What happens to the housing market if the U.S. breaches the debt ceiling depends on what would happen to Treasury yields.
The classic assumption here is that spooked investors would demand a higher return on their money, sending long-term rates on U.S. government bonds higher. And, of course, higher yields would mean higher mortgage rates. That was the starting point for the scenario painted by National Association of Realtors President Gary Thomas, who testified before Congress yesterday. “Historically,” he wrote in prepared remarks, “an increase in mortgage rates of 1 percentage point reduces home sales by roughly 350,000 to 450,000 units.” For a homeowner making $60,000 a month, it would mean a hike in borrowing costs of $120 a month. Worse still, noted Thomas, the 1% increase could push the same imaginary borrower over the debt-to-income limit set by the new housing finance regulations, making her ineligible for the most affordable loan rates.
There’s another, less obvious impact of a climb in Treasury rates. Higher yields would mean falling bond prices, which would reduce the value of banks’ holdings of U.S. government bonds. Faced with lower core capital assets, banks could pull back from lending just when credit conditions seemed to be finally loosening up. This could magnify the impact on housing sales of that hypothetical 1% rise in mortgage rates, Thomas said.
Still, some analysts note that in a default scenario in which the Treasury keeps making principal and interest payments to bondholders reassured investors could actually push yields — and consequently mortgage rates — down. That would of course significantly cushion the fallout from a debt limit breach.
It remains to be seen what a defult, even a short, selective one, would do to consumer confidence, which, as Thomas noted, is a key indicator of whether people are in the mood to buy a house or not. Today’s release of the Thomson Reuters-University of Michigan Consumer Sentiment Index showed confidence plummeting to a nine-month low in September — and that was at the mere prospect of a possible government shutdown and debt crisis.
The latest proposal from Speaker John Boehner envisions lifting the debt ceiling until Nov. 22, which would avoid the possibility of catastrophe in the housing market, if you assume that yields would move up. In all likelihood, though, it will take more than that to lift American consumers’ spirits.
Bohener’s offer also proposed funding the government through Dec. 15, meaning the negotiations are moving away from the Republican’s original idea of decoupling the debt-ceiling from the government shutdown. That’s a very good thing because a protracted government shutdown could choke the housing recovery.
The shutdown doesn’t affect Fannie Mae and Freddie Mac, the government-supported housing finance giants, the Wall Street Journal’s Nick Timiraos noted. But it does affect the Federal Housing Administration, a federal agency that also processes a sizable amount of loans.
The biggest obstacle to housing activity, though, comes via paralysis at the International Revenue Service, on whom the U.S. housing market depends in order for lenders to be able to verify borrowers’ income. Banks and other mortgage originators are free to make loans even in the absence of such verification but are legally liable if borrowers turn out to have misstated their income and default on their debt. Not surprisingly, most institutions don’t want to go there.
The shutdown, in other words, is a giant bureaucratic bottleneck on housing activity: Nothing to worry about in the short term but very serious if it keeps going.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.