Artificial Stimulus Causes Market Failures
HOT responds to WSJ article, "Mortgage Reform Can't Ignore Sacred Cows," which discussed the large tax subsidies for housing.

HOT responds to Wall Street Journal article.

We already have an oversupply of housing and a shadow inventory not yet counted and yet we still subsidize homeownership and homebuilding? Why? Artificial stimulus, such as those shown below, causes market failures in a free market society when they favor special interests over competitors and public interests. Who are the real beneficiaries? If buyer stimulus artificially inflates home values, how does the consumer benefit? Aren’t these programs really to benefit big builders, realtors and lenders? How much money did the bill’s sponsors get from them?

1. Tax Credits (free money) for first time home buyers and extensions to repeat buyers. See why "Housing Stimulus and FHA Loan Guarantees put Taxpayers at Risk."

2. Artificially Low Interest Rates and Adjustable Rate Mortgages.

3. Federal Mortgage Insurance. Banks no longer demand 20% down when loans are federally insured. FHA, VA, Freddie Mac and Fannie Mae now guarantee some 80% of all mortgages and have insured 96.5% of new mortgages so far this year, putting even more risk burden on taxpayers.

4. Low Down Payments. The USDA and several states have zero-down home loan programs and down payment assistance programs. Haven’t we learned that zero-down loans put borrowers at risk and taxpayers on the hook, because buyers with little or no skin in the game are more likely to default? These were sold as ways to extend the American Dream and put more renters into homes, but it was really to line the pockets of homebuilders. In a form of money laundering, builders would give money to non-profit corporations such as Nehemiah Corporation in California, who then gifted the funds to the buyer for a small fee paid by the builder.

5. Net Operating Loss Carryback. The extension of this tax provision allowed big builders to re-file their tax forms and get over $2.6 billion in rebates from taxpayers, a windfall they've been using to buy up land at discounted prices and to disadvantage smaller builders.

6. Residential Construction Guarantee Loan Program. This gives smaller builders their own tax breaks.

The shadow inventory is due to (1) banks holding foreclosed properties off of the market, (2) banks who have not yet forclosed on borrowers who are several months past due, and (3) individuals who want to sell their homes but who are waiting until the market strengthens.

SELECTED READER COMMENTS:

JEFF LAUNIERE wrote:
As a Realtor I will go against NAR on this one. I believe that if we got rid of the mortgage interest deduction along with all these other tax credits, the market would correct itself and we would find the true values of the homes. Renters and those that own their homes outright should not have to pay extra taxes to help someone else own a home and beside these just make it possible for people to afford larger homes. Beside this, a large percentage of those that could take the mortgage interest deduction do not even take it due to not itemizing. However, I believe the Fair Tax should be implemented which would get rid of all of these terrible tax laws created by lobbyists influencing Congress and the White House. It also would help reduce the interest rate by about 1/4% which would help people buy homes more than the tax credits and deductions.

Dale Ogden wrote:
Although I HATE income taxes, I agree that tax breaks for home ownership should be eliminated. The entire bubble was caused by government manipulation of the real estate market through the tax code, Fannie and Freddie, etc. However, there should be a commensurate reduction in the top marginal income tax rate.

There can be no doubt that tax breaks on mortgage interest pushes up the price of housing; people have bigger mortgages to get the tax breaks.People who cannot afford houses (some of whom don't pay all that much in taxes anyway) buy them for the tax breaks, and because they somehow believe that a depreciating asset is an investment. The main beneficiary of the high prices and the housing bubble were realtors, a strong lobby, who get commissions based on the price of the transactions and who assumed no risk at all. As housing prices soared, commissions soared.

SANORAN TRIAMESH wrote:
Tax break on mortgage interest = Penalty on people with no mortgage.

If you do not take out a loan, you subsidize those who do. It is nothing but robbing Peter to subsidize Paul (the home-buyer). Since the majority of the people are home-buyers (with no cash, ....so they have to take loans), the minority are forced to subsidize them.

Freddie/Fannie are not going anywhere! Their CEOs work hand-in-hand with our elected Congress Men! Did you know Freddie/Fannie donate money to all sorts of organizations etc? These donations are usually tied to some Congress Man's pet. These donations allow Fannie/Freddie CEOs to cook the books, give themselves bonuses based on 'cooked up' profits, and still face neither investigation nor charges when their corruption is exposed. Congress protects Fannie Freddie because Fannie/Freddie bribes congress (while taking their own cut). So, when tax-payers bail-out Fannie/Freddie, Congress Men get a cut too, -in an amazing third-world style corruption ring.

