Sign of the Times: Housing Derivatives

The scene at the Chicago mercantile exchange is somewhat akin to rival street gangs — men and women, decked out in colorful jackets, flashing hand signals to each another. But that is where the similarities stop.

Through these hand-signaling traders, and others at a number of “futures” exchanges, banks and institutional investors balance the risk in their portfolios by purchasing contracts that provide an upside if their other investments go down. They trade “futures” contracts in everything from lumber and pork bellies to the dow Jones industrial average and the Standard & Poors 500 Stock index.

In recent years, the Cme has aggressively branched out, offering more ways to hedge against bets in all types of asset classes at home and abroad. missing from the mix has been housing, a $19 trillion asset class. Beginning in the 2nd Quarter of this year, perhaps as early as april, the Cme will pioneer trading in futures and options contracts that are linked to indices of the housing markets in 10 major metropolitan areas: Boston, Chicago, los angeles, new York, las Vegas, San francisco, denver, Washington, miami and San diego.

Traditionally, if you own housing, or land zoned for housing, it meant two things. You own it for a reasonably long period of time. and, in the uncommon circumstance that housing real estate values go down, you take a hit. after april, individuals and institutions that wish to hedge their real estate bets, or spread their investment exposure to other housing markets can simply call their broker and get it done.

This is truly brilliant. and the timing could not be better, particularly with the inflated state of housing prices that even alan Greenspan called them “frothy” in some places. These housing futures are sure to be a hit among the institutional investment crowd: banks with large mortgage holdings, big home building companies with large investments in certain cities, etc. individual investors are not likely to be big users of these contracts, but that is because they don’t understand them, nor will they want to take the time to do so. Really smart remodelers, particularly those that buy-and-flip on speculation, might want to take a hard look at these.

Several times over the past two years, this space has been devoted to the enormous risks that remodelers take, agreeing to do work with hosts of unknowns. all sorts of margin-eating impediments lurk behind old walls. Heck, if the ePa gets its way with its proposed rule governing renovation work practices as they relate to the removal of lead paint, the cost and liabilities of being in this business could skyrocket. The risks are found everywhere in this business.

Many top remodeling companies in “frothy” housing markets like Boston, Washington, San diego and San francisco built their reputations and their book of business with an inherent investment in these markets. Buying these futures and options won’t be everyone’s cup of tea, but why not put some of your local housing market risk on the colorful shoulders of traders who flash hand signals for a living. despite all appearances to the contrary, they know what they are doing.