Asset Math

As you may be aware, there exists a futures market for the Case-Shiller house price indices.

More on the subject can be seen at MacroMarkets.

I look forward to the time when there are products available to help smaller investors purchase simple forms of price insurance. Clearly, the futures markets have a role to play.

My concern has to do with counterparty risk. With all of the turmoil in the financial/banking systems, how does an investor purchase insurance against an event that would be correlated with a broad financial collapse?

Don’t we need futures markets with non-paper settlement policies in cases of counterparty failure or market failure?

Would the purchase of insurance that pays you a fixed amount in the case where your home price (or that of your city/MSA) falls 50% really just buy you very little protection?

For some time now (years?), Mish has made the case that we would see a deflationary collapse. I think he is right.

But I also think this deflation could be short-lived, as the government/cabal will use all available options to stimulate the economy. But, I am no economist. I see this from the perspective of a software guy who wants to conserve capital and make money building systems that will profit from this secular change.

The change I am talking about is one where the psychology associated with the purchase of many, if not all classes of assets is re-evaluated.

Obviously, average people with some amount of money to invest are going to have some increased barriers to entry in making certain investments. Lets take real-estate, for example. What increased barriers might exist for residential real estate investment going forwards?

• Uncertainty about the direction of prices–psychology has changed. Greed has become fear.
• Tighter lending standards
• The small matter of much of the banking system being insolvent, and the impacts that may have on the availability of credit

No doubt, house prices have fallen. In my view, they have further to fall. Prices have to get back in line with incomes.

Who will buy, then?

I think the buyers will be investors with the following:

• ability to hedge against capital losses due to falling prices (or guts)
• confidence about their ability to prove ownership
• confidence about their ability to manage properties
• appropriate scale to manage their properties
• an edge with regards to finding and retaining good tenant
• some capacity to strike a bargain with good tenants

Good Tenants? How about Good Landlords?

Good tenants will need something extra. A different relationship with the owner. The Landlord/Renter relationship has to change, because the risks are different.

These days, who is more likely to go belly up? The Landlord or the Renter? Surely this has to be factored into the solution.

We need new sources of trust in real estate. We don’t need more NAR economists like Yun or Lereah. We need:

• contractual rebalancing (contracts chosen by both parties based on a market system)
• proper payment escrow support
• practical, verifiable standards of tenant responsibilities
• practical, verifiable standards of landlord responsibilities
• balanced arbitration support

Sure, there are laws that will get in the way. But this will happen by mutual consent of both parties.