Home Buyer Tax Credit Econ 101
If American taxpayers get a bill for $43,000 for the sale of every home to a first-time buyer who would not have bought if he or she didn’t get an $8,000 credit, is the program, which is set to expire in 60 days, worth it?
This estimate comes from our preferred calculator of risk, Calculated Risk, but we contend that this is a miscalculation of risk. Follow CR’s original logic here:
The NAR recently reported:
NAR estimates that about 1.8 to 2.0 million first-time buyers will take advantage of the $8,000 tax credit this year, with approximately 350,000 additional sales that would not have taken place without the credit.
You can calculate the new $15 billion projection; 1.9 million times $8,000.
But this only resulted in 350,000 additional sales. Divide $15 billion by 350 thousand, and the program cost is about $43,000 per additional buyer. Very expensive.
Now the National Association of Home Builders estimates that expanding and extending the credit through 2010 would generate 500,000 additional sales at a cost of about $30 billion. So this is approximately $60,000 per additional house sold. And I think the cost will be much higher.
Since that original post, the $43,000 price tag per incremental home sold thanks to the $8,000 tax credit under the terms of the American Reinvestment and Recovery Act of 2009, has gotten wide play among economists who generally posit that Americans would spend their tax money in better ways.
Recently, using that same calculus, CR goes so far as to assert that the 350,000 incremental home buyers in 2009 is 1) wrecking the apartment rental market, and 2) very likely to exert a deflationary fieldforce on the Consumer Price Index if a home buyer tax credit gets an extension.
The rental vacancy rate was already at a record 10.6% in Q2 2009. Some quick math suggests the tax credit will push the national vacancy rate above 11% soon.
And that means even more pressure on rents (rents are already falling). This is good news for renters, but this will also lead to more apartment defaults, higher default rates for apartment CMBS, and more losses for small and regional banks.
And falling rents are already pushing down owners’ equivalent rent (OER), and my guess is OER will probably turn negative soon. Since OER is the largest component of CPI (and almost 40% of core CPI), this will push down CPI for some time.
CR can continue to build a fabulous series of scenarios from his original assumption, but we believe that original assumption is a miscalculation.
Paul Krugman writes below, not about the home buyer tax credit, but about calculating accurately, the cost of proposed cap and trade legislation. But his logic on that issue is what leads us to believe that Calculated Risk’s $43,000 figure is an erroneous benchmark of the program’s cost:
Beck got his number from someone who learned about a guesstimate of what the auction value of permits might be (way higher than current estimates, by the way), divided by the number of households, and proclaimed this the cost of the bill. In effect, he looked at a guess about the size of the blue rectangle, which does not represent an economic cost, and called that the cost to the economy.
In a way, though, what Martin Feldstein did was worse. He took the CBO’s estimate of “compliance costs”, which was $1600 per household in an early report (it’s now down to $900, but who’s counting?), and implied that this was the economic cost of the legislation. But “compliance costs” are basically the sum of the blue rectangle and the red triangle; the true economic costs are just the triangle, and are much smaller.
Another way to say this is that under the Feldstein method, any time you try to correct an externality, which necessarily means changing relative prices, all of the negative effects of the price change will be counted as a cost — but none of the positive effects will be counted as a benefit.
Bad stuff. And what you should bear in mind is that all I’m doing here is conventional neoclassical economics, quite literally basic textbook material. What does it say when the people who claim to believe in this stuff throw it out the window as soon as it leads to policy conclusions they don’t like?
I.e. It is possible to do the arithmetic correctly and get the math wrong. (It should be noted though, that Krugman has voiced opposition to tax credits for new home buyers as well, so this example is not to say that he supports our view about the potential extension of the program).
Everybody knows the immediate pressing issue is we need to get the public sector out of the grill of the private sector. That’s going to take jobs. First jobs have to stop going away, and then they–private sector ones–have to start coming back.
We need an extension of the home buyer tax credit to keep the economy headed toward where it will begin to expand jobs sooner than later. Let’s talk about the program from a realistic cost and benefit analysis.
KB’s Mezger Emerges from the Shadow of His Former Boss
KB Home chief executive officer Jeff Mezger is a cautionary tale incarnate, in a positive sense. He succeeded the larger-than-life Bruce Karatz as KB chief, just as 2006 shut its eyes on all that was home building’s halcyon era three years and a life-time ago. Almost like an understudy thrust suddenly into a lead role on Broadway, the limelight was all Mezger’s.
