Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't

about 3,000 Miles (Comparing Manufacturer Suggested Retail Price with Kelly Bluebook Prices and Certified Used Prices for the same 2006 models on September 27, 2006)
Some of us probably feel cheated in life. After all, many experts know more about whatever product or service we are buying from them than we do. Whether it is doctors or lawyers or auto mechanics, we seem to be at the mercy of specialists who have the ability to dupe us.
In Freakonomics, Levitt and Dubner portray America’s free market as a cut-throat environment in which consumers are constantly swindled by so-called experts. Habitually attributing economic anomalies to some kind of scam, the pair don’t seem to realize that market forces exist that punish dishonest behavior. Their distrust of the market is especially evident in their discussion of real estate agents. (Dubner once wrote an article on Levitt entitled “The Probability that a Real-Estate Agent is Cheating You.”)44 Levitt and Dubner are certainly entitled to their opinion, but in asserting that “the Ku Klux Klan [is] like a group of real-estate agents” because both groups use the “principle” of “fear” to take advantage of others, they push the rhetorical boundaries beyond what is tasteful.45
Are real estate agents really ripping off their own clients? Levitt and Dubner provide an anecdote by an anonymous Mr. K to illustrate how realtors cheat the sellers they represent by refusing to maximize the sale price of their homes:
[K] was prepared to offer $450,000 but he first called the seller’s agent and asked her to name the lowest price that she thought the homeowner might accept . . . .The agent told K, “Let me say one last thing. My client is willing to sell this house for a lot less than you think.” Based on this conversation, K then offered $425,000 for the house instead of the $450,000 he had planned to offer. In the end, the seller accepted $430,000. Thanks to his own agent’s intervention, the seller lost at least $20,000.46
It’s hard to see why real estate agents would deliberately depress bids. What can the agent gain from encouraging bidders to lower their offer? A lower bid means less money for everyone, including the agent. If agents are lowering the asking price solely to make a faster sale, then this is a poor example; the lower bid didn’t help sell the house any faster, since “K” was, in fact, willing to pay a higher price.
Assuming this story is completely true, a far more likely explanation for the agent’s actions is that she thought that the buyer was unwilling to make a higher bid. There is no way the agent could have known K was willing to bid up to $450,000, and perhaps she wasn’t sure whether K would even bid at all. There are many other possibilities; maybe the seller was under pressure to sell quickly and there were no other likely buyers. Perhaps the agent knew that other houses in the neighborhood would soon go on sale and would depress the price of K’s home. Or, K may have simply been a good negotiator in this transaction. But that doesn’t mean the agent was chiseling her client for her own benefit.
Consider this true-life example. With a growing family a few years back, my wife and I were considering adding on two bedrooms to our existing house. But we were not sure and thought it might possibly make more sense to sell our house and buy a larger one. So we went for advice to an agent with the local Patrick D. Welch real estate office.
Now, if you believe Levitt and Dubner’s view of realtors as Klansmen-like swindlers who are out to make a fast buck, you would probably expect the agent to have recommended that we allow her to sell our house and find us a new one—a potential for two commissions. But instead, she told us, “I’d love to sell your house, but you’ll have a lot fewer hassles by putting on an addition.” She did not receive a commission or even charge a fee for her advice. And there is a market incentive for this kind of honesty—her actions enhanced her reputation and that of her employer as honest and reliable realtors. These reputations are extremely important for professionals such as real estate agents, who get many clients through recommendations from previous clients. And the importance of these reputations helps prevent experts from cheating their customers. If Levitt and Dubner could discover that the real estate agent selling the house to K was underselling her clients’ houses, odds are that other people have found that out, too.
Levitt and Dubner’s core argument is that realtors encourage their customers to “sell their houses too cheaply and too quickly,” while the agents themselves, when selling their own houses, leave them on the market longer and earn on average an extra $6,000-$10,000 on the sale of a $300,000 house. At first glance, this seems like a lot. But in reality, the difference is only 2 to 3.3 percent.47 This indicates that if a realtor lives in a home for even just a few years before selling it, the extra return she gets on the sale for being a real estate agent is merely a little over 1 percent per year.
True, realtors typically earn a lowly 3 percent commission when selling someone else’s home but keep virtually all the revenues when selling their own homes, and this gives them a greater incentive to get the maximum price for their own abode. But one would still expect realtors to make more money selling their own houses simply because—as experts—they probably found a good deal when they originally bought them.48 Given all the time that realtors spend getting their license, learning the business, and spending every workday looking for bargains, a 2-3 percent higher price actually seems quite low. If anyone spent years looking at houses, they would also occasionally come across some great deals.
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