RealEstateEconomyWatch.com

For the past year, I have been an enthusiastic proponent of the homebuyer tax credit. The housing downturn was severe and there was an irrational under exuberance permeating the nation’s housing sector. Households had lost confidence in homeownership and removed themselves from the home buying marketplace, aggravating an already dire market situation. This was a situation that could justify a government favor.

The first-time homebuyer tax credit has been highly effective, prompting thousands of households to purchase homes at a time when the housing industry needed it the most. And an extension of the tax credit which was expiring at the end of November, seemed like a good idea since such an extension would buy time for some of today’s negative influences, like monthly job losses and falling home prices, to become positive influences on housing activity by mid- 2010, keeping the housing recovery on track.

But it took months for Congress to decide on extending the tax credit which took its toll on the housing markets. Wild swings in the housing data released this past week indicate that both homebuilders and households were heavily influenced by the extension debate. Housing starts fell by a whopping 10.6 percent in October to 529,000 annualized units after hovering at an encouraging 590,000 annualized unit pace during the previous four months.  Housing starts are now down 31 percent compared to a year ago.

Weekly mortgage applications to purchase homes dropped 4.7 percent for the week of November 13 compared to a week earlier. After experiencing a wobbly but steady increase in purchase applications the previous two months, purchase applications have tumbled 31.2 percent since October 2.

Existing homes sales were reported to surge 10.1 percent in October to 6.1 million annualized units from a month earlier. October’s home sales pace was the strongest since February 2007. Existing home sales in October is now 23.5 percent higher than the 4.94 million units pace posted in October 2008.

Large monthly swings in housing data is not desirable and can be primarily attributed to the homebuyer tax credit saga. Homebuilders sharply cut back on production because they were nervous about the tax credit expiring at the end of November, explaining why starts plummeted 10 percent in October. A meaningful number of households decided not to apply for a mortgage loan, thinking that it was too late to take advantage of an expiring tax credit, explaining a 31.2 percent plunge in purchase mortgage applications. A substantial number of households rushed to purchase homes in October believing that the tax credit would expire at the end of November, helping to explain the 10 percent surge in existing home sales for the month.

For the past several months, fear of an expiring tax credit has driven market behavior, strongly influencing home builders and households alike. Now that Congress and the Obama Administration extended the tax credit for another seven months, that fear will be replaced by optimism. However, this time around, there is more optimism to hand out. The first-time homebuyer tax credit was expanded to include homeowners and household income eligibility requirements were raised. So there will be many more households swayed by the financial opportunity of a tax credit buying homes over the next seven months.

What concerns me is how strong an influence the original tax credit had over housing demand. Just the fear of an expiring tax credit generated an astonishing 1 million unit increase in annualized existing homes sales in a two month period. Existing homes sales soared almost 20 percent to 6.1 million annualized units in October from 5.09 million annualized units in August.

Now imagine the impact of today’s expanded tax credit on housing demand. Was it really necessary to expand the first time homebuyer tax credit to include homeowners and raise household eligibility requirements? This means that the tax credit’s influence over housing demand will be even greater over the next seven months than during the past seven months.

The reason for a tax credit is to buy enough time for some of today’s negative influences, like monthly job losses and falling home prices, to improve so that when the tax credit is lifted the housing sector is healthy enough to expand on its own without the government favor. That could have been accomplished by just extending the first-time homebuyer tax credit. But an expanded tax credit poses a greater risk that the housing recovery will stumble and retreat when the credit is lifted.

The expanded tax credit borrows more homebuyers from the future to purchase homes today compared to the original tax credit. So when the tax credit expires, there is likely to be a large drop off in home sales because there is a smaller pool of potential home buyers available to purchase homes.

Looking forward, the expanded tax credit promises to advance the housing recovery by enticing thousands of households to purchase homes over the next seven months. And there is likely to be another “rush to buy” during February and March of next year as the April 30 expiration date approaches. It is what is likely to occur after April 30 that generates a greater concern.