Tax Credit Leads to Burst in Sales in September

November 4, 2009 (Housing Market Monitor)

By Dean Baker

November 4, 2009

Vacancy rates hit a new record in the third quarter.

The National Association of Realtors’ pending home sales index jumped 6.1 percent in September after rising 6.3 percent in August. It stood 36.9 percent above the low hit in January, almost reaching the year-round average for 2006 at the peak of the bubble. There were substantial differences by region. Pending sales in the Northeast and South were down by 14.2 percent and 13.6 percent, respectively, compared with 2006 levels. By contrast, September sales in the West were 31.3 percent above 2006 levels. This is likely the result of foreclosed homes being resold. Sales in the Midwest were down 3.3 percent from 2006 levels.

Clearly the rush to buy a home before the November 30th expiration of the first-time homebuyers’ tax credit was the main factor spurring the September jump. This can be seen by the persistent falloff in the Mortgage Bankers Association’s mortgage applications index for applications for purchase mortgages since the end of September. This index is now below year-ago levels, a period in which the economy had already entered its stage of sharp descent.

The extension and expansion of the homebuyers credit will help to sustain the market until its expiration at the end of April, but it is unlikely to have anywhere near as large an effect as the original credit. Many potential first-time buyers moved forward their purchase with the expectation that the credit would expire at the end of November. As a result, the pool of potential first-time buyers is much smaller now. Extending the credit to homeowners who have been in their homes for 5 years will enlarge the pool somewhat and spur some additional purchases, although probably not as many as the initial credit.

Of course, after this credit expires at the end of April (the new credit is based on the contract date, unlike the current credit which is based on closing dates), Congress will face the choice of whether it is prepared to remove this source of support for the housing market or will just let demand slump again.

The Fed is committed to ending its purchases of mortgage-backed securities by the end of March. This date can also be pushed back, but the Fed will be reluctant to do so because of the signals it would send about the state of the economy. This means that we could be seeing substantially higher interest rates (the Fed’s purchases probably lowered rates by between 0.5-0.75 percentage points) at the same time that the tax credit is expiring.

The decision to raise the income caps on the tax credit make for some very peculiar targeting with this money. Only about 5 percent of families had incomes that pushed them above the original cutoffs. Therefore, the impact on purchases will almost certainly be very small. Also, since higher income families are generally buying more expensive homes, the tax credit is less likely to make the difference in their decision on buying a home.

The main impact of raising the income cap on the tax credit will simply be to redistribute taxpayer dollars to relatively upper-income homebuyers. This is a peculiar choice for Congress at a time when so many people are suffering the effects of high unemployment.

The Census Bureau released its vacancy data for the third quarter last week. The new record high went largely unreported. The vacancy rate for rental units jumped 0.5 percentage points to 11.1 percent, a new high. The vacancy rate for ownership units also edged up to 2.6 percent. The total number of vacant units stood 400,000 above its year-ago level.

The vacancy data is the best measure of the underlying supply and demand in the housing market. If analysts had paid more attention to trends in the vacancy rates during the boom years, they would have more quickly recognized the housing bubble. Unfortunately, even after this incredible failure of foresight, this important data release is still being largely ignored. The implication of the data is that there continues to be an enormous amount of excess supply in the housing market. This will only be brought down through sharp further declines in prices.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.