patrick.net

I am interested in knowing how much leverage will be built into the contracts. It will be practically useless if no leveragize is involved because one will need 800K cash to hedge a 800K home. Most people just do not have this kind of resource.

If this product is reasonable, I see at least one advantage for renters...

Realtor(tm): Buy now or you will be priced-out forever!

Renter: I have no fear because I am hedged with MACRO securities.

Realtor(tm): But... but...

...

SIM, thanks for bringing up the issue. We should look more closely into the development of this product. It will dramatically change the our outlook of the market and our game plans.

News, I agree. It is quite doubtful that this product can mature before the coming downturn. I am still predicting a remarkable shift of sentiment by the end of October that will mark the beginning of the crash.

In the long term, it is conceivable that such product can be of value. I believe that it will moderate the housing cycle by removing the fear factor from both buyers and sellers. Home prices will be allowed to track the fundamentals more closely with less severe swings. (Greed will not be removed though.)

Let's hope that this product will be more successful than weather contracts. But I really do not have much faith in the market.

Fake P, the pricing and the amount of leverage are not determined yet. The article might just be giving an example. In my opinion, the cost is perhaps missing a zero. :)

Fake P, you are right, 75K seems too high. We need to be very careful about the payout schedule though.

I do hope that they will have one with a shorter term.

TWIT, I am not even sure whether it will trade like futures or options. I suspect that it will be neither. I am going to check out US Patent 5987435 tonight and see if I can get some clues.

On the other hand, I thought most people do not exercise early anyway. Because of the remaining time vaue, usually it makes more sense to sell the option instead. It only make sense to exercise early for a deep-in-the-money American PUT option. Well, if it crashes real bad, perhaps that would be the case. :)

"I suppose they key with an instrument like this would be to ensure that the investor would, in the economic dislocations unleashed by a housing correction, remain solvent enough to pay up. "

I agree. Our financial system is a house of cards (no pun intended). Increasing reliance on hedging is not necessarily a reasonable and prudent approach.

Can I throw in a time-out here? I took it upon myself to do a little homework on this "hedging" business because I was NOT following all of the posts very well. Ok, I understand what hedging is now....and macros...but it took a minute. :-)

BUT...your average Joe and Sue Homebuyer/Homebuyer will not know anything about this, nor will they stop to figure it all out. Your friendly neighborhood real estate pro will not play "let's edu-ma-cate these folks so they will know what their options are". A very small number of people even understand how the housing market is tied into the global economy. And an even smaller number probably know about futures, stock, blah, blah, etc.

In the last topic a lot of people were missing who had very actively participated in the discussions. But like me, they are probably sitting on the sidelines really trying to digest this new stuff.

So, I ask....can we step back a moment and address this in more layman's terms? Here's are some questions: if it may be possible for a home-hedge insurance in the future, where would you secure it? Who would be person to talk to for such a thing? Will you have to be in the "in-crowd" to know about it and thus get that protection?

Sorry I'm being a baby, but I want to be clear on this. And it will probably help others reading this blog, too.

BayQT~

BayQT, most probably this product will not be popular among homeowners. However, it is conceivable that more "creative" mortgage can be invented using MACROs as a tool.

How about a mortgage that cannot be upside-down?

One can imagine that the mortgage issuer can use "down" MACROs to hedge against a fall in home value on behalf of the homeowner. The cost can be charged as points or a higher rate. When it is time to refinance or sell the home, any possible deficiency can be made up using the gains in the "down" MACROs and a small adjustment. Over a large sample, all the adjustments should sum to virtually zero, if all goes well.

The possibilities are unlimited.

"I can’t be sure who would take the other side of the bet, that housing prices would increase."

Speculators. Prospective buyers who want to hedge against rising home prices. Hedge funds (gasp).

Those who are interested should seriously read the patent text:

http://tinyurl.com/ccj9w

SIM, you have raised many valid questions. I guess we will just have to wait and see. The concept of "Proxy Asset" definitely sounds more complex than Option ARM. We are entering a new era of financial complexity in which bold attempts are being made to tame greed and fear. In the end, I still think that primitive emotions will prevail.

