In February of 2009, with the housing market in a free fall, Congress decided to add a first-time homebuyer tax credit to the stimulus proposed by President Obama. While the credit paused the decline in home prices, a new report from the Center for Economic and Policy Research (CEPR) shows this was only temporary and actually resulted in luring millions of homebuyers into paying too much for their homes.
“While offering a tax credit to new homebuyers did lead to a jump in home sales, a big part of the story is that people who were thinking about buying in the next year or two simply bought earlier to take advantage of the credit,” said Dean Baker, author of the report and a co-director of CEPR. “Of course, after the expiration of the credit, prices began to slide as home sales fell once again.”
The report, “First Time Underwater: The Impact of the First-time Homebuyer Tax Credit,” examines the effects of the first-time homebuyer tax credit on the housing sector. Baker estimates that hundreds of billions of dollars were redistributed from new homebuyers to sellers and creditors due to the tax credit. Then the paper looks more closely at the impact of the tax credit in ten cities that were most affected by it.
With home prices falling at close to a 20 percent annual rate at the time of the passage of the stimulus package, the first-time homebuyer tax credit did temporarily reverse the drop in home prices. Unfortunately, since the housing bubble had not fully deflated at that time, this reversal could not last. In effect the credit artificially held prices above trend level.
Once the credit expired, sales plummeted and home prices began to slide again. Many of these new homeowners soon saw their mortgages ‘underwater’, a situation in which the value of a home is less than the value of their mortgage. On the other hand, those who sold their homes before the expiration of the tax credit benefited as did their lenders since they may have been forced to accept short sales or possibly deal with a foreclosure had the tax credit not pulled purchases forward. This amounted to a significant transfer of wealth from new buyers to sellers and creditors. Baker estimates the size of these transfers as ranging from $5,300 to $10,600 (in 2009 dollars) for every homebuyer who purchased a home over the 34 months from passage of the tax credit through the end of 2011.
Of course, these differences varied by region. Since the credit was capped at $8,000, it had the largest impact on the lower portion of the market in less expensive cities. To clearly demonstrate these differences, the report examines the price decline in the lower tier of the housing markets in ten major cities – Atlanta, Chicago, Las Vegas, Miami, Minneapolis, New York, Phoenix, Portland, Seattle and Tampa. The worst losses were seen in Chicago, which saw a decline of 31.5 percent, and Atlanta, where prices in the bottom tier fell by 49.1 percent. In all ten cities, prices in the bottom tier fell by at least 10 percent between the tax-credit induced peak of 2010 and December of 2011.
While the tax credit was successful in temporarily halting the collapse of the housing sector, the report demonstrates that this was a stop-gap solution at best. By enacting this tax credit when home prices were still above their long-term trend level, this policy mainly had the effect of transferring wealth to sellers and lenders at the expense of new homebuyers, who quickly saw their mortgages go underwater after the credit expired.