The U.S. economy is in a period of expansion with low inflation that points to continued raising of interest rates, Federal Reserve Chair Alan Greenspan said in prepared testimony to the House Financial Services Committee today.

 

Greenspan cited three “significant uncertainties” that could alter the Fed’s outlook and policies: inflation, energy prices, and the behavior of long-term interest rates, which he called “especially surprising” given the Fed’s rate increases.

 

Low long-term rates are fueling a housing boom in the U.S., the Fed chairman said. That’s creating “signs of froth” in some local markets where prices have risen to “unsustainable levels,” he said, and “we certainly can not rule out declines in home prices, especially in some local markets.”

 

Greenspan acknowledged that if declines were to occur, “they likely would be accompanied by some economic stress,” though the Fed chair said he didn’t think it would necessarily be major.

 

“Nationwide banking and widespread securitization of mortgages make financial intermediation less likely to be impaired than it was in some previous episodes of regional house-price correction,” Greenspan noted.

 

The Fed chair also said a decline in the home prices nationwide would probably not trigger significant rises in foreclosures because most homeowners have “substantial equity,” despite large withdrawals of home equity in recent years.

 

Greenspan expressed “particular concern” over the increase in interest-only loans and the adjustable-rate mortgages. He said some may be using these instruments to buy otherwise unaffordable homes, “and consequently their use could be adding to pressures in the housing market. Moreover, these contracts may leave some mortgagors vulnerable to adverse events.”

 

Greenspan said, “It is important that lenders fully appreciate the risk that some households may have trouble meeting monthly payments as interest rates and the macroeconomic climate change.”

 

Overall, though, Greenspan said, striking his usual positive but measured note, the U.S. economy has remained on a firm footing, and inflation continues to be well contained. Moreover, the prospects are favorable for a continuation of those trends, he said.

 

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