Looking at the Long Depression, the Great Depression, the Japanese Depression, the Great Recession and contrasting that to shorter episodes including Korean Armistice Recession and the Dot-Com recession I am starting to speculate that the key sticky price is land or real estate more generally.
Not only is there of course a strong association between land bubbles and the size and scope of a recession but real estate appears to be very very sticky in transactional price, more on that. And, there are some strong reasons why one would expect it to be.
So real estate prices move relatively slowly. We know that. The “bursting” of the housing bubble was a three plus year event that may not have ended yet.
However, even that grossly overstates the speed at which the market actually comes to equilibrium. The volume of transactions collapses during the burst and both market and shadow inventory builds up. There are units which buyers would like to sell but are not willing to lower the price on – why?
We all know this phenomenon. People even going so far as to take a house off the market and wait until a better time to sell. This is fantastic price stickiness. Between waiting to put on market, waiting for an offer, attempted buy and holds, etc a decade could go buy before a single property clears to its equilibrium owners at its equilibrium price.
Now why would we do this? Part of it could be sticky mortgages of course. But, I am starting to think that’s not it. Part of it could be irrationality, but then its hard to see how vulture capital funds could be profitable by buying and holding.
What I suspect it is, is a fight over agglomeration rents. The last one to sell out takes the rents and each player is holding on to be that individual.
Imagine an extreme case. An entire neighborhood goes into foreclosure and everyone is kicked out. The banks sell off the properties to investors who simply pay a portion of the amount owed on the mortgage. You might think we have cleared the market and everything can go back to normal.
But, no we see neighborhoods where the houses stand empty. What’s going on. Well, a house in an empty neighborhood is worth less than a house in a full neighborhood. In fact, each family to move into the neighborhood raises the value of the neighborhood. However, to get the first family in you have to offer a price equal to the value of an empty neighborhood.
No investor wants to be the one to do that. Each one wants to be the very last investor to sell, the one who sells into a full value neighborhood. However, since they can’t all be last and one must be first, there is a standout.
The lack of credible communication between investors only makes this problem worse. The best they can do is just hold out for as long as they can hoping to get as much as they can. This causes an extremely slow movement towards equilibrium.
Most cases aren’t this extreme. However, home owners have the same sense. They know that selling in a down market or at a “bad time” is different than selling at a “good time” They are reluctant to be the first to take loses. As more potential sellers pile up each one is hoping that he or she will be able to out last the others; to sell after the market has bottom out and is on its way back up.
Questions to be answered:
If this is the origin how does the disruption spread throughout the economy?
The non-housing related busts were fast in (korea, dot-com) were quick and shallow respectively in GDP terms but not in job terms, how do we square that?
How does this tie into the rational inattention and stickiness literature?
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Sunday ~ August 14th, 2011 at 4:55 pm
Curt Doolittle
(Prices aren’t sticky, humans are.)
They are sticky because of recalculating (re-planning) and the dramatic loss aversion humans have against social status, and self image.
Sunday ~ August 14th, 2011 at 6:22 pm
Lorenzo from Oz
The two markets that matter most to most people are notoriously “sticky”: labour and housing. Both (labour and land-use), not coincidentally, tend to be highly/significantly regulated, and to protect incumbents. But both also have a considerable cross-temporal element. Obvious in housing, but also applies to labour since people build up obligations which does much to make them highly resistant to receiving less money for the same work.
Also, taking houses off market, is that really a sign of price stickiness? Surely, that is waiting for prices to change: if you thought they were really sticky, you would not bother.
Sunday ~ August 14th, 2011 at 6:39 pm
Roland
Don’t forget that real assets generally perform, although below some preferred level, while waiting for the market to clear. You rent. And there are generally significant dollars involved. That is what I am doing. For me the cost of waiting is about 5%of my annual income. The expected payoff? By my estimates greater than 50% of my annual income. So the overhang can endure for a while..
