With proposed tax changes from President George W. Bush's advisory Tax Reform Panel considered detrimental to the housing market, MBS market participants are now up in arms and hindering the implementation of the suggested changes.

Specifically, the panel recommended limiting the mortgage interest deduction by lowering the mortgage interest cap - the loan amount that homeowners could receive a tax break for interest paid - from $1 million to the local Federal Housing Administration loan limit. The deduction would be replaced by a credit equal to 15% of interest paid on mortgages up to the interest cap. The panel also suggested changes viewed as making second lien and second homes less attractive.

Industry participants are skeptical as to whether these proposals could actually come to fruition. "First off, I personally think it is highly unlikely there's going to be a meaningful reduction in the mortgage interest deduction," said Robert Curran, senior director and primary homebuilding analyst at Fitch Ratings, adding that the most that could happen is the maximum amount could come down modestly. "The National Association of Realtors and National Association of Home Builders - the two most potent lobbying forces in the country - have already expressed their concern about the issue. That may be enough to quash anything from happening." Curran added that opposition from the general public could also be expected, an important factor that could also hinder the changes from happening.

Peter DiMartino, head of ABS and MBS credit strategy at RBS Greenwich Capital, said that because many housing industry observers view the current proposals as potentially detrimental to the residential housing sector, "the initiative has a low probability of success, at least the way it's currently proposed." DiMartino added that, "while a broad tax proposal may make sense in its totality, it will be defeated if the housing component loses along the way."

In a release, the National Association of Realtors said the nation's residential property values could drop 15% or more if the Tax Reform Panel's proposal to convert the mortgage interest deduction to a tax credit takes effect, noting that the housing sector makes up roughly 15% of the nation's GDP. The NAR added that the proposed elimination of the tax deduction for second homes would affect at least 5% of the GDP, noting that second homes comprised 36% of all home sales last year. "The NAR urges that real estate be recognized as a long-term investment, so the tax system should reflect the stream of income and expenses associated with long-term investments," the National Association of Realtors said in its release, adding that a workable tax system should treat home ownership as investment rather than consumption.

Meanwhile, National Association of Home Builders CEO Jerry Howard similarly opposed the changes in an official statement saying, "It's the biggest tax hike for home owners ever considered." Howard added that replacing the mortgage interest deduction would punish millions of borrowers, specifically those in California and other high-cost markets. The effects would be twofold and "equally disturbing," Howard said, as " the tax reform proposals would reduce home values and send a chill through the housing market, which has been leading the economic expansion for the past three years," Howard stated.

In an interview, Howard said that the proposals made also appear to be detrimental to homeowners across the credit spectrum. For instance, the repeal of the low income tax credit -the only rental housing incentive given to the private sector - hits underserved borrowers. "We've looked at this thing in its totality and are pretty much against it," Howard stated.

The Mortgage Bankers Association joined the fray, stating that replacing the mortgage interest deduction with a tax credit not only effectively increases taxes on homeowners, specifically in high-cost areas, but would also add more complexity to the tax code by requiring grandfathering provisions as well as additional indexing. The MBA also criticized the panel's proposal to remove the deduction of interest paid on home equity loans and opposed the elimination of local real estate tax deductions.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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