Monday, September 1, 2008

Hedging against house prices

Bet against the bubble - how to head off a subprime crisis

There were any number of people in 2005/2006 saying that these house price rises simply couldn't go on, that we were in an unsustainable bubble. But there was no way for such people to actually influence the market. You can bet on houses going up by buying one. But currently there's no good way to bet on their falling. You can't go short houses. But as we know from stories like Galton's Ox and Surowiecki's Wisdom of Crowds, you only end up with a realistic estimation if all of the crowd can have their say. In housing we could only hear, in the market itself, the voices of the bulls. The bears couldn't make themselves heard.

Posted by kernow @ 11:10 AM (1365 views)
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11 thoughts on “Hedging against house prices

  • It can’t be that easy. You can’t just hedge against everything. How can you make money without taking any risk whatsoever?

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  • “Wisdom of Crowds”? must pick up that book – because it is not my experience.

    “The Madness of Crowds” – more like it.

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  • Why didn’t the Case-Schiller index become big enough to perform this hedging function? Would bulls buy property rather than play in such a futures market (it’s easier to buy and hold property than it is to take physical possession of e.g. a lot of oil)? Lenders hedged by insuring their loans but the rating agencies were worse than useless and the guarantors went bust. Would a large housing futures market obviate the need for ratings agencies and insurance? Would such a market start driving the underlying asset? Just questions. Any answers?

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  • What is the relative leverage for a property bull of (a) buying property and (b) going long on property in a futures market? If you obtained greater leverage via the former it may be difficult to get many bulls to play the latter.

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  • wisdom of crowds makes some good points.

    it is basically ‘ask the audience’ from ‘who wants to be a millionaire’

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  • stillthinking says:

    Bears made themselves heard by selling to rent. Hence the enormous glut of unsold properties for the latecomers.

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  • Cheap credit = bubbles, irrespective of how many futures markets you have.

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  • The author makes a strong case, but he is only partly right.

    First of all, the existence of deep, highly liquid, and well-informed markets did not prevent share prices reaching silly valuations during the dot-com bubble. If anything, the ability of ordinary punters to use leverage (via spread-bets) on share prices made the spike even worse.

    Secondly and more fundamentally, a futures market requires arbitrage between the future and the commodity. If I notice that the futures market has priced oil at $120 a barrel next month, but oil only costs $100 now, then I can go out and buy a million barrels of oil and hold them in storage until next month. That can’t happen in the housing market because unlike oil or other commodities, houses aren’t fungible.

    Thirdly, a normal commodities futures market is made up not only of speculators, but also of real traders: e.g. oil producers and airlines; hog farmers and butchers; wheat farmers and bakeries. In a pure futures market based on an index, unless builders and landowners choose to enter the market and hedge their investments, the market will become meaningless. This is related to the second problem above – builders and landowners could provide some arbitrage, but it is debatable whether they can provide enough.

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  • @drewster: you don’t need to go and buy a million barrels of oil. You can buy contracts to deliver a million barrels next month, then when the contract is about to expire, say you want delivery the next month. And the next, and the next, and so on.

    Alternatively, the market allows you to cash in at the contract end at the cash settlement price – the value of the index on the day the contract expires. From https://www.theice.com/marketdata/brentCrudeFuturesView/brentIndexView.jsp: “The ICE Futures Brent Index is published on a daily basis for information and is used by the Exchange and LCH.Clearnet on expiry of the front month futures contract as the final cash settlement price.” See also https://www.theice.com/publicdocs/IPE_Brent_Crude_futures_contract_specification.pdf.

    The fact that contracts can be rolled and cash settled means that speculators who have no interest in actually ever acquiring any oil can play in this market. The number of these speculators has been increasing over recent years and instead of reacting to actual production events, they react to fears over global events. Worse still are the ‘index speculators’ who invest in commodities according to the proportions of each commodity that makes up an index such as Goldman Sachs’ Commodity Index. Their decisions are based solely on how much money they have to invest and general market conditions, not on anything to do with the production of the commodity itself.

    The oil price ramping since 2003 is nothing whatever to do with the Iraq War – the taps were already off in Iraq as far as global markets were concerned before this point – and entirely to do with speculative price ramping. In other words, it’s a bubble. Thankfully it’s now bursting.

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  • whiteknight,

    There is a difference between mob rule (e.g. a placard-waving gang of otherwise rational housewives when confronting a paedophile) and a group of people making independent decisions resulting in a single observable outcome (e.g. Northern Crock).

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