August 2nd. The day looms over the American public drearily, as failed negotiations leading up to the imposing government debt deadline make the possibility that the United State will default on its debt all the more likely. We have heard from pundits and economists that the consequences would be devastating, that inflation would soar and unemployment would also increase, all while spiraling the U.S. economy into a double-dip, “U-shaped” recession. The consequences of default on some facets of the U.S. economy seem more apparent than others, like the demand for government issued securities and the market for our bonds. Among all of the apocalyptic speculation about what would happen if we defaulted, however, little commentary has emerged focusing on the housing market.
However, Christian Weller of the Washington-based Center for American Progress, a left-of-center think tank, had already analyzed the effects that a potential default would have on the housing market as early as last May. Now, Weller’s analysis seems all too apropos, as default increasingly looks like it could be a real possibility. Back in May, long before most analysts even considered a default scenario, Weller wrote in a CAP brief that “if Congress fails to raise that ceiling then the U.S. housing market would most likely experience a severe double-dip contraction marked by lower housing sales and depressed home prices.” It turns out, albeit not surprisingly, that the potential downgrade of treasury securities and the depressed market for government issued bonds could have a devastating effect on the housing market as well.
The brief goes on to outline six main contentions as to what a default would mean for housing: 1) mortgage interest rates will rise more than U.S. Treasury rates; 2) mortgage rate will remain high for some time; 3) new home sales could drop to record lows; 4) existing home sales will decrease; 5) housing prices will drop in the wake of fewer sales; and finally, 6) the economy will suffer.
Throughout the analysis, a subtly consistent point emerges: mortgage rates are directly tied to treasury interest rates, and thus, higher treasury interests would translate to higher mortgage rates. Because U.S. government debt is perceived to be an almost risk-free investment, a default would very likely increase the interest rate on U.S. Treasury bonds. As the table above shows, the correlation with between increased debt and higher mortgage rates are staggering.
But what’s worse, according to Weller, “the assumption is that even if the debt ceiling is not raised in August, members of Congress will eventually come to a budget agreement to pay for the government’s operations and pay the outstanding debt.” However, even a temporary default will have an impact a major, perhaps permanent impact on interest rates, as investors, for the first time, will associate risk with U.S. debt.
While all of this may come across as overly abstract and theoretical, the effect that a default will have on the housing market, and more specifically, on St. Ambrose and the Baltimore community, will be huge. To name just one example, much of revenue that helps fund our operation here in Baltimore comes from home sales [hyperlink], as our inventory of competitively-priced, high quality homes in the Baltimore area has long been an asset building and neighborhood stabilizing resource for low and middle income homeowners of Baltimore City. With higher mortgage rates, however, fewer and fewer families would realistically be able to secure a home loan that may fund even our modest properties. This fact coupled with the recent news that a median income Baltimore resident may be unable to afford a Baltimore home makes the prospect of a default significant.
Beyond this, our foreclosure prevention department, which is swamped with cases, would certainly have to shoulder an increase in clients. More foreclosure and less affordable housing means more vacant properties, depressed mean home values in neighborhoods, and depleting household equity for Baltimore families. In total, the effect on our community would be devastating, and we hope that our two major political parties will find a way to stave off this disaster. Time will tell.