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Building on the bubble.

In late February, Federal Reserve Chairman Alan Greenspan--to the befuddlement of many financial analysts--floated the suggestion that homeowners should consider switching from fixed-rate mortgages to adjustable-rate mortgages (ARMs). This advice made no sense, given that interest rates are at 30-year lows, and are almost certain to rise soon--meaning that those who change to ARMs would end up paying a great deal more in interest. Greenspan's suggestion was "the strangest bit of advice ever to be proffered by an American central banker," opined Jim Grant, publisher of Grant's Interest Rate Observer.

"But sometimes wacko ideas can betray deeper truths," pointed out Benjamin Wallace-Wells in the April Washington Monthly. "Quite simply, Greenspan is trying to keep a wobbly and fragile economy alive--and using mortgage refinancing to do it."

"Americans have been using their homes as ATM machines, refinancing their mortgages in order to fund their spending" continues Wallace-Wells. "The one sector of the economy that has consistently swelled has been housing prices.... Because of these rising prices, people have felt that despite all the ups and downs in stocks and salaries, their overall situation was okay.... For that reason, Americans have felt more comfortable buying big-ticket items, from SUVs to new computers to Disney World vacations. Much of that spending has gone right onto the VISA card. But that debt has been kept somewhat manageable by another factor in housing prices: mortgage refinancing."

By keeping interest rates low, Greenspan's Fed has triggered an unprecedented "refi" boom, with millions of homeowners refinancing two or three times over the past several years. However, with the Fed's fund rate now pegged at one percent, Greenspan has nothing left in the toolbox--except the counter-intuitive suggestion that homeowners refinance again to ARMs. Furthermore, for the past six months "refinancing has been tapering off," despite the still-available record low rates. Greenspan's bizarre advice notwithstanding, a rate increase will almost certainly choke off refinancing altogether.

The unpalatable truth, Wallace-Wells notes, is that "we're 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."
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Title Annotation:Insider Report
Publication:The New American
Geographic Code:1USA
Date:May 3, 2004
Words:390
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