Another looming showdown over the debt ceiling—the amount the federal government can borrow without further congressional approval—could derail one of the few bright spots in our fragile economic recovery: the housing market.
If conservatives in Congress refuse to allow the government to honor its financial obligations by borrowing money, investors will likely lose faith in the government and demand higher interest rates for Treasury bonds. Those bonds are the benchmarks for many other U.S. interest rates, including many mortgage rates. That means the cost of borrowing money to buy a house will increase, which could depress the housing market and slow our economic recovery.
The housing market accounts for only 3 percent or 4 percent of total U.S. spending, but it has a disproportionate importance to economic recovery. Spending on new homes typically rises quickly in a recovery because households usually feel more upbeat about their own prospects at the start of a recovery than during the preceding recession. These households then start to put more money into longer-term projects such as buying a new home. These actions ripple through our economy in forms such as more construction and construction-related jobs and increased spending on other items such as furniture and household appliances.
This column first explores in greater detail why a congressional refusal to lift the debt ceiling will increase housing costs and depress that market. It then looks at why it’s so important to the overall economy that we maintain a strong housing recovery.
Congressional failure to raise the debt ceiling will harm the housing market
Estimates show that the federal government will reach the debt ceiling at some point in the middle of February. Failure to raise the debt ceiling means the government will have to immediately default on some of its debt obligations. Once the debt ceiling is raised, the government will return to the global financial markets to borrow more money. If the debt ceiling isn’t raised, investors will be once bitten, twice shy in the future about lending more money to the U.S. Treasury. The federal government will have to offer higher interest rates to entice lenders into lending more money after a default, which would be automatically caused by a failure to raise the debt ceiling, even if it is just temporary.
Interest rates on treasury bonds will go up if Congress refuses to raise the debt ceiling and the government defaults on its debt payments. Those interest rates on government debt are the benchmark for many other U.S. interest rates, including many mortgages. I estimated in 2011—an estimate that is still valid—that a 0.5 percent increase in the government’s interest rate could result in a 0.66 percentage point jump in mortgage rates. Higher mortgage rates will lead to fewer mortgages and much less housing spending. My estimates suggested that a 0.66 percentage point increase in the mortgage rate could reduce new home sales by between 41,000 and 48,000 over the course of one year—equal to about two-thirds of the growth in new home sales in the 15 months from June 2011 to September 2012, when the housing market began its recovery.
Fewer new-home sales will have serious ripple effects, resulting in less economic growth and fewer jobs being created. Fewer home sales lead to lower house prices and thus slow future home sales even further, since past house-price increases are a key driver of home sales. Fewer home sales means less construction and related jobs, and thus even less demand for housing. This devastating cycle will slow the economy markedly.
Maintaining a strong housing market is crucial to the overall economy
Maintaining momentum in the housing market is particularly crucial right now. The bursting of a massive housing market bubble got us into the Great Recession, replete with record foreclosures, widespread bank failures, a double-digit unemployment rate, and shrinking economic growth. After the housing market was depressed and generally in decline over the first two years of the recovery that started in 2009, it is finally gaining steam and has substantially contributed to economic growth since the middle of 2011. The newfound momentum in the housing market has allowed the economic recovery to continue, despite massive headwinds such as a lingering European economic crisis and higher global oil prices.
Maintaining the housing-sector recovery would boost economic and job growth, as it has in the early stages of past recoveries. Housing spending on average contributes 9.3 percent to economic growth during the first three years of a recovery, but it only contributed 2.5 percent to economic growth in the first three years of this recovery. That is, the economy could grow about 10 percent faster than it otherwise would—say at 3.3 percent instead of 3 percent—for the coming years due to the direct effects of spending on new homes.
The effect on economic growth would likely even be larger than that. Direct housing spending will result in spending in other parts of the economy, as construction and related employment increases and as people spend more money on items related to new homes such as furniture.
The housing market also has a lot more room to grow. Housing spending in September 2012 amounted to only 2.4 percent of gross domestic product—well below its historical average of 4.7 percent prior to the Great Recession. Housing spending has on average grown by 41.2 percent during the first three years of an economic recovery, compared to only 10.3 percent during the first three years of this recovery. The housing momentum could continue and substantially strengthen our economic revival, but Congress must raise the debt ceiling to enable this outcome.
Not raising the debt ceiling quickly and unconditionally is economic malpractice that could derail a modest economic and jobs recovery. Political ideology should not trump the well-being of the U.S. economy and the labor market. Congress needs to act fast to raise the debt ceiling so that the economy can maintain and even gain more steam in the coming years.
Christian E. Weller is a Senior Fellow at the Center for American Progress and a professor in the Department of Public Policy and Public Affairs at the University of Massachusetts Boston.
 All figures in this column are based on the author’s calculations of the Bureau of Economic Analysis data.