Gresham's Law for Real Estate
The incompetent, low integrity brokers drive out the competent, high integrity brokers. Those brokers who focus on client acquisition drive out the brokers who focus on conveying real property.
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In economics, Gresham’s Law is a monetary principle that states: Bad money drives out good. So for example, if you have quarters made with silver and quarters made with nickel, but all quarters are worth twenty-five cents, the silver quarters will begin to disappear (because people hoard them for their intrinsic value and use the nickel coins for daily transactions).
Now Thomas Gresham was a sixteenth century English merchant and financier, and this principle was actually named for him three hundred years later, by nineteenth century Scottish economist, Henry Dunning Macleod, in 1860. But of course, as all coinage today is intrinsically worthless, the monetary value of Gresham’s Law is purely academic.
But let’s move forward about sixty years to a passage by former Canadian Prime Minister Mackenzie King. Please indulge me, his language is somewhat dated:
Something analogous to Gresham’s Law will be found to obtain in the case of competing standards in Industry. Assuming there is indifference in the matter of choice between competing commodities or services, but that in the case of such commodities or services the labor standards involved vary, the inferior standard, if brought in this manner into competition with a higher standard, will drive it out, or drag the higher down to its level. This is effected by the opportunity of under-selling which comes, where in such cases human well-being is sacrificed to material ends. The superior standard, not being recognized or demanded, is unable to hold its own, and in time disappears. This Law is just as real and relentless in its operation in Industry as Gresham’s Law of the precious metals is with respect to money and the mechanism of exchange. Indeed, a more accurate exposition would describe both as manifestations of one and the same law, which I propose to call the Law of Competing Standards.23 [Emphasis added]
So in broader terms, Gresham’s Law can be applied to any circumstance where true value is different from that which people are required to accept, or are simply willing to accept, or perhaps even blindly accept. King points to indifference, but it can be due to any number of factors including lack of information, knowledge, experience, or even corruption, deceit, or pretense. Plus a lack of enforced standards (and ethics), consequence, or penalty.
That is to say, if we make no distinction for the worthy and no penalty for the unworthy, the unworthy proliferates, and over time becomes the new standard.
Let’s move forward, again about another sixty years, to Charlie Munger. For those of you who do not know, Charles Munger is Vice Chairman of Berkshire Hathaway. Munger offers a simple modern update and expansion of Gresham’s Law. He called it a new form of Gresham’s Law, but personally, I think of it as Gresham’s Law for Our Age: Bad morals drive out the good. Unethical behavior is contagious.24
Here Farnam Street offers an excellent descriptive example:
This can be common in some business fields. Take two drug salespeople – one willing to bribe doctors to make sales, and one not willing to do so. If the industry functions such that fraudulent business practices are not punished, and the bribery goes uncovered by the buyer’s organization, then bribery obviously gains a sustainable competitive advantage over non-bribery. Clearly, the deceptive practice will take hold, as salespeople unburdened by morals are promoted and compensated better than the high-roaders. It’s a clear form of Gresham’s Law.25
In the real estate business, we have brokers who focus on client acquisition and brokers who focus on conveying real property. And if we merge King and Munger, we arrive at: Two distinct competing standards of service, competence, and integrity. Let’s call them a low integrity standard and a high integrity standard.
And we have consumers with imperfect information, limited experience, and inadequate knowledge and understanding of the market. Over the course of a lifetime, most consumers only enter the real estate marketplace occasionally. So some will unknowingly accept the lesser standard. Others will accept it based on pretense and stereotype and sometimes just sheer credulousness. And if the price is right, others will not care about these standards one way or the other.
Finally there is no real penalty to brokers for maintaining a low integrity standard. They are not penalized by the market or by industry norms or ethical requirements. In fact, the only real consequence is when and if they choose the high integrity standard: They make less money.
So combine these three factors: Consumers with imperfect information, brokers with two distinct competing standards of integrity, and little or no consequence for the low integrity standard, and you have the perfect environment for Gresham’s Law to take root.
It is not that brokers actually choose the low integrity standard. But they do choose to focus their attention on client acquisition above all else. Client acquisition becomes the singular focus and with little downside. And competence at conveying real property takes time and effort. This is the actual choice brokers make: A focus on client acquisition or a focus on conveying real property. And hopefully over the course of this book, I have convinced you that this truly is a choice.
In the real estate business we reward low integrity, and just as importantly, we fail to reward high integrity. And this goes largely unnoticed by our customers, and therefore, unpenalized. To use the Farnam Street language, the low integrity brokers gain a sustainable competitive advantage over the high integrity brokers. Client acquisition gains a sustainable competitive advantage over conveying real property.
The bad drives out the good. The unworthy drives out the worthy. The lesser standard drives out the higher standard. Bad service drives out good service. Bad morals drive out good morals. Incompetence drives out competence. The low integrity brokers drive out the high integrity brokers.
Before we leave, is it either/or? That is, surely there are brokers who focus just enough on client acquisition so that they can spend an adequate amount of time on conveying real property? And vice versa. And the answer is: Yes, there are some. But they don’t call it Gresham’s Law for nothing. As Mackenzie King pointed out, the incentives favor the inferior standard, and over time this is what prevails. Sadly, this is what we see in the real estate business.
Now, this is a rather bleak assessment of the business. Must it be so? And is it static? If I thought yes was the answer to either question, I would not have bothered writing this book. This work is my attempt to shine a light on the problem. I hope that broader understanding of the problem, by consumers and brokers, puts us on the path to resolution; the path to competence and integrity. Only together can we change the low integrity industry dynamic. Demand better.
And with technological advances, more of the real estate process will be turned over to the consumers themselves. Hopefully this will lift some of the murkiness, and consumers will notice the nonsense and understand that they should not tolerate it. One hopes.
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23. Mackenzie King, Industry and Humanity: A Study in the Principles Underlying Industrial Reconstruction. Houghton Mifflin, 1918.
24. I have seen this in several places but they all seem to trace back to Munger. The irony of course is that Berkshire has become one of the largest real estate brokers in the United States and as such benefits from this industry dynamic. I like to think that if Messrs. Buffett and Munger would spend an hour with a typical real estate coach and their broker clientele, they would promptly exit the business. Not only are these gentlemen Captains of Industry, but both have written extensively on business ethics. I just find it impossible to believe that Buffett and Munger would find the ethical standards of this business acceptable. But as of this writing, Buffett is 89 and Munger is 96. So I’m not sure they’ll get around to this.
25. See: Gresham’s Law: Why Bad Drives Out Good As Time Passes, Farnam Street Blog, December 2009. Find it here: https://fs.blog/2009/12/mental-model-greshams-law