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Would A New Homestead Act Reduce Foreclosures

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It was back in 1862 in the midst of the Civil War that the government passed the first Homestead Act, legislation that would give pioneers160 acres if they settled west of the Mississippi.

The original Homestead Act and its successors proved enormously successful: by 1934 more than 270 million acres had been homesteaded,10 percent of all U.S. lands.

Now there's a serious proposal floating around Washington to create a new Homestead Act. Instead of free land, the idea would be to get huge numbers of investors and first-time buyers into the market with outright cash grants and substantial tax incentives.

The plan comes from investment strategists Carl Goldsmith and Ed Yardeni. Their proposal looks like this:    

  • First-time buyers purchasing a prime residence could get as much as $20,000 in down payment matching funds from the federal government. As many as 2 million homes could be purchased under the program, meaning a cost to the government of as much as $40 billion.  
  • Investors would not get cash but  they would get a ten-year tax holiday on rental income. Up to one million single-family investment properties could be purchased under the program.

There's no doubt that soaking up three million houses would do much to improve not only the real estate market but the economy in general. One inevitable and desirable result would be more employment, a natural by-product of increased home sales.

But could it work?

Follow The Money
Let's start with that $40 billion. It's a lot of money and many in Washington would instantly oppose the program merely because of the numbers involved. However, Goldsmith and Yardeni have a clever way to get around political opposition.

To understand what's going let's forget about real estate and talk about corporate profits. In rough terms American corporations are holding $1.4 trillion in overseas profits, money that could be used to create jobs within our borders. Companies, however, now refuse to repatriate such profits because there's a 35 percent tax once the money enters the U.S.

Another solution would be to tax overseas profits whether they come into the US or not — this is the approach of the Bipartisan  Tax Fairness and Simplification Act of 2011 proposed by Senators Ron Wyden  (D-OR) and Dan Coats (R-IN). Part of their plan would be to create a tax holiday so that corporations could transition to the new system.

A very different idea is the Freedom to Invest Act of 2011. It would drop the tax rate on overseas profits to 5.25 percent for a one-year repatriation holiday

Goldsmith and Yardeni have third approach: They say the tax should be lowered to 10 percent. At that rate overseas profits would flow back to the U.S. and tax collections would increase by more than $40 billion over the 5.25 percent proposal — enough to fund their program.

Flipping
One of the buzz words which somehow seems to upset a lot of people is the term flipping. Why this is a "problem" with real estate is unclear — no one objects to the quick purchase and sale of stock. In any case, the Goldsmith-Yardeni plan say "to reduce the incentive to flip taxable into tax-exempt rental properties, purchasers would be prohibited from participating in the program if they sold any rental property during the three months prior to the introduction of the program and until its termination when the one-million-unit quota has been filled."

Given that congressional discussions can continue for months and months without an assured end date, investors would wait for Congress to pass the new homesteading plan — bringing the housing market to a crawl before passage while further slowing the market if it did not.

A better solution would be to say the tax holiday for rentals applies only to investment properties bought or converted after the legislation is enacted.

Another anti-flipping provision applies to owner-occupants: "To reduce the incentive to flip houses, the subsidy could be structured as an interest-free loan reduced by a one-fifth every year for five years."

This provision actually works in the sense that it does not penalize owners who are forced to sell because of a job relocation or the loss of income.

"Goldsmith-Yardeni is well within the realm of consideration," said RealtyTrac spokesman James J. Saccacio. "There would surely be tweaks, but we have  not had a broad-scale effort which has successfully re-started the housing  market and there's a lot of logic to this program. The idea of getting large numbers of distressed homes off the market is hugely attractive, especially when combined with a government program that would also bring home enormous sums of capital."

Targeting
One of the criticisms of the various tax-credit plans for first-time home buyers  that began in 2008 and 2009 was that a large percentage of the beneficiaries would have bought homes anyway and for that reason government money often did not produce a real marketplace benefit.

The same issue exists with the Goldsmith-Yardeni plan — it doesn't quite get to the foreclosure inventory directly. In a word, it needs to be targeted.

The real estate pricing problem we  have today relates in large measure to foreclosures. Basically, there's no hope of selling your house for a premium price if the place across the street is foreclosed and looks like a war zone.

"Distressed homes — foreclosures and short sales typically sold at deep discounts — accounted for 31 percent of sales in August," says the National Association of Realtors. NAR spokesman Walt Molony says a "deep discount" means 20 percent or so. RealtyTrac says the discount is even more, 32 percent below comparable properties in the second quarter of 2011.

If foreclosed properties are the heart of the housing slow-down then why not aim the Goldsmith-Yardeni proposal  directly at the problem? Make the benefits of their plan available only for the purchase of a foreclosed home, a property where the borrower has not made payments for six consecutive months or where an owner has suffered a substantial hardship such as a 50 percent income loss.

It's difficult to imagine how the combination of huge pricing discounts, historically-low mortgage rates and substantial government benefits could not begin to knock down the shadow inventory. In turn fewer distressed homes, short-sales and foreclosures would mean less downward pressure on property values. That would help all owners, the market and the economy.
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Peter G. Miller is syndicated in newspapers nationwide and operates the consumer real estate site, OurBroker.com.


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