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Advantage--Prediction Markets!:

CNN Money:

Robert Shiller, a Yale economist who had argued for years that a bubble was forming in real estate prices, points out that one group was on target about where prices would go - investors in a real estate futures market that he helped set up on the Chicago Mercantile Exchange.

Starting in May 2006, the CME set up futures contracts for 10 metropolitan real estate markets, allowing investors to bet whether prices would go up or down and by how much.

By the end of 2006 those futures were pointing to real estate price declines between 5 percent and 7 percent in those markets, Shiller said. That ended up in line with the 6.7 percent annual decline in the October reading of S&P/Case-Shiller home price index, which was the largest drop recorded in that 20-year-old price measure.

"I'm not normally an advocate of market efficiency, but there's something to be said when you're putting money on the line with your prediction, rather than just talking," he said.

Those futures today are far more bearish about future housing prices than most current economists - foreseeing an additional 4 percent to 14 percent drop in prices over the next year.

PersonFromPorlock:
I don't know where the surprise is: while we can never say that a particular house is overpriced if it sells, we can say if a particular market is. It was obvious from about 2002 on that either the traditional standard (that mortgage payments should be 30% or less of the borrower's income) was 'way off, that there'd been a sudden increase in borrowers' incomes or that house prices had reached an unsustainable level.

In the nearby Bangor, Maine market, house prices are still about double what they were fifteen years ago (adjusted for inflation) with no compensating increase in income. I fully expect them to fall almost 50% before the correction is over.
1.3.2008 8:52am
liberty (mail) (www):
Yeah, so look to them on the eve of Iowa - they don't spike with each day's shift of opinion, but take a longer term view into account.
1.3.2008 9:22am
qwerty (mail):
"I'm not normally an advocate of market efficiency"

That's an understatement.
1.3.2008 10:21am
SeaDrive:
"I'm not normally an advocate of market efficiency"

Meaning?

"I'm not a fan of market efficiency."
or
"I'm not a believer in market efficiency."
1.3.2008 10:50am
OrinKerr:
Right yet again.
1.3.2008 10:52am
New World Dan (www):
PersonFromPorlock,

Don't forget that housing prices were undervalued 15 years ago. Also look at other price drivers for housing, particularly population trends. A growing population will put a strain on supply and keep prices elevated for some time. Changes in building codes can make new construction more expensive beyond the normal rates of inflation, boosting the value of older homes in the process.

I suppose that's part of the accuracy of prediction markets -- people with more intimate knowledge forcasting things than that average idiot out there trying to buy a house. If you want to win your office football pool, just look at the Las Vegas odds each week and stick with them.
1.3.2008 10:57am
neurodoc:
"I'm not normally an advocate of market efficiency, but there's something to be said when you're putting money on the line with your prediction, rather than just talking," he said.
Well, most who bought houses (exception those with 100% financing) put money on the line with what amounted to their predictions that the value of what they were purchasing would increase.

New World Dan is right about "people with more intimate knowledge forecasting things." They are the true "investors," as willing to place their bets on a decline in real estate values as an increase in them, not subject to the "emotion" of buying a house to live in or the auction fever that affects many of the flippers who drive prices north, until the pool of greater fools dries up.

Those "investors" might be seen as "speculators" if what they are doing is to be likened to gamblers betting on price movements. Some among them, though, may actually have been hedging "real" investments, that is ownership interests, in real estate. (Are the CME real estate futures contracts based on residential real estate, commercial real estate, or a mix of those?)
1.3.2008 12:48pm
whit:
as somebody who spends several hours a day every day trading futures... you are spot on in regards to hedgers

there are specs, hedger, etc.

for example, some who are shorting the housing futures are not doing so out of spec (iow, hoping for a drop in prices so they can realize a gain). people also short in order to hedge a physical long (like grain producers do).

when you are looking at futures markets, the specs are just (in many markets a small) piece of the puzzle.

if i was long a bunch of real estate in a certain market, i could hedge my longs by going short the futures.

futures markets were DESIGNED to accomodate the commercials (producers and consumers) who generally go into the market to hedge their respective positions.

speculators (in most futures markets) are a smaller piece of the trade volume. they help provide liquidity, too.
1.3.2008 1:12pm
A. Zarkov (mail):
New World Dan

“A growing population will put a strain on supply and keep prices elevated for some time.”


