Housing: What's Behind the Boom

The Wall Street Journal, November 21, 2005
By JAMES R. HAGERTY

Conditions have been almost ideal for the housing industry in recent years.

Mortgage interest rates hit their lowest levels in more than fourdecades, making it much easier for Americans to buy houses. Manypeople who were burned in the stock-market bubble of the late 1990s decided that real estate was the best place to stash spare cash. The children of baby boomers began buying their first houses even as theirparents started purchasing second homes or speculating on rentalunits. And American businesses finally began creating jobs again.

Home builders couldn't put up houses fast enough to keep up with all this demand. As a result, home prices are up by an average of 53% from five years ago, according to the closely watched index published by the Office of Federal Housing Enterprise Oversight.

Almost everyone agrees that prices can't keep rising this fast much longer. The debate now is whether the boom will lead to a soft landing, with gentler price increases, or to a long, painful bust, in which prices fall considerably in some places before buyers regain confidence.

However the current boom ends, longer-term forces are reshaping the housing industry. Here is a look at some of them.

1. SHORT ON SPACE

America still has lots of wide-open spaces, but many of them aren't where people want to live. And builders are finding it more difficult to get permits to put up new houses in many of the more economically vibrant metropolitan areas, particularly along the East and West coasts.

"The housing supply has been constrained by government regulation as opposed to fundamental geographic limitations," concludes a paper released in December 2004 by Edward L. Glaeser, an economics professor at Harvard University, and two colleagues.

Homeowners share the blame. Prof. Glaeser's paper says they have grown savvier about organizing themselves to block proposals that would bring new and more densely packed housing to their neighborhoods --something that they fear could reduce the value of existing homes.

In the more crowded markets, home values no longer have much to dowith the cost of building a home. In San Francisco, the paper estimates, the structure itself typically accounts for no more than30% of a home's value; the rest of the value reflects the costs of land and obtaining regulatory approvals to build. That's why somepeople pay as much as $1 million for an old home, immediately tear itdown and build a new one.

2. STRAINED BUDGETS

The housing boom has enriched many Americans by pushing up the values of their homes. But it hasn't been splendid for everyone. Nearly a third of American households spend more than 30% of their income on housing, and more than one in eight households spend more than 50%,according to the Joint Center for Housing Studies at HarvardUniversity. Others move to distant suburbs so they can pay less for housing, but then must pay high costs to commute. A third of all households in the Boston area are at least 30 miles from the central business district, according to a Harvard study, and about a fifth live 40 or more miles out.

For people with modest incomes, housing has soared out of reach insome areas. The California Association of Realtors estimates that only15% of households in that state earn enough to buy a median-priced home, currently costing about $544,000, without spending more than 30% of their income on mortgage payments, real-estate taxes and home insurance.

3. A SHRINKING FORECAST

For years, homes have been getting steadily bigger. The median size of new single-family homes in 2004 was 2,140 square feet, up from 1,535 square feet in 1975, according to the Census Bureau.

But some academics and industry people believe more Americans will embrace smaller, more urban homes, to avoid long commutes. James Z.Pugash, chief executive officer of Hearthstone Inc., San Rafael,Calif., which finances housing developments, predicts that American cities will become more like their European counterparts, with more midrise buildings, higher housing costs and fewer square feet per person.

In a 2004 paper for the Brookings Institution, Arthur C. Nelson, a professor at Virginia Tech, says there are at least tentative signs of growing demand for more "walkable" living environments combining homes, entertainment and offices. He cites as a model Arlington County, Va., near Washington. In 1990, Mr. Nelson writes, the conventional wisdom was that the county was "built out" and lacked space for more residents. Yet the population continues to grow rapidly. Mr. Nelson says the county is encouraging higher-density housing on former industrial sites and near mass-transit stations, while preserving the character of established neighborhoods.

The desire for more urban living -- and speculation that it will grow-- has spawned a boom in condominiums. In the 12 months ended in August, sales of condos and cooperative housing soared 14%, to a seasonally adjusted annual rate of 942,000 units. In the same period, sales of single-family homes rose a more modest 6.9%.

4. TAKING A RISK

As home prices have soared, lenders have promoted loans that help people afford houses that otherwise would be beyond their reach. These"affordability" loans hold down monthly payments in the early years but subject borrowers to the prospect of much higher payments later.

