Did the 1975 tax credit really work as its advocates claim? Are tax credits what the housing market needs today?
In arguing for the Senate to adopt his amendment to double the existing tax credit from $7500 to $15,000, Senator Jonny Isakson (R-GA), a Realtor before entering politics, credited the 1975 tax credit with restoring health to the market. In 1975, when there was almost a three-year supply of vacant houses on hand, Congress approved a $2,000 annual credit. Within one year, two-thirds of the available inventory that was on the market was gone, he said. “The market moved back to a balanced
inventory, values stabilized and things became very healthy. The only reason I know all of that is I was selling houses in 1974, that’s what I was doing to feed my family and make a living.”
Is that the whole story? Well, not quite. What actually happened is even more interesting and instructive for us today.
Market conditions were different in 1975 than they are today; then the economy wasn’t nearly as bad as it is today. While existing home sales were holding steady at a rate of 2.5 million per year, new home sales fell, new home inventories rose and housing starts plummeted from over 2 million to less than 1.2 million. The large overhang of unsold homes stalled the economy. Working down the inventory was seen as a key to recovery. .By the time the tax credit became effective (March 26, 1975), nearly 400,000 homes remained for sale. At the end of 1974,the Consumer Confidence index was at its lowest point ever recorded-until last October.
The strategy used during the housing downturn of the 1970s did not rely on a tax credit alone. It had two key components: a temporary tax credit for the purchase of a newly-constructed home and a temporary “buy down” of mortgage rates.
Congress authorized Ginnie Mae to purchase a specific dollar amount of mortgage commitments for new home loans at rates between 7.75 percent and 8.25 percent. Market rates at the time ranged from 9 percent to 10 percent. The amount of the credit was limited to 5 percent of the purchase price up to $2,000. It wasn’t until Tandem rates hit 8 percent that sales started to gain traction. In January 1975 an additional $3 billion was authorized at 7.75 percent, and due to the lower rate, the entire amount was committed in a single day. Finally, an additional $2 billion was authorized in August 1975 at an even lower 7.5 percent rate. Demand began rising almost immediately.
The credit was equal to 5 percent of the purchase price up to $2,000. It applied to new homes that were in production before March 1975, under contract by December 31 and occupied by January 1, 1977. At least three quarters of the buyers of the roughly 700,000 eligible new homes sold during that period applied for and received the credit. By the end of 1976, 535,000 taxpayers claimed $716 million in credit, most of it on their 1975 tax returns.
Some argue that it was the recovery of the national economy in 1977, not the tax credit, that should get credit for the real boom in sales. New home sales increased from 477,000 in March 1975 to 600,000 later in the year. But that was from a depressed level as shown on the graph, he argues, and the real turnaround didn’t occur until housing starts were back up to near 2 million by 1977. Real GDP growth rebounded to better than 5 percent the very next year. Unemployment also began to improve in 1976, although it took until 1978 for the rate to fall back into the neighborhood of 6 percent. Consumer confidence was surging in 1976 after reaching an all-time low at the end of 1974.
Which did the trick-the credit, the buy down or the recovery of the overall economy? The answer is all three, for they worked together to change the climate for housing. The credit and the buy down sold new homes, which in turn stimulated the overall economy. The restoration of consumer confidence moved the new housing market from a recovery mode to a period of sustained growth.
Is the 1975 experience a prescription for today? Times have changed. If the housing economy of 1975 had the flu, the economy of 2009 has double pneumonia. In 1975, existing sales were relatively healthy; lenders and the financial markets were stable and credit was available, Investors had confidence in mortgage backed securities. The foreclosure rate then was not even in the same ballpark as ours. Then, consumer confidence was low, today it is in free fall. Unemployment then was actually higher, at 8.5 percent; today we’re at 7.6 percent but layoffs are driving it up every month.
Our illness requires a double dose of every cure that’s ever worked before. The lesson from 1975 is that lower rates, credits, and tactics to stimulate the overall economy will work if they work together.
Is the Isakson Amendment enough? When adjusted for today’s median home prices, the $2,000 credit is less than the $15,000 provided by the Isakson Amendment, which would apply to existing as well as new homes. The buy down being quietly discussed in the TARP program is dramatically larger than the Tandem program of 1975. If all goes as planned, 1975 should repeat itself.[attachments docid=453 title="Chart Animation"]