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Impact of the Downgrade

You know the saying, “If I had a dollar for every time…”

Well, that certainly applies here.  The question: What is the impact of the S&P Downgrade of the US Federal debt on mortgage rates?

What a great question?! I really am glad so many have asked! Here’s a great explanation of what we are seeing thus far…

The following was adapted from a very well-written blog entry which can be found here: http://www.zillow.com/blog/research/2011/08/08/impact-of-downgrade-of-fanniefreddie-debt-on-the-housing-market/

On Monday morning, S&P followed up on its Friday downgrade of US government debt by downgrading the debt of several entities that S&P views as significantly dependent on US government debt. In that pool you will find mortgage giants Fannie Mae and Freddie Mac. The involvement of these large mortgage entities in the downgrade story certainly leaves many wondering about the impact on the U.S. housing market.

Given the standard mental association of credit ratings with bond rates, most initially think about the impact of the downgrade on mortgage rates. But, as we have seen so far this week, that’s probably not where the initial damage will be felt.  In fact, near-term, we expect almost zero impact on mortgage rates.

With European sovereign debt fears and renewed signs of a ever-slowing economic recovery, there’s a real “flight to safety” in the markets right now, leading global investors to snap up U.S. bonds. The reality is that, even with a downgrade, U.S. debt is still one of the safest bets around relatively. 

It seems that the real near-term impact of the downgrade on the housing market won’t happen via mortgage rates but rather through reduced consumer confidence. Consumer confidence is being buffeted right now with negative signals, from reports early last week of declining consumer spending in June to more tepid job growth numbers reported on Friday of last week. In periods of economic turmoil, many consumers tend to hunker down, making it less likely they will engage in high-priced transactions like home purchases.

Moreover, the stock market declines that have accompanied the debt ceiling debate and the credit rating downgrades by S&P won’t help consumer confidence either, making any consumers invested in the markets feel that much poorer. All of the major indices are already on pace to make August one of the worst months on record. This makes it even more difficult to call the bottom.

Longer-term, there could be an impact of lower credit ratings for both the U.S. government and Fannie and Freddie, but there are a lot of “ifs” between here and there.  These include continued political stalemate on solving the Federal structural deficit and an improving international economic climate that makes the safety of U.S. bonds less interesting. The prospects for the former are quite uncertain right now but the latter appears to be quite a way off as well.

If you have further questions, please do not hesitate to contact me.

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