Jonah Lehrer has a very useful post at Wired that views the dysfunctional housing market through the lens of loss aversion:

The phenomenon was first identified by Daniel Kahneman and Amos Tversky in the mid-70s, after they gave their students at Hebrew University a simple survey asking them whether or not they’d accept a variety of different bets. The psychologists noticed that, when people were offered a gamble on the toss of a coin in which they might lose $20, they demanded an average payoff of at least $40 if they won. The pain of a loss was approximately twice as potent as the pleasure generated by a gain. Furthermore, our decisions seemed to be determined by these feelings. As Kahneman and Tversky put it, “In human decision making, losses loom larger than gains.”

After explaining how loss aversion has shaped the housing market in past busts, Lehrer ends his post with the following:

The housing market will only recover when we get over our collective bias, and realize that home prices have fallen and aren’t coming back (at least not anytime soon). Our irrationality got us into this mess – we binged on credit cards and took out unreasonable loans and mistook a bubble for a boom – and the only way we’re going to get out of it is to see through a new set of irrational quirks, which prevent us from fully equilibrating to our new financial reality. Sometimes, the wisest thing to do is cut our losses and run.

Everyone is susceptible to loss aversion. But my sense is that some are less susceptible than others. It is unlikely that we will get over our collective bias all at once. Rather, some are already over it — some Americans have already cut their losses, and they’re preparing themselves for the next phase of life. This is part of how inequality is reproduced over time.