Housing Markets - 6

Your advisor likely has a different perspective than you and may make recommendations that are "good for you" though you may not perceive this to be the case. For example, you advisor may suggest taking a hard course that has a chance to lower your GPA, because your advisor believes you will experience more personal growth from that than from taking an easier course. This is not moral hazard. That the advisor doesn't sugar coat the recommendations is part of the job and in this sense the advisor is playing an educational role. However, the advisor may project his or her own personal likes or dislikes in making a recommendation and to the extent that your talents and aptitudes don't mirror that of your advisor suggestions of this sort do exhibit moral hazard. The extent to which the advisor tells you what you want to hear rather than work through with you what makes the most sense for you in the long term may very well depend on how well the two of you know each other. Certainly, it is easier for the advisor to say what you want to hear and have you walk away quickly.

Let us turn to another intermediary, the appraiser. If the buyer is seeking to get a mortgage to purchase the new home, the lending institution will insist on having the property appraised because the property will serve as collateral for the loan. The appraisal is presumably an independent valuation of the property. Of particular interest to us, the appraiser's job is something like identifying the marginal buyers and sellers. (See the Scale worksheet from the S&D Updated module.) But of course this is much harder to do in actuality than in the textbook case because one has to find "comparables" that differ in some respects from the property under consideration and because the known transaction prices will have occurred in the past and market conditions do change over time. It is hard for the appraiser to measure short term temporal changes in market conditions. Moreover, the appraiser doesn't get evidence from nearby homes that may be quite similar to the property under consideration, if those homes have not been bought and sold recently.

It is important to note that he appraiser's client is the bank or other lending institution, not the buyer or seller or the home. The bank's profit is in part determined by the size of the loan and so in some sense the bank has incentive to have the house appraised high, because if the house appraises low the transaction price will be negotiated down and that will reduce the loan size. However, most mortgage loans are re-sold on a secondary market rather than held by the initial lender and that resale serves to discipline the appraisal and not have it overvalue the property. But one should realize there is potential for moral hazard in the appraisal process.

It is recognized that appraiser valuations vary less than actual transaction prices. Moral hazard may be one explanation for this but it might also have to do with the appraiser's need to rely on historical transactions and the tendency to average those.
Another ARUEA Paper

Since we've covered a lot of ground here let's conclude this section by having you summarize the salient points of housing markets and how they differ from retail markets.