What a tough act Mezger had to follow in terms of the legend Karatz had become. If there were doubts about Mezger’s ability to step out of the shadow of his former boss, they should be fading memories by now.
Inside of a year, Mezger–who’d gotten credit for developing an internally vaunted KB Next program for transforming construction operation management, product offerings, and overhead costs inertias around a streamlined organization–was retooling KB’s skill set. Gone was the strategic prong focused on elevating KB Home’s average selling price from the bottom of the cellar among its peers. Gone was the have-it-anyway-you-want-it infinitude of choices, options, and upgrades, in favor of a manageable spectrum of choices based more on monthly-payment reality vs. constant house price appreciation fantasy.
KB Home bee-lined for its roots in entry level, and having picked up word that at least some home builders in some markets were reshaping product offerings down to the square foot based on real money monthly payments–Meritage, for example–KB swung for the fences in its value engineered offering. The Open Series was born.
What Mezger did earlier on than most of his CEO peers was to act rather than to watch. If one was a spectator for too long into 2007–believing that a tide of worldwide liquidity was due to reinforce demand the way it had again and again from 2003 to 2006, one got stuck in the financial maelstrom that became the global economic crisis of 2008.
If you were Jeff Mezger, you got ahead of the curve. You were looking at the same data he was in 2006 and 2007–foreclosures were a wave that was rising, the economy was weakening, and credit and jobs were going to come under severe stress.
To cut his land losses, keep the company focus on moving inventory, and do what he knew how to do well from his time in KB’s far-flung trenches, he ratcheted up emphasis on construction speed and lowering cost. He wanted to own the new-home alternative to foreclosures, and he knew his boys in the field could get KB there if they had to. And they did.
For more than a year–mostly in 2008–Mezger took a fair amount of grief on orders, overheads, and financial performance decline. About the only positive piece of the KB Home story from an outsider’s perspective was the sale of KB Home’s French unit, the one-time benefit of which saved a quarter’s worth of profitability and became KB’s dry powder for times ahead.
Right out of the gate as KB launched its Open Series, it found success.
- Here’s comment from Mezger on the role of the Open Series in KB Home’s Q3 financial report last week.
At least one or two of every 10 prospective home buyers who were looking to move into homeownership for the first time wanted a new home, vs. a financially distressed home. The Open Series not only did well in its own right, it attracted copy-cats–low-cost, simplified, reduced square footage homes that would be built to fend off foreclosure sales from complete domination of the landscape.
Of course, privately funded home building companies found it unfair. The terms of their bank loans prevent them from writing down their land costs, lowering the direct construction costs and price of the home, and pressing “unload.” The same impairment that hits public companies’ shareholder equity can take away everything a private home builder owns 10 times over.
But what Mezger and those others who’ve come into the market with me-too low-cost models for entry-level price points have done is to create a niche opportunity just above that price level for public and privates where they can fight more expensive foreclosures. That might mean that a positive story at the lowest end for publics could soon provide a price point haven for privates to offer more at a great value–but they still have to build fast.
We were talking with some younger professionals recently who more or less affirmed Mezger’s bet that, tax credit or no, entry level buyers are the stepping stones to recovery.
One such young professional said, “Put it this way, the Social Security system will be shot by the time we retire; 401ks have proven they’re not the answer to a secure post-career life, and companies are certainly not going to take care of us through pensions. So we’re on our own, and real estate is the only asset we can depend on to build up enough value to be able to retire some day.”
Now, it may be that further analysis of personal investment strategic alternatives could reveal that a more diversified program might be wise for this young professional. But homeownership seems to have solidified itself as an anchor to the plan.
So, it’s arguable, given who is keeping their jobs and driving households toward lifestage changes and adjustments at the most accelerated pace, that the $8,000 tax credit for first-time home buyers “pulled forward” buyers enough to deplete demand among them.
Birth rates during the Generation Y years ranged from the mid-3 millions to the mid-4 millions per year. There’s a lot of demand in the pipeline for first-time home buyers, especially when they’re the most-well educated generation in history and are bound for the most part to weather even double-digit unemployment rates with a mission to self-ensure their future.