Supply is not strained. Currently we a historical high in homeowner vacancy rates of almost 2.75% compared a historical average of approximately 1.5%. That’s not even counting rental vacancies.

If you want to see if a particular market is overpriced, look at rent to price ratios. Rents, both actual and imputed, also provide information on the expected appreciation rates as discussed here. When you can rent a house for a fraction of what it would cost to own, even assuming that rents will go up with inflation, you know that housing market is likely overpriced. You can also look at the cost of land and construction. If you can buy a lot and build a house for much less than the selling prices of similar houses then you know something is wrong with the market. The failure to consider real estate fundamentals leads to disaster as so many people have painfully found out.
1.3.2008 1:24pm
happylee:

"I'm not normally an advocate of market efficiency, but there's something to be said when you're putting money on the line with your prediction, rather than just talking," he said.


Yep, that maks sense. Afterall, the "market" is but the unwashed "masses" expressing their desires by buying and selling willy-nilly -- without detailed supervision by "government"(read: superior folks like...Shiller). Here, of course, the poor masses were spending money that had been created out of thin air by Greenspan. Ooops. The futures market allowed the few wise folks to bet against the trend.
1.3.2008 1:38pm
x:
Robert Shiller, a Yale economist who had argued for years that a bubble was forming in real estate prices .... ended up in line with the 6.7 percent annual decline in the October reading of S&P/Case-Shiller home price index ... that 20-year-old price measure.

For the first time in nearly thirteen years, U.S. home prices experienced a quarterly decline. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.4 percent lower in the third quarter than in the second quarter of 2007. This is similar to the quarterly decline of 0.3 percent (seasonally-adjusted) shown in the purchase-only index. The annual price change, comparing the third quarter of 2007 to the same period last year showed an increase of 1.8 percent , the lowest four-quarter increase since 1995. OFHEO’s purchase-only index, which is based solely on purchase price data, indicates the same rate of appreciation over the last year.


Those futures today are far more bearish about future housing prices than most current economists - foreseeing an additional 4 percent to 14 percent drop in prices over the next year.

How about we wait another year to declare this outfit omniscent?
1.3.2008 2:14pm
legaleagle (mail) (www):
When you have a lot of people ill-informed about general market conditions making large investments(e.g. housing buyers), that creates a massive opportunity for speculators to inform and rebalance the market, assuming such a market can be set up. However, I would have thought that the mortgage securities market already was such a market, so that this futures market is redundant. Did this futures market ever get out of synch with the risk premium for mortgage tranches? If so, either the futures market is very thinly traded or folks missed out on a very lucrative arbitrage opportunity.
1.3.2008 6:23pm
neurodoc:
legaleagle, if I understand your point, I think it a very interesting one. Aren't the real estate futures market and the mortgage securities one intimately related, the latter in effect something of a derivative of the former? So why should there be a disconnect in their predictive power, and why should some of the presumably smarts of risk arbitragers have taken huge hits? (The NYT yesterday had an article noting how unusual 2007 was in that retail customers fared better than the sophisticated brokerage house and bank traders who were long in mortgage securities.) Longterm Capital was brought low by some very unusual turn of events in Russia and elsewhere; but those who lost big at Merrill, Citibank, Bear Stearns, and so many other financial titans can't point to unforeseeable "external" events as the cause of their losses.

Maybe someone will tell us more about the CME real estate futures - how actively traded and how much money in it?, how volatile?, closely correlated with interest rates?, all based on residential real estate?, how is the price of a contract set?, how much variation between metropolitan areas?, etc.
1.3.2008 6:39pm