Greenspan, Regulators Raise Housing Red Flags

Federal Reserve (search) Chairman Alan Greenspan (search) this week added to a chorus of worry about the growth of home loans that are seen as far riskier than the traditional 30-year mortgage.

Those alternatives, called "exotic" by the Fed chief on Thursday, have played a big role in sustaining the four-year housing boom by making homes more affordable, which in turn stoked demand and drove prices higher and higher.

But these hundreds of alternative mortgage products have also injected more risk into the market — both for lenders and borrowers, according to regulators and some analysts.

Of most concern are loans that require little downpayment and delay big principal payments, leaving homeowners highly leveraged for longer just as rates appear poised to rise.

"The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages (search) are developments of particular concern," Greenspan told Congress.

He's not alone.

Banking regulators have been raising red flags over the past weeks, warning the lenders they supervise that competition to win borrowers must not compromise lending standards.

Donald Powell, chairman of the Federal Deposit Insurance Corp. (search) , which supervises banks and insures deposits, this week said more than 30 percent of all home loans in 2004 were "nontraditional," or anything other than a 30-year, fixed-rate fully amortizing mortgage.

"There are some signs in certain markets that banks have been aggressive and liberal in their underwriting," he said.

Fed Governor Susan Bies (search) Tuesday said the United States has developed "an aggressive lending culture" on home mortgages that is veering toward unsound practices in some communities.

Some economists and analysts said Greenspan is trying to talk the market down just in case the housing sector boom turns out to be more bubble than localized "froth."

"I think there is a certain amount of frustration that the Fed's got," said Carl Steidtmann, chief economist of Deloitte Research. "They keep pushing up interest rates and mortgage rates keep going down."

But not everyone is as worried as regulators appear to be.

Adjustable-rate mortgages, and even interest-only mortgages, are the right product for certain borrowers, according to analysts and economists.

"I don't want to throw cold water on it and say, 'Oh this is a terrible product,"' said Frank Nothaft, chief economist at mortgage finance company Freddie Mac (FRE). "For some people it is perfectly the right product."

Greenspan's goal, Nothaft said, is to remind consumers that prices are not likely to keep climbing at rates topping 10 percent, as they have in recent years.

And as the FDIC's Powell said, homeowners do not want to get "upside-down" and owe more on the loan after five years than they did when they first took it out.

"It's to remind consumers that bad things can happen to good people," Nothaft said.