ETFs That Bet on Housing Values: Is This a Joke?

Is this what you get from the best and the brightest on Wall Street? On Tuesday, June 30, 2009, a day that should live in financial infamy, investment manager MacroMarkets launched two ETFs designed to track housing values. But they don't own any houses. And they're 3-times leveraged.

They are legalized gambling.

"Investors" can now bet for or against a recovery in the residential real estate market. The two ETFs are designed to mimic the movement of U.S. home prices. The two ETFs are called MacroShares Major Metro Housing Up (UMM) and MacroShares Major Metro Housing Down (DMM).

Incredibly, Robert Shiller, the Arthur M. Okun Professor of Economics at Yale University, and best-selling author of Irrational Exuberance, is involved. In fact, he is MacroShares' co-founder and chief economist. Both ETFs are benchmarked to the well-known S&P/Case-Shiller Composite-10 Home Price Index of home prices in the country's 10 largest cities.

How do they work? The securities are "paired" and feature a 300% leverage factor. "Up" is designed to rise when U.S. housing prices climb. Its counterpart, "Down," goes in the inverse direction, rising when real estate values fall.

Unlike most ETFs, Up and Down do not invest directly in a relevant underlying asset such as stocks, bonds, or houses. Instead, they invest in short-term Treasury securities and overnight repurchase agreements. The paired trusts have a binding agreement to pledge assets to one another over time, according to a predetermined formula that is driven by changes in the housing index, based on the movement of housing prices. This transfer of value back and forth gives "investors" exposure to the direction of U.S. home prices.

The structure resembles a see-saw as the assets are shuffled between the paired trusts. Because of the pairing requirement, an equal number of shares for each fund will be created. Because of the leverage factor, the Up and Down ETFs will experience changes of 3x the changes in the S&P/Case-Shiller Composite-10 Home Price Index.

This has to be the low point in what has been a distinguished career. Shiller said,

For the first time, the market will have available exchange-traded benchmarks as an indication of where investors believe U.S home prices are headed. Our current financial crisis is largely due to a failure to manage housing risk. At approximately $20 trillion, U.S. housing is a large and important asset class that has suffered from the lack of liquid, transparent markets.

A couple of months earlier, as part of a failed attempt to auction basically these same vehicles, Shiller said,

Our current financial crisis is due to a failure to manage housing risk. MacroShares Housing products will begin to fill this massive void. MacroShares Major Metro Housing Up and Down are market-based solutions to this unprecedented financial crisis.

In what way these ETFs provide a "liquid, transparent market" for homes or provide a way to reverse the "failure to manage housing risk" is unclear. Unlike REITs, they don't buy any real estate. They won't own any homes. They just swap money back and forth between the ETFs, that is between those who place their bets one way or the other on the direction of home prices.

What's next, ETFs based on Manny Ramirez's batting average? The roll of dice? The turn of a card? We already have casinos for that. These bets would be better placed in a sports book in Las Vegas than touted as an "investment" that "provides liquid, transparent markets" on home prices or promises to help begin to solve the "unprecedented financial crisis" created by the housing bubble.

Oh, I forgot to mention a couple of things.

• For one, MacroMarkets warns that the prices of the funds may diverge from underlying value. "For example, the market price of...Down will reflect supply, demand, and investor expectations regarding the future path of home prices over the remaining term of the security." So unlike Las Vegas, bettors are also risking that the house (pun intended) won't actually pay off the bets correctly.
• Two, the funds will make quarterly distributions of net income, if any, on the Treasury securities.
• And third, they have an expense ratio of 1.25%. Which is all you need to know to understand why these have been introduced.

Technically, these are not exchange-traded "funds," because they own no underlying relevant assets--no houses. They are exchange-traded "products."

So there you have it: A perfect "product" for post-industrial USA. It creates no value and offers great risk. The only guaranteed payoff is to the offeror. Since the ETFs do not own any relevant assets, one cannot even make a case for efficient price discovery in residential real estate to justify them.They are the antithesis of "investing." They are vehicles for naked gambling. Just bet up or down (black or red). You have a 50% chance of winning.

Disclosure: I have a weakness for seeing America's best and brightest build something useful.

Comments

[Roger Knights:]

There are social benefits: First, these products would have allowed a home-owner to lock in or realize profits at the top of the bubble. (I wish I'd been able to buy DMM a year or two ago.) He wouldn't have to sell and move to a rental unit. Or a nervous home-buyer could have hedged against a decline.

Second, if lots of investors had been "short" housing values as the bubble expanded, it would indirectly have dampened the excess. So it's not just gambling; there's a feedback process at work.

