August 8th, 2011 8:24 AM by Lehel S.
It appears politicians have averted catastrophe, cobbling together a tentative deal Sunday ending the political stalemate over the debt ceiling. Nevertheless, America's chronic debt problem could still have far-reaching consequences, damaging not only the United States' reputation as a fiscally responsible nation, but further hobbling an already haggard housing market.
Though the United States may have narrowly sidestepped default, experts say there's no guarantee the nation's pristine credit rating will remain intact. Ratings agency Standard & Poor's warned in July that it would consider downgrading the nation's 'AAA' rating debt if lawmakers did not strike a deal cutting deficits by $4 trillion. The tentative agreement reached Sunday falls well short of that level, calling for about $2.4 trillion in cuts over the next 10 years.
Experts say a downgrade would likely trigger an increase in interest rates and put further downward pressure on home prices. "We're on track for an inevitable downgrade at some point," says Greg McBride, senior financial analyst at Bankrate.com. "It's a more modest impact [than default], but it's not so much the initial move in interest rates, it's the permanency of the higher level" of interest rates that will keep some prospective home buyers on the sidelines.
Higher borrowing costs would likely decrease the sum prospective home buyers could mortgage, in turn cutting into the amount they could afford to pay for a home. "If it costs more to get a mortgage, that means you're going to have less income to qualify with, which means you can only afford to buy a lower priced home," says Bob Dietrich, managing director of FMV Opinions, a national financial advisory firm. That would likely translate into more demand for homes at lower price points, putting further pressure on already sinking sale prices.
Against the backdrop of disappointing GDP figures released Friday—the economy grew just 1.3 percent compared to the almost 2 percent growth rate economists had expected—and a struggling housing market already dragging significant weight, any additional headwinds created by higher borrowing costs could be disastrous.
Even rock-bottom mortgage rates for the past few years have failed to stimulate any meaningful energy in the lethargic housing market. With the exception of a brief uptick in 2008 and 2009 when the federal government offered the home buyer's tax credit, sales have been flat or falling in most regions. The most recent monthly existing home sales figures from the National Association of Realtors showed a decline of almost 1 percent from a year ago, while the total inventory of homes for sale rose to 3.77 million homes representing a 9.5 month supply at the current sales pace.
"Economic uncertainty and the federal budget debacle may be causing hesitation among some consumers or lenders," NAR chief economist Lawrence Yun said in a July press release.
But while a downgrade is certainly not positive for the housing market, default would be a much more serious and harmful affair; an event that could plunge the United States back into an even deeper recession. "If Uncle Sam defaults, nobody's going to want to lend to anyone," McBride says. "There's a real risk that credit markets freeze, which would jeopardize the entire economy." A downgrade on the other hand would increase interest rates, but credit markets would be relatively unaffected, McBride says.
But with the federal government looking to pare down its presence in the housing market, other experts are unsure whether the private lending market will fill the enormous void currently filled by quasi-governmental agencies Fannie Mae and Freddie Mac. The mortgage giants currently back more than 90 percent of new home loans, and absent the government guarantee, private lenders may not be willing to lend, even at higher interest rates. "There's not a lot of private lenders out there who are not lending against a guarantee from Fannie and Freddie, so if you take that away, you could have a serious problem," Dietrich says of consumer mortgage credit availability.
Another wildcard is the prospect of government spending cuts. With the economy already at stall speed and government spending at nearly 25 percent of GDP, any cuts could drastically change the dynamic of a struggling recovery. "The aspect to be mindful of if [politicians] do come to some agreement on spending cuts is when those spending cuts kick in," McBride says. "Too much too soon could be devastating to the overall economy."
A provisional agreement to raise the debt ceiling enables the United States to avoid default, but it does little to resolve the underlying debt issues the country faces. And while the tentative agreement might have quelled financial market jitters, ratings agencies will keep a close eye on how politicians plan to rein in the nation's soaring public debt. A downgrade would not be catastrophic, experts say, but it would add headwinds for an economy still carrying the dead weight of a debilitating recession.