Homebuyer tax credits: A post mortem

Almost exactly three years ago, in one of my City Talk columns in the Savannah Morning News, I predicted that Savannah area home prices were probably about 30% too high.

Some readers who had been closely following my researched columns about real estate prices and tax values took my tentative estimate thoughtfully.

Others went ballistic.

I remember one particular email that was CC-ed to everyone and their brother, in which I was called a “gossip columnist” who had no credibility on serious issues. It was laughable. I’d been writing a column for years already by then, so I knew from experience that a reader like that would never be convinced of the obvious, no matter how much data was put in front of him. The only thing I could do was let time pass.

I got similarly hysterical reactions over the last year or so when I would criticize the various tax credits for homebuyers, which many credited with “rescuing” or “reviving” the market.

Given the large overhang of housing inventory, it was obvious early on that the homebuyer tax credits would produce short-term gains at the expense of long-term health in housing, i.e., that the credits would forestall the inevitable correction of prices based on simple supply and demand.

But any time I wrote about the inevitable declines in home prices after the expiration of the tax credits, someone would have a conniption. In a long, rambling rant on SavannahNow, one reader said that I must be a miserable lifelong renter who would never own a home and was envious or ignorant of the values of homeownership. In fact, I bought my home for a reasonable price in 1996 and paid it off in full in the spring of 2010. With the housing downturn, I’ve taken a huge hit to my personal wealth (on paper anyway), just as others have.

A few comments about the various tax credits (from April 2008 to June 2010), and their aftermath:

1. According to the WSJ, the total cost of the credits to taxpayers was about $22 billion.

2. Homes are not consumable products. If you subsidize sales of potato chips this month, that won’t have much effect on next month’s demand for potato chips — and it might even boost next month’s demand. But a homebuyer tax credit removes likely buyers from the market for many years, perhaps for the rest of their lives. (See my closing anecdote at the bottom of this post.)

3. Given the sheer cost of homes and the difficulty of getting a mortgage in the post-boom economy, the homebuyer tax credits probably created very little fresh demand for homes. The credits simply pulled demand forward: folks who were likely to buy in coming months and years were drawn into the market early. Nor did the homebuyer tax credits significantly boost household creation, which is the key to absorbing excess housing inventory. The credits most likely simply pulled households from the rental market, which caused some downward pressure on rents. Since there’s a fundamental relationship between rents and prices, that drag on rents was also a further drag on home prices, although that drag was masked by the illusion, created by the tax credits and by marketing spin, of a bottom in housing.

4. The additional buyers in the market and the tax credit deadlines put upward pressure on prices. Check out this post from Calculated Risk: House Prices and Months-of-Supply, and Real House Prices. The graphs clearly show the effectiveness of the tax credit deadlines in stopping the slide in house prices.

5. Some economists and housing market observers downplayed the role of the tax credits. See for example posts on the Economix blog on the NYT here and here. So some analysts were surprised that sales fell by about a quarter in July 2010, despite plenty of evidence that many buyers had been rushing to meet the June 30th deadline. With the decline in total sales, especially at a time of seasonal strength, the months of inventory ballooned. While increases in inventory do not guarantee lower prices, there is a general correlation. In the Savannah area, our supply of single-family homes on the market shrank somewhat during the tax credit’s final months, but is now stubbornly stuck in the 18-month range. [UPDATE: See my comment below for more information on this.]

6. With nationwide prices now falling again and widely foreseen to fall 5-10% over the course of 2011, many of the buyers who took advantage of the tax credits will find themselves with negative equity — or close to it. About a third of Georgia’s residential mortgages will likely be underwater through the rest of this year.

7. It’s arguable that home prices have already fallen close to a level that would make historical sense. But now we’re at risk of an over-correction to the downside, in part because so many buyers were lured too early from the sidelines.

8. In retrospect, the biggest beneficiary of the tax credits might have been the banking system. Banks hit hard by the fast decline in real estate prices before 2008 might have gotten some important breathing room because of the temporary support for home prices. (It’s also possible that as many or even more banks will eventually be worse off because of the sheer length of the downturn in housing.) It could also be argued that the temporary stability in home prices contributed to the overall recovery that we have seen since the recession ended; now, it could be argued, even if home prices continue falling, the economy is strong enough to withstand the blow. I’m dubious of that conclusion, but it’s a fair argument to make.

I’ll end this long post with a quick story. A young couple bought a home in my neighborhood about two years ago. He has a job with the federal government and she works in health care. I thought they overpaid, but it seemed obvious that they would have no trouble making payments, given their professions and other factors. But last year he was transferred. They immediately realized that they could not possibly sell their unit for enough to cover the note, so they decided to rent it out for just enough to cover their monthly payment. But there were no takers at that price, so now they are left with a variety of options, all bad: slash the asking rent to a number far below their monthly obligation, sell the home for a large loss, or let the home go to the lender. Would they have even bought the home if there hadn’t been so much misplaced hype about the tax credits and about housing having hit bottom? I don’t know, but it’s clear that plenty of buyers were lured into the market too early, at prices too high. It’s a problem we’re going to be dealing with for many years.

1 comment for “Homebuyer tax credits: A post mortem

  1. bill dawers
    January 11, 2011 at 2:31 pm

    I wanted to add a couple of things to this post based on data I’ve seen since making it.

    For Dec., in the Savannah area, the inventory of single family homes in middle class areas like the Southside and West Chatham stands at about 10 months. Six-months is generally considered “normal,” although healthy balanced markets typically have closer to 4 months. More expensive areas have closer to 20 months of inventory. Sales are always low in January, but last year we saw new listings in January balloon (perhaps in anticipation of the tax credit). It will be key to watch the number of new listings in January and February.

    More data was released today about falling prices nationally, on the verge of retracing the gains made a year ago with the tax credits in place: CoreLogic: House Prices declined 1.6% in November (http://www.calculatedriskblog.com/2011/01/corelogic-house-prices-declined-16-in.html)

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