It doesn't matter that there's no underlying assets held (because their safety comes from being offset against each other), or that the products don't track the C-S Index or actual house prices exactly, because that just creates an opportunity for arbs.

Jul 05 07:20 AM

[Lightway:]

Agree with your article completely.

These vehicles MIGHT seem useful if they were providing liquidity for distressed real estate assets. There's a tremendous amount of toxic real estate that's overinflated and still out there, that needs moved into liquidity. Owners still want housing bubble sales prices, and buyers are not (or don't have the means necessary) going to pay them.

Shiller has lost me on this one. The Case-Shiller index, which is widely referenced as an indicator for home affordability, was baselined in the year 2000. By the year 2000, the housing bubble was already way underway, so the index baseline is already inflated from what most of us would call affordability. It's a relative index which shows housing affordability relative to...the Case-Shiller index. Good for identifying trends and direction, but not for deep fundamental correlation to actual affordability.

There are more traditional measures of housing affordability out there, such as:

1) Three times gross income equaling purchase price
2) Rental parity for an equivalent purchased home.

I agree with David's frustration, what exactly are we building here? This type of gamble belongs in Las Vegas.

Jul 05 07:30 AM

[valuepredictor:]

The core problem with Case-Shiller and MacroMarkets if it’s false assumption that there is a correlation to the metro area to the local or hyperlocal housing market, which there is NOT. Example, in the Phoenix Metro Market there are over 2,229 hyperlocal markets (Block Groups). And in comparing the min and max to the median, there is over a 15% error. So this ETF is more of a true gamble than most economist relies, which I find interesting. Counting cards at the Rio, seems smarter, since this way, at least you know the odds, and do not directly pay the house.

Jul 05 08:09 AM

[American in...:]

It's very simple. There is no way of hedging risk when you buy a home or have an economic investment tied to residential real estate. Macros Shares provides that vehicle. It's similar to the CBOE futures on housing prices.

Shiller has consistently and convincingly argued that our market system lacks markets for sharing risk. In particular, there is no market for unemployment insurance, real estate values, etc.

You want to hedge your home? Now you can!

I am going to buy the down shares because I believe that is good way of hedging the possibility of an aborted economic recovery. If housing prices continue to fall as I expect for several years, my portfolio will be at risk.

I frankly think the blog writer is being obtuse. Lost of futures such as the S&P 500 index options are not tied to any thing 'physical'. No one can take delivery of a basked of S&P 500 stocks. It is always settled in cash.

Why should investors have the ability to hedge their S&P500 index mutual fund, but not their real estate investments.

Less is not better ...


On Jul 05 07:30 AM Lightway wrote:

> Agree with your article completely.
>
> These vehicles MIGHT seem useful if they were providing liquidity
> for distressed real estate assets. There's a tremendous amount of
> toxic real estate that's overinflated and still out there, that needs
> moved into liquidity. Owners still want housing bubble sales prices,
> and buyers are not (or don't have the means necessary) going to pay
> them.
>
> Shiller has lost me on this one. The Case-Shiller index, which is
> widely referenced as an indicator for home affordability, was baselined
> in the year 2000. By the year 2000, the housing bubble was already
> way underway, so the index baseline is already inflated from what
> most of us would call affordability. It's a relative index which
> shows housing affordability relative to...the Case-Shiller index.
> Good for identifying trends and direction, but not for deep fundamental
> correlation to actual affordability.
>
> There are more traditional measures of housing affordability out
> there, such as:
>
> 1) Three times gross income equaling purchase price
> 2) Rental parity for an equivalent purchased home.
>
> I agree with David's frustration, what exactly are we building here?
> This type of gamble belongs in Las Vegas.

Jul 05 12:17 PM

[American in...:]

That's absolutely rubbish. The Shiller index is not 'inflated'. It is a very accurate meausre of housing price movements. The idea is that just as we can hedge our stock portfolio by buying options, we should be able to do the same for housing assets.

There is a market missing - the market to share risky fluctuations in the prices of housing.


On Jul 05 07:30 AM Lightway wrote:

> Agree with your article completely.
>
> These vehicles MIGHT seem useful if they were providing liquidity
> for distressed real estate assets. There's a tremendous amount of
> toxic real estate that's overinflated and still out there, that needs
> moved into liquidity. Owners still want housing bubble sales prices,
> and buyers are not (or don't have the means necessary) going to pay
> them.
>
> Shiller has lost me on this one. The Case-Shiller index, which is
> widely referenced as an indicator for home affordability, was baselined
> in the year 2000. By the year 2000, the housing bubble was already
> way underway, so the index baseline is already inflated from what
> most of us would call affordability. It's a relative index which
> shows housing affordability relative to...the Case-Shiller index.
> Good for identifying trends and direction, but not for deep fundamental
> correlation to actual affordability.
>
> There are more traditional measures of housing affordability out
> there, such as:
>
> 1) Three times gross income equaling purchase price
> 2) Rental parity for an equivalent purchased home.
>
> I agree with David's frustration, what exactly are we building here?
> This type of gamble belongs in Las Vegas.

