Hedging on Home Prices
Creating a liquid market could make housing prices more efficient, says Yale economist
Robert J. Shiller
When it comes to housing, Yale University economist Robert J. Shiller is the man of the
hour. Not only is the author of Irrational Exuberance among the most prominent
believers that there's a U.S. housing bubble, but he recently helped launch a system that
will let people speculate or hedge on housing prices in 10 metro areas. The Chicago
Mercantile Exchange is about to begin trading futures and options based on Standard &
Poor's-branded indexes that were invented by Shiller and several colleagues.
The metro areas covered by indexes are Boston, Chicago, Denver, Las Vegas, Los Angeles,
Miami, New York, San Diego, San Francisco and Washington, D.C. BusinessWeek
Economics Editor Peter Coy had this e-mail
exchange with Shiller:
What's the most important mental mistake that people make as buyers or sellers of
homes?
At the present time, it is the mistake of thinking that homes will generally be a terrific
investment. People typically think that home prices will go up at something like the
return on the stock market. If home prices had done this for the last century then their
real value today would be roughly a thousand-fold higher, while our real per-capita
incomes are only about 6-fold higher. That is clearly not what happened — it would
mean that practically none of us could afford homes today. Quite the contrary, we are able
to afford much bigger and better homes. Homes are a manufactured good, and in the long run
construction keeps prices down.
What do you think is the strongest evidence that we're in a housing bubble?
Speculative booms and busts have been in the housing market from time immemorial; the only
thing that is new now is the national -- and international -- character of this boom. The
pattern of speculation should be well known to people who read history, though most people
don't.
We see immense public excitement, scrambles to invest in homes amidst rising prices and
rising construction activity. The excitement is sure to fade, just as supply comes on
line. Of course, speculative booms have not always ended in busts. There have been soft
landings as well as busts, and no one can be sure what will happen this time. That is why
we need new markets that will help us by delivering market expectations for future dates.
You've written that consumption doesn't fall as much in a housing bust as it rises in
an up market. Does that mean we don't have to worry about a big hit to the economy if a
housing bubble bursts?
It is true that people will try to maintain their standard of consumption even if home
prices fall. This time, however, they are starting out with a personal saving rate that
has been very low — negative in 2005. So, there may be bigger contractions in
consumption this time. There is cause for some worry: Housing busts have been a leading
indicator of recessions. Monetary policy has improved, though, and with [Fed Chairman] Ben
Bernanke at the helm, maybe the economy won't take a big hit even if there is a housing
bust.
Housing price indexes haven't caught on in the past. Why do you think they'll catch on
this time?
When my colleagues Karl Case and Allan Weiss and I started our campaign for futures
markets for housing in 1990, the science of real estate price indexes was in its infancy.
Nobody trusted the median home price data that was in the news then because it was so
noisy as to be obviously unreliable. Technical progress in index-number construction, as
well as technical progress in markets and increasing financial sophistication all point to
a day before long when home price risks will be actively traded.
Would instruments like these tend to stabilize the housing market, making bubbles less
likely, or fuel speculation and make bubbles more likely?
I believe that creating liquid markets for home prices will have little effect on home
prices at first, but eventually will tend to make home prices more efficient. That
probably means that home prices will be more volatile from month to month. That is
as it should be — if information can be incorporated into market prices more quickly,
prices will react faster.
But greater efficiency probably also means that home prices will be less volatile
from year to year or decade to decade. The new futures and options markets will be
creating an opportunity for people all over the world who are skeptical of local housing
market booms to express their opinions early on by taking short positions — something
that is just not possible today. They will be a beneficial influence on the housing
market. |