Home Prices Defying Law of Economics

An article in the New York Times, “Why Home Prices Keep Falling,” describes the plight of U.S. home prices and the expectation that they will continue to fall through 2010, maybe even 2011.

“Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss?[…] If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.”

The article continues with several plausible explanations for this behavior. They include…

  • Sales of existing homes are mainly by people who are planning to buy other homes.
  • Other sellers are not in a rush to sell due to the decreased value of their home.
  • The decision to buy and switch to renting often requires the assent of multiple parties: spouse/partner, children, etc.
  • Prospective buyers are dissuaded to buy due to the gloom of unemployment that surrounds them.

Source: New York Times “Why Home Prices Keep Falling”

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