Do We Need a Home Buyer Credit 3.0?

Due to July's awful numbers for new and existing home sales, people have begun to ask whether Washington should renew the home buyer credit. The credit that expired in April is largely blamed for the epic plummet in home sales for July. So why not just renew it and keep the relatively good times rolling? This is a terrible idea, because another credit will simply continue to prolong the housing market's agony and have little success genuinely creating sales.

This past weekend, Housing and Urban Development Secretary Shaun Donovan indicated that a home buyer credit 3.0 is still being mulled over by policymakers. Reuters reports:

"It's too early to say whether the tax credit will be revived," Donovan said in an interview on CNN's "State of the Union" program. He said the administration would "do everything we can" to stabilize the shaky U.S. housing market.

Little Demand Truly Created

The argument for renewing is pretty simple: if the government continues to provide additional incentive for home sales, then demand will be stronger. Of course, our recent experience with the credit shows that this isn't quite right. While some truly new demand may be created, a lot of the sales just consist of future demand pulled forward by buyers who would have purchased anyway but do so early to collect free money from the government. That's one of the reasons why home sales were so incredibly low for July. Some of the would-be buyers in July probably wouldn't have rushed to purchase a home by the end of April if there hadn't been a credit -- but would have ultimately still bought one.

The following chart helps to show why a buyer credit 3.0 would be particularly weak in genuinely creating sales that wouldn't have occurred anyway:

effect of the credit 2010-08.png

The buyer credit 1.0 was slated to end in November. You can see how high sales rose at that time, before it was extended. Then sales dropped because the rush was over. When sales picked back up to collect buyer credit 2.0, which ended in April (though its force was felt through June), sales didn't rise nearly as much. This likely indicates that most of the sales such a credit could truly create were already used up during the 1.0 phase. Even by the time 2.0 hit, most of the inflated sales that took advantage of the credit consisted of demand pulled forward. Consequently, a buyer credit 3.0 would raise sales a little, but they would now even more likely just consist of people buying a little sooner, not feeling motivated to buy purely due to the credit.

Prices Need to Bottom Out

At first, the home buyer credit was well-intentioned. The fear was that demand could virtually disappear and prices could freefall. As a result, the credit existed as an attempt to create a softer landing for home prices as they bottomed-out. But that's not what happened. Instead, it kept prices static and even increased them in some places, which failed to allow home prices to decline to their natural equilibrium. This chart shows that prices still likely have farther to fall.

Because the credit hasn't allowed the housing market to hit its bottom, it's pretty clear that a renewal isn't a good idea. Obviously home prices can't fall forever. If prices somehow manage to decline below where history dictates they should be, then demand will begin to rise on its own. But as long as there's a legitimate fear that prices could still be inflated, then many buyers will remain wary of buying a home. They should be. If the government continues to encourage sales in spite of that, then it will just continue to distort the market without allowing real estate to truly heal.