Housing Prices Aren't Fed Target

Alan Greenspan says he rejects using monetary or regulatory policies to control a potential bubble.
By: GREG IP: The Wall Street Journal Online
Recent warnings by bank regulators on risky housing-related lending aren't meant to rein in a potential bubble, Federal Reserve Chairman Alan Greenspan said.

"The regulatory system is not designed to influence or control asset bubbles, but rather to ensure that bubbles, should they develop, do not lead to unsafe lending practices," Mr. Greenspan said in a letter to Rep. Jim Saxton (R., N.J.), chairman of the Joint Economic Committee of Congress.

The remarks, dated July 11 and released yesterday by Mr. Saxton's office, show the Fed has rejected using either of its major tools -- monetary or regulatory policy -- to rein in housing prices. Mr. Saxton had asked whether the Fed and other bank regulators that had recently issued guidance on risky home-equity loans, were using "regulatory suasion" instead of higher interest rates to rein in a housing-price bubble.

In his letter, Mr. Greenspan also said that the economy is "coping pretty well" with higher oil prices and that the shrinking gap between short-term and long-term interest rates isn't a worrisome sign for the economy. But Mr. Greenspan said his staff expects the rise of crude-oil prices to the range of $60 a barrel to reduce U.S. economic growth by about three quarters of a percentage point this year from what it otherwise would have been, a bigger effect than in 2004.

Mr. Greenspan has long rejected the use of interest rates to tame asset bubbles, such as the stock bubble of the 1990s. He has argued that bubbles are difficult to identify in advance and reining them in may require interest rates so high that they do more damage than a burst bubble. Still, some have speculated the Fed might use its regulatory sway over banks to tamp down the mortgage lending that is now fueling housing activity. In May, the Fed and other bank regulators warned lenders about interest-only home-equity loans, loans made with little or no documentation of the borrower's credit-worthiness, and higher loan-to-value and debt-to-income ratios. Similar guidance on mortgage loans is expected.

But Mr. Greenspan said the guidance isn't a form of bubble-pricking. "It was a response to indications that some banks were not appropriately managing risks in the home-equity area," he wrote. The factors cited by regulators in May "have not necessarily had a material effect on housing prices. The possibility that home prices may be unsustainably high does, however, contribute to the risks associated with such lending, since it may suggest that the value of some loans' collateral may be vulnerable to declines."

The shrinking gap between short-term interest rates and long-term bond yields isn't a "foolproof indicator of economic weakness," Mr. Greenspan wrote. Moreover, forecasting models based on that gap spell "continued moderate" growth "for the foreseeable future," he wrote.

-- Joseph Rebello contributed to this article.