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You’re more likely to be struck by falling home prices than by lightning | Feb 13th at 3:10pm

Posted by Jenny Schuetz | 1

Chris Joye pointed out that recent events have shown us that “a single-family home is a phenomenally risky investment.”  This certainly isn’t a new idea – economists have for years pointed out that putting all your eggs into the single basket of your home, rather than diversifying across markets (as we do with our equity investments by choosing mutual funds rather than individual stocks), exposes you to enormous risk.  But it’s a little hard to convince potential homebuyers of that, especially with a message from the federal government (among others) that purchasing a home is the American dream.  Buying a home is often encouraged as a means of insulating against risk – owners don’t have to worry about landlords raising their rent or evicting them (or turning co-op, in New York).  And homeownership is a means of forced savings, leading to the accumulation of a nest egg for retirement – as long as the value of the home increase, of course.

But, as Raphael Bostic just mentioned, we know from behavioral economics that people are not very good at estimating risks.  We tend to overestimate the likelihood of being attacked by a shark, for instance, while greatly underestimating the probability of more familiar problems, like being hit by a car.  So although in theory homebuyers know that their house might drop in value, they tend to believe that it won’t happen to them (that’s probably not true for residents of Detroit).

So it seems that voluntary policies that depend on homebuyers’ accurate perception of risk (such as buying equity insurance) are unlikely to solve the problem.

Jenny Schuetz is an Assistant Professor of Economics at the City College of New York and a Senior Research Affiliate at the Furman Center for Real Estate and Urban Policy at New York University.