Wednesday, December 08, 2004

Hedging the house

Chicago Mercantile Exchange exploring a new financial product that could soften losses if housing market drops

BY Tami Luhby

After years of watching their homes soar in value, some people are worried housing prices are headed for a fall.

The Chicago Mercantile Exchange is hoping to allay those fears with a new financial product that could help homeowners insure themselves against a collapse in prices.

The exchange is exploring the development of futures contracts tied to housing prices, the first of their kind. These would allow institutional investors like insurance companies to make bets on the movement of housing price indices in specific regions, including New York. If the index declined, the futures contract would pay off and make up the difference.

In turn, insurance firms could use the contracts to finance policies that protect individual homeowners against falling prices.

"It will take some of the financial risk off the table," said Sam Masucci, chief operating officer at Macro Securities Research, which is developing the contracts with the exchange.

But the concept must overcome several serious hurdles before it hits the market. The proposal, announced Friday, is still in the earliest stages and it remains to be seen whether insurance companies will take to the idea. Also, some experts question whether homeowners are concerned enough about depreciation to buy such policies.

The contracts would be based on CSW's housing price indexes. Macro is hoping to roll out the financial instruments by the middle of next year.

The idea of home price depreciation insurance has been around for years and has been promoted by Yale economist Robert Shiller, who founded both CSW and Macro.

But insurers are not likely to develop such policies anytime soon, said Robert Hartwig, chief economist at the Insurance Information Institute, a trade group. Firms typically do not get involved in market-based risks nor use derivatives in their insurance lines.

Most importantly, it would be tough to convince an insurer to create such a product after the recent boom in housing prices. Even a small downturn in home prices could result in huge losses, Hartwig said.

The risks are indeed high, given the staggering size and speed of the rise in home prices. The median price in Suffolk was $363,500 as of September, up 120 percent in the past five years; in Nassau, $445,000, up 95 percent, and in Queens, $375,000, up 88 percent. Some experts are concerned a housing bubble has developed, and that when it pops, prices could fall hard.

"Insurers are being asked to bet that real estate prices will continue to rise, or at least not fall," he said. "That's a bet we're more likely to lose today than just a few years ago."

Leading homeowners insurance firms Allstate and Travelers said they were not interested in developing such a product at this time.

"We have no reason to believe our customers would be interested in this type of product," said Michael Travino, an Allstate spokesman. "Also, we think it would be difficult for us to make money on it."

Those who are concerned about falling home prices can protect themselves somewhat from that risk by investing in "hedgelets," a new financial instrument from HedgeStreet, an online marketplace. Investors can bet on short-term changes in housing prices in local markets such as New York.

If, for instance, investors thought New York housing prices would rise less than 2.25 percent by Feb. 28, they could buy a hedgelet for $7, the current going price. If they are right when the hedgelet expires at the end of February, they would receive $10, for a profit of $3, less trading and settlement fees. If they are wrong, they lose the $7.

"HedgeStreet allows people to better manage the economic risks that affect their everyday lives," said Russell Andersson, HedgeStreet co-founder.


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