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Greenspan Worries About Housing Market, Says Fed Will Raise Interest Rates

Posted on: Thursday, 21 July 2005, 18:00 CDT

Jul. 21--Although the U.S. economy is in generally good shape, froth in the housing markets could lead to problems down the road, Federal Reserve Board Chairman Alan Greenspan warned a Congressional committee Tuesday.

He also indicated during his testimony to the House Financial Services Committee that the Fed intends to raise interest rates when it next meets Aug. 9, continuing a process it began in June 2004 to slow the economy as a way to fight inflation.

"Our baseline outlook for the U.S. economy is one of sustained economic growth and contained inflation pressures," he said.

"This outcome will require the Federal Reserve to continue to remove monetary accommodation," he added, using words generally understood to mean more interest rate increases are coming.

The message came through loud and clear, experts said.

"The reason for Mr. Greenspan's apparent determination to push rates significantly higher is clear enough," Ian Shepherdson, chief U.S. economist for High Frequency Economics Ltd. in Valhalla, N.Y., wrote in a commentary Tuesday afternoon. "The Fed expects growth to remain about 3 percent for the foreseeable future, raising the risk of inflation breaking out."

Greenspan said that a generally favorable economic outlook is shadowed by "some significant uncertainties that warrant careful scrutiny."

Those uncertainties included rising labor costs; high and volatile energy prices; and low long-term interest rates, which have helped drive growth in the housing markets in many large urban areas around the country.

On housing prices, Greenspan reiterated his past statements that some regions around the country were exhibiting signs of "froth."

"We certainly cannot rule out declines in home prices, especially in some local markets," Greenspan said. "If declines were to occur, they likely would be accompanied by some economic stress."

"A decline in the national housing price level would need to be substantial to trigger a significant rise in foreclosures, because the vast majority of homeowners have built up substantial equity in their homes despite large mortgage-market-financed withdrawals of home equity in recent years," he added.

But Greenspan is being too optimistic about the possible consequences of housing price declines, said John Collopy, Milwaukee-based president of South Beach Capital Markets Inc., an investment bank in Miami.

"I think that this real estate market could be a serious problem at some point," Collopy said. "There is serious risk in that market. You don't need a big decline in housing prices to wipe out whatever equity there is there."

Collopy warned of a "crowded doorway" of people trying to sell all at once to avoid defaults. Such a stampede would only make the problem worse and put even more pressure on prices.

In the past, Greenspan has downplayed such panic scenarios, noting that it takes time to sell real estate, and after houses are sold, people still need somewhere to live.

In his testimony, Greenspan spoke at length about long-term interest rates, which haven't risen in tandem with the shorter-term rates as they typically do. He said this is because the world is saving more money than it is investing.

Long-term rates would probably return to more normal levels as the investment climate improved in the United States and Asia, he said.

Greenspan also expressed concern about rising labor prices, saying inflation could become a problem if wages continue to climb without a corresponding increase in productivity.

He was presenting what could possibly be his last semiannual report on the economy to Congress. After 17 years as chairman, Greenspan is expected to retire at the end of his term in January 2006.

The New York Times contributed to this report.

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Source: The Milwaukee Journal Sentinel

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