Put your money where your mouth is
I love Wall Street. God bless ‘em, I just really love those guys. For all the slings and arrows we shoot at them, there is another side to Wall Street that shows just how fairly they are willing to treat us.
Wall Street’s job is not to make money for us, it is to complete transactions by matching buyers and sellers of securities. There are always plenty of sellers; money is made by finding buyers. This is the reason why Wall Street is always imploring us to buy one investment or another.
Whenever someone is making an impassioned plea for me to buy something, I try to turn the tables on them and get a sense for their reaction. In effect, I ask the question, “If you think this is so great, are you willing to put your money where your mouth is?”
I do not want to know whether the person owns some of this investment for himself, instead: Is he willing to make a bet with me that he is right? I want to be able to enter into a trade whereby he makes money if he’s right, but he has to pay me money if he’s wrong.
Mind you, I don’t really enter into such bets on a regular basis, but I like to know if the opportunity is on the table.
When it comes to virtually any investment asset class that Wall Street wants us to buy, it turns out that Wall Street will make such bets with us. If your stock broker is imploring you to buy Nasdaq stocks, you can turn the tables on him and ask that he instead buy the Nasdaq from you. You can do this even if you don’t own any of the Nasdaq.
You might recognize this trade as a short position. Almost any investor can take a short position in almost any conventional investment. Techniques include direct short sales in a brokerage account, the use of the futures and options markets, and specialized mutual funds set up just for this purpose.
This is where Wall Street doesn’t get enough credit. In order for a market to operate fairly and efficiently for all participants, there needs to be a mechanism by which market players can take an opposing position. If everybody thinks bonds are going up, you can make a bet that they go down. This is an important feature of an efficient market, and is instrumental in allowing various market players to manage their own unique risks and situations.
However, there is a glaring void in the market for making contrarian investments: the market for the average American family’s single largest asset class, residential real estate.
Here in California, we hear no end of exhortations to buy more house. Either trade up or refinance or buy a second one or improve the one you have. I can hardly step into a coffee shop without a friendly Realtor telling me how prices will go up at double digit rates forever and that I really need to get in on the action.
Just as I would do with a stockbroker, I turn the tables. I ask whether the real estate promoter would enter into an agreement with me. I will pay them money if prices are higher in two years, they pay me if prices are lower.
I have actually made this offer and have had no takers to date. If I made the same offer to a stockbroker, she wouldn’t bat an eye and she would send over the paperwork right away.
This absence of a mechanism to make a contrarian decision about housing prices means that housing market participants cannot manage risk. A bank with a large portfolio of home loans cannot enter into trades that will protect the bank should home prices fall. A homebuyer that has stretched the family budget with a low-money-down loan cannot buy insurance against declining home values that would wipe out the family’s net worth. We can easily do both of those things for our stock portfolios.
Help might be on the way. A group called Macro Securities Research is working to develop a futures contract through which investors can take either side of a housing price trade. Among the people behind Macro Securities Research is Yale economist Robert Shiller, whom you might recognize as the author of “Irrational Exuberance.”
Efficient markets require that all market participants are free to take either side of a trade. Lacking this mechanism, the housing market cannot be considered to be efficient. Risks are not allocated optimally and shocks to the system often end up hitting hardest those most unable to absorb the blow.
Rick Ashburn manages investments for private clients. Write to him at firstname.lastname@example.org or 7777 Fay Ave., Suite 230, La Jolla, 92037.