Home Purchase Tax Credit Extended: Is This Wise?

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.

Realtor ® Magazine, at Realtor.org (here), stated that the new law is expected to contribute approximately $22 billion to the economy. This source also stated that the expiring tax credit law was taken advantage of by approximately 2 million people. Since this year is on track to see less that 5.6 million home sales, this means the tax credit will be involved in approximately 36% of all home sales for 2009.

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.

Comments

[chris coonan:]

the shitstorm will happen next year, and values will crater

Nov 08 08:22 AM

[basehitz:]

We are on the same page.

“Realtor Magazine. . . stated that the expiring tax credit law was taken advantage of by approximately 2 million people”

That is overstated per NAR (well known for spinning everything in their favor), From an AP article:
“About 1.4 million first-time homebuyers have qualified for the credit through August, and the National Association of Realtors estimates that 350,000 of them would not have purchased their homes without the credit.”
finance.yahoo.com/news...=

Above was August totals. Assume 2 million was reached, but only 25% additional purchases from the handout. 75% would have bought anyway. Assume that the 75% who didn’t need the money were the most qualified buyers. It is also reasonable to assume that those who wouldn’t have bought, didn’t have the means without the taxpayer subsidy. So for the marginal buyers, let’s see how that’s working out. From the NY Times:
“. . . 20 percent of F.H.A. loans insured last year — and as many as 24 percent of those from 2007 — faced serious problems including foreclosure.”
www.nytimes.com/2009/1...
(NYT article gives specific examples of marginal buyers. The risk is obvious.)

Mind you, the 2007/8 loans were originated before the $8K subsidy, when at least the buyer presumably had the 3.5% FHA downpayment. Now we have “buyers” (the 25%) who NEED the $8K to make the downpayment. What do they do when the A/C breaks or the roof leaks? If 20% defaulted within 2 years who had the 3.5%, what do you figure the rate will be for those who don’t?

Bottom line as I see it. . . the govt knows many banks can’t take another round of heavy writedowns of both mortgages and CRE loans, that market forces would likely deliver. They also know of the shadow inventory that CNBC and other propaganda outfits don’t want us to know about. So in desperation they are trying anything to artificially prop up prices hoping the new foreclosures they are NOW creating won’t sink them next year.

But remember, all these new FHA loans carry taxpayer backing. So the taxpayer gives them the $8K, then sucks up the loss if (when) it defaults.

Nov 08 09:24 AM

[John Lounsbury:]

basehitz - - -

Excellent analysis. Your determination that 25% of the potential four million sudsidized home purchases could be no money down or marginally qualified seems very sound based on the references you quoted. So my estimates that one million future defaults may be a little too high because some portion may be able to stay the course in the face of further home price declines. I think the portion not defaulting would be less than 50%.

So my guess that one million future defaults could occur would be better stated as "between 1/2 and one million future defaults".

Thanks for adding some worthwhile analysis to the discussion.

Nov 08 09:43 AM

[User 16123:]

John,
I see we just miss the tax credit for living in out homes 5 of the last 8. We will miss it by 3 months.
I guess I am wanting a handout. Everyone else seems to be living rent and mortgage free while we continue to honor our debt obligations. Our medical will now change from private, soon to be government run. Cap-n-trade will be the final straw for this once great nation as we will be penalized for too much carbon emissions and will be forced to reduce to a 3rd world level. Next -Default on out debt and give military equipment and technology to developing country's to defray any further retribution one might want to give us.
Run and hide into gold. The game is rigged so that there is no known currency that may survive the next 5 years of hyper-inflation and dollar destruction. The only things we possess that the world may need is: Beef, wheat, coal and new-found religion.
In the meantime let's go buy a house.

Nov 08 09:46 AM

[John Lounsbury:]

There is one other aspect that I recognize I did not address in the article. If some of the home purchases were from sellers that had significant equity in the home sold, then there is potential for added money to circulate in the economy. If that equity was immediately applied to purchase another existing home, however, then it would still be dead money and not circulated. We could go through a series of such sales and eventually segregate some of the money not reinvested in housing and therefore going into circulation.

I think this effect is probably small and less than the $6 billion added to money in circulation identified in the article. So a better statement would be that the $38 billion spent probably added between $6 and $12 billion to money in circulation.

Nov 08 09:52 AM

[skwestorange:]

Whichever way one looks at this disastrous path we are on, it cannot but end bad in a few years. Govt. handouts are always bad and can easily be subject to fraud and abuse. I agree that any Govt expenditure should always look at the multiplier effect first.

