Reading the news about the American economy this week, I can’t help but think of the words written by Bob Dylan and made famous by Jimi Hendrix: “There must be some way outta here,” said the joker to the thief. “There’s too much confusion, I can’t get no relief.”

Just as Americans were breathing a collective sign of relief over the resolution of the debt ceiling crisis, the stock market plunged and credit agency Standard & Poor’s downgraded the United States from a perfect credit rating of AAA to AA+. (While an AA+ might be an excellent grade for a high school student, it’s pretty lousy for a world economic superpower.) Economic forecasts are uncertain but generally grim. What do these things mean? And how will they affect the real estate industry?

First, the basics. The American federal government, as generous and engaged as it is, spends more money than it takes in. In order to make up the difference, the United States Treasury goes into debt by selling bonds and other securities to investors. This has been standard operating procedure for years now. Decades ago congress put a limit on the total amount of debt the United States could incur. As we are constantly accruing more debt, we’ve periodically increased our “debt ceiling” to reflect the current budget. Usually this increase is a straightforward legislative operation, and so it would have been this time, except that Republican congressmen, alarmed that the amount of debt was approaching the American GDP, seized the opportunity to push for pet spending reforms. As House Speaker John Boehner put it, “I don’t want to allow this moment that we have in our history to pass without real action to solve our long-term economic problems.” In order to increase the debt ceiling, President Obama would have to reach a compromise with Republican-dominated House of Representatives. And in the end this compromise was reached, but only after a lengthy and embarrassing political circus that led the American government to the brink of an unprecedented default. (The whole fiasco reminded of parents at the beach, threatening stubborn children, “Okay, bye bye! Stay if you want to say, but We’re leaving without you,” only in this case the parents actually got in the car and drove away.)  

In short, the US used its international debt obligations as a bargaining chip in the local arena. Such maneuvering is extremely troubling to the international investor who previously thought American treasury bonds were as liquid and reliable as cash! Congress has demonstrated that it is willing to engage in political brinksmanship to achieve its ends. Brinksmanship is all well and good, but you can’t go back after you push the red button. Furthermore, the compromise reached did not include provisions robust enough to put a large dent our ever-increasing debt obligations. As one of China’s official news agencies bluntly put it, the US has yet to “cure its addition to debt.” And we may well be entering rehab in the next couple years.

While markets remained relatively stable throughout the debt ceiling crisis, after its 11^th hour resolution the Dow Jones plunged. Days later and for the first time ever, S&P downgraded the United States credit from a risk-free AAA status to the less reliable AA+. While partisans on both sides are presenting the causes of this downgrade selectively, in a way most conducive to an “I-told-you-so” browbeating, the fact is that S&P gave two reasons for its decision. They not only believe that the debt-reduction compromise “falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics,” they also believe that “the effectiveness, stability, and predictability of American policymaking and political

What does this mean for the real estate industry? Well, mortgage rates and Treasury bond rates generally track, and as American bonds are now considered less reliable, there is a good chance that, in the long term, rates will be going up. However, in the short term, mortgage rates have dropped to record lows, causing a rush among homeowners to apply for mortgages and refinancing. (I remember waking up a few mornings ago to Facebook statuses from people outside the industry extolling their friends to REFINANCE NOW. SERIOUSLY.) During times of economic turmoil, the American government will typically do everything in its power to prop the markets up, including attempting to keep interest rates depressed. How effective these efforts might be remains to be seen.

The fact is right now there are no clear answers. Analysis is in disagreement, and experts were for the most part surprised by the events of the past week. There is no way to predict with any certainty what the financial climate will be in the near future—we are, it is true, in a time of confusion. But what we can do is educate ourselves about current events and come to an understanding of how our industry plays into the larger financial scheme.

 

Mandrien Consulting Group