Jul 05 12:19 PM

[optionsgirl:]

These are not etfs. They are trusts investing in treasuries. You will get a K-1 at the end of the year, if you participate in these products.

Jul 05 12:35 PM

[Marianthi:]

This whole market is a joke anymore...AIG 1-20 reverse split, FAS/FAZ upcoming reverse splits...I don't think anything would surprise me anymore...

Jul 05 02:34 PM

[klarsolo:]

If the author cannot see the value of being able to hedge house prices after all the harm that the recent house collapse has caused, he should not post on Seekingalpha.

This product is another quiver in the hands of skilled traders and investors. Everybody else who is overwhelmed (like the author seem to be) just stay away. It really is that simple. Nobody forces you to buy something you do not like or understand.

Yes, the levered structure of the product might be suboptimal. But if it turns out to be successful we'll see more and better designed products.

Jul 05 02:49 PM

[Old Trader:]

As pointed out above, the levered ETFs all invest in a mixture to treasuries and overnight swaps. The author seems to be confusing these products with sector ETFs which actually hold shares in some, or all of the companies represented by a sector.

Jul 05 05:10 PM

[David Van K...:]

Thanks for all the comments.

Certainly I understand that how these products work and that “Down” can be used to hedge the value of home(s). I don’t have them confused with real ETFs. I thought I made that clear.

But how many people would have actually hedged the value of their homes with “Down”? Not now, when we know so much of the extent of the disaster, but then, when it was happening?

We already know the answer to that question from the behavior that actually occurred: Millions of people assumed that the value of their homes would continually rise. We know this because they re-financed their homes, over and over. Not prudently, to lower their interest rates or monthly payments, but to take money out. Others bought houses they couldn't afford with mortgages that shouldn't have been issued. The resulting lack of retained equity created a greatly diminished incentive and ability to pay back the mortgages.

This is the activity that took place at the house/lender level. It was enabled by lax (some would say predatory) lending practices, MBS's, CDS's, and other derivative products which the banks themselves did not understand. These instruments were sold around the world, creating interconnections and counterparty issues that are not yet fully understood. Combined, the misguided nature and failure of all these instruments and activities led to the housing and credit collapse.

So realistically, how many of these millions of people would have hedged their "house value risk" in the correct direction had "Down" been available? Is anyone suggesting that the housing and credit collapse would have been averted? That's laughable.

I'll stick by my original point. These exchange-traded products are second-level derivatives. They are symptomatic of what has gone wrong with Wall Street and our financial institutions in the run-up to and explosion of the current crisis. Our best and brightest (who used to go into industry) for years have been going to Wall Street and applying their creativity to invent more and more complex and dangerous financial products. America creates more paper and fewer goods. We're way overleveraged--at the individual, institutional, and governmental levels. I'm not overwhelmed. I am sorrowful.

Jul 05 06:53 PM

[klarsolo:]

This is a question we cannot ever answer. But I certainly like having this hedging option as a professional now and in the future. Often these products are a beginning and we don't know what other products they'll eventually lead to.

Our "best and brightest" come up with both good and bad inventions and sometimes something that starts out good ends up bad (and vice versa). The fact that CDO's blew up in our faces does not make the underlying idea of structuring cash flows a bad thing per se. But certainly the risks were little understood. Now they're better understood. Who knows what kind of advantages we'll experience down the road from the knowledge we've gained from this catastrophy.

People complaining about such products are like toddlers who stumble over obstacles in their quest to learn how to walk and then vow to never walk again.


On Jul 05 06:53 PM David Van Knapp wrote:

> Certainly I understand that how these products work and that “Down”> can be used to hedge the value of home(s). I don’t have them confused > with real ETFs. I thought I made that clear.
>
> But how many people would have actually hedged the value of their> homes with “Down”? Not now, when we know so much of the extent of> the disaster, but then, when it was happening?

Jul 05 07:27 PM

[optionsgirl:]

You can hedge any long investment by shorting another likely market. You don't need a product named " real estate" to do that. Just like the Macro shares oil up and down products are flops, I bet this will be, too.

Jul 05 11:37 PM

[Lightway:]

Take a look at this chart, and notice the swing upwards beginning in 1998:

mysite.verizon.net/vze...

