Tag: homebuyer tax credit

Government’s Unwelcome Economic Distortions

A couple of weeks ago, David Boaz discussed the Old Testament story in which the people of Israel ask Samuel for a king to rule over them. God’s instructions to Samuel can be summed up as “tell them to be careful of what you wish for.” David brought up the passage in the context of civil liberties, but the story’s lesson also applies to economic liberties.

Over the past eighty years, the public has become conditioned in times of crisis to turn to their rulers and demand that they “do something.” That the rulers had a hand in the crisis is all too often either unrecognized or it’s a secondary concern. As Robert Higgs demonstrated in his seminal book, Crisis and Leviathan, the rulers will willingly oblige the public and, in the process, come away with more power and control than they had prior to the crisis. Unfortunately, the rulers’ enhanced authority begets more crises in the future.

The latest chapter in this story is the economic downturn. Many of the “seeds” for the recession were planted by government. Regardless, the average citizen reflexively looked toward Washington to quickly fix the economy. The public’s limited patience meshes well with policymakers who are naturally inclined to operate on a short-term horizon (i.e., the next election). Therefore, policymakers responded with quick-fix measures with almost no regard to the long-term consequences.

The long-term economic problems caused by massive deficit spending and mounting debt are the most obvious. But as two stories in the news show, short-term measures implemented by policymakers to “fix” the economy have also introduced unwelcome economic distortions.

First, following the expiration of the federal homebuyer tax credit, home sales have fallen off the cliff. The Christian Science Monitor asks: was the homebuyer tax credit the “scam of the century?” The program was riddled with fraud, some folks who were induced to purchase a house are already underwater or are headed in that direction, and the billions of dollars spent on the program did zilch for the long-term health of the housing market.

When one looks at ultimate beneficiaries of the tax credit, it’s easy to see why the CSM calls it a “scam:”

[I]n trying to fully understand why the government undertook such a useless and poorly calculated program, it’s important to recognize those who truly walk away from this policy in better standing.

Realtors, home builders and mortgage bankers… some of the most notable culprits of the housing bubble years… all walk away cleanly skimming the proceeds coming from the transactions of an estimated 2 million temporarily stimulated home purchases.

It should come as no surprise that these were the very same industry groups that worked tirelessly lobbying to enact this failed policy… it was a simple exchange… your tax dollars to their wallets.

Second, we go from “scam of the century” to the “the dumbest program ever.” The latter refers to the “Cash for Clunkers” program, which Chris Edwards submitted for nomination in August 2009. Chris cited numerous problems with the program, including that “Low-income families, who tend to buy used cars, were harmed because the clunkers program will push up used car prices.”

A senior editor at Edmunds.com tells a reporter from WIOD news radio in Miami that used-car prices are way up (h/t Radley Balko):

If buying a used car is among your cost-cutting measures… be prepared to pay up to 30-percent more than you did last year.

It is a simple case of supply and demand.

Trouble is … there are fewer used cars.

The cash-for-clunkers program took a bunch off the market.

Plus, Edmunds Senior Editor Bill Visnick says 5-million fewer new cars were sold last year…which pares down the used car supply even more.

As Radley sarcastically notes, you can’t blame those supposedly selfish limited government types for this one:

[W]e have a government program whose stated aim was to shore up huge, failed corporations by giving public money to mostly upper-income people that in the end will penalize low and middle-income people. But remember folks, it’s the libertarians—who opposed C4C—who are greedy corporatists who hate the poor.

There could be a silver lining in the cloud if more Americans start to realize that asking policymakers to quickly fix problems that government policies helped foster isn’t much different than asking the arsonist to put out the fire.

Reassessing FHA Risk

As the Federal Housing Administration edges closer to a taxpayer bailout due to the large number of risky mortgage loans it has insured, it continues to insist that no such bailout will be required. However, a new study from a group of economists at New York University finds that the FHA’s assurances might not be based in reality.

According to the study, the actuarial analysis FHA used to determine it won’t need a bailout seriously understates its exposure to risk:

  • More FHA mortgages are underwater than the FHA’s analysis identifies, and unemployment is naturally particularly high in areas where FHA borrowers are furthest underwater. Therefore, potential default costs are underestimated.
  • FHA’s analysis relies on house values that are inaccurate. Overvalued houses means the FHA could end up recouping less than expected on defaults.
  • Underwater FHA mortgages that were “streamlined” into new FHA mortgages are not properly accounted for, which further underestimates risk.
  • The FHA got clobbered on a previous no-downpayment assistance program. However, the current homebuyer tax credit can effectively eliminate downpayments on FHA loans, but its analysis doesn’t take this into consideration.

One of the study’s authors, Prof. Andrew Caplin, writes the following on his website:

Rather than looking to structure the markets of the future, they [policymakers] have stumbled along in business as usual mode, waiting for kind fate to save them. It may. Then again, it may not. Either way, this is not a good way to run a business, or a government for that matter.

How does he see this story playing out?

