As of writing this on Thursday, the world is watching and waiting for a key issue to be resolved in the government shutdown regarding raising the debt limit. While many people seem to feel that perhaps we should quit borrowing more, defaulting on our obligations is not a viable option.
What few realize is that everything in the financial world just about is tied either to the U.S. dollar or the U.S. treasury bill yields. We are not talking about the impact of not funding bridges to nowhere, we are talking about maintaining the liquidity of the global economy. Every share of stock, every mortgage, every credit card, every bond in the world is tied to the U.S. being able to pay its debt.
If Congress were to refuse to raise the debt limit there is no historic precedent as to what might happen. Even if at worst the repayment is delayed (but eventually assured) which would be more smoke than flames, the impact will likely be dramatic.
Between Tuesday and Thursday the yield (which reflects the level of risk) on a 30-year treasury bill has doubled. The fact that the yield is still near zero is the only reason this has not created shockwaves throughout the markets, but it is being closely watched by a lot of investors and could well be a indicator of what might happen.
Anticipating a default
Currently, the rate on a 30-year fixed mortgage follows the yield on the 10-year T-bill by a markup of about 2 percentage points. If the yield on the 10-year bill were to double to the mid-5 percent range, mortgage rates would rise to the mid-7 percent range, and this could happen in a matter of a day or two. From Wednesday to Thursday this week we have seen mortgage rates rise as much as ¼ percent on anticipation of the impact of a default.
But far beyond mortgage rates and the market for 30-year and 10-year T-bills are numerous smaller bond markets for everything from municipal bonds to corporate bonds. This is where governments and private enterprise raise capital to run essential services and build factories to create jobs. If those markets were to seize up and quit operating, then we would see complete chaos in the level of government services, demand for goods and job security. There is a historic precedent for this happening — it happened in 2008 when Lehman Brothers collapsed, and it took years to revive many of those markets. This could make Lehman Brothers look like the kindergarten class picnic.
In addition there could be massive outflows of capital from the U.S. economy, not for any sound economic reason (assuming that the debts will be paid in time) but more “just because.” Markets love to operate on hypothetical situations, and there are no end of theories out there about what could happen and few of them are good.
In the event that the U.S. ever were to totally default on its obligations and tell bond holders to take a hike, we are talking global financial Armageddon. I hope we never live to see that day. This country must figure out budgetary restraints, but defaulting on the federal debt is not the way to do it, as the global economy and markets are too intertwined to risk such a move.
As for mortgage rates between now and Wednesday, it will be too volatile to call. As such, I am not posting rates with this column this week because we have no idea where they will end up even a few hours from now.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers.