Housing Bubble
Greenspan: Debt servicing costs "not a significant cause for concern"
In his Issues for Monetary Policy speech to the Economic Club of New York yesterday, Fed Chairman Alan Greenspan made reference to the role of the housing market, mortgage refinancing and consumer debt. Brief mention was also made of the outlook for these factors.
He noted that low interest rates had provided considerable support to economic activity and that "new home sales have been buoyed by low mortgage interest rates as well as favorable demographics."
The role of cash out refinancing, frequently cited as an important driver of consumer spending was also referred to:
"Cash borrowed in the process of mortgage refinancing, an important support for consumer outlays this past year, is bound to contract at some point, as average interest rates on households' total mortgage portfolio converges to interest rates on new mortgages. However, applications for refinancing, while off their peaks, remain high. Moreover, simply processing the backlog of earlier applications will take some time, and this factor alone suggests continued significant refinancing originations and cash-outs into the early months of 2003."
The potential impact of high household debt levels has been gaining greater media and specialist coverage recently, although Mr. Greenspan commented that "often-cited concerns about the levels of debt and debt-servicing costs of households and firms appear a bit stretched". Primarily, financial innovations were seen as enabling lenders to control their risks more effectively:
"The combination of household mortgage and consumer debt as a share of disposable income has moved up to a historically high level. But the upward trend in the series reflects, in part, financial innovations that have increased access to credit markets for many households. These innovations include the development of a deep secondary market for home mortgages, along with the advent of credit scoring and automated underwriting models that have enhanced the ability of loan officers and credit card companies to identify good credit risks. These innovations lower the risk level of any given amount of debt."
He noted that while mortgage debt to income levels were historically high, low interest rates meant that repayments to income levels were around the historical average. He concluded that debt servicing costs were not a significant cause for concern:
"To be sure, the mortgage debt of homeowners relative to their income is high by historical norms. But, as a consequence of low interest rates, the servicing requirement for that debt relative to homeowners' income is roughly in line with the historical average. Moreover, owing to continued large gains in residential real estate values, equity in homes has continued to rise despite very large debt-financed extractions. Adding in the fixed costs associated with other financial obligations, such as rental payments of tenants, consumer installment credit, and auto leases, the total servicing costs faced by households relative to their income appears somewhat elevated compared with longer-run averages. But arguably they are not a significant cause for concern."
The full text of his speech is available online
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