Housing Analysts Jittery About Debt Default Scenario

Fueling fears about a federal default scenario, fragile debt-ceiling negotiations continued to splinter this week, with Republicans refusing to budge on a higher tax proposal and Democrats fighting to keep entitlements off the chopping block. If trends continue and the federal government defaults on its debt, housing economists and mortgage rate analysts predict spikes in interest and mortgage rates, corresponding with catastrophic and steep declines in home sales.

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On Friday ""CNN"":http://articles.cnn.com/2011-07-13/politics/debt.talks_1_debt-ceiling-short-term-extension-debt-ceiling-hike?_s=PM:POLITICS reported that President Barack Obama abruptly walked out of a meeting with House Majority Leader Eric Cantor (R-Virginia) and other congressional leaders, concluding a fourth-straight day of negotiations between public officials without a resolution in sight.

In response, ratings agency ""Moody's Investors Services"":http://www.moodys.com/ placed the U.S. sterling bond rating on review for possible downgrade, citing ""the rising possibility"" that the political standoff will result in a default. ""Standard & Poor's"":http://www.standardandpoors.com/home/en/us followed suit Friday by placing its long-term ""Aaa"" and short-term ""A-1+"" U.S. ratings on CreditWatch, according to ""_Bloomberg News_"":http://www.bloomberg.com/news/2011-07-15/markets-shrug-after-s-p-says-50-chance-of-u-s-credit-rating-downgrade.html.

""If the current political gridlock prevails, and Washington defaults on its debt payment obligations, the economy would begin freezing up almost instantly, and it could be many years before it thaws,"" writes Greg McBride, a senior financial analyst at ""Bankrate"":http://www.bankrate.com/finance/mortgages/volatility-imperils-mortgage-stability.aspx.

Not everyone agrees about the potential for a debt default, but economists and analysts across the board say the scenario would trigger sharp increases in one- and five-year Treasury yields, forcing mortgage rates to soar and break up a still-brittle housing recovery.

""Do I think the [U.S.] will default on [its] debt? No. But if they don't start making substantial progress soon we should look for interest rates to start to moving higher,"" a ""Bankrate"":http://www.bankrate.com/finance/mortgages/volatility-imperils-mortgage-stability.aspx article reports Bob Walters, chief economist for ""Quicken Loans"":http://www.quickenloans.com/?gclid=CJfToL_sg6oCFYsd2god1xaQyA&qls=GBR_K0009869.0000542706&ef_id=YedN8lhcinoAAIbX:20110715171424:s, as saying. ""And that could happen before Aug. 2.""

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A default ""would not be good,"" agrees Frank Nothaft, vice president and chief economist at ""Freddie"":http://www.freddiemac.com/, adding that he thinks ""it's a relatively low probability that Congress would allow an event like that to occur,"" but that should it happen ""it would lead to a spike upward in Treasury yields, and if Treasury yields move up sharply, it will cause mortgage rates and Treasury yields to move up considerably.""

This week the ""Treasury Department"":http://www.treasury.gov/Pages/default.aspx released data signaling that Treasury yields persist in fluctuating, as one-year and five-year indices zigzagged from 0.20 percent to 0.15 percent and 1.80 percent to 1.51 percent since the beginning of July.

Reflecting the instability, a weekly ""Freddie"":http://www.freddiemac.com/ report posted a 3.29 percent average for five-year Treasury adjustable-rate mortgages, reflecting a dip from one-year Treasuries.

These numbers would jump sharply in the event of a debt default by the U.S. government, says Paul Dales, senior U.S. economist at ""Capital Economics"":http://www.capitaleconomics.com/. ""That wouldn't help the housing market because it is quite fragile at the moment.""

In testimony before the Congressional Democratic Policy and Steering Committee, Heather Boushey, a senior economist with the ""Center for American Progress Action Fund"":http://www.americanprogressaction.org/, outlined much riskier and far graver consequences for the housing sector and homebuyers.

In a scenario where the federal government defaults on its debt, she said, ""bondholders will likely require higher interest rates on U.S. Treasuries├â┬ó├óÔÇÜ┬¼├é┬ª eliminat[ing] nearly 650,000 jobs"" in the economy.

""If the Treasury rates immediately go up by 0.5 percentage points, the household debt service burden for the average U.S. family would also increase by at least 0.5 percentage points,"" she added. Partly as a result, ""[a] debt default would likely cause an increase in the 10-year Treasury rate by half a percentage point, which could translate into a jump in the mortgage rate equal to 0.66 percentage points, the highest levels since 2008. This will further depress the housing market.

""The U.S. housing market would most likely experience a severe double-dip contraction marked by much-lower home sales and depressed house prices,"" she added.

Set to expire on August 2 ├â┬ó├óÔÇÜ┬¼├óÔé¼┼ô unless Congress approves a ceiling-raise ├â┬ó├óÔÇÜ┬¼├óÔé¼┼ô the current statutory debt limit hangs at $14.3 trillion.