Saturday, December 04, 2004

Merc says volatile housing market a recipe for futures


Initial trading would likely be by large mortgage holders, such as big banks, but individual investors might be attracted later.

By Robert Manor
Tribune staff reporter, Chicago Tribune

Want to bet on the future price of housing in Los Angeles or New York or Miami?

Think of the Chicago Mercantile Exchange.

The exchange is studying whether to offer futures contracts based on the cost of housing in different major cities.

"The most volatile regions would be looked at first, like Los Angeles or San Francisco," said exchange spokesman Allan Shoenberg.

Chicago is a likely candidate as well.

A successful real estate futures market could allow homeowners to insure that their residence doesn't lose value if a housing bubble bursts.

Insurance companies could offer policies based on futures trades that become profitable when housing costs go down.

"There is nothing available today for people to hedge their risk" of a housing decline, Shoenberg said.

The first and most likely traders would probably be large mortgage holders, such as major banks or Fannie Mae.

They are particularly vulnerable to any downturn in real estate value because it is the collateral for their loans.

Eventually, though, the futures might be offered in the form of insurance to individual homeowners.

Homes don't typically drop in value--they go up, sometimes rapidly.

There has never been a nationwide decline in home prices.

That would be an incentive for people to buy futures that rise in value when housing appreciates.

Still, some markets, particularly along the East and West Coasts, have experienced significant drops in home prices in the past. And with home prices rising dramatically over the last few years, some people say a correction may be in order.

The exchange will decide whether to offer the contracts next year. If it does, they will be based on city housing cost indexes provided by Macro Securities Research.

"By any measure, housing is the largest asset class in the country, $22 trillion," said Sam Masucci, chief operating officer of Macro.

He said his company has already gotten inquiries from insurance companies who are interested in both sides of the trade.

Some would like to buy into the future price of housing because they expect it to go up.

Others, like insurers, want to offer it to their clients who are seeking protection in case the value of their house goes down.

The size and duration of the futures contracts are some of the details that need to be worked out.

And there is always the possibility that the exchange will open a market for housing futures, only to watch it fail.

Jake Morowitz, a longtime trader at the Chicago Board of Trade, has many examples of new futures products that never caught on.

"They have tried canola oil, crop yields, they tried to do electricity futures," Morowitz said. They went the way of bankruptcy, barge freight rate and fertilizer futures when traders never materialized.

Morowitz said that even trading in Treasury bonds, now a staple at the CBOT, was slow to win acceptance.

George Constantinides, professor of finance at the University of Chicago Graduate School of Business, said he is typically skeptical of new futures products.

"But this one makes sense," he said.

He said that people living in cities like Los Angeles, where it is not unusual for a homeowner to have $1 million in equity, might be willing to protect that investment.

"It would not be just another market for speculation," Constantinides said.

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