Cash for Clunkers meets housing bubble

In today’s Washington Post, Simon Johnson and James Kwak parse the notion of extending the home-buyer tax credit as economic stimulus and call it “a bad idea.”  In the first place, home prices do not need any more artificial support from government as they still have not returned to a normal valuation after the burst of the housing bubble.  Even if they had, it would mainly subsidize purchases that would have been made anyway, accelerating them somewhat by stealing them from the near future.

Sound familiar?  It’s like a marriage between the CR-fired housing bubble and Cash for Clunkers:

The main argument for the tax credit is that it stimulates the economy and stabilizes the housing market. Seen purely as a stimulus, the tax credit is highly inefficient. The National Association of Realtors claims that the credit created 350,000 new sales; the Calculated Risk blog calculates that this means the government is paying $43,000 for every extra house sold (since most sales would have happened anyway). According to the Wall Street Journal, Goldman Sachs estimates 200,000 new sales, implying a cost of $80,000 per marginal sale.

Even at a price of $43,000, what are we getting? Given that these are first-time home buyers, and given the glut of homes on the market, most of these are financial transactions where a house changes hands in exchange for cash (and additional transaction costs). The $43,000 is not being invested; it isn’t buying anything for the public, like a new road. It’s just cash going into people’s pockets. …

As of July, the real price of housing, according to the Case-Shiller Composite 10 Index (adjusted using the consumer price index), was still 20 percent higher than in January 2000 and more than 30 percent higher than its average for the entire 1990s. Now, there is a risk that a weak economy can cause housing prices to fall well below their long-run average. However, housing prices appear to have stabilized, at least for now, and at too high a level. That is in part due to the tax credit, in part due to the partial economic recovery we are witnessing.

What happens when you artificially prop up housing prices? Imagine the credit were expanded to all home buyers and made permanent. This would simply boost housing prices at the low end of the market by close to $8,000, since all buyers would be willing to pay $8,000 more. (Prices would rise by a little less than $8,000 because at higher prices, more people would be willing to sell.) Whom does this benefit? Not first-time home buyers. It benefits people who already own houses (and their real estate agents) because it’s a one-time boost in housing values. This would be just the latest chapter in a long history of government policies to boost housing prices — the mortgage interest tax deduction, the capital gains exclusion on houses, the extension of the mortgage interest tax deduction to second houses, etc. Each of these policies pushes up prices just once; if you want to keep pushing up housing prices, you have to keep adding sweeteners.

And as we have seen, pushing up prices creates irrational valuations, which create speculation and inordinate risktaking. That’s exactly what led to the housing bubble and its collapse.  This is a milder version of a hair-of-the-dog approach.

What this essay touches on briefly in a slightly different context is the cost to taxpayers for these interventions.  What do we get for subsidizing these price supports, which is exactly what they are?  Not too much, actually.  We supposedly get the benefit of expanding home ownership, but only by pushing prices upward, which will make purchase for people on the edge more difficult, one-time tax credit notwithstanding.  Those are the people who won’t be able to afford the home after the tax credit, which could lead to more instability in mortgages, precisely what we don’t need at the moment.

As with Cash for Clunkers, this program does nothing to make home ownership more affordable in the long run.  The tax credit only encourages people to buy sooner rather than later while temporarily inflating prices due to the increased demand.  When the people stop buying houses, that bubble will pop again, and the resales for the subsequent year will suffer from having accelerated the purchases that normally would have taken place then.  It’s a transparent bid for a very temporary boost in economic indicators rather than a plan for solid, dependable, long-term economic stability.

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David Strom 8:41 PM on January 30, 2023