Monday, October 13, 2008

More Markets?

Over at Labour & Capital (who I've noticed has been kind enough to add me to his blogroll) a post about shorting that ended up in a discussion about the potential for shorting on housing. Nick Drew likes the idea and suggests some kind of market for housing, personally I'm not so sure, firstly because Nick is right wing capitalist type and second because I'm not sure it would give any great benefit.

First, I'll have a crack at how such an idea might work (this is unknown territory for me so it's just a guess). Obviously we can't go buying and selling bricks and mortar so I'm thinking a system of vouchers, the value of these vouchers tracks a housing index (so £1,000 of vouchers when average houses are £100,000 would translate to £1,500 worth when they are £150,000), a governing body redeems these vouchers against the purchase of a house and regulates the market and participants buy and sell contracts and options on these vouchers.

The relationship between such a virtual market and a housing market would not be exact, but likely to follow in roughtly the same vein, the market could drag prices up or down because it would reflect what housebuyers who participate in the market would be prepared to pay. It would go up and down with the housing market although there's likely to be some level of difference.

Regardless of whether my little setup above is on the ball or not, the big problem with the market is that it would allow additional participants not really interested in speculation more than bricks and mortar. The injection of speculative capital in the housing market would almost certainly drive house prices up generally, further to this if behavoir in other markets is anything to go by, we can expect this speculation to drive pro cyclical behavoir.

It seems to be an instinctive thing among city types that they seem to think inside a box that views a market as a solution to almost any problem. The problem seems to be that the most active participants are are likely to be middle men looking to make money rather than genuine producers and consumers. As I understand things, this kind of behavoir is exactly what happened in the oil and commodities markets driving up prices beyond actual realistic levels.

I would question whether we really need this kind of financial innovation and whether it ultimately gives any great benefit that could not be addressed created by other means. To me the idea of creating a new market for housing seems like more trouble than it's worth, further to this, I do wonder whether same is true for some of the other more exotic markets.


Nick Drew said...

Tom P has kindly directed me to your blog, Andreas, *wipes shoes and dons surgical mask* and I hope not to infect you

your stab at how it might work is near enough to be going on with (I would merely point out that it wouldn't need vouchers or a governing body, just a reliable and widely-accepted index against which to settle. What you've described is similar to the CO2 trading scheme, but remember that participation in CO2 trading is compulsory for many companies)

obviously if you're intrinsically skeptical about / hostile to markets in general (which is a real pity, because properly-structured markets have so much to offer), there's not much more to add ...

otherwise, my points would be these

(a) any wicked speculator wanting to take a punt on house prices rising has had several ways to do this, direct and indirect, for a long long time - so a new vehicle isn't suddenly going to release huge pent-up enthusiasm for going long, or thereby add to house-price inflation

(b) actually, of course, the point was that such a market could have driven prices down, sooner ! I know loads of people who would have taken a punt on the short side of the UK housing several years ago if it had been easy to do so (some of them sold to rent, of course, but I don't call that 'easy')

(c) I assert - (but space here doesn't permit ...) - that speculators were not the cause of the commodity-price spike

(d) I'm not pressing for 'someone' to set up such a market. The best markets evolve spontaneously from real need, and I rather infer there isn't much of a demand for this, useful though I think it could be (see the examples I gave at Lab&Cap). People have wasted a lot of time and money trying to get markets going for which there was no natural demand. The key, for me, is that there should be freedom to establish markets, and templates of best practice on how to structure and (where appropriate) regulate them.

To reinforce my doubts on whether a UK property-index market would prive successful: I mentioned at Lab&Cap that Enron had plans for such a market for UK commercial property indices in 2001 - & no-one else stepped in when Beelzebub dragged them down to the Pit

Andreas Paterson said...

Hi Nick,

Many thanks for your comments, sorry that it's taken a while for me to respond. You're right, I'm generally quite hostile to markets, not to the point that I'd like to purge them all from the face of the earth, my big issue is the obsession with capital gains that seem to come as part and parcel of the whole market thing.

On your individual points

a) I'm not 100% sure what methods your referring to, but I've always assumed that traders will use whatever vehicles are available to them a market would have the added bonus that it would be easier to move money in and out of it. I think any effect would be minor, but I'd say that there would probably be some effect.

b) I do wonder what the effect would have been here, the peak of the housing market seems to have been predicted for years but never arrived. What seems to happen is that a lot of speculation seems to occur when the direction of travel. I'd suspect that a lot of potential shorters would hold off until a downward movement looked pretty certain, but obviously I couldn't say for sure.

c) I'm interested as to what did cause the spike, because every politician and his dog seem to be gunning for speculators on this subject. From what I can tell the spike did occur because of genuine increases in demand, but was a good deal higher as a result of speculation driving it up. Do please correct me if I'm wrong here.

d) Not much to disagree with here.

Nick Drew said...

(c) what caused the spike

well many acres of blogspace have been dedicated to this (me included), and as you say a lot of folks take great pleasure in blaming speculators (not hard to see why this is highly convenient) but i'm with you on 'genuine increases in demand'

and my take on why the spike was so high, in brief, is this

most people broadly understand the impact of supply/demand balances in directional terms, but they are surprised by how acute things become when the balance becomes extremely tight / crosses over from outright surplus to outright shortage (most things are in surplus most of the time, BTW)

things are frequently not at all linear at such points, and various profound qualitative changes can happen

prices, specifically, can become ultra volatile and, as we've seen, can spike - higher than seems 'reasonable' for an observer who's thinking intuitively of a linear relationship between supply/demand and price

the crash can be 'surprisingly' steep, too: in this case, as marginal (Chinese) demand cratered in response to the financial / economic downturn

incidentally, this was all entirely predictable and indeed predicted ( by me !)

Andreas Paterson said...

So as supplies get short a sort of bidding war develops for the last few items, that would seem to make a lot of sense. Thanks Nick.