Economists' Commentary: Unleashing Pent-Up Housing Demand and Sustainable Economic Recovery

October 9, 2009

By Lawrence Yun, Chief Economist

There is no delight in watching the budget deficit soar. The $1.4 trillion deficit in the completed 2009 fiscal year to September is the highest ever in the U.S. in sheer dollar figures, and the highest since the Second World War if measured in relation to the overall economic pie. It's a huge burden to the future generation and could easily cause interest rates to rise much sooner and quite sharply. Washington needs to come out with a credible plan to reduce the deficit over time.

However, one area where federal taxpayer dollars have effectively been utilized is in providing a homebuyer tax credit. The key to any future sustainable economic recovery lies in home values stabilizing or, better yet, a return to a historical appreciation rate of 3 to 5 percent each year. The bubble prices crash landed. All the excesses have already been removed. In fact, one could legitimately argue that home values have overshot downward. Price-to-income ratio is now below the historical average. The monthly mortgage payment for a middle income person buying a middle priced home is well below its historical norm.

Meanwhile, price correction and over-correction have wreaked havoc to the broader economy. Wall Street balanced sheets were bleeding heavily (before the major assist from the $700 billion TARP funding), foreclosures spiking, strategic defaults rising among financially capable but underwater homeowners, appraisals becoming messier, and most importantly in terms of economic impact, a bulk of American families have witnessed a major destruction to their wealth accumulation by more than $4 trillion in the past three years. The economy will have a difficult time gaining firm footing without government life support if home values continue to fall. To achieve home value stabilization we need financially healthy individuals to enter the market and buy up homes.

A review of the latest incoming data strongly suggests that the homebuyer tax credit has had its intended impact of significantly stimulating home sales. From about 4.5 million annualized home sales pace in the few months prior to the stimulus, sales have jump to 5.1 million in recent months. That is a change of 600,000 additional existing home sales. New home sales have risen from mid 300,000 to low 400,000 over the similar period. The rise in sales has been concentrated in the lower-priced homes largely because first-time buyers are looking to stay, rightly, well within their budget.

Inventories, though still higher than a desired level, have been trimmed. The latest months' supply of inventory at 8 months is much better than the double-digit figures of last year. Home values have likewise moved in an "improving" direction. Broadly speaking, they are down from one year ago, but the declines have been less steep in recent months compared to the pre-stimulus times. The median existing home price as of August was down 12.5 percent compared to nearly 20 percent fall early in the year. In short, sales have risen and home prices are on the verge of stabilizing. But the housing stimulus package is set to expire. A settlement, and not the contract signing to buy, must occur by the end of November. Some first-time buyers who are a signing contract to buy in October may just make the deadline.

It would be an utter pity if the housing market, just at the cusp of self-sustaining recovery, rolls downhill again. That could indeed happen if potential buyers step back and inventory again climbs. Falling home values - independent of whether overcorrecting is happening or not - will bring back all the associated collateral damage.

A much happier scenario would be that the buying momentum continues for few additional quarters such that inventory falls back down to the normal 5 to 7 months, a level consistent with home value stabilization. Once that is accomplished, the consumer "fear factor" of waiting and waiting for a lower price later down the road will no longer be part of home buying decision. We will have reached a point of housing market self-sustainability. Consumer confidence will be lifted. The wealth impact of consumers opening up their wallets for general consumer goods will steadily turn positive. Thus, the broader economy also gets set for a sustainable recovery without needing further stimulus dollars.

For that happy scenario to play out, a time extension on the home buyer tax credit is critically needed. At a cost of about $10 billion (if extended through the middle of next year), the housing market will likely have recovered nicely with the broader economy on track for a solid robust expansion. The cost of $10 billion is rather modest if compared to the $700 billion in TARP funding and the $800 billion of the broader economic stimulus package that was passed early in the year (with debate still raging over the effectiveness of that broad spending bill). Moreover, the cost of $10 billion is a static measure that does not take into account of job creations and increased tax revenue from rising economic activity. If fully accounted for economic dynamic responses, the home buyer tax credit can be argued as a net positive revenue generator for the federal government. As with all budgets, there is nothing like economic growth that dents budget deficits. If the economy was already in full capacity the housing stimulus would simply be moving dollars from one sector of the economy to the next. But as is fully visible out in the streets, we are nowhere near full capacity. Factory capacity utilization was 69.6 percent in August, compared to 80 percent rate that should be the case in normal economic times. On the job market the country is facing a double-digit unemployment rate rather than the healthy 5 or 6 percent unemployment rate. Therefore, there is a plenty of room for growth for a win-win situation for the housing market and other sectors of the economy.

Despite these vast potential benefits to the economy from extending the homebuyer tax credit, valid questions should nonetheless be asked. Is there any pent-up demand remaining? Will the tax credit just go to the people who would have bought a home anyway and thereby allow them to simply pocket the $8,000 check? Well, the following table presents a compelling case for tapping the financially healthy renter population. In 2000, the year before any boom in the housing market, there were 11.5 million renter households who had the necessary income to buy a median price home at the prevailing market conditions. Today, the pool of renters who can buy a median priced home is over 16 million. Just nudging even a small slice, say 5 percent, of these financially healthy renters into buying, by flashing a tax credit check as incentive, will mean 800,000 additional home sales. That number is sufficiently meaningful to get the inventory down to the level of home value stabilization. The housing market will then be on the path to a self-sustaining recovery. After what we through this decade, it would be quite nice to observe the return of a boring housing market with annual price growth of a steady and normal 3 to 5 percent - without any of the fits, frenzy, and panic.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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