Critical Thinking for Business

During the Romanian credit boom of 2004-2007 a lot of families hurried to buy houses, often in foreign currency, although house prices were at all-times-high, salaries were in local money, credit conditions were not always friendly and, without anyone knowing, the real estate crisis was looming around the corner. The following story is a fictional one, but is based on many real situations. Please try to identify the errors in this family’s decision to buy a house. Some of the errors are caused by allowing fallacious reasoning to convince them (fallacies), others are caused by not thinking at all (cognitive biases). Can you identify fallacies and biases in their story?

The Saga of Buying a House

When Ioana told him that she’s pregnant, Mihai was overwhelmed by both joy and concern. They were trying to have a baby for a long time and they wanted one badly. Ergo the joy. On the other hand, Mihai only enjoys predictable situations, situations for which he is prepared 100%. Ergo the concern. “There are so many things to be done in such a short time! First, we need to move, second, we need to buy a larger and safer car, then to furnish the baby’s room, and then a ton of other things!”
The year is 2007 and for the last 2 or 3 years Romanians could enjoy life at western standards for the first time in history, mostly due to credit. “Credit” became everybody’s favourite word. Ioana and Mihai Popa consider themselves winners of the recently concluded Romanian transition: they were lucky to have chosen a profession – dentistry – that provides a well-above-average income.
The Popas live in Bucharest, in the 3-room apartment Ioana grew up in. Her parents retired and moved to the countryside and gave them the apartment as a wedding gift. Now Mihai glances happily in the window of the real estate agency down the block every time he passes by, because he can see there apartments just like theirs for sale for as much as 100,000 Euros. Just 3 or 4 years ago the price was barely 30,000. When he was little, mafia guys were killing each other in American movies for a suitcase with 100,000! And those were dollars, not Euros!
Mihai and Ioana grew up in the city and they are happy where they live now. But as all their friends who became parents bought a house in the outskirts of Bucharest, the dream to have a house with a garden began to charm them as well. So they planned to sell the apartment, take a credit for the difference and buy a house up North, in one of the fashionable residential outskirts of the capital. Obviously, Mihai felt that he needed to ask his in-laws for advice, because they were the ones to give the apartment as a present, after all.
His father in law, Professor of Special Mathematics and Pro-Dean at the Constructions University, gave him a surprise answer: “Mihai, the apartment was a gift, now it’s yours; you do whatever you want with it. But, listen to me, because I’ve taught 30 generations of building engineers: they don’t make buildings like these anymore. These are strongly built, after the earthquake. And any fool knows that real estate should not be sold unless there’s some urgency. Brick is brick, the best investment, not like all these financial products they sell today. Mihai, why don’t you check whether you can get a credit for the whole sum? So you can get to buy a house and keep the apartment?”
The next day, Mihai and Ioana went to the real estate agency. The manager told them that, should they decide to sell, he will gladly help them sell the apartment for 100,000 Euros, but for buying a villa up North he recommends another colleague. And this is how they met Mr. Gabi.
Mr. Gabi, despite his daily visits through the muddy construction sites, always wears a suit and drives a clean Audi. “How many square meters do you have in mind?” “Well”, answers Ioana, “we would like a living room and three bedrooms.” “Oh! Well, that means at least 250 sqm. At around 1,300 per meter, the total is around 325,000 Euros. I can show you some nice villas in Gulia and in Otopeni, and also some villas under construction in Pipera, in the coolest residence, North Star.”
After visiting the entire portfolio, Ioana and Mihai fell in love with a house in North Star residence. The price, 320,000 Euros, didn’t mean anything to them, but it was smaller (if only by 5,000 EUR) than the calculations made back at the real estate agency. And this shouldn’t be bad, should it? The only small issue was that they could only move in 6 months from now.
So the next visit was paid to Ms Istrate at the bank, to see what mortgage they can rely upon. Ms Istrate, their 2nd floor neighbour and unit manager at the bank across the street, was considered the undeniable authority in banking, because she had worked within the system since forever, and also because her son writes for a financial newspaper. “With your income, you could get a 280,000 EUR credit in Romanian Lei, 290,000 EUR credit in EUR and 300,000 in CHF. But this Swiss francs offer is only available now, next week we will stop offering credit in CHF altogether, I don’t know why.”
The numbers worked well: they already had 50,000 EUR in their savings account (but that sum should have covered the car as well), so they began the process: they filed the papers for the CHF credit and they signed a pre-contract for the house with a down payment of 20,000 out of their own reserve, the rest being covered by the credit.
The house was ready in November, with Ioana being in 8 months. A few days before signing the final purchase contract and the mortgage, Mihai spoke with his brother in the US and found out that there are problems with the real estate market over there, so he began to worry. But then he talked things through with Ioana and the conclusion was that, if they wouldn’t have paid the 20,000, they might have reconsidered, but once they have paid that sum, they must go forward. So, beginning of December they signed the final papers and got the key for the house.
Today Mihai and Ioana have a cute little boy, an apartment in Drumul Taberei only worth of EUR 55,000 (but producing a small rent), a house in Pipera only worth 170,000 EUR, and a credit in CHF for the next 23 years which, due to the appreciation of the currency, strongly destabilized their financials.

Please answer, in your journal, to the following questions:
- What judgment errors were made?
- What advices would you give the Popas if you could?
- Did they succumb to fallacies? To which ones?
- Did they succumb to cognitive biases? To which ones?