As David mentioned, this type of gambling is the exact same destructive force that got us into this mess in the first place. There used to be people who bought homes to live in, and then a niche group of speculators, and another group of responsible real estate investors. By 2006, this situation had reversed itself, with a home being treated as an ATM machine or a get rich quick scheme.

As mentioned, there are plenty of other traditional vehicles you could invest in, to hedge against fluctuating real estate prices. Also, do you really think someone is going to pay a $50,000 down payment on a home, and then another $50,000 on some risky "sortof ETF but not really an ETF" 3x leveraged fund based on whether or not they feel the real estate market is going up or down? That's the most unrealistic situation I've ever heard, especially with unemployment getting worse before it eventually gets better. This is a extremely niche product, with no significant wealth-building contribution to what it is actually representing, and is destined for failure, just as the oil up and down products were.


On Jul 05 12:19 PM American in Paris wrote:

> That's absolutely rubbish. The Shiller index is not 'inflated'. It
> is a very accurate meausre of housing price movements. The idea is
> that just as we can hedge our stock portfolio by buying options,
> we should be able to do the same for housing assets.
>
> There is a market missing - the market to share risky fluctuations
> in the prices of housing.

Jul 06 05:01 AM

[American in...:]

Absolute rubbish. :)

Derivatives did not create the housing crisis. And a market like this actually helps to assess risk and do price discovery.

And no, there are not a lot of ways to hedge real estate.


On Jul 06 05:01 AM Lightway wrote:

> Take a look at this chart, and notice the swing upwards beginning
> in 1998:
>
> mysite.verizon.net/vze...
>
>
> As David mentioned, this type of gambling is the exact same destructive
> force that got us into this mess in the first place. There used to
> be people who bought homes to live in, and then a niche group of
> speculators, and another group of responsible real estate investors.
> By 2006, this situation had reversed itself, with a home being treated
> as an ATM machine or a get rich quick scheme.
>
> As mentioned, there are plenty of other traditional vehicles you
> could invest in, to hedge against fluctuating real estate prices.
> Also, do you really think someone is going to pay a $50,000 down
> payment on a home, and then another $50,000 on some risky "sortof
> ETF but not really an ETF" 3x leveraged fund based on whether or
> not they feel the real estate market is going up or down? That's
> the most unrealistic situation I've ever heard, especially with unemployment
> getting worse before it eventually gets better. This is a extremely
> niche product, with no significant wealth-building contribution to
> what it is actually representing, and is destined for failure, just
> as the oil up and down products were.

Jul 06 10:00 AM

[American in...:]

You need to be provide reasons, not just assertions.

I don't know whether this idea will be successful or not. But I think it is worthwhile to create a market to place a value on the risk of real estate. You can look at the CBOE options. But many investors do not find futures particularly appealing to the price-to-market adjustments that are made everyday.


On Jul 05 11:37 PM optionsgirl wrote:

> You can hedge any long investment by shorting another likely market.
> You don't need a product named " real estate" to do that. Just like
> the Macro shares oil up and down products are flops, I bet this will
> be, too.

Jul 06 10:04 AM

[American in...:]

Shorting is not an attractive strategy because the risk is infinite. Options are complicated.

This is very intriguing because it is simple and well designed.


On Jul 05 11:37 PM optionsgirl wrote:

> You can hedge any long investment by shorting another likely market.
> You don't need a product named " real estate" to do that. Just like
> the Macro shares oil up and down products are flops, I bet this will
> be, too.

Jul 06 10:06 AM

[American in...:]

You keep spouting plain rubbish. Derivatives have been with us since the commodity exchanges. They are essential.

The real estate crisis was caused by a mispricing of risk. You want to solve that problem? It's the rating agencies, stupid.

And by the way, it doesn't matter whether the vast majority of homeowners sign up for Macroshares. The vast majority of bread consumers do not trade wheat futures either ...

This market would allow financial institutions to hedge their risk.

And for those of us who want a diversified portfolio of US real estate, Macroshares is one more vehicle.


