A New Tool for Tracking Housing Prices

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Traders at the Chicago Mercantile Exchange think the U.S. housing market may be slowing down and they've got the numbers to prove it, thanks to Yale economist Robert Shiller. Shiller explains a new tool he co-wrote to track housing prices and establish a market in residential real estate futures.

NEAL CONAN, host:

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Today, tracking and trading on the U.S. housing market. Traders at the Chicago Mercantile Exchange think the U.S. housing market may be slowing down and they've got some numbers to prove it, thanks in part to Yale economist, Robert Shiller. A new index he helped to develop tracks housing prices in 10 different U.S. cities, and will be used to establish a futures market in residential real estate. If you have questions about cooling prices or how a housing futures market would work, our number is 800-989-8255, that's 800-989-TALK. Our e-mail address is talk@npr.org.

Professor Shiller joins us now from a studio at Yale. His books include, Irrational Exuberance, which was about the U.S. housing market. And professor, nice to have you back on TALK OF THE NATION.

Professor ROBERT SHILLER (Economics, Yale; Author): Hi, glad to be here.

CONAN: So what is this new index, and what does it tell us?

Prof. SHILLER: We have both new futures markets and options markets that are cash settled based on home prices indexes. And what it's going to do is open up the home market to investors and hedgers. I think it's a major development.

CONAN: Mm hmm. Well, tell us a little bit - for those of us who aren't familiar with these terminologies or futures or options markets - tell us a little bit about how it works.

Prof. SHILLER: Well, I think most of our customers, at least initially, will be institutional investors. But let me bring it down to an individual level, because I think some of our customers will be individuals. Suppose you bought a house, and you put a lot of your wealth into that house and you're worried that it might decline in value. But you don't want to sell the house because you live there.

CONAN: Mm hmm.

Prof. SHILLER: So what you can do is you either sell a futures contract on the house, or you buy a put option on the house. Either way, those are contracts whose value will increase if home prices fall, and that will help hedge you, because it will offset any losses you might make on your home. This is what hedge funds do. That's why they're called hedge funds.

CONAN: You're hedging your bet.

Prof. SHILLER: This is what professional investors do, and anyone can do it.

CONAN: So let's say I bought a house for a nominal $100,000, and I'm afraid the market is going to drop here where I live, where I bought the house. So, in other words, if I put out an option on it at $90,000, if the price declines to $90,000, I can buy it for that? Is that the way it works?

Prof. SHILLER: Well, it wouldn't actually be your house. It would be, the option would give you, ideally, it would give you $10,000 if your house dropped to 90,000. It may not do exactly that because the option is based on the city and not your house.

CONAN: So it's based on the market in your area, and that's where your index comes in, right?

Prof. SHILLER: That's right. What we need - see, futures contracts used to be settled based on delivery. When you have corn futures or wheat futures, you actually deliver the corn and the wheat at some warehouse. But we can't do that with houses. So it has to be based on a price index. And that's where the challenge was, to get a good price index up and running and to get public confidence in the index.

CONAN: And the problem with that is, of course, you go - well, obviously, it's different in different cities, but even neighborhood to neighborhood, you know, both the volatility of the market and, of course, prices can be very, very different.

Prof. SHILLER: That's right. Although, you know, recently, the U.S. Housing market has shown a lot of coherence. It has been going up just about everywhere, and in some places much more than others.

CONAN: Mm-hmm.

Prof. SHILLER: But there has been - we also are trading a national re-composite home price for, not just for cities, but for an average of ten cities. And that has shown a lot of increases, recently. So I would say it's not just a local phenomenon, it's substantially a national one.

CONAN: Mm-hmm. But some people say, and of course, I'm sure you're familiar with this criticism, that given all of these local variations, there's no index that could possibly capture all of these fluctuations.

Prof. SHILLER: Well, that's true. There's no perfect way to capture them. The real estate market has a very strong local component. But I think that, you know, no hedge is perfect, as hedge funds will tell you.

CONAN: Yes.

Prof. SHILLER: But it really helps to protect yourself by - it's like taking out an insurance contract. And, you know, insurance contracts aren't perfect. You know, people, you might insure yourself for the wrong thing. But taking a hedging position is analogous to insuring the value of your home.

CONAN: And that's obviously when it is the most important asset for so many families. That's an interesting - see, why do you think institutions are going to be the most important investors, though?

Prof. SHILLER: Because right now, institutions are the biggest players in the futures and options markets already, it's just that most people don't think in those - it's a little bit sophisticated.

