Why sellers won't take a loss

Interesting commentary over the weekend in The New York Times: Economist Austan Goolsbee explores the unwillingness of home sellers to accept the reality of falling prices and sell their homes at a loss: "Classical economics can’t explain this behavior. That’s because people who refuse to sell their houses for less than they paid for them are violating a cardinal rule of the market: stuff is worth what it’s worth. It doesn’t matter what you paid for it."

Goolsbee, an advisor to the Obama campaign, cites a little history -- the unwillingness of Boston condo owners to sell at a loss in the big real estate slump of the early '90s: "... much of the market went into a deep freeze as many people held out for market prices that no one would reasonably pay."

Our take: Goolsbee attributes this economically foolish behavior to an irrational hatred of losing money.  We have a different take on this: We believe sellers in the current market who are at risk of selling at a loss are operating on a razor's edge of solvency: they can't afford to lower their price -- they bought with little or no money down, they're now upside down, and selling at current market prices won't pay off their mortgage. It's not that they're too proud to take a lower price; it's that they can't afford it.  We believe this is one of many factors that makes the current slump different from the last one, at least in bubble-inflated markets like Southern California.

Your thoughts? Insights? Email story tips to lalandblog@yahoo.com.

Comments

[MyLessThanPrimeBeef]

The housing market is not really a free market.

You can't even short a house.

[Jason]

Two words: Short Sell!

[Charles Wilson]

One of my brothers was caught in the price crash in East Boston, where the market had been distorted by fraud perpetrated by Dime Savings Bank. The techniques were similar to what we've seen all over the United States during the George W. years: No-doc loans and conspiracies among phony bidders and appraisers and agents and mortgage brokers.

In the late '80s he and some friends paid $180,000 for a triple decker. A couple years later there were hardly any bidders. When one did appear, they'd offer $100,000 or $110,000. My brother and his friends decided to stay put, and by the mind-'90s the market had recovered enough so that he could sell the place for break-even.

For a while, I think you'll see a bunch of people doing what my brother did: just holding on, figuring that the market will come back. This time around, though, we're got a deeper and wider set of problems. In the early '90s, there were only a few markets in the sort of distress that faced my brother. Now, most of the country is overbuilt and overpriced, and the fraud has been rampant and national.

I agree with the one economist, Schiller, who's been predicting that house prices will be cut in half. If you do the rent vs. buy equation (rational house price = 150-170x month rent) you can see just how overpriced things have become. By that yardstick, my "$850,000 house" in Seattle is treally a $350,000 house on a good day.

The big question in mind is how the political system will deal with all of this. We can see the Federal Reserve getting cranked up to hyperinflate the debt away, which is going to be just as much of a disaster as the deflationary alternative.

Meanwhile, no one in power is looking at the real issues, which are rampant criminality and a huge shift of economic returns from labor to capital. In the past 25 years we've seen average corporate return on equity go from 11-12% to 17-18%. This has sucked purchasing power out of the middle class, which has responded by putting their living expenses onto their credit cards and sucking phantom equity out of their houses.

This has been a game of musical chairs, and now it's going to stop. "May you live in interesting times," as the Chinese say. It's the 1920s all over again, and it won't be pretty.

[Jeremy (jemarqu)]

This process of the market correcting is going to be a slow miserable event.

I think that a lot of sellers are not in the position to budge on their asking prices but I do believe that in some cases Goolsbee is also right. Some sellers on the market have enough equity to lower their prices. The problem is the homes are not going to start moving until the prices drop tremendously.

Since lending standards have tightened, the only potential (qualified) buyers are people with strong FICO scores and some money in the bank. People that were thrifty enough to sock away a 10% down payment are going to be a little less quick to jump into a bad deal.

One thing is for sure, get ready for more foreclosures and inventories to rise.

[Charles Wilson]

Markets ALWAYS correct. If the Fed hyperinflates, then people will get high dollar prices for their homes but the real prices will still be dirt cheap. If the Fed doesn't hyperinflate, then we'll have national housing deflation that will quickly filter through the economy and cause a depression, in which case the nominal prices of houses will be dirt cheap.

Given our political culture these days -- the rampant desire of people to be lied to, and the eagerness of our national institutions to accommodate them -- I think hyperinflation is more likely. Either way, it's going to end very badly.

[investorguy]

Jason: Short sales are easier said than done.As a buyer, I have to get agreement from the TD holders in inverse order: 3rd gives up just about everything, 2nd gives up almost as much, and the first gives up what's left. Each of those parties need 7-10 days and a boatload of documents to make their decision. I there's RE agents involved, the seller's agent has to get those approvals and negotiate the short sale. So you could be 30 more days in before you get approval. Then you get into escrow, if they all approve, and hope it closes.

And there's the issue of the potential 1099 and tax liability -- if they can't afford the $200K they're upside down, how will they pay the $66K tax bill that goes with it?

