Wisest of the crowds

The Washington Post has a hilarious (but real) article discussing the inside of New Century Financial - the sub-prime mess to end all messes that is now bankrupt. I first read about the article at Inman blog, entitled You WILL play ball. Below is a WP sampler:

“The stress in that place was ungodly. It was like selling your soul,” said Hardiman, who worked for New Century in 2004 and 2005. “There was instant notification to everyone as soon as you rejected a loan. And you dreaded doing it because you paid for it. Two guys would come with a bat, and they were all [ticked] off because you cut their deals.”

I have posted several times about the conflicts between the appraisers, lenders, and agents here, here and here. Bottom line is that it may be time for buyers to hire their own appraisers. This doesn’t represent a new expense but rather a disaggregation of a current expense. If a buyer uses cash, rather than having the costs buried in other transaction costs, than the buyers can control quality and appraiser can get on with their jobs with conflicts.

Also, we might consider the conflicts from the lending side as to communicating affordability to consumers. Does it make sense to expect a lender, who is commissioned based on the number of closed transactions, to actually protect the customers side of the equation? I suppose the logic is that its the banks money but in truth, lenders sell loans and loan agents get new jobs. So the buck gets passed, Wall Street just play the odds (and gets a commission), and the financially illiterate get stuck holding the bag. Nothing new from “big business” but certainly NOT something part of the new business models powered by the internet - including ours.

The solutions to these and other vexing consumer problems are being addressed by market forces. Entrepreneurs like us see this problems as opportunities to add value to people by being open and transparent about our businesses. We put people at the center of our model and drive everything to satisfy this focus. Gone will be the days when trapping and or tricking a customer into a piece of business is THE model. Gone will be the oligipoly’s upon which many incumbent industries are based. Power is being pushed down to people and the economics will follow. Selling your soul in sub-prime, or any other industry, is a dinosaur waiting to happen. A lot of other charts will look like the one below over the next few years.

Yesterday, Russel Shaw at Bloodhound Blog posted a note he received from a young person sniffing the real estate industry. Entitled “I’ll bring you a big basket of cash if you’ll let me sell your house for free” Shaw responds to the young persons overt question whether the industry is crowded and the covert question as to whether pricing can be used as a competitive weapon. Shaw tells the young person not to use pricing to differentiate (and yes there are too many agents). This got me thinking. If EVERY industry has price discrimination, why doesn’t housing? (yes there are firms like Redfin and FSBO’s but traction is light) This is not whether orange people get better prices than purple people. Not that kind of discrimination. This is you using e-trade for stock execution rather than Morgan Stanley. Does variation in transaction costs make sense for housing?

I am not an economist but here goes.

The graph above is what Shaw is saying. There is one price for transactions (or something like that) and that you should stick to it. An economist would say that given the demand at that price, sales will be S1. Lets see if we add new prices…..

So by adding new prices, we tap into a larger amount of the total demand. From an industry perspective, price discrimination (price variation) yields HIGER total number of transactions. This is why airlines use it. This is why software companies use it. This is why EVERYONE uses it. Ever clipped a coupon? Ever cashed in on frequent flier miles? This is price discrimination at work.

So the one thing to consider that might debunk this basic economic notion is whether the demand curve (in blue) is in fact oddly shaped. Lets take a look….

So if demand is the same regardless of price then Mr. Shaw is correct. In fact, if demand in the real estate industry is oblivious to transaction costs than Mr. Shaw and all the other realtors are bloody idiots for not raising prices. So I guess the question is this: is demand for housing sensitive to transaction costs or not? If it is, like most things, then everyone stands to be better off by offering differing levels of pricing (and service). If demand for housing is not sensitive to transaction costs…then put your orders in for those new german cars because margins are about to get much better.

Giddy up little doggy!