Congress Never Misses An Opportunity to Miss an Opportunity

November 5th, 2009 by Al Lewis (alewis)

As of this writing, Congress is poised to extend the first-time homebuyers $8000 tax credit for more months and possibly institute yet another credit, for $6500, to other homebuyers.  Such an action would illustrate exactly what we say in the introduction to OOBonomics:   A perfect example of the government trying to undo the mess made from years of subsidies (in this case, almost unlimited deductibility of mortgage interest), with another subsidy.

A much better and cheaper idea would be a slight variation on what is proposed in OOBonomics about making real estate commissions more transparent and negotiable.   Instead of offering $8000, the government could offer much less, perhaps $2000, but say that the only house purchases that are eligible are those bought in a manner in which the buyer is responsible for making his or her own brokering arrangements. The seller’s commission is thus halved, so that the half of the total commission that normally gets rebated to the buyer’s agent is excluded from what comes out of the sales price.   (Houses bought with no broker on either side would qualify for the $2000 too, of course.)

For instance, a house sold for $300,000 would generally include a $15,000 commission, payable at closing.  Of that commission, half ($7500) goes to the seller’s agent and half ($7500) to the buyer’s.  (Occasionally, the seller’s agent reaps a windfall because the buyer happens to buy one of his or her listed houses through the same office, a practice akin to an attorney representing both sides in a dispute.)  

If a prospective buyer had to write the $7500 check himself, would he really want to spend $7500 to have someone tell him to “look at those hardwood floors?”   Is there really $7500 of value in being chauffeured to various open houses?  We don’t know, because the buy-side broker’s commission is hidden in the seller’s brokerage fee, so the buyer never has a chance to negotiate a price with his own broker.    In general, people hide a fee when they think the fee is too high to stand on its own, and we here at OOBonomics suspect that real estate brokerage commissions are no exception.

So…in order to qualify for the $2000 credit, why not say that the house price can contain only the seller’s half of the commission?   The buyer would then be responsible for making his or her own arrangements with his or her own broker.  The arrangement could be a check at closing, like today, or an hourly fee, or a fee per showing, or nothing at all.   Of course what will happen in practice is that the $7500 fee will come crashing down, on average, to perhaps $1500, $6000 less than the hidden fee.  How do I know this?  I don’t, but I do know that transparency has caused many other middleperson commissions in other categories, such as commercial insurance, to fall by similar amounts.

And guess what?  In this particular example, the $2000 tax credit plus the $6000 price reduction equals the exact same amount — $8000 —  that Congress may extend as a tax credit.  However, in the OOBonomics scenario only $2000 of the $8000 comes from taxpayers.

What is also likely to happen is, the buy-side broker/consultant concept will start extending to non first-time homebuyers as well, reducing overall real estate transactions costs and increasing the liquidity of residential real estate.   Higher liquidity means easier sales, which in turn means fewer foreclosures.

The only argument against this:  first-time buyers would lack the savvy to negotiate on their own.  There are two ways to address this.  First, have the rule apply only to the second-time homebuyers, if indeed Congress is still considering that possibility.  Second, prospective homebuyers who do not use a broker at all need a “fairness opinion” from a disinterested party.  This whole argument is pretty moot because a buyer couldn’t get a mortgage if the appraisal, done for the mortgage company, suggests that the buyer is overpaying.

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