Fed's Olson Urges Care With `Novel' Home Mortgages (Update3)
Fed's Olson Urges Care With `Novel' Home Mortgages
Sept. 16 (Bloomberg) -- Federal Reserve Governor Mark Olson urged U.S. lenders to use care with ``non-traditional'' types of home mortgages such as interest-only and adjustable-rate loans, because some borrowers will be ``severely challenged'' to repay them if interest rates rise.
Regulators are also concerned about the surge in commercial real-estate loans, especially in markets where vacancy rates are high and in possibly ``overheated'' housing markets where there is a ``significant amount'' of residential construction, Olson said at a Middle Tennessee State University conference in Murfreesboro.
His comments on mortgages echo remarks by Fed Chairman Alan Greenspan in July that he is concerned about some types of ``exotic'' mortgages, such as loans that let a borrower pay no principal for a period. Olson said in text prepared for the speech that banks ``must take into account the unique characteristics and credit risk profile'' of the loans, especially because regulators' experience with them is limited.
``We're allowing our banking system to issue what are essentially infinite mortgages -- you can pay on an interest-only mortgage ad infinitum and never pay it off,'' said Jim Stack, president of Investech Research in Whitefish, Montana. He said the Fed's actions in dealing with the housing market will determine the severity of the next U.S. recession.
Adjustable-rate loans, which allow for rate fluctuations as opposed to traditional fixed-rate mortgages, accounted for, on average, 32 percent of mortgage applications each week since the start of 2004, according to the Mortgage Bankers Association. That compares with an average of 19 percent in 2003 and 15 percent in 2002.
Some Prices `Unsustainable'
Federal Reserve policy makers raised the benchmark overnight lending rate 10 times since June 2004 as manufacturing and payrolls expanded. That increases the monthly payments of adjustable-rate mortgages, Duncan said yesterday.
``In many markets, the increase in housing value is unsustainable,'' Olson told the audience. Some areas will see a ``leveling'' or decline in home prices, he said.
Olson told reporters afterward that ``we do not see a national bubble'' in home values.
``What we have noticed is the rate of appreciation in values in some markets is clearly unsustainable and in some markets we've seen what the chairman referred to as `froth,' '' Olson said. ``It seems likely the rate will at least plateau and in some places could even decline.''
Not Seeing Delinquencies
Even so, borrowers are having little difficulty repaying their mortgages so far because of low interest rates, he said in the speech. ``We're not seeing the delinquencies yet,'' Olson said.
The bankers group said yesterday that U.S. delinquencies rose in the second quarter, led by prime adjustable-rate mortgages that saw their payments increase as short-term interest rates climbed.
The share of prime ARMs with late payments rose to 2.19 percent from 2.06 percent in the first quarter. The delinquency rate will likely increase again during the next two quarters in the wake of Hurricane Katrina, Doug Duncan, the group's chief economist, said yesterday.
In commercial real estate, Olson said that ``we do not yet see a weakness in the performance of those loans, but it's the concentration of those loans and the sole reliance on that category of loans for growth that causes us some concern and makes for careful monitoring.''
``As we go into banks and examine that element of their loan portfolio, we're looking very carefully at the underwriting standards,'' he said.
Internal Controls
Olson also stressed the importance of good corporate governance for banks, saying that ``almost all'' recent problems with individual institutions ``have resulted from weaknesses in the internal controls.''
``Where we see losses, we tend to see major losses,'' Olson said. ``The problems resulting from lapses in internal controls tend to explode in front of you.''
Olson and other Fed policy makers meet on Sept. 20 to decide on the level of interest rates, and Fed officials typically do not comment on monetary policy or the economy during the week before a rate decision. Olson followed that practice today.
Olson, 62, previously worked as a partner at Ernst & Young LLP, a Minnesota bank president and a congressional aide before joining the Fed board in 2001 to serve a term ending in 2010. As a governor, Olson is a voting member of the Federal Open Market Committee, the Fed panel that makes interest-rate decisions.
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.
Market Data 
Markets 
AI