Hellboy, according to the patent document, "the initial Down Proxy Asset could also be for individual zip codes or even census tracts, thereby facilitating very accurate hedging for individual homeowners."

The document also suggests that Up Proxy Asset for different cities can be bundled for investors who desire diversification.

Regarding speculation, this Proxy Asset may not be as bad as stock index futures. With SPX, actual stocks are usually bought and sold to maintain arbitrage relationships. It is difficult to buy and sell homes for this purpose. So I do not expect too much additional volatility in home prices because of this.

Sizing for ZIP codes is just a possibility suggested in the patent document. I doubt that there will be sufficient liquidity to do that, and even if it can, the correlation will still be far from one-to-one.

I wish that the index will be more robust than a simple median price that is quote (manipulated) by the industry.

I do expect that the Proxy Asset itself can be volatile, although I hope that it can take volatility from home prices by providing an alternative vehicle of speculation.

I doubt that it can even get to the market in time before the crash.

Peter P,

Thanks so much for your reply. :-)

Today I read that Alan Greenspan is due to retire in January 2006. Any thoughts as to how this will impact Fed Reserve activities and interest rates? Mortgage rates been holding pretty steady below 5% for weeks now, and many thought that there would be more increases.....instead, the opposite happened. How is the Fed Reserve chairman selected? Would it be a person who Alan is grooming right now? Or, is this person selected by a committee?

BayQT~

BayQT, whoever elected to be the next FED chairperson will probably be consumed by either greed or over-confidence, or both. I do not have high hopes.

It took 1 year of monetary tightening to kill the tech bubble. The current tightening cycle started about a year ago. I think the rate hikes have already been killing the housing bubble from the inside. It is just that we will not see this until it bursts.

The long rate will remain a conundrum for now. It is quite possible that the bond market is just predicting a recession ahead. A do not see that as a boon to the boom.

On the other hand, the change in speculative expectations alone can collapse the bubble. We are definitely witnessing some of those changes.

Time will inevitably tell.

Check out Ben's post here:

http://thehousingbubble2.blogspot.com/2005/06/unbridled-reporting-making-bubble.html

Inventory is up 242% year over year.

Also, 944 homes were reduced in the *last 7 days*:

http://www.lasvegashomes.com/Default.cfm/Page=/ListingsReduced.htm

One article has the following to say about Las Vegas:

"At the end of May, 15,066 homes were listed for sale, up 1.6 percent from April. The median list price of available units was $359,900, up 1.4 percent from April and up 13.4 percent from May 2004."

Where is the year-over-year inventory number? I heard that it has increased 232% over May 2004!

I am going to Las Vegas next week. Perhaps I can see what is going on there.

Even median selling price is not very representative because it is sensitive to cross-sectional shift in the market.

Y/Y changes in inventory number and time on the market tell a lot more about the shift in sentiment, which is all important in a speculative market.

I think PMI protects the mortgage insurer in case of foreclosure. I doubt that homeowners can get much out of it other than the fact that they would not have been able to get a mortgage without that in the good old days.

Jack, at the very least, this new instrument can take fear out of both homeowners and propective buyers. The result is milder bubbles in the future.

"And the “index” is the bookie. Is that close?"

Yes, absolutely. I hope that it can take speculative pressures from the housing market itself.

We are have a bubble is because the very act of speculation and the effect of that act form a positive feedback loop. An alternative speculative device that is disconnected with the actual housing market should soften the effect.

There are still a lot of unanswered questions regarding the proxy asset itself. I am quite excited personally. It will be at least academically interesting.

Hellboy, if I am a speculator, I would just buy an "UP" MACRO to participate in any price gain? It will be a lot cheaper with much better liquidity and it is also easier to diversity.

RISmedia?

Soon they are going to say thet renters will be drafted and sent to Iraq while homeowners can stay free.

Jack, this hedging product will not add liquidity to real estates. The transaction cost of housing will still be high. Because of the difficulties in arbitrage operations, it is unlikely that volatility in the proxy will find its way into the underlying asset.

