The narrow avoidance of a potential economic catastrophe caused by the United States defaulting on its debt appears to have been achieved by a deal struck between the White House and congressional leaders this week to raise the debt ceiling limit.
But while some of the worst scenarios no longer loom, the bitter dysfunction evidenced by leaders in the federal government over a crisis they mostly created has unsettled global markets as well as credit rating agencies skeptical about the ability of the U.S. to tackle its debt and deficit problem amid a weak economy. And though that may seem a distant and somewhat abstract problem from here in Montana, economic uncertainty causing a rise in interest rates could have concrete impacts on the Flathead Valley, from the real estate market to road work projects.
If America’s credit rating is downgraded by agencies like Moody’s or Standard and Poor’s the likely result would be increases in the various interest rates on everything from mortgages to government bonds. This would essentially increase the cost of doing business for banks and those borrowing from them. By no means would the rise be as severe as in the event of default, but the concern persists.
“If rates go up, that’s actually kind of a hidden tax on everybody,” Bob Schneider, First Interstate Bank’s market president for the Flathead said. “And it slows down the economy.”
For example, the average mortgage rate for a 30-year loan has been hanging around 4.5 percent, but has begun to creep higher in recent weeks amid concern that lawmakers may fail to increase the debt ceiling. That’s still quite low, but with loans costing more, the already shaky housing market in the Flathead could take a hit since there would be fewer buyers able to afford that higher rate.
“You take that many people that can afford a home out of the market,” Schneider said.
Glacier Bank President Bob Nystuen emphasized that the public’s money is safe and banks will still continue to process home equity lines of credit, mortgages and other transactions.
“The question gets to be, what is the interest rate going to be on those?” Nystuen said.
Another possibility, according to Schneider and Nystuen, would be an increase in the New York Prime Rate, also currently quite low, which is a short-term index rate used by all different kinds of American lending institutions – from major national banks to credit unions.
“It would certainly be challenging,” Nystuen said. “I can’t see how it does anybody any good to see that kind of jump in interest rates.”
“We have put together a number of financial models as to what happens to our bank’s income statement if the cost of servicing the bank’s incomes goes up,” Nystuen added. “We’ve played through a number of the scenarios.”
Furthermore, most banks use U.S. Treasury bonds regularly, since they’re judged to be among the safest investments available. Though investors continue to buy Treasury notes and bonds, driven primarily by fear the economy could return to recession, some analysts warn those yields could increase.
Many local banks, including those in the Flathead, use Treasury bonds as backing capital for their transactions. And though, again, a default would be worse, if the credit rating of the U.S. is no longer rated perfect, and those bonds are judged to be more risky, John King, the CEO and chairman of Three Rivers Bank, is concerned deals typically backed up by Treasury bonds may require something even safer: cash.
“We may have to back with our own cash – that’s unheard of, but we may have to,” King said. “I’m very worried about that.”
That could, in turn, force banks to keep more cash on hand – taking it out of circulation.
“Then it takes our liquidity away to make loans to our community and we’re not getting any return,” King added.
Ron Rosenberg, president of Valley Bank, echoed King’s concern.
“Banks have invested in U.S. treasuries and they could force us to provide allowances for potential losses on our investments,” Rosenberg said. “Any kind of fiscal recovery or economic recovery that might be in the works, with the problems you’ve got in Washington, just prolongs the recovery here.”
Aside from banks, local governments could also encounter difficulties stemming from the debt ceiling issue. A July report by the Pew Center on the States asserts that, should the federal government lose its AAA rating, or the equivalent, thousands of municipal credit bond ratings across the country could also see a downgrade. (The Pew report also states municipal bonds could become more attractive if investors consider them safer than Treasury bonds.)
Flathead County Administrator Mike Pence said increased rates on municipal bonds could make it more expensive for citizens using them to finance a rural special improvement district for road building.
“The impact would be it might discourage the citizens from doing a road improvement because their costs are higher,” Pence said. “Their annual assessments could be higher.”
But those projects, which are relatively small, would see only slight increases in the cost of borrowing. Were a local government attempting a larger undertaking, like building a new jail or library, it’s possible the increased rates could be enough to quash the project all together.
Everyone interviewed for this story expressed their desire to see a long-term solution to raising the debt ceiling put in place, beyond just a six-month fix, and the outline of the current deal appears to push another debate over the debt ceiling to 2013. But the prospect of a replay of the recent high-stakes round of partisan head-butting in a little over a year could prove to be detrimental for interest rates, investor confidence and the economy at large.
“The American economy can’t just live on borrowed time; we have to make some decisions here,” King said.
“I am very concerned that if we kick it down the road it’s going to come back and get us again and again,” King added. “So we can’t have a quick fix.”