Point is, the only strategy for right now–whether you’re a multi-regional public executive or a private entrepreneurial firm–is a foreclosure-fighter strategy. Competing against other new-home sellers is still, of course, a given. But the real race is to build fast enough and low-cost enough, at every price point, to compete with a foreclosure or a distressed sale that is 30% below your best sticker price.
You can get at it with your monthly cost-of-ownership story. When younger decision-makers hear that story clearly, they’ll get it.
The Great Home Buyer Tax Credit Debate
We’d like to see a live debate among three economists on the issue of whether a tax credit for home buyers should continue, be extended, or be expanded to include all buyers of primary residences.
The three we’d pick–whom we believe have the best understanding not only of the direct cost-benefits of the program, but of the multiplier effects of the new construction dimension of the impact–would be Moody’s Economy.com’s Mark Zandi, the National Association of Home Builders’ Robert Dietz, and independent Thomas Lawler.
Here Lawler talks with CNBC’s David Faber about the home buyer tax credit’s impact in 2009. He cites Calculated Risk’s widely quoted estimate of $40K per incremental home sold.
If all that $40K or thereabouts did were to stimulate about 350,000 purchases that would not have occurred, then the current program measures out as too expensive. But that $40,000, or rather the total cost of the $8,000 tax credit for first time home buyers running from Jan. 1 to Nov. 30, 2009, is actually paying for far more than moving home buyers off the sidelines.
In addition, it’s actually paying for hiring, consumer spending, corporate earnings, and a reduction in excess inventory, all of which exert both a psychological as well as mathematical force.
Anyway, we’d like to see this debate.
One Tough OSB
84 Lumber founder Joe Hardy talked before dawn in Pittsburgh with CNBC Squawk Box co-anchor Carl Quintannia, offering a more than a half-century’s perspective on housing’s ups and downs.
He talks about how being a private company has allowed 84 Lumber to make adjustments for survival that will position it for strength in years to come.
Referring to lumber prices, Joe says they’re very low right now, in sync with the fact that home prices have fallen by as much as 40% or more in some locations. What’s more competition from SOBs, he says, are another source of pressure. He corrects himself later–acknowledging he meant to say OSBs (oriented strand board).
Desperate Words from Home Building’s Trenches
A home builder who’s fighting for dear life with operations in two regions called in a panic. He’s got new product coming on line, designed and priced to offer buyers a new-home alternative to resale and distressed sales cropping up all over his markets.
But he’s got two problems:
- One is that his new product line is residential over retail and office units, and he can’t get banks to appraise the residential units in a way that reflects any value in the commercial units.
- Two, he’s had not one, but two potential mortgage lenders come back with word that FHA loans now require a minimum 640 credit score for borrowers.
Getting his units valued and getting his customers loans for places where buyers could qualify on the remaining 60 days of the $8,000 first-time buyer tax credit are now big sudden headwinds, after all the investment and construction operational speed and efficiency in getting the product ready to go online before the tax credit expiration.
FHA loans, which dropped to single-digit percentage share of new-home mortgages in the first part of the decade thanks largely to the proliferation of subprime and other exotic mortgage products, now account for six or more out of every 10 new-home loans, and without the FHA to back lenders now, many borrowers would be out of options.
On Sept. 4, The Wall Street Journal reported:
Some economists say the FHA’s lending has been crucial to preventing a deeper bust in property. Thomas Lawler, an independent housing economist, said “the alternative could have been a complete meltdown of housing finance” that would have ultimately led to much larger losses. Critics have said the FHA, which has never had a chief risk officer, isn’t able to manage such a large portfolio in an unstable market.
Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%.
As default rates in FHA loans notch up–7.8 of FHA loans are late 90-days plus, i.e. in default, per Inside Mortgage Finance – stress gets added to their guidelines to banks. This means more nail-biting for home buyers who may have qualified at a lower credit score even a month ago.
These stories are legion.
In a virtually no-debt available environment, private home builders are pulling out the stops to meet the market at least half way. They’re virtually locked out of lending for cheaper land reloads, and loans to go vertical are almost as scarce.
This latest set of tidings out of the banks make it abundantly clear why more and more privately funded home builders say “bank” like it’s just another four-letter word.
