The National Association of Realtors (NAR) reported that Pending Home Sales plunged 16.0% in November from October, but are 15.5% above year-ago levels.

Used home sales are recorded at closing — not when the deal is reached — which often results in a delay of as much as two months. The pending home sales report is based on the number of handshakes, and is thus a good leading indicator of the number of closings over the next month or two.

In recent months, used home sales (which are what the report tracks) have been much stronger than new home sales. Historically there had been a stable relationship of about 6 existing home sales for every new home sale; in November, the ratio was 18 to one. However, the tax credit for first-time home buyers (now expanded to include almost all home buyers) has mostly gone to stimulate used home sales.

Used home sales only indirectly stimulate the economy, mostly by raising the incomes of the people working at Coldwell Banker, and because people tend to slap a new coat of paint on the walls after they move in, which is good for firms like Sherwin Williams (SHW). It is new home sales that really stimulate economic activity and have historically helped pull the economy out of recessions.

However, with a glut of housing on the market, in a “big picture” sense it is not a very good idea to be pouring resources into making more houses, even if it would result in more construction jobs and more profits for firms like D.R. Horton (DHI).

How the Economics of Housing Are Shaping Up

For that to make sense, new household formation has to increase, which will stimulate real new demand rather than efforts that simply shift people form being renters to being owners. That just results in higher rental vacancies, which puts downward pressure on rents.

Since renting a home is a good substitute for owning a home, downward pressure on rents will result in downward pressure on housing prices. The tax credits can prop up housing prices in the short term, and the evidence suggests that they have been doing just that.

A large part of the $8000 home-buyer credit is captured by the seller of the house rather than the buyer through a higher price for the house. At the margin, this might be keeping some people from slipping underwater on their mortgages and thus is encouraging them to continue paying. That is obviously also helpful to the holders of those mortgages, like Wells Fargo (WFC) — yet another indirect form of aid to the big banks.

However, unless we are going to make the tax credit permanent, it is only going to delay the price adjustment for houses. To stimulate household formation, we need to see more jobs. A good job will get the 25-year-old out of Mom’s basement and into a place of his own. A steady salary will allow people who are sleeping on friends couches since they got foreclosed on to be able to rent their own place. That is the only real long-term solution to the excess housing inventory we have in the country (other than the bulldozer, which is about the purest form of the “broken-window fallacy” — check your Econ 101 textbook for reference).

What to Expect from the Home-Buyer Credit

For awhile it looked like the tax credit program was going to expire (it was later not only extended but expanded). That caused a rush of people to buying houses before the deadline. Now we are seeing the hangover from that.

Under the current version, buyers will have to have a contract in place by 4/30/10 and close by 6/30/10 to get the tax credit. Look for another surge just before the deadline, and another slump right afterwards this spring.

“Cash for Clunkers” Better Than “Cash for Castles”

I have thus been skeptical about the “Cash for Castles” program, even though I was in favor of the “Cash for clunkers” program. The latter resulted almost entirely in the purchase of new cars — which results in a lot of economic activity, not just the sale of used cars, which, like used houses, does little to help the overall economy. Yes, it helps out used car dealers, just as the “Cash for Castles” program is helping out used house dealers (aka realtors), but beyond that, used car sales don’t increase GDP.

Yes, there was a bit of the broken-window fallacy to “Cash for Clunkers,” since some still-running used cars were taken off the road, but that is offset by the improvements in safety and fuel efficiency of a new car versus a 10-year-old one. The direct economic effects of the “Cash for Clunkers” program were dramatic.

Besides, we get some of that money back to the extent it helps out General Motors and Chrysler, because you, dear taxpayers, are major shareholders in both of them. Even to the extent it helps out Ford (F) it indirectly helps, since the workers there (and at the suppliers) will be back at work, and paying taxes rather than collecting unemployment benefits. Thus, on a dynamic basis, the cost of the program is probably far less than the $3 billion price tag.

“Cash for castles” is simply going, for the most part, to people who would have moved anyway, and does not have any of those ancillary benefits. Besides, home owners, as a group, have higher incomes and more wealth than do the population as a whole (i.e. homeowners plus renters). So why are we taxing renters to subsidize homeowners — on top of the MASSIVE subsidies we already provide to them in the form of mortgage interest deductions?

Since used home sales are not that important to the economy, I would rate this report, while disappointing, to be only a minor negative.

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