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The S&P Case-Shiller home price data for the first quarter of 2011 are so dreadful that nearly everyone agrees that the U.S. housing market is in the midst of a “double dip.” Curiously absent from many of these analyses is the role played by the federal government in helping to engineer a double-dip with its ill-devised homebuyer tax credit. Originally aimed only at first-time homebuyers and set to expire at the end of November 2009, the tax credit was later extended through the end of June 2010 and expanded to all homebuyers below certain income levels. The extension and expansion was attributed to the early “success” of the program, evidence for which consisted of nothing more than households’ willingness to accept free money from the government.
As explained here, the homebuyer tax credit never made any sense in the first place. For every homebuyer motivated to make a purchase by the credit, there are several more that would have made the purchase anyway. For this second category of homebuyers, the tax credit is pure windfall. For the first category, the true marginal sales made possible by the credit are likely to be far fewer than those who likely would have purchased a home in the near future but decided to expedite the purchase process to capitalize on the credit. So even among the population who wouldn’t have otherwise purchased a home during the tax credit’s eligibility period, a large portion probably would have ended up buying later in 2010 or today.
Given this background, the basic arithmetic made clear that under the most optimistic estimate the program would give away $1.33 for every $1 that was used to stimulate a sale. Under the more probable estimate that accounts for accelerated sales, it was probably closer to $7.50 of pure windfall for every $1 of stimulus. According to IRS data, the total cost of the credit was nearly $24 billion. This means that in a time of record deficits the government essentially decided to handout between $13 billion and $21 billion.
But wait: it gets worse. The recent Case-Shiller data make clear that the tax credit not only wasted tens of billions of dollars, it actually aggravated the problem. As predicted here last June, by inducing prospective buyers to move purchases forward to take advantage of the credit, the tax credit spared sellers from having to lower prices to generate sales. Eventually, those first-time buyers who were intending to buy had done so, which necessitated expanding the credit’s reach to cover all homebuyers to maintain buying activity. At that point, so many sales have already been transferred forward in time that maintaining current price and sales activity levels would have required making available an even more generous tax credit to an even greater universe of taxpayers. Congress decided against further extensions and expansions, resulting in the inevitable downturn in prices and transactions we are currently witnessing.
The bitter irony of the downturn is that those homebuyers who accelerated transactions to take advantage of the credit probably lost money by doing so. Average home prices have fallen by 4.34% since June 2010 when the credit expired. There is a lot of variation across metro area, but this means that a home that sold for $250,000 last June, is, on average, worth only $239,150 now. This price fall happens to be very consequential because, as shown in the table below, it means that in many cases the fall in the value of the house now exceeds the value of the tax credit which was worth up to $8,000 for first-time buyers and $6,500 for other eligible taxpayers.
Leaving aside time value of money issues – which would make the decision to buy in June 2010 look even worse – the typical household that accelerated their purchase to take advantage of the tax credit lost nearly $3,000 as a result. The benefit accrued entirely to sellers, who were able to offload their properties at artificially inflated prices.
Homebuyer Tax Credit Harms Rather Than Helps
| 6/1/2010 | 4/1/2011 | |
| House Price | $250,000 | $239,150 |
| Tax Credit | ($8,000) | - |
| Final Cost | $242,000 | $239,150 |
| Savings | $2,850 |
Today’s sellers are robbed of the bids from homebuyers who bought in 2009 and 2010 to take advantage of the credit. To generate sales, they have to lower prices to compete with foreclosed and other distressed properties – many of which are landing on the market today because of failed mortgage modification plans. Therefore, supply is increasing at the same time demand remains artificially low due to the time shifting induced by the credit. Rather than serving as a catalyst, the credit offered false hope that the market had bottomed and simply put off further adjustment for a later date.
According to the Case-Shiller Index, house prices today are lower than they were in January 2002, on average, in the Phoenix, Atlanta, Chicago, Detroit, Minneapolis, Las Vegas, and Cleveland metro regions. In the Miami, Las Vegas, and Phoenix markets the peak-to-trough house price declines exceed 50%. These are averages, which means many properties in these markets have likely lost in excess of 75% of their value; some condos that sold for $400,000 in 2006 might not fetch $150,000 today. In some markets these prices are below replacement cost, which has led distressed investors to come to the market. Of course, this activity makes one wonder how much better shape the housing market would be in today if distressed investors were not effectively barred from the market through artificial price supports two years ago.
The failure of the homebuyer tax credit is so frustrating because it was so predictable. No one in retrospect would spend $24 billion to make the housing market worse today than it otherwise would have been. But this is not a case of hindsight bias. Going in, policymakers should have recognized that whatever the cost of the program, the great bulk of the spending would be captured by households that would have bought anyway or simply accelerated their purchase. On balance, this was always likely to result in substantial losses and weak housing demand in the months following the expiration of the tax credit.
