So far, Fannie Mae and Freddie Mac have stayed mum on the specter raised by Moody’s. Downgrade could be KO for housing

As the rating agencies have recently made clear, failure to raise the nation’s debt ceiling would threaten more than Social Security checks and interest payments to China.

The chain reaction from a downgrade of the Treasury’s top rating would hit thousands of municipalities, student loan provider Sallie Mae, too-big-to-fail banks and places that have dealt with plagues of truly biblical proportions: Israel ($11.9 billion of U.S. guaranteed debt) and Egypt ($1.25 billion).


But nothing might be more vulnerable than the housing market that spawned the financial crisis three years ago.

Mortgage firms Fannie Mae and Freddie Mac could lose the top-notch ratings made possible through their government conservatorship.

Tucked into Moody’s recent report is a footnote estimating that, without explicit government support, Fannie Mae and Freddie Mac would have the equivalent of a B2 junk bond grade.

In perspective, the sovereign debt of Sri Lanka, recovering from a 26-year civil war, has a better stand-alone rating. And up until June, so did the dangerously cash-strapped and protest-laden nation of Greece.

So far, Fannie Mae and Freddie Mac have stayed mum on the specter raised by Moody’s and the other two rating agencies, Standard & Poor’s and Fitch.

“Our policy is we don’t comment on rating agency actions,” said Freddie Mac spokesman Michael Cosgrove.

Nonetheless, those with knowledge of the situation on both the corporate and governmental sides were willing to speculate on two possible scenarios if there were a downgrade.

The firms issue debt in order to buy mortgages that are then securitized, enabling lenders to issue more home loans.

Under the optimistic scenario, a lower bond rating would increase borrowing costs for both entities, causing a gradual ripple effect that might eventually make it more expensive for home buyers to get mortgages.

Lawrence Yun, chief economist at the National Association of Realtors, suggested the reaction of global investors would largely determine the impact of a downgrade. If investors were to hold onto their bonds, the damage could be minimal.

The more pessimistic scenario starts with the fact that housing is already on government life support, with about 90 percent of the loans backed in some form by the feds.

A destabilizing element such as a rating downgrade could present extreme problems. Current homeowners might not be able to refinance in a panicked environment. And housing prices — now at 2003 levels, according to the S&P/Case-Schiller index — would sink further.

Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association, said “no serious analytics” can speak to the consequences of a downgrade, but he expects interest rates could jump by more than a full percentage point.

“That magnitude of a rate increase would shut off refinancing and would probably slow purchase activity as well,” he predicted. “The great unknown is how consumers and businesses would react to the downgrade. That is an unquantifiable effect.”

But, he added, “one could imagine a deer-in-the-headlights reaction, where commerce essentially halts for a time.”

Wall Street POLITICO is a weekly column looking at issues that drive business.