Former Treasury Secretary Larry Summers has warned that growing federal deficits could lead to a dramatic spike in mortgage rates, unless productivity gains from artificial intelligence boost government revenues.
Summers, who served as Treasury secretary in the Clinton administration and was a top economic adviser in the Obama administration, laid out two possible scenarios in comments at the Mortgage Bankers Association annual conference in Las Vegas on Monday.
“One scenario is that growth continues more or less as it has for the last 20 years. If so, the current federal fiscal trajectory is unsustainable,” he said. In that case, Summers predicts the bond market will “hit a wall,” with investors demanding higher yields to purchase government debt.
If that scenario comes to pass, Summers sees the 10-year Treasury yield jumping 75 basis points in a month, and mortgage rates rising a full percentage point in the same period.
“I think that’s probably the most likely consequence of the path we’re on,” he said, suggesting that a bond market reckoning could occur at any point over the next several years.
However, Summers also acknowledged that gains in AI technology have the potential to revolutionize the economy through massive increases in productivity, which would supercharge growth and ease concerns over the growing federal debt.
“If we were to get a major acceleration in productivity growth, then a lot of this fiscal bad news would suddenly look more controllable and more sustainable,” he said. “So I think we’re somewhat hostages to fortune on what the rate of growth is.”
Gary Cohn, a White House economic adviser during President Donald Trump‘s first term, spoke alongside Summers at the event, where he expressed similar worries about the ballooning federal debt.
Cohn said that during his time in the White House, he tried to raise concerns about growing deficits from time to time, but found that those concerns were always overruled by more pressing questions of political expediency.
“I can’t remember one real debate where that argument landed,” he said. “More of Washington, unfortunately, lives in the moment.”
However, Cohn also expressed hope that technological innovations could save the day, similar to how the internet revolution of the ’90s contributed to a brief period of government surpluses.
“I’m extremely bullish on AI. I also remind people here that AI is the front door to where we’re going, and where we’re going is quantum [computing],” he said. “When you grow productivity, you grow the size of the economy. As you grow the size of the economy, even if you keep the tax rate the same, you collect more taxes.”
For the fiscal year that ended in September, the federal deficit, or the difference between government spending and revenue, totaled $1.78 trillion, down slightly from the prior year.
The total outstanding federal debt is now more than $30 trillion, roughly equal to 100% of annual GDP, and near the highest on record since World War II, as measured by share of GDP.
Some economists who study the housing market have expressed concerns that growing deficits could impact the mortgage market, because mortgage-backed securities compete with long-term government bonds for investor dollars.
MBA Chief Economist Mike Fratantoni on Sunday predicted the risk of growing budget deficits and elevated inflation expectations will keep longer term interest rates such as mortgages from falling further, even as the Federal Reserve cuts short-term rates.
Fratantoni forecasts that these factors will keep mortgage rates between 6% and 6.5% at least through 2028, potentially dashing hopes that rate relief could help ease affordability pressures on homebuyers.
