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Is bulldozer the best option for some boom-time housing?

Douglas Duncan, vice president and chief economist for Fannie Mae, raised a provocative idea this morning at a meeting of real estate journalists in Austin: Some of the misconceived housing developments built during the boom years might have to be torn down because they don't make financial sense.

Duncan agreed with Stan Humphries, chief economist at Zillow.com, who warned that a "tremendous shadow inventory" of homes is poised to come on the market. That includes future foreclosures (due to negative equity and continued high unemployment), homes that will end up in foreclosure after a failed loan modification, and homes from what he calls "sideline sellers" who have been biding their time until markets improve. According to Humphries, home prices won't bottom out until the third quarter of this year, leading to "the second phase of the housing recession": below-normal price appreciation for several years. (The long-term appreciation norm is 3 to 5 percent per year.)

Said Duncan: "Some of that shadow investment could have to be torn down. It was not economically viable when it was put in place." That include some boom-time developments in California's Inland Empire and central Florida. Duncan said people could find that the cost of sustaining their lifestyle in some developments--including high transportation costs to far-away jobs--is greater than the cost of the home. That would wipe out demand.

Who would pay for tear-downs? What would happen to people who've hung on to their homes despite the foreclosures all around them? All unanswered questions.

The idea is being discussed by economists, but Duncan said he doesn't know of any policymakers who are considering it. "It's un-American to think about tearing down housing," he said. "But we have a long history of ghost towns."

By Elizabeth Razzi  |  June 4, 2010; 12:15 PM ET
Categories:  Foreclosure , Neighborhoods , The economy , The market  
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Comments

So Mr. Duncan (yes we have the same last name) would rather tear down the houses than put the houses on the market because putting them on the market would force down the selling price of homes even futher? Force them down to the prices they should be? What GREED!

Posted by: duncanthescott | June 4, 2010 5:03 PM | Report abuse

Duncanthescott, that is not at all what the article says, you have it very very wrong.

The existence of cheap properties where no one wants to live does not affect the prices of houses in neighborhoods where people want to live. You can buy a house for $10,000 in Cleveland, OH and for $20,000 in Detroit but townhouses in DC will still sell for $1 million because you can't live in Cleveland and commute to DC.

Posted by: bbcrock | June 5, 2010 12:03 AM | Report abuse

Even if we keep prices of homes artificially up -- they'll head down as people cannot afford these lofty prices. All the financial wizardry could not sustain the housing boom ... so this wizardry is of no use.

Posted by: free_np | June 5, 2010 8:38 AM | Report abuse

What caused the bubble? Eliminating the tax on capital gains from home sales -- not financial wizardry or CRA. We should restore this tax so that such gains are taxed at regular income tax rates. The tax code is unfortunately an exercise in social engineering: You tax something less, then of course you get more of it. Individuals, families and businesses are generally rational economic actors.

While this change may sound good from a federal tax revenue standpoint, it may not be appealing to everyone: A lot of people are currently sitting on paper losses. On the other hand, this would allow them to move, assuming they are not also under water in their mortgages -- restoring the tax on gains also means we can restore the ability to record a loss, something you haven't been able to do since 1997, except on investment properties.

The federal deficit may take a short-term hit on restoring the taxability of the gains and the deductibility of the losses: many people don't have huge capital gains sitting around elsewhere to offset the loss on their home.

Why is this such a big deal? TRA97, or the Taxpayer Relief Act of 1997 (one of several overlooked Clinton tax cuts) was a major cause of the residential real estate bubble. Prior to TRA97, homeowners had to carefully track their "basis" during the whole time they owned their home. Receipts were necessary for every home improvement. Upon home sale, the seller owed a capital gains tax on the sales price minus the adjusted basis of the home. The IRS and many others said this was an almost impossible compliance task for long-time homeowners. Then there was the complicated exception for retirees who could postpone their capital gains liability when moving after age 55.

TRA97 changed all that. A single homeowner would owe no tax on gain of $250,000 or less. A couple would owe no cap gains tax on gain of $500,000 or less. No documentation of basis is necessary. You just need to hold the home for two years and/or live in it for at least two out of five years. My boss' daughter married a guy whose full-time occupation was buying fixer-uppers and then selling them every two years -- he hope to net a million dollars after only 10 yrs of doing this. He certainly wasn't alone. The downside to this change was apparent after 2006 -- home sellers could no longer deduct capital losses on home sales!

In summary, TRA97 did more than anything else to change one's home from a place to live for 30 years to an "investment" that could be flipped every two years. Thus, it did more than any other single factor in leading to the bubble. Poor people didn't cause the bubble. It was middle-class and affluent people who wanted to be more affluent.

Posted by: CesarSozei | June 7, 2010 1:26 AM | Report abuse

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