I’m not sure if groups of recovering stock traders ever hold hands to intone, “God, grant me the serenity to cut my losses short, the courage to let my profits run, and the wisdom to know the difference,” but they should.
Millions of American homeowners who were sitting on big gains in their home value a few years ago are now having a similarly hard time letting go of profits they never actually realized.
Economic theory has long relied on the assumption that humans made important decisions rationally. Rational people don’t cry over spilled milk, but focus instead on the future over which they have some control. If such a person owns an asset that has declined in value, they don’t obsess over what they’ve lost. Instead, they decide to hold or sell the asset based on its market price right now versus its anticipated future value. Its worth two years ago is irrelevant.
Market veterans have long noted that people are more willing to sell any stock that has increased in price after its purchase than one whose price has dropped, even when the gainers probably will continue to go up and the losers will drop further. They hope against all evidence that the dud shares will somehow recuperate enough to at least recoup their purchase price.
Similarly, people are much more willing to sell a house when it has appreciated than when its value has dropped. This is true even when the drop is from some appraised value rather than the purchase price. Once people come to believe their house was “worth” something, they hate selling for less.
In the 1970s and 1980s, thousands of Minnesota miners in Virginia and Eveleth lost their jobs when taconite mines closed. House values in those towns plummeted, just as they did in rust-belt cities like Pittsburgh, Pa, and Youngstown, Ohio.
A major reason many people hesitated to move from such depressed areas to places where jobs were plentiful was that doing so would force them to sell a house for less than it had been worth a few years earlier. This was true even if they had no mortgage and even if the home value remained above its original purchase price.
What mattered was what they could expect to earn, relative to living expenses by moving to Colorado, Arizona or California, also taking into account amenities like tranquility and access to good hunting and fishing. Those who did move generally ended up financially better off than those who stayed.
In today’s slumping housing market there reportedly are many elderly people who planned to sell their homes to move into assisted living or other retirement communities who are delaying those moves because the houses they occupy have dropped in value compared to a few years ago.
The problem is that, in most areas, the odds are that their home’s value will drop even further, and it probably will be a long time before it returns to 2005 levels. Delaying a needed transition, especially at an age where one’s health circumstances can change rapidly, is a bad idea.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.