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Saving The Economy At The Expense Of The Economy

April 19, 2012

Glug...glug...Back in 2009, one of the components of the American Recovery and Reinvestment Act (aka ‘The Stimulus’) was a tax credit for first-time homebuyers. As a plunge in the housing market was a key driver of the Great Recession, this made a certain amount of sense. And it worked, sort of.  For a while, there was a rush of consumers snapping up homes at reduced prices so they could take advantage of that $8000 tax credit. Realtors rejoiced.

The problem was that those homes had not yet hit the bottom in their price drop. The program delayed the market hitting rock-bottom, but it didn’t stop it. So now we had a whole new group of first-time homeowners – underwater with the rest of us.

The temporary boost to the market from the credit allowed many homeowners to sell their homes at prices that were still partially inflated by the bubble. This was good for these homeowners, as well as their creditors, who might have otherwise been forced to accept short sales. However, it was bad news for homebuyers who were persuaded to buy homes at prices that were often still above trend values. (Dean Baker – CEPR Blog – emphasis mine)

Wait. Did Dean Baker pretty much just say that the ARRA homebuyer tax credit created a sort of mini-bubble in the midst of the bigger bubble’s deflation? Yes, I believe he did. In fact, Baker’s Center For Economic and Policy Research has just released a report on the impact of the credit.

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. (CEPR – emphasis mine)

Can we just admit that tax credits to prop up ailing industries are not always the best solution?

Unlike the famous “Cash for Clunkers”, which at least helped get a few dirty gas guzzlers off the road, this tax credit really had no upside. It didn’t save the housing market, and in fact increased the size of the problem with underwater homes.  For once, it would be nice to see the government respond to a financial crisis by assisting consumers, rather than trying to salvage the out-of-control industries that took advantage of those consumers.

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