Tuesday, February 24, 2009

How simple policies could make a real difference

Two good friends of mine, Russell Redenbaugh and James Juliano, have come up with a simple and elegant solution to the housing crisis. The basic problem we have today is falling home prices, which signal that the supply of houses exceeds the demand for them. Since the supply of new housing, as measured by housing starts, is at an all-time low and closing in on zero, there's no need to worry about fixing the supply portion of the housing market. It's demand that needs stimulating.

So he proposes to change the incentives of home buyers. He suggests offering an income tax holiday to buyers of existing homes that is tied to the purchase price of the house. The buyer of a $500,000 existing home would receive a tax holiday for, say, six months on $500,000 of income. This idea combines the power of lower income taxes with targeted relief for the troubled housing sector. Buyers would have a big incentive to buy homes because they would receive a significant boost in their after tax income, and many would likely work harder to take advantage of that. Banks would find immediate relief as housing prices stopped falling and began to increase—no more need to write down toxic mortgage paper. Homeowners on the verge of foreclosure would find relief as prices rose.

This exercise in creative problem solving highlights the necessary characteristics of effective stimulus plans. They must change incentives in order to expand the economy. We can only grow the economy if our collective work input and output increases. The best way to do that is to increase the incentives for working and investing by lowering taxes on income and capital. Unfortunately, to date the Obama administration has completely ignored this type of stimulus in favor of the discredited and illogical notion that taking money from one person and giving it to another can result in higher levels of output.

17 comments:

Barbarous Relic said...

How about letting home prices fall down to their long term trend so that I can afford one some day?

Scott Grannis said...

Relic: You could wait for home prices to fall further, or you could use the income tax holiday to make them fall right now, since your net cost would be the bid price less the income tax savings. A $500K house would only cost about $425K for someone making $250K of income.

Mark A. Sadowski said...

$500,000 of income over six months? In other words the only people who could claim the maximum tax credit would be in the top 0.1% of housedhold incomes or perhaps 100,000 households in a nation of over 300,000,000. Good thinking. That will solve everything.

Scott Grannis said...

Mark: think of this as a concept, not a finished product. The point is, a proposal of this sort would use incentives to hasten the healing of the housing market. Also, I wanted to feature this proposal since it is a good example of how incentive-based policies can make a difference.

Mark A. Sadowski said...

Of course incentive based policy changes could make a huge difference! My point is that why are you restricting the maximum benefit of these policies to such a tiny percentage of the vastly overprivledged uberpopulation?

d said...

It will be difficult for anyone to buy a home if they don't have a job.

The only way to solve the housing problem is is to solve the unemployment problem.

No one is hiring at the moment. Finding a job is near impossible for a lot of people. So buying a home is out of the question.

Remember all the people that bought up all the homes 2-5 years ago are the sample people today that are unemployed and foreclosed.

Where will the new buyers come from, when most of them are out of work? (sorry if this sounds a bit redundant.)

Scott Grannis said...

Mark: point well taken. I'll suggest to Russell that he change his parameters.

Scott Grannis said...

d: it is still the case that only a fraction of the workforce is unemployed. On the margin that restricts the number of potential homebuyers, but that explains only a very small part of the housing problem.

Gene Prescott said...

As I recall, George Gilder thinks using the tax system to influence personal behavior is short sighted.

My notion is with the impetus for 'stimulus' there will be targeted concepts no matter what, so go for the most palatable.

Scott Grannis said...

Gene, you're right. The best system would be a low, flat tax with no deductibles. But that's probably too idealistic. Politicians love to tinker. If they have to tinker, they should try to tinker intelligently.

Bernard said...

Cut payroll taxes 10% for the next 5 years and our problems are solved. People will be instantly wealthier, have a greater ability to service debt, save, and consume, all by using one simple tool.

Why is that so difficult???

Tom Burger said...

The proposal to manipulate housing demand is no solution at all. There is no way anybody can know what prices must be to create a stable, sustainable housing market. Let market prices go where they need to go. That is the ONLY way to make things better without simultaneously setting us up for the next bust.

Our biggest problem in this country is that we have too many economists and politicians believing that they can positively impact society with their favored tweaks -- be it through spending, credit creation, or tax policy adjustments.

STaggart said...

The feds seem to be pretty poor at devising incentives that make a difference.

The stimulus bill includes an expanded first-time home buyer tax credit. Haven't owned a home in three years? Buy one before November 30, 2009 and you'll get a tax credit of the lesser of 10% of the purchase price or $8,000. It is fully refundable, ie you get a check back, and doesn't have to be repaid.

Great incentive to buy a home but it has a significant problem: One must buy a house first.

The problem most first-time buyers have in making a purchase is coming up with the downpayment and closing costs.

It would seem that the credit would be an avenue to plug that gap. HR Block and virtually every car dealer in the country will do your tax return and provide a tax anticipation loan. So, why not use that for a house purchase?

Most first-time buyers use a FHA loan. But, FHA bans borrowing from any private entity -- even if the repayment source is clearly identified (ie. the tax return).

So, we've got the most generous first-time buyer incentive since the GI bill. But, most first-time home buyers are barred from accessing to close their home --- meaning they can't buy.

I just shake my head at this one . .

Scott Grannis said...

Question: can a buyer use seller financing to get his down payment? I haven't heard much about seller financing/second mortgages lately. They were very popular in the late 1970s and early 1980s.

STaggart said...

FHA banned seller financing last year through administrative rule. There was a court decision (arguing that the notice was insufficient) that allowed two entities to continue offering such into the Fall.

But, seller financing for downpayment purposes is now banned completely.

A seller could, of course, finance a buyer's entire purchase. The problem is that the seller must own the home free and clear to do so. Modern mortgages bar assigning it to a 3rd party without lender permission through the "due on sale clause" (ie. if you sell you need to pay off the mortgage). Institutions rarely grant permission. They typically require a buyer to apply for a loan.

The reason for the limitation is that much of the S&L crisis was fueled by sellers assigning their loan to new buyers. So, it is today improper in virtually all circumstances.

Some folks who do seminars (often hawked on late night tv) claim that your just ignore the bank. That is deceptive and dangerous. I've seen seller financing trigger the lender launching a foreclosure action. Not paying your mortgage is not the only grounds for foreclosure.

STaggart said...

I noticed my posting wasn't very clear.

Seller-paid downpayment assistance was banned last year by FHA. When 100% loans disappeared two years ago, that became the avenue for most first-time buyers.

In seller-paid downpayment assistance, the seller would "gift" a sum, usually 3% (because FHA then required a 3% downpayment) plus a fee to a "non-profit" third party. The third party would then "gift" the money to the buyer.

The reason for this scheme was that FHA allows gifts to buyers from immediate family, an employer, labor union or non-profit group.

These organizations set up as go-betweens. The largest was the Nehemiah -- run by a black church in Pennsylvania. They made a small fortune serving as a conduit.

FHA hated this. They thought the whole process was a shame. And, they claimed that default rates were higher --- hence their administrative rule banning seller-paid downpayment assistance.

Scott Grannis said...

Thanks for the explanation. Seems to me like some smart person could figure out a way to solve the need for a down payment.