If a seller is already in deep credit trouble from trying to make all their payment, it's actually simpler to walk away and go BK. In two years or less after BK, they're back in the game. I know folks who have had credit cards the day after a Chapter 7 discharge, and have bought seller financed homes in a few weeks.

Many landlords will work with them, especially if they move out of LA. And even in LA, they understand market dynamics. They may have to hunt for an understanding landlord, but they can find one.

[William E. Jones]

Houses are not purely financial investments (as owners are painfully discovering, in more ways than one!). Many homeowners have a sentimental/emotional attachment to their home, and the thought of "letting go" of it is a hard one. Most individuals have a lot of memories associated with their homes, and selling it for a "sale" price (even though it's where the market really is) cheapens the memories they've built-up over the years.

I live in a cramped one bedroom apt. in Pasadena. It has absolutely no charm or architectural appeal, but it is still my little home - crazy as that sounds.

[Jason]

Did say it was easy, but hey, walking away is just as good I guess. Either way, the result will be a swelling of inventory.

I agree that anyone who has a 30 yr fixed mortgage and can afford the payments will wait this thing out, but everyone with creative financing may as well just walk out the door and not come back.

[jaded]

>

I was driving through Murrieta this weekend, and the streets were papered with signs for bank repo information. Apparently it was the local Tarbell realtor who posted all the repo signs, but I also spotted an enormous banner on the Coldwell Realty building touting deals on bank-owned properties.

I know Riverside County is suffering the worst in the foreclosure rates, but you get the feeling that the dam is going to burst for the rest of So Cal any moment now. We prospective buyers are just going to wait this out. And no amount of seller reluctance to discount is going to keep prices from falling through the travertine-tiled floor.

[Tex]

A parallel to this theme is how many sellers apply the same mentality to selling for less than last year's comps. In their minds, it's actually a "loss" to sell now for less than what their neighbor got last year, even if they bought the house in 1940 and whatever price they sell for will be pure profit. I came across one such seller who decided to take his house off the market instead of taking $50K below his asking price, even though he bought the house in the 60s for peanuts. Similarly, there are people who bought for $200K in 2000 and now they refuse to sell for anything less than 300% profit!

[Rich]

Pretty much everyone here seems to have a better take on the psychology than the quoted economist, which doesn't surprise me given how many invalid assumptions about human behavior are built into the "dismal science" from Econ 101 through Phd.

My own take as a washed-out undergrad psych major is that the psychology behind this behavior is part of a complex of thinking that also goes on in gambling. One feature is that people will hold tight to the tangible when things are going badly, even if mathematical theory tells them they're wrong; what they can touch is real, and evolution has conditioned the unschooled to "defend" property. Another feature is that people will let go of the "real" when the imagination buys into an imbalance between present goods and future possibilities tipped in favor of the possible; gambling thrives because of it, as instinctual perceptions of ownership and value overwhelm probability theory every time.

In a fight between house sellers and free market theory I have seen enough in a couple of market cycles to convince me that, for the most part, homeowners (but not investors) will mostly win in defiance of market theory by expending their lifespan as a resource against the market. As others pointed out above, fewer will win this time around because the imbalance between income and debt is severe for more of them, but plenty will live to break even another day....

[MyLessThanPrimeBeef]

My take on the human psychology is that the homesellers who refuse to sell for less than what they paid for are not much different than the highly paid economists who accept 3% less GDP if it goes from 5% growth to 2% growth, but think it is a catastrophe for the same 3% less in GDP if it goes from 1% to negative 2%.

In both cases, you get the same 3% less in GDP.

There is something about zero and negative.

I know, I know...5% GDP engenders inflation, or so they say, except if you are China or India, in which case, 8% is OK.

[abbytherabbit]

As as seller in the SFV, I don't even know what the price should be set at. Nothing is selling in my area. I'm priced below bank owned and fixers and still no one is interested. My thinking is why should I give my house away if no one is buying anyway? If I started to see homes in the lower price range sell or if I received low ball offers then maybe I would consider lowering but that's not happening.

Any advise?? I'm all ears.

[Ace]

There are only 3 reasons that people are lowering their asking prices right now.

1. They are moving out of state to much cheaper housing.
2. They can't afford their payments and are desperate to get out.
3. Divorce/death

Everyone else seems content to keep their price up and sit on their house. Afterall, why sell your house for less money if you cannot buy the next one at a huge discount? No one appears to be trading up right now so the market is at a stand still.

The market will only really decrease (more than 30%) if our area suffers economic hardship and people are forced to sell. Anyone see that happening?

[Teresa Rothaar]

Tex,

Further to that, there are only two reasons why people sell their homes:

1) They absolutely have to move because of a job loss or transfer, illness/death in the family, their banana republic loan resetting, or a happier event such as having a baby (or another baby) and needing more room.