On Jul 05 06:53 PM David Van Knapp wrote:

> Thanks for all the comments.
>
> Certainly I understand that how these products work and that “Down”
> can be used to hedge the value of home(s). I don’t have them confused
> with real ETFs. I thought I made that clear.
>
> But how many people would have actually hedged the value of their
> homes with “Down”? Not now, when we know so much of the extent of
> the disaster, but then, when it was happening?
>
> We already know the answer to that question from the behavior that
> actually occurred: Millions of people assumed that the value of their
> homes would continually rise. We know this because they re-financed
> their homes, over and over. Not prudently, to lower their interest
> rates or monthly payments, but to take money out. Others bought houses
> they couldn't afford with mortgages that shouldn't have been issued.
> The resulting lack of retained equity created a greatly diminished
> incentive and ability to pay back the mortgages.
>
> This is the activity that took place at the house/lender level. It
> was enabled by lax (some would say predatory) lending practices,
> MBS's, CDS's, and other derivative products which the banks themselves
> did not understand. These instruments were sold around the world,
> creating interconnections and counterparty issues that are not yet
> fully understood. Combined, the misguided nature and failure of all
> these instruments and activities led to the housing and credit collapse.
>
>
> So realistically, how many of these millions of people would have
> hedged their "house value risk" in the correct direction had "Down"
> been available? Is anyone suggesting that the housing and credit
> collapse would have been averted? That's laughable.
>
> I'll stick by my original point. These exchange-traded products are
> second-level derivatives. They are symptomatic of what has gone wrong
> with Wall Street and our financial institutions in the run-up to
> and explosion of the current crisis. Our best and brightest (who
> used to go into industry) for years have been going to Wall Street
> and applying their creativity to invent more and more complex and
> dangerous financial products. America creates more paper and fewer
> goods. We're way overleveraged--at the individual, institutional,
> and governmental levels. I'm not overwhelmed. I am sorrowful.

Jul 06 10:12 AM

[Lightway:]

Who said derivatives caused this crisis? There are many factors involved. There is also something called scope and scale, both of which the derivatives magnified tremendously. The MBS derivatives in particular were decoupled from the original loaning institution, eliminating their risk for the transaction, yet overloading the system with too much risk, by encouraging volume of sales, not QUALITY of sales.

I fail to see how this provides real price discovery into an actual property or local market, other than speculation (gambling) onto where fund holders might think national house prices are going. You might as well take that money and bet it on who is going to win the Superbowl next year.

And please tell me exactly how this is providing liquidity into the entire US real estate market. "That's rubbish" doesn't count as an explanation.

On Jul 06 10:00 AM American in Paris wrote:

> Absolute rubbish. :)
>
> Derivatives did not create the housing crisis. And a market like
> this actually helps to assess risk and do price discovery.
>
> And no, there are not a lot of ways to hedge real estate.

Jul 06 12:39 PM

[manya05:]

Well, 5 days of trading and the jury is out already. UMM is down from 20 (starting point) to 13. A nearly 33% drop in 5 days? is this following the price or houses or what? Looks like the product is broken right off the gate. What a rip-off.

Jul 07 01:24 PM

[The Admiral:]

Probably the worst article I've seen on Seeking Alpha. So a play on an index price has to actually OWN the underlying? Really. Ever hear of an interest rate swap, or any other sort of derivative?

There are many significant advantages to taking exposure to an asset in a synthetic way rather than through owning the underlying. For one thing, transaction fees and other "friction" costs are greatly reduced. Sure, I could sell my house - and pay a realtor 6%. If I can obtain the same economic position while deferring the cash outflow associated with deal cost, why wouldn't I? In addition, the leverage allows me to invest more of the principle I would otherwise have to tie up in the investment.

Let's say I want to hedge a $300,000 home and didn't want to pay $18K to a realtor. In an unleveraged index play, I'd need to tie up $300K in assets, not easy for everyone. In the case of a leveraged fund, I could tie up $100K and deposit $200K in a fixed income investment which earns interest. I get the same economic exposure, but at a far reduced cost.

Jul 15 01:08 AM

[The Admiral:]

"Certainly I understand that how these products work ... I don’t have them confused with real ETFs. I thought I made that clear."

- Nope. You sounded confused. If you say you understand the concepts I'll take you at your word. But then your article is poorly written, because it gives the impression that you've not a clue.

"But how many people would have actually hedged the value of their homes with “Down”? Not now, when we know so much of the extent of the disaster, but then, when it was happening?"

- I have been looking for a way to short real estate, other than by selling home builders, since 2001. This is a godsend for me, albeit 8 yrs too late.

"These exchange-traded products are second-level derivatives. They are symptomatic of what has gone wrong with Wall Street... Our best and brightest (who used to go into industry) for years have been going to Wall Street "

- Ah, your true agenda emerges. You want to go into industry, work with your hands, etc? Be my guest. Have at it. But please don't tell me what the rest of us should do.

"I'm not overwhelmed. I am sorrowful."

- If you say so. But you appear to be over-whelmed by the subject matter. Why don't you write on industrials, since that is what you profess to admire? And if you really want to be helpful, write it for Parade magazine, an audience whose level of financial sophistication might be better suited to your writing style.

Jul 15 01:18 AM