WASHINGTON - Although mortgage debt is rising, most Americans have built up so much equity in their homes that they could weather a price drop without serious harm, Federal Reserve chairman Alan Greenspan says.
"Most homeowners have a sizeable equity cushion with which to absorb a potential decline in house prices," he said.
The Fed chief's remarks on housing prices were more reassuring than in August when he said the housing boom would "inevitably" cool and that there might be declines.
Although some regions were seeing unsustainable price gains, Greenspan said that by the middle of this year less than 5 per cent of homeowners were highly leveraged - which would make them vulnerable if prices fell - on their loans.
"In the US, signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels. "It is still too early to judge whether the froth will become evident on a widening geographic scale or whether recent indications of some easing of speculative pressures signal the onset of a moderating trend."
Analysts noted that, if home prices dropped, it might rattle homeowners' confidence enough to make them rein in their spending and so affect the pace of expansion.
"Given all the leverage the household sector has built up, their confidence in rising home equity has been an important part of their willingness to take on all that [mortgage] debt," said Avery Shenfeld, of CIBC World Markets in Toronto.
Sales of existing homes climbed to the second-highest level on record in August - a 7.29-million-unit rate - while prices shot up 15.8 per cent from a year ago for the fastest price appreciation in 26 years.
Greenspan said housing-market froth might be spilling over into markets in the form of new types of mortgages that made it easier for homebuyers to qualify for big loans.
"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," he said.
Judging by the acceleration in buying and selling second homes, it seemed speculation was playing a larger role in recent home-price rises than in the past.
Greenspan cited a study he co-authored with Fed staffer Jim Kennedy that found about four-fifths of the rise in mortgage debt resulted from people extracting home equity.
He said the decline in savings over the past decade could be explained by lower interest rates that had fuelled the housing boom and by the increase in household wealth - which also includes gains in sharemarket wealth.
If mortgage rates rise or home prices hit levels that become unaffordable, there might be a chain reaction of falling imports and more savings with a consequent shrinking in US trade and current account gaps.
"How significant and disruptive such adjustments turn out to be is an open question," Greenspan said, but the US economy was flexible enough that "shocks should be largely absorbed by changes in prices, interest rates and exchange rates, rather than by wrenching declines in output and employment".
- REUTERS
Equity to 'cushion' house price drop
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