2 A New Kind of Home Insurance
By Damon Darlin

(Business 2.0) – The Strategy: Hedge the Value of Your House Minimum Investment: Less Than $50,000

You could call Yale Business School professor Robert Shiller a Cassandra. In 2000 he published the jeremiad Irrational Exuberance, warning that the stock market was a bubble ready to pop. Now he's warning that the real estate market is due for a similar fall. But Shiller isn't one to wring his hands in despair as his prophecy unfolds. Instead, he has devised a means for people to hedge the value of their homes in case the market takes a sharp turn south.

Just as farmers have long used futures contracts for insurance against a sudden drop in crop prices, Shiller argues, homeowners should be able to hedge their risk through tradable securities based on home values. After all, while futures markets cater to virtually every other type of asset whose price can fall precipitously--from pork bellies to heating oil to the Nasdaq index--investors still don't have a way to hedge in the $22.3 trillion residential real estate market. "Our homes are a major asset class for which there has never been a liquid market," Shiller says.

Recently the professor's idea has been gaining traction. Given the dramatic rise in house prices during the past eight years, would-be homebuyers are more worried than ever about getting in at the market's peak. So Shiller--along with longtime research partner Allan Weiss and derivatives expert Samuel Masucci--formed a company, Macro Securities Research, that last year requested permission from the Securities and Exchange Commission to approve a home-hedging security called a "macro." Shiller declined to discuss the specifics while the proposal is under review, but documents filed with the SEC hint that the three have designed a product with broad appeal.

According to the filings, it would work like this: When closing the purchase of a home, the new owner could buy a "down" macro certificate to protect against falling real estate prices. An investor--perhaps an institution looking to balance the risk in its portfolio--would match that position with an "up" macro, a bet that real estate will increase in value. If home prices go down, the investor forks over cash, offsetting the declining value of the home. If prices rise, the homeowner is out the cost of the contract but comes out ahead overall, since his chief asset has continued to appreciate.

If given a green light by the government, Shiller's macros could be traded before year's end on the American Stock Exchange. Los Angeles homeowners--whose houses have more than doubled in value since 1999--would get the first crack at the macros. Analysts are already calling the plan the most significant breakthrough in housing finance since the invention of mortgage-backed securities in the 1970s. Homebuilders could read the macro prices for clues as to which way the market is headed, evening out the boom and bust cycles. Mortgage lenders could use macros to insulate themselves against the risks of low-equity loans, eliminating the need for costly mortgage insurance and perhaps even allowing them to offer lower interest rates. Best of all, worried homeowners could stop reading articles that try to prophesy the burst of the real estate bubble. -- D.D.

How the Hedge Might Work

House value: $500,000

Cost of 15-year macro: $7,500

Housing index after 15 years: -10%

Payout: $100,000