Debt ceiling default could have severe consequences on the housing market

The interest rate on a standard 30-year mortgage would jump as high as 8.4% if the U.S. defaulted on its debts this summer, raising housing costs for new buyers by 22, according to a new analysis by economist Jeff Tucker. Indeed, the federal government is inching closer to a potential default on the national debt since Congress still has not passed legislation raising the statutory debt ceiling. The “X-date”—the date on which the Treasury Department can no longer meet its obligations without raising debt in excess of the ceiling—is projected to land as early as June, but almost certainly by August, depending on the flow of income tax receipts this spring.

A default would cool the housing market overall, reducing sales by 23% by September. Over the next 18 months, sales would drop by an estimated 700,000 units relative to the current, non-default projection. Home values would fall by 5% relative to the baseline. Several economic models have been developed to anticipate scenarios of housing-market reactions.

If the U.S. were to enter default in the coming months, one near-certain consequence would be rising debt yields and interest rates. Indeed, U.S. Treasury Bills (T-bills) provide some of the bedrock and benchmarks for “risk-free assets” on which the economy and most financial models depend. Introducing default risk would be like an earthquake rattling that fundamental assumption and causing investors to question the safety of T-bills. Unemployment is also expected to have a dramatic effect on the housing market if the U.S. government were to default. Indeed, federal expenditures alone account for 34% of total GDP in the first quarter of 2023. Failing to raise the debt limit would mean that the U.S. government can only spend as much revenue as it receives each month in 2022. A large reduction in spending would necessitate furloughs among federal and state employees, which would trigger layoffs at contractors and other employers more directly connected to federal spending. And these laid-off employees will find it hard to make mortgage payments.

According to some economic models developed to forecast the impact of unemployment on the housing market, a sharp increase in the unemployment rate staring this summer jumping from 3.4% to a peak of 8.3% in October before gradually declining—and an increase in 30-year mortgage interest rates to a peak of 8.4% in September before declining. According to this model, if unemployment peaks at 8%, this means that the United States will already be in a recession; a far more severe recession than the “mild” recession that the Fed has been predicting, and the recovery will take much longer than a year. If unemployment reaches 8%, this also means that the housing market will undeniably collapse since many homeowners will probably default on their mortgages due to the lack of consistent mortgage payments.

At the end of the day, the scenario presented was only a theoretical model. Therefore, it is important to remember that theoretical models do not necessarily represent reality since they are not always accurate. But it is fair to say that the debt limit will undeniably have a consequential role in the housing market.