My best guess is that it will end with a crash in the housing finance sector, with the federal government forced by popular revulsion at mushrooming losses to remove itself almost entirely from the housing finance equation. The Resolution Trust Corporation will look like an amateur warm-up act…

The bottom line is simple. The continuation of “business as usual” is re-creating the essential problem that made the sub-prime crisis so disastrous. Once again, taxpayers have been forced to subsidize the private purchase of massive amounts of residential housing, and to offer guarantees against future losses, without any effort to reduce costs should their funding help turn some markets around. Warren Buffett made huge profits for his shareholders by investing in under-valued assets. By contrast, our leaders are making massive losses for taxpayers by investing in over-valued assets.

See this essay for more on the problems with housing finance and government intervention.

Housing Market on Government Crutches

My house has been on the market for a month and it has drawn a lot more looks than I expected. I’ve been quizzing realtors as they come through, and each one tells me the same story: the government is single-handedly propping up the demand for housing. In addition to the homebuyer tax credit and government-induced low mortgage interest rates, most sales are being done with Federal Housing Administration backing.

As a seller, I’m looking to get out before the tax credit expires and interest rates starting ticking upward. But when I do sell, I certainly won’t be looking to buy a house, particularly since I’ll be selling at a loss. If my situation is representative of other current sellers, the housing market could be in for another tumble if the government crutches are removed. However, if the government instead continues trying to prop up the housing market, the risk that taxpayers will take another bath goes up. It’s a nasty Catch-22 that demonstrates the problems with the government distorting the housing market to begin with.

A recent New York Times article looked at the housing market in the “beleaguered” manufacturing city of Elkhart, Indiana, which has twice served as a prop for President Obama. The Times says Elkhart “symbolizes the failure of federal efforts to turn around the housing slump at the heart of the economic crisis” and that “[h]ousing in this community has become almost entirely dependent on a string of federal support programs.”

The situation in Elkhart described by the Times matches perfectly with what realtors are telling me:

To the extent that the real estate market is functioning at all, people here say, it is doing so only because of the emergency programs, which have pushed down interest rates on mortgages and offered buyers a substantial tax credit. Equally important is an expanded mortgage insurance program run by the Federal Housing Administration, which encourages private lenders to accept borrowers with small down payments. The government takes the risk of default.

The one problem with the Times piece is that it doesn’t completely connect the dots. Namely, the problem the government is trying to solve is a problem that its housing policies instigated: the housing boom and bust. For instance, the article cites a good example of government policies mimicking the irresponsible lending that helped create this mess in the first place:

The programs favor first-time buyers, who have the fewest resources to bring to a deal. Heather Stevens, a 23-year-old nurse here, is closing on a three-bedroom house this week. Since her loan was insured by the Federal Housing Administration, she had to put down only 3.5 percent of the $74,900 purchase price.

“It was a breeze to get approved,” she said.

The sellers are covering her closing costs, which agents say is often the case here. That meant Ms. Stevens had to come up with only the $2,600 down payment, which still took all her savings.

But the best part is the $7,500 tax credit. She will use that to remodel the kitchen. “If it wasn’t for the credit, we would have waited to buy,” said Ms. Stevens, who is getting married this year.

Buying houses with no money down was a feature of the latter stages of the housing bubble. It gave prices a final push into the stratosphere. But buyers with no equity were the first to abandon their properties as the market turned south.

But there’s no mention of the role Fannie and Freddie, HUD, or the FHA played in fostering that bubble.

The article continues:

With housing prices stagnant, bolstering the market by again letting people buy with hardly any money down is viewed in some quarters as a bad bet.

Neil Barofsky, the special inspector general for the government’s Troubled Asset Relief Program, wrote in his most recent report to Congress that “the federal government’s concerted efforts to support” housing prices “risk reinflating” the bubble.

He noted one difference from the last bubble: taxpayers, rather than banks, are now directly at risk in these new mortgages.

I would argue that the mere existence of TARP is proof that taxpayers were directly at risk to begin with. The risk may be more explicit now, but that’s only because the bubble’s bursting washed away a lot of the private sector’s bad actors. But the ultimate bad actor, Uncle Sam, who encouraged the private sector’s risky lending activities, has stepped in to fill the void. Just how badly this turns out for taxpayers remains to be seen.

Homebuyer Tax Credit Complications

Most people would agree with Chris Edwards that the federal tax code is insanely complicated. The IRS Commissioner doesn’t do his own taxes, the Treasury secretary and other Washington policy experts haven’t paid what is owed, and the already overwhelmed IRS would be given an expanded role under the Democrat’s health care legislation.

A key problem is that the social engineers on Capitol Hill have run amok. Recently, they have been enamored with home-buying tax credits, and CNN.com notes how it is further overwhelming the IRS bureaucracy:

On Thursday, CNNMoney revealed that buyers who purchased their properties after Nov. 6 were unable to claim the refund because the Internal Revenue Service had yet to release a new form and instructions. But on Friday, the IRS finally posted the new form 5405.

