Impact of Downgrade of Fannie/Freddie Debt on the Housing Market

This 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 substantially dependent on government debt, among them mortgage giants Fannie Mae and Freddie Mac. The involvement of these large mortgage entities in the downgrade saga leaves many wondering about the impact on the U.S. housing market.

Given the mental association of credit ratings with bond rates, many people initially think about the impact of the downgrade on mortgage rates. But that’s probably not where the initial damage will be felt.  In fact, near-term, expect almost zero impact on mortgage rates. With European sovereign debt fears and renewed signs of a slowing economic recovery (which was already moving in slow motion before), 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.  The yields on 10-year U.S. Treasury bonds are higher Monday than they were on Friday before the S&P downgrade (and mortgage rates closely track yields on the 10-year notes). In the Zillow Mortgage Marketplace, there was almost a 20 basis point increase in rates this weekend after the S&P downgrade, but intraday rates have falling today and are back down to their Friday levels.

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. 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. The S&P 500 and NASDAQ are already on pace to make August the worst month on record since February 2009 and November 2008, respectively.

This makes it even more difficult to call the bottom. Our Q2 Real Estate Market Reports are out tomorrow, and based on that data, we’re continuing to expect a national bottom in 2012, at the earliest.

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.

Dr. Stan Humphries is a real estate economist and real estate expert for Zillow. Stan is in charge of the data and analytics team at Zillow, which develops housing market data for most major metropolitan statistical areas in the U.S., and provides economic research for current real estate market conditions. He helped create the algorithms for the popular Zestimate® home value and the Zillow Home Value Index (ZHVI).