Among the most popular of these loans are interest-only mortgages, which allow borrowers to avoid paying down any of the principal in thefirst few years. Another twist is the payment-option loan, giving borrowers a choice of several payment levels each month, including one that is less than the interest due. If the borrower makes that choice, the loan balance increases, something known as negative amortization.

Lenders also have reduced the amount of documentation that many borrowers have to provide to verify their income and assets.

Bank regulators have started asking questions about all of these practices. The fear is that some borrowers have exaggerated their income or won't be able to meet the higher monthly payments once they come due. Another concern is that affordability loans have artificially pumped up housing prices by allowing people to bid more than they can really afford to pay in the long run.

5. THE HOME AS PIGGY BANK

The traditional goal of homeowners is to pay off the mortgage -- well before retirement, if possible. For now, many Americans seem to have forgotten that notion.

To take advantage of lower interest rates, Americans regularly refinance their loans. In the process of refinancing, they often borrow a bit more -- in effect swapping home equity for cash to spend on other things. Such "cash out" refinances totaled $139 billion in 2004, according to Harvard's Joint Center for Housing Studies. Egged on by lenders, other people take out separate home-equity loans, using their homes as collateral.

"I guess this generation believes that real-estate values will go up forever, so there's no need to pay down principal," said Angelo R.Mozilo, chief executive officer of Countrywide Financial Corp., the nation's largest mortgage lender, during a conference call with investors last year.

This blithe attitude has fueled consumer spending. A recent Federal Reserve study found that borrowing against home values added $600 billion to American consumers' spending power last year, or 7% of personal disposable income, up from 3% in 2000 and 1% in 1994.

6.FOREIGN FRENZY

The proliferation of riskier mortgage loans comes as foreign investors are playing a larger role in financing the U.S. housing market.

Investors in Asia and Europe have long been major buyers of debt issued by Fannie Mae and Freddie Mac, the two government-sponsored providers of mortgage financing. Now they also are buying an increasing amount of mortgage-backed securities, bonds backed by the payments of interest and principal on large pools of mortgages.

There are no reliable figures on the total size of foreign investments in U.S. mortgage securities, because many of the purchases are indirect, made through U.S. entities. But the direction is clear. Inside Mortgage Finance, a newsletter, estimates that foreign holdings of one type of mortgage bond -- those not guaranteed by Fannie orFreddie -- jumped to $40 billion as of June 30 from $30 billion six months earlier.

7. REDUCED-RATE REALTORS

The Internet hasn't slashed transaction costs in residential real estate, as it has in such areas as airline reservations. Commissions paid to agents still average more than 5% and sometimes reach 7% or more, according to industry estimates.

But brokers offering various cost-saving alternatives finally seem to be gaining traction. Many small brokers charge a flat fee, generally around $500, for putting a house into a multiple-listing service and providing a limited menu of other services; the consumer then typically offers to pay an additional 2.5% or 3% of the purchase price to any agent who supplies a buyer. Other brokers offer to rebate part of any commissions to the consumer.

Some traditional brokers are experimenting with their own discount arms, even as they try to preserve the full-commission business by backing state laws that mandate a minimum level of service.

U.S. antitrust enforcers at the Justice Department and Federal TradeCommission are putting heavy pressure on the industry to give new models a chance. For instance, the Justice Department in September sued the National Association of Realtors, alleging that its policy on sharing of listing information discriminates against brokers that mainly use Web sites to engage with their customers. The association denies that claim.

8. THE BIG GET BIGGER

Home building used to be mostly a local business, and there are still around 80,000 home builders in the country, most of them tiny. But the biggest builders are gobbling up more of the market. This year, the top 10 builders account for about 24% of the market (excluding homes built for customers on land they already own), up from 10% in 1997, says Ara K. Hovnanian, chief executive of Hovnanian Enterprises Inc., a large builder based in Red Bank, N.J. Within a decade, he predicts, that share will be more than 50%.

Big players have the upper hand partly because they have the financial resources to acquire prime parcels of land. Robert I. Toll, chief executive of Toll Brothers Inc., Horsham, Pa., says he often approves land purchases of $100 million or more, something small builders couldn't contemplate.

But Ivy Zelman, chief housing analyst at Credit Suisse First Boston in New York, says the big builders already have grabbed the easiest market-share gains in fast-growing metropolitan areas and now increasingly are butting heads with one another. That may make future market-share gains slower and more expensive.