CONAN: Mm-hmm.

Prof. SHILLER: Of course, it's entirely possible, and some individuals do do it. But I'm hoping that eventually, as these markets develop, we'll see more retail institutions that help people to make use of the risk management implicit in these markets.

CONAN: Well, let's get some listeners involved in the conversation. And again, if you'd like to join us, it's 800-989-8255. E-mail is talk@npr.org.

Let's go to Mark(ph) - Mark calling from Greer, South Carolina.

MARK (Caller): Hi, Neal.

CONAN: Hi.

MARK: My question is, when items like this become part of the futures market, does it not create a distorted outlook on the actual price in the consumption by the consumer? For example, like, when oil became part of the marketplace, then we see that the price of fuel goes up based on potential disasters - or so-on and so-forth - and never really recovers back to where it should be. And would that not be the same for the housing market, where the actual value based on the raw materials and everything dictates the price, or the demand in this specific area?

CONAN: Professor Shiller?

Prof. SHILLER: Well, I think that the creation of liquid international markets will improve the efficiency of the market for homes. Right now, the housing market is really dominated by amateurs, ordinary homeowners, and professional investors have very little presence in this market. Once we get more professional investors, I think we'll be less vulnerable to the kinds of ups and downs that we've seen recently.

MARK: Okay, thank you very much.

CONAN: Thanks for the call, Mark.

And, ups and downs - I mean, obviously, the futures market benefits from the fact that it looks as if prices are changing in this country at the moment. That's, I guess, just a happenstance that you would develop this new instrument for investment, but I guess it comes at a fortuitous moment.

Prof. SHILLER: Well, right now there's a lot of questioning whether we're at a turning point, because, you know, home sales - existing home sales have been up and down a lot, but they've kind of slowed down. And, you know, in some cities, home prices are falling, or at least the upward momentum seems to have been broken. The real question is where do they go from here? And, you know, nobody knows. That's why we need markets.

Once we have well-established prices in these markets, we will know what the market thinks that home prices are going to do. We'll have a whole road map ahead of us, which will, I think, make for a more rational economy.

CONAN: Let's get a question from Mike, Mike calling from Cincinnati.

MIKE (Caller): Yes. My question concerns, it's pretty much also it reflects what the previous caller said, and I'd like to quote from a Wall Street Journal article from 8/26/04, that says, quote, "JP Morgan Chase and Company, which had just ten energy traders and sales people a year ago says it has built its operation back up to 30 people and wants to become one of the top players." They're talking - George Soros, in this same article, said that just as you had everybody crawling over one another to get into the dot com business in the 1990s, you'll have the same thing with the oil futures.

And, in fact, that's what's happened. Oil has gone through the roof, and mainly, you see a row of the banks speculating on this, driving it higher and higher - much higher than it would ordinarily go if it was just supply and demand. And I think this should be legislation to prevent banks from getting into this, because people have to live in homes.

CONAN: Mm-hmm.

MIKE: And it's denying, it will deny homes to people who can't afford it now. I just want the banks to stay out of this, because it's going to be, mean a lot more people living in trailer parks.

CONAN: You're talking about big investment banks. Obviously, mortgage companies, they're banks too, so they're already in the business. But...

MIKE: Mortgage companies and banks and insurance companies - I mean, look what's happened. I mean, insurance companies have always had this reputation of being these shoot-straight people. Then you had the insurance banking industry scandals of, I think a year ago, where they were falsifying their accounting books.

CONAN: Mm-hmm.

MIKE: So they know better than anybody else.

CONAN: Well, let's give Robert Shiller a chance to reply.

Prof. SHILLER: Well, I think that, obviously, oil and other forms of energy are very important to our economy, and we have to have a national policy that helps people to deal with these market fluctuations. The problem is that these market fluctuations are fundamental and international, and it's not something that - I wouldn't know who to blame or who to regulate to change it.

You know, I don't think it could be blamed on the oil futures markets, which go back to the 1970s. Actually, you know, we've had oil crisis long before the futures markets were invented. You know, in the 1890s there was a big jump in the price of oil, and what that led to was a break-up by the anti-trust -break-up of Standard Oil of New Jersey.

There was another on in the 1920s called the fuel folly. These things happen, whether or not there are futures markets. And I think futures markets actually help rationalize and help prevent these things.

