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Debating fairness of upfront tax credit

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Posted: Sunday, June 7, 2009 10:00 pm

If you've been reading this column since it started a few weeks ago, you by now have realized that I have a lot to get off my chest. So much so that I never took the time to introduce the new column and its subject matter, which is somewhat different from my normal real estate consumer advocate-cheerleader material.

However, the May 29 announcement of U.S. Housing and Urban Development Department Secretary Shaun Donovan's decision (after much very public dithering) to allow homebuyers to use the $8,000 first-time homebuyer tax credit upfront, toward their down payment and/or closing costs, was such a pure manifestation of behavioral economics in practice that it reminded me to circle back and do a proper introduction to this "Mood of the Market" column.

So, here goes.

Wikipedia, that ultimate arbiter of what any given concept signifies in the blogosphere on a given day, defines behavioral economics (today) as "a separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers, investors, and how they affect market prices, returns and the allocation of resources."

I like to say that behavioral economics (BE) is where psychology, decision-making and economics intersect.

It's a real science, rather than being, like my interest in BE, an unintentional collision of right-brain and left-brain, the mashup of soft and hard sciences that happened when a psychologist went to law school and ended up becoming a working real estate broker. BE (the real estate flavor of which, by now, you've realized is the topic of this column) is such a real science, in fact, that you can hold a doctorate in BE, there is an academic Journal of BE and there's even a scholarly Society for the Advancement of BE. (And yes, I did a little happy dance upon learning of the latter.)

Now, back to last Friday. I woke up to an e-mail from some East Coast colleagues asking if I would do a televised debate of the HUD announcement, on the pro side. I ended up getting bumped, but only after first hypothesizing what arguments the con-side debater would find at the bottom of the very deep barrel he must have had to scrape to come up with a rationale against allowing first-time homebuyers to monetize their tax credit upfront, rather than waiting for it until after close of escrow. I later saw my woulda-been opponent discussing his position about the past-, present- and future-looking "problems" he saw with the plan. And every issue he brought up, as I'd surmised, was an issue of behavioral economics.

The "past" and "future" arguments are really two sides of the same coin. "Past" includes things like, "Isn't this (e.g., allowing homebuyers to buy with little of their own skin in the game) how we got into trouble in the first place?" His "future" point: "Won't we end up returning to the bad old days of 100 percent financing if we go down this road?"

My counterpoint: We live in a totally different era of lending guidelines now than in the stated-income/subprime heyday. And the upfront credit deal applies only to FHA loans, which require full-income documentation and impose the debt-to-income ratios of a generation ago.

The upshot? No fast-food employee will be using his or her $8,000 tax credit money as the down payment on a palatial McMansion anytime soon. These folks will be using the funds to buy homes with 30-year fixed mortgages at low interest rates and at purchase prices they can well afford on their current, proven income.

The "present"-based arguments against allowing homebuyers to monetize the $8,000 upfront go something like, "What kind of message does it send to the tortoise-style savers, who've been tucking their pennies away, when some other Joe Blow can just waltz into the market with a government check for eight grand?" This is a variant on the "It's not fair!" theory. As a mother, not as a commentator, my response would be, "That's right, life's not fair - deal with it." Seriously. But beyond the obvious, my counterpoints included:

  • It's even less fair for the property values of innocent homeowners to continue to freefall because we're afraid of giving a buyer an "unfair" $8,000 leg up.
  • It's $8,000 - not a lottery-style windfall. It's really a matter of timing - do you get the credit before or after close of escrow? That's it.
  • The "tortoise" folks will benefit, too - assuming they're eligible, they'll get an $8,000 boost just like Joe Blow, so their saving habits will still pay off and they'll get a little boost in purchasing power or affordability - their choice.

Don't get whiplash on me, but let's go back to Wikipedia on BE. The definitions go on to explain that BE focuses on the role of rationality in economic decision-making. This column's spin will be to add to this rationality the reality of how real-life real estate consumers make their real estate decisions and the realities of how real-life real estate and lending institutions execute programs and guidelines, including the irrational bits, and throw that into the mix, or under the microscope, or whatever throwing-related adage makes the most sense (but not under the bus).

For example, what I know from working with entry-level, FHA-financed homebuyers and nonprofit down-payment assistance programs is that the nonprofits often overlay their own, more-restrictive requirements on top of the FHA guidelines in an effort to maximize the chances the buyer will be able to afford the home over the long term. Even though FHA doesn't require savings or reserves, the nonprofits through whom you must go to get your $8,000 upfront might.

Long story short - I like the upfront credit monetization deal. But I understand why others don't. To me, it's all about the goal - if we as a nation want to stimulate buyer activity, then enticing and empowering assistance for buyers in a context of responsible lending guidelines is the ticket. I know - they're calling me asking about how they can get their $8,000. And that, my friends, is stimulus.

By the same token, if you want to understand real estate economics, I submit, you must understand behavioral economics. Think about it - many of the core concepts with which we analyze the markets, from consumer confidence to supply and demand, are essentially psychological and behavioral. For better or for worse, on the ground, in real-life real estate, there are no other sort of economics except behavioral.

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

***

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