Greenspan Says Forcing Lenders
To Alter Terms Would 'Tax' Economy

WASHINGTON -- Former Federal Reserve Chairman Alan Greenspan said that compelling lenders to alter mortgage contracts would be a damaging tax on the economy and it would be less harmful to simply give the homeowners money.

Mr. Greenspan, clarifying remarks he made on television Sunday, said in an interview with The Wall Street Journal yesterday, "I'm saying instead of in effect 'taxing' financial institutions and giving the funds to the homeowners, we'd be far better off, as far as the future structure of our financial markets are concerned, to do it strictly with cash. Do it out in the open. Do it cleanly and with transparency, not by hidden processes."

Mr. Greenspan said on ABC News's "This Week" that "cash is available and we should use that in larger amounts, as is necessary, to solve the problems." But he wasn't specific about what form that cash would take, and some have interpreted his comments as advocating a massive fiscal bailout, a stance at odds with his longstanding reputation as a fiscal hawk.

Assuming the government is going to act to help out homeowners, Mr. Greenspan clarified that he would like it to do so in a way that minimizes the distortions to private behavior, which economists say can result in the misallocation of resources, less efficient markets and a lower standard of living.

He said, "Emergency aid is what I'm talking about, similar to what government does in natural disasters. I would make the criteria for who gets payments exactly the same for who would get rate relief. You still have the problem of drawing a line between those who were irresponsible and those who are innocent victims. That's a tough political value judgment to make." But once that judgment is made, "it is far less damaging to the economy and far simpler, without the ongoing consequences for the markets, if you give homeowners cash."

Mr. Greenspan's concern is if lenders are compelled, either by law or by government arm-twisting, to change the terms of their mortgage contracts, that would erode trust in such contracts in the future and impair the functioning of markets.

"If I'm a mortgage lender and I know my contracts with borrowers can be abrogated for political reason I will feel it necessary to charge a higher premium to offset that. Any time you undermine contract rights, there are consequences for risk premiums in the future."

Higher risk premiums could take the form of higher mortgage rates or decreased availability of credit.

Treasury Secretary Henry Paulson has hammered out a plan with mortgage servicers creating a streamlined process for certain homeowners with subprime mortgages to have them modified. Its goal is to avoid scheduled increases from their introductory rates that would likely result in foreclosure. Mr. Greenspan's views would be supportive of that only as long as investors determine such modifications to be in their own interest and the modifications are strictly voluntary, as Mr. Paulson's plan is meant to be.

Moreover, Mr. Greenspan worries that even voluntary measures could be harmful if they get in the way of a "selling climax" sending home prices down as rapidly as possible to their natural equilibrium level. "Involuntarily altering the forms of a contract or intervening in the market-price-adjustment process will delay the selling climax, which is necessary to end the current crisis," he said. "At the end of the day, we will experience a far worse outcome."

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