Legislation is impactful to the cyclical nature of this business. And today, there are critical issues on the horizon that will affect the next leg of this cycle. Here is our take on the current pressures facing housing and the economy:
We expect a lame-duck special session of Congress in November with the following outcome:
* A second consumer stimulus package in the $150-$300 billion range, mostly helping the most affected (the unemployed, etc.).
* An employment stimulus package, possibly in the form of tax breaks to businesses, an extension of the NOL look-back period to 4 years because it will help more than home builders at this point, and “Federally encouraged” lending by banks.
* Unfortunately, no tax credit for home buyers.
* A sustained low Fed Funds rate.
* The implementation of an unprecedented homeowner loan modification program.
Additional measures that may be postponed until next year:
* Additional regulatory powers that could make it more difficult and expensive for banks to make and securitize loans.
* A more formalized process for bank asset disposition.
The Waxing Phase: What Will Be Revealed?
It has been nearly three months since the passage of the Housing and Economic Recovery Act of 2008 (a.k.a. the Housing Stimulus package), and less than one month since the Emergency Economic Stability Act (a.k.a. the Bailout) was signed into legislation.
As each initiative burst onto center-stage, they were scrutinized for their ability to restore consumer confidence, stave off a recession, and grease the dehydrated wheels of national (and then global) lending machines. Instead, attempts to plug the leaks proved ineffective. When housing and the economy needed a welding kit, they were handed bubble gum.
But, almost immediately following the Bailout, it was apparent that the current administration would be pressured into one more attempt at a “fix.” Last week, the much-discussed idea of a second stimulus got a nod of support from Federal Reserve Chairman Ben Bernanke. Following the election, Congress typically would not be scheduled to reconvene until January 3, 2009, when new elected officials take office. But now that Bernanke is throwing his weight behind a second stimulus, there is strong indication that Congress will scramble to fast-track the consideration into a structured bill during a lame-duck session. Reports are that both the House and Senate will convene on November 17.
Word in Washington is that the package being discussed ranges from $150-$300 billion in total. Many feel that the bulk of its eventual provisions will likely target individuals (by way of extensions in areas like unemployment benefits, loosening qualifications for food stamps, low-income heating assistance, etc.). Leaders are still pondering what they can do on the business side.
So what does this mean for housing?
In an earnings call with analysts on October 29, Centex CEO Tim Eller referred to a “coalition” of builders supporting stimulus measures that would ultimately have a “strong impact on housing supply and demand.”
The package of measures he cited includes:
* Offering a home buyer tax credit, which we discuss below.
* Targeting the potential foreclosures from an estimated 2 million ARM resets due to occur in the next two years. The FDIC and Treasury are reportedly hammering out details on a foreclosure relief plan this week that would provide $50 billion of bailout money to troubled homeowners. But the impact of potential ARM resets is an anticipated aftershock to the current fallout caused by the subprime mortgage quake.
* Offering below-market mortgage rates.
Eller also noted that other industries back these ideas because they recognize the impact housing has on the general economy. “There [are] a lot of constituencies and stakeholders in this – it’s not just the builders,” said Eller. “That is our message, and that is the coalition that we are building.”
In our October 8 e-mail newsletter titled Running with the Devil, we took an in-depth look at the Bailout and highlighted key housing initiatives that were excluded. Here’s an update, along with our take on the odds of their likelihood of making it into this next piece of legislation:
* The Senate is (again) talking about a net operating loss (NOL) carry-back extension. When discussion on this issue began earlier this year, it was viewed as a housing handout for a small number of public companies. The fact is: the tax benefits apply to many private companies as well – not just in housing.
Today, banks, insurance companies, automakers, retailers and others desperately need it for the same reason: if businesses can’t carry back losses, they lose deferred tax assets. Now that the entire economy is in a recession, there is more momentum behind this push.
ODDS OF INCLUSION: 50%
The Senate has already telegraphed they would like to include it. House Democrats are still not in favor, but recognize both banking and housing need to be invigorated. Insiders predict a one-year extension.
