Friday, October 23, 2009

Is the Tax Credit + FHA a toxic combination?

It would be churlish not to think today's strong existing home numbers were good. But there is an aspect of it that worries me.

The tax credit is $8000. FHA loans require 3.5 percent down payments. Consider the position of an unscrupulous investor in housing. He gets someone to front for him as a first time buyer on a $200,000 house. He puts $7,000 down, and then collects the $8,000 credit. He pays the front person a commission of $500. So the investor gets $500 plus the house. If the house goes up in value, he sells; if not, he walks.

Of course, we have no recent experience with this kind of behavior....

9 comments:

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Austin Kelly said...

I think we have more direct evidence. In my paper on Zero Down Mortgage Default I find that FHA mortgages where the borrower didn't make a down payment from their own resources end up with lifetime foreclosure rates north of 20% in MSAs where prices were going UP at 4% per year. In an environment where prices are flat or falling it will be uglier.

Austin Kelly said...

OK. Embarrassing when you don't remember the numbers from your own paper. No equity at all mortgages had cum default rates lifetime north of 20%. Real equity, but not from the borrower's own resources, was more like 15%. This is the case most like the monetized tax credit. But the difference between 3% equity at origination and no equity at origination implies that the difference between 4% appreciation and 0% appreciation in house prices will get you to some foreclosure rates that will be nasty indeed.

Anonymous said...

They are trying to slow the drop in prices, but the method they chose will create a whole new generation of defaulting loans. Better to just let prices rapidly revert to marginal utility, which will clear the market. Then a recovery can be built upon a solid foundation of good debt.

The debt market will never get off taxpayer support unless foreign savers regain confidence in the integrity of private sector loans. A country that depends completely upon imported savings must carefully maintain its international reputation.

Alternatively, domestic savings could be balanced with domestic credit demand, but this would require positive after tax real interest rates to promote such balance.

Anonymous said...

I'm sure there are some who would take the chance, but for the overwhelming majority the tax fraud risk and deficiency judgment risk would be too great, especially for a net gain of $500.

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