www.washingtonmonthly.com/features/2004/0404.wallace-wells.html
Newt Gingrich is one of these public figures, Robert Byrd another; Youll be sitting in the audience listening to a sensible speech by, say, Gingrich, and all of a sudden you get the notion that aliens have captured his brain. Befuddled, youll turn to your friend next to you, the libertarian true-believer, and hell shrug his shoulders and whisper back: Oh, its just Newt. And then, a few minutes later, the speakers episode will subside, the aliens return the brain, and the speech continues on its before-we-were-so-rudely-interrupted track. The capitals press gives these folks a pass from its usual lawyerly scrutiny because they are regarded as sages who can be relied upon to speak some kind of unusual and valuable truth, whose occasional episodes of profound intellectual oddness are thought to stem from the same deep source as their general brilliance. It was the strangest bit of advice ever to be proffered by an American central banker, Jim Grant, publisher of Grants Interest Rate Observer , told the San Francisco Chronicle . It is tempting to ask what stake the chairman might have in trying to convince millions of people to do something so contrary to their own interest. One theory floated by Fed-watchers is that the chairman is trying to help out his classic institutional constituency, the big banks, which hold trillions of dollars in fixed-rate mortgage paper. There may be something to that theory, but there is almost certainly a deeper and more important motive behind this curious advice. Quite simply, Greenspan is trying to keep a wobbly and fragile recovery alive-and using mortgage refinancing to do it. There are many strange things about the choppy recovery were in, but among the most curious is that it is being fueled largely by consumer spending. Why consumers should continue to spend, and why theyve done it throughout the recession, is not immediately obvious. After all, average income growth has been puny in the last few years. And the stock market has spent the last three years unsuccessfully huffing and puffing to get back to the level where it was in early 2001. One is that Americans have so lost their moorings that theyve had few qualms about going deep into debt. The average persons debt as a percentage of his income is now higher than its ever been. But theres another reason, too: Americans have been using their homes as ATM machines, refinancing their mortgages in order to fund their spending. The one sector of the economy that has consistently swelled has been housing prices. This has intrigued and surprised many economists, because housing is supposed to operate in sync with the economy, expanding during flush times and contracting when things go poorly. Because of these rising prices, people have felt that despite all the ups and downs in stocks and salaries, that their overall situation was okay. Homes are the biggest asset most families own, and their value has been rising nicely. For that reason, Americans have felt more comfortable buying big-ticket items, from SUVs to new computers to Disney World vacations. But that debt has been kept somewhat manageable by another factor in housing prices: mortgage refinancing. With home prices rising and the Fed keeping rates low, a mortgage refinancing industry that barely existed 15 years ago exploded into one of the fastest growing sectors of the financial services industry. Last year, one-third of all homeowners used cash-out mortgages to refinance their homes, a rate roughly consistent over the past five years. Savvy investors, says Harvard economist William Apgar, are likely to have refinanced two or three times in the last two years. Each time they do, they have either been able to lower their monthly payments, or walk away with a chunk of cash. The ubiquitous Ditech TV ads say it all: I just refinanced my home and paid off my credit cards! American homeowners have gained $16 trillion in cash from refinancing in the last five years, and those gains have flowed almost wholly into purchases of consumer goods. The resulting spending, says Whartons Susan Wachter, is propping up the American economy. But with the Fed funds rate at 1 percent, the chairman cant do much more to sustain it. Tens of millions of Americans have already refinanced their mortgages, and at current rates, cant be induced to do so again. This small window is closing, fast: For six months, refinancing has been tapering off, and economists expect it to narrow further-many economists have argued the gains from refinancing are likely to halve ths year. Moreover, as soon as interest rates rise as Greenspan himself has said they will within the next year, virtually all refinancing will cease. Greenspans rather ham-handed effort to get them to go for ARMs, is a sign not of the chairmans own eccentricity or advanced age, but, instead, of the economys current unsteadiness. Greenspan knows, perhaps better than anyone, that this economy is perched nervously on top of a wobbly, Dr. Our recovery is propped up by consumer spending, which is in turn propped up by mortgage refinancing, and if that refinancing dries up before more props can be put in, the whole edifice could fall. Since long-term interest rates cannot fall low enough to facilitate another wave of fixed-rate refinancings, he is trying to encourage homeowners to refinance one last time: fixed to ARM, Peter Schiff, president of Euro Pacific Capital in Los Angeles told the San Francisco Chronicle. Lets assume for a moment that enough people get fooled, and the refinancing boom gets extended for another year. Because if you think Greenspans being cagey on refinancing, the truth hes really avoiding talking about is that were in the midst of a huge housing bubble, on a scale only seen once before since the Depression. Worse, the inflated housing market is now in an historically unique position, as the motor of the rest of the economy. Within the next year or two, that bubble is likely to burst, and when it does, it very well may take the American economy down with it. House bound Whether or to what extent American home prices will plummet soon is open to some debate, but not much. Even the professionally optimistic housing economists employed by the real-estate industry are now admitting that the good times may be over: What we would ask for is kind of a slow slowdown, Jeff Culbertson, president of Coldwell Banker-Northern California, told Knight Ridder at the beginning of March. Virtually every housing economist is concerned that prices may be unstable, and growing numbers are becoming outright alarmed. To understand why that is-and why warnings of a coming housing collapse havent been front-page news-just look at the numbers. Perhaps the crucial ratio from which economists determine whether housing markets are out of whack is the ratio of home prices to annual income. In most of the country, it is modest, 24:1 in Wisconsin, 22:1 in Kentucky, 29:1 in Illinois. Only in about 20 metro areas, mostly located in eight states, does the relationship of home price to income defy logic. The bad news is that those areas contain roughly half the housing wealth of the country. In California, the price of a home stands at 83 times the annual family income of its occupants;
Getting a home loan used to be a particularly nerve-wracking and unpleasant process. A stern loan officer behind a big mahogany desk would pore over your income and credit, suspiciously probing your portfolio for weaknesses. And sensibly enough: The bank that lent you the money would have to collect on the mortgage for the next 30 years and had to make sure you were really good for it. It hired independent appraisers to make sure the price was in line. This process was a little stingy, and meant some people on the low end of the income scale couldnt buy a home and many others got less home than they might have wanted, but the system usually kept prices in check. The one exception to this general process was mortgages sold on the secondary market. In the 1930s, Congress created the Federal National Mortgage Corporation Fannie Mae to encourage banks to make loans to low-income Americans by agreeing to...
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