An interesting take from the editorialists over at the Washington Post argues Monday that one of the little-noticed provisions in the Senate’s most recent housing proposal may actually encourage foreclosures.
We’re referring, of course, to the $7,000 tax credit, payable over two years, to anyone who purchases a foreclosed home.
Supposedly, this would help clear the nation’s swollen inventory of repossessed properties, thus propping up home prices more generally. Here’s the catch. For lenders as well as borrowers, foreclosure is an expensive hassle. If at all possible, most banks would rather avoid repossessing a house, which they must then try to resell. But, by making it cheaper to buy a foreclosed house than a comparable unforeclosed property, the tax credit makes it more feasible to sell one. The cost and hassle — for the lender — of foreclosure go down, and the benefits go up. Other things being equal, lenders would be that much more likely to foreclose — rather than to help homeowners stay in their houses on modified terms.
Our head spins thinking about the pricing implications here, but as best we can tell, the tax credit wouldn’t be likely to make it less expensive to foreclose — the buyer is getting the credit, not the lender, after all — but it could make foreclosed properties easier to move, which would reduce loss severity. But we don’t know, on first blush, that doing so is really such a bad thing.
Greater concern would seem to warranted for those properties that haven’t been foreclosed on, which could be pressured downward further in price. Imagine property A, an REO listing, and property B, a owner-occupant listing — property A has a $7,000 tax credit and property B does not. How is the owner of property B supposed to justify their price relative to the $7,000-cheaper property across the street?
The issue here isn’t whether the proposal will increase foreclosures; we think the issue here is whether the proposal will force a further downward adjustment in housing prices right when the housing market can least afford such a move.
As far as I can tell, it’s basically a round-about payout to the lenders who made the bad loans and now are foreclosing. The tax credit will allow the banks to sell REO properties at a premium relative to other non-REO properties, which will effectively put the $7,000 in their pockets as an offset to the (presumed) loss on the loan. It will also encourage foreclosures in the “close” cases, since it will be effectively cheaper.
I don’t think you’d have to worry about downward pressure on the market in general resulting from this, though. REO’s seem to be the properties driving the actual market correction, since banks are more realistic about prices, and generally don’t hold properties forever waiting for the mythical rebound. This will just delay the correction, while fattening the pockets of a few more irresponsible bankers who (in a less socialist economy) would be taking the losses for their bad investments instead of the taxpayers.
Also, as a side-note, I personally disagree with the sentiment that the market cannot afford more downward adjustment to housing prices, when houses are still not affordable for people. The market could use more downward pressure, to flush out the bad debt, inflated values, phantom equity, and other malinvestements which are hampering the necessary correction. It’s the politicians who can least afford what the market desperately needs.
Very well argued article, though one suspects that both effect will happen. The credit should be given pro rata to how long a foreclosed property has been on the market has been waiting for a purchaser.
The tax credit is costly and unnecessary. Therefore, it’s bad public policy.
Economic theory and reality seems to instruct us that the $7,000 credit would make equivalent REO more attractive than non-REO, thereby suppressing non-REO prices and/or increasing REO prices. For REO properties, the credit would be split betwen the buyer and seller of REO based on supply and demand.
Why should REO sellers or buyers be rewarded? And why should non-REO sellers and buyers be penalized?