From Jason Payne, Market News Analyst …
I didn’t want my first Market News Update to be like this – full of bad news.
As a former stock market analyst and bona fide news junkie, I enjoy reading and reporting good news as much as the next guy does. In fact, I probably enjoy it more.
But when I recently agreed to join Real Estate Mogul as your new Market News Analyst, I made a promise to my new employer…
I did not promise to quickly become Mogul’s most popular faculty member.
And I did not promise to quickly increase Mogul’s membership by writing warm and fuzzy economic “spin” reports, in which every day is a good day for real estate investors.
Instead, I promised to be truthful. I promised to choose long-term integrity over short-term popularity.
I promised to provide Mogul’s readers with the same unbiased and “brutally honest” commentary that characterized my previous research in the award-winning Equity Research Department of a large regional investment bank…
…even when it means discussing bad news.
And on weeks like this, when the U.S. government has been partially shut down for nine consecutive days, the news is undoubtedly bad.
However, knowledge is power (it really is), so I find it a bittersweet privilege to share the following observations, musings and real estate-related insights about the latest developments – or lack thereof – in Washington.
After all, your REI business should be able to capitalize on this analysis in one way or another, regardless of your investing niche. But that part is up to you …
A Brief Explanation of the U.S. Government’s Partial Shutdown
Before extrapolating any real estate-related insights from the ongoing U.S. government shutdown, it will be good to ensure that we are all on the same page regarding “Where are we?” and “How did we get here?”
So here's a quick Q&A to get you caught up on what has happened and what to expect:
Why did the government partially shut down?
According to the Constitution, Congress has a few key responsibilities, including (i) a duty to pass spending bills that fund the government and (ii) a duty to ensure that the government is paying its bills.
On Monday of last week (September 30th), Congressional representatives needed to agree on a new federal spending plan before the beginning of a new fiscal year on Tuesday morning (October 1st), but Republicans and Democrats could not agree on a plan.
Since Congress was unable to pass a spending bill for funding the government in this new fiscal year, federal coffers are now underfunded and most government functions have ground to a halt.
What was the problem?
House Republicans insist that any new spending bill should include provisions to either defund, derail or otherwise chip away at the president’s signature healthcare law (“Obamacare”). Senate Democrats are equally insistent that it should not.
Although the health care law is not directly tied to funding the U.S. government, it is being used by both parties as a powerful bargaining chip.
Has the U.S. government shut down before?
Yes, but this current instance is the first time since late 1995. The shutdown in 1995 lasted 21 days, into 1996.
What will this do to the economy?
Essentially, the economic impact of a shutdown depends on how long the shutdown persists.
If it had only taken a few extra days for Congress to pass a new spending bill last week, then we would not expect the economic hit to be severe. But this political stalemate is now nine days old, and Washington is still no closer to ending the shutdown, as Democrats remain unmoved by refocused GOP efforts to reach a broader budget deal.
(Check-out the second half of this report for Jason's robust discussion of the economic impact for real estate investors.)
And why is everybody suddenly talking about the “debt ceiling”?
As if one political showdown was not enough, some House Republicans are now threatening to use the national debt limit as an additional bargaining chip in this ever-escalating skirmish.
As occasionally happens, the U.S. is once again on the verge of maxing-out its federal credit limit -- currently set at $16.7 trillion -- so the president must ask Congress to raise the country’s debt ceiling. But this arrangement is quickly becoming another political bargaining chip in the aforemetioned battle over health care reform.
Meanwhile, the Treasury Department’s deadline for raising the debt ceiling is Thursday, October 17th, as in "seven days from now". If Congress fails to raise the debt ceiling by that date, it could lead to a default on U.S. debt obligations, which would be a much bigger economic concern than the government’s current shutdown-related woes (see details below).
National Economic Council Director Gene Sperling reiterated Monday that the president is not planning to negotiate on the debt ceiling, because he believes it will set a precedent that threatening default can be used as leverage in future budget-related talks.
However, according to Sen. Ted Cruz, R-Texas, "The debt ceiling historically has been among the best leverage the Congress has to rein in the executive.”
Accordingly, while we have every reason to hope for the current shutdown to be resolved during the next week, there are reasons to suspect that the U.S. economy may yet be held hostage a while longer.
Implications for Real Estate Markets & Investors
So what does all this mean for real estate investors?
Well, a few things are certain, including this heartwarming reminder: The ongoing government shutdown comes at a time when construction activity and new housing sales are recovering from the worst financial crisis since the Great Depression.
