Fixing Your Home Hedge

On Monday the Chicago Merc is planning to launch futures and options based on real-estate prices in 10 U.S. cities: Boston, Miami, New York, San Diego, San Francisco, Washington, D.C., Chicago, Denver, Las Vegas and Los Angeles.

Nicely timed to fail (he ironically says), as this Merrill economics report makes obvious:

We have just experienced one of the most impressive housing cycles on record, but it has quickly come to an end — so much so, in fact, that housing starts have fallen at a 56% annual rate over the past three
months, a turndown of sudden proportions that we have not seen since the opening months of 1991.

[Update] Breakingviews does a nice job of explaining why the CME’s home hedge is likely to flop:

What makes for a successful futures contract?

From the start, there must be demand from both buyers and sellers and hedgers and speculators. Futures markets need liquidity to survive. It’s also useful if the derivative’s underlying assets or commodities are uniform.

… Unfortunately, housing futures don’t meet these criteria. First, there’s a danger the market will be one-sided. Many people may want to hedge their housing exposure, including holders of mortgage-backed securities, home builders and banks. Only speculators and investors have an interest in going long housing futures. They could be deterred if the real-estate market were to tank.

There also are problems with hedging the house. Homeowners might want to sell short futures to protect themselves against a housing crash. But if prices kept on rising, they would face a cash drain from losses on their futures positions. Institutional hedgers face a different quandary. The Merc’s housing futures will be priced off the regional S&P Case-Shiller housing indexes. It’s unlikely these indexes will match the housing exposure of anyone seeking to unload risk. Further, as traders can’t sell houses short, there’s no mechanism to keep the futures in line with spot prices.


  1. Who are the buyers and who are the sellers of these contracts going to be?…
    The idea that retail investors are going to use these things to hedge their real estate exposure seems far-fetched to me.
    Let me ask you, for example, Paul: How closely do you think the value of your home in SD will correlate to the SD housing market index?… Not that closely, I bet.
    The next question then is: How many people, whose homes *will* correlate well with their local index, are now, or will become, sooner rather than later, comfortable using (brand new) futures contracts to hedge their real estate exposure?… Not that many, I bet.
    (Subsidiary question: “And btw, how do you think we got here [the real estate bubble] in the first place?!…” Most people don’t think in terms of hedging their real estate exposure in the first place. They think of their homes as either “money in the bank,” or [worse] “something you buy and sell for more” – the way stocks were in the 90s.)
    Or will the market for these things be developers? This makes more sense to me, but who’s going to be on the other side of the market?… I’m sure there’s an answer. I just can’t think of it off the top of my head — and I’m still skeptical that it’s a good answer, in the sense that there’s going to be a lot of demand there.
    Bottom line: Very hard for me to imagine that these contracts will succeed.
    Do you disagree?…

  2. Woops! smile… When did you post that “Update?!…” Couldn’t’ve said it better myself…. Sorry for what amounts, in retrospect, to comment spam, but I (perhaps obviously) hadn’t seen your “Update” before posting.

  3. No problem, Matthew. My pieces here are in fairly constant flux, so you note appeared here between updates.