Can I Buy a House without Speculating ?
Robert Waldmann
Matt Yglesias wonders if people have to speculate in housing. What if someone wants to buy a house but doesn’t want to gamble that house prices will increase ? Is there anything to be done ?
In theory, this problem has been solved. It is now possible for home buyers to hedge. It is also possible for professional investors to speculate in housing. I’m not sure they would do better than the amateurs, look how well the RMBS and stock markets function.
The solution, in theory, is the Case-Shiller house price index. You can roughly hedge the price of a house you own using the index. The problem is that the risk you want to hedge is that you want to sell the house and it is cheap. So long as you own the same house, the price only matters for property tax assessments.
Shiller really really honestly believed that he had made the world a much better place when he confinced the Chicago Commodities board to introduce trading in the index. But then almost no one traded it (what if you held an index and nobody came ?).
I think that the correct innovation which will really fix things is one in which the balance of a mortgage is indexed to the Case-Shiller index. If the index were perfectly matched to your home, your equity in the house would just grow with repayments minus interest. Oh the interest to be paid would be constant (OK indexed to wages or the CPI to be perfect), not a constant times the balance owed. So, to the extent that the index worked, interest and principle payments and equity in the house wouldn’t depend on housing price fluctuations.
This makes mortgage initiators waay long the local Case-Shiller house price index, but they can hedge that risk by shorting it.
Problem solved (except for people who own their houses outright and, hey they can bear a bit of risk) ? Or not ?
We live in a world of risk. If you but a house you take a risk. If you do not buy a house you still take a risk–even if it is just opportunity cost.
Even if you own your home outright there is nothing stopping you from using the Case-Shiller index to hedge it.
Isn’t reality (on net) long on everything?
Apparently Denmark has had something smart for mortgage buyers for a hundred years but I can’t make heads or tails of it. Oh look, Wikipedia has a page about it:
http://en.wikipedia.org/wiki/Danish_mortgage_market
Let me get this straight -he says he wants to own it (buy it), but without most of the risks and rewards of owning.
I don’t understand the question – doesn’t he just mean renting?
“What if someone wants to buy a house but doesn’t want to gamble that house prices will increase ? Is there anything to be done ?”
What does it mean to gamble that the price of the house will increase? That means that you must rely upon that increase, i. e., that you must refinance in a few years. If you do not want to take that gamble, write the terms of the mortgage so that you do not have to refinance in a few years. The bank may not agree, but there you are.
Sorry to reply to myself, but if I had been buying a house in the ’00s and was told, “You can refinance in a couple of years,” I would have said, “Good. Let’s put that in writing.” 🙂
No. The difference is the mortgage tax deduction, a haven not (yet anyway) available to renters. Outside a 401K this is about the only legal tax dodge a working guy can get.
That loophole is for most of us salary earners the incentive to risk – speaking for myself it’s an attractive hedge. If the value of my house goes down I at least have the net tax writeoff on the interest portion of my payments for the first decade or so. So even in a declining market I can still end up better off than if I’d had to live without the deduction. At some point though even that isn’t worth it (i.e. if I lose my job and get a lower paying one the deduction isn’t worth so much etc.)
Part of the issue is how long you intend to stay in the House. If you intend to stay more than 10-15 years, then you will not be speculating. Better yet get a 15 year morgage and after 10 you will most likley not be underwater. Don’t think of a house a an investment, it costs far to much to be a good investment. The fundamental lesson is an old one that does not make homeownership compatable with our current lifestyles, home ownership is for stay in one place types. If you are mobile rent.
I should have written “gamble either that house prices won’t fall a lot or that I won’t have to move.” If one loses big when house prices stay about the the same, one has chosen to make a reckless gamble. That wasn’t what I had in mind.
The risk I had in mind is that you want to move and your mortgage is underwater. If you will never sell the house, it’s price doesn’t matter except for property taxes and the way home equity loans relax liquidity constraints.
But if one works in a big factory and it closes one has to move to get another job. But one’s house will be worth very little as everyone else is moving out too.
Oh and I already own a house. I might move. I sure can’t hedge that risk, because there is no Case Shiller index for somewhere considerably South East of Rome.
Lyle that is a very key issue. It is the reason that shorting a Case_Shiller bond doesn’t solve the problem. There are two issues. First people might plan to stay in a house but then have to move (see factory closing example above). Second underwater mortgages create a hard to hedge risk for mortgagees — jingle mail. They can’t tell how many people will just walk away. If they are bearing the risk for sure, they can hedge it with Case-Shiller bonds.
But my proposal is, if anything, a minor improvement over something which should have solved the problem and didn’t.
Given that in more normal times mortgagees have a risk of prepayments on mortgages, (not likley with todays rates other than normal moving and the like). As a result its kind of hard to figure out what they are worth is the income stream good for 2 years or 20 years? I keep wondering why the geniuses on Wall Street don’t come up with something, but perhaps the states say that ordinary folks can’t invest in this stuff since its to exotic.
Its sort of like my new fangled mortgage proposal. The basic mortgage is a 5/30 arm with a right to prepay every 5 years, but you can buy a fixed rate, you can buy a right to pre-pay other than at 5 year intervals, you could add your option that you can buy a hedge on the house price going down.
Of course had such things existed in 2004-2007 no one would ever have bought them because housing prices had never gone down nationwide in the mind of man. (Evidently the 1930s when prices went down 50 % are no longer in the mind of man).
It would be interesting to see what the pricing on such an option would be. (priced as all of the above as an add on to the interest rate)
Robert Waldman: “The risk I had in mind is that you want to move and your mortgage is underwater. If you will never sell the house, it’s price doesn’t matter except for property taxes and the way home equity loans relax liquidity constraints.”
When I bought my house I never considered buying a put. 😉
This is effectively what Shiller said would be the solution in his book. Deeper, more liquid, markets based upon Case Shiller.
Two effects: it allows both sides to hedge risk, which is nice. But much more importantly, without such a market there’s no real way of going short of housing (neutral is easy, short very difficult).
And it’s only if people actually can go short that we get the wisdom of the crowds thing kicking and then speculation dampens price volatility.
great post!
yea, we have another solution at http://www.homeequityguard.com/
we think it’s better than the alternatives
Min, there’s very litttle i’ve read on this subject over the past 3 years that has been as short and as sweet as that.
This mortgage comparison tool is really helpful http://www.houza.com