Bidding wars are caused by underwater homes missing from MLS inventory

Bidding wars in an environment of weak demand are a sure sign of restricted inventory, a problem intentionally engineered by lenders.

When I wrote Must-sell shadow inventory has morphed into can’t-sell cloud inventory, I outlined how lenders removed inventory from the MLS by denying short sales and by modifying home loans rather than foreclosing on delinquent borrowers and selling the resulting REO. Lenders schemed to reduce the MLS inventory enough to engineer an artificial shortage of homes available and force buyers to pay higher prices.cloud_inventory_view

They were successful.

But other than rising home prices, what evidence do I have that these policies contributed to rising prices?

We know from the graph of purchase mortgage originations that demand for housing hasn’t increased over the last six years. Some have argued (not very persuasively) that purchase mortgage originations are understated and demand is actually larger than what the data shows. Of course, this completely ignores the fact that sales haven’t increased much over the last six years either, so it’s clear that rising house prices since 2012 is not a result of a resurgence in demand for houses among owner-occupants.

More evidence of restricted supply comes from the NAr. During the housing boom from 2003-2005 when demand barriers were eliminated, plenty of supply found its way to the market. It wasn’t until mid 2011 when lenders decided to stop foreclosing in favor of loan modifications did inventory really dry up.


During the housing boom, buyers often engaged in bidding wars, mostly because lenders removed most restrictions on how much someone could borrow (think liar loans, teaser rates, and option ARMs). With no limits on what people could bid if two or more buyers wanted a property, a bidding war was likely to break out.

So when the housing bubble burst, wouldn’t it be reasonable to expect bidding wars would also subside? For a while they did, but when the weak demand of the post-bust period was overcompensated by a 50% decline in listings, the few remaining buyers were forced to compete for the even fewer remaining homes. Ongoing bidding wars are a side effect of lenders engaging in price fixing by conspiring to restrict MLS inventory.

A legacy of the housing bubble that won’t go away: bidding wars

By Emily Badger March 10

The housing bubble brought bidding wars — wars over $500,000 properties that ultimately sold for $600,000, wars over under-listed condos that drew dozens of would-be buyers, wars over starter homes that a few years earlier would have fetched a fraction of the price. This manic bidding was, in effect, a sign of the bubble, as well as a factor that helped inflate it.

Bidding wars during the bubble were enabled by lenders who allowed borrowers to obtain as much as they wanted to buy a house. Since qualification standards were simultaneously eliminated, both the quantity of borrowers and the amount those borrowers were given increased at the same time. This was bound to lead to competition for housing, no matter the supply.bankers_afloat

But a curious thing has happened since the housing market has returned to something more rational: The bidding wars haven’t gone away.

A practice that was rare in the 1980s and 1990s now seems here to stay in markets like Washington, D.C., a permanent gift of the housing bubble (if you want to look at it that way).

This is not a permanent gift. Bidding wars will largely go away once prices reach the peak of the housing bubble and no borrowers are trapped underwater and unable to sell.

… only around 3 to 4 percent of homes on the market across the country were selling in bidding wars for years prior to the bubble. Then at the bubble’s peak, nearly 30 percent of homes in metropolitan D.C. were selling this way, the highest share of any metro Han and Strange studied. The same was true of about 22 percent of home sales in Baltimore and Norfolk, 23 percent in Las Vegas and 26 percent in Los Angeles.Since the housing collapse, these crazy numbers have declined, but not back to their earlier levels. As prices have fallen and the number of home sales has, too, bidding wars haven’t disappeared apace.

This is clear and confirming evidence of the restricted inventory hypothesis. If demand is down as measured by both quantity and quality of bids, the only reason for bidding wars is for supply to be down even more.4.2.7

That means that we’re probably seeing not just a lingering effect of the housing bubble, or even a pure product of high housing demand, but a new strategy for selling homes that was embraced during the bubble.

The persistence of this suggests that people have decided that this is a good way to think about selling these kinds of goods,” Strange says, “selling housing in a more auction-like way.”

These analysts identified a curious phenomenon, but they have absolutely no idea what causes it. If supply matched the demand, the bidding war auction-like technique fails to work because buyers aren’t motivated to play along. Why would anyone compete for a house when there are plenty of alternatives available?

If a list price once meant the seller’s ceiling, for many homes it’s now the buyer’s floor — the number with which the auction can begin. Part of what’s going on here, Strange says, isn’t just that the small supply of homes for sale continues to push up their price in certain markets like D.C. (bidding wars still made up about 12 percent of sales here as of 2010). Real estate agents are also strategically listing homes below their value to create bidding wars. …

This is generally a bad strategy. Even in circumstances were the house sells for more than the original asking price, it still often sells for less than its fair-market value. People who bid on below-market properties are generally not the type who get caught up in a frenzy and overpay.

If you’re a buyer or a seller, you sign a contract with a real-estate agent who understands what’s going on a lot better than you do.

LOL! Yeah, right.


Whether or not that tactic is actually making sellers more money — it’s hard to know in this data — some agents must believe that it does. The result for the rest of us is that an opaque market becomes even more so. You may think a $300,000 home is in your budget, only to find that the sellers never intended to accept that little anyway. You may struggle to gauge the difference between a $400,000 home and a $500,000 one because you can’t tell which one — or both? — is intentionally under-listed.

Buyers don’t need to figure out what a property is worth to the market, buyers need only evaluate what they are willing to pay. If it turns out the property is underpriced, they will be outbid and not get it. While this may be disappointing, it’s hardly a major disruption to pricing in the housing market.no_money_down

Now add to the confusion of buying a home the sometimes irrational emotional of an auction. Other research suggests, for instance, that some people online are willing to pay more at auction than they will for the exact same item on a one-click purchase. It’s hard to believe similar behavior doesn’t seep into housing auctions as well.

On rare occasions this does happen, but a bidding war on a house is not like an open-outcry auction. There isn’t a frenzied atmosphere and the requirement to make a split-second decision. And while some realtors will manipulate their clients with emotional arguments, most buyers have the time to make a measured emotional decision and not get caught up in the animal spirits of an open-outcry auction.

“People are making these million-dollar trades,” Strange says of homebuyers. “But we really don’t know that much about the housing market, where it’s going, what demand and supply are. It’s an amateur market where people are making these huge, huge decisions.”

This is one of the main reasons I publish a housing market report, and why this website has a detailed cost of ownership analysis of every for-sale property on the MLS. An informed and educated borrower makes better decisions.


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