Should Congress fail to lift the federal debt ceiling limit by August 2, not only would U.S. mortgage interest rates jump sharply, as my colleague Christian Weller recently argued, but government services that are essential to the mortgage markets also would be shut down. The Obama administration would have no choice but to freeze these so-called “nonessential” government services—even though they are anything but nonessential to the U.S. housing market.
A failure to increase the debt limit would force the federal government to shut down all government activities deemed “nonessential” to the security and well-being of Americans, including most administrative activities at the Federal Housing Administration, the Internal Revenue Service, and the Social Security Administration. In the aftermath of the housing and financial crises that occurred in the last years of the Bush administration, private mortgage financing essentially disappeared, and lenders are requiring much tighter underwriting for new mortgages. As a result, these agencies now play a central role in the mortgage markets, especially for the first-time, moderate-income, and minority homebuyers most critical for a housing recovery.
An extended federal debt ceiling impasse would shut down these critical activities, removing many potential homebuyers from the market and causing significant delays in mortgage approvals for everyone else. This would cause a devastating new shock to our extremely fragile housing markets, exacerbating the weaknesses already illustrated by the latest Case-Shiller numbers.
How would this happen? Let’s begin with the Federal Housing Administration. In the post-crisis world, private mortgage financing is but nonexistent, leaving the government to fill the vacuum. Consequently, FHA 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.
Currently, FHA is the only major source of financing that accepts loans with down payments of less than 20 percent, which makes it particularly important for low- and middle-income borrowers, for minority borrowers, and particularly for first-time homebuyers. FHA accounted for nearly 40 percent of all purchase mortgages through the third quarter of 2010, the most recent period for which FHA’s regulator provides data, and an even higher percentage of first-time homebuyers. What’s more, FHA accounted for 60 percent of African American home purchases and 61 percent of Latino home purchases in 2009, the last year for which such data are readily available.
FHA is also a critical source of mortgage capital for those communities hardest hit by the home mortgage foreclosure crisis, without which they have little chance of rebounding. Following the increases to the FHA loan limits in the 2008 Housing and Economic Recovery Act, FHA has been a particularly important source of lending in the Sun Belt states, including California, Nevada, Texas, Arizona, and Florida, all of which have been among those hit especially hard by the foreclosure crisis.
Any extended suspension of FHA 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. It would also be devastating for those neighborhoods hit hardest by the foreclosure crisis, effectively squashing any hopes of a recovery.
Then there are the key administrative activities at the IRS and Social Security Administration that underpin the approval of new mortgage loans. Following the financial crisis, mortgage lenders adopted much tighter mortgage underwriting standards, including verification of the borrower’s income and identity. Most lenders now require mortgage applicants to submit the last two years of their tax returns and file a Form 4506T with the IRS, which authorizes the IRS to send transcripts of the applicant’s tax returns to the lender. Any extended shutdown of IRS services due to a debt ceiling freeze would almost certainly see a suspension of the IRS’s processing of these tax forms, potentially delaying the mortgage approval process by at least the length of such a freeze and perhaps longer, depending on how much of a backlog built up.
Similarly, many lenders now require mortgage applicants to consent to a Social Security identity check, which is submitted through a Form SSA-89 to the Social Security Administration’s Consent Based Social Security Number Verification Service. The Form SSA-89 may be filed electronically but it is not clear that such electronic verification would continue to operate during a government shutdown of “nonessential” government services, particularly given the sensitivity of this information. Such a shutdown also would cause a major delay in mortgage approvals.
The delays in mortgage approvals that would likely result from an extended debt ceiling freeze would wreak havoc in the housing markets by preventing potential homebuyers from either closing on the purchase of their new homes under contract or from receiving the mortgage preapproval that allows them to shop for homes. This lessened demand could cause prices to fall significantly, and would also cause housing markets to lock up by significantly delaying mortgage approvals.
In short, a debt ceiling freeze would remove a large number of key homebuyers from the market—causing a sharp and sudden drop in demand—and cause significant delays in the mortgage approvals of everyone else.
Almost certainly, these would lead to large house price declines, which would have significant effects for millions of Americans. Those seeking to sell, purchase, or refinance a home during a debt ceiling impasse would be most directly affected, but all homeowners would suffer, some irreversibly, as falling home prices cause their home equity to decrease. Americans who might be able to use home equity to pay for unexpected expenses, such as medical bills or sudden unemployment, or even planned expenses such as retirement or college tuitions, will find themselves unable to do so.
Moreover, the number of Americans who are “underwater”—owing more on their mortgages than their homes are worth—would spike, exacerbating the problems in the housing markets. Many underwater homeowners who would otherwise like to move are unable to sell their homes because they cannot afford to pay the “negative equity”—the difference between the likely sale price of their home and the amount of money they owe on their mortgage. At the same time, underwater homeowners are more likely to default on their mortgages, creating even further downward pressure on house prices.
Potential homebuyers might at first glance cheer the prospect of lower home prices, but most of them would not benefit either. The lack of mortgage financing options, coupled with long potential lags in mortgage approvals due to shutdowns at the IRS and the Social Security Administration, would mean that most homebuyers would be shut out of the market as well, leaving only a handful of cash-only investors to benefit from the housing market woes that result.
Coupled with the higher mortgage rates likely to arise from a debt ceiling standoff between conservatives in Congress and the Obama administration, it is clear that the negative consequences of such brinkmanship would be toxic for our national housing markets. Members of Congress cheering the prospects of an extended debt ceiling freeze should take a close look at the neighborhoods in their districts and decide if they really want to run the risk of triggering another major housing crisis.
David Min is the Associate Director for Financial Markets Policy at the Center for American Progress.
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