Shutdown: Economic Support Systems Would Continue, Even As Housing, Small Businesses Take Hits

04/08/2011 03:24 pm ET | Updated Jun 08, 2011

If the federal government shuts down tonight, much of the apparatus that has helped prop up the faltering economy will remain in place.

The Federal Reserve will continue its $600 billion asset-purchase program, buying government debt from Wall Street banks in an effort to get money flowing through the economy. The Treasury, which, as of late March, owned $142 billion of mortgage securities, will continue to sell that portfolio, as it works to earn a profit on the taxpayers' investment. The New York Fed will continue selling the toxic securities it bought from AIG during the height of the financial crisis.

Even if thousands of workers are furloughed, and struggling families miss government checks, these economic support systems will continue.

"We got ourselves in a situation by letting banks become too big to fail, that they're now basically sucking at the tit of the government," said Mark Blyth, a professor of international political economy at Brown University. "If we let them go, we harm ourselves."

Two and a half years after the worst financial crisis since the Great Depression, the broader economy remains on fragile ground. The unemployment rate is close to nine percent. Home prices are still falling. As fighting continues in the Middle East, oil prices are rising, pushing up energy costs and tearing precious resources from the American economy.

During the last major government shutdown, from late 1995 to early 1996, the economy was stronger. Then, as now, the country was emerging from a recession. But at that point, the recovery was being felt throughout the broader economy. The unemployment rate was 5.6 percent.

Nothing like today's economic support system was in place back then.

"The apparatus wasn't in place because it wasn't necessary," said Gus Faucher, director of macroeconomics at Moody's Analytics.

A shutdown now would come at a time when the economy is relying on government support to a historic degree. Since the recent financial crisis, government programs have helped promote a recovery. But the progress has been uneven. Flush with the taxpayer bailout and confident in explicit and implicit government guarantees, big banks have seen their revenues and profits skyrocket. Pay at Wall Street firms last year hit a new record, while wages for middle class Americans stagnated.

Since the Fed launched a second so-called “quantitative easing” program late last year, the central bank's New York branch has been buying U.S. government debt from big banks, allowing those firms to reap easy profits. The policy is designed to lower interest rates throughout the economy in order to stimulate a broader recovery.

The Federal Reserve, which relies on separate funding, would not be affected by a shutdown of the federal government.

Similarly, the Treasury holds a massive portfolio of mortgage-backed securities, which it bought during the worst of the crisis in an effort to calm markets. It began the process of selling this $142 billion portfolio last month. Those operations will continue if the government shuts down, a Treasury spokesperson confirmed on Thursday.

But other economic programs that aren't explicitly tied to the current slump would halt. The Federal Housing Administration, which insures and guarantees nearly a third of U.S. mortgages, would stop its operations, potentially causing further slowdowns in the housing market. Since spring is normally peak home-buying season, the shutdown could present a further obstacle to an already weakened sector of the economy.

Without the government insuring mortgages, some mortgage issuance will likely stop. JPMorgan Chase plans to stop making new FHA loans in the event of a shutdown, The New York Times reported.

"This is the worst time that we could introduce that uncertainty into this fragile housing market," Housing Secretary Shaun Donovan told a Senate subcommittee on Thursday.

Small businesses, too, could suffer. The Small Business Association would stop approving applications for loan guarantees and direct loans to small businesses, potentially hampering these businesses' growth. Small businesses pay 44 percent of the nation's private payroll, according to the SBA.

"We will continue to do our part, we just won't be able to close loans," said Dave Rader, executive vice president of SBA lending at Wells Fargo. A shutdown, he added, would hamper the bank's ability to "provide access to capital for small business borrowers."

If the shutdown drags on for more than a few weeks, it could wither Americans' confidence enough to provoke a relapse into recession, Mark Zandi, chief economist at Moody's Analytics, said last week.

But the real danger, experts say, is if the gridlock in Congress infects the debate on whether to raise the federal debt limit. The government must borrow money to finance its existing debt and other obligations. It will hit its ceiling in mid-May, Treasury Secretary Tim Geithner said this week before a Senate subcommittee.

If the government were to default, U.S. interest rates would likely rise, potentially touching off an economic crisis that could send panic around the globe.

"This is a symbolic exercise we're going through," said Robert Shapiro, a fellow at the Georgetown Center for Business and Public Policy and a former U.S. Under Secretary of Commerce for Economic Affairs. "If it goes a month, that means you've got much more serious problems. You've got problems with real political gridlock, at a real fundamental level. That begins to really worry markets."

Nathaniel Cahners Hindman contributed to this report.