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Why Were People Buying Houses While Prices Were Dropping?

Published by Lawrence Roberts | December 26th 2008 | Views:

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There is a great deal of price volatility in California. There are significant periods of time where house prices will appreciate faster than incomes increase. This is purely the result of irrational exuberance. Prices cannot rise faster than incomes on a sustained basis, but prices can certainly go up faster than incomes when a bubble is inflating.

When prices start rising faster than incomes, price change alone can serve as a precipitating factor that ignites a rally. When prices rise faster than incomes, people see that the quality of the house they can afford declines. They do not need to fear being priced out forever; they just need to see the reality that they are slowly being marginalized by the increasing prices. This often prompts people to accelerate their buying plans and get what they can today rather than wait until they are more financially capable tomorrow because if they wait, they will have to settle for less. This buying further drives up prices. The rising prices causes more people to notice their buying power is decreasing which prompts even more buying. The irrational rally is on. Once it gets started, then people start buying out of greed to profit from the transaction, and the rally really takes off.

So why are knife catchers being active in a decline? There are two reasons:

1. They believe they are buying at the bottom (foolish but that is what they believe,) and
2. They fear being priced out of another rally.

It is the second fear that is self-perpetuating. During the decline of the Great Housing Bubble, the low end fell more than the high end. This increased the gap between the move-up tiers. In this circumstance, people who wanted to move up were seeing their buying power diminishing, and they bought before it diminished even more. It is the same phenomenon that is witnessed in a price rally, but it is operative in the initial stages of a decline. This is one of the main motivations of knife catchers, and it explains a great deal of the foolish buying during the price drop.
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