2) They'd LIKE to move because they'd prefer more room, or to be closer to work or family, or they always dreamed of living near the beach/in the mountains/whatever.

People in Category No. 2 may or may not be serious about selling their houses. If they can't get the price they want, they'll just stay put, because unlike the people in Category No. 1, they have a choice to do so.

William E. Jones: I know I'm a weirdo in that I can separate myself from my house in a way most people cannot. When this thing goes up for sale (in about two years), it won't be my precious, beloved home going up for sale, but a PRODUCT going up for sale. That's the way it was when I sold my house in Florida. The house was a product and nothing more. I knew that buyers didn't give a rat's patootie about how much I loved the garden or whatever.

I think that's one of the reasons why a lot of FSBO's fail; they cannot distance themselves from the product they are selling. You MUST be able to do that if you are going to go FSBO. Otherwise, every time some idiot walks in and makes a snide comment, you'll have a nervous breakdown instead of responding with a resounding, "Meh."

[david]

How many people are still holding on to the Yahoo they bought in 1999 at $100/share?

How many people are still holding on to the now-worthless Enron certificates?

I'd imagine there are quite a few.

Homes are a lot more personal. So it makes sense that people will hold on to them and not take the loss. It will take years of depressed prices before people will finally give up.

[Jonathan]

The same thing you describe about this slump---that it's driven by illiquidity rather than psychology---may well have been true in the Boston condo slump Goolsbee describes.

If you had put 20% down on a $200,000 condo and three years later you could only get $120,000 for it (40% decline, as Goolsbee describes), you would have been almost $40,000 underwater even before closing costs and agent commission (figure another $8,000 or so), so you'd have been unable to sell unless you had at least $48,000 cash. If you'd put less down, you'd have been even less able to sell.

And even if you had the cash to sell and pay off the uncovered debt, you'd still have to find somewhere to live, which would mean yet another down payment to buy or first/last/security to rent. In Boston then, as in LA today, sellers may have stayed put mostly because they couldn't afford to move.

[JK]

I've given up trying to time the market... as soon as I see a house I can comfortably afford (emphasis on the word comfortably), I am jumping in. Problem is, I can't afford much. $350-$400k. I guess I should look for a better job. I figure when / if prices reach that point again, the flippers and investors will quickly drive the market right back up to where it is now anyway.

[Pat]

to abbytherabbit:

Try sending a note to Kate in the Valley. I hear she's looking for a house in the SFV.

[AnnS]

Pretty much everyone here seems to have a better take on the psychology than the quoted economist, ........ Posted by: Rich |

You are correct fo more reasons than you know.

He teaches at the University of Chicago - a place that lives solely in it's own little world of theories and graphs withou much of a grasp on reality..

My husband graduated from the University of Chicago Law School - even suffered through a seminar jointly taught by Milton Friedman (and he concluded that Friedman was nuttier than a fruitcake) and was a student of a now-US Supreme Ct Justice who was fond of sitting around in the student lounge playing bridge and shooting the breeze. He describe the U of C as a place where they can literally debate the question of how many angels can dance on the head of a pin and never reach a decision. He also told me that, as a law student, not one of his classes every covered the basic concepts of 'negligence and liability' as it exists in the US legal system. The professor whose course should have covered it spent the entire year on the concept of whether the free market economy could cause individuals to reduce their risk-taking behavior which could result in injuries to others. (And this is not a joke.) He said that what he learned about garden-variety negligence, he picked up clerking at law firms in the summer break.

So you expect anything else from a U of C prof??? I don't. They are utterly brillant and completely lack any common sense or experience with he reality that exists for 95% of the US.

(And, oh yeah, this guy is also Obama's economic advisor - those U of C people stick together.)

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[John T Watts]

Teresa Rothaar is probably very correct about her category 2. There are probably lots of people sitting on plenty of equity in homes they have owned for a very long time. They are the move up or move over buyers of the future who will move when the time feels right. No big hurry. They will be back in the market when the bottom is reached and prices start back the other way.

[BetterVillage]

Fuzzy recollection from the game theory wunderkinds of a study that demonstrated that it is actually more important for people not to lose, relative to their peers, than it is to do better. In a footrace, this amounts to always looking over your shoulder to make sure you're staying ahead of the pack, or on the freeway to making sure that no one passes you (ever notice how if you signal your intention to change lanes, the people behind you in your intended lane often speed up to block your lane change?). This might explain part of the fact that people are clinging desperately to their asking prices. I agree that the major factor here is being mortgaged to the hilt and upside-downiness.

[sfvrealestate]

I agree with Tex, and I'm a Realtor. You'd think that asking somebody to take a little less than what the neighbor's mansion across the street went for last year is the same as asking for their first-born child. Also, people have been using their homes as their combined ATMs/savings for the past few years. Sure, they bought for $250,000 -- but they've pulled enough money out that by now they owe $800,000 on it.