Congress will soon debate if the home buyer tax credit should be extended beyond the currently scheduled expiration date of November 30th.

The key reason for the economy coming out of a recession is due to the upgrade in the housing market. The housing revival in turn was due to the first-time home buyer tax credit. But a sustainable recovery in the housing market requires home price stabilization, where we are very close to getting there. Given that the home price to income ratio and other metrics are showing that home prices have overshot downward and below the fundamental economically justifiable values, stimulus to get the financially healthy home buyers back into the market is well worth it.

Home buyers will naturally become hesitant to buy if they view (rightly or wrongly) that home values will continue to fall. That buyer hesitancy can lead to self-fulfilling prophesy of rising inventory and falling home values. Falling home values will in turn push the economy back into recession. Consumer spending will be weaker as homeowners continue to experience destruction in housing wealth. Bank balance sheet will turn for the worse and possibly lead to another round of severe credit crunch.

To offset that pessimism the stimulus money needs to be put on the table for homebuyers. As more buyers enter, inventory will be trimmed and home values will stabilize. From that point onward, no further stimulus will be needed. But we are not there yet.

The home buyer tax credit extension could cost the government about $10 billion more or less depending upon how long it is extended. That is a rather reasonable sum to stimulate the economy compared to the $700 billion in TARP funds that went to Wall Street and the $787 billion broader economic stimulus bill that was passed early in the year. The tax credit benefits main street consumers. Homeowners indirectly benefit as well, as housing equity no longer gets destroyed.

The resulting economic growth and job creation will automatically lead to a rise in federal tax revenue, thereby easily covering the cost of tax credit. The upcoming GDP forecast could easily get raised to 4% to 5% if the tax credit is extended.

Article by Lawrence Yun, Chief Economist