Illiquidity will not prevent a crash. This is evident in many prior real estate delines. On the contrary, it actually reduces market efficiency and encourages cycles.

Perhaps this is another thing that we should agree to disagree.

"Derivatives on another hand are just an insurance which is not likely to produce new housing."

But worried renters can also buy this insurance instead of homes. This will reduce the demand for housing as an asset.

I may be misguided, but I hope that this hedging product can allow home prices to follow fundamental factors more closely in the long run.

Jack, home prices are sticky because it is difficult to find buyers in the downturn due to illiquidity. The "train wreck" can be seen in slow motion, but one will have to escape in slow motion too.

JG, thanks for the update in Mass. Year-over-year inventory is way up in many places. The signs are out there if one cares to look.

I will be looking for bargains. Perhaps a complete crap on a decent lot. I am going to demolish it and put a pre-fab house there. :)

Or foreclosed land with approved permits...

Will they still have construction-to-permanent loans?

Since construction cost is mostly constant and is a large portion in home price, a decline in home price will entail a severe decline in land value.

Speaking of pre-fabs, I have quite some respect towards Michelle Kaufmann.

Take a look at this house:

http://livemodern.com/glidehouse

Love it or hate it, but a lot of thought regarding sustainability has been put into the project.

Jack>"One thing I DO know is that a reasonably and realistically priced house in ANY market will sell, and by “slow motion” I meant that it is easy to see what the prevailing prices are and price a house accordingly. If a seller really wants to sell IN ANY MARKET, all he has to do is drop the price rather than wait. I have seen this first hand over and over again."

And that brings us to square one....a lot of people are not being reasonable OR realistic in this market. There are also a lot of hard-headed sellers that insist that "their" house will sell at the price they set (which to them is the correct price). Until they see the handwriting on the wall, they will either stand pat and wait for the hungry hunter or take it off the market.

BayQT~

"You’re going to wait 5 or 6 YEARS?"

I will wait 15 years if it is necessary.

"Seriously though, I was just saying that there IS a simple remedy for a slow moving market– drop the price."

This is true though. But in a down market recent comps are not easy to come by and sellers do not like to ask for much less than the comps. Realistic prices are almost always good most of the time.

"Its only necessary if you say it is"

There are actually quite a few things that will change my mind even without a correction:

1) A realisitc forward looking P/E ratio due to increasing rent or realistic expectation of such case

2) A jackpot win :)

3) A successful emergence of the aforementioned hedging product that somehow restricts participation in the upside. (I will explain this later)

4) A successful emergence of a 0% loan with a 70 years interest only period

I really hope that sustainable engineering can get more attention. With great ideas and some smaller compromises, the world can be a lot more livable, now and in the future.

I absolutely agree with you, Jack.

For you local posters....did anyone notice on the news story (KRON4) tonight that San Francisco has lost 32,000 people between 2000 and 2004. They included a lot of census info, and that the biggest reason was/is that people are being priced out of the housing market. They did, however, interview a guy (city planner??) that mentioned that there are a lot of plans for new affordable housing on the planning table. Hmmm...I wonder what he means by "affordable".

SF Population in 2000 - 776,665
2001 - 774,479
2002 - 761,983
2003 - 751,908
SF Population in 2004 - 744,230

BayQT~

If they only provide a way to hedge against falling home values without a way to speculate on higher prices, the bubble may stay inflated for a bit longer.

This arrangement will take risks away from homeowners without taking fear away from prospective buyers. The strategic balance will be altered forever. Prices will fall only when people finally realize that owning costs a lot of more than renting. This will be a very slow process without having to bear the pain of falling prices.

Please tell me that I am wrong.

Jack > Affordable means too small in a bad neighborhood and you cant re sell it EVER

LOL! That sounds about right. :-(

BayQT~

"And the REASON you can always sell by dropping the price, even in a slow market? The “slow train wreck” factor of course! One of the many benefits of real estate!"

That is if you have a reasonable house though. Fixers will be a tough sell.

There is also an art of pricing. If you lower too much buyers may think that you are desparate and further low-ball you.