President Obama signed into law today an extension until April 30, 2010 of the home buyers' tax credit. Contracts signed by April 30 must close by June 30 to qualify. The new law has several provisions not in the existing law:
- Income limits have been increased to $125,000 for individuals and $225,000 for couples. These were formerly $75,000 and $150,000, respectively.
- Current home owners who have lived in their home for five of the past eight years are eligible for a tax credit of $6,250.
- Qualifying home prices must not exceed $800,000.
- First time home buyers continue to be eligible for an $8,000 tax credit.
Other information from Realtor.org indicates that the industry had extensive lobbying activities on behalf of this legislation:
- NAR (National Association of Realtors) members sent more than half a million letters to leaders in congress.
- NAR members made nearly 13,000 phone calls to Senate offices last weekend.
- So far in 2009, REALTORS® have spent nearly $14 million lobbying Congress.
So has this lobbying actually been for the public good? I think not and the rest of this paper will try to explain my reasoning. I'll start with a quote from an article last week at TheStreet.com (here):
James R. Hagerty of WSJ Blogs reports that, according to a paper by Goldman Sachs, federal and state government actions to encourage mortgage modifications and delay foreclosures, as well as the $8,000 first-time home buyer tax credit, have added about 5% to current home prices.
As I pointed out (here), 5% is almost exactly the amount of the recent up tick in the Case-Shiller housing index. This means what has been called by some a bottom in home prices may merely be an aberration due to temporary government programs.
So the effect of government programs is to:
- Increase home sales by some fraction of 2 million in 2009.
- Possibly increase home sales by at least a similar number in 2010.
- Increase prices received by sellers an average of 5%.
- Increase real estate commissions by about $2.3 billion total for both years.
- Reduce federal tax revenues by a total of approximately $38 billion for 2009 and 2010.
Not Wise: Reason #1
What is the multiplier for those $38 billion dollars? I don't know, but I expect the multiplier is a lot less than if the money had been spent on infrastructure projects. Let me explain my logic.
Construction projects totaling $38 billion might have created as many as 400,000 jobs directly and perhaps another 200,000 to 400,000 jobs through a multiplier effect as wages were spent repeatedly, spreading through the economy.
The money spent on houses was largely dead money. Yes, the increased income derived from real estate commissions would enter the economy. And any money spent on new home construction would enter the economy. I don't have the fraction of new home sales using the tax credit. We do know that new home sales are about 10% of total home sales (ballpark figure). Applying that ratio, construction costs would have added another $3.6 billion or so to the economy.
The total amount of money entering the economy as a result of these home purchase tax credits is about $6 billion dollars. This is in return for $38 billion spent by way of foregone tax revenues that could have been put completely into the economy in infrastructure projects. Employment could have been increased by more than half a million.
The home buyer's tax credit is not the best way to be spending money when unemployment is such a big problem.
Not Wise: Reason #2
The second reason the tax credit program is problematic is that it provides a vehicle for more no money down home purchases. This can be a successful strategy when home prices are rising, but they may still be falling. Let me use a hypothetical example.
Mr. and Mrs. X have no savings. They have sufficient income to qualify for a 3.5% down FHA mortgage of $193,000. That means they can buy a house for $200,000, get $8,000 back on their taxes and take possession of the house with $1,000 left over for closing costs. If they get a seller rebate of the closing costs, they have $1,000 in beer money.
There are a wide variety of estimates regarding the future direction of home prices over the next 1-2 years. Some say the bottom is in. I maintain they are the dreamers. Others say that prices have 5-10% further to fall. I say these are the realistic optimists. Then there are some who have predicted further declines of 20-40%. These are the doom and gloom pessimists.
Continuing with the hypothetical analysis, it is not unreasonable to assume that the X's home value could fall be 10% in the next 1-2 years. Their house is now worth $180,000, less any selling costs. If sold by realtor they would get less than $170,000. Given any sort of financial stress, when they start looking at where to cut expenses, the high "rent" they are paying (mortgage payments, plus HO insurance and property taxes) may come right to the top of the list. They have negative equity ($20,000 + under water). They are prime candidates to join the ranks of those who stop making mortgage payments and live rent free until evicted by foreclosure. Alternatively, they could just "mail in the keys" and walk away.
There may be in excess of 4 million home purchases made with the tax credit incentives. What if half are done with no equity put up by the buyer? Is it possible that half of them could default? It is not unreasonable that an additional one million foreclosures could result from this program.
Some of these foreclosures will be properties that would have remained on the market had there been no tax incentive programs. Therefore, additional foreclosures may not be adding to the inventory of unsold housing when integrating the effects over many years. It may be simply delaying the resolution of housing market disconnects.
I have difficulty rationalizing the merit of deferral. When are we going to stop kicking cans down the road and start picking up trash?
Conclusion
The housing tax credit programs are serving two positive purposes:
- Creating a "feel good" situation.
- Increasing money circulating in the economy by approximately $6 billion.
The negative effects are:
- Diverting $32 billion from circulation in the economy.
- Creating future potential mortgage defaults.
- Delaying reaching a bottom in the housing collapse.
Of course, if those I have labeled dreamers are actually correct and home prices really have bottomed, my concerns about future defaults are reduced. And if we have a sustained recovery starting in 2010, with two million or more new jobs created each year for several years, my concerns about lost opportunity for job creation are not important.
However, if the two rosy scenarios I just outlined do come to pass, then we didn't need to spend $38 billion on housing incentives in the first place. I view my arguments as a rare case (for me) of heads I win, tails you lose.
Note: I have not discussed the allegations that fraudulent claims have been submitted for tax credits when no home purchase actually occurred, because I have not been able to personally document the cases.
