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» VISIT US ONLINE @ DSNEWS.COM POINT—COUNTERPOINT T he year is ending with one very important question looming—will the country fall over the approaching fiscal cliff? Depending on the course of action chosen by the administration and Congress, tax cuts and other measures that could either hurt or help consumers are in limbo. The government could also fail to take any action before the year-end deadline and risk a stalemate that could greatly diminish the United States' line of credit with other countries and bond investors. All scenarios will have a definite impact on the housing market, so DS News asked Dr. Alex Villacorta and economist Mark Lieberman to weigh in on the cliff's ultimate impact. According to Dr. Alex Villacorta Let's be honest. We've been hearing about the dangers of falling off the fiscal cliff for months now. There's been a tremendous amount of speculation about what that means from all sides. When it comes to housing, we not only see great risk from a fall, but also from the fear of falling as we await resolution. Why? Because the uncertainty of this figurative cliff poses a real threat to the middle class, eroding consumer confidence. Our research has shown that when we see a drop in consumer confidence, home prices fall. Congress has the opportunity right now to positively affect housing by working together and taking action to remove the uncertainty surrounding the fiscal cliff. It Pays to Have Confidence Consumer confidence is fundamental to home price growth and stability. Last summer's debt ceiling debate was a reminder of the negative impact uncertainty has on consumer confidence and prices. Consumer confidence dropped 14.3 percent, and within the same period, home prices posted yearly losses of 6.8 percent. This dynamic works both ways. At the start of 2012, home prices began climbing back into positive territory, in line with gains in consumer sentiment. Consumer sentiment rose 29.8 percent over the last year, according to the Reuters/University of Michigan mid-November index results. During that same timeframe, home prices rose 4.5 percent. Before homebuyers jump back into the market, they look for signs of stability. The Phoenix metropolitan statistical area MSA is a textbook example. In the first six months of 2011, Phoenix home prices were mostly flat, with just 0.8 percent in declines. This stability supported demand as prices, now up 27.7 percent since July 2011, began to recover rapidly. In the case of Phoenix, market stabilization encouraged re-engagement from investors as well as owner-occupant buyers on the sidelines. Middle Class Impact Is Undeniable While investors' support of the market has been instrumental to the recovery, pent-up demand from non-investors, and especially the middle class, must return to maintain current momentum and support long-term recovery. So let's talk about what's at stake for both the middle class and housing. The Tax Policy Center estimates an average of almost $3,500 in additional taxes for 90 percent of households in 2013 if scheduled spending cuts and tax hikes take place. Middle-income households would see a tax increase of nearly $2,000, pushing many out of the qualified homebuyer pool. The national housing recovery has been led by Arizona, California, Florida, Minnesota, and Nevada. While these five states have seen improvements in affordability since the peak, they've also seen a 13 percent average rise in prices in just the last year. Rising prices, coupled with higher taxes and lower incomes, will have a negative impact on the middle class' ability to borrow and will shrink the buyer pool. Let's not forget rents are also up 2.8 percent over the last year, according to the U.S. Bureau of Labor Statistics. If a fall from the cliff doesn't disengage prospective buyers, higher taxes and rising rents will diminish potential homebuyers from saving for down payments in a tight lending environment. Consumer confidence is key to giving housing a fighting chance to remain stable and continue gains in key markets. But for now, we will have to wait and see. According to Mark Lieberman The impending fiscal cliff has four aspects: expiration of the Bush-era tax rates, expiration of the payroll tax cut, sequestration, and the debt ceiling—each with a different possible solution, though some are closely intertwined. For starters, if the government decides to let the Bush tax rates expire on January 1, Democrats should then propose a tax cut for the first $250,000 of income and let Republicans respond by pushing a cut in rates for income above $250,001. Democrats win that fight hands down. Someone earning more than $250,000 still gets the lower rates on most income. There will be no impact—except for perhaps a cash-flow squeeze—on taxpayers if the tax issue is not resolved before the Bush-era tax cuts expire. Any eventual changes could be retroactive. The next move should be to separate sequestration—a mechanism through which automatic, across-the-board spending cuts are made—into "entitlements," which may be a misnomer, but palatable for the average American. In reality, they are a pension, representing deferred wages as part of the individual's compensation package on hiring. Social Security should be off the table and any projected shortfall can be addressed by eliminating the cap on salary subject to payroll tax, making it less regressive. Tax changes have to go under the same microscope to determine the effect of reducing the mortgage interest deduction on home prices and construction jobs. Eliminating that deduction reduces home prices and homeowners' perceived wealth and, thus, consumption spending. Housing faces its own cliff with the expiration of three provisions specific to the industry: the Mortgage Debt Forgiveness Act, the taxdeductible mortgage insurance, and Operation Twist. If the tax break that allows mortgage debt to be forgiven is allowed to expire on December 31, unpaid mortgage debt will be treated as taxable income, undercutting efforts to assist struggling homeowners by encouraging short sales, putting an abrupt halt to the fledgling housing recovery. The law providing for the deductibility of mortgage insurance premiums also expires at yearend. Unless it is renewed or revived by Congress, it will mean a tax increase for many homeowners or an inability to obtain higher LTV loans. The Federal Reserve's Operation Twist, a program designed to lower loan term interest rates—including mortgage rates—is scheduled to come to a close at the end of the year. While not dependent on congressional action, the Fed could well pull the plug—raising rates and, again, cutting off a recovery as it begins as a way to pressure the administration and Congress. What will happen if we fall off the "cliff"? We'll be a cartoon character suspended in mid-air until he realizes there's nothing beneath him. Any protracted debate over the debt ceiling—even if it is eventually (unnecessarily) increased—is the same as failing to change it. After a similar crisis in 2010, Standard & Poor's downgraded U.S. debt, resulting in a rush to buy, not sell, government bonds. A word of advice to our Wile E. Coyote-like fiscal cliff negotiators: Don't look down! 87

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