The National Association of Realtors reported today that existing-home sales declined 2.7 percent in August to a seasonally adjusted annual rate of 5.10 million units – below the consensus estimate of 5.35 million. While the pace of sales slowed, the inventory of existing homes decreased by more (10.8 percent), resulting in an 8.5 month supply of homes, down from a 9.3 month supply in July.
The summer months saw a reduction in inventory for new and existing homes, and a slight increase in housing prices, both of which are consistent with the Federal Reserve’s statement yesterday that “activity in the housing sector has increased.” But it is still a soft market. While the price-to-rent ratio is back to historical norms, the inventory is still high, albeit much lower than the peak last year.
But there are some serious downside risks to the housing market.
First, the Federal Reserve yesterday said it will phase out (by the end of the first quarter of 2010) its program of purchasing agency mortgage backed securities (MBS). So far, the Fed has purchased about $400 billion of agency MBS and intends to purchase a total of $1.25 trillion by the end of the phase out. Government’s historical involvement in the mortgage finance market has been seriously problematic, leading to the virtual nationalization of the market through Treasury and Fed actions over the past year. But right now, the Fed is the only supplier of funds to the MBS market. Once it leaves the market, mortgage interests will likely rise, leading to a dampening of activity in the housing sector.
Second, foreclosures will remain extremely high this year, stemming from the high unemployment rate and the recasting of option-ARM loans. Also unclear is how many bank-owned properties will show up in housing inventory. All of these factors will increase inventories, slowing the housing market correction.
A soft housing market will further calls for extending and expanding the first-time homebuyer tax credit. This refundable tax credit, which was part of the February stimulus bill, gives $8,000 to first-time homebuyers (but is phased out at higher incomes). It is scheduled to expire on December 1, 2009, although the sponsor of the initial proposal, Senator Johnny Isakson, now wants to extend the credit for another year, and expand it to $15,000. This extension would be a mistake.
The tax credit is very poorly targeted. Approximately 1.9 million buyers are expected to receive the credit, but more than 85 percent of these would have bought a home without the credit. This suggests a price tax of about $15 billion – which is twice what Congress intended – for approximately 350,000 additional home sales. At $43,000 per new home sale, this is a very expensive subsidy.
It’s even worse in that most of the new home sales just result in moving renters to owners, which does not absorb the excess supply of houses. The core of our weak housing market is that the housing bubble led to too many homes being built, and the recession has led to a decline in household formation. By moving renters into owners, the tax credit does not address either of these causes.
An extension and expansion of the tax credit will cost far more than the $15 billion of the current credit, likely in excess of an additional $30 billion. And the cost per new house sale will likely be much higher going forward, as a greater proportion of the sales will be for those who would have bought anyway, without the credit.
Finally, there are two larger points we should not lose sight of. First, tax expenditures are not a free lunch. The billions of dollars spent on the tax credit will ultimately have to be paid back through higher, economically distorting, taxes. And while a tax credit is unlikely to be the straw that breaks the camel’s back, our growing debt burden is something to fear. Second, government policies to promote homeownership (or, more accurately, home-borrowership) were partial contributors to our housing and credit market problems. Ultimately, we need to decrease the government’s housing incentives, including the mortgage finance subsidies, the mortgage interest deduction, and the favorable capital gains treatment for housing. A good place to start this weaning would be by not extending or expanding the home-buyer tax credit.