The Government Shutdown and the Housing Recovery

Wow! All we can say is “Wow!” The two federal parties are like a dysfunctional marriage where each parent is accusing the other of abusing their child. And to prove their point, they each starve their child to show how terrible the other is at parenting.

The U.S. economy has finally started showing signs of a sustainable recovery as jobs are slowly created and family incomes slowly rise. Add four years of record low mortgage rates that even now at 4.5% are still nearly half the long-term average of 8.62%, and you get a housing market revival that has seen annual housing starts nearly double from 478,000 new homes per year ending in April of 2009 to 891,000 per year ending this past August.

Until politicians decided to put the whole recovery on pause by refusing to agree on a budget, forcing the government to close most of its departments, including a number of offices needed in the processing of mortgage applications.

“The last thing we need is anything that shakes the confidence in a softly recovering housing market,” David Stevens, chief executive officer of the Mortgage Bankers Association, scorned to Bloomberg. He warned, “If it’s long term, it’s a broader story about the adverse impact to the economic recovery.”

Just how bad can it get for home buyers and the housing recovery? Potentially worse than you might think.

The Shutdown’s Impact on Housing

New home loan applications have been dramatically slowed with the closure of several government offices that play integral roles in the mortgage approval process.

With the Federal Housing Administration running on a skeleton crew of less than 5% its usual staff, approvals of federal loans and mortgage insurance are severely backlogged. The Department of Agriculture, for its part, isn’t even accepting new rural applications until the shutdown ends. Even something as simple as verifying Social Security numbers to prove identity and retrieving tax information to prove income are not possible at this time.

Some mortgage lenders are attempting to get much of the process completed that does not require services by federal offices, leaving tax verification, for example, to the very end. Others have turned to dealing with Freddy Mac and Fannie Mae instead of the Federal Housing Administration to the extent possible, since Freddy and Fannie are funded by private lenders, not taxpayers, and are thus fully operational throughout the government’s closure.

These two privately funded mortgage backers can still keep the mortgage market humming, but only at roughly two-thirds capacity, as they handle about 65% of mortgage lending. The temporary closure of the Federal Housing Administration, the Department of Agriculture, and the Department of Veterans Affairs will thus take a 35% bite out of the housing market.

Yet the impact of a government shutdown on housing will not be limited to just new property purchases or new home construction. It will also affect the vast majority of government employees no longer receiving paychecks. No paychecks mean no payments on existing mortgages, which could lead to penalties and fines for those who do not have extra cash in their accounts to cover their monthly deadlines – not to mention the stains on their credit histories for any missed payments.

A Default’s Impact on Housing

As harmful as a prolonged government shutdown can be, there is another threat that could deal considerably more damage to the housing recovery – the federal debt limit, which is due to be reached October 17^th.

If Congress does not get its act together and approve a borrowing limit increase by then, the U.S. government would have no funds with which to honor its debt obligations and would default, triggering a series of misfortunes that are never good in any economic period, let alone one of slow recovery.

Economists admit no one knows precisely what horrors will be unleashed on the American economy upon defaulting. But this we do know: the government’s credit rating would be slashed and the U.S. dollar would suffer serious depreciation.

For the rest of the scenario, we have countless examples from countries all over the world, whose currencies have been falling since May. As their money depreciates, products and services become more expensive. The only way to combat this inflation of prices is to strengthen the currency by raising interest rates.

Unfortunately, higher interest rates raise the cost of borrowing – not only for the nation’s government when it sells its bonds, but also for its companies when they go looking for business loans. The higher cost of capital is ultimately passed on to the consumer, slowly grinding the gears of commerce and industry to a halt.

Back in America, then, a default on October 17^th could plunge the USD into a severe devaluation, forcing the government to raise interest rates to strengthen its money and stop inflation. Since borrowing money now costs more, companies would pay more on their business loans, and home owners would pay more on their mortgages. Commerce, industry, and housing would be crushed.

Notice how this is the exact opposite of what the Federal Reserve has been doing? For five years, the Fed’s chief concern has been keeping interest rates low to keep businesses and the housing market alive. In one careless moment of idiocy, politicians run the risk of triggering what the Fed has been desperate to avoid… killing both the economic and housing recoveries by forcing a rapid and premature rise in interest rates.

Stuart Gabriel, director of the Ziman Center for Real Estate at UCLA, expressed to Bloomberg the gravity of that scenario. “All bets are off and the downside economic impact will be grave. All aspects of the debt markets would be adversely affected. It would have serious and egregious effects on the U.S. economy.”

If the 2008 credit crisis didn’t completely kill the housing market then, the looming default of October 17^th, 2013 would certainly finish the job.

Investors

The government shutdown is forcing investors to do a lot more research into their investment choices. Since investors have not had to deal with this exercise in over 17 years, they may be a little rusty.

For most stocks, you should look into their sources of income. Any company that receives a large part of its revenues from the federal government – such as defense contractors and healthcare providers – might be best avoided while the shutdown persists.

You might need to probe even deeper when researching housing stocks – home builders, for example – to learn which mortgage providers their clients deal with most. Builders with a greater risk of slowing sales are those whose clients obtain their mortgages from the temporarily closed Federal Housing Agency, Department of Veterans Affairs, and Department of Agriculture – such as D.R. Horton Inc (NYSE: DHI), Lennar Corp. (NYSE: LEN) and KB Home (NYSE: KBH).

To a lesser extent, home building suppliers such as Home Depot (NYSE: HD) and Lumber Liquidators Holdings Inc. (NYSE: LL) could also take some damage to their stocks if the shutdown drags on.

“We do not expect a decrease in demand, since the FHA stoppage should delay rather than cancel [mortgage] closings,” Jay McCanless, analyst with Sterne Agee & Leach Inc, informed Bloomberg. That is, “Unless the shutdown turns into weeks rather than days.”

Bob Walters, chief economist at Quicken Loans Inc, echoed the concern over the closure’s duration. “In the early days, very little impact. But the longer it goes on, the more impact there’ll be,” he stressed to Bloomberg.

If the government closure drags on, keep your eye on all of those groups – defence, healthcare, builders, and suppliers – as you just might find a buying opportunity there when the government reopens. As federal funding is restored to either the companies directly or to their clients, their stocks should climb back to normal levels – but only if they take a hit during the shutdown.

And of course, only if the government avoids defaulting. If there is a default, everything would change on its head. The only thing you would likely be owning then is gold.

Joseph Cafariello

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