies to help my Realtor and mortgage originators friends close their deals) I spent some time with the people getting in over their heads with these mortgages. Without the ARM loans, these people wouldn’t have gotten the mortgages to begin with. “not major” ? What data is he looking at?
December 13th, 2007 at 1:33 pm
You’re right that mortgages are tied to longer term rates. But I think that’s what Greenspan meant: he made a policy change with direct impacts on short-term rates, and he expected, “as a bonus, a consequent increase in long-term interest rates, which might have helped to dampen the then mounting U.S. housing price surge.”
A rate cut by the Fed has no direct impact on long-term rates, but it does affect investor expectations about economic growth and inflation, which will impact long-term rates through bond trades. Since the impact on long-term rates is indirect, Fed policy’s effect on long-term rates and thus mortgages are not always predictable.
What was predictable, though, was that rates on an ARM will increase. I completely agree that people should have known that their mortgages are not sustainable. But most people are just not financially long-sighted like that.
December 14th, 2007 at 12:18 pm
I agree with Ernesto. Working as a mortgage broker myself in 2005-2006, many if not most of the people interested in ARMs wanted them precisely because they couldn’t afford something else.
This was particularly true of the Option ARM, which had an initial teaser rate that didn’t even cover the actual interest. I had people applying for mortgages when even the 1.5% teaser rate was a stretch for them, and insisting even when I spent considerable time laying out exactly how the mortgage worked and how it could impact them.
Also +1 to what Honest Dollar said. Spot on.
December 15th, 2007 at 10:17 am
Check out the subprime origination chart.
http://www.investopedia.com/articles/07/subprime-blame.asp