Getting Case-Shillered

Can you spell conflict of interest?

June 1, 2008

If the unemployment rate is historically low yet your customers are waiting for home prices to drop 30 percent before they buy, you’ve just been Case-Shillered. The S&P/Case-Shiller Home Price Index is the benchmark the financial press uses to tell us how terrible the housing market is.

One must wonder why. The index’s findings are notoriously softer than the indexes used by the Office of the Federal Housing Enterprise Oversight, NAR, and even Realogy. In 2007, home prices went down for the first time in decades, but by how much? OFHEO said by 0.3 percent, NAR 1.4 percent, and Realogy 1 percent. Case-Shiller? 8.9 percent. Yale economist Robert Shiller, cofounder of the index, is scaring home buyers with proclamations that home prices “will fall further than the 30 percent drop in the historic depression of the 1930s,” as he told the Associated Press in April.

Prognostications like that are a problem because financial journalists such as Michael Grynbaum of The New York Times, Les Christie of CNN, and Rex Nutting of CBS MarketWatch, as well as securities investors and analysts, call his index “the best gauge” of real estate values.

Since when do reporters feel the need to fluff a source, and why are analysts so enthralled with the index? One reason might be its Wall Street seal of approval: It was launched to provide information for hedge funds.

Created by Shiller and Karl Case, an economics professor at Wellesley, the index is licensed exclusively to Macromarkets LLC for “developing, structuring and trading financial instruments,” says the Macromarkets Web site. Among Macromarkets’ products is the Housing Futures and Options index, which forms the basis for “directly investing in and hedging U.S. housing” on the Chicago Mercantile Exchange, where futures and options on the index are traded. “Every time a CME hedge is made, revenue flows to Macromarkets,” says NAR’s chief economist, Lawrence Yun.

“People would hedge only if they believe price movements will be volatile.” Shiller is a founder and chief economist of Macromarkets.

So, is the index biased to the negative? Its divergence from OFHEO’s findings is so wide that Andrew Leventis, the agency’s senior economist, has undertaken studies to find out why. A January 2008 study, “Real Estate Futures Prices as Predictors of Price Trends,” showed that while “implied price forecasts” were reasonably accurate for the most recent round of expiring futures contracts, the index’s contract prices have tended to significantly “overshoot” actual price declines. A February 2008 paper, “Comparison of House Price Measures,” found the index uses a very different mix of markets and weights than OFHEO. Among other things, it gives more weight to the Pacific Coast, where prices have been volatile.

A third paper, “Revisiting the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes,” tried to overcome the differences in outcome by mimicking how Shiller weights its data. For example, it added data on nonconforming loans, which are dominated by subprime loans. Even after these changes, OFHEO’s test index only came within 4.7 percentage points of Case-Shiller’s 8.9 percent plunge.

By making other adjustments such as adding weight to faster selling homes, OFHEO whittled the difference even further, but still came within only 1.6 percentage points of the index. What this shows is that the “weights” are selective.

In any case, OFHEO researchers admit that they don’t really know the source of divergence between their index and Case-Shiller’s; indeed, NAR’s Yun has said that the lack of transparency with the Shiller index has been a problem for economists.

Case-Shiller might be lauded by the financial press, while NAR is assumed to be promoting a positive spin, but let’s be clear: OFHEO and NAR don’t have relationships with hedge funds on the side.

Blanche Evans is a writer/editor and CEO of evansEmedia. Formerly, she was a senior editor with Realty Times, where she was named by REALTOR® Magazine as one of the most influential people in the real estate industry.