 Gearing up for the fight
It hasn’t been a pretty sight in the first month without the tax credit.
Pending sales for existing homes fell 30 percent in May. New home sales (which measures contracts and not closings) fell by 33 percent to its lowest level in nearly 50 years. Single-family housing starts also took a dip in May, falling 17 percent. The big declines should have been expected because consumers are rational when making purchase decisions and they respond to incentives. Why sign a contract in May when doing so in April resulted in an $8,000 check? Going forward, contract signings for June and July could also remain similarly weak.
However, even with these short-term setbacks the overall tax credit stimulus can only be called a success in terms having stabilized home prices. Stable home values lessen foreclosure pressure, improve bank balance sheets, and most importantly, help steadily revive consumer confidence about a home purchase. Currently there are signs of home price stabilization in nearly every market. Prices are, surprisingly, rising at a double-digit pace in San Francisco and San Diego. Be mindful, however, that low sales activity over the short-term will cause housing inventory to rise, and the months’ supply of homes available for sale could reach 10 months or higher. Provided such elevated inventory will only be for the short-term and not prolonged, then home prices will not undergo heavy pressure to fall. Experience shows, unlike sales, prices are far less immune to big month-to-month fluctuations.
The key test of a sustainable long-term recovery, without the stimulus medicine, will only start to show in the next several months. For this to happen, we need job growth. Not the artificial temporary Census jobs, but true private sector jobs. The net private sector jobs, expanded so far this year to June, were at 593,000. This is relatively small potatoes after the eight million job cuts in the past two years, but it is nonetheless a start of an expansion. And the latest report from the Bureau of Labor Statistics shows that in June the economy lost jobs for the first time this year. Those temporary Census job additions are over, and state and local governments also cut payrolls. Businesses did add 83,000 payrolls, and – surprisingly – the unemployment rate declined. Expect one million job additions for the balance of the year and another 1.5 to 2.2 million in 2011.
Mortgage rates also need to remain favorable. Because of the uncertainty regarding the strength of overall economic expansion and of uncertainty regarding the future of the Euro, many investors have put money into the safe U.S. Treasury bond market. That has pushed down the 10-year Treasury yield to three percent as of this writing. The 30-year fixed rate mortgage then can be at around 4.8 percent. That is super favorable for consumers.
Barriers must be removed for recovery
While jobs expand and rates remain low (fingers crossed), we need to assure that any unnecessary barrier to market recovery be taken down. One of these barriers was the lack of flood insurance. Because the private market has difficulty in providing national flood insurance, the federal government has been involved in the program. This is not a new or stimulative federal program, but simply an old program that has been in existence for many decades. Nearly seven percent of all owner-occupied homes require flood insurance in the country. The figures are as high as one-third of all homes in Louisiana and Florida (which as we know are also now being negatively impacted from the oil spills). Without flood insurance, a homebuyer cannot obtain a mortgage. Fortunately, lawmakers listened and understood the damaging impact and a bill to reauthorize flood insurance passed with a strong majority.
Another barrier to recovery could have been the psychologically demoralizing impact of not getting the tax credit among those homebuyers who signed their contracts in April and earlier. They responded to government stimulus, yet they were unable to receive the benefit – through no fault of their own. Many homes require a “short sale” approval from a bank. However, this process is far from being short; it often takes several months and is can be very messy. As a result, many home purchases were not able to close by the June 30 deadline. Fortunately, Congress passed legislation on the very last day – June 30 – to extend the closing deadline to Sept. 30. It is estimated that up to 180,000 homes that were under contract could have fallen out had the extension not occurred.
The flood insurance and tax credit deadlines were short-term barriers and they were removed. But another much higher barrier to recovery which could arise is the elimination of or a reduction in the mortgage interest deduction (MID). There has been increased chatter among opinion makers about the need to eliminate or trim this deduction, particularly in light of a very high U.S. budget deficit. In addition, after witnessing an unprecedented rise in foreclosures, some commentators are attacking the essence and societal value of homeownership, implying that housing should not get favored tax treatment.
As we have painfully learned from the recent housing market debacle, people who are not yet financially qualified should not become home owners, period. However, to blame the housing market collapse in any way or in any part on the mortgage interest deduction is equivalent to suggesting we need to completely scrap the free market system because of the banking crisis. Remember, mortgage interest deductions have been in place for many decades without bringing volatile swings to the housing market. Perhaps we should turn our attention to what was new in the recent unprecedented housing cycle; namely, the very lax mortgage underwriting standards and faulty work of credit rating agencies.
If we were to rewrite the tax code beginning with a blank slate, perhaps, a full discussion on the benefits and costs of having MID should take place. But the country is not starting from scratch and we have to contend with history. The mortgage interest deduction has been part of the U.S. tax code since the inception of the income tax nearly a century ago, when the U.S. income tax code came into existence. Under 17 U.S. presidents and their administrations, hundreds of millions Americans have purchased their homes with the understanding of this important tax break. As a result, many hard-working, tax-paying citizens have been able to realize one of the sacred tenets of the American Dream – of owning a piece of America. Homeowners, aside from paying about 80 to 90 percent of all federal income tax, have been an important stabilizing force in the country as they are rooted in the community and the country. Homeowners are already taking on a massive burden of taxation, and to say they need to be taxed more is simply unjustified.
In my view, to eliminate or change the mortgage interest deduction – a long-running, settled portion of the U.S. tax code – would be to change the rules in the middle of a game. It would result in a massive, unexpected redistribution of wealth in the country. While in any particular year only about one-third of taxpayers itemize, most homeowners have resorted to claiming the mortgage interest deduction at some point in their homeownership life. In the most recently available data from IRS tax returns, 63 percent of the families who claim the mortgage interest deduction earn between $50,000 and $200,000 per year. That is only small part of the story, however. Because of the capitalization impact of the expected stream of future mortgage interest deductions, a removal of the mortgage interest deduction would lead to home values falling by 15 percent, equating to a destruction of housing wealth equivalent to $2.5 trillion. That wealth destruction would be felt by all homeowners, including those who purchased homes with cash and those who have fully paid off their mortgages. Even in today’s economy – that is a lot of dough. Because the mortgage interest deduction has been around for generations and generations, any changes may lead people to doubt about what is settled and what is not. Does a change mean future capricious changes to other “well understood” contracts? For example, will future opinion makers start mentioning the need to tax ROTH IRA earnings in retirement for those who are able to pay (i.e., the rich) to help reduce future budget deficits? Even though the ROTH IRA was created with expressed purpose of providing tax-free earnings (since this retirement contribution is made with after-tax dollars)?
A final and very important aspect to consider in the debate about the mortgage interest deduction is positive societal externalities. Academic studies have demonstrated the positive social benefits of ownership, including lower juvenile delinquency rates, lower teen pregnancy rates, and higher student achievement levels among children of homeowners versus those of non-owners who were of similar socioeconomic background. Yes, homeownership is not for everyone. However, for those who are financially qualified, have demonstrated financial responsibility, and are willing to purchase a home that is well within their budget, tilting the field in favor of ownership through the mortgage interest deduction – as America has done for the past century – can induce immeasurable societal benefits beyond the counting of the dollars. The fight over this well-established tax benefit is coming. Be ready.
Article taken from Real Estate Insights, July 2010. Find it at http://www.realtor.org/research/reinsights/economistcommentary.
Copyright National Association of REALTORS®. Reprinted with permission.
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