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Illiquid Assets and Real Estate

  1. Jul 13, 2010 #1
    In a perfectly competitive market there should be less market imbalances then observed in reality. For instance it is always more profitable to be renting a house then letting it sit unused. However, by not renting it people forgo profit in the hope of a greater future profit. This mechanism has the effect of creating shortages without the requirement of collusion.

    The surplus of housing is not reflective of the fact that there is too much housing rather it is a reflection of the fact that by hording these assets people believe they will get a greater return in the future. This type of savings will be attractive if the expected rate of return is greater then other methods of savings (for instance. interest on debt).

    Therefore not only do low interest rates help to create an over investment in housing in the good times but they also help to sustain the surplus of housing in the bad times by allowing housing speculators to refinance their debts so that they can afford to hold onto the homes until the price recovers.

    Well, increasing demand though low interest rates can help to create or at least reduce loses in employment, a lower cost of living could help people pay off their debts so that they will have more money left for consumption. This should eventually let the economy recover but in a much healthier state then one where large debt loads are subsidized though central bank policies.

    The consequence is that the people who did not have the money to speculate in an obvious bubble are forced to pay the price for the people who speculated on real-estate both though artificially high housing prices in the good times and in the bad which result from an artificially low interest rate.
  2. jcsd
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