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Volume 1 | Download MacroPerspectives (PDF) U.S. Home Prices Overshoot Down Inside John Paulson’s Shorts The Evolution of the Abacus The Mother of All Disclosures The Longs (Wrongs) – What Were They Thinking? Risk & Reward Tiger-Taming Government-Sponsored WMD and the Mother of All Non-Disclosure A Few Words from Our (Unaffordable Affordable Housing) Sponsors The Way Forward and the Geithner Test MacroMarkets Home Price Expectations Survey Debut Using CME Home Price Futures | |
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In the aftermath of the deflated bubble, home prices in the United States have broken below their pre-bubble, baseline trend. According to the MacroMarkets Gap Gauge, a new interactive tool for performing basic technical analysis of real estate prices, U.S. home values fell to almost 8% below their baseline trend level as of the end of Q1 2010.
In his 2009 book, The Greatest Trade Ever, author Gregory Zuckerman recounts how, in early 2006, Paolo Pellegrini, co-manager of the Paulson Credit Opportunity Fund, estimated that U.S. home prices would have to fall about 40% in inflation-adjusted terms in order to return to their long-run, pre-bubble trend. Pellegrini presented John Paulson with a chart depicting the gap, a picture that Zuckerman described as Paulson’s Rosetta Stone, and about which the now-famous hedge fund manager remarked, “I still look at it. I love that chart… it’s the first key piece of our research.”
Some historians say that the Chinese invented the device, while others claim it was the Babylonians; estimates of when this mechanical counting contraption was first used range from 2,500 to more than 7,000 years ago. In the wake of a different variety of historical speculation, a modern-day abacus (model # AC1-2007) has emerged to reignite controversy.
The evidence of mounting home price risk that surfaced over the years leading up to Abacus 2007-AC1 was compelling and in public view around the world. Shiller’s chart was just one warning flare, but it was spot-lit starting in 2005, casting a very tall and ominous shadow that the fearless “long & wrong” crowd chose to discount or ignore altogether.
Those institutions who sold subprime credit protection, or otherwise established long positions in subprime credit and home price performance (or, left existing housing exposures unhedged near the market peak) succumbed to prevailing conventional wisdom. They really thought - or, really wanted to believe - that the combination of historically low mortgage rates and robust population growth would prevent a crash in home prices.
Although hindsight has proven the prudence of those who developed short strategies in subprime mortgage credit and home price performance during 2005 – 2007, execution of this strategy entailed foresight and fortitude. Those who acted on their short views were bold, courageous, and shouldered plenty of risks on their road to riches.
While the final chapter concerning the fallout from the U.S. housing bubble fallout may not be written for years, the bust has already delivered many valuable lessons regarding the residential real estate market. Alas, with fresh memories of financial crisis and dysfunction, some people have suggested that securitization, derivatives, and financial innovation (broadly) were the primary causes of extreme market volatility and ensuing wealth destruction, and thus, must be discouraged or even stopped. Without qualification, such sentiment is myopic and dangerous.
The eye-popping, still-growing and open-ended losses at Fannie and Freddie make it all the more puzzling that recent scrutiny of financial system failures has been pointed almost exclusively at Wall Street and the banking industry. After all, most analysts seem to agree that the catalyst for the global financial crisis was the creation and subsequent failure of mountains of lousy subprime and “Alt-A” loans amidst a sharp and broad reversal in U.S. home prices. Contrary to popular belief, Wall Street banks were not the primary driver of subprime and Alt-A products.
Snake Eyes? Add Washington D.C. to the list of “casino-like environments” where massive speculative bets can be made. "I do think I do not want the same kind of focus on safety and soundness that we have in OCC and OTS. I want to roll the dice a little bit more in this situation towards subsidized housing."
There are few, if any, markets that would benefit more from financial innovation than the U.S. housing market. The global repercussions of the home price boom and bust over the past decade, the subprime mortgage debacle, and the controversy surrounding Abacus underscore just how obsolete, inefficient, and incomplete the residential real estate market is, and how financial innovation and well-functioning derivatives markets are needed to manage home price risk.
MacroMarkets LLC recently published the results of its first monthly survey of home price expectations. The data, collected over the first two weeks of May, suggested that the onset of price recovery in U.S. single family real estate is widely expected by 2011, and home prices will increase by more than 12.4% between 2010 and the end of 2014. 
The recent MacroMarkets survey on forward home prices was a great effort, but it prompts several questions: “Ok, what do I do with this information”, “How can I take advantage of the strength of my convictions”, and importantly, “What can I advise my clients to do if they share my outlier bullish (bearish) outlook”. |
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