Maybe Alan Greenspan Was Right About Floating-Rate Mortgages

Back in 2004, Alan Greenspan suggested Americans might benefit from taking out more floating-rate home loans.

More than a decade after the former Federal Reserve chairman touted adjustable-rate mortgages, James McAndrews, the New York Fed’s director of research, has suggested that the U.S. may indeed have been better off with more floating-rate home loans. And just like Greenspan’s comments, the latest remarks come just as the U.S. central bank is preparing interest-rate increases that would ostensibly make it more expensive for borrowers with such debt.

Greenspan’s advice seemed particularly ill-timed.

From May 2004 through June 2006, the Fed increased its benchmark interest rate by 4.25 percentage points. Defaults then began to surge as borrowers with the adjustable rate mortgages, known as ARMs, failed to keep up with rising mortgage payments. Given what happened during the slump —combined with new underwriting regulations— almost no one is getting ARMs anymore, as seen in the chart below.

The point McAndrews makes is that had more homebuyers gone with floating-rate debt, perhaps in some ways the years following the crisis would have been less painful.

The benefits of the stimulus and ultra-low interest rate policy enacted by the Fed beginning in 2008 wasn’t passed on as quickly to homeowners with fixed-rate mortgages. Many borrowers got stuck in fixed-rate loans on which they owed more than the now-depressed values of their homes. Even as the Fed moved to cut official interest rates, the average interest rate paid on the total stock of outstanding mortgages fell much more slowly and by a lower amount, according to McAndrews.

“All this implies that a higher share of ARMs at the start of the financial crisis would likely have enhanced the effectiveness of monetary easing in reducing foreclosures and stimulating the macroeconomy,” McAndrews said in a speech last week.

see more: http://www.bloomberg.com/news/articles/2015-05-27/maybe-alan-greenspan-was-right-about-floating-rate-mortgages