Capital Markets
allocation—still don’t have
an efficient means to tap the
unique risk-adjusted returns of
single-family property.
This financial crisis was substantially caused by a failure to
manage real estate risk. On the
residential side, individual ho-meowners were not diversified.
They were investing in their
own house in their own city and
were highly leveraged. They put
all their eggs in one basket.
That would be bad advice
coming from a financial professional. It’s no wonder that the
growing number of underwater
mortgagors—those whose
home values have plummeted
below their loan balances—has
commanded so much attention
lately. There are enormous social,
as well as economic, repercussions to this still-unfolding risk
management lesson. Think how
much better off these people
would be if they had the ability to manage their risk with a
house-price hedging product.
REIT: What options do investors have in this area?
Shiller: My firm, MacroMarkets LLC, has been a catalyst
for the development of new real
estate investment and hedging
products, but these nascent markets haven’t gotten traction yet. I
have also long been a proponent
of home equity insurance—
coverage added on to homeowner’s
insurance that would protect
them against decreases in the
value of their home, just like
they’re protected against fire.
Institutional investors can
manage residential real estate
risk with the housing futures
and options contracts that are
listed by the Chicago Mercan-
tile Exchange (CME). These
provide a prediction of home
prices in 10 different cities for a
whole array of time horizons.
REI T: Has your company offered
any other products in this area?
Shiller: MacroMarkets also
sponsored and listed a financial
innovation called MacroShares
Major Metro Housing on the
New York Stock Exchange last
year—five-year investments
based on the S&P/Case-Shiller
Composite- 10 Home Price
Index—a proxy for the price
performance of a diverse portfolio of approximately 30 million
U.S. homes. You could buy a
long security to gain exposure
to the broad U.S. single-family
housing market or, if you were
over-exposed to home prices,
you could buy a short security to
offset your exposure.
It was intended to be a market
for single-family homes traded
on the NYSE that would deliver
meaningful price discovery—to
give a sense of where the market
at large thinks prices are going
for houses. Although there was
significant interest among both
retail and institutional investors in
these securities, it didn’t result in
significant asset growth or trading
volume, so we decided to terminate these products late last year.
REIT: Does that mean there
isn’t a need for this type of in-
vestment product?
Shiller: Although this product
failed, the fundamental market
need for this sort of innovation
remains. Importantly, we have
learned a lot from launching
these products, and the market
knows that what we’re trying to
do is beneficial, but also ground-
breaking, hard work. Market
stakeholders have been very sup-
portive and have helped us iden-
tify enhancements to product
design and execution. I am hope-
ful that exchange-traded housing
derivatives will eventually get
traction and become liquid.
REI T: In the meantime, what
will be your next innovation?
Shiller: In the very near term,
our firm is focusing our development efforts on over-the-counter
(OTC) products and markets in
partnership with a select number
of global banks. To date, all the
success in real estate derivatives
has been OTC. The instruments
include property index swaps
and forwards, as well as notes
with returns linked to real estate
price indices. Most of these are
institutional products, but their
development can be a catalyst
for creation and liquidity in
retail-facing property investment
and hedging products, such as
MacroShares for residential and
commercial real estate prices and
home equity insurance contracts.
OTC and exchange-traded
products and markets should
both flourish and complement
each other. Mature exchange-traded products are standardized
and deliver price transparency
and liquidity to institutions and
the masses, while OTC products
enable flexibility and customiza-tion, typically for institutional
transaction counterparties.
If you look at the history of
financial innovations, it always
goes in fits and starts. This was
true of property insurance. Property insurance contracts have
been around since the 1600s, but
they were not firmly established
until the 20th century. In light of
the sheer size and concentration
of the risks, I just hope it doesn’t
take 400 years for property derivatives to take hold.
