The Republicans under George Bush passed a series of tax cuts that are due to expire at the end of 2012. Republicans are making this a campaign issue by scaring voters with the specter of a “fiscal cliff.” Economists have stepped forward with varying but dire predictions of the end of the US economy. Republicans hope they can scare enough people to win the upcoming election. They just might.
Lost in the campaign rhetoric is a careful examination of what the expiration of the various tax cuts really means. Will expiring tax cuts cause housing to fall off a fiscal cliff? It might, but not in the way most pundits imagine. The real danger is not from a damaged economy. That’s a red herring. The real danger is from higher personal tax rates resulting in a lower affordable debt-to-income ratio.
Debt-to-income ratios
There are three variables that determine how much a borrower can finance to buy a home: (1) interest rates, (2) income, (3) debt-to-income ratio.
Interest rates are inversely related to loan balance. At low interest rates, loan balances are very large, and at high interest rates, loan balances are very small. The federal reserve has drastically reduced interest rates to make bubble-era prices financeable to give borrowers the ability to bail out the banks with large, affordable loan balances.
Income is necessary to make payments, so obviously it’s part of the borrowing equation. That’s why lenders ask potential borrowers to prove they have income to service the loan. However, there is a limit as to how much income a borrower can reasonably set aside each month to pay a mortgage. Lenders forget this occasionally and inflate massive housing bubbles.
When prices began to crash in 2007, the government worked to develop the first loan modification programs. Since the government was working to save the banks, they set the debt-to-income ratio they considered “affordable” at 38% of a borrower’s gross income. A debt-to-income ratio of 38% is not reasonably sustainable, so nearly everyone who got those loan modifications failed. Later loan modification programs were set to the GSE underwriting guideline of 31% of disposable income. More recent loan modification efforts have been marginally more successful, although these efforts are still mostly can-kicking by the banks.
Prior to the housing bubble, bank underwriting standards and financial planner’s advice was to keep the debt-to-income ratio at 28%. So how did a 31% debt-to-income ratio become affordable?
Tax cuts.
The same tax cuts that are due to expire at the end of 2012.
Of course, it will take a few years for underwriting standards to reflect this fact. If personal income taxes do go up, it will take some time for the new defaults to become widespread enough to force lenders to tighten debt-to-income ratios. Lenders will be “surprised” by the increasing delinquency rates because they don’t want to acknowledge the connections between higher tax rates and the need to lower debt-to-income ratios to keep disposable income available to live a life. Banks don’t want to admit anything which would serve to limit lending and reduce their profits.
If the personal income tax cuts are allowed to expire at the end of 2012, the housing market will suffer. It won’t crash, but the pressure on borrowers will cause higher default rates which will inhibit lending. Eventually, this will lead to even more conservative debt-to-income ratios and smaller overall loan balances. Perhaps incomes will rise to compensate, but it’s still one more factor serving to limit future appreciation. And we all know how popular that is.
Could Housing Fall Off The Fiscal Cliff?
Morgan Brennan — 8/30/2012 @ 11:21AM
Fiscal cliff fears are here. With nearly $500 billion in simultaneous tax hikes and spending cuts set to take effect in January, economists have been forewarning the devastating consequences the so-called “fiscal cliff” could cause if Congress fails to come to a budget agreement before the end of the year. The latest report hails from the Congressional Budget Office (CBO), warning that inaction could plunge the U.S. into a “significant” recession in the first half of 2013.
Economists have focused primarily on the impact to overall gross domestic product (GDP), the financial markets, and businesses’ bottom lines. But what about housing? …
“Most consumers aren’t paying attention to the fiscal cliff. If the [local] housing affordability condition is good and they can get a mortgage, they are in the market,” says Lawrence Yun, chief economist of the National Association of Realtors (NAR). “However if the cliff was to be realized come January 1st and we do go into a recession, job losses could hamper the housing recovery.”
An outright recession and associated job losses would force the banks to rebuild shadow inventory as more borrowers go delinquent and fewer buyers step forward to mop up the mess. I don’t think this is very likely.
