Seansonfire (46.39)

Waiting for the End: To the Housing Tax Credit

March 30, 2010 – Comments (6) | RELATED TICKERS: PHM , MTH , MDC

There has been much speculation as to what will happen once the government repeals its $8,000 first time home buyer tax credit and $6,500 repeat home buyer tax credit.  From a pure economics perspective it does not look very rosy on the other side. 

Lets breakdown from a macroeconomic standpoint what has happened with this Tax Credit.  The government has actually done two things with the tax credit not just one. 

1) First it has artificially driven up the Demand for Housing as the post tax benefit from purchasing a house is positive (+$8,000) and not neutral as it was prior to the tax credit.  People take this into account (if they are rational) when deciding to purchase a house and translate to a shift in the Demand function to the right(Up) within the Housing Market.

2) Second the government specifically give a timeframe for when the tax credit will end (similar to a temporary income tax decrease driving up the supply of labor in the short term, but reducing it in the long term). It was originally planned to end in November now it is pushed back to end of April.  By doing this it has also caused people to be incentivized to purchase a home now instead of a future time, as it essentially costs a person $8,000 if they buy a home May 1st verse if they buy one before that.  This has cause housing demand to be compacted into a shorter timeframe (or pulled back) than it would have naturally have been.  Thus demand that would have naturally been within the remainder of 2010, and 2011 was pulled back into 2009 and Q1 2010.  This also artificially drove up the demand curve in housing.

What will happen once the tax credit ends:

1)  The artificial effect that created by the 1) will correct immediately.  The demand curve will shift back in the same why it shifted up but it is hard to say the impact (will it go back to where it came, will it go further down, or less down).  All we know is demand will fall in housing.

2)  This will have more lasting effects than 1), as you have now artificially manipulated the demand over the timeframe of the next couple of years.  If this was any other goods market this would not play as big of a role in the demand function, but due to the long turnover times in housing it will take years for demand to fully rebound.  This will hold demand lower than it would have previously been during the next year or so (depending on how far out you think people had originally planned/desired to purchase a home) if we had not provided a tax credit at all.

The Hope:  That the artificial demand that was created by the Tax Credit reduced the supply enough that prices would actually stabilize over the long run. 

The Reality:  It didn't. 

The only thing holding up Housing Stocks right now:  Irrational Exuberance & the chance that the government extends the housing Tax Credit again, as I assume they know the same information that I just presented.  As we approach the end of April I will wait with all my Red Thumbs on all the overbought housing stocks.