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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 |