And housing has arguably begun to recover (albeit unevenly, with some markets still suffering losses). On Wednesday, July pending home sales were at their highest level in more than two years, according to NAR, and inventory continues to contract. The association projects home prices will increase 10% cumulatively over the next two years.
The NAr has no shame. Ten percent cumulative? I guess 5% a year — which is still optimistic bullshit — isn’t good enough, so they need to find a more exciting way to dress up their ridiculous predictions.
… the CBO projects a fiscal cliff could cost the U.S. two million jobs next year and cause the unemployment rate to stay stubbornly stuck above 8% through 2014. Fewer jobs could translate into less demand for new homes, possibly even a new wave of foreclosure filings as newly unemployed workers struggle to make mortgage payments.
That’s exactly what would happen.
While Yun asserts that buyers of U.S. homes currently pay little attention to what’s coming … . If 2010’s Bush Tax cut debate was any indicator, mounting economic and financial uncertainty could cause Americans — particularly Americans with higher levels of discretionary income — to pull back on consumer spending, holding off on major purchases like homes. At least until a resolution is realized.
… “The stability of people’s jobs does impact their confidence to spend moving forward,” adds Mark Cole. … Cole says average American families have been cautious about taking on new debt (if they can even qualify), choosing rentals over home purchases, according to the organization’s data.
The greatest fear of homebuilders is that potential futures buyers may chose to rent instead. California kool aid will make that unlikely here, but in the rest of the country, the bitter taste of the housing bubble may prompt many not to buy homes in the future. Many in the masses who are underwater regret their decision.
Indeed the one area of housing that could gain from mounting economic uncertainty is the already-booming rental market. “Renting is the cautious alternative and I think that trend will be exaggerated a little bit more if there is a fiscal cliff — or even if we come close to one,” says Barry Hersh, a professor at New York University’s Schack Institute of Real Estate. Rents are already expected to increase an average of 4% nationally this year and 4% in 2013, according to NAR. …
New home building will be hit hard if a recession is realized, too. “It will reverse the small gains we have made in home building thus far,” says David Crowe, chief economist of the National Association of Home Builders (NAHB). … New home starts remain about 50% down from the rate required in a healthy housing market. The lack of new supply is already causing an inventory crunch in some areas; a reversal could lead to larger inventory shortages in the coming years.
Despite the speculative doom and gloom, economists believe a fiscal cliff-spurred recession would not spark the kind of home price-hemorrhaging witnessed when the housing bubble burst five years ago. “Markets have already corrected from the bubble, and in some places, over-corrected,” asserts Yun. “Even if there is a fiscal cliff, I suspect Congress will rectify that situation within a few months so it will be a very short term negative before the problem gets resolved.” Here’s hoping the realtor’s right.
Given the dismal failures of our centrally planned economy over the last several years, I don’t hold out much hope for future success of government or federal reserve policy.
The fiscal cliff may cause disruptions in the housing market, but how would we tell? Banks have already completely manipulated the market by creating a massive shadow inventory and endlessly can-kicking. Even if we do fall off the fiscal cliff, the banks will continue just as they have before, and our housing market will exist in a surreal never-land of bank and government manipulation just like it does today.
More than four years of squatting
If anyone doubts the can-kicking game the banks are playing, have them explain properties like this one. The owners were served their first notice of default in December of 2007 (which means they were delinquent at least 90 days before then), and the foreclosure didn’t happen until December of 2011.
- Today’s featured property was purchased on 2/2/1996 for $240,000. The owner used a $228,000 first mortgage and a $12,000 down payment.
- On 12/29/2000 he refinanced with a $276,000 first mortgage.
- On 3/18/2002 he refinanced with a $386,750 first mortgage.
- On 7/28/2004 he refinanced with a $518,000 first mortgage.
- Total mortgage equity withdrawal was $290,000. As with the other former owners I have profiled, this excessive borrowing cost him his home.
