ANDREA SEABROOK, host:
From NPR News, this is ALL THINGS CONSIDERED. I'm Andrea Seabrook.
It's economic common sense: when the demand for a product goes down, sellers lower their prices. Let's say people stop driving so much. Well, the price of a gallon of gas might drop by a dime. Yeah, we wish. But for some reason homeowners don't abide by that rule.
In this depressed housing market many homeowners would rather not sell at all than mark down their asking price. Hersh Shefrin is a pioneer in the field of behavioral finance at Santa Clara University. He joins me now to explain the thinking here. Hello there.
Professor HERSH SHEFRIN (Behavioral Finance, Santa Clara University): Hello.
SEABROOK: So, first, what is behavioral finance?
Prof. SHEFRIN: Behavioral finance is the study of how psychology impacts financial decision making.
SEABROOK: So let me ask you this: why does this happen? Why won't homeowners lower their price when they're trying to sell their house and it's not selling?
Prof. SHEFRIN: When a homeowner thinks that they're going to have to take a loss if they sell their house, they're inclined instead to gamble by setting a much higher asking price, hoping that they can beat the odds and the magic buyer will come in and is willing to pay at least what they originally paid for their house so that they don't have to feel that they have taken a loss on the investment in their house.
SEABROOK: So what's this effect do to the housing market as a whole?
Prof. SHEFRIN: In normal times, sellers ask for something like 12 percent more than they think is reasonable to get for their house. And on average it takes about six months to sell a house. In a down market, what happens is sellers ask for about a third more - not 12 percent more - but 33 percent more than what they think is the reasonable going rate for their home.
You know, they can wait up to two years to sell their house if they manage to sell it.
SEABROOK: That's really odd seeming. I mean, why in a worse market would they ask a much higher price for their house?
Prof. SHEFRIN: Ego. We call it the psychological tendency aversion to a sure loss. And so the psychological pain is something that is difficult for most people to accept and so they defer it.
SEABROOK: So what does this do for all those buyers out there driving around looking at the signs on the front lawn? I mean, if people are looking for a bargain and they're finding prices that are set a lot higher this time, how do they and how should they react?
Prof. SHEFRIN: Well, most buyers are simply going to find that they're going to be coming up against sellers who look like they won't negotiate. And that's the reason why the sales don't actually happen. That's why even though there's a lot offered on the market in terms of number of homes during down markets and housing cycles, the turnover rates rocks dramatically.
SEABROOK: You know, I would tend to assume that that would be because there aren't very many buyers on the market. But you're saying that part of the blame goes to the sellers for being stubborn about their asking price.
Prof. SHEFRIN: That's right.
SEABROOK: How does this whole scenario play out? What happens? How does recovery happen?
Prof. SHEFRIN: Housing cycles last for about four years. I think what will happen is that prices are going to continue to decline, and as they continue to decline, we're going to go through a bit more pain. But ultimately the excess supply of housing, people are going to buy it. There are going to be bargains. There are going to be professional investors who buy homes and put them on the market as rentals.
So what will happen is that prices will do their job and the excess supply of housing will get absorbed and then we'll be back to normal. But going to just stay (unintelligible).
SEABROOK: Hersh Shefrin is a professor of behavioral finance at Santa Clara University. Thanks very much, professor.
Prof. SHEFRIN: My pleasure.
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