Monday, August 22, 2005

The Futures Market and Real Estate

Today’s NY Times had a story about the futures market and its predictive value as related to housing. According to the article, given the prices of house futures for various regions in the US, it is likely that prices will continue to go up.

Although I don’t doubt that the predictive value of the futures market is compelling, I wonder if its value is as applicable to housing as it is to predicting who the next Pope or President will be.

The future’s markets in the article describe two different kinds of markets in my opinion, one of which is speculative (a bet on the next Pope) and one that is used as a hedge (betting on the direction of house prices.) In short, there is no underlying “Pope” security that will move in the opposite direction of the “Pope” future. On the other hand, the “Home” future could be bought to move in the opposite direction of the price of the actual house that is actually owned, thereby creating a hedge. Therefore the buyer of the home future is more likely a hedge investor whereas the buyer of the pope security is more likely a speculative investor and the motivations are going to be different.

That still does not explain why house future prices point to higher house prices, in light of all indications that actual house prices seem to be reaching a zenith. But maybe it does.

Over the past year, we have all witnessed irrational behavior on the part of real estate investors in the bidding up of houses beyond their fair value. As a result, we should not be surprised if these irrational investors do not take advantage of hedging opportunities in the futures market, even though they exist. In other words, these irrational investors were to dumb to over pay for a house and they are still to dumb to buy a security that will go up when the price of their house is going down.

Meanwhile, the futures market allows people who have smartly cashed out of there real estate investments to still hedge themselves in the event they bet wrong. A person who sold and took the cash and is now renting would probably want to hedge against a further increase in home prices by going long house prices in the futures market.

Snip…

“Now one of these markets has turned its gaze to a consumer activity that is a favorite discussion topic these days: real estate. And the bettors see no signs of a bursting bubble anytime soon.

San Diego? Prices will rise another 5 percent in the third quarter, according to the bettors at HedgeStreet, another Web site. New York? They will inch up 2 percent. In Los Angeles, they will jump 7 percent. In each of the cities, as in San Francisco, prices will be more than 10 percent higher than they had been a year earlier.

The Internet has allowed these betting markets to flourish, and their predictive power stems from what the writer James Surowiecki calls "The Wisdom of Crowds," in his recent book of that name. When people take the time to study something and then put their money where their mind is, their cumulative intelligence can be cunning. As long as there are enough prognosticators, they gather their evidence independently and their backgrounds are diverse, they often do better than individual experts who have spent years studying the subject.”

Continue…

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