It is becoming increasingly clear that the housing sector needs to play an important role in reviving our struggling economy. Of course, it was the collapse of the residential real estate markets that got us into this mess in the first place, but sometimes you need to treat the cause to accomplish a successful recovery.
According to most recent indicators, the recession is getting deeper, not shallower. The unemployment rate is expected to rise to at least 9 percent, with the economy losing close to five million jobs from peak to trough. The manufacturing sector is sharply contracting and consumer spending and confidence have plummeted.
There are two conventional ways that government fights an economic contraction: conducting accommodative monetary policy and applying fiscal stimulus. The Federal Reserve has certainly been accommodative during the past year, cutting the Federal funds rate 10 times in 15 months. The Federal funds rate is now hovering in the 0 to 0.25 percent range. Since there are lags in the effects of monetary policy, the full impact of easy money and low rates have not yet been felt. Hopefully, the economy will soon benefit from the Fed’s accommodative posture.
Fiscal policy usually involves a combination of government spending and tax cuts to increase aggregate demand. The $825 billion stimulus package proposed by the incoming Obama Administration and House Democrats consists of 60 percent spending programs in areas like infrastructure (roads, bridges) and alternative energy sources, while 40 percent of the package consists of tax cuts for both consumers and businesses.
As I mentioned in a previous commentary, neither government spending nor general tax cuts are completely effective tools for quickly reviving the economy. Tax cuts can be put in place immediately but households are likely to save a percentage of those cuts rather than spend it on goods and services. Similarly, government spending on infrastructure may create jobs, but it takes considerable time to implement.
There is something sorely absent in the Obama/House Democrat $825 billion stimulus package—the housing sector. There are two reasons why housing should be included in a stimulus package. First, you need to treat the primary cause for the recession which was the real estate bust.
Second, the housing sector usually leads economic recoveries because activity in the housing sector downstreams into related industries more so than any other sector in the economy. Historically, activity in the housing sector accounts for about 16 to 20 percent of GDP.
It is evident that as the housing industry expands so do other industries like furniture, appliances, remodeling, settlement services, construction, landscaping, and so on. If you are looking to create jobs, there is no better sector to accomplish that feat than housing.
I am not suggesting that housing become the primary target for fiscal stimulus. Given the current state of the economy, the Obama Administration and Congress probably have the right mix of spending programs and tax cuts. I am suggesting that housing be included in the mix because of its unique ability to jump start an economic recovery. At present, there is a delicate balance between the housing sector and the economy—both need each other.
The housing recession is worsening because of the economic recession. Job losses and falling consumer confidence are keeping households from purchasing homes so the housing sector needs the economy to recover first. Similarly, the economic recession is worsening because the housing sector is contracting, resulting in a contraction and job losses via a multiplying effect in many industries that are touched by the housing sector.
There are many ways to stimulate the housing sector that could be part of a stimulus package. Although its name sounds self serving, the Fix Housing First coalition recommends some programs that would strengthen housing demand while promoting economic recovery. The coalition’s proposal includes two programs that were successful in reviving the economy and housing sector during the 1974/1975 recession—a homebuyer tax credit and an interest rate buydown.
I would also recommend a third program to reduce housing supply;subsidize loan modifications to reduce foreclosures, as proposed by the FDIC.
Homebuyer Tax Credit
A homebuyer tax credit would directly affect housing demand in a positive way. The proposal would apply a tax credit, ranging from $10,000 to $22,000 based on local house prices, to all buyers of principal residences. The tax credit would not have to be repaid and there would be an income phase-out of $125,000 ($250,000 for married households). The credit would also be eligible for claiming at settlement for use as a down payment. Households could not save this tax credit since the credit is triggered only for a home purchase.
Mortgage Rate Buydown
Mortgage rates have dropped considerably during the past several months with 30-year mortgage rates hovering around 5 to 5.25 percent during the past several weeks. The drop in rates has resulted in an increase in mortgage applications to purchase homes.
Falling rates have also given us more favorable pending home sales numbers. But the fallout rate from mortgage applications and pending home sales (contracts) to actual home closings has increased markedly. In other words, stricter underwriting standards have kept people from buying homes. A meaningful percentage of these fallouts are due to the inability of the borrower to raise the required 20 percent down payment.
Of course, some households just do not have the financial wherewithal to purchase homes no matter how low mortgages fall. Job losses, wealth losses and falling consumer confidence are keeping these households from purchasing homes. But a combination of a homebuyer tax credit that can be used at closing with lower mortgage rates via a buydown could positively influence home purchases for a meaningful percentage of households.
A buydown program could bring 30-year mortgage rates down to say, 4 percent for mortgages purchased during a specific time period.
Buydown programs have been commonly used by homebuilders over the years incentivizing consumers to purchase new homes. Buydown programs need to be implemented quickly because once the buydown program is announced; buyers will postpone purchasing a home until the buydown rate is in place. I would also consider a similar buydown program for jumbo mortgage rates, which are still hovering around 7 percent. High cost housing areas like California also need a jump start for housing demand.
Subsidize Loan Modifications
FDIC Chairman Sheila Bair has proposed a loan modification subsidy program that could reduce the supply of homes available for sale in the nation’s housing markets. The program uses a combination of interest rate reductions, term extensions and deferred principal. If the loan defaults after the loan is modified, the government will share up to half of the losses on that re-default. This program would be effective in reducing the number of foreclosures in the marketplace. The funds for this program could come from the remaining TARP funds or could be included in a stimulus package.
David A. Lereah, president of Reecon Advisors, is a recognized expert in real estate economics and financial services. Dr. Lereah was Senior Vice President and Chief Economist of the National Association of Realtors and Chief Economist for the Mortgage Bankers Association of America. This commentary first appeared in the Reecon Advisory Report, an independent source of news, insight and intelligence on the real estate economics that are shaping real estate markets. For more information, go to ReeconAdvisoryReport.com