One of the many negative effects of an extended shutdown of the federal government is its impact on the very fragile housing markets. The government’s key roles in mortgage lending would be put on hold, and a shutdown would also increase interest rates. The last thing our economy needs is for mortgage lending to seize up, which would weaken housing demand and put downward pressure again on still-battered home values. Every family that owns a home—not just those seeking a mortgage in the coming weeks—could feel the consequences.
Department of Housing and Urban Development Secretary Shaun Donovan noted earlier this week during a Senate subcommittee hearing that a government shutdown could significantly disrupt the offering of loans insured by the Federal Housing Administration, or FHA, a key source of mortgage financing since the financial crisis of 2008.
A shutdown could also have serious impacts on the non-FHA part of the mortgage market. This is because underwriting standards today typically require verification of a borrower’s Social Security number and IRS tax return. These verifications would be disrupted by any furloughs for “non-essential” Social Security Administration and Internal Revenue Service employees.
Finally, the uncertainty around U.S. Treasuries caused by a shutdown could cause interest rates to increase, just as they did in 1995, which would also negatively affect the housing markets.
In total, these effects could cause turmoil in the mortgage markets just as we get into the traditionally important spring season in the housing market. It’s worth examining them in more detail.
A government shutdown could quickly cause FHA lending to cease
My former CAP colleague Andrew Jakabovics explained in 2010 what the FHA does:
FHA insures mortgages that are then securitized and sold to investors with an explicit guarantee. Borrowers with FHA mortgages pay an upfront insurance premium as well as an annual premium. Those premiums go toward a fund that pays out claims when insured mortgages go through foreclosure.
Government-backed loans account for about 90 percent of all mortgages today, with virtually all the remaining 10 percent coming from federally insured banks and thrifts. The Federal Housing Administration is a critical piece of this market because the government-sponsored mortgage enterprises Fannie Mae and Freddie Mac, now in conservatorship, have dramatically tightened their underwriting standards.
FHA is the only major source of financing that accepts loans with down payments of less than 20 percent. That makes it particularly important for homebuyers—as opposed to those refinancing their existing homes—and even more so for first-time homebuyers. FHA accounted for about 40 percent of all purchase mortgages in 2010 and an even higher share of mortgages for first-time homebuyers.
It is also a critical source of mortgage capital for communities that have suffered a high concentration of foreclosures, without which those communities might have little chance of rebound.
A shutdown of the Federal Housing Administration that lasted more than a couple of days would have serious ramifications for the housing markets. FHA lenders can make FHA-qualifying loans during the shutdown knowing that once FHA is reopened they can later receive insurance from FHA. But during the period between origination and FHA insurance, lenders hold significant risks, including the risk of a default—which would make the loan ineligible for FHA insurance—and the risk of interest rate spikes, which are more likely with a shutdown.
Most lenders are ill-equipped and unwilling to hold such risks right now given that they must hold capital against these risks.
As a result, any shutdown that lasted more than two to three days would almost certainly lead to a dramatic decline in FHA lending. This would take roughly 40 percent of homebuyers—and even more first-time homebuyers—out of the market. The simple laws of supply and demand dictate that this would have a significant impact on house prices and the value of all homes whether or not they are for sale at this time.
A government shutdown could create a backlog in non-FHA mortgage lending
Underwriting standards were tightened—particularly for residential mortgage lending—following the meltdown of the housing markets and the subsequent financial crisis. Today mortgage lenders typically require strong verifications of underwriting standards, including confirmation of a borrower’s Social Security number and IRS tax return.
A federal government shutdown would likely suspend these verifications since it is difficult to see how such activities would be deemed “essential” and allowed to continue during a closure of the government. A potential outcome of this could be a delay in mortgage approvals lasting at least as long as the shutdown and possibly much longer depending on the length of the shutdown and how much of a backlog this created.
This in turn could wreak havoc in the housing markets by preventing mortgage loans from being finalized and preventing potential homebuyers from either closing on homes under contract or from receiving the mortgage preapproval that allows them to shop for homes.
A government shutdown could cause mortgage rate increases
As I noted last October, a government shutdown would create significant uncertainty among investors, which could cause Treasury rates to spike. This is precisely what happened during the 1995 government shutdown. Indeed, we are already experiencing rising Treasury rates due to investor concerns about the uncertain impacts of an extended government shutdown.
Such rising rates would almost certainly bleed over into mortgage rates. Higher mortgage rates would limit the purchasing power of potential homebuyers, of course, exerting significant downward pressure on home prices.
Conclusion
A government shutdown would have a severe impact on the availability and pricing of mortgage finance by suspending FHA insurance and other government functions that are important to the mortgage markets and creating major investor uncertainty around U.S. Treasuries. The effects would be particularly harmful if the shutdown is extended for any significant period of time. This in turn would exert large downward pressure on home prices, actualizing and exacerbating the housing double dip that many have predicted.
David Min is the Associate Director for Financial Markets Policy.
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