Front Loading

Cash for clunkers and home-buyer tax credit provided huge subsidies for each incremental sale but failed to sustain the car and housing markets.

During the Great Recession that started in 2007, the US government tried many ways to stimulate the economy. Among these measures were cash for clunkers and home-buyer tax credit.

Sales of cars and homes were artificially pumped up only to fall back below trend when the stimuli were phased out. Such front loading of economic activities are quite typical of market economies that are obsessed with immediate results.

Narrowly speaking, front loading is a very expensive undertaking. In the cash for clunkers program, 690,000 vehicles were sold but only 125,000 of the sales were estimated to be incremental to what would have been sold even without the tax rebate. Dividing 125,000 into $3 billion of the total rebate budget, each of the additional sales cost the taxpayers $24,000. This is some 89% of the average price of a new vehicle sold in August 2009. Deceptively, the average cash rebate for each new car sold (including incremental sales as well as normal sales) was only $1,667.

This leakage of incentives was also found in the home-buyer tax credit program. On paper, first-time home buyers were given a tax credit of only up to $8,000 towards the purchase of a home. But since some of the sales would have happened without the tax credit, the tax credit amounted to $43,000 to $80,000 for each marginal sale. This subsidy amounted to some 26 – 48% of the price of a median home in February 2010.

Whatever else might be said about these stimuli, their stimulus effects were anything but sustained. A gauge of housing-market activity plunged in November 2009, largely due to front loading of home buyers to beat the October deadline of the tax credit. The deadline was since extended to April 2010 to prop up the housing market. But the slide in the sales of existing and new homes continued.

A similar fall back of demand happened with the cash for clunkers program. After the August 2009 sales spike, sales fell back to below trend for at least 4 months in a row.

It is widely known that many public companies engage in front-loaded accounting to make their books look better for the current quarter. This practice is also known as channel stuffing by over-selling of products to customers. Indeed, the Great Recession is basically the bad after-taste of a giant experiment in front loading the housing market. By extending mortgage loans to subprime borrowers and packaging the loans into securities of unknown risk, many financial institutions drummed up their short-term performance only to fall flat in the subsequent bust.

Front loading may be justified as a means of pump-priming the expenditure multiplier during demand recession. But the results may be disappointing because it is difficult to target the stimulus. And it may not be a good idea to pick fruits before they are ripe.