The Coming Train WreckJune 22nd, 2012 4:37 pm Bruce Judson
The U.S. housing market and any economic recovery are confronting a brick wall, and no one is discussing it. Like a speeding train, the housing market and our economy are heading over a cliff with no bridge. Yet, no one in Washington wants to discuss this very real and approaching danger.
Recently, Salon ran an article on the conflicting, confusing, and ineffective nature of housing policy to date. The article traced the conflicting narratives and debate associated with principal reduction and the Obama Administration’s efforts in this arena.
Andrew Leonard, the author of the article, interviewed me as he was trying to sort out the different issues, and the article correctly states, that I believe there is a “night-mare scenario” in which Congress fails to extend essential legislation before it expires at the end of this year. If Congress does not act, we will almost inevitably see a further collapse in the housing market, with a ripple effect that has the potential to destroy vital consumer confidence, stop any economic recovery, or even cause an economic catastrophe.
There’s even a nightmare scenario in which the entire fight over principal reduction becomes, in Judson’s words, “irrelevant.”
That’s because, says Judson, tax law historically treats principal reduction as income to the homeowner who gets it. In other words, if you have a $300,000 mortgage on a house that is now only worth $200,000, and your bank gives you a $100,000 break to bring the mortgage and the home value in line with each other, the IRS will consider that $100,000 break taxable income.
Congress recognized this obvious insanity in 2007 and passed a provision that gave homeowners a waiver from that liability, but the waiver will expire on Jan. 1. Not only would the change in tax law mean that getting a principal reduction would make no sense for a beleaguered homeowner, but it would also destroy the market for “short sales” — in which banks allow homeowners to get out of their mortgage by selling their property for less than the mortgage is worth. Judson believes some 30 percent of home sales are currently short sales. Knock the legs out of that market, and you’re asking for serious trouble.
“If we hit a train-wreck on Jan. 1,” says Judson, “it will take the housing market and any economic recovery down with it.”