13.1. Fractional Home Ownership

John O'Brien is one of the founding fathers of the field of financial engineering. He understands the field as well as anyone, from both academic and practical experience. As a founder of Leland, O'Brien, and Rubinstein (LOR), he was one of the inventors of portfolio insurance, a dynamic hedging strategy for equity portfolios to reduce downside risk.[] Portfolio insurance worked very well in relatively stable markets, and by October 1987, firms managing over $60 billion in assets were using the system. The basic idea was to sell futures in declining markets to protect the underlying assets, and the desired results were achieved. However, when the stock market tanked on October 19, 1987, there was insufficient liquidity in the futures markets to absorb the selling by portfolio insurers and others, and the volume of selling drove down the futures prices and in turn the stocks themselves. Portfolio insurance was not the only or even the principal cause of the crash, but it may have contributed to the speed and size of the decline.

John has taken the lessons of portfolio insurance to heart, and perhaps more than others, considers the unintended consequences of financial ideas. In that spirit, he proposed what I believe is a particularly well thought out approach to dealing with the underlying cause of the Mess of '08—the collapse of home prices. His idea lets people remain in their homes, avoiding the displacement, grief, and blight that are plaguing ...

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