Question

Recently, a woman named Mary Krawiec attended an auction in Troy, New York. At the auction, a bank was seeking to sell a foreclosed property: a large Victorian house suffering from years of neglect in a neighborhood in which many properties had been on the market for years yet remained unsold. Her $10 offer was the highest bid in the auction, and she handed over a $10 bill for a title to ownership. Once she acquired the house, however, she became responsible for all taxes on the property and for an overdue water bill of $2,000. In addition, to make the house habitable, she and her husband devoted months of time and unpaid labor to renovating the property. In the process, they incurred explicit expenses totaling $65,000. Why do you suppose that the bank was willing to sell the house to Ms. Krawiec for only $10? (Hint: Contemplate the bank’s expected gain, net of all explicit and opportunity costs, if it had attempted to make the house habitable.)

Answer 1

The bank determined that the net gain they would get from renovating the house and then selling it, will be lesser than $10.

Net gain from selling post renovation=Expected gain from auction-(65000+2000+taxes).

Expected gain from auction=probability of house getting sold*price at which house will be sold + probability of house not being sold*0.

So,

Net gain from selling post renovation=probability of house getting sold*price at which house will be sold + probability of house not being sold*0 - (67000+taxes)

It is given that there were many houses in the neighborhood which were not selling since years. So probability of house being sold was also very low. The bank determined that the net gain from renovating and trying to sell was going to be below $10 and hence was willing to sell the house at that price.