Thursday, October 04, 2007

The futures of housing

Thanks to my new favorite blog, Burbed, I was pointed at this Wall Street Journal article outlining a new Chicago Mercantile Exchange futures vehicle for housing prices 60 months out.

If you're not familiar with futures trading, the idea is for commodities sellers and buyers to hedge against massive changes in the price of whatever they need to sell or buy. Say you own an orange juice company and need a supply of 5,000 oranges a day. You don't want your business to expose itself completely to the retail prices of oranges. If there was a short term orange shortage, you'd pay through the nose but probably can't reflect that price change in your own product. Likewise, the orange grower wants to ensure his prices in case there is an orange glut. So you might buy a contract to buy 50,000 oranges in April 2008 for $1 an orange, and pay $50 for the contract. The contract itself is worth something, because if the oranges were suddenly worth $2 an orange, and you have a contract for $1 an orange, you could turn around and sell your oranges for a cool $50,000 profit. If everyone thought oranges would be worth $2 at the time the futures contract delivered (April, 2008), that $50K would be priced into the current exchange price of the contract.

That was originally why futures were created. Today they have become entirely financial instruments unrelated to anything material like orange delivery. You can trade futures in stock prices, interest rates, currencies, and so on. But market watchers really really like these futures markets because they have proven to be remarkably accurate predictors. The hive mind seems to be at work within those.

One of my favorite websites that uses this is the Hollywood Stock Exchange. I'm not sure HSX has released numbers as to how accurate it has been as a predictor of box office, but my own experience is that it has been pretty darn good. The games industry has started getting in on this with a site called The Sim Exchange (unrelated to "The Sims").

The US government once controversially tried to introduce a futures market for Terrorism. The hope was that it would help predict terrorism attacks. Putting aside the ethical debate, few disagreed that this had a good chance of being a decent terrorism predictor.

Which brings us to today's topic: housing prices.

The Merc -- by the way, it's the exchange featured in Ferris Bueller's Day Off, I've visited the exchange myself when I was in high school -- has started trading futures in housing prices that are tied to the house price indices. Again, there's no material good you get from this future, but you can profit or lose money from it essentially the same way if you bought or sold a house in these areas.

According to the futures market, the San Francisco area is poised to drop 28% by 2011. Considering what we've seen for sale lately, this should be no surprise. In any case, you can hedge your house using these futures. Maybe it's worth looking into it for very large mortgage lendees who carry any risk with their situation.

That is, of course, if anyone could find out what the current price is...

Hey CME, you guys might want to turn off print exceptions for the world to see. Just a thought.

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