Monday, June 28, 2010

Tax Credit Pumps Up Latest Home-Buying Bubble

by Ryan McMaken
Cross posted at Mises Economics Blog

Existing home sales did not do as well as expected in May, while new home sales fared even worse.

Last week's new home sales data released by HUD and the Census Bureau revealed yet again the underlying weakness in the housing markets in the United States. New home sales, not to be confused with existing home sales, fell 32.7 percent from April to May. The negative month-over-month change was expected by many in the real estate industry, although most major media outlets called the drop "surprising." The drop surprised no one who was watching to see the response to the expiration of the home buyer tax credit in April.

So, while the April to May drop was expected, the year-over-year drop signaled a significant lack of demand for new housing. From May 2009 to May 2010, new home sales dropped 18.3 percent. This is especially noteworthy since May 2009 was near the bottom of the market following the financial panic of late 2008.

One would be tempted to think that there was no where to go but up when comparing real estate trends to the first half of 2009, but the 18 percent drop put an end to that hope.

Existing home sales fared better. According to data released last week by the National Association of Realtors, existing home sales were up 2.2 percent from April to May and increased 19.2 percent from May 2009 to May 2010. The year-over-year increase from the doldrums of May 2009 was correctly anticipated.

Now, the lackluster performance of home sales in the absence of the homebuyer tax credit has spurred talk of extending the tax credit yet again. Staff at Moody's admits that the proponents of the tax credit had miscalculated how the tax credit would stimulate home buying.

Some supporters had "expected the tax credit to pique buyer interest in a manner that would carry over for months following the credit's expiration." How exactly this was supposed to happen remains a mystery. Real estate agents who work daily with buyers knew that the tax credit was merely cannibalizing buyers from later in the year. In other words, people who were planning to buy in, say, August, moved up their plans to take advantage of the tax credit. There has been very little evidence that the tax credit created any significant number of buyers who hadn't otherwise been considering a home purchase.

Now, with many of the summer's buyers electing to purchase before the end of April instead, the summer is looking to be particularly grim for home purchasing.

The latest real estate bubble isn't much of an argument in favor of a tax credit with the sole purpose of increasing spending on residential real estate. All things being equal, tax credits are good because they mean more control can be exercised by the taxpayer over his or her wealth. However, a tax credit that exists only to convince people to spend more money faster is problematic.

The answer is not to end tax credits, but to make them far more broad. Why do renters not deserve tax credits? And why must one buy a house to get a tax credit? If the Keynesians in government want to really increase spending, shouldn't they just give everyone an $8,000 tax credit? Or they could cut tax rates.

Policymakers won't do this, however, because they fear that people would use such an open-ended tax credit or reduction to save money or pay off debt, which is totally unacceptable for the Paul Krugmans of the world.

Politics explains a lot in this case also since renters simply don't enjoy a powerful lobby as do the real estate agents, mortgage brokers and home builders. Thus, tax "breaks" are written to subsidize a single industry rather than provide relief for the taxpaying population overall.

Even if the tax credit were extended again, it would not produce any income growth or job growth any more than did the last extension of the credit. Without job creation and income growth, there will not be any sustainable increases in demand for home buying. Despite many claims to the contrary, demand for real estate will improve when the economy produces jobs and income growth, and not the other way around.

The need for actual job growth will especially be seen among younger home buyers, or lack thereof. One of the ways that the home buying bubble was sustained during the last decade was to make home purchasing available to younger and younger segments of the population. Job creation during the bubble allowed for wildly optimistic estimates of future job prospects and earning power for twenty-something who then looked to homebuying as the next logical step. Combined with incredibly low requirements for down payments and credit histories, 25-year-olds were buying up houses.

Today, with unemployment among twenty-somethings at 25 percent, and with income growth near zero, there is nowhere from where to draw new households looking to buy houses. The tax credit can be extended, but like so many of the "stimulus" efforts that have been used in the last two years, this one may have run out of steam.