The Volcker Speaks
Meet the new boss. Same as the old boss.
Paul Volcker
Paul Volcker is trying to help the men and women elected to serve our nation’s interests on the Senate Banking committee get their brains around what needs to change in the financial system to safeguard the economy from the failings of human nature.
He’s drafted a now widely quoted — The Big Picture and Calculated Risk, to name a couple — prepared statement that states that the nation’s big banks have enjoyed official protection via government policy that effectively keeps the private sector from checking and balancing these institutions in a healthy way.
Bottom line, analysts are reading Volcker’s guidance as a call for restoration of Glass-Steagall Act provisions that have been on hiatus since Nov. 1999. A 10-year joyride. Here’s some thread from the statement:
Over recent months the Administration has set out important proposales which, taken together and implemented, would provide a reformed framework for financial regulation and supervision. There are key elements of the Administration’s approach that I believe deserve your full support. I particularly welcome the strong reaffirmation of one long-standing principle — the separation of banking from commerce — that has long characterized the American approach toward financial regulation. In practice, over a numbe of years that approach has been eroded by loopholes in the legal framework and by technological changes in financial instruments and the nature of banking. As emergency measures, further exceptions to the rule were accepted in the face of the severe crisis.
Failure to close those existing loopholes will inevitably weaken needed prudential safeguards and raise difficult questions about the extent of “moral hazard”, an issue that looms very large in the light of events of the past year. It is those events — including particularly the rescue of money market mutual funds and the decisions to broaden direct access by non-banks to Federal Reserve credit facilities — that ponit to the need for strong enforcement of the distincting between banks and other financial or commercial institutions.
The Big Picture points out several other key recommendations from the former Fed chief:
Volcker also notes two other key needed elements in need of reform: the Moral Hazard of the bailouts, and the ongoing policy of “Too Big To Fail.”
And, Volcker also emphasized the importance of the Federal Reserve maintaining independence from political pressures.
He also called for a new “resolution regime” for insolvent or failing non-bank institutions of potential systemic importance. Rather than toss trillions at these self-wounded entities, we should instead appoint a special “Conservator” to take control of a bank in clear danger of defaulting on its obligations.
The Conservator should have the authority to negotiate an exchange of debt for new stock to resolve the near insolvent firm, to arrange a sale or merger, or, to arrange an orderly liquidation.
This authority would preempt normal bankruptcy/reorg, justified only by the risk of systemic breakdown.
The question now is how well Volcker knows [at least on part of] his audience — Congress. And whether they know what he means by it all.
Maybe new local and community banks will start up after the scorched earth period plays out over the next 12 to 18 months or so.
Home Builders Buy–and Bide–Time via Debt Moves
Tell us, have we tired of the phrase “the new normal” yet?
Also, do those who favor Adam Smith policy eat more of one kind of breakfast cereal at some point in their formative years, whereas the ones who adopt John Maynard Keynes’ principles to manage through economic hard times eat, say, Lucky Charms?
The question of the moment for businesses that make a living — or try to — in new residential construction is what to do in a mixed-signals economy other than dodge the carcasses of America’s regional banks and try to convince another buyer that a new home for 25% more is still better than a used home coming out of foreclosure.
To look at how public home builders are behaving–especially in managing their near-term debt maturities–a long runway to recovery is what they’ve got in mind. They’ll comp better year-on-year when we arrive in 2010, but regaining profitability may be more likely to occur on a run-rate basis during the back half of the year rather than on a 2010 fiscal year measuring stick.
Everybody with debt due in 2010, ’11, and ’12, has been working hard to get terms extended, with varying success. In this environment, what collateralizes that debt as it gets extended is slippery. Everybody’s got to have more cash capital backing loans, so borrowers are performing financial acrobatics to collateralize debt that’s pushed down the road to where it’s less menacing.
Home builders are averse to have cash sitting in a bank account as collateral for their debt, so they’ll alternatively look to supply lenders with a letter of credit that would allow the lender to come after the whole amount if there’s a default.
This is all to say that 2010 looks as if it’s another year of living dangerously for home builders. With jobs ranks still shrinking and household formations in a slow-down mode, expectations around cash from home sales have more to do with keeping the lights on and the wheels turning than generating a whole lot of equity growth.