MIKE: Well, I can only say that with the increase of all kinds of derivative markets, where - essentially setting up a kiting mechanism, where one debt gets sold to another and then another and another. You're creating a situation where you've got an economy built on debt. And what's happening, if you look for example at the percentage of the economy investment, for example. Compare it with manufacturing, and then you look at the investment involved in banking and finance. Banking is going up, manufacturing is going down. The only people who are making out in this economy are people at the top, while people at the bottom like myself are getting screwed royally. And quite frankly we're very, very pissed off at it. Because...

CONAN: Mike, cool it.

MIKE: Yeah?

CONAN: Cool it.

MIKE: Okay.

CONAN: Your language.

MIKE: Oh. Well, anyway, we're angry at it, because we don't like to see CEOs make a thousand times or two thousand times the value of a wage. This kind of stuff drives people out of the housing market. It drives people - it increases social inequality.

CONAN: All right, Mike, we're going to give somebody else a chance, but we wanted to thank you very much for the call. We appreciate it.

We're talking about a new market in housing futures. And you're listening to TALK OF THE NATION from NPR News.

And let's see if we can get another caller on the line. This is Aaron, Aaron calling from Beverly, Massachusetts.

AARON (Caller): Hi, yes. I'm a recent college graduate. I am searching for a job right now...

CONAN: Mm hmm.

AARON: ...but I was just wondering, what type of investment should a person like myself be looking for in housing, in terms of mortgage and...

CONAN: Is this for your own house, for your home?

AARON: No, this is a long term, yeah, for my own home. Yeah.

CONAN: Okay. Robert Shiller?

Prof. SHILLER: Well, this is an interesting time to be in the housing market, because the market is very volatile. I would question whether someone just out of college and looking for a job is really well advised to feel that he has to buy a house now. I think it's a risky investment.

And one could get an exposure - if you're worried about prices going up - you could get an exposure either by investing in real estate investment trusts, or one could take a position in the new futures markets. If you're worried that home prices will get away from you, you can take whatever amount of exposure you want and you can then profit from the increase in home prices. That would be hedging. That would be protecting.

The basic thing, though, is that I think it's a mistake for a young person to feel that he or she has to get into the housing market, because it's just going to go up and up. We really don't know where the market is going to go.

AARON: Okay.

CONAN: Good luck, Aaron.

AARON: Thank you.

CONAN: Let me ask you about another issue before we let you go, Prof. Shiller. The New York Stock Exchange has made an offer to buy Euronext, which is a European Stock Exchange, for something like $11 billion. How much power would a combined NYSE-Euronext Exchange have?

Prof. SHILLER: Well, I don't think it's a major step up of their power. I think that the New York Stock Exchange is recognizing that derivatives trading is becoming the major force in the 21st century economy. And while I share with Mike, the previous caller, his concerns about this, I think it is modern technology and it's the future - that we're going to see, realistically, more and more derivatives trading.

The New York Stock Exchange has worried, because it's not a big player in this field, and so I think it's a good move for them to try to do this. But I'm not worried about their power. There's plenty of competition. There's plenty of other exchanges still out there.

CONAN: Yet, the other exchanges, you know, there seems to be a consolidation going on.

Prof. SHILLER: Well, there's a tendency for mergers, that's right. But, you know, we also have the International Stock Exchange, the Chicago Mercantile Exchange, and CBOT, there's Deutsche Börse, and Euronext. So there's a lot of competition still. And it's, I don't think that this is any, the move that apparently is - may be made between New York Stock Exchange and Euronext is, you know, anything that we should be alarmed about.

CONAN: Mm hmm. And, finally, getting back to the real estate futures market, what will signal to you - we just have a few seconds left - but what will signal to you success or failure in this regard?

Prof. SHILLER: Well, I want to see - I think it's going to take a awhile. This is a very new market, and people are not accustomed to it. But I want to see people hedging a substantial fraction of their real estate on it. The total value of real estate owned by households is about $20 trillion. It's bigger than the stock market. And most of that is just unhedged, unprotected, held in very concentrated individual portfolios. I want to see that changing. I want to see people protecting themselves against fluctuations in this market.

CONAN: Robert Shiller, thanks very much. Appreciate your time today.

Prof. SHILLER: A pleasure.

CONAN: Robert Shiller is the originator of a new index to gauge the U.S. housing market for the Chicago Mercantile Exchange. He's a professor of Economics at Yale University - he joined us from their studios today. He's the author of a book named Irrational Exuberance.

In Washington, I'm Neal Conan, NPR News.

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