Claiming the credit now requires sending paperwork to the IRS – no e-filing allowed:

And these new buyers can no longer file electronically. They have to mail in paper forms, including the new 5405, whether they are amending their 2008 taxes or claiming it on the 2009 taxes that are being filed this spring. That is going to dramatically slow refunds, but taxpayers can’t blame the IRS. Instead, it’s people scamming the system who are at fault. For example, in October tax preparer James Otto Price III was the first person convicted of this crime. He falsely claimed the credit for 15 clients. So buyers must now file documentation with their taxes – including proof of residency, a signed mortgage statement and drivers license – which the e-file system is not equipped to handle.

The original homebuyer tax credit, which became available in April 2008, generated a nightmare of fraud. In one case, the credit was claimed by a four-year-old. Even IRS employees filed “illegal or inappropriate” claims for the credit. As a result, when Congress extended and expanded the credit in November, the IRS began requiring extra documentation.

Thus, micromanagement through the tax code is a bureaucratic Catch-22. If the IRS streamlines the paperwork, tax breaks get riddled with fraud and abuse. If it tries to cut down on the fraud and abuse, taxpayers and federal workers get bogged down in a pile of wasteful paperwork.

The solution to the problem is for the government to get out of the social engineering business. Federal attempts to foster homeownership are a perfect example of why such attempted engineering can ultimately cause more harm than good. The homebuyer tax credit should be allowed to expire at the end of April, and the federal tax subsidies for homeownership should be ended.

A Double Dip for Housing?

Washington is fretting this week over news that mortgage applications fell dramatically in November. Coupled with earlier indications of renewed softening in the housing market, there is growing fear that housing is headed for a “double-dip downturn” that could further damage the economy. As a result, Federal Reserve policymakers are considering additional stimulus, while the National Association of Realtors is suggesting an(other) extension of the “temporary” homebuyer tax credit.

Remarkably, neither policymakers nor the media are asking the obvious question: Given all of the emergency interventions in housing that government has undertaken, and the fact that the housing market continues to erode, do such interventions do much good?

Since the bursting of the bubble in 2006, the great unknown has been whether housing prices will revert to their historical trend (and possibly to below trend for a short period), or stabilize at some permanently higher level because a portion of the bubble (aided perhaps by public policy) would prove enduring. There is good reason to expect reversion to trend, but the economy can surprise us.

Let’s use an example to understand this better. The graph below depicts the course of house prices for my hometown of Hagerstown, MD, an area within commuting range of suburban DC that was hit particularly hard by the bubble and its deflation. The black line is a house price index computed by the Federal Housing Finance Agency for 1989–2009. The red line is an extended linear trendline drawn using index data from the period 1989–2002. (You can do the same analysis for your area using these FHFA data.) The question, then, is whether house prices will fall all the way back to the trendline or will stabilize at a level above the trendline. 

Figure

The sharp downward slope at the end of the price line and  the latest housing news suggest that Hagerstown is destined to revert to trend (perhaps after a period below trend). I’ve drawn similar figures for several other locations and they show similar patterns. It looks like the nation’s housing markets, for the most part, are reverting to trend.

When this crisis first began in 2007, Bush administration officials vowed to “stabilize house prices at the highest possible level.” However, despite their efforts and those of the Obama administration, Congress, and the Fed,  reversion to trend appears inevitable. At best, those efforts may have slowed the reversion — in which case, I suppose the Bush goal has been met.

It can be argued that a gentler reversion to trend may be more tolerable than a sharp return. On the other hand, there are fears that a lengthy softening of the housing market will lead to more defaults, less worker mobility, continued weak consumption, and a long period of high unemployment and stagnant wages for those who are working. Perhaps a sharp return would be the quickest way to shed the ill effects of the bubble.

This leaves us with a final question that policymakers, the media, and the public should be grappling with: If all of these emergency housing interventions only result in a slower reversion to trend, then is that benefit worth the cost?

Government of Continual Failure

The Washington Post is full of so many stories about government failure these days, it’s hard to keep up.

Today, on page A19 we learn about a Small Business Administration subsidy program that has a 60-percent default rate. On the same page, we learn that the U.S. Postal Service will lose $7 billion this year.

Flipping over to page A20, we learn that former New York City Police Commissioner Bernard Kerik is a liar, a tax cheat, and thoroughly corrupt.

Then flip back to A15, and columnist Steve Pearlstein rightly lambastes the latest stimulus scheme from Congress: ”This $10 billion boondoggle is nothing more than a giveaway to the real estate industrial complex.”

Finally, on A14, we’ve got government-owned Fannie Mae losing a colossal $19 billion this year and asking the Treasury for another $15 billion taxpayer hand-out.

The federal government is a mess. Policymakers have no idea what the effects will be when they spend billions on scheme after scheme. Most of them don’t read the legislation, they don’t understand economics, and they never admit mistakes when their schemes almost inevitably fail. Fully 40 percent of the vast federal budget will be debt-fueled this year, but few policymakers seem to care. And public corruption seems never-ending. 

Isn’t it time to give libertarianism a chance?