Uncle Sam’s Credit Downgrade Hits Americans in Pocketbooks

Fitch’s downgrade of the U.S. government’s creditworthiness earlier this month is hitting Americans seeking to become homeowners squarely in the pocketbook.

That’s because mortgage rates have surged in response to the downgrade. Bankrate’s Jeff Ostrowski reports on what that means to today’s homebuyers:

A bond rating agency’s downgrade of U.S. government debt roiled markets—and created just one more reason for mortgage rates to stay firmly near their highest level in two decades.

Fitch Ratings announced late Tuesday it had cut the U.S. government’s credit grade one level, from AAA to AA+. On Wednesday, yields on 10-year Treasury notes peaked as high as 4.1 percent. The 10-year Treasury is the benchmark most closely connected to 30-year fixed mortgage rates....

For borrowers, the jump in rates has been a budget-buster. Borrowing $300,000 for 30 years at 3 percent means a monthly payment of $1,265. Jack up the rate to 7 percent, and the payment becomes $1,996.

Through August 16, 2023, the Bankrate survey of the national average of 30-year mortgages has reached 7.31%. With a higher interest rate, a $300,000 mortgage is now even more costly.

But why is that? Ostrowski points to the role of the downgrade in causing interest rates to rise:

In its announcement, Fitch—one of the “big three” credit rating agencies in the U.S.—pointed to a cycle of partisan brinkmanship in Washington. The latest standoff came in June, when Congress flirted with a government shutdown before reaching a last-second agreement on the federal debt ceiling.

“In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” the rating agency stated. “The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”

Fitch also pointed to rising levels of government spending and to what it called the likelihood of a “mild” recession later this year—although many economists have begun to say it’s possible the U.S. economy will avoid a recession entirely.

Essentially, the rating agency believes U.S. government debt is riskier than previously thought. Investors, therefore, demanded a higher yield for holding the debt.

That’s a perfectly reasonable response. To see why, put yourself in the shoes of one of the investors doing the lending when the name of your borrower is Uncle Sam.

Lending to a Borrower Who’s Breaking Bad

Uncle Sam has had a good track record of paying back what they owe with interest. Even though it seems like they’re borrowing quite a lot, because Uncle Sam has been a good risk in the past, you’re willing to consider it.

But lately, you can’t help but notice Uncle Sam has become erratic in managing money. To make promised payments to existing creditors when they’re due, Uncle Sam has had to take extraordinary measures that look more like a shell game than prudent fiscal management. If that was a rare event, that might not be so bad. But recently, it has become a frequent occurrence.

Worse, Uncle Sam has become really bad about keeping spending within their means. Uncle Sam used to make an orderly budget and hold to it, but that’s not happening. Instead, Uncle Sam seems hell-bent on going to the extreme of finding out how much more spending they can get away with, even if that means more and more borrowing. It’s like they’re out to play a stupid game of chicken.

A stupid game that will be funded by you with the money they borrow. A game that, if they keep playing the way they are, will someday lead Uncle Sam to default by failing to make their payments to you on time. A game that, if it continues, could lead to you losing all the money you loaned to them.

Compensating for an Increasing Risk

As an investor, you might be willing to take the risk of making a new loan to them even with those shenanigans going on. But you’ll charge a higher price to make that deal. If things keep going the way they are, you’ll need it to recover as much of your investment as you can to minimize your potential losses before it might all go south. In lending, you do that by increasing the interest rate you charge the borrower.

Fitch Rating’s downgrade of the U.S. government’s creditworthiness has set the stage for those higher charges because of the stupid game of debt chicken U.S. politicians and bureaucrats have been playing with each other. Games that are harming the creditworthiness of both Fannie Mae and Freddie Mac, two government-supported enterprises that guarantee mortgage lenders get paid back when mortgage borrowers default. Because if Uncle Sam can’t be counted on to reliably make promised debt payments on time, Fannie Mae and Freddie Mac cannot either.

The end result is Americans looking to buy a house will pay more for their mortgage than they otherwise would. The extra expense will continue until U.S. politicians and bureaucrats stop playing games and start restraining the growth of the federal government’s spending until it falls within its proven means.

Craig Eyermann is a Research Fellow at the Independent Institute.
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