9. GIMME MORE SHELTER

Americans have made so much money from their homes that they can't resist buying more real estate. Investment properties and vacation homes accounted for 14% of new mortgages last year, up from 7% in2000, the Federal Reserve says.

Much of this buying comes from baby boomers seeking retirement homes or people hoping to strike it rich as landlords. While these purchases have helped to feed the recent strength in housing, they also could make the market more volatile. That's because second homes and rental properties, unlike primary residences, can easily be dumped onto the market if their owners lose confidence or fail to find reliable tenants.

10. WATCHING THE RANKINGS

J.D. Power & Associates, the consulting and research firm best known for its surveys of automobile quality, also quizzes buyers of newhomes. The home surveys, which began in 1997, now cover 30 largemetropolitan areas.

Companies that have done well in the surveys -- such as Pulte Homes Inc. and Centex Corp. -- are trumpeting the results. That's forcing other builders to try harder to score as well.

One problem for the industry is that it relies mainly on a continually changing cast of subcontractors to perform tasks like pouring foundations, installing heating ducts and shooting nails into roofing tiles. That makes it hard to ensure that quality standards are always met. Hovnanian Enterprises is experimenting with using its own employees to do more of the tasks in some markets in an effort to improve consistency.

Among other things, says Bruce Karatz, chief executive of KB Home, the surveys have nudged his company into communicating better with customers, including giving them earlier estimates of when houses will be completed. If KB is more than 30 days late, he says, "many customers will never forgive us."

Housing Market Cooling, Data Say

In Washington, Sales Are Down, Inventory Is Up
Washington Post, November 11, 2005 - p. A1
By Kirstin Downey and Sandra Fleishman

Lynn Edmonds and his wife, Sebnem, could barely wait to sign on the dotted line back in May when they committed themselves to pay $796,000 for a three-floor townhouse under construction in Alexandria's Cameron Station.

But since May, the sales prices for the development have fallen -- and units like the one the Edmonds bought are now being sold for $699,900. The Edmonds are facing the prospect of a $100,000 loss in value before they even walk through the front door.

"We blithely stepped into the contract, thinking it would hold its value -- but that's not the case," said Edmonds, 46, a program analyst and Air Force veteran. "I feel so stupid putting myself into it. It's real estate -- I knew on a theoretical basis that it might go up and it might go down, but now I know it on a practical level."

New data released yesterday show that in the past year, home sales in the Washington region have declined sharply, the inventory of unsold homes is up significantly, and prices have flattened and, in some cases, fallen.

The trend is most striking in Northern Virginia, where most of the region's growth has occurred, but it is evident almost everywhere. Statistics on home sales released by Metropolitan Regional Information Systems Inc., the regional multiple-listing service, show that:

- In the two counties and three cities that make up the Northern Virginia market, more than twice as many homes were available for sale in October as in the same month one year ago -- 7,122 homes, compared with 3,254 -- and sales are off 28 percent.
- In the District, listings are up 62 percent and sales are down 28 percent.
- In Montgomery County, listings are up 49 percent and sales are down 8 percent.
- In Prince George's County, the listings are up 45 percent. But home sales have remained fairly stable, dropping only 2.6 percent.

The last time the region had this many houses for sale was the late 1990s, the MRIS figures show .

With housing supply higher and demand lower, prices have fallen from their summertime peaks -- though prices fluctuate every month and often decline in the fall because summer is the busiest home-buying season. Nevertheless, some slides are evident almost everywhere: In the District, the median price -- the point at which half the houses cost more and half cost less -- was $425,000 in October, down from a high in August of $435,088. In Fairfax County, the peak was in July, when the median price was $503,000; in October, it was $489,450. The peak in Montgomery County was also in July, when prices hit $460,000; the median price in October was $429,000.

The notable exception in the region was Prince George's County, where October's price was an all-time high of $315,000 -- possibly because demand, spurred by prices that are still less expensive than elsewhere in the region, has remained high.

The MRIS, which is jointly owned by the 25 local associations of Realtors, has been tracking home sales since the late 1990s, compiling its monthly figures from 72 counties in four states and the District. Its data mostly reflect sales of existing homes, since builders usually sell new developments themselves, rather than through real estate agents. But new-home sales are also faltering: Within the past two weeks, two of the biggest developers in the region, Toll Brothers Inc. and NVR Inc., have reported that their sales are slowing.