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Proprietary OC Housing News home purchase analysis
22351 FALLEN LEAF Rd Lake Forest, CA 92630
$529,900 …….. Asking Price
$240,000 ………. Purchase Price
2/2/1996 ………. Purchase Date
$289,900 ………. Gross Gain (Loss)
($19,200) ………… Commissions and Costs at 8%
============================================
$270,700 ………. Net Gain (Loss)
============================================
120.8% ………. Gross Percent Change
112.8% ………. Net Percent Change
4.8% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$529,900 …….. Asking Price
$105,980 ………… 20% Down Conventional
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$423,920 …….. Mortgage
$101,929 ………. Income Requirement
$1,915 ………… Monthly Mortgage Payment
$459 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$132 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$126 ………… Homeowners Association Fees
============================================
$2,633 ………. Monthly Cash Outlays
($300) ………. Tax Savings
($661) ………. Equity Hidden in Payment
$121 ………….. Lost Income to Down Payment
$86 ………….. Maintenance and Replacement Reserves
============================================
$1,879 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,799 ………… Furnishing and Move In at 1% + $1,500
$6,799 ………… Closing Costs at 1% + $1,500
$4,239 ………… Interest Points
$105,980 ………… Down Payment
============================================
$123,817 ………. Total Cash Costs
$28,800 ………. Emergency Cash Reserves
============================================
$152,617 ………. Total Savings Needed
The property above is available for sale on the MLS.
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31 Responses to “Will rising taxes force housing over the fiscal cliff?”
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Kind of a damned-if-we-do or damned-if-we-don’t situation, isn’t it?
If the tax cuts are permitted to expire and taxes are hiked in January, there will likely be higher unemployment and buyers will be able to afford less… and housing prices will crater again.
But if we were by some miracle to be touched by common sense and REDUCE FEDERAL SPENDING BY REDUCING THE HUNDREDS OF BILLIONS TO TRILLIONS WE SUPPLY IN SUPPORT TO LENDERS AND THE HOUSING MARKET, we could cut federal spending, avoid tax increases altogether and edge away from a fiscal precipice…… but without that support, the housing market would crater.
I like the second solution better as it is fairer and allows price discovery, but I sincerely doubt that even the most ardent Tea Party Republican really wants tax cuts at the expense of his house values and that if we were to take these people at their word and let the free market function freely, these people would be wailing as loudly as any Welfare State Democrat.
The local house Republican, John Campbell, has consistently lobbied for more government handouts to prop up local home prices. His hypocrisy is appalling.
Although, I wrote Campbell and asked if he supported Obama’s desire (Feinstein’s bill) to extend HARP 2.0 to non-agency mortgages, and he responded with a very detailed well-explained letter as to why he wasn’t supporting this bill.
I wonder how he would stand on a bill to raise the conforming GSE limit?
He should take a stand against extending HARP 2.0 to non-agency mortgages. All this would accomplish is to allow lenders to offload their toxic jumbo loans on the US taxpayer. At least he had the courage to make that stand.
Both parties love to spend taxpayer dollars. Please don’t suggest otherwise in a partisan post…
Remember Clinton ran on being anti-NAFTA, but his priorty once in office was to pass NAFTA. 1st Bush: No new taxes, once in office fee (not a tax) on each saving deposit. 2nd Bush: No indiffent arresting without trial like Clinton is doing, release the 2 univ. professors, but almost immediately re-arrested them, but gave them a trial. Then the Patriot act.
Reality is, an imploded business model has already pushed housing over the cliff.
Relying on credit to leverage income and lowering interest rates to increase leverage only works when incomes rise and you can lower rates.
The next push will come on the income side as interest rates are left at super low levels to create inflation. Of course, inflation-based wage growth is an illusion, but as long as nominal prices go up, the masses won’t complain.
Hard for the average family to complain about a gallon of milk costing $8 when their family is pulling in “six figures.” That’s the magic mark, no?
Perspective,
Say 99 people’s income is $10,000 per year and 1 person’s income is $1,000,000,000. The average is 100,099,000. The medium income is $10,000. An $8 gallon of gas would have lots of people complaining.
The median household income for OC is under $100,000. The median for Irvine is zip code dependent — $110,000 to $160,000 a few years ago. Since many in Irvine are self employed or executives, income can be hidden or postpone into capital gain as opposed to wage earners who can’t hid income.
