Homeowners could someday have a financial tool to defend against a rapid drop in home prices. Much like derivatives markets can buffer companies from the effects of severe weather swings, similar products could be developed to help home builders, insurance companies and homeowners weather a deep depreciation in home prices.
The Chicago Mercantile Exchange, the nation’s largest futures exchange that offers products relating to interest rates, stock indexes, foreign exchange and commodities, has begun to explore the concept of creating a house-price derivatives market.
This month, the exchange announced that it has completed a letter of intent with MACRO Securities Research LLC to explore the development of derivatives based on CSW housing price indexes, which are used by mortgage lenders for loan originations and mortgage analysis.
David Lereah, chief economist for the National Association of Realtors, said, “Hedging on home values makes sense and can be accomplished. NAR Research has been in discussions with several academics and consultants to work together on developing hedging vehicles like the one being announced on the exchange.
“Hedging vehicles should improve liquidity in the marketplace,” he said.
Hedging vehicles are financial tools that can be used to minimize severe losses in the future – much like a homeowners’ insurance policy can guard against substantial losses for a comparatively low price.
Allan Schoenberg, a spokesman for the Chicago Mercantile Exchange, said a home-price derivatives market could serve large banks that have an asset class of large mortgages, for example, or insurance companies that have a large number of customers in the housing market.
“Ultimately there could be something to pass along to consumers to help them guard against a house-price decline,” Schoenberg said. “At this point everything is up for discussion.”
The exchange has a history of investigating new products, he said. “We feel this is an area that has been untapped.”
As with weather derivatives, house-price derivatives would by nature be a very localized marketplace, Schoenberg added. Areas with more historically volatile home prices, such as Los Angeles and San Francisco, “would probably be good candidates” for such derivatives, he said.
There will probably be a decision announced in 2005 as to whether such a market is feasible for the exchange.
The Chicago Mercantile Exchange is not alone in pursuing futures relating to the housing market.
HedgeStreet, an Internet-based derivatives exchange, offers derivatives products to hedge against rising mortgage rates and speculate on mortgage rate trends, and to hedge against changes in the Fed’s prime interest rate and speculate on interest-rate decisions.
The site features trading of financial instruments called “Hedgelets,” which are financial instruments that can be purchased for under $10 apiece. Mortgage rate Hedgelets are available for the one-year adjustable-rate mortgage interest rate and for the 30-year adjustable-rate mortgage interest rate.
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