Many local real estate agents say the market is returning to normal. "We're rebounding in terms of evolving to something close to a balanced inventory," said David Howell, a past president of the Northern Virginia Association of Realtors and executive vice president and managing broker at McEnearney Associates Inc. in McLean. He said the true aberration occurred from 2003 to early 2005, when the number of listings fell to record lows, causing what he called "unbelievable and untenable" increases in appreciation.

Howell and others point out that the Washington area is unlikely to experience a major decline in prices because of its continued job growth and the prevalence of government jobs, which tend to be more stable than private-sector employment. "We're the most insulated of any market in the country" from extreme price volatility, Howell said.

The slower market "is so much healthier, it really is," Susann H. Haskins, president of the Greater Capital Area Association of Realtors and a broker at Long & Foster Real Estate Inc. in Potomac. "It's a better balance between buyers and sellers."

Economist Gregory H. Leisch, chief executive of Delta Associates, an Alexandria-based real estate consulting firm, said consumers would benefit in the long run from the slowdown because house prices had been rising so quickly that the market was destabilized. "The market is fatigued, and it should be taking a breather," Leisch said. "It's healthy that it takes a breather."

Housing experts say the slowdown is occurring for several reasons. In the past few months, a lot of homeowners put their places on the market speculatively, hoping to cash in, creating a surge in housing supply. Many investors, whether speculators or landlords, have done the same, either because they believe the market has peaked or because they cannot make enough money in rent to support the mortgages.

They are finding fewer buyers because the double-digit price appreciation of the past few years has priced many people out of the market. The recent rise in mortgage interest rates, which causes monthly payments to rise, adds to price pressures. And now, with fears that the market has peaked, more people are simply afraid to buy.

Meanwhile, new construction is inflating the housing supply, as condominium developers rush projects to market. According to a recent report by Delta Associates, 47,000 units in dozens of projects are hitting the local market in the next three years, which is about five times as many condo units as were sold last year.

Some real estate speculators are starting to feel burned by investments that have turned sour.
Merzad Ranjbaran, a real estate agent with Weichert Realtors in Bethesda, bought a one-bedroom condominium at 1150 K St. NW in the District a year ago at a pre-construction price, hoping to flip it quickly. But it has not sold. He said he will only break even on the sale, after taxes and other costs.

"The market is changing from a seller's market to a buyer's market," Ranjbaran said.
Real estate investor Andy Cabral has had a townhouse on the market at the Wheaton Metro station for 11 months, and though he has steadily dropped the price, it has not sold.
"It's now below the appraised value," Cabral said. "I'm really not happy."

His sister-in-law, Sandra Cabral, a real estate agent with Re/Max Pros in Kensington, puts it more succinctly: "He needs to get rid of it; it's an alligator eating all the money."

But she sees an upside to the situation, with good opportunities to make purchases cheaply in the future. "Within two or three years, there's going to be a whole lot of foreclosures, because with all of the interest-only loans, a whole lot of people don't realize that in two years their payments are going to go up."

Homeowners who want to sell, meanwhile, are drumming their fingers and waiting for buyers to knock on the door.

Violain Romans-Murray, 33, is sick of the long commutes from her four-bedroom home in Gainesville; it can take her husband three hours to get home from his job as a technical manager for General Dynamics Corp. in Fair Lakes. The couple put the house on the market last month for $589,900, hoping to buy a home closer to their jobs. But three weeks have passed, and only two buyers have even visited. When they sold their previous house in Centreville in 2002, it sold in five hours.

"Honestly, we're thinking we might pull it off the market," said Romans-Murray, a mother of three and special projects coordinator for a trade group based in Herndon. "It's scary."
But many would-be buyers have withdrawn from the real estate market, saying prices are just too high to consider making a purchase. Dan McGrath, an organizer for the Service Employees International Union, and his wife, Teresa, who works at the Environmental Protection Agency, have been married for four months, have a combined income of about $100,000 a year and would ordinarily be good candidates to become first-time homeowners. But the McGraths, who live in the District's Shaw neighborhood, have been shocked and repulsed by the prices for homes in the area, including the $400,000 price on one 800-square-foot studio they visited.
"We can't figure out who -- for the life of us -- would buy a place with two doors for $400,000," said McGrath, 28. "We want to think about a future but homeownership here is just not possible."

News analysis: Expedia founders bet on housing

Inman News, November 07, 2005
By Jessica Swesey

Small-team innovators are constantly entering the real estate market, but there hasn't been a significant industry-changing entrant since the dot-com boom. Until now.