Corruption and nepotism is common in every US Government agency to some extent. What makes Fannie/Freddie unique is the scale of the amounts. 'Dr' Bernanke is hiding 2 Trillion dollars worth of junk mortgages that former Fannie/Freddie CEOs got bonuses for. 2 Trillion!!! 'Dr' Bernanke's paymasters do not want Fannie/Freddie to go away.

So, while we count millions and billions, the trillion-dollar of rape of America continues. Fannie/Freddie are not going anywhere. Not as long as Congress has anything to do with it :)

Stalling the Housing Recovery, One Stimulus Bill at a Time

By Morgan Housel, The Motley Fool, 06/08/2010
http://www.fool.com/investing/general/2010/06/08/stalling-the-housing-recovery-one-stimulus-bill-at.aspx

In last year's annual letter to Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) shareholders, Warren Buffett gave a three-part recommendation on how to solve the housing crisis.

First on his list: "Blow up a lot of houses."

His tongue was firmly in cheek, but the idea is exactly right. Falling prices aren't the problem; they're a symptom of a bigger issue, which is that there were too many houses built during the boom. Detroit already figured this out: Mayor Dave Bing has a plan to bulldoze 10,000 empty homes over the next three years.

Congress, sadly, hasn't. Last week, three House members introduced a $15 billion stimulus bill to provide homebuilders with construction loans. Yep -- the plan is to build more houses in an attempt to save the housing industry from its oversupply of houses. Irony just died.

If you build it, they will come (at lower prices)

The bill is mostly being pushed by small, privately owned homebuilders upset that the big boys -- Beazer (NYSE: BZH), Lennar (NYSE: LEN), KB Homes (NYSE: KBH), and Pulte (NYSE: PHM) -- rode out the bust with easy access to capital markets and a smattering of stimulus-backed tax breaks. The little guy wants fair access to the dole, which you can't blame him for.

Or maybe you can. There's ample reason to believe this bill will do more bad than good, and arguments used to justify its existence are easy to shoot down. 

The National Association of Home Builders, for example, wrote that without this bill and its fostering of new construction, we'd threaten "to end the budding housing recovery before it has time to take root." That's so perfectly wrong, it hurts. You have to put the laws of supply and demand in a medieval torture device to come up with an example of additional supply healing a crash caused by oversupply. When the price of something is falling, increasing supply accelerates the drop. Conversely, removing supply (blowing up houses) lifts prices. No secrets. No magic. No tricks. They call these the laws of supply and demand because there aren't practical exceptions.

Another argument given by the bill's main sponsor, Congressmen Brad Miller, is that, "We're not talking about continuing to build in overbuilt markets. We're talking about continuing to build in markets [where] there is a demand."

This is somewhat reasonable, but still flawed. Individual markets are more connected than that. To clean up the mess, you have to let low prices in overbuilt markets lure in buyers from tighter markets. A real-world example of this was the explosion in Sacramento's housing demand after San Francisco's market priced most people out.

Some will say the correct way to solve this imbalance is by building more houses in San Francisco (just using San Francisco as an example), which is what the bill's proponents are getting at. What's stopping builders from doing this already? They can't get a private construction loan to build in San Francisco. Why? Because banks fear these loans will rot as prices keep falling, and they're probably right. You need someone impervious to losses and blind to risk to provide financing. Like Congress.

Digging our way out

Bottom line, fixing housing means reducing the national oversupply of homes. How big is that oversupply? [chart not shown]

Supply has come way down from its high, but this is largely because sales volumes have been juiced by a rush to beat the April expiration of the first-time buyers' credit. The number will almost certainly spike next month. You shouldn't be excited until supply falls below average for several months, showing vigorous demand on the part of buyers, and giving builders legitimate reason to build again.

More importantly, this chart doesn't factor in so-called "shadow inventory," which are primarily pseudo-bank-owned homes in the process of foreclosure that haven't been brought to market. Bank of America (NYSE: BAC), for example, just disclosed that the foreclosure process has been taking an average of 13 to 14 months to complete. That creates a big backlog of homes that should be for sale, but aren't.

Credible estimates on the size of shadow inventory are upwards of 1.7 million homes. Factor those into the supply figures, and the true months-of-supply number is probably north of 10 months. That's what is -- and will continue to -- dragging down housing prices.

In Buffett's perfect world, we'd blow up houses. In a rational world, we'd simply stop building more. Only in America do we build more houses and hope it'll drive up prices. ['Great closing line!]