Nov 08 10:43 AM

[davidbdc:]

Virtually anything that involves our money going to the government is not wise!!!

Should it be any surprise that the sponsor of this bill is a real estate agent?

We have a housing crisis because people bought more house than they could afford and one of the solutions is to try to keep housing prices artificially 8000 higher?

Idiots

Nov 08 10:50 AM

[lower98th:]

The current-owner credit (COC) will not cover your transaction fees, but it could cost you a big chuck of your remaining equity.

Nov 08 11:42 AM

[Old Trader:]

OT, (and yet not): Last night, the House passed the Healthcare Bill.. "and the hits keep coming"...we are SO screwed...

Nov 08 12:27 PM

[badScooter:]

Thank you, John, for your (as usual) thoughtful commentary. As an investor, so-called 'helicopter money' drives me nuts. Would I take some if it were dumped on me? I reckon I already do...anybody who takes the mortgage interest tax credit does. I surely would give it up in favor of a government that actually taxed fairly, and restrained itself to collecting taxes to pay for valid objectives rather than the simple and obvious redistribution of wealth in the name of social justice.

I know, I'm not adding anything substantive here, I just feel the need to rant briefly after listening to the health 'care' debate on c-span all day yesterday.

blog at strikeback2010.com

Nov 08 01:22 PM

[BRUCE E. W.:]

The fallacy of dillemma once again. I didn't see the option to put $38 Billion into Housing "or" infrastructure construction, so to weigh the one against the other is simply not proper.
I had seen the earlier testimony of Simon Johnson in Congress who also spoke against the expenditure of more capital on this expiring tax credit, presumably a position against false bottoms in the industry simply draining the till. But in tracking the history of criticism on this tax credit the issues seem to be more about accountability and abuses which were marginal to its application.
Overall, the actual implementation could use some stricter guide lines and it is puzzeling why they appear to have been loosened instead, but this does not seem to be in question. With all the capitaliztion and "quantifying debt" being "eased" all over the banking and finance sectors, this seems to be a minimal application towards a middle class "pump" that should hold some infrastructural extremity in its walking stride.
I suppose this may well turn out to be one of those items that look bad to the people who are already in a well healed home setting, But it may well be a last helicopter leaving Saigon to those at the other end of the spectrum. It seems very little "demand side" incentives exist to be throwing out the baby with the bath.

Nov 08 04:30 PM

[very rare:]

doesn't most of this extra $6000 to $8000 go to the lenders as alot of the homes bought now are bank owned or foreclosure or short sales. We bailed out the banks and now give them extra money? are we nuts?

Nov 08 05:48 PM

[Steven Hansen:]

John,
the purpose of all this is to put a floor under housing - not to drive it up.

what we should have learned from the great depression and the japanese L is that wealth destruction restrains recovery.

this might be the least damaging of all the incentives (yes i am against incentives) - but the potential wealth stabilization result tips the scale for me.

Nov 08 11:22 PM

[Mark Bern:]

Our government is trying to build a foundation underneath housing values. It may fail or it may work. Only time will tell. But the bottom line for me is that those of us who have tried to live within our means will continue to pay for the excesses of those who do not. Personally, I have big doubts about the strength of the foundation or its ability to last beyond the end of this extension period. Below is a photo that illustrates how strong things appear to me.

static.seekingalpha.co...

Nov 09 02:14 AM

[Smalltownba...:]

Reason #1 False. The tax credit comes back to the consumer after they buy a home. This money is going to be used to furnish the home and make improvements such as landscaping, painting, upgrades, etc. in most cases because that is what first time buyers do when they buy a home. The infrastructure projects expenditures are simply moving projects up which needed to and would have been done anyway eventually. The tax credit stimulates sales on the low end resulting in move up sales and thus rejeuvenates a market that was virtually dead.
Reason #2 False: They do not receive the money at closing and cannot use it to defer downpayment, closing costs or other expenses unless some fool non-profit organization makes a loan to them to enable this. Regarding home prices. When land value as a percentage of home price falls to Zero how much more real price depreciation can occur? The answer is none because once recovery begins prices will rise to a level that supports the cost to build plus a profit or homes will not be built.

By the way Case/Shiller index is not an accurate measure of market activity today and does not reflect the true total fall in market value because it excludes foreclosure sales. Real prices have fallen farther than it indicates.