Zillow, a hush-hush online real estate startup founded by former Expedia executives Rich Barton and Lloyd Frink, could represent the first serious challenge to how real estate has been sold for decades. Consider the quality of its founding team, the size of the initial investment and the founders' appetite for new business models.

While Zillow's tight-lipped approach has afforded little indication of what exactly the business will look like, records at the U.S. Patent and Trademark Office lend some clues about what the Seattle company may be planning.

Early patent and trademark recordings filed by the company indicate that it has plans for some kind of online marketplace for real estate listings. Specifically, one record at the Patent Office is for providing an online computer database and online searchable database featuring information and listings for real estate, and to provide real estate research services.

The patent and trademark record also notes the design of computer software, and providing online computer services for real estate, consumer goods and consumer services. Another record drops hints of plans for an Internet auction business for real estate and online services featuring tours of residential and commercial real estate.

It will take more than patents to crack a formidable real estate tradition that stands on a 5-6 percent commission and a broker cooperation business model. But no one underestimates the seriousness and ingenuity of Barton's team, who single-handedly transformed the travel industry with the introduction of Expedia in the late '90s.

The timing seems to be right; there hasn't been a well-capitalized online startup in real estate since HomeGain and HouseValues opened their doors in 1999. These two firms changed how the industry thinks about lead generation and Web marketing.

Now, the next generation of change seems to be upon us with the vast majority of home buyers and sellers starting their real estate searches online and the Justice Department's investigation of the real estate industry clearing the decks for new business models.

The online real estate segment has heated up, with last year's successful IPOs of ZipRealty, an online brokerage model, and HouseValues, which sells online leads, conversion and marketing tools to real estate companies and agents. Media giants including Gannett, Tribune Co. and Knight Ridder stepped up earlier this year with the acquisition of HomeGain.

Google, craigslist and host of other innovative technology companies are paying more attention to real estate, which creates an atmosphere of excitement and spawns new investment.

While Zillow is shrouded in secrets, the expectation is that over the next several months everyone will know who they are and not everyone will like what they're doing. The company has not officially commented on what its business model will be, but has made public the members of its team, a new round of financing and a recent Web site launch.

The company on its newly launched Web site says it is "working hard to develop a new kind of online real estate service." It has been hiring new employees and is looking for more talented people, according to job postings on Zillow.com.

Two top venture capital firms, Benchmark Capital and Technology Crossover Ventures, are betting the team that built Expedia has another success story on its hands. The multibillion-dollar funds, which have long-standing ties to Barton, led the first round of venture financing, though the terms were not disclosed.

Bill Gurley, general partner at Benchmark Capital, and Jay Hoag, founding general partner at TCV, have joined Zillow's board of directors, which also includes Barton; Frink; Greg Maffei, president and CFO of Oracle; Gordon Stephenson, co-founder and managing broker of Real Property Associates; and Erik Blachford, former CEO of Expedia.

Both venture funds have ties to the online real estate industry, with Benchmark as one of ZipRealty's early funders and TCV funding all three rounds of the HomeGain venture.

Zillow's venture funding came just three months after the company raised $6 million in financing from its directors and employees.

Mortgage shopping:

Taking the time to learn the facts
Inman News, November 07, 2005
By Jack Guttentag (This is part 1 of a seven-part series.)

Most consumers, before they start shopping for an automobile, decide on the brand, model and options they want. They realize that they can't shop effectively unless they know exactly what they are shopping for.

When they enter the mortgage market, in contrast, where their financial commitment may be 10 times larger, many consumers don't have a clue as to what they want. They look to the loan provider to guide them through the maze. This dependency is one major reason they often end up with a mortgage that is over-priced and, even worse, does not meet their needs.

This article poses eight questions that prospective borrowers should ask themselves before entering the market.

Subsequent articles provide guidelines on how to answer them.

What type of mortgage should I select?

The major decision is between fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). ARMs have lower payments in the early years than FRMs but expose borrowers to the risk of higher payments in later years. ARMs with the lowest early-year payments have the greatest risk of future rate and payment increases.

Which mortgage options should I select?

The major options are to waive the obligation to maintain an escrow account for taxes and insurance payments, which will cost you a little; an interest-only payment option, which also costs little; and a prepayment penalty, in exchange for which the lender will usually pay you.