I think the problem is that wages usually lag costs – gas will go up FIRST and then people will push for higher wages to try and “keep up.” In the inflation of the late 70′s (before the sky high interest rates killed it) this was the problem. Of course, the economy back then was far more dependent on energy prices, so increases in oil costs had a much bigger effect on the economy. The psychology is one of enormous fear as consumers see prices increase more rapidly than their wages. This leads to demands for price controls, or accusations that producers of a given commodity (oil, milk, whatever) are “gouging” the public.
Will,
The 70s are so far removed from the experience of today’s consumers, most have forgotten all those ills. But you’re right, the cost push always precedes the wage inflation. With high unemployment, I don’t see this time as being any different.
“the cost push always precedes the wage inflation” usually there’s a few round of inflation with little deflation in the middle to justify delaying the wage inflation.
For the older ones, remember the “W.I.N.” whip inflation now . It was just a govt program to slow wage inflation while allowing inflation in all other area. The govt and talking heads blamed inflation on wage inflation and the unions instead of monetary policy with excessive debt and money supply greater than productivity and rigging commodities and oil prices.. Wage inflation lagged inflation.
Any body remember WIN or am I that old?
newbie2008, I remember Ford’s “WIN” program and yes, you are that old…
Is an illusion that tricks people. With the progressive tax codes on wage earners, they are kicked into a higher tax bracket, so lose a higher percentage of their income. Also important expenses such as medical care and education goes up faster than income. The caps to recevied financial aid goes up less than inflation. It’s as lose/lose for wage earners. It’s a win/win for percentage based income collectors (govt who collect taxes, groups that charge a fee based on percentage, e.g., RE peddlers, loan originators, etc.). A win/lose who have hard assets. A possble win for those that have debt at fixed long-term rates.
“A possble win for those that have debt at fixed long-term rates.”
That’s one of the best reasons to buy real estate today. I heard Peter Schiff say that people who pay off thirty year mortgages today will spend more on postage on the final payment than the payment itself.
It’s a little short on details, but I though some people here would be interested. I wonder if each candidate will release more details now.
Romney releases some details about his housing plan
Overview
For millions of Americans, homeownership is about more than just a place to live. For many, owning a home is the fulfillment of the American Dream. Yet today, the dream of home ownership is out of reach for many Americans as a result of President Obama’s failed policies and stalled economy.
Owning a home is oftentimes the most significant investment a family makes during their lifetime. The housing crisis of the last few years has reduced the value of this investment at a time when middle-class families already continue to struggle in an economy stuck in first gear.
Obama’s Failure
The only path to a healthy housing market is a healthy economy, but a housing recovery is central to a healthy economy. President Obama promised a much healthier economy by now, but the economy he promised is nowhere to be found. Instead, our nation’s economy remains stuck with unacceptably high unemployment and economic growth too slow to ever reach a full recovery. The bottom line is that the President’s policies to improve the economy haven’t worked.
Under President Obama, home prices have fallen, homeowners have received more than 8.5 million foreclosure notices, and 11 million Americans owe more on their mortgages than their homes are worth. President Obama’s only plan to address the housing crisis was the same plan he used to try to fix the economy: spend more taxpayer money on big-government programs. To address the housing crisis, President Obama rolled out an alphabet soup of more than ten housing finance programs rather than offering a real solution. Meanwhile, credit-worthy borrowers are struggling to get a loan as a result of the uncertainty caused by the President’s policies.
By continuing to insist on a government-centric approach to housing and to the economy more generally, President Obama has hamstrung the economic recovery and slowed the recovery of the housing market. Right now taxpayers are on the hook for almost 90 percent of all new mortgages. The two government-sponsored government housing corporations (Fannie Mae and Freddie Mac) fueled a predictable disaster and President Obama has done nothing to reform these entities.
Mitt’s Plan
Understanding that a healthy economy is the key to a healthy housing market, Mitt Romney has an economic plan that will result in more jobs and more take home pay. Independent economists estimate that the plan will create 12 million jobs by the end of his first term, an essential element to ending the housing crisis.