I disagree with all of your conclusions on this measure. "Feel Good" give me a break. $6 Billion is a gross underestimation of the true impact and $32 Billion diversion is absurd. The tax credit may in some cases increase the buyers willingness to bid but I have seen no cases where it has led them to bid up a price and I do mortgages for a living. My market is primarily move up buyers and lots of them are coming our way now since the credit has led to the sale of their previous residence.

If the credit were available at time of close it could be inflationary but in 99% of all cases it is not monetized to be used at closing. Therefore I do not believe this credit is impacting the quest for a bottom to pricing.

Nov 09 11:03 AM

[John Lounsbury:]

smalltownbanker - - -

You wrote:

"The tax credit may in some cases increase the buyers willingness to bid but I have seen no cases where it has led them to bid up a price and I do mortgages for a living. My market is primarily move up buyers and lots of them are coming our way now since the credit has led to the sale of their previous residence."

Nice to have a comment from someone who is involved in the home sale process. Your market may not be typical of what I was discussing in that the you are dealing with the folks that sold their homes to first time home buyers rather than the people actually getting the tax credit.

I attempted to cover the situation you discussed regarding a seller with equity recovered from the sale in the second comment I made following the article.

If you have any other thoughts, I would welcome them.

Nov 09 11:33 AM

[lower98th:]

I read the ratified bill (HR3548 as passed by House and Senate) in its entireity, and read the Congressional summary of the original tax credit bill (as the new one was actually an amendment of the first).

There was nothing in it about selling the first residence.

My take - and I hope someone will set me straight - is that any qualifiying "current-owner" can use the credit to acquire a second property as long as for some period of time (also not addressed in the Law) the new property is classified as their legal residence.

Hmmmmmmm.....

Nov 09 12:32 PM

[tripleblack:]

Yes, my thought exactly. I was looking at the same stuff, though I would love a more authoritative and clear pronouncement from the Feds so there are no misunderstandings.

This sort of thing would track well with past practice in regard to tax treatment for ideas like this.


On Nov 09 12:32 PM lower98th wrote:

> I read the ratified bill (HR3548 as passed by House and Senate) in
> its entireity, and read the Congressional summary of the original
> tax credit bill (as the new one was actually an amendment of the
> first).
>
> There was nothing in it about selling the first residence.
>
> My take - and I hope someone will set me straight - is that any qualifiying
> "current-owner" can use the credit to acquire a second property as
> long as for some period of time (also not addressed in the Law) the
> new property is classified as their legal residence.
>
> Hmmmmmmm.....
>

Nov 09 12:40 PM

[dieuwer:]

I don't understand what is so good about rising house prices.

1) It won't help the owner of the house when he wants to move, because the house he wants to buy has also increased in price.
2) Unless the salary of the home owner increases as well, the owner is forced to pay an increasingly larger amount of property taxes from his salary.
3) If higher house prices are due to inflation, the owner also will pay more for upkeep.

Conclusion, higher home prices without a match in higher salaries is bad.

Nov 09 03:10 PM

[Selva:]

To be honest, this law will only fill pockets of realtors and mortgage brokers and lenders at the expense of tax payers and the innocent people who will fall in to the pitch of these salesman.

Why should NAR look for the benefit of common man and econom?. It will only look for realtors fat, risk free income at any cost. In no other country you get 6% commission, so I will do anything to keep used home sales going.

What govt can do is to give $15,000 for buying new homes and not to guarantee the loan using FHA. The tax payers risk should be limited to only $15K for each new home.

Nov 09 04:12 PM

[kcroyals77:]

I qualify as a first time home buyer, yet I have sense to know that it is difficult to determine a fair market price because of this insane tax credit. Thus, I have to sit on the sidelines until I see a bottom. Rising unemployment, wages stagnant for those that have work, tightening credit standards, shadow inventory all signal that there is room to drop. The federal government is now all tapped out and I doubt there is going to be any new kegs brought to this party.

By the way to the poster that says the 8,000 credit is being used on furniture..not always the case. Some lenders are fronting the borrowers the 8,000 credit as part or all of the down payment.

Nov 14 10:59 PM

[CDTD:]

This is a great article. It is what I've been preaching to my friends, family and real estate agent since the first credit came out. At least that one was an interest free loan that had to be repaid. The government, while well-intentioned, is just furthering this real estate "crisis". The tax credit will delay the impending doom: further drops in home values and more foreclosures and short sales.

Unfortunatley we have not yet learned from our mistakes. More often then not the economy will work itself out without intervention from the government. It may take years, but history shows that organic economic stimulus is the best way to go.

Nov 18 01:38 PM