Will Tax Cuts and Fiscal Stimulus Improve the Real Estate Market?

The recent G-20 meeting appears to have embraced the Keynesian notion that in order to stimulate aggregate demand there should be a fiscal stimulus of about 2% of global GDP. Without going too deeply into the Keynesian theory the multiplier effect can then enable this direct stimulus to be translated into more jobs and investment, all of which will enhance aggregate demand in a self-reinforcing manner that should, at least according to the theory, arrest the contraction in global economic activity.

Several major problems exist now for this diagnosis not the least of which is the nature of the multiplier effect and the ability and willingness of consumers and corporations to actually spend the additional purchasing power that governments are intending to create.

The ability will depend a lot on the indebtedness and solvency of many households, especially in those economies which have non-existent savings rates such as the US and the UK. The marginal propensity to consume for such households may be virtually zero and therefore inhibit the multiplier effect. Even those who may be tempted to use their extra purchasing power, but require it to be supplemented by bank borrowing or access to credit, will face the fact the banking sector will, probably for the foreseeable future, be more intent on hoarding the cash being injected by governments to rebuild their balance sheets than wanting to make loans.

But the biggest problem is that the marginal propensity to consume at the level that really matters, in other words getting consumers to start purchasing homes again, depends on whether potential home buyers feel that there is another kind of multiplier effect at work – capital appreciation.

The median price of homes in the US and UK are still essentially not affordable, in terms of their relationship to median income for those economies.

Also it is becoming harder to justify home ownership from a purely economic perspective in comparison to the costs/benefits of renting.

It is only when you can add in a sizable capital gains amount to the future cash flows from home ownership that buyers will be tempted back into real estate. Being able to factor in periodic capital gains into the cash flow analysis of course alters the affordability calculations as it is somewhat equivalent, or at least was perceived that way, to having supplementary income that increases one’s ability to service the mortgage costs.

Critically, it is the re-emergence of even a nascent housing bubble that needs to kick in again to drive this “multiplier” and this must surely be the hidden agenda of all of the government rescue plans. Whether or not it will work is unclear but what is most alarming is that if it does it will only be sowing the seeds for another credit crisis down the road.

Fundamentally it will fail to address the real problem with the housing sector, and many other parts of the economies of the developed world, which is that they are nowhere as rich as they think they are and for most of their citizens the realization has to come that, even at current depressed levels, they simply cannot afford to own their own homes.

This will remain the case unless real estate prices come down a lot further still or incomes for average workers go a lot further up.

Alas neither of these options is easy for politicians to sell so the recession, that ultimately hinges on finding some bottom to home prices, may have to continue long enough for Wall Street to come up with a new daisy chain to resurrect some version of a mortgage backed securities market.

Disclosure: no positions

Comments

[Tony Petroski:]

I sat in an economics class at the University of Minnesota taught by Walter Heller. In the class, us young pups were taught that in order to maximize the "multiplier effect," the government had to spend money through infrastructure projects and transfer payments because if people were "given" money in the form of a tax cut, they would only spend part of the money thus reducing the stimulus effect. Professor Heller called this government spending the "leaky bucket."

Heller was teaching us this at the very time Ronald Reagan and supply-side economics was smashing Professor Heller's world-view.

As for Heller's leaky bucket and real estate: People will flock to real estate as an inflation hedge once everyone realizes that Heller's prescription leads to stagflation.

2008 Nov 19 05:14 PM

[Drew Horn:]

The writers and commenters in Seeking Alpha seem to ignore the fundamental principals of capitalistic economics. SUPPLY & DEMAND, SUPPLY & DEMAND, SUPPLY & DEMAND !!!

The most important of Clives comments is: "The median price of homes in the US and UK are still essentially not affordable, in terms of their relationship to median income for those economies." Thus demand is rightly dampened because many reasonable buyers cant afford home prices.

SUPPLYof homes is disconnected from demand. The reason for the disconnect is that planning & zoning are LOCAL functions. Increased DEMAND almost totally results from immigration (legal & illegal) and that is totally in the juristiction of the FEDERALgovernment but nearly uncontrolled.

Local government planning/zoning boards often attempt to defend the community from the expense of educating newcomers children by limiting growth using large lot and other similar limits to construction. If you want to verify this, ask a builder about the permiting process.

Getting back to Clives premise, tax cuts and fiscal stimuli may help with credit card and auto loan debt because there is no actual(physical) limit to supply . Tax and fiscal policy wont change the ratio of supply & demand in housing and thus wont, in the long run, fundamentally change size of population or the supply of housing .

What could help is simply to recognize that planning for US housing needs should be connected to wages and population change and to be effective must be done at the SAME LEVEL OF GOVERNMENT.

My hope is that a new federal government will recognize that A and Z have to be connected by the rest of the letters.

2008 Nov 20 10:47 AM