A Plan To End The Housing Crisis
* Responsibly sell the 200,000 vacant foreclosed homes owned by the government
* Facilitate foreclosure alternatives for those who cannot afford to pay their mortgage
* Replace complex rules with smart regulation to hold banks accountable, restore a functioning marketplace and restart lending to creditworthy borrowers
* Protect taxpayers from additional risk in the future by reforming Fannie Mae and Freddie Mac
In towns across the nation, foreclosed homes sit empty, depressing the value of entire neighborhoods. The government owns about 200,000 of these homes, or almost half of all of the foreclosed homes in the country. Mitt Romney will responsibly get the government out of the homeownership business and return these vacant homes to productive uses that will increase neighboring home values.
Foreclosures are a difficult, long, and expensive process for homeowners and lenders alike. Mitt Romney will facilitate creative alternatives to foreclosure for those who cannot afford to pay their mortgage. These alternatives will minimize the instability of communities hard hit by the housing crisis, preserve the credit of homeowners, and can help keep families in their homes.
Since the housing crisis, the government has produced more than 8,000 pages of new rules and regulations. The problem is that they are poorly designed, and have made it harder for people with good credit to get loans. Mitt Romney will put in place smarter regulations to restore a functioning marketplace that holds banks accountable and restart lending to creditworthy borrowers.
Any serious plan for ending the housing crisis must address its root cause. Two government-sponsored companies known as Fannie Mae and Freddie Mac were at the center of the housing crisis. Mitt Romney will reform these government-sponsored companies to protect taxpayers from additional risk in the future by ensuring taxpayer dollars in the housing market are replaced with private dollars.
‘a little short on detail’
what details? There are no details whatsoever in this so called plan. It sounds like a list of ‘wishful thinking’ without any plan on how he plans to get there.
REO Saturation Rate Falls for First Time in 2012: Clear Capital
While home prices remained little changed, the REO saturation rate fell for the first time this year, according to Clear Capital’s Home Data Index Market report, which included data to the end of August.
The REO saturation rate, which calculates the portion of REO sales relative to total sales, slipped 6.4 percentage points from the previous quarter to 20.5 percent. The drop is the lowest the REO saturation rate has been since April 2008. At its peak, the REO saturation rate was 40.2 percent in the first quarter of 2009.
Although the market is seeing a decrease in the volume of REO sales, fair market sale volumes are increasing, leading to more activity in the owner-occupied sector, the real estate data provider explained.
According to the report, the first phase of the recovery was strengthened by REO-only price trends, but August gains were due largely to strengthening in the fair market segment as investment purchases slow down.
“Sustained growth in the fair market segment could build a foundation for Phase Two of the recovery,” Clear Capital stated.
Home prices, which include sales prices for REOs, increased 1.9 percent on a quarterly basis in August, little changed from the 2 percent quarterly gain in July. Year-over-year, home prices rose 2.9 percent.
All four regions saw price gains, with the West leading growth with a 3.8 percent quarterly increase and 7.7 percent yearly rise. Prices in the Midwest rose for the first time since April 2010 on a yearly basis, edging up 0.5 percent; quarter-over-quarter, prices were up 2 percent.
Prices increased quarterly and yearly in the South by 1.5 percent and 2.5 percent, respectively. The Northeast saw respective quarterly and yearly increases of 0.5 percent and 1.3 percent.
Quarter-over-quarter, two metros posted double-digit gains: Milwaukee, Wisconsin (12.5 percent) and Seattle (10.4 percent).
Despite having an REO saturation of 48.8 percent, Detroit managed to see a 5.9 percent price gain, but still experienced a yearly decline of 1.7 percent.
Dayton and Houston were the worst performing metros on a quarterly basis, each seeing price declines of 4.9 percent.
Every pop or increase in price, no matter how short, will be used as an arguement that you better buy before you’re priced out of the market.
Every RE transaction is a large transfer of wealth (RE sale 4 to 6%, loan origination fees 1%, loan application fees, RE transfer tax fees, hidden fees of bank’s loan service fees, WS MBS fees, ….). The question is: “Is the increase in the velocity of money worth the sum of all these fees?”
The % fee based on transaction cost really doesn’t make sense if their skin or money is not in the game. It takes just as much work to sell a house in the mid-west as it does it OC, but the commis is 3x less in the mid-west than in OC.
Percentage-based business models will do well going forward. They always keep up with inflation.
