July 8 (Bloomberg) -- If you are buying or selling a home in a market glutted with distressed properties, it’s time to change your attitude.

Don’t be misled by pundits saying the bottom may be visible in this stultifying decline. The real-estate recession will continue unless a massive brain freeze thaws. Buyers are afraid of purchasing a home at the wrong price while millions of sellers are locked into unrealistic listing prices.

Some good news after almost three years of deterioration is welcome, of course. In the latest S&P/Case-Shiller Home Price Index of 20 major U.S. cities, values fell 18 percent in April. That pace was slower than forecast.

That’s cold comfort as the collective psychology of the U.S. home market has been short-circuited for some time. We are largely hostage to the way our mind works. According to prospect theory, pioneered by psychologists Amos Tversky and Daniel Kahneman, the idea of losing money is a much more powerful motivator than a gain.

Our brains are telling us it’s painful to price our homes to reflect 20 percent to 50 percent losses in market values. So sellers overprice houses and wait for something to happen.

A myopic, loss-averse view of the market, for example, means listing for $500,000 or more when comparable upscale homes are selling for $400,000 or less. I have seen it in my suburban Chicago neighborhood, where homes have been on the market and unsold for years.

Logic Circuits

Our loss-aversion fears are so powerful that they override our logic circuits. We tend to ignore economic reality because we are emotionally anchored to our homes and values based on boom-era prices. It’s like holding on to a favorite stock long after it has tanked.

There are also influential cerebral centers for optimism and self-confidence. We hang on to properties, falsely believing that prices will rebound to the bubble years of 2005-2006.

Actual market conditions don’t offer much hope, however. “Real house prices have fallen by more than 30 percent from their peaks in 2006, destroying more than $6 trillion in housing wealth,” writes economist Dean Baker in his Housing Market Monitor. “They have been falling at the rate of 2 percent per month thus far in 2009. There is no evidence that this rate of price decline has slowed, much less stopped.”

Rewiring Brains

How do you succeed in this market? When you are selling, take into account all market conditions.

Forget listing prices that you are anchored to; in most places, homeowners have lost equity that may not be restored, especially if unemployment is rising. The only way out may be a short sale for less than the mortgaged amount.

What are comparable homes actually selling for and how much discounting moves a property? Are there foreclosures in your neighborhood, which will necessitate even more discounting?

Reframe your pricing decision. Focus on the benefits instead of seeing a price as loss-inducing.

Will you get out of an unaffordable mortgage payment? Will your property taxes drop by moving? Will you be able to save more for college or retirement?

Buyers, in contrast, should beware. There are still too many reasons to wait before you jump into this market. Congress and the Obama administration haven’t shut down foreclosures. Unemployment is the highest it has been in almost 26 years. More than 15 million homeowners owe more on their mortgages than their homes are worth.

Fixing the Market

Is help on the way? There are many carrots that Congress is considering to get buyers into the market again.

Under the stimulus plan passed in February, you can reap an $8,000 rebate if you are a first-time buyer. One proposal would raise that credit to $15,000.

Yet all the tax credits in the world won’t make a difference if foreclosures continue, prices keep falling and unemployment rises. Congress seems to be avoiding this reality.

More sensible ways to curb the foreclosure crisis would be to allow homeowners to write down principal or enroll in a rent- to-own arrangement.

Congress should consider guaranteeing all mortgages in the primary and secondary markets through the full faith and credit of the U.S. Treasury until the market stabilizes.

The government helped create the false euphoria that led to the bubble and meltdown. The least it can do is to enact sober solutions on fostering the market’s recovery.

(John F. Wasik, author of “The Cul-de-Sac Syndrome,” is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net.

Last Updated: July 8, 2009 00:00 EDT