How long of a term should I take?

The term of a mortgage is the period used to calculate the mortgage payment. The longer the term, the lower the mortgage payment but the slower you pay down the balance. Term selection is an issue primarily on FRMs, which are available at terms ranging from 10 years to 40 years. While 15-year and 40-year ARMs exist, most lenders offer only 30-year ARMs.

How many points should I pay?

Points are fees you pay the lender at the time the loan is closed, expressed as a percent of the loan. On a $100,000 loan, two points means a payment of $2,000. The more points you pay, the lower the interest rate. Hence, points should be viewed as an investment on which the return is higher the longer you have the mortgage.

How large a down payment should I make?

The down payment is the difference between the loan amount and the lower of the sale price or appraised value. If you have discretion over how much to put down, the down payment, like points, is best viewed as an investment.

Investment in a larger down payment can yield a high return if it flips the loan into a lower mortgage insurance or interest rate category.

If I put less than 20 percent down, what type of mortgage insurance should I select?

Borrowers who put down less than 20 percent are charged for the risk they impose on lenders. However, borrowers often can choose how to pay. One option is to pay a premium to a private mortgage insurance company (PMI) selected by the lender. A second option is to pay the lender a higher interest rate, which is called lender-provided mortgage insurance (LPMI). In this case, the lender purchases insurance from a PMI, though not always. The third option is a "piggyback" arrangement, where the borrower takes out a first mortgage for 80 percent of property value, and a higher-rate second mortgage for the balance of the funds needed.

How long a lock period do I need and when should I lock?

The lock period is the period during which the lender guarantees the rate and points: the longer the lock period, the higher the price. Borrowers must choose when to lock and for how long.

What documentation requirements should I seek?

A lender's "documentation requirements" stipulate the information about the borrower's finances that must be provided and how this information will be verified, and then used by the lender. Lenders offer choices ranging from "full documentation" to "no-docs." Because the risk to the lender rises as documentation requirements become less stringent, the price of the mortgage rises correspondingly. Borrowers may or may not have any leeway, depending on
what documentation they can provide.

Next week: How should borrowers decide the type of mortgage that best meets their needs?

Goodbye, My Sweet Deduction[!]

New York Times, November 3, 2005
By EDUARDO PORTER and DAVID LEONHARDT

There are no cows more sacred in the tax code than the deductions for mortgage interest and property taxes.

Together, they add up to at least a $75 billion annual subsidy for housing and homeowners. President Bush, in establishing his advisory panel on tax reform, specifically asked the group to preserve support for home ownership.

So it was quite a shock that the panel, which released its final report on Tuesday, concluded that it had no choice but to significantly trim the home mortgage deduction and eliminate state and local tax deductions if it wanted to find a way to simplify the income tax.

By combining that move with a variety of other measures, the panel was also able to bury the alternative minimum tax, a complex tax originally intended to prevent the wealthy from escaping taxes that is now starting to hit millions of otherwise ordinary upper-middle-class families who have a typical range of itemized deductions and personal exemptions.

The panel had a powerful rationale behind its proposal: many economists say the real estate subsidy is one of the tax code's most unfair features, overwhelmingly benefiting the affluent and pulling investment from the rest of the economy into the housing sector.

But for millions of homeowners, what no doubt matters most about the plan is how it affects their bottom line. And for many of them, especially those living in houses in expensive markets in California and the Northeast, the answer is clear: If it becomes law, the value of their homes will almost certainly fall.

The pain that would be caused by putting an end to deductions for mortgage interest and property taxes explains a lot of the motivation behind the attacks that greeted the panel's proposals.

"I think the short-run prospects of Congress adopting these are very low," said Joel B. Slemrod, the director of the Office of Tax Policy Research at the University of Michigan. "They take away a lot of the deductions and credits that people have gotten used to, and we know that losers cry louder than winners sing."

The plan by the presidential panel would reduce the mortgage deduction on homes in two ways.

First, it would limit the amount of the mortgage eligible to be deducted, cutting it from the current cap of a little more $1 million to as low as $227,000 in cheaper housing markets like Springfield, Ohio, to as high as $412,000 in places like New York and many of its suburbs.

Second, families would receive a credit equal to 15 percent of the interest paid on a mortgage below the cap, rather than a deduction that can be worth as much as 35 percent for taxpayers at the high end of the income scale.

