Housing crisis datapoint of the day, tax-relief edition

By Felix Salmon
August 2, 2012

In 2007, it became clear to Congress that there was a serious mortgage crisis, with lots of underwater borrowers. And it was also obvious that an important part of working through the mess would comprise some combination of short sales and principal reductions. Thus was the Mortgage Forgiveness Debt Relief Act of 2007 born. Until the act was passed, any lender offering a short sale or a principal reduction would in doing so leave the homeowner with a massive tax bill, since the written-off debt would count as simple income for income-tax purposes.

In 2007, however, no one had a clue how long the mortgage crisis would drag on for, or how slow lenders would be to offer principal reduction. The original act expired at the end of 2009; it was then extended, through the end of 2012. But here we are, in August 2012, and principal reductions are only just beginning in earnest.

David Dayen has a good piece on the expiry of the tax break, including the interesting nugget that the CBO has put the cost of extending it for two more years at $2.7 billion. If the average underwater homeowner pays a marginal tax rate of 20%, then that means the CBO expects write-downs from principal reductions and short sales of somewhere in the $10 billion to $15 billion range during 2013 and 2014. And this, remember, is six years after the housing bubble burst.

My guess is that the tax break will be extended, somehow, somewhere in the horribly complex mess of legislative give-and-take that will arrive with the fiscal cliff. But it’s instructive to realize that if Ed DeMarco had actually agreed to Fannie and Freddie doing principal reductions, they would realistically only get started, in earnest, in 2013. As it is, thanks to his obstructionism, they’ll probably only happen even later than that.

The housing recession is dragging on for longer than anybody anticipated, and there’s no end in sight. Principal reductions are a good way of bringing it to an end; they should of course not incur a massive tax bill. I hope that we’ll see most of them done by 2015, eight years after the housing bubble burst. But in my heart of hearts, I don’t actually believe that. This housing crisis, I think, is going to last a decade. Or more.

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