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Smash the Debt Ceiling, and the Roof Falls In on Housing

Failing to increase the federal government's borrowing limit would amount to kicking a wounded dog -- the American homeowner. Says Christian Weller, a professor of public policy at the University of Massachusetts, in a report for Washington think-tank the Center for American Progress:

If Congress fails to raise that ceiling then the U.S. housing market would most likely experience a severe double-dip contraction marked by much lower home sales and depressed house prices. That in turn would spark a return of the economic pain of the past few years for many families as foreclosures would remain at or near record highs, and jobs in key sectors, such as construction, would disappear again.
Quantifying that pain, Weller calculates that mortgage rates would jump 0.66 percent. That would boost the interest rate on a conventional 30-year fixed mortgage, which as of March averaged 4.84 percent, up to about 5.5 percent.

Why would mortgage rates rise? Because U.S. Treasuries would, reflecting the greater rate of return lenders would demand to offset the added risk of buying American government debt. Citing bond investors, Weller estimates that exceeding the debt limit would cause benchmark rates to rise by 0.5 percent (click on below chart to expand). That would increase borrowing costs for all manner of loans.

How bad would it hurt?
Higher mortgage rates would obviously slam the still fragile real estate market. As the housing sector was collapsing between 2005 and 2008, new home sales fell by nearly 48,000 for every one percentage point rise in the "real" mortgage rate (mortgage rates minus the rate of house price increases).

So a 0.66 jump in mortgage rates would put a big gouge in the market for both new and existing homes. Slackening demand for homes in turn would make it harder to clear the market of the millions of homes in some phase of foreclosure, further depressing prices.

Another impact of rising mortgage rates -- higher house payments. Homeowners would lose even more wealth at a time when their home equity has already sunk to a record low.

Crossing the Rubicon
Since housing is a key component of the broader economy, the damage from rising interest rates would ripple across the country. For instance, Weller notes:

A double dip in the housing market -- fewer sales and lower prices -- would send construction employment lower again and prolong the economic pain for laborers and specialty contractors alike.
Meanwhile, the adverse impact on the housing sector and the broader economy would likely persist even after Congress finally stopped playing games and upped the debt ceiling. Plunging the federal government into default, even only temporarily, would set a precedent that global investors would have to factor permanently into the rate they charge the U.S. to borrow money. Because if something can happen once, it can happen again.

Lawmakers are, of course, well aware of the repercussions of refusing to raise the debt limit by the government's August 2 deadline. Or at least they should be, even if Republican hardliners pretend the danger is all one big hoax. It's not.

Thumbnail from Flickr user Woodleywonderworks

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