Which is fine if you’re a public company, … one that can get the runway … toward the new normal. Ok that’s the last use of that term except to take pot shots at others who’ll go on to use it to death.
The Home Buyer Tax Credit Crunch Bunch
Cartoon by Randy Bish, Pittsburgh Tribune-Review
Make no mistake, any extension or expansion of the tax credit after the current program’s hard sunset on November 30 will reflect venal political motivation (i.e. reelection bids) more than it does Congressional math skills.
Still, why are so many people getting the math wrong as they voice pro or con about whether more home buying stimulus is worth our tax money or not?
- Big Builder’s Sarah Yaussi sets at least one part of the record straight on the economics of the $8,000 first-time home buyer program.
We know that Calculated Risk–a solid economics analyst–believes the policy should have never happened and should go away. He’s done much-quoted arithmetic that puts a U.S. taxpayer pricetag of $43,000 on each house sold under the program that would not have sold if the program did not exist.
Today, he says “most economists–left and right–oppose” the tax credit. He links to a J. Patrick Coolican Las Vegas Sun article that quotes a slew of right- or left-leaning economists who give myriad, often conflicting reasons the current measure is bad.
We’ve heard economists who contend that a home buyer demand stimulus can act as an adrenaline dose that can stabilize home-price declines, slow foreclosures, get people working, and steady the economy for a sustainable period.
Maybe they’re actually a minority of economists, but we think the claim that “most economists oppose” the credit may be pushing the truth.
Thing is, who do economists employ, anyway? They don’t make jobs happen or even household formations, so why should a bunch of economists–the majority of whom did not, like Tom Lawler or Robert Shiller, call the housing bubble nor anything else in the past 10 years–have any say at all? Venal political motivations cloud most of their best economic judgment anyway, so they’re really no different than the politicians.
In this case, best trust people who actually run companies large and small that put people to work. Ask them whether or not it’s worth taxpayers’ money to give housing a bit more of a bump to keep some momentum going.
Lennar Q3 in Subject Line Tidings
In home building, it still may be a misnomer to call quarterly financial reports an earnings report.
Still, the tone of the latest call with analysts, and their take on the most recent performance, is refreshing.
Here’s Subject Lines from several key equity analysts’ post-ups on the Lennar report.
- Stephen East, Pali — Lennar (LEN, Buy, PT $20.00) – Solid Results, Good Guidance. Investors Need To Guard Against Short-Term Exuberance.
- David Goldberg, UBS — LEN F3Q09 EPS: Improving Conditions Already Priced In
- Buck Horn, Raymond James — LEN: Selling Conditions Continue to Improve; Reiterate Outperform
- Josh Levin, Citi — LEN: Migrating to Normal
- Michael Rehaut, JP Morgan — 3Q Order Decline Better than our Estimate; Gross Margins Ahead of Our Estimate; Reiterate OW – ALERT
- Carl Reichardt, Wells Fargo Securities — Lennar Corporation: Reports FQ3 Loss Per Share of $0.97 (Revising Estimates) Gimme a Breakeven
Added up, the analysts have struck a positive chord we haven’t seen in a couple of years… with caveats, of course.
Florida’s CDD Mess Gets Forbes’ Attention
A reader sent us a link to Forbes’ analysis of Florida’s Community Development District bond debacle.
It’s a must-read if you’re a bond investor. If you’re a real estate speculator, it’ll ping the salivary glands, but don’t get too excited. Getting at the actual dirt will be like trying to claw a home loan out of a CMBS.
Interesting that Forbes’ reporter Matthew Schifren should adapt structure, sources, and even phrases from a story we posted here in July, but with no attribution to that story.
For example, here’s a line we wrote in our July 11 post, “Ground Under Repair–Florida’s CDD Comeuppance:”
For more than a year, Tern Bay has been slogging through foreclosure proceedings, and the legal complexities are too numerous to go into. Now, multiply the Tern Bay case by say 120 or 130 times, with upwards of $2 billion in bond debt at risk, collateralizing land that may be worthless or at least far less than the face-value of the bonds outstanding.
Now, have a look at how the Forbes story moves from the Tern Bay example to its thesis on Florida’s CDD woes:
Multiply this scenario by 100 and you get a picture of recently issued community development bonds in Florida.
I guess Shifren liked what he read enough to borrow a fair amount of it.