MICHELE NORRIS, host:
One of the things holding up America's economic recovery is the enormous backlog homes now sitting on the market.
David Kestenbaum, with our Planet Money Team, has been asking why the housing market is taking so long to sort itself out. The answer may have something to do with a coin toss.
DAVID KESTENBAUM: The man with the coin is Eric Johnson, a professor at Columbia's Business School.
Professor ERIC JOHNSON (Marketing, Columbia Business School): Here's a coin, real American currency.
KESTENBAUM: Johnson is not an economist. He's trained in psychology. And he says one reason the housing market gets stuck on the way down has to do with this weird way our brains think about losing, compared to winning. He demonstrates with the coin.
Prof. JOHNSON: I'm going to flip it in the air. If it comes up heads, you win $6. If it comes up tails, you lose a dollar. Do you want to play that gamble?
KESTENBAUM: If it comes up heads, I win $6?
Prof. JOHNSON: Yes.
KESTENBAUM: If it comes up tails, I lose $1?
Prof. JOHNSON: Yes.
KESTENBAUM: Yeah, sure.
Prof. JOHNSON: Okay, good.
KESTENBAUM: He keeps pushing: Heads I win $6, tails I lose $2, sure. Lose $3, okay.
Prof. JOHNSON: What happens if we say now: Heads you win $6, tails you lose $4?
KESTENBAUM: I'm less enthusiastic about that.
Mr. JOHNSON: And what most people do at that point, or at the point before it, they switch.
KESTENBAUM: Switch and say: No, I won't take that bet. And yet, as one economist told me, if you don't take that bet, you shouldn't be doing any investing at all. Mathematically, that is an awesome investment. Half the time its heads, half the time its tails. But the amount you win is more than the amount you can lose. Yet somehow it doesn't feel that way. And that's if you play it once.
Mr. JOHNSON: Just imagine you were going to play that 1,000 times. You'll end up with a nice chunk of cash.
KESTENBAUM: You'd win, on average, $1,000. Still a lot of people won't take that bet. I went out on the street to test it out on random people. Here are Lisa Marie Elliot and Frank Blake. Heads you get $15. Tails you lose $10. Would you take that?
Ms. LISA MARIE ELLIOT: No. No, I wouldn't. I don't want to give up $10. There's a chance I might have to.
(Soundbite of laughter)
KESTENBAUM: What about you?
Mr. FRANK BLAKE: I'm on the same page. The $15 makes no difference in my life as far as gaining it, but losing the $10 in my pocket does.
KESTENBAUM: And what does risk-averse Frank Blake do for a living?
Mr. BLAKE: I'm a stunt man
KESTENBAUM: A stunt man. Yes, car crashes, jumping through windows, that stuff. Eric Johnson says what this coin toss experiment demonstrates is that in our brains, we feel losses and gains differently. Losing feels worse than winning feels good.
So now, as promised, back to housing. This is one reason the housing market is taking so long to sort itself out. In a down market, people don't want to sell because when they actually sell, it feels like losing.
Professor CHRIS MAYER (Real Estate, Columbia Business School): Psychology matters a lot in understanding economic behavior.
KESTENBAUM: This is Chris Mayer, professor of real estate at Columbia business school. He found real evidence for this fear of losses when he studied the Boston condo bubble in the 1980s. He would compare two basically identical condos. Owners had both paid off their mortgages.
But one had bought at the peak of the market, and that person, he found, would stubbornly ask for a higher price and keep it on the market longer than the other person who had no dreamy memory of the boom days when it was worth a lot more.
Prof. MAYER: The overall magnitude of this effect is very big. Most people believe this is an important factor in how housing markets operate.
KESTENBAUM: There are certainly other reasons the housing market is taking so long to sort out. Some people are stuck financially with their mortgages. But this psychological quirk is also slowing the healing process. Again, Eric Johnson.
Mr. JOHNSON: It's sort of like having a Band-Aid, where you know you'd be better off if you just pulled it off at once. But instead, what you do is you tend to pull it off very slowly, if at all.
KESTENBAUM: It's unclear why our brains are wired this way, why we overemphasize losses. Johnson says it could go back millions of years, to when losing a bet was way more serious, when we were avoiding animals that wanted to eat us. Today, we're selling houses. But part of our brains may be still be thinking about the leopards in the trees.
David Kestenbaum, NPR News.
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MELISSA BLOCK, host:
More ALL THINGS CONSIDERED coming up right after this.
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