Using Game Theory to Define the Housing Crisis

I was reading an interesting article the other day (hat-tip Congolmerate) on the housing crisis and the best time for investor who can't pay their mortgage to sell. This got me to thinking about game theory a bit.

Here are the basics: Remember when you used to play Monopoly as a kid and someone wanted to trade you a couple properties for your "Boardwalk". Now the boardwalk would give the other guy a monopoly, but the trade would also enhance your position by giving you a monopoly on a "weaker" set of properties. The debate was always whether you should do the trade and bank on the fact that you could get your hotels up and running before the other guy. I also should point out that by not doing a trade you could essential eliminate yourself becuase a 3rd player already had a monopoly and you did not. If you refused the deal you essentially allowed the other guy to win. What a dilemma. How much can you get for the guy you wants "Boardwalk?" Maybe you can get more. However, how long can you afford to hold out before you are gobbled up by the 3rd player?

I posit that many of the same decisions go into make a decision on whether to buy or sell a house. You are in the same position. You have a high mortgage and presumably can't afford the payments. You might be in a better position if you sold the house and "downgraded." However, much like the monopoly analogy, you think of whether you can get a better deal. Maybe by holding out a bit longer you might be get a "better" property. However, if you hold on too long you will be "gobbled up" by the third player (read Bank - who with foreclose). It appears from my observations that many people are stuck in this situation. Do you hold out in an an attempt to gain more, or do you make the "trade" an potentially improve you position, but lose out on the possibility of more short term gain.

Unfortunately, I do not know enough about mathamatics to justify what the best decision would be. I just remember my monopoly strategy. Becuase a trade would put me in the best position, I would usually do it. Considering the other players in the game (in the real world investors), generally seek to hold out for more, the "trade" might seem to be the more viable option. Although the thought of losing the current "property" is tough, it allows the owner to cut their loses and move into a new place that better suits their means. In Monopoly terms, the trade at least gives you a shot at the win.

- ps. If any math majors/professors read this please feel free to add on. Like I said, I'm no math major.