We’re with the government and we’re here to help
There is an old phrase that says “That guy couldn’t find his backside with two hands and a map”. It’s a great saying because conveys both humor and information at the same time. Upon hearing it you know exactly the type of person that you’ll be dealing with. This phrase reminds me of the government’s actions lately. There has been a lot of meddling in the markets as the bureaucrats try to “fix” things and we’re starting to see a few unintended consequences. I don’t generally need reminders that the government isn’t good at running things, but sometimes you get one that is so funny that it hurts. Today a report is out on the governments “First Time Home Buyers” program. This program gives up to an $8,000 tax credit to first time home buyers under the theory that this will stimulate demand for houses (more on this later).
The latest headline news on government efficiency reads “Treasury says that Four-Year old child received homebuyer tax credit.” Now that headline really makes me smile. It’s not the kind of smile you get when you hear of some hard working American experiencing the pride that comes with buying their first home…it’s more the smile of the experienced veteran watching the head-strong rookie stumble blindly from one bad situation to another that could have easily been avoided if only he’d asked for some advice. Treasury dryly noted in their testimony before congress that “Some key controls were missing to prevent an individual from erroneously or fraudulently claiming the credit and receiving an erroneous refund of up to $8,000”. Classic government operations at their best. Can you imagine the press conferences on capitol hill if a BANK had done this?
Low rates for “an extended period”
The government is bending over backward to keep rates low to support a broad based economic recovery. The Fed took short rates to zero and has been buying heavily in the MBS and Agency sectors to keep spreads low. If you push the Treasury curve down and then push MBS spreads down too you will generate lower mortgage rates…which is exactly what the Fed has done. However, just because you make rates artificially low doesn’t mean that people will magically qualify for loans.
The first obstacle to this plan is that we are in the middle of a bad recession. People are scared and generally don’t want to take on more debt…as witnessed by the declining consumer debt figures and the increasing consumer savings figures. It’s a pretty natural development…if you’re worried about losing your job and your home, your behavior changes. You shed debt and you increase your savings. Cash becomes king and living within your means is cool again. Suddenly you don’t feel the burning desire to go out to eat every night, buy big screen TV’s, and look for a new house complete with a big payment attached. So behavior is the first obstacle. And this obstacle doesn’t look likely to change any time soon.
The next obstacle is the credit quality of the prospective buyers that do exist. Just because someone likes current mortgage rates doesn’t mean that they qualify for a loan. Credit standards have tightened…and rightfully so. Now, if you multiply the remaining prospective buyers times the percent that actually qualify under current credit standards your pool of potential buyers is beginning to shrink in a material way.
Another consideration is oversupply and foreclosures. These factors need time to work themselves out. Many willing and able buyers are going to stay on the sidelines until they feel confident that factors like foreclosures won’t continue pushing home prices down immediately after they buy. Who wants to be underwater the month after you buy? A recent story on CNN Money states that the national median home price is expected to drop 11% by June 2010.
No amount of short cuts and government programs can change the fundamentals in this sector.
First time homebuyers
The first time homebuyers program is designed to stimulate demand by giving up to $8,000 to qualifying buyers. Obviously this will draw some people into the market, which will support home prices to an extent, which will have far reaching effects down the line. So easy a bureaucrat can do it. What could be easier?
The problem is that at its best this program is simply pulling future consumption into the present. So the question becomes what happens to this demand when the program stops? It’s not too difficult to reach the conclusion that when the free money stops demand will slow down. The problem with this type of demand is that it’s not sustainable. The government simply can’t spend enough on these tax credits to “fix” the housing sector.
Two big hurdles for the housing sector are approaching. The first is going to be the end of the first time homebuyer credit program. This program is due to expire in November. At the least this will reduce demand from new home buyers, at worst it might have already sucked future activity into the present…leaving a gaping hole where that demand would have been absent the program. Yogi Bera was at a pizza shop one time and they asked him if he wanted his pizza cut into six slices or eight. He responded “six slices…there’s no way I could eat eight.” The government will find this same situation in the housing market. You can pull future buyers into the present with a tax credit but you’re really just shuffling buyers around…you can slice it any way you want but the market is still the same size. So that’s the first hurdle.
The second hurdle USED TO BE THE FIRST HURDLE…in that it was supposed to have already happened. The Fed was supposed to terminate their MBS purchase program in October. That didn’t happen. They realized that there was nobody there to take the baton from them. If they quit buying then MBS spreads would widen out until they reached a level that enticed new buyers. I talk to a lot of investors and I don’t have even ONE investor that is clamoring for more low coupon 30 year MBS. The Fed currently owns 34% of the MBS pass through market…they are the only ones willing to buy long MBS at these levels. And they NEED these levels for their plans to work…they must keep borrowing costs low. They couldn’t quit the program in October because doing so would have caused mortgage rates to rise…so they kicked the can down the road to 1Q 2010.
Will they be able to exit in 1Q 2010? Who will step in to buy at these levels? If they exit and nobody steps in to buy then MBS spreads will widen until the market finds them attractive…water will seek its own level so to speak. The Fed is looking at a tough set of choices. If organic market liquidity hasn’t returned by March 2010, then they are either going to have to extend their buying program again or find a way to get comfortable with higher mortgage rates….but who knows…maybe they’ll come up with another new and efficient government-run plan.
Tax Credits for kids
I guess tonight I’ll go home and ask my 6-year old daughter and 9-year old son what they would do with $8,000 apiece. I think I know the answers…and it involves a lot of Chuck E. Cheese and video games. Maybe this government program fraud stuff is the way to go…it would surely stimulate the economy better than any government program I’ve seen so far.
As always if you have any questions or if there is anything I can be doing for you just let me know.
Steve Scaramastro
800-311-0707
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