The Housing Tax Credit: Maintaining a Market on the Brink

Although the past several months have shown an improving sales environment for housing that has raised most of our hopes, recent data supports the idea that the housing market is still tipped precariously on the edge of re-disaster.

Make no mistake, similar to the cash for clunkers program in August, the housing market has been kept active with a cocktail of government programs. Like most others, we agree that the outlook has been getting better and some progress is being made, but there is still a lot of work to be done. And, even though I generally oppose spending taxpayer money, now is no time to pull the plug on the lifelines.

If the latest housing data show us anything, it's that the upcoming deadline of the nationwide $8,000 tax credit is going to be a big crossroads. Our first concern was the NAHB Wells Fargo Housing Market Index, which gave us a glimpse into the market so far in October, and what we saw wasn't promising as confidence fell. Present conditions deteriorated slightly from September, while traffic and the outlook for future sales were worse.

The pending end of the tax credit is a very likely culprit, as it generally takes a month or two to close on a home purchase, and we are getting to the point when it is too late to take advantage of the credit. As a result, we are beginning to see a slowdown in activity. In addition, housing starts and permits were lackluster and well below consensus estimates for September, remaining flat from August, as it seems builders were already bracing themselves for a drop in sales last month.

Nevertheless, the tax credit is not dead in the water, as legislators are indeed mulling an extension and, perhaps, even an expansion to include buyers making more than $75,000 per year and people who are not first time buyers. As it stands, however, we cannot say conclusively if, or in what form, the tax credit will be continued.

A few weeks ago, I estimated the amount of sales that could be lost if the tax credit is not extended. I used a survey from Zillow.com that noted 18% of potential first time home buyers see the $8,000 tax credit as their primary incentive to buy a home, while 25% cited it as a significant influence. Although it is subject to change, our current forecast is for home sales to reach 5.8 million units over the next year; 2.3 million of which would qualify for the credit. If we assume that the 18% of buyers who cite the tax credit as the main driver of a purchase would exit the market, then we conclude that approximately 415,000 fewer homes would be sold. If about half of the people who said the tax credit is a "significant influence" also pulled out, then the loss of sales would be upward of 600,000.

All in all, instead of reaching our 5.8 million forecast for 2010, home sales would likely be limited between 5.2 million and 5.5 million, which would be flat with current conditions, but there would be a preliminary drop-off following the deadline.

But unfortunately it's not as simple as just the sales side, as unless inventory is kept under control there will continue to be downward pressure on prices. As it stands, even with the tax credit sales are barely outrunning additional supply. In fact, the last reading on inventories from August showed that August inventory of existing homes is essentially flat with January. The reason is people are still foreclosing on their homes at alarming rates, and the onset of a recession and job losses has only made it worse.

According to RealtyTrac, the third quarter of this year was the worst quarter on record for foreclosures. July, August and September were the worst three months in history, despite vast efforts to get struggling borrowers refinanced into more affordable loans. On the positive side, foreclosure filings did decrease by 4% from August to September but, looking at the data, one cannot conclude that we are turning the corner. Worse yet, the percentage of filings represented by repossessions is rising. Repossessions jumped by 15.4% month to month, which is likely the result of a number of loan modifications going back into default and the result of foreclosure delaying processes cycling over. As a result, we may see and increasing number of vacant houses hitting the market, which of course will not bode well for home values.

It's also important to note that many lenders have implemented moratorium programs under which the lenders do not act on the foreclosures, but rather seek out alternatives for extended periods of time. Over the next several months many of these programs are expected to end, leading to more waves of foreclosures filings. As of October 1, the White House noted that it has entered more than 500,000 homeowners into its mortgage modification program, which may have led to the decrease during the month, but so far the program has not kept up with the problem sufficiently. The consensus among economists is that foreclosures will continue to hit new records through mid-2010.

There is also the issue of the "shadow inventory" of foreclosed homes currently held by banks that has yet to be placed on the market. Some believe the size of the shadow home supply could be as high as 7 million, although others argue that the number is insignificant.

We tend to agree that there is likely enough out there to tip the supply number higher in the coming months, but the question is when and how fast it will hit the market. In our assessment, the aforementioned foreclosure moratoriums will be another form of shadow inventory, as one main solution for struggling homeowners is to delay the foreclosure filing process by a couple of months while the lender and borrower explore alternative options, while the situation is not being recorded officially as a foreclosure.

In the end, the majority of these homeowners are eventually foreclosing. In the end, we would not be surprised to see hundreds of thousands of currently unaccounted-for homes hit the market over the next several months.

In the end, without the tax credit extension and/or other programs to keep housing on its feet, the pace of supply of foreclosed homes soon to land on the market seriously risks surpassing the rate of demand and causing another drop in prices.

That being said, the Administration is skirting disaster as it pushes its agenda to provide loose lending to low income borrowers. While not officially labeled as "subprime" we are seeing examples of home buyers being accepted into the FHA program that at times have less than $30,000 of income per year and work several jobs, while paying upward of $1,300 a month on mortgage payments. This only serves to re-inflate the existing housing bubble which could easily crash again if the economy hits a speed bump.

We would urge the Administration to extend the tax credit, while steering further away from the loose lending solution and more towards lowering mortgage rates.

