Home sales are plummeting. In the Times, David Leonhardt focuses on Paramount, CA, site of the most precipitous drop in home sales in the country:
Just south of Los Angeles, there is a small city called Paramount where houses have all but stopped selling.
Since the summer, only about three homes a week — including houses and condominiums — have sold in Paramount. In the third quarter of this year, only 30 homes changed hands, down from 134 in the third quarter of last year.
That 78 percent drop is bigger than the decline in any other ZIP code in the country, according to an analysis that a research firm called DataQuick Information Systems did for me. The biggest declines can generally be found in moderate-income towns on the outskirts of major metropolitan areas, where adjustable-rate mortgages had become the norm. (In more affluent areas across the Northeast and California, the declines haven’t been so big.)
In parts of Florida, Arizona and Nevada, home sales have fallen more than 60 percent over the last year. In several ZIP codes in California’s Inland Empire, east of Los Angeles, the decline is greater than 70 percent.
Why are home sales falling so quickly? As the economist Austan Goolsbee notes, “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.” In other words, home owners aren’t acting like the rational agents in economics textbooks. Shocking, I know.
This is where loss aversion enters the picture. A 2001 study, “Loss Aversion and Seller Behavior: Evidence From the Housing Market,” by Christopher Mayer and David Genesove demonstrated how our irrational sensitivity to losses distorts the real estate market, causing home owners to overvalue their homes. The two economists looked at condos in the Boston area from 1989 to 1992, when the average value of of such dwellings dropped 40 percent. If condo owners acted like rational agents, then a steep drop in the market price shouldn’t lead to a cessation of selling. If they really to want to sell their home, then they should be willing to sell their home at the lower price, since that’s what the market is currently offering. The potency of loss aversion, however, means that people are unwilling to sell their property at a loss. According to the 2001 study, condo owners who bought at the peak of the Boston market listed their properties for an average of 35 percent over the expected sale price. As a result, less than 30 percent of the condos sold within six months.
No doubt a similar process is at work in Paramount, CA. People despise losses so much that they will postpone the loss for as long as possible, even if it means flirting with foreclosure.