Tuesday, January 26, 2010

The Housing Hangover: How Bad Will It Be?

By Erwan Quintin, Assistant Professor of Real Estate at the Wisconsin School of Business

According to the National Association of Realtors (NAR) sales of existing homes in the U.S. tumbled by 17% in December, the largest monthly decline since the Association began reporting this measure in 1968. Drops of this magnitude usually come with a simple explanation. In this case, we are witnessing the home buyer tax credit hangover that economists have been anticipating for months.

The home buyer tax credit program gives buyers who haven’t purchased a home in at least three years and who meet certain income criteria a tax credit equal to 10% of the purchase price of their new home, up to $8,000. The program was originally set to expire on November 30th, but was extended in early November in both time and scope. The program’s intent was to give potential homebuyers incentives to purchase homes now; and, to some extent, to bring new buyers into the market. The fact that home sales rose at a healthy pace in the second half of 2009 and are now falling is evidence that the program “worked.” The NAR’s report also contains more direct evidence that many first-time homebuyers accelerated their purchases to secure the credit: they accounted for 43% of purchases in December, down from 51% in November.

At first glance, it may seem surprising that sales tumbled while the median home price rose by 1.5%. However, this result is a false positive which is essentially the hangover effect at work. Until last November, the credit was limited to first-time home buyers whose income was below $75,000 for singles, and $125,000 for households. Households who meet those criteria tend to buy cheaper homes. When they left the sample of home buyers in December, median prices mechanically rose.

Most people would agree that the program had the desired effect: it has moved home purchases forward. One could argue that the goal of all stimulus plans (fiscal and monetary stimulus, accelerated depreciation schemes, etc.) is to cause a spending shift. The goal is to borrow from a presumably stronger future to support flagging activity today. All stimulus plans, therefore, are bound to come with a hangover. The hope is that the hangover does not overwhelm the initial gains. (For a more detailed discussion the hangover effect, click here.)

How bad will the hangover be in housing markets? Over the next few months, home sales will benefit from the extending the housing credit program to a broader set of buyers until April 30, 2010. However, the same set of questions will arise in May. As is the case with all stimulus programs, the timing of the withdrawal is critical. If economic conditions have improved sufficiently by May, and a recovery is under way, the losses associated with the credit expiration will have limited effects. If, on the other hand, markets remain dependent on policy support, then a relapse is certainly possible.

Take, for instance, the foreclosure crisis. Foreclosure rates have tripled since mid-2006. Without policy support, however, things may have been worse. One incentive for households who experience financial difficulties to hold on to their home is the prospect of selling their home at a good price in the future. (For more information on this topic, click here.) If it becomes clear in May that selling prospects have suddenly worsened, the hangover could come with yet another foreclosure spike.

As they say in policy circles these days, we need an exit strategy. I would like to recommend the “
Wisconsin Foreclosure and Unemployment Relief" program, or WI-FUR, a plan developed by my faculty colleagues Morris A. Davis, Stephen Malpezzi, and François Ortalo-Magné.

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