If the federal government fails to increase its borrowing authority prior to when the U.S. Treasury says it will run out of money to pay its bills, debt default is not necessarily the first consequence we’ll see, says NAR Chief Economist Lawrence Yun. Rather, the government could decide to pay the interest on its debt, which is about three percent of the U.S. gross domestic product, and ensure that global investors of U.S. Treasury bonds are made whole. That would help protect the dollar as the world reserve currency. But to do that, the government would have to curtail spending elsewhere.
The government spends one dollar for every 75 or 80 cents it takes in, Yun says, so, if the borrowing limit isn’t raised, “it will be a tough decision as to where the tax revenue gets spent. Does it mean that interest costs on past borrowing gets suspended? Is it the case that some people who have been relying on Social Security checks no longer gets those checks, or some of the military jets or tanks that have been purchased will not be purchased any more?”
Should the government decide to pay bills other than interest obligations, we can expect interest rates on Treasury bonds to rise as investors look for more return to compensate for the increased risk of their not getting paid. And if that happens, mortgage rates will rise, because mortgage rates follow Treasury rates.
Yun says home sales can be expected to drop by 350,000 to 450,000 units for each 100 basis-point rise in mortgage rates.
It’s possibe global investors will not over-react, at least in the short term, should the U.S. choose not to make its interest payments. “I believe that the global investors recognize that the U.S. will come through at the end, even if it’s a delay for a couple of weeks or even in a worst-case scenario of a few months. . . . Therefore, I don’t believe there will be immediate bond market panic.”
Even so, since the economy remains weak, with tepid employment growth, any impact on interest rates would be a problem. “You are in a situation in which the economy is at a tipping point, with rising rates, and that’s certainly not a good combination,” Yun says.
In the four-minute video above, Yun talks abut the looming debt crisis with REALTOR® Magazine.