To wit, homebuilders broke ground on new residences at an annual pace of 891,000 in August 2013, representing an 86% increase from the recent low pace of 478,000 in April 2009 (although still 33% below the historical average rate), according to Commerce Department data compiled by Bloomberg.
Meanwhile, home prices have increased 21% from their post-recession low in March 2012, but still remain 21% below their June 2006 peak, according to the S&P/Case-Shiller Index of property values in 20 major U.S. cities.
When Congress failed to pass a spending bill last Tuesday, the government’s subsequent shutdown immediately slowed the approval processes for thousands of mortgages – a frustrating setback for many of the homebuyers, sellers, builders and investors who have been spearheading the recent recovery.
And now that the political stalemate has persisted for nine days, with no immediate conclusion in sight, the lack of government functionality increasingly poses a threat to both the housing market and the broader U.S. economic recovery as well.
Sluggish Mortgage Approvals for Private & Public Lenders
Thousands of borrowers in the process of obtaining home loans are now being delayed as private lenders are blocked from verifying the borrowers’ Social Security numbers and accessing Internal Revenue Service tax transcripts (which are used by many lenders to confirm the validity of borrower-provided tax returns).
Although some private lenders are offering to accommodate eager borrowers by postponing their requirements for certain tax transcripts, other lenders are unwilling to take that risk.
Additionally, the Federal Housing Administration (FHA) has temporarily reduced its fulltime staff to less than 10% of its normal size, which lengthens the waiting time for any borrowers who seek approval for FHA-backed mortgages as well.
Similarly, the U.S. Department of Agriculture, which backs mortgages in rural areas, is refraining from processing any new business during the shutdown.
Fannie Mae and Freddie Mac fund their operations through fees collected from private lenders (not taxpayers), so loans that conform to the guidelines of these GSEs are not being directly impacted by the shutdown.
Threats to the Housing Market & Economic Recovery
According to economists’ median estimate, the first week of this partial shutdown probably reduced the country’s annual GDP growth by 0.1 percentage point – which is certainly detrimental, but not devastating.
On a similar note, the recent short-term disruption of FHA loans “shouldn’t have much long-term impact on either demand or housing affordability,” according to a recent blog post by Zillow Inc.’s chief economist.
However, while economists and analysts agree that the first week of federal inactivity was relatively tolerable, the weekly costs associated with this shutdown will only accelerate as the stalemate persists. As inactivity in Washington now approaches its third week, consumers and businesses are already beginning to defer purchases and expansion plans.
According to Moody’s Analytics, a three- to four-week shutdown would cost the economy approximately $55 billion – which would represent significant economic damage and suggests a current month-to-date impact in the $15-20 billion range.
And local economies and housing demand would certainly be hurt – especially in markets where furloughed federal employees comprise more than 10% of the local workforce, such as:
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Washington, DC
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Virginia Beach, VA
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Dayton, OH
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Honolulu, HI
But at this time, a bigger economic concern would be Congress’s inability to raise the debt ceiling by Thursday, October 17th – which could lead to a default on U.S. debt obligations.
Among numerous other troubling consequences in the wake of such an unfortunate event, mortgage rates would probably rise sharply and make homes unaffordable for many buyers.
You see, interest rates on treasury bonds will increase if Congress fails to raise the debt ceiling (due to the government’s increased likelihood of default on its near-term debt payments). And those interest rates on government debt are the benchmark for many other interest rates, including many mortgages.
Analysts at the Center for American Progress estimate that a 0.5 percent increase in the government’s interest rate could result in a 0.66 percentage point jump in mortgage rates, and a 0.66 percentage point increase in mortgage rates could reduce new home sales by 41,000-48,000 over the course of one year…
…which would take a truly significant bite out of the housing market’s recent progress, as well as the U.S. economic recovery in general.
The Bottom Line
So what is the bottom line for you and your business?
Well, after nine days, the government’s ongoing partial shutdown has been detrimental but not devastating to real estate investors and the U.S. housing market. A resolution during the next few days will leave market participants bruised but not beaten, although each passing day carries an exponentially greater economic cost for buyers and sellers alike.
But keep an eye on Congress’s willingness/ability to raise the debt ceiling by Thursday, October 17th, because unless you are currently wrestling with delayed mortgage approvals, this debt ceiling debate represents the most important shutdown-related variable in your upcoming REI pursuits.
Jason Payne’s next Market News Update is currently scheduled for Wednesday, October 23rd.