How Debt Ceiling Dithering Could (Further) Wreck the Housing Market

Although I try to keep it off the blog, folks around the office know me as an inveterate real-estate bore. Last year, I tracked mortgage rates with the intensity that other guys reserve for their fantasy football teams, and refinanced not once, but twice. Sadly, this isn't some passing phase. It's been a fixation of mine since back when housing was driving the economy, rather than dragging it down.

I mention this because I've become increasingly puzzled why more people aren't alarmed about the possibility of a debt-ceiling default and the effect that even a whiff of one should have on mortgage rates. If the U.S. were to default on its debt, interest rates would jump. And if rates were to jump, the effect on an already weak housing sector would be calamitous. That, in turn, would harm the broader economy--maybe enough to tilt a weak recovery back into recession. But right now that's not happening. The reason is that the weakening economic outlook has prompted a lot of people to buy bonds, driving up their price and driving down interest rates. Mortgage rates are currently near their lows for the year. It's not a hard and fast rule, but mortgage rates often track the yield for the 10-year Treasury bond. Here's how that's been moving for the last three months:

10 YR Treasury.jpg

So obviously, the bond market isn't particularly concerned about a debt ceiling default. Or perhaps better to say it's paying more attention to weak economic forecasts than the possibility of default. As somebody who follows Congress pretty closely, that doesn't make a lot of sense to me. Sure, both parties are paying lip service to the idea that we "must" raise the debt ceiling. But at the same time they're hardening their positions and making a deal more difficult. That seems worrisome, since it pretty much takes a "forcing mechanism," as we call it in Washington, for Congress to make any difficult decision these days.

We're now within 60 days of Treasury's August 2nd D-Day for default, but few people seem concerned. I think Sarah Palin would have to blurt out something about interest rates from her bus for the issue to gain any traction. But sooner or later the bond market will get nervous and start pricing in a risk premium--we know this because the GAO studied past debt-ceiling showdowns and found that that's what happens. I'm certainly no bond trader, but if I were I'd demand an added premium because the threat of default seems much more real this time than at any in the recent past. And if I were about to buy a house or refinance my mortgage, I'd lock my rate real soon.** That is, unless you're confident that Congress will get its act together in plenty of time and willingly perform the politically painful task of raising the debt ceiling.

Just to be sure I wasn't missing something or misunderstanding some variable, I got in touch with my first mortgage guy, Dan Green (no relation) of Waterstone Mortgage in Cincinnati, who also runs an excellent blog, The Mortgage Reports. I asked what a default would do to rates. "In theory," he said, "if the U.S. government defaulted on its debt, mortgage rates would rise -- rather sharply, in fact." But he added that since nobody knows quite what the fallout would be, there could be a different effect. "Should the U.S. default on its debt, there are so many nations downstream that fear of global contagion would be inevitable. In a strange way, then, a looming U.S. debt default might lead [mortgage-backed-securities] higher"--producing lower interest rates. "That said, I see the risk as miniscule."

So I guess for now, I'm a Cassandra. But I'll be interested to see if others join me, as the deadline approaches.

**Disclaimer: You would not be smart to follow my financial advise. Trust me.