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Analysts: U.S. Default May Crimp GSEs, Close FHA

With recent reports signaling a throwback for public officials involved in debt-ceiling negotiations, housing analysts and market watchers worry about the possible fallout for government-backed mortgages in a default scenario come August.

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Concerns continue to grow after a series of breakdowns between Congress and the White House this week. According to the ""_Huffington Post_"":http://www.huffingtonpost.com/2011/07/21/mcconnell-reid-debt-plan_n_905699.html, House Republicans refuse to back a debt-ceiling raise agreement in which the federal government slashes spending by $1.5 trillion over 10 years, with ""President Barack Obama"":http://www.whitehouse.gov/administration/president-obama gaining the ability to suggest additional cuts in the future.

If the federal government defaults on its debt, analysts say, still-brittle mortgage markets will splinter as mortgage rates follow spikes in Treasury yields.

A default ""would not be good,"" agrees Frank Nothaft, vice president and chief economist at ""Freddie Mac"":http://www.freddiemac.com/. ""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.""

Paul Dales, senior U.S. economist at ""Capital Economics"":http://www.capitaleconomics.com/, agrees with the scenario, adding that spikes in mortgage rates ""wouldn't help the housing market because it is quite fragile at the moment.""

Throw GSEs ""Fannie Mae"":http://www.fanniemae.com/kb/index?page=home and ""Freddie Mac"":http://www.freddiemac.com/ and the ""Federal Housing Administration"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory (FHA) into the mix, some analysts say, and mortgage markets become less certain in a debt-default scenario.

David Min, an associate director for financial markets policy at the ""Center for American Progress"":http://www.americanprogress.org/, says that the GSEs will ""not be impacted.""

""My understanding is a debt default would slow up the underwriting,"" he says. The scenario ""would not directly impact the GSEs."" He adds that a rise in mortgage rates would likely crimp their servicing activities, and that ""as Treasury rates go up or investors become more worried about their promise to repay, they [investors] may become more worried about ""Fannie's"":http://www.fanniemae.com/ and ""Freddie's"":http://www.freddiemac.com/ bonds.""

Dales cites a 2010 ""Treasury Department"":http://www.treasury.gov/Pages/default.aspx statement on receipts and outlays, suggesting that a meager $0.01 billion cash flow from ""Treasury"":http://www.treasury.gov/Pages/default.aspx to the ""Federal Housing Finance Agency"":http://www.fhfa.gov/ ├â┬ó├óÔÇÜ┬¼├óÔé¼┼ô the agency responsible for oversight of the GSEs ├â┬ó├óÔÇÜ┬¼├óÔé¼┼ô would hardly dent the mortgage giants. He also points to a $4.2 billion infusion of capital from ""Treasury"":http://www.treasury.gov to ""HUD"":http://portal.hud.gov/portal/page/portal/HUD for rental assistance, dismissing claims about a larger impact by saying a loss in federal funds ""will not have an impact on the residential buying market.""

Min thinks differently about the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory. In a recent paper, titled ""Federal Debt Freeze Looming for Housing Market"":http://www.americanprogress.org/issues/2011/06/debt_freeze_housing.html, the associate director argued that a default by the federal government in August would not only cause a spike in mortgage rates but shut down ""government services that are essential to the mortgage markets.""

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"" ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory today is a key source of mortgages, particularly for first-time homebuyers and other demographic groups who are critical for restoring some equilibrium to our still-ailing housing markets,"" he writes, adding that the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory accounts for almost 40 percent of mortgage purchases, according to a HUD report on single-family mortgage originations for the third quarter last year.

""Any extended suspension of ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory lending activities due to a freeze on nonessential government services would cause the housing markets to lock up and prices to potentially free fall, particularly at the lower end of the market where younger, lower-income, and first-time homebuyers are critical,"" Min continues in the paper. ""It would also be devastating for those neighborhoods hit hardest by the foreclosure crisis, effectively squashing any hopes of a recovery.""

A ""HUD"":http://portal.hud.gov/portal/page/portal/HUD spokesperson declined to comment about the potential for a ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory shutdown for a previous story, waving away concerns and emphasizing the government entity's reliance on premiums paid by government-insured mortgage borrowers.

Speaking to _MReport_, Min says that his concerns focus on the bare facts surrounding the federal budget, predicting that the Obama administration would need to make tough decisions in a default.

""If the debt ceiling isn't expanded, [the Obama administration] will have to decide which payments [it is] going to make good on,"" he says, suggesting that federal agencies would need to gut 40 percent of the budget to continue funding essential services. He cites ongoing military operations in Iraq and Afghanistan, payments on outstanding Treasuries to investors, and Social Security and Medicare obligations as just a handful of services important for the ""safety and security"" of the American people.

""This would be a White House decision at the end of the day,"" he says, attributing his predictions to off-the-record conversations with undisclosed HUD personnel. Despite ""HUD's"":http://portal.hud.gov/portal/page/portal/HUD refusal to comment, he says that ""my understanding is that the folks at the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory are expecting"" a shutdown.

Min calls a debt-default scenario ""unprecedented,"" calling the infamous shutdown of the federal government in 1995 the closest and most comparable point-of-reference.

Speculation notwithstanding, Min's colleague, Heather Boushey, a senior economist with the ""Center for American Progress Action Fund"":http://www.americanprogressaction.org/, painted a dim picture for the future of mortgage markets in recent testimony before the Congressional Democratic Policy and Steering Committee.

""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 said. 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,"" adding that ""[t]he U.S. housing market would most likely experience a severe double-dip contraction marked by much-lower home sales and depressed house prices.""

With mortgage rates certain to spike in a default, one question remains: Will a shutdown of non-essential services render problems more directly for the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory?

""I hope it doesn't happen,"" Min says. ""I think the impacts would be a lot bigger than anyone would imagine, and I think the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/fhahistory shutdown scenario is just one"" possible consequence.

About Author: Ryan Schuette

Ryan Schuette is a journalist, cartoonist, and social entrepreneur with several years of experience in real-estate news, international reporting, and business management. He currently lives in the Washington, D.C., area, where he freelances for DS News and MReport.
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