The latest data from the S& P Case-Shiller house price index suggest that U.S. housing prices are increasing at an accelerating rate. Sufficient time has elapsed to conclude that U.S. house prices bottomed in January 2012. Since that time, house prices have rebounded by over 10%, on average, with increases in excess of 20% in both Las Vegas and Phoenix. The housing rebound has stimulated construction spending to refurbish foreclosed properties and build new ones, which has added about 0.4% to GDP growth over the past year. While the conservatorship of Fannie Mae and Freddie Mac ensured mortgage credit continued to flow during the crisis, most other housing policy initiatives – especially the homebuyer tax credit and mortgage modifications – served to postpone today’s housing recovery rather than accelerate it.
As explained by e21 in 2009, the homebuyer tax credit was a dreadful idea. Since there is no way to delineate between those homebuyers incented by the tax credit to make the purchase from those who would have bought a home anyway, the policy was always likely to prove to be a highly inefficient use of taxpayer resources. Estimates of transaction volumes suggest the program spent between $1.33 and $7.50 for every $1 of stimulus. But the bigger problem was that the artificial transactions stimulated by the credit prevented housing from finding its natural bottom, which pushed investors and developers to the sidelines. Between early 2009 and the expiration of the credit, U.S. house prices rose by 5%, on average, only to fall by 7% in the months following the credit’s expiration (see Figure 1).
The credit actually made buyers worse off than if they had ignored the policy and waited to purchase a home when the credit expired. For a $250,000 home, the $8,000 credit amounted to a 3.2% savings on the purchase price, which was less than half of the 7.1% decline in average home prices between the credit’s expiration and January 2012. The buyer who waited until January 2012 saved $17,750 instead of $8,000. By stimulating artificial transactions, the credit subsidized existing homeowners by allowing them to sell at a higher price than would have prevailed otherwise.
The lack of appreciation for market dynamics also doomed the Home Affordable Modification Program (HAMP). SigTARP estimates that 46% of HAMP permanent mortgage modifications from Q3-2009 subsequently re-defaulted. These re-defaults generated foreclosures that added to the unsold inventory of 2010-2011, which placed further downward pressure on house prices during that time. If a homeowner has a $300,000 mortgage on a house with a market value of $150,000, a policy aimed at reducing the interest rate on the $300,000 balance is unlikely to prove successful. Temporarily keeping these homes out of foreclosure through payment modifications simply delayed the inevitable defaults necessary to recalibrate mortgage balances to house prices. At the end of Q1-2013, only 862,279 homeowners were in an active permanent HAMP modification, less than 25% of the 4 million expected.
The upturn in house prices only occurred when investors began buying homesen masse as rental properties. These investments boosted economic activity because the homes generally needed to be rehabilitated before they could be rented, which required investment in construction materials and labor. In the hardest hit markets, the market price of a home dipped below its replacement cost. This meant it was cheaper to buy a home and refurbish it than to invest in the materials and labor necessary to construct a new one. Moreover, the cost of buying a home in these markets fell below the cost of renting an otherwise equivalent residence. Both anomalies made buying homes as rental properties attractive and the bids from institutional investors exerted upward pressure on house prices. By setting a floor, these investors also led cautious prospective homebuyers to come back into the market and transformed “deflationary expectations” into expectations of increasing prices, which also boosted construction spending on new homes and apartment units.
Some have questioned the ethics of allowing institutional investors to profit from housing investment given the scale of the human suffering since the bubble burst. But the recent gains in house prices are extremely modest relative to the bust. As shown in Figure 2, house prices remain 30% to 50% below their 2006 peak in the key “bubble” markets of Florida, Arizona, Las Vegas, and parts of California. The typical $400,000 property in Las Vegas, for example, is now worth just $185,000 even after the 21% increase since January 2012. The house is still worth less than half of the typical mortgage originated in 2006 (equal to $380,000 assuming a then-customary 5% down payment). For the homeowner, the economic damage stems from owing $380,000 on something worth a fraction of that; the 21% gain enjoyed by the investor who purchased this house for $153,000 in 2011 is of no consequence. Government policy aimed at keeping these households in their overpriced homes through payment modifications simply delayed the inevitable default, which was the only way for the household to discharge the overpriced liability.
By generating artificial sales at inflated prices and delaying the natural pace at which the inventory of foreclosed properties came to market, government policy retarded the housing recovery by pushing investors to the sidelines until prices found new bottoms and the size of the “shadow inventory” could be better quantified. Government policy was based on a mis-specified social goal of “keeping people in their homes” when the problem was an economic disconnect between house prices (which had fallen dramatically) and mortgage principal balances (which remained fixed at elevated levels). In these situations, the best government can do is to ensure that credit remains available for would-be borrowers and to lower interest rates, to increase the price of homes and other long-lived assets. Had policymakers avoiding dabbling in tax and mortgage renegotiation policy, today’s housing recovery would have likely occurred 12-24 months earlier.
