Greenspan: I misjudged subprime lending crisis

The former US Federal Reserve chairman, Alan Greenspan, has warned that house prices in the US are likely to fall by at least single digits and probably double digits before they reach the bottom of the cycle as a result of the subprime lending crisis.

However, despite acknowledging that he had underestimated the impact of such risky lending practices on the broader economy, Dr Greenspan said the bigger long-term risk for the US economy and the global economy was inflation.

Dr Greenspan led the Fed for 18 years, under four presidents.

In a round of media interviews to publicise his memoir, The Age of Turbulence, released yesterday, US time, he told the Financial Times the fall in house prices "is going to be larger than most people expect" and that he would expect "as a minimum, large single-digit" percentage declines in US house prices from peak to trough.

He said he would not be surprised if the fall was "in double digits".

As Fed chairman, Dr Greenspan had talked about "froth" in the housing sector but never said there was a bubble in the market as a whole. He told the Financial Times that froth "was a euphemism for a bubble".

Some sectors have blamed Dr Greenspan for the loose credit that fostered the housing market boom, giving rise to subprime lending. Between 2001 and 2004, he cut interest rates several times to stimulate the economy.

House buyers who would not have ordinarily qualified for finance from a conventional bank took subprime loans, which were marketed by mortgage brokers with little regard for whether or not the borrower would be able to meet the repayments.

Many subprime loans had low initial teaser rates for the first two years, but then rose precipitously.

Refinancing options have dried up and consumer groups predict that as many as 17 million Americans could lose their homes in the next two years.

"While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late. I really didn't get it until very late in 2005 and 2006."

Even though one of the Fed's governors raised concerns about the lending practices that were going on, Dr Greenspan said there was little he could do.

"Well, it was nothing to look into, particularly because we knew there was a number of such practices going on, but it's very difficult for banking regulators to deal with that," he said.

The Fed board is due to meet today, US time, and is expected to cut interest rates by at least 0.25 percentage points, from 5.25 per cent, in an attempt to alleviate some of the chaos in the financial markets that has arisen from the subprime lending crisis.

Dr Greenspan sounded a warning to his successor, Ben Bernanke. "We were dealing in an environment back there where inflation was easing.

"We could have acted without the fear of stoking inflationary pressures. You can't do that any more," he said.

He warned that the problem over the long run was a re-emergence of inflation.

"We will get through this credit crunch, we always do. This is a human behaviour phenomenon and it will pass. The fever will break," he said.

"The problem over the long run is the re-emergence of inflation. I have a line in the book saying this looks pretty gloomy," he said.

- © Fairfax NZ News