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US Debt Downgrade - What Will Happen to Mortgage Rates?    

 

by Keith Luedeman, CEO   

News 

08/08/2011 - US Debt Downgrade by S&P - What does it mean to mortgage rates?

Late Friday, August 5th, 2011, Standard & Poor's debt rating service cut the long-term U.S. Credit rating by one-notch to AA-Plus (AA+) on concerns about the budget deficit and rising debt burden.  On Monday, August 8th, 2011, they also cut the senior debt issuer ratings of Fannie Mae, Freddie Mac, the Federal Home Loan Bank System, and Federal Farm Credit Banks to AA+.

"The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics," S&P said in a statement.  The outlook on the new U.S. credit rating is "negative," S&P said in a statement, indicating another downgrade was possible in the next 12 to 18 months.  S&P had warned that if the debt reduction passed by Congress and signed into law did not reduce the deficit by $4 Trillion that they may downgrade the U.S. Debt.  The passed legislation reduced the deficit by only $2.1 Trillion and S&P made good on their warning.

The U.S. has had a AAA Credit Rating since 1941.  Many folks have asked us what this action may mean for mortgage rates.

First - it's important to note that only S&P downgraded the U.S.'s Credit Rating.  There are two other major rating services, Moody's Investors Service's and Fitch Ratings.  Moody's confirmed the U.S. AAA Credit Rating last week.  Fitch said they would issue its opinion by the end of August. 

And AA+ is not an awful rating.  No one rated AA+ has defaulted on their debt.  In other words, don't expect the U.S. to go bankrupt anytime soon.  Other major countries rated AA+ are China, Japan, and Spain.  But the US is below Australia, Canada, France, Germany, and the UK in terms of their ranking.  (See this S&P link for all countries)

Warren Buffett even said, "US Debt should be rated Quadruple A" as the country will not have any trouble paying off its long term debt obligations.  Investors agreed on Monday August 8th since they bought more US Debt driving bond prices up and interest rates down. (see Bond Prices and Rates)

However, lending is about risk.  If the person you are lending too has a higher risk of not re-paying the debt, you most likely will want to earn a higher interest rate to compensate for that risk.  It's why a person with a lower credit score has a higher mortgage rate.

If the investors in US Debt - private investors and other counties - believe that we are truly a higher risk, that means rates will go higher.   And since mortgage rates are 'generally' based on the 10 Year Bond Rate plus a margin - we may see mortgage rates go up if investors believe S&P.  'Generally' because mortgage rates are really based on Mortgage Backed Security bond rates, but the 10 Year Bond has proven to be a fair index.  Why?  It's about risk - the US Government is viewed as safer than Mortgage Backed Securities - so their rates are lower.  Again showing the point - rates are about risk.
 
Of concern is the performance of the U.S. Economy and ability to weather this downgrade.  Right now the Government is limited in what stimulus it can provide.  Why?  Well they have provided an awful lot of stimulus lately, which drove up the debt burden, which earned the downgrade of all our debt. 

The impact on our stock market is yet to be seen, but since this will cause pressure on our economy, we should see the stock market drop (update late August 8, the market is down over 600 points in one of the largest down days ever).

These may be a huge drag on the economy, and thus cause folks to invest in the safety of bonds, driving rates down. 
 
Is It Over Yet?
 
This is actually just the beginning.  The Federal Reserve may act to help the economy.  It's hard to say how far the financial markets will fall.  And what investors will do about investing in US Debt. 

Stay tuned, it should be an interesting week.



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