Sunday ~ August 14th, 2011 at 6:56 pm
White Rabbit
House prices are stickier partly because houses are dual purpose: they can be sold or they can be used indefinitely.
The latter is equivalent to a constant stream of interest payments: no rent has to be paid.
This makes it very easy (and profitable) to just not sell your house, possibly for decades – unless you are forced to sell.
For banks it’s (much) cheaper to hold a house in inventory at inflated valuation than to realize and write down the losses.
Then there’s the spreading problem of impossible to sell property, where the robosigning fraud has put the legal title in doubt.
All these forces reduce liquidity, and slow down and distort price discovery.
Monday ~ August 15th, 2011 at 3:46 am
teageegeepea
I often hear people (such as Austrians or other libertarian types) contrasting the recession under Warren Harding, which was remarkable for its extreme decline in prices (largest on record?) and short duration relative to severity. But the prices usually given as examples are labor and commodities. Does anyone know what happened to real estate prices in that period?
Monday ~ August 15th, 2011 at 4:48 am
links for 2011-08-14 | FavStocks
[...] The Stickiest Price: Land and Recessions – Modeled Behavior [...]
Monday ~ August 15th, 2011 at 7:57 am
Why are house prices sticky? « Modeled Behavior
[...] a recent post, Karl offered a theory as to why house prices are sticky downward. In short, he argues that house [...]
Monday ~ August 15th, 2011 at 9:09 am
Those Sticky Real Estate Prices - Global Economic Watch - Global Economic Crisis: Cengage Resource Center
[...] The Stickiest Price: Land and Recessions here. Posted 08-15-2011 8:59 AM by Graham Griffith Filed under: housing, real estate, housing prices, [...]
Monday ~ August 15th, 2011 at 9:27 am
David Pearson
Good analysis but it misses today’s dynamic. Would-be sellers don’t want to sell not because of rent agglomeration, but because they are underwater and don’t want to take the hit to their credit rating. Bank REO owners don’t want to sell because they are being allowed to carry assets at historical values — if they marked them to market, they would have no incentive to continue to carry them. Also, the Fed is allowing banks to finance REO at close to zero cost.
I think where you go wrong is in imagining that most foreclosures are concentrated within specific neighborhoods. In fact, this was the case when the majority of foreclosures were subprime. Now that the subprime foreclosure wave has crested, I believe foreclosures are more evenly distributed. The type of fight for rents you describe will mostly occur in new neighborhoods where borrowers all paid the peak price (and therefore are more likely to be underwater). Many of these were marginal buyers: flippers and subprime. Delinquencies in these groups appeared first and crested first.
Bottom line: how many neighborhoods today are “empty” because of foreclosures? I would say a small percentage of the foreclosure pool.
Monday ~ August 15th, 2011 at 11:30 pm
Kaleberg
During the 1930s it took years to get everything straightened out. Title was unclear, ownership of debt was unclear and the values of properties were unclear. This made it hard to move forward. Sometimes the problem was with the infrastructure the developers had installed in hopes of selling house lots, and this infrastructure – sewer pipes, roads, sidewalks – had to be ripped out, before the land could be developed economically.
We have a similar problem with a lot of speculatively built housing where the surrounding infrastructure, particularly, schools, stores and jobs, had not caught up and are not likely to soon to catch up. If you build exurban housing, you are relying on surplus demand from nearby cities and suburbs, and when the economy falters, a 90 minute commute suddenly becomes unreasonable. We also have the matters of title, debt and valuation.
Sunday ~ September 4th, 2011 at 4:09 pm
Status update on the macroeconomy « azmytheconomics
[...] Some prices adjust faster than others when hit by an economy wide demand shock. In the absence of monetary disequilibrium, relative price changes represent the effects of supply and demand in that individual market. However, when the whole economy is hit by a demand shock, some prices adjust more quickly than others. For example, commodities adjust nearly instantaneously, whereas wages and houses fall the slowest. Which areas of the economy are the most out of equilibrium? Why, wages (unemployment) and housing. [...]