You might think there's little to be negative about with the $8,000 First Time Homebuyer Tax Credit. After all, I've already shown how it boosted sales and housing starts in the Billings area. The credit proved to be so "popular" that it was extended for an additional 7 months (but as one commentator wryly noted, it's hard to find a government giveaway that's not "popular!").

While we're still on the temporary credit-induced high, I'm going to argue that this program will eventually hurt the Billings market more than it has helped it. Here are the four reasons why:

1. The tax credit delayed a necessary downturn

In early 2009, I presented evidence that prices were already falling significantly in Billings. Some sellers were desperately trying to unload at 10% or more below what they paid a few years earlier. Then the homebuyer credit kicked in and changed things. Sales improved, and prices seemed to stabilize.

Propping a market up using a temporary subsidy can work, but only for awhile. The unintended consequences that follow may be worse than the original downturn would have been.

Since 2006, I have been cautioning that the Billings housing market seemed overheated and overpriced for the current income levels. If it needs to come down as I suspect, then it would have been better to allow home prices to take their natural course and come down gradually. Tampering with a market to postpone an inevitable correction only makes that correction sharper when it finally comes.

2. The tax credit encouraged marginally-qualified buyers to jump in

This is not a new phenomenon, but I think the tax credit made it worse. Increasingly over the last decade, the government has encouraged anyone and everyone to buy a house. But the "ownership society" idea missed the simple (and to some, uncomfortable) fact that many people are not in a position to buy a house. Some don't have any money saved, and some don't have the income to support the kind of house they want. People were encouraged to buy anyway instead of working to get into a better position.

5+ years of easy money drew in many people who shouldn't have bought a house when they did, or shouldn't have bought as much as they did. Unfortunately, the tax credit just provided another incentive for people to get themselves in trouble. With interest rates unbelievably low, a free $8,000 just for buying a house, and almost zero cash required, who wouldn't be tempted?

Thanks to this policy, we'll probably see increasing defaults and foreclosure problems in Billings in the coming years.

3. The tax credit spurred homebuilding when we already had too many houses

In early 2009, I presented supply and demand graphs showing how home inventory was rising at the same time that sales were falling. These market forces were driving prices down.

Then the homebuyer credit threw a wrench into things. Sales rose almost immediately as buyers took advantage of the money. These buyers particularly demanded houses in the $100k-$200k range. Local home builders ramped up construction efforts to fill this need.



Above you can see a street in the Riverfront Pointe subdivision. Wells Built Homes filled this street with houses in a matter of months, thanks to the tax credit. These newer, entry-level homes (most of them $180k-$200k) were in high demand by first time home buyers.

In this whirlwind of activity, a few important points may have been overlooked. I'm not sure that the fundamentals in place a year ago really changed. We probably still have too many houses, but that fact was temporarily hidden by the frenzy of sales from the tax credit. Builders built and built (and are still building) during a time that we already had high inventory. When the credit goes away, we may find we are in even worse shape than before-- falling sales, and even higher inventory.

4. The tax credit pulled demand forward even further

Just a generation ago, it was quite common for a married couple to save for years and be well into their 30's before buying a house. The housing boom changed that. Suddenly, it's become quite common to own a house in your mid-20's. For young newlyweds, it's almost expected. We've even seen college students buying houses to get in on the appreciation.

This is known as "pulling demand forward." During the last decade or so, new demographic groups of buyers entered the market as never before. All the normal buyers plus these newer, younger buyers combined to help fuel the housing boom of the last 10 years.

And now this tax credit for new home buyers has pulled demand forward yet again. Anyone who was even thinking about buying recently now has a great incentive-- grab the $8,000 before it goes away in June. Every person who could possibly want a house should have one by this spring.

At the end of this tax credit-- who's left to buy? Sure, we have new workers coming from the college and high school ranks (if they can find good-paying jobs, that is). But we've been so busy selling houses that our metrics for "normal" home sales have been skewed for years. All of those new buying demographic groups have been used up nearly all at once.

Conclusion

This is a tricky issue. We all know people locally who can thank this tax credit (directly or indirectly) for keeping busy or even keeping their job. The homebuilders and Realtors, of course, think Max, Jon, and Denny have really helped Montana by supporting this. Nothing's free in economics, however, and I believe that market manipulation tends to have undesirable side effects. By seeking a temporary fix to a fundamental problem (overpriced and overbuilt housing), we may instead see a longer and deeper downturn in the future.