Comments on: UK: Property Futures Say Housing Prices to Fall 50% in Real Terms

By: Ginger Yellow

Ginger Yellow — Mon, 09 Jun 2008 13:19:00 +0000

Yves, I realise it’s over four years, but that’s kind of my point. I’m only going on the people I’ve spoken to (lenders, investors and analysts, mainly) and the research I’ve seen, but nobody among them predicts the fall to continue to 2011. I’m not saying it couldn’t happen, but it’s absolutely not a market consensus. Similarly, while there are people who see a 90s severity crash as a distinct possiblity, very few see it as “likely”. Worth hedging against, yes. Worth betting the farm on, not for most people. To cite one investor who called US subprime correctly, he sees a 30% peak to trough decline as a 1/3 to 1/5 probability. That’s up from 1/10 to 1/5 from two months ago. Now I’m probably more pessimistic than that, but not by much.

By: Anonymous

Anonymous — Mon, 09 Jun 2008 12:39:00 +0000

I agree that it is not useful to compare the Halifax index with a commodity, for the reasons Yves mentioned, and so concepts such as contango/backwardation are not so relevant. They apply more to derivatives where the position is (practically) hedgeable.

However I still think that there is a significant risk it is not a good prediction market because of the supply-demand factors.

People taking short positions can cancel out their risk exposure by taking the long cash position (eg by buying, or already having, a diversified portfolio of UK residential property) but people taking long positions can't. That's why I think there may be a risk premium in these prices because both sides of the trade aren't almost equally hedgeable (as in commodity futures) or equally unhedgeable (as in prediction markets for politics etc).

Anyway, it's been interesting to think about this morning. Another great post Yves, thanks.

By: Danny

Danny — Mon, 09 Jun 2008 12:12:00 +0000

And I understand that is beginning to happen with oil and food, but the blame is being laid on ’speculators’ and ’shortages’, when it is commodities across the board that are showing the worldwide debasement that is occurring. People will ’speculate’ in commodities as long as the central banks continue to prop up bad businesses, and encourage the total misallocation of capital.

By: Danny

Danny — Mon, 09 Jun 2008 12:06:00 +0000

50% in real terms doesn’t seem too far off. I think the final number in the US will be something similar.

People really need to start distinguishing the difference between real and nominal, and by people, I mean average everyday people. There should be some outrage over what is happening to paper money worldwide. Assets (stocks, bonds, homes) are losing their value at a much faster rate based on a commodity type standard.

By: Yves Smith

Yves Smith — Mon, 09 Jun 2008 11:01:00 +0000

cahagnes,

This is not a commodities future. You don't settle to physical. In fact, this sounds like it's more like a prediction market (as in participants are placing bets on what the Halifax index will be) but I would assume you have the mechanics of an exchange-traded derivative,

Backwardization is a function of storage costs on a deliverable commodity. That would not seem applicable here. From "Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures" by Michael Frankfurter and Davide Accomazzo:

Accordingly, the current expectation of the future spot price (which is in actuality an unknown) is theoretically driven down because the commodity is held back from the market and kept in storage. As described by Kaldor (1939), holding back a commodity in storage is referred to as a ‘convenience yield,’ and together with congenital weakness forms the basis of the phenomenon known as ‘backwardation.’

By: Cahagnes

Cahagnes — Mon, 09 Jun 2008 10:40:00 +0000

Yves,

Very briefly, because of time constraints (I’ll try to add a few lines later today): Fed funds futures differ from commodity futures in that they do allow you to infer expectations about future rates. The Cleveland Fed approach and similar methods won’t work with commodity futures. It’s therefore most likely that the Guardian article is based on simply (and incorrectly) equating the futures price and the “consensus” estimate of the future spot price.

By: Yves Smith

Yves Smith — Mon, 09 Jun 2008 10:15:00 +0000

Ginger,

But remember, the 47% is real over four years, while your 25% is nominal. And I believe the UK housing market when down over 20% nominal in the early 1990s, and (at least per what I am hearing here, but I am at quite a remove) this housing recession appears likely to be more severe.

By: Ginger Yellow

Ginger Yellow — Mon, 09 Jun 2008 10:09:00 +0000

What anonymous said, although techinically you can take out CDS on mortgage backed securities and (maybe) covered bonds. Not many people have the capacity to do that, however, and obviously it’s not a perfect short. There’s definitely a consensus now that the housing market is in much worse shape than people thought even a month ago, but nobody I’ve spoken to thinks 50% is anything like realistic. The most pessimistic people I know (and that includes people who are short) say 25%.

By: Yves Smith

Yves Smith — Mon, 09 Jun 2008 10:05:00 +0000

Given the lack of specificity in how the article is written, and my lack of access to the actual data, I cannot tell whether they are literally looking to the futures price and treating it as a forecast, or whether, as the Cleveland Fed does for Fed funds futures, they made the computations to back out the price forecast implicit in the futures price.

By: Cahagnes

Cahagnes — Mon, 09 Jun 2008 09:59:00 +0000

Yves,

Anonymous is right: the futures price should not be viewed as an estimate of future spot prices for commodities like houses. Oil futures are often misinterpreted in similar fashion as pointed out in this FT Alphaville post: http://ftalphaville.ft.com/blog/2008/05/09/12892/calling-oil-wrong/. For more background, see any textbook on futures and forwards, under “contango” and “normal backwardation”.