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Citigroup (NYSE:C) banker and former Obama adviser Peter Orszag is proposing transferring more taxpayer money to banks like Citigroup in order to "solve" our problem of excess housing inventory.

Bankers and politicians are desperately trying to find ways to sell millions of foreclosures without driving down home prices in the process. Not only would lower prices lead to enormous losses for banks, but they would create millions more foreclosures as even more homeowners would choose to walk away.

So, how do you sell millions of foreclosures while still propping up home prices/bank profits? Massive taxpayer subsidies of course ... Orszag writes:

No matter what the government might try to do to break the housing-economy cycle, the deleveraging process will still be painful and take some time. But that’s not an argument against action; just because a headache can still hurt some even if you take aspirin doesn’t mean you should skip the aspirin. One thing the Obama administration could do now -- probably with Republican support -- would be to attack the oversupply of housing stock by allowing a tax write-off for investors who buy empty properties and rent them out.

To understand why this would help, consider that the problems in the residential real-estate sector have two dimensions. First, we have an excess supply of owner- occupied housing, which puts downward pressure on prices. Second, millions of American households now have negative equity in their homes. Dealing with excess inventory by shifting vacant properties into the rental market would help to stabilize prices and thereby mitigate, to some degree, the negative-equity issue -- although additional action would also be warranted to attack such “underwater” situations.

Bad analogy. We don't have a headache. We are pregnant with quadruplets and are only in the 2nd trimester. Also, there isn't an oversupply. These homes will happily be bought by private buyers and investors once they hit the market.

The "issue" is that without more government manipulation, this increased supply will drive home prices down further. This is great for buyers, but bad for banks. Shifting vacant properties into the rental market does nothing to mitigate the negative-equity issue. However, "shifting" properties at elevated prices, propped up by the taxpayers would, in theory, make home prices not fall as fast in the short term.

It’s normal to have some vacant homes for sale as part of the market process that matches buyers with sellers. On average during the 1990s, for example, the home vacancy rate was about 1.5 percent, according to the Census Bureau. By 2008, the figure had risen to 2.9 percent. And by the second quarter of this year, the vacancy rate had come down only slightly, to about 2.5 percent. With this much supply still available, it’s no wonder that prices are still depressed.

The percentage-point difference between the latest vacancy rate (2.5 percent) and a more normal historical rate (1.5 percent) amounts to an excess inventory of almost 1 million vacant homes. (Estimates based on other methodologies are roughly in that range.) If the government does nothing, that extra inventory will be slowly worked off, as the economy gradually recovers and more households are formed. The question is whether the government can do anything to accelerate that process, to support home prices and, ultimately, to promote a stronger economic recovery.

"Accelerating that process" is indeed the correct solution. The problem is that Orszag is confused about exactly what process we need to accelerate. Falling home prices, foreclosures, and short sales ARE the process. These are how we as a society deleverage ourselves from way too much real estate debt.

The problem isn't that home prices are falling, it's that they haven't fallen far enough yet to clear the market of the excess supply. We cannot "accelerate that process" and "support home prices" at the same time because falling home prices ARE a part of the healing process.

One way to bolster demand would be to change our immigration laws to make it easier for foreigners to move here and buy homes. That might be a good idea, but it has no chance of being enacted soon. Former Federal Reserve Chairman Alan Greenspan once highlighted a different idea, focused on supply instead of demand: Get the government to buy the excess vacant houses and destroy them. He argued that could be the lowest-cost approach to mitigating a housing-driven decline -- but also noted that it would be politically inconceivable.

A more realistic approach would be to try to get the vacant houses rented out, rather than sold to owner- occupants. And one way to do that -- proposed by real- estate practitioners (such as Kyle Jividen of Alamo Appraisal Group in San Antonio) and economists (such as William Wheaton of the Massachusetts Institute of Technology and Gleb Nechayev of the research firm CBRE Econometric Advisors) -- is to provide an immediate tax write-off to investors who buy vacant houses and rent them out.

Currently, people who purchase residential real estate depreciate the value of the property for tax purposes over 27.5 years. To encourage other forms of investment, policy makers have allowed businesses to immediately depreciate the full cost of most of their investments. But real estate hasn’t been eligible. So Congress could give investors the incentive to buy vacant houses now by allowing them to write off the value immediately, as long as they hold on to the properties for some number of years and rent them out.

Investors don't need additional tax breaks. The system isn't currently broken - properties are selling to investors all over the country. Giving investors tax breaks would create extra demand and allow investors to achieve better cash-flow on properties purchased at higher prices. Ask the investors, and they would happily rather buy the same house for less without the gimmicks.

This plan hurts investors, other buyers, and taxpayers. The only group this helps is the banks.

... Maintaining this policy for two years would, under these assumptions, work off half or more of the excess inventory at a present-value cost to the government of $20 billion. That seems like a pretty good deal -- and at least worth trying.

To avoid letting the tax break outlive its purpose, it should be tied to the supply of vacant homes for sale. Once that number returns to a more normal level, the write-off should automatically end.

This kind of accelerated depreciation wouldn’t bring the housing market fully back to health. But since the economy is stuck in a rut and homes prices are a key reason, it is worth trying. Perhaps most importantly, in this era of political polarization, the idea of giving real-estate investors an immediate write-off for buying and then renting out vacant homes should appeal to Republicans. And that means if the administration proposes the idea, Congress could actually make it happen.

IF the owners of these vacant homes actually tried to sell them, they would sell within two years anyway and save the taxpayers $20 billion. That's a better deal.

This stealth transfer of taxpayer dollars to banks accelerated depreciation wouldn't bring the housing market to health. It would make it worse by simply prolonging the day until we actually do get to the bottom.

And all of those poor investors who bought during this program would see the resale value of their investments fall once the subsidy disappeared. But banks like Citigroup would be able to unload a bunch of their foreclosures at higher prices in the meantime.

Source: Citigroup Banker Proposes More Taxpayer Money To Prop Up Bank Balance Sheets ... Shocking