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Built on Jenga Blocks, Home Prices Look Shaky

The Homebuyers’ Tax Credit, in many ways, has done exactly what it was suppose to do – stimulate the economy. Notice I didn’t say increase home ownership. The tax credit was never really about buyers. It was about keeping home values stable so the housing sector would not have another wave of foreclosures that would cause a further deterioration of the economy.

The administration realized early on that the number one cause of foreclosures was an increase in ‘negative equity’. Negative equity occurs when the value of a home is less than the mortgage balances on that home. Other terms for this situation are being ‘underwater’ or ‘upside down’ on your mortgage.

Studies have shown that once a borrower falls into this situation they are much more likely to stop paying the mortgage. An article in the Los Angeles times addresses this issue:

Research by three academics suggests that the willingness of people to default depends largely on just how far underwater they are. Or, as the study’s authors put it, “People default because of the size of their negative equity, not just because they cannot afford to pay.”

The administration realized that if they didn’t stop prices from falling, more and more homeowners would fall into negative equity and eventually into foreclosure. So what did they do? They artificially increased demand for housing by keeping mortgage rates low and incenting people to buy homes with the tax credit.

You might ask – “How do you know this?” Let’s hear it directly from the administration itself. In the TARP Quarterly Report to Congress which was released this past Saturday, it was stated:

Supporting home prices is an explicit policy goal of the Government. As the White House stated in the announcement of HAMP for example, “President Obama’s programs to prevent foreclosures will help bolster home prices.” In general, housing obeys the laws of supply and demand: higher demand leads to higher prices. Because increasing access to credit increases the pool of potential home buyers, increasing access to credit boosts home prices. The Federal Reserve can thus boost home prices by either lowering general interest rates or purchasing mortgages and MBS. Both actions, which the Federal Reserve is pursuing, have the effect of lowering interest rates, which increases demand by permitting borrowers to afford a higher home price on a given income. Similarly, the Administration is boosting home prices by encouraging bank lending (such as through TARP) and by instituting purchase incentives such as the First-Time Homebuyer Tax Credit. All of these actions increase the demand for homes, which increases home prices.

The government has been and continues to be in the business of ‘bolstering home prices’ in this country. I am not arguing that was the incorrect thing to do. Perhaps, it needed to be done to save the overall economy.

However, if the actions the Fed is taking are propping up prices, what happens when they terminate those programs? I believe it is logical to conclude that prices will again feel downward pressure.

And I am not the only one feeling this way. Here are some examples:

From The Wall Street Journal:

“A withdrawal of government support, combined with high unemployment and rising mortgage foreclosures, could push home prices down 20%,” said Ronald Temple, portfolio manager at Lazard Asset Management

From Reuters:

A recent decline of home sales is swelling the supply of houses and may push prices down, adding to losses from an earlier three-year slide, said rating agency Standard & Poor’s in a statement on Friday.

“While home prices have been trending up since spring 2009, existing, new and pending home sales are waning, which suggests that lower prices are on the horizon,” said the statement.

From Housing Wire:

Moody’s does not expect a bottoming of house prices before Q310, with another 11% national decline likely before the worst is over.

From the New York Times:

“I’m worried. Everyone’s worried,” said Karl E. Case, the Wellesley College economist who helped design the housing index that provided fresh cause for alarm on Tuesday. “If prices sink 15 percent from here, which is a possibility, and the 2008 and 2009 loans go bad, then we’re back where we were before — in a nightmare.” Mr. Case, who chided himself for his optimism over the summer, said he now believed “the probability is very high of a serious double dip.”

The Fed has already announced that they are exiting the mortgage-backed-securities market on March 30th and the tax credit requires a buyer to be in contract by April 30th. If demand falls off after that, won’t prices fall?

From The TARP Report:

“In general, housing obeys the laws of supply and demand: higher demand leads to higher prices.”

We must realize the opposite is also true.

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