Stabilizing Housing Won't Be Easy...

...but it can be done. Most so called experts agree that for any economic recovery to occur housing prices must first stabilize. Yet, housing prices have been falling with no end in sight. Now, before we can look at how to stabilize home prices, we need to examine why they are falling in the first place. The first reason they are falling is because their growth occurred in large part because housing became speculative. All speculative markets have huge falls once they bust and this is part of that bust. Second, the housing boom was built on no and low money down loans to a market in which a minimum of 20% is almost always required. What this has done is create far fewer new buyers available then there currently are sellers. Finally, because no one knows just how many loans there are that are in trouble the specter of a foreclosed property popping up in a neighborhood to drive prices even further is always there.

Unfortunately, most politicians view the solution to stabilization of the housing market in exactly the opposite way of the one that would best stabilize the market. As in any speculative market, in order for the market to stabilize all those that caused it to speculate must be removed with heavy losses, and only then will the market stabilize. The housing market became speculative through a combination of flippers, highly leveraged investors, and unqualified borrowers receiving loans they should never have gotten. The first two categories have already been removed from the market through market forces. The third category is also, slowly and painfully, being removed from the market through its own forces, mostly foreclosures. Yet, politicians like John McCain are attempting to force these people in the market by artificially propping them up with mortgage the market place would never give them on its own. Imagine if after the internet boom crashed, the government covered the losses of all those that became day traders during the boom. Imagine if everyone that bought on margin during the 1920's, was covered by the government after the crash of 1929. That is the equivalent of what folks want to do in this market. These folks need to be removed immediately, and yet McCain, and others like him, are attempting to keep them in the market at all costs.

Unfortunately, the best way to stabilize the market is to remove all of these unqualified borrowers from the market as quickly as possible. Since leaving distressed borrowers to fend for themselves would take a lot of political courage, it's highly unlikely that any politician would ever propose such an idea. That said, the first part of any stabilization plan would remove all of these borrowers as quickly and painlessly as possible. Fortunately, politicians have taken one small step towards that. They have removed the tax consequence from a short sale to the seller. A short sale is when a distressed borrower sells the property for less than what is owed with the agreement of the bank. Normally, the difference becomes a taxable income, but a new law passed at the beginning of this year removed that tax consequence. HUD has also raised the limit on FHA loans from $275,000 to $410,000 in most areas and in a select few areas as much as $729,000. FHA is the last bastion for low money down loans as they require a minimum of 3% down. FHA was never meant to carry a massive portfolio though, and I worry that these looser restrictions may overload the system and possibly eventually bankrupt it down the road.

The way to stabilize the market is to give as much encouragement to qualified borrowers to jump into it. The first way to do this is to suspend the capital gains tax on any property purchased over the next three years. There are still plenty of well qualified borrowers available, and many know there are potential bargains if they invest in these properties long term. The removal of the capital gains tax would provide extra motivation for these borrowers to go bargain hunting. Second, there should be a three year moratorium on taxes and penalties for removing any retirement fund income that is used to purchase property. There are many qualified borrowers that don't have enough of a down payment saved up. By allowing them to raid their retirement accounts with no penalty, that will give millions of borrowers the savings necessary to make a purchase.

There are other smaller steps that can be used. Increasing the tax credit for first time home buyers from $7,500 to something like $12,500 would increase the incentive for first time home buyers looking to enter the market. Increasing the mortgage interest tax credit from $2,000 to $5,000 would provide more tax relief for the purchase of a home, and it might be just the added tax incentive to create millions of new borrowers. In my opinion, the best way to increase home purchases though is to not only make the the Bush tax cuts permanent but to cut them by an extra 3% across the board for the next three years.

Unfortunately, stabilizing housing will take a comprehensive program of tax cuts, incentives, and waiver of fees. Without something comprehensive, housing prices won't stabilize for years. Furthermore, it is unlikely that any Democratic administration or Congress would ever back any lower tax proposals. As such, I worry that the only thing any politician would do to stabilize the market is to provide giveaways to unqualified borrowers and provide them with new loans at lower rates and mortgage balances. Such a move, on its own, would make the housing market even worse, as it would only sustain borrowers that need to be removed immediately. If a politician ever did propose low tax, high incentive proposals to stabilize the housing market, that is a proposal I believe would find cross section support.