Securitizing The Housing Bubble - CME Will Introduce Housing Futures

Friday, November 11, 2005

Are you worried that the current market value of your property may not be sustainable? Don't worry, soon you will be able to short it. The Chicago Mercantile Exchange (CME) will offer housing futures in April. The futures will be based on the median home prices in 10 US cities but are aimed rather at mortgage companies than the individual home-owner.
From The Miami Herald:
Worried the value of your home may fall?
Go ahead, bet on it. Or if you don't, maybe your mortgage holder will.
The Chicago Mercantile Exchange, a financial marketplace dealing in the value of everything from interest rates to foreign currencies to pork bellies, has committed to offer trading next year in a category many consumers take personally: sky-high U.S. home prices.
Housing-price futures, based on the median home price in Miami and nine other U.S. cities, aren't being tailored specifically for individual homeowners. But they may provide some protection for mortgage companies, home builders and anyone else with a large stake in residential real estate if housing values slide -- while giving other investors a way into a lucrative market.
The novel investment product is set to debut in April 2006, based on a final go-ahead given by the Merc earlier this fall after months of exploratory work.
''There really is no way [now] for anyone to hedge home prices,'' said CEO Sam Masucci of Macro Securities Research, the financial research firm that's developing the contracts with the exchange. "Or for institutional investors to gain exposure to the market without going out and buying homes.
Housing Is The Largest Asset Class
''Housing is one of the largest asset classes in the world [and] we thought it made a lot of sense to give people access to it,'' he said.
While unusual, it won't be the most exotic contract offered by the world's largest futures exchange. That distinction has been held for six years by weather futures, which are based on regional temperature indexes and enable utilities and others with a lot riding on the weather to hedge their risk.
The concept of real-estate futures has been discussed since the early 1990s, but it took a boom in housing prices to propel it to reality.
Home values appreciated 65 percent nationwide from 2000-04 and more than doubled in some areas, reports the National Association of Realtors. U.S. residential real estate was valued at $18.6 trillion at the end of 2004 - more than the amount in equities.
The price run-up has meant a huge increase in wealth. A negative sales forecast from home builder Toll Brothers sent stocks falling on Tuesday by fueling fears of an economic slowdown. Such recent evidence of cooling may have only fueled interest in protecting the market.
''One never knows when you launch something like this, whether it's going to be successful or bomb,'' Masucci said. "But all the elements are there for it to be successful.''
Investors will be able to trade contracts electronically based on median home prices in Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco or Washington D.C. -- or a composite index of the 10 cities. The indexes were developed by the real estate research firm Fiserv Case Shiller Weiss.
Short Your House Instead of IBM
Those who are optimistic that prices will continue their double-digit rise can simply buy contracts, making a profit if the increase exceeds their costs by the expiration date.
Investors who want to soften the potential blow of a steep decline can buy versions of the contracts called put options that will pay money if the price drops, ensuring that they recoup some of their lost profits.
That strategy is akin to taking a short position in a stock, according to Felix Carabello, Merc associate director for alternative investments. But ''instead of shorting IBM, you're shorting your house,'' he said.
Robert Hartwig, chief economist at the Insurance Information Institute, a trade group, said insurance companies are unlikely to get involved in anything as speculative as housing futures or develop home price depreciation insurance based on them, as has been suggested.

As products are created by demand that needs a supply it can be assumed that mortgage companies and real estate funds are looking for ways to insure themselves against a decline in house prices. Or did I just place a wrong bet?
UPDATE: SignonSanDiego.com has the list of the ten cities whose home prices will be used as the underlying for the housing futures. They are Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington DC. Other contract specifications have not been specified yet.

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