Just about everybody involved in the housing and real estate market has raised objections to this proposal. In a statement released Monday, the National Association of Realtors estimated that home prices across the nation would fall by 15 percent, with "a devastating effect on the nation's housing economy." The Mortgage Bankers Association called the proposals "a tax increase for a lot of working Americans."

Even supporters of the changes acknowledge that house prices would fall. "Almost any economic analysis will conclude that there will be some downward effect on prices, especially at the top of the market," said James Poterba, an economist at the Massachusetts Institute of Technology who is on the president's panel. "The question is how large it will be."

The elimination of the deduction for state and local taxes, including property taxes, also has the potential to bring down house values, especially in high-tax states like New York, California and New Jersey, where homes are selling at record-high prices.

One way to estimate the total impact is to calculate how the change would affect a household's monthly housing payments. If home buyers try to keep their monthly house payment steady, an analysis by Dean Baker, co-director of the Center for Economic Policy Research in Washington, suggests, prices could fall by more than 20 percent in higher-priced markets like New York City. Even in cheaper markets, homes that are priced above the average could
take a substantial hit.

A family living in Lansing, Mich., for example, with $90,000 in taxable income, would have a marginal income tax rate of 25 percent. In Lansing, the average home price is around $250,000.

If that family were to buy a $500,000 home today with 20 percent down and a 6 percent fixed-rate mortgage - a fairly typical arrangement - the I.R.S. would effectively refund about $7,125 in the first year, according to Mr. Baker's analysis. Adding a 0.9 percent property tax, the total monthly payment, net of federal taxes, would be about $2,160.

Under the new system, however, the family would receive a return of $2,250 from the I.R.S. - 15 percent of the interest at the mortgage limit of $250,000 - effectively pushing their net payment up by $400 each month. If the maximum monthly cost they could afford was $2,160, they would have to settle for a house worth about $70,000 less.

The more expensive the home, the larger the effect. According to a similar analysis by Mr. Baker, a family in the top tax bracket who today could afford a $1 million home in Manhattan would have to trim their budget by more than $200,000 to keep monthly payments the same.

To soften the blow, the panel proposed to phase the change in over five years. But as home buyers across the country were forced to cut back on the value of homes they could afford to buy, they would inevitably drag home prices down.

"If you look at it that way, you have to be prepared for prices to plunge," said Mr. Baker, who has long been expecting housing prices to drop for other reasons.

Mr. Poterba argues that it is unlikely home prices would fall as much as others fear. For one, the changes would also slow investment in housing, reducing the supply of homes along with the demand. Methods of financing homes would also change in response to the tax laws.

Notwithstanding homeowners' pain, reducing the tax code's subsidy to housing is a sound idea, many economists say.

"It's an appropriate change to the tax code," said Mark Zandi, chief economist at Economy.com, a research firm.

"While it may have made sense a quarter of a century ago, now I don't see a compelling advantage to providing these tax advantages to housing."

To begin with, the mortgage deduction diverts capital from other industries by subsidizing investment in housing relative to other economic activities. Moreover, while the tax deductions were conceived to help people who otherwise could not afford to buy a home, the principal effect today is to encourage upper-income taxpayers to buy ever bigger and more expensive houses.

For all the talk of bolstering home ownership, said Edward L. Glaeser, an economics professor at Harvard, the mortgage tax deduction has done very little to help people into homes. He said the subsidy to taxpayers implicit in the deduction had varied widely over the last 40 years, going up and down with the fluctuation of inflation and interest rates.

Yet home ownership over the period has drifted in a band of 63 to 69 percent. And home ownership levels in other affluent countries without such subsidies are generally no lower than in the United States.

Instead, what the subsidy has done is encourage people to build and buy bigger and more expensive houses. "The deduction increases the amount spent on housing," Mr. Glaeser said, "but it has almost no effect on the home ownership rate."

Today, most of the mortgage tax advantages accrue to the rich rather than struggling first-time homeowners. More than 55 percent of the mortgage tax subsidy last year, according to the Congressional Joint Committee on Taxation, accrued to just 12 percent of taxpayers with incomes above $100,000.

Low-income homeowners often do not claim the deduction, opting instead to take the $10,000 standard deduction available to families. Turning the deduction into a tax credit would equalize its value and make it available to more people on the lower end of the market.

"At the high end it reduces demand and will probably push prices down," Mr. Slemrod said. "For low-end housing, it could go the other way around."