* The industry is increasingly vocal about its desire for a true home buyer tax credit of $15,000 or more. Last week, during the company’s quarterly earnings call with analysts, Pulte’s CEO called for a $20,000 tax credit with no repayment provision. We’ve heard more of the same this week as the bulk of public builders report earnings. He and other builder executives have made it clear that last summer’s $7,500 tax-credit-as-loan incentive was not effective at stimulating demand. But there are questions as to whether political leaders view a do-over as warranted.
Conventional opinion is that there were two strikes against the current tax credit initiative:
1. The Dollar Amount: In late summer, when the initiative was being formed, the large public builders hoped for a higher dollar amount and expressed their disappointment with the $7,500 figure. The only other time a buyer tax credit was implemented was in 1975, during the Ford administration. Indexed for inflation, that $2,000 credit would amount to nearly $8,200 in today’s dollars, which is above the credit currently offered.
2. The Tax-Credit-as-Loan Structure: The fact that this was not a true credit, but a loan that needed to be paid back, was a great source of confusion. Some builders used the scenario to a marketing advantage, offering to assume the pay-back status and wiping out the connotation of a $7,500 “loan” – but to no avail. Consumers who were uncertain about making a purchase decision – even with prices that had dropped by $120,000, free pools, free landscaping, upgraded appliances and more – have not viewed the tax credit as the final nudge they need to jump into a new home purchase.
ODDS OF INCLUSION: 50%
One could argue that, by addressing the concerns above, a true buyer tax credit would be an effective stimulus. But, now that it has been tried once, the initiative carries a stigma of failure. In addition, such an initiative is estimated to cost roughly $75 billion. Layer that in, and it becomes even tougher to imagine Congress allocating such a large percentage of any new package directly at this measure.
Another consideration: Banks are getting relief in a variety of forms. Home building should lobby hard to ride the coattails on measures that are applicable. One example: An IRS measure that promotes M&A activity. If a bank acquires another bank with losses, normal rules dictate the new owner can’t take those losses in the future. That rule has been waived for banks. Home builders should have that too. Why not encourage companies that want to do M&A and stay afloat?
The Waning Phase: What’s In the Shadows?
Today, financial stability is priority number one, including the ability to assure and continue lending for small businesses, plus the restructuring of mortgages and mortgage lending. Both parties are calling for government to get involved in the mortgage issue in some form: either to re-write existing contracts so that troubled borrowers get a windfall, or to provide a huge infusion of cash to make up the deficit.
The thinking is that if the government directs its funds toward buying mortgages and restructuring bad loans, stability will be restored. However, one link in that food chain is broken: Remember, just because we are pumping finds into the banks, doesn’t mean they are forced to lend it. Are banks really going to loan funds to people who get a down payment by virtue of the government giving it to them?
As always, the pendulum swings . . . question is, where does it stop?
Theory 1: “We’ll never do this again because, in the end, nobody wins.”
Given the rampant abuses, many speculate that – regardless of the powers in place – we will overcorrect into a “never-again” period, creating a highly regulated environment. Underwriting standards are likely to revert back to what they were 20 years ago.
Theory 2: “Can we try to make it happen again?”
A clean sweep of Democrats might not want to undermine what they turned Fannie/Freddie or the CRA into. The party’s “welfare mentality” will put the onus on the banks to encourage low-income and minority lending. Some who subscribe to this theory even believe that a Super Majority in Congress would make moves to liberalize the FHA. We might see a return of initiatives like DPA, a re-packaging of subprime-like lending and other creative programs that push to get people into houses.
Today, as much remains unknown, industry leaders shouldn’t abandon their core business strategies in response to the outcome of this election – or any other election, for that matter. But as you head to the polls next week and continue to navigate through the ensuing stormy climate, keep this perspective in mind:
The ownership society that Presidents Clinton and Bush respectively envisioned is a laudable goal – supporting the idea of Americans living in homes. But there is a level of practicality that can’t be ignored: Creating an environment where homeownership can flourish is desirable. But forcing it to flourish brings trouble.