Yale economics professor Robert Shiller made his mark in 2000 as the author of Irrational Exuberance, a book that astutely forecast the bursting of the late-1990s stock market bubble. Now he’s hoping to help avert another potential bubble -- this time in the housing market.
Last month the Chicago Mercantile Exchange announced plans to launch futures contracts tied to home price indexes that Shiller, 60, helped to develop -- giving investors a unique opportunity to bet directly on the $21.6 trillion residential real estate market. The indexes track home prices in ten big U.S. cities, including Boston, Miami, Las Vegas, New York and San Francisco. The CME will offer futures on each city index, as well as a contract based on a broader index comprising prices in all ten locales.
Shiller devised the indexes in 1991 with fellow economist Karl Case. They pitched the idea of derivatives tied to the indexes back then, but exchanges didn’t bite. Shiller and Case instead marketed the benchmarks to mortgage-bond portfolio managers, investment banks and insurers, who have come to rely on the measures as an industry standard for gauging their exposure to the market. Now, amid widespread interest in residential real estate, the CME believes
investors will flock to housing futures. (The indexes are being licensed to the exchange through a joint venture of Shiller’s MacroMarkets research firm, financial technology concern Fiserv and Standard & Poor’s.)
The futures will be marketed to institutional investors as a pure-play alternative to homebuilding stocks and real estate investment trusts. Other potential users include banks, homebuilders, mortgage-bond investors and REITs that want a more direct hedge than interest rate swaps against the risk of home values declining. Insurers may even decide to offer policies protecting individual homeowners against price depreciation and use the housing futures market to lay off their risk.
Shiller believes that creating a derivatives market for home prices could reduce volatility -- and help ensure that any fall in home values takes the form of a soft landing rather than a burst bubble. “Home prices since the 1990s have increased year by year, and that doesn’t happen in the stock market,” he says. “That’s a reflection of inefficiency that these new products would correct.”