Falling mortgage rates are something most homebuyers are aware of, and can help to drive traffic while also lowering monthly payments for those buying new homes, as well as those who already own homes and wish to refinance. It's no secret mortgage rates dropped below 5% between the end of September and the beginning of October. In fact, the gradual rise in applications over the past couple of months correlates fairly flush with falling mortgage rates. Well, mortgage rates have now edged back up above 5%, and as a result there is no longer a frenzy to get refinanced into lower payments or try for a home purchase as seen by the 14% drop in mortgage applications for purchases and refinances last week.

As long as we keep the tax credit going, keep rates low and have other policies to support housing, then we can keep a slow rate of improvement in place. However, the tax credit is looming and the uncertainty is already looming large; the latest round of data reflects it. If we take our eye off the ball now the heavy burden of more foreclosures is going to tip the scales in favor of supply rather than demand and put housing back into a hole.

The September existing home sales report comes out on Friday but it may not give us proper insight. It is likely September sales will have gone higher, seeing as the tax credit was still in full effect and mortgage rates fell throughout the month. Consequentially, the numbers may actually be positive and send housing stocks higher, although we will have an eye on inventory. However, don't celebrate early as October is likely to show a different story, we've already started to see the fallout. Hopefully congress makes a move soon.

Comments

[Papaswamp:]

I think there was a bit of a fraud wrench thrown in with 4 yr olds getting the tax credits.
www.marketwatch.com/st...

Oct 22 05:44 PM

[OldSusanna:]

I'm wondering how in the world we can imagine that real estate markets can be nursed into health by government subsidies (you seem to agree that too-lax mortgage terms are a no-win). Though I can't even pretend to understand how this mess all came about--I do know that home prices are, in MANY areas of the US, still well-above what would be consistent with affordability to its residents (an affordability that is able to promote quality of life). Painful though it may be (especially with such excessive inventories), don't we really need to let the housing markets fall to realistic conditions? When prices are in line with the consumer's ability to purchase, they will, will they not?

Oct 22 09:19 PM

[Moon Kil Woong:]

#1 We will have a dip in housing starts and sales after the summer no matter what. It's called seasonality.

#2 Government attempts to prop up and/or encourage home ownership for those who can't afford it is bad for the market as much or more than it is bad for those buying into the programs. There is nothing wrong with renting. It is much preferred over losing your shirt in real estate and winding up owing more than you can make in a couple years.

In the end housing prices should be a function of financial decision making based on whether or not it's more affordable to rent or own and based upon real income within an area. If income and jobs are falling in an area it is absurd to try to pump up and support housing. The government is focusing on the effects not the cause once again.

The cause is jobs, wages, and real productivity not the stock market, banks, and home prices. So far asides from extending unemployment and hiring even more government workers we can't afford with our taxes they have done practically nothing to address the root causes. They are enamored with the Federal Reserve's focus on the effects because they feel that is the fastest and easiest way to solve the problem. But it isn't. It doesn't even address the problem. In economics there is no easy way out. Until we ask how do we make a market which can identify the avenues for growth and prosperity tomorrow we really can't expect to reach tomorrow any better off than we are today no matter how much extra money we crank out.

Oct 22 11:47 PM

[Michael Clark:]

I agree, OldS. Conservative lending standards say home prices should be 2-3 times the annual household salary. If two people are working earning $90,000, that's $180-$270,000. But now that people are losing jobs, that might cut the household earnings down to $45,000, which means $90-$135,000. Unless we 'grow jobs' we CANNOT grow housing prices.

Housing averages an appreciation of 2-3% per year. We had an appreciation of 150-300% in five years, 2001-2006. Those who owned a house felt VERY RICH. But it was a false high. The Fed is acting like a dope dealer, in fact, pedaling money highs for high fees. Now we are coming down, trying to de-tox. The Inflationists want a constant high. They think a good economy is on a constant high. In fact, a good economy inflates and deflates sequentially, expands and contracts, as if breathing.


On Oct 22 09:19 PM OldSusanna wrote:

> I'm wondering how in the world we can imagine that real estate markets
> can be nursed into health by government subsidies (you seem to agree
> that too-lax mortgage terms are a no-win). Though I can't even pretend
> to understand how this mess all came about--I do know that home prices
> are, in MANY areas of the US, still well-above what would be consistent
> with affordability to its residents (an affordability that is able
> to promote quality of life). Painful though it may be (especially
> with such excessive inventories), don't we really need to let the
> housing markets fall to realistic conditions? When prices are in
> line with the consumer's ability to purchase, they will, will they
> not?

Oct 23 04:05 AM

[Jimmy K:]

extend the tax credit>??? Insanity. Home prices need to go back to 1%-3% appreciation per year; in my humble opinion- roll all the way back to 1995 pricing.

Oct 23 07:13 AM

[TripleG:]

I'll agree with JimmyK.......the sooner we get to 1991-2 prices, the sooner we will stabilize the market and can then work on appreciation.

Oct 23 10:05 AM

[Michael Clark:]

I agree with JimmyK also -- and let's remember when we eventually start appreciating, that modest appreciation is best. The hither up you go, the farther you fall. (Greed is NOT good. Greed today becomes punishment for greed tomorrow. Remember Nemesis in Greek mythology.)


On Oct 23 10:05 AM TripleG wrote:

> I'll agree with JimmyK.......the sooner we get to 1991-2 prices,
> the sooner we will stabilize the market and can then work on appreciation.

Oct 23 11:15 AM