Policy Follies in the Housing Market: The First-Time Homebuyers’ Tax Credit

The right is very good at making progressives pay for their mistakes. They still trot out failed programs from the '60s as a warning of the risks of wrongheaded liberalism.

Unfortunately, the left cannot hold a grudge the same way; otherwise the folks who started the war in Iraq and allowed the housing bubble to grow out of control would be hiding under rocks instead of holding positions of power. But this crew gets amnesty not only for its big blunders; it also can count on a no-blame policy for even more mundane screw-ups. The first-time homebuyers' tax credit is one such case.

The basic story was fairly simple. The first-time homebuyers' tax credit was put in place as part of the stimulus package that Congress approved in February of 2009. The credit gave 10 percent of the purchase price of a home, up to $8,000, to first-time homebuyers or to people who had not owned a home for at least three years.

The credit was not part of the stimulus package proposed by President Obama. It was inserted as an amendment to the bill by Johnny Isakson, a Republican senator from Georgia, who had worked in the real estate industry for more than three decades before turning to politics. Isakson was able to quickly get a large number of senators from both parties to sign onto his proposal, and President Obama indicated that he would not oppose it.

The logic behind the tax credit was that it would provide a boost to the housing market at a time when prices were in a free fall. Prices were declining at the rate of 2 percent a month nationwide and in some of the cities with the worse bubbles the rate of price decline was more than 3 percent a month.

The tax credit was explicitly intended to be temporary. It was initially scheduled to end in November of 2009, but was later extended to April of 2010. This was supposed to give people an incentive to buy a house right away rather than waiting with the hope that prices would fall further.

The credit had its intended effect. There was a big surge in buying before the initial credit was scheduled to end (people did not know it would be extended until just before the expiration date) and then another huge surge in the spring of 2010 as buyers rushed to beat the end of April deadline.

This ended the plunge in house prices, with prices actually showing modest price increases in the late summer and fall of 2009. They remained stable through the expiration date of the extended credit.

However, there was a simple logical problem with the response to a credit of this sort. Very few people are going to buy a home who would not have otherwise because of an $8,000 credit. Relative to the purchase price of a home and related financial commitments (e.g. maintenance, property taxes etc.), $8,000 is not much of a consideration.

What a credit like this can do is to cause people to move an intended home purchase forward. In other words, people who might have otherwise bought a home in the second half of 2010 or 2011 could be persuaded by an $8,000 credit to buy their home in 2009 or the first half of 2010. The result is that the demand for homes would be expected to plummet after the expiration of the tax credit.

This is exactly what happened. Home sales fell by almost 40 percent in the months after the expiration of the tax credit. And with the collapse of the demand side of the market, house prices resumed their decline. By one widely used measure, home prices at the end of 2011 were more than 7 percent lower than they had been at the peak reached with the tax credit.

Of course, not all housing markets were affected equally by the tax credit. The lower-priced homes in the less expensive markets saw the biggest impact. This is for the obvious reason that first-time buyers are likely to buy less expensive homes, and an $8,000 credit will have more impact on the price of a $100,000 home than a $400,000 home.

In these less expensive markets, the impact of the ending of the tax credit was truly disastrous. For example, in a year and half, prices for homes priced in the bottom third of the market in Minneapolis have fallen by almost one-quarter. In Atlanta, prices in the lower portion of the market have fallen by more than half. Similar stories could be told in many other cities.

This means that, in effect, the government persuaded many people with a $8,000 tax credit to buy a home on which they may have lost $40,000-$50,000 in less than two years. This is incredibly foolish policy.

If this policy had been proposed by liberals with the idea of helping the poor, its failure likely would have been a huge political issue in the 2012 election and likely for many years beyond. After all, the government spent somewhere between $15 billion to $20 billion on a policy that ended up hurting the people that it was intended to help.

However, this was a policy that was pushed by the real estate industry, ostensibly to promote homeownership. As a result, it would almost be viewed as unpatriotic to call attention to its failure. One result of this bias in policymaking is that we are likely to see many more ill-considered policies along these lines in the future.

We also will continue to see a pattern whereby every failure of a policy designed to help moderate-income people is a political albatross on its proponents for decades, while the failures by the right are quickly swept under the rug. Is it any surprise that with a game played by these rules the country continually drifts rightward?