A U.S. Default Could Be Catastrophic For Real Estate Investors—Here’s What You Need To Know

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The financial press is abuzz again about the debt ceiling deadline and the risks of another government shutdown and perhaps a catastrophic default on U.S. debt if an agreement cannot be reached. The ceiling (currently sitting at $31.4 trillion) is set to be hit on June 1.

 The Washington Post is particularly apoplectic,

“Federal workers furloughed. Social Security checks for seniors on hold. Soaring mortgage rates. A global financial system sent reeling… 

“Leaders from Congress and the White House are trying to forge an agreement to lift the federal debt ceiling, with only a few weeks before the Treasury Department may no longer be able to avert an unprecedented U.S. default. If they fail, and the government can’t meet its payment obligations, economists and financial experts predict chaos.

“’It would be a lethal combination,’ said Mark Zandi, chief economist at Moody’s. ‘You can see how this thing could really metastasize and take down the entire financial system, which would ultimately take out the economy.’”

Well, that sounds rather bad. So, is this something real estate investors should be concerned about, and if so, how should one prepare?

Let’s first start with a quick overview of what’s going on and how such “fiscal cliffs” have gone in the past. 

A Recent History of Debt Ceiling Debates

The debt ceiling is supposed to set a cap on the total amount of money the United States federal government is authorized to borrow. Over recent years, this “ceiling” has, for the most part, been something of a joke. 

As the website for the U.S. Treasury Department notes, “Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit.”

I’m not sure what you call something that has been raised more than once a year for over half a century, but a “ceiling” doesn’t seem like quite the right word for it. 

Every once in a while, however, negotiations break down, and the clock strikes zero before an agreement to either raise the debt ceiling or lower spending (or a mix of the two) is reached. In such cases, a “government shutdown” ensues. Although, it should be noted that such shutdowns are only partial and usually involve furloughing government employees and suspending entitlement payments and the like.

There have been 10 government shutdowns since 1980, although the four that took place in the 80s all lasted under a day (two for only about four hours). The longest that occurred before the turn of the century was in 1995 and 1996 and lasted 21 days. Only some agencies were affected, and about 284,000 federal employees were furloughed. (This took place shortly after 800,000 were furloughed in a five-day shutdown a month earlier.)

Since the Great Recession and subsequent ballooning of the federal debt, political fights over the debt ceiling have intensified. Since then, there have been two nasty debt ceiling fights that resulted in shutdowns. The nastiest one was probably in 2013, which led to a 16-day shutdown that affected all agencies and led to furloughing 800,000 federal employees. 

A bipartisan “super committee” was supposed to find $1.5 trillion in cuts over the next 10 years but failed to do so. Thus, we defaulted to an across-the-board (excluding entitlements) budget sequestration that basically no one was happy with. 

The cuts lowered spending by about $1.1 trillion over the next eight years below what they would have otherwise been. (Although some of that sequester was subsequently removed).

In January 2018, there was the longest shutdown on record—35 days—that was predominantly held up over disagreements about a proposed border wall. The cost to the government was estimated at $5 billion.

That’s not chump change, and there were plenty of disruptions from these shutdowns. For example, air travel was strained, national parks were closed, and a bunch of other problems and inconveniences occurred. But there were no major effects. And it almost went without notice to real estate investors as prices showed no effect from any of the shutdowns nor the sequestration.

If budget deficits were rustling some feathers back in 2013, then said rustling has likely increased several times over as the U.S. budget deficit passed $1.1 trillion for just the first half of fiscal year 2023. And this is after the brunt of the Covid-19 pandemic is no longer there to justify such spending.

U.S. Deficit Tracker – Bipartisan Policy Center

Of course, just because the budget is out of whack doesn’t make it obvious how to address such an imbalance. What gets cut? How much? Should taxes be raised? Which ones and by what amount? Obviously, there’s a lot to debate.

At issue here are a variety of issues, including clawing back unspent Covid-19 money (about $30 billion), future budget caps, regulations on energy development, and whether to increase work requirements for those receiving food stamps, Medicaid and/or TANF (Temporary Assistance for Needy Families). In other words, there are a lot of things on the table to discuss.

With so much on the table, it could be difficult to work out a deal. Thus, the deadline might get missed, which is what all the fuss is about. If the deadline is missed, the Treasury would keep making payments despite a shutdown until it runs out of money. If it did run out without some sort of resolution, then the U.S. federal government would default on its debt for the first time in its history (or at least officially, some argue it has effectively defaulted in the past). 

And while a shutdown wouldn’t be particularly bad, a default would be catastrophic.

Should We Worry About a Potential Default?

The last article I wrote was on Stoicism and the importance of not letting things you cannot control affect your well-being. And presuming you aren’t a member of Congress, this is definitely one of those things you cannot control.

But further, the odds of an outright default are extremely negligible. I don’t have a lot of faith in politicians, but the sheer insanity of failing to pay our debt payments when the money is available to do so would be incomprehensible.

It needs to be remembered that this is not an either/or issue. The government will not either come to an agreement or fail to. There are plenty of makeshift and temporary measures that can be (rather easily) taken to avoid a default, even if they don’t avoid a shutdown. This would include passing a temporary extension on the debt ceiling deadline, something that has been done before.

If a default were to happen, it would cause an array of very serious problems for real estate investors. There would be a run on U.S. banks, and credit would dry up. So, getting a bank loan would be close to impossible. Yahoo! predicts mortgage payments would go up a cool 22%! Lines of credit would probably be called, so investors would lose access to those. Thereby, real estate prices would likely plunge. The economy would plunge into a recession, and many tenants would lose their jobs, causing delinquency to spike. Contractors and vendors would go out of business, making it difficult to find people to do work even if you had the money to pay.  

As far as how to prepare, well, if you haven’t already built your underground bunker and stocked a year’s supply of food, there’s not a lot you can do at this point other than take out any money you have in the stock market. 

In short, it would be very bad for real estate investors, and having my predictions from this article thrown in my face would be the least of my problems.

That being said, it’s not going to happen. After all, these are the steps we’d have to go through to get there:

1. No deal can be reached by June 1.
2. No deal can be reached before the Treasury runs out of money to make interest payments.
3. No extension nor temporary deal is made to pay for interest payments.
4. Once the financial markets begin to panic after a payment is missed, Congress doesn’t immediately change course and make its debt payments.

I would say the odds of 1) and 2) are at least possible, albeit unlikely. 3) is basically impossible, and 4) is downright unfathomable.

And that’s all assuming the Biden Administration doesn’t pull an end run around Congress through some legal chicanery, which they could potentially do if the debt ceiling deadline passes and default looms near.

Yes, it’s never wise to bet your money on the wisdom of politicians, but I do expect them to intentionally breathe and eat and sleep, and avoiding a default when there’s money to pay isn’t asking much more than the previously mentioned expectations.

Conclusion

MSCI puts the odds of default at 2%, with its head of portfolio management research, Andy Sparks, stating that the probability “is small, but it’s not zero.”

That kind of reminds me of this meme.

Yes, the prospect of a potential default makes for great headlines, but it’s extraordinarily unlikely. 

But moreover, there is little the average person can do to affect it, and it’s too late to make any broad adjustments to such a dire scenario.

In general, however, we are sailing through volatile economic waters even if a government default is not in the cards. As I wrote before, 

“[The] best investors often do the best during recessions or volatile economies. They don’t do so, however, by sitting on the sidelines. Instead, they keep their [cash] reserves high, adjust to the environment, sharpen their pencils, and continue…”

There will be economic troubles ahead. Be cautious and conservative, but don’t stop and merely hunker down because of a few doomsaying headlines. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.