That includes markets for hedging risks.

Shiller, being a lot more intelligent than his detractors on this list, is simply exploring ways of using markets to hedge those risks.

Wisdom Speaker is totally off-base. Wanting insurance is not a sign of moral failure. It means you are risk averse.

And how is Shiller, who predicted both the Dot-com and real estate crashes, guilty of ‘pre-crash mentality’?

On a more philosophical plane: I would hate to live in a world where everyone was “hedged” or “insured” and thought they had no risk, and yet would earn some kind of return. A world of prudent risk-takers, willing to put actual capital on the line because they’ve done their homework and willing to work to make their commitments work out, is better than a world of “hedged” risk-averse “free lunch” seekers who just want some counterparty to make everything all better for them if they turn out to be wrong.

There’s a moral hazard aspect to insurance — think about how popular the high-hazard “extreme” sports are, now that everyone feels entitled to having someone else pay for their wrecks. There’s also the problem that your average individual, regardless of means, is just not sufficiently sophisticated financially to make proper use of these “hedging” tools. We live in a nation where 90% of the population cannot do something as simple and obvious as paying off their credit cards in full each month! This applies all the way up to the highest levels of business and government — Representatives, Senators and even national presidential candidates are up to their eyeballs in debt that is clearly not in their financial interest. Should we really be turning the Wall Street marketing mafia loose with new “financial innovations”, on such ignorant prey?

My intuition tells me that it would be better for society if people who aren’t comfortable owning a particular asset were encouraged (”invisble hand” style) to stop owning it, NOT for them to maintain “ownership” but with “insurance”. Shiller and other advocates of hedging tools seem to be living in the pre-crash mentality, where financial complexity seemed like a good thing, and counterparty risks could be ignored. Such is not the case now. With the number of publicly filing businesses down about 1/3, and the number issuing “going concern” warnings rising dramatically, it’s flawed logic to assume that “insurance” (as a generic concept) is “guaranteed”. Would you sell a future on your home to the next AIG? The next Countrywide? The next Lehman Brothers? In the absence of financial transparency, particularly with respect to off-balance-sheet (and allegedly “hedged”) risk exposures, there’s no way to tell that your counterparty of choice won’t blow up in the next 10 years (or whatever time horizon). In such an environment, hedging makes little sense from a Graham-ian investment perspective, because upon thorough analysis the risks are quite likely too high.

And yes, I try to offset my consumption-related short oil position by always having some long oil exposure, although not currently with futures.

Please note that the Shiller products are structured as ETFs rather than futures in part to prevent margin calls from knocking out the unwitting. They really do look like well-thought-out mechanisms for hedging by those who most need the function.

Doesn’t your real estate hedging logic extend to life insurance? Life insurers don’t have a natural exposure to your life, but through pooling are able to offer a product that allows you to hedge your idiosyncratic risk.

I agree that speculation, particularly with credit default swaps, can be destabilizing, but you seem to be saying something more and relying on an arbitrary definition of gambling. You seem to be implying, for example, that all commodity futures transactions should only involve counter-hedgers. Or even that one should not buy non-dividend stocks in a secondary market (unless you’re buying enough to possibly steer the board and the actual business).

I have enjoyed your writing for years but I disagree with your conclusions as I understand them here.

As for Shiller’s product, it is probably not a good hedge in the short run — if you are planning on holding it to maturity, it might work, but remember, it works off of an index that tends to lag underlying price moves.

The problem is something that that my lawyer pointed out to me years ago: an individual home is unique. There’s no exact substitute for my home or your home. It’s not like a security, where one stock or bond or barrel of oil is interchangeable with another.

Trying to hedge the price moves of my house with a security will always be an imperfect hedge, and it might even fail. In the Boston area, for example, the range of housing price changes over the last year spanned about -15% to +10%, depending on the town and neighborhood. In the aggregate (e.g. the S&P 500/Case-Shiller Boston index), prices were down, but some individual houses went up.

These hedging tools might make sense for a national homebuilder. Beyond that, I think Shiller’s hedging securities will largely be used by speculators and naive retail investors.