I also expect we will hear more kool aid about being priced out to create urgency. Liars never learn.
The fiscal cliff argue is akin to the mob saying “if you don’t pay our friends and me, you’ll have a house fire and hopefully no one will be injured. But we’ll be there to help rebuild after the fire for a fee.” Or the drug addicts saying “if you don’t supply me to supply the community with subsidized or free junk, you’ll have high crime rate and I won’t be responsible for what happens to you or your family.” These people are all hoods in disguise.
Swedes had a good model for taking care of their prior banking crisis and getting on the road recovery. Maybe the USA can regain their sovereignty.
I wonder what it will take for Americans to rise up against the corporate oligarchy. I thought Obama would be more of an FDR populist, but he has done little to wrestle control of the government back from the too-big-to-fail corporations.
People have to abandon the parties. But the media machine is just too powerful and influencing these days. The last time Americans revolted against the two parties was in the 1800′s.
Nothing will change except our ability to afford anything. Welcome to Banana Republic of America.
For BHO it was obvious. You just had to look at who was funding his campaign four years ago. WS dumped the Republicans and when in full-force with the Internet non-disclosed contributions. WS got $2 to 3 trillion more bailout money and removal of much of the liability in BHO’s first act to “avert a depression” or” just the best govt that money can buy”. I don’t understand why delivering $3 trillion to WS was not enough. No loyalty from WS or a great game to play both parties on who can please the master the most. Remember FDR rolled back the anti-trust legislation and created govt sanctioned cartels (corporate controlled regulatory agencies) to set minimum prices, but FDR did strengthen the labor movement.
There is essential no opposition party or news media in America. People in America are have too much to lose. As well fed slave is not likely to buck the system and is willing to sell off their children for an easier life.
FDR has a populist radio talk to assure Americans that their govt has not forgotten them and cared for them. FDR has media support. While Americans were starving, FDR had farmers destroy crops by burning grain, plowing under crops instead of giving the food way or allowing food prices to drop to an affordable level. It was more important to keep up the illusion that the govt was doing all it could for the little guy while the bailouts were for the larger industries and large $ political friends/supporters. Powerful political enemies were maligned in the media, while less powerful political enemies were imprisoned. There really nothing new in govt.
Many people though the bank robbers as folk heroes.
The banker’s fantasy of a housing market recovery
By Irwin Kellner, MarketWatch
PORT WASHINGTON, N.Y. (MarketWatch) — As the U.S. economy rounds the Labor Day turn, it appears that, after several false starts, the long-depressed housing market is finally climbing out of the basement.
It is nothing more mysterious than supply and demand. For the first time in a number of years, the supply of both new and used homes available for sale has dropped below demand.
No matter what the product or service, whenever demand exceeds supply, rising prices are sure to follow. Housing is no exception. Prices are rising both quarter-to-quarter and year-over-year for the first time in two years.
This turnaround in prices is apparently convincing would-be homebuyers that it does not pay to delay — especially since mortgage interest rates are at 60-year lows, and homes are the most affordable they have been in at least a quarter of a century.
As a result, buyers have begun to deal. Home sales are up more than 20% from a year ago, while pending sales are now at a 2-1/2-year high. This should kick home prices even higher, and thus spur even more buying.
Tell you what, a lot of seasoned OC ‘flippers’ and ‘slumlords’ I’ve maintained contact with over the years are cry’n the blues BIG TIME right now…..absolutely livid about the voluminous cash outlays required to bring their newly acquired REO SFR’s up to par before presenting to market.
hearing the words “not penciling out” quite frequently.
“hearing the words “not penciling out” quite frequently.”
In Orange County, it never did. Even now, it’s difficult to find any property with a cap rate above the investor loan interest rate. Many people think they find properties that work, but mostly these are inexperienced landlords who don’t realize how much it actually costs to maintain a property.
Lots of newly refurbished inventory (on someone elses dime
) slated to hit the pipeline once they decide to ‘cave’ and head for the exits. Should wages/labor fail to gain significant traction in the coming months (it wont), the ‘when’ could be as early as this Spring.
I hope you are right. I’m guessing that too. I’m keeping my 20% locked and loaded.