Location and myopia

by Russ Roberts on November 20, 2008

in Housing

In two recent posts, I talked about the enormous variation across locations in the proportion of houses in a location with negative equity along with how myopic many of us were about the fragility of the housing market and the potential for meltdown. Here’s an interesting analysis from the FDIC in February 2004 on both of these questions. Don’t miss the justification for why home prices will stay high:

The most recent OFHEO data (see see Table 2)
show that markets registering the weakest home price growth are, for
the most part, cities that have seen significant recent economic
deterioration as a result of the loss of dot-com or telecom jobs or, in
the case of Salt Lake City and Provo, Utah, a
post-Olympics slump. The markets with the strongest home price growth
are mostly cities in California and the Northeast that typically have
shown a tendency toward wide price swings because of supply
constraints. These markets generally did not experience a
disproportionate level of economic distress during and after the 2001

Table 2


Variations in Home Price Appreciation
(annual percentage change in home prices, third quarter 2003)
10 Fastest Markets 10 Slowest Markets
Fresno, CA 16.05% Austin, TX -0.31%
Fort Pierce, FL 14.70% San Jose, CA 0.43%
Redding, CA 14.44% Boulder, CO 1.07%
Chico, CA 13.79% Denver, CO 1.35%
Riverside, CA 13.34% Springfield, IL 1.57%
Providence, RI 12.03% Provo, UT 1.62%
Bakersfield, CA 12.01% Lafayette, IN 1.69%
San Diego, CA 11.90% Salt Lake City, UT 1.73%
Ventura, CA 11.81% Fort Collins, CO 1.73%
Santa Barbara, CA 11.62% Greensboro, NC 1.89%

The history
of U.S. home prices suggests a clear potential for home prices to
decline in individual markets, particularly in cities that have shown
wide price swings in the past and where prices recently have risen
dramatically. However, this same history also strongly suggests that it
is highly unlikely that home prices will fall precipitously
across the entire country—even if rising interest rates raise the cost
of mortgage borrowing and reduce housing affordability. Further, a
significant price decline does not inevitably follow a sharp rise in
local home prices. In many cases, the aftermath of a housing boom has
been characterized by slower sales and price stabilization until the
underlying fundamentals have a chance to catch up with market prices.

Understanding the
behavior of both buyers and sellers is key to understanding home price
dynamics. Were prices to fall in certain markets, history and academic
research suggest that potential sellers would tend to withdraw from the
marketplace rather than proceed with panic sales. In fact, studies show
that "household mobility [selling] is significantly influenced by
nominal loss aversion," or a willingness to continue to hold the asset
and take further losses in the hope that the price will go up one day.5
Because of homeowners’ loss aversion, homes tend to stay on the market
longer with asking prices set well above selling prices, and many
sellers withdraw their homes without sale.6
This behavior is typical in all but the most economically distressed
markets. Unless the number of homeowners who must sell because of job
or income loss is a significant portion of sellers in a market,
weakness in a local real estate market is more likely to result in a
slowdown in transactions than a plunge in home prices. Although owners
may be more inclined to sell in a down market if the property is not
their primary residence, high transaction costs weigh against quick
"trades" by investors.


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