Alan Greenspan on ARMs in 2004

It was a bit surprising to read this comment by Bob McTeer, the former president of the Federal Reserve Bank of Dallas, regarding the criticism directed toward former Fed chief Alan Greenspan for his 2004 remarks on adjustable rate mortgages.

Now, what about the chairman luring unsuspecting consumers into adjustable rate mortgages they couldn't afford? The origin of this charge is his speech on Feb. 23, 2004, to the Credit Union National Association. In a technical discussion of "Mitigating Homeowner Payment Shocks," the chairman noted fixed-rate mortgages had the advantage of allowing homeowners to prepay debt when interest rates fall but don't require higher payments when rates rise.

His research indicated, however, that this advantage was probably overpriced by the market. "Homeowners pay a lot of money for the right to refinance and for the insurance against increasing mortgage payments. Calculations by market analysts of the 'option adjusted spread' on mortgages suggest that the cost of these benefits conferred by fixed-rate mortgages can range from 0.5 percent to 1.2 percent, raising homeowners' annual after-tax mortgage payments by several thousand dollars. Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward."

Somehow, I doubt the chairman's geek speak sent Joe Six-pack running off to apply for an ARM he couldn't afford. Affordability, let's remember, is primarily a matter of income. At the Economic Club of New York a week later, the chairman, asked about his earlier remarks on ARMS, emphasized that their focus and applicability was limited to a very small segment of households.

What part about saving "tens of thousands of dollars had they held adjustable rate mortgages" is incomprehensible to Joe Six-pack?

This too came from the February 2004 speech in question - a sort of "call-to-arms" (no pun intended) for mortgage lenders to "get creative".

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

Bob McTeer was lauded here at this blog not more than three months ago for his dissent on the savings rate versus wealth creation debate (see An Economist Breaks Ranks).

What's happened to this once-clear thinking former Fed governor?