DURING A SPEECH TO THE Credit Union National Association in February 2004, Federal Reserve Chairman Alan Greenspan proclaimed the virtues of adjustable rate mortgages (ARMs). He told the group that if households were willing to manage the additional interest rate risks associated with ARMs, then those loans might serve them better, making the traditional fixed rate mortgage “an expensive method of financing a home.”
What a difference 18 months can make. By this past summer, Greenspan was talking about housing market froth. During testimony before Congress in July, he described the rise in the use of interest-only loans and other forms of ARMs as “developments of particular concern” and warned that “their use could be adding to pressures in the housing market.” His comments about the mortgage industry have grown increasingly critical since.
No wonder the debate rages on about what changes in the mortgage market will mean for housing. New and more widely available creative mortgage instruments, coupled with an influx of capital into the mortgage market and historically low interest rates, have made it possible for more people to own homes.
But Greenspan's shift reflects widespread concern that some of those homeowners will default when their loans adjust at higher interest rates. Many in the home building and mortgage industries think those fears are exaggerated, but analysts caution that it's difficult to predict what will happen, and federal banking regulators are sufficiently troubled that they are preparing new rules for issuing mortgages.
DIZZYING CHANGES The banking industry has come far from the housing busts of the late 1980s and early 1990s, when it also weathered the savings and loan crisis, says Bert Ely, a banking consultant in Alexandria, Va. “The solvency of the industry is much greater,” he says. “It's subject to higher capital levels and much tougher regulation.”
Frank Nothaft, Freddie Mac's chief economist, sees changes in the industry, too. He describes the wide availability of credit, made possible by the growth of the secondary mortgage market, as “strikingly different today.” Freddie Mac and its sister company, Fannie Mae, buy mortgages from lenders and package and sell them as bonds to investors. Banks use Fannie and Freddie's money to bankroll new loans.
For investors, real estate has been a winning venture since the stock market fell five years ago. Domestic and global institutional investors have redirected large portions—as much as 20 percent—of their portfolios toward real estate, says Gary Painter, director of research at the University of Southern California Lusk Center for Real Estate. California's state employee pension system, CalPERS, gained 12.7 percent during fiscal year 2005, due largely to a 38 percent jump in the value of its real estate holdings.
That availability of credit has been a boon for home buyers looking for mortgages. “It has been a key factor in taking some of the cyclicality out of our business,” says John Landon, co-chairman and CEO of Meritage Homes Corp. “Now, it's not a matter of whether you can get a loan, it's a matter of what you pay. It's a huge driver in our current housing business.”
GETTING CREATIVE Many of today's most popular mortgage products were actually developed more than 20 years ago. ARMs were introduced in California in 1974 and expanded nationally in 1981, “the moment of the highest mortgage yields since the Civil War,” says Michael Youngblood, managing director and director of asset-based securities research at Friedman, Billings, Ramsey and Co., an investment bank. The high interest rates that persisted in the early 1980s encouraged creative financing, he adds.
With as many as 200 types of mortgages now available, buyers are able to match their monthly payments to fit their budgets. Low interest rates, coupled with products designed to lessen monthly payments, such as interest-only mortgages or loans with multiple payment options, have enabled buyers to afford higher-priced homes. “Some of the ARM products are a great way for the consumer to offset increasing sales prices,” says Dan Klinger, president of K. Hovnanian American Mortgage.