Monday, April 7, 2008

Are Hedge Funds Affecting Real Estate Values?

What I know about hedge funds wouldn't fill a Post-It Note. But the little I do know about them seems a bit sketchy. Not all of them, mind you. Just the ones that are banking on the demise of the US economy. For example, T. Boone Pickens, a legend in oil and gas across the globe, has his own hedge fund, BP Capital. They bet that oil prices would rise beginning in 2005 and it ended up making him over $1.5 billion dollars that year. Yes, billion. So basically it's like gambling in Vegas but for mega-rich businessfolk. And the "big game" they're betting on is real life. Are rising oil prices good for the average Joe? Of course not. And isn't it a bit odd that one of the world's richest men, who hangs with the most powerful and influential businessmen and women across the globe, is hoping for gas prices to reach $4.00 a gallon? I'm not saying Mr. Pickens assisted in the rise of oil prices but if anyone had the power to make this happen, it would probably be him. There is an inherent conflict of interest here and his gain is the average Joe's loss.

Blanche Evans discusses this phenomenon using Robert Shiller, a finance professor at Yale University. Apparently he's a pretty important guy and makes up one half of the S & P Case-Shiller real estate pricing index. According to Evans, the Case-Shiller Index wields quite a bit of influence on how newspaper headlines read across the country and are notoriously pessimistic. We all know how doom and gloom headlines can -and have - affected the psyche of today's home buyers. And it's interesting to note the Case-Shiller index tells a different and much more disheartening story than 3 other well known real estate indices. But here is the kicker from the Evans article.
"The Case/Shiller Index is licensed by Macromarkets LLC. In partnership with the Chicago Mercantile Exchange, Macromarkets created the "Housing and Futures Options" for trading. The CME Group, a Chicago Board of Trade Company, describes trading housing futures as having multiple benefits to investors:
  • A new means of risk transfer to a broad range of investors
  • Low cost exposure to real estate values without direct ownership of properties
  • Access to a unique asset class
  • Opportunity to profit from a movement in housing prices
  • A way to make trading in real estate a short-term and liquid investment

This is a hedge product, folks, and guess who one of the owners of Macromarkets LLC is? None other than Shiller.

"Every time a CME hedge is made, revenue flows to Macromarkets," says Lawrence Yun, senior economist for the National Association of Realtors. "People would hedge only if they believe prices will fall big time."

Is this not a glaring conflict of interest? Isn't there a huge opportunity for abuse here? Is this a good thing for the powerful and ultra-rich to bet on economic downturns?


  1. Jeff,
    You are correct that there is the potential for some conflict of interest, but hedging risk is a very important aspect of American finance. For example, an airline wanting some cost certainty might hedge their fuel costs by betting on a rise in oil prices (so if oil prices rise, they'd make some money on the hedge to offset losing money from having to pay a higher price for jet fuel). And other industries might want to be on the other side of that contract - I'd be that an oil drilling company or an electric car maker would be candidates to hedge against falling oil prices. So you can see that these hedging techniques can be quite useful for legit business practices.

    I think that we've all watched too many thriller movies (or even comedies like Trading Places, with the Duke brothers doing insider trading on orange futures) that have made us paranoid about market manipulation. Stock chat rooms are always lamenting how shortsellers are playing unfair. In reality, I think those conspiracy theories are way overblown.

  2. I definitely see what you are saying and understand. And I freely admit this sort of stuff is so way over my head. My 2 degrees are in Biology and Sport Psychology. I stayed far, far away from the business building in college. Part of me wishes now that I had taken a few courses. Then I could sound almost as smart as you!

  3. I can fool some of the people some of the time. ;)