I'm interested in buying a house in California, but I'm worried that
housing prices may tumble and so I'm concerned about the financial
risk involved.  Is there any sort of financial instrument I can use to
insure myself so that I will not lose money if the value of my house
drops and I sell it several years later?  (I'd be happiest with an
instrument related to the value of my actual house, but might also be
satisfied with an instrument related to the housing market in general,
since I doubt that my house's value would decrease significantly
unless the entire market did so too.)

medovina-ga,

The short answer to your question is, "No, there is not any sort of
financial instrument you can use to insure against losing money if the
value of your house drops and you sell it several years later [after
the drop in value]."

There are no conventional financial instruments that solve this
request. (Be extremely wary of those who say they can solve it).
Renting seems to be the only sensible alternative. If you are trading
one house for another to reside in and plan to continue doing this,
market price changes shouldn't affect you much either way. If you are
a first time buyer, however, it would be bad to make the first
purchase in a bubble, so temporarily renting would be the alternative.

In short, there is no
"My-house-is-worth-less-now-than-when-I-bought-it-insurance," so you
must treat it as the investment vehicle which it is. All investments
have risk, and all you can do is manage that risk, it cannot be
eliminated.

The way to manage that risk, in this case, thereby "insuring" yourself
against potential losses, is to avoid making the home purchase until
you and your financial advisors feel that the market is no longer in a
bubble state. (Or, alternatively, you could buy a home in another
geographic area which is not currently in a bubble).

Of course, no one has a crystal ball, but it is the consensus of the
real estate community that the California market--especially the
southern CA market, and ESPECIALLY San Diego--is currently in a
bubble. How long this bubble will last, no one can say for certain,
but this is considered a "seller's market" for now.

An excerpt from DQnews.com, 

http://www.dqnews.com/ :

"New records for Southland Home Prices in August: Home prices in
Southern California edged up to a new peak as sales showed no signs of
a slowdown. . ."

Also from the same site:

"Bay Area Home Sales, Prices Steady in August 
Home prices in the Bay Area stayed unchanged at their July peak last
month as the sales pace also remained steady. . . "

You have good reason to be concerned about the financial risk involved
in buying a home now in California, especially in southern CA.

Google search strategy:

Keywords: "california home real estate market"

://www.google.com/search?hl=en&ie=ISO-8859-1&q=california+home+real+estate+market
,

"home value depreciation insurance" [Note that the links on this page
(and those of similar queries) contain no solutions-- or even pretend
to--for the situation you (and many others before you) are attempting
to guard against].

://www.google.com/search?hl=en&lr=&ie=ISO-8859-1&safe=off&q=home+value+depreciation+insurance
,

"home buying risk assessment"

://www.google.com/search?hl=en&lr=&ie=ISO-8859-1&safe=off&q=home+buying+risk+assessment&btnG=Google+Search

If there is something specific you would like me to clarify, please
don't hesitate to ask.

Good luck in continuing your inquiries!

~omniscientbeing-ga

Thanks - this wasn't the answer I was hoping to hear, but you seem
well informed, and so I believe you.  I know that when I purchase a
stock there are ways to use options to hedge my bet, and I was hoping
that there might be some analogous instrument for real estate, but
apparently there is not.  Of course, renting is the easiest and most
common way of avoiding this risk altogether, and so I guess I'll just
plan to continue renting for now.

Medovina wrote, "I know that when I purchase a stock there are ways to
use options to hedge my bet, and I was hoping that there might be some
analogous instrument for real estate, but apparently there is not."

Right, because when you use options to hedge against a loss on General
Electric common -- in this case, you buy puts at a given strike price
-- there is someone out there, your counterparty, who has sold
identical puts on General Electric common. There are millions of
perfectly identical GE shares outstanding (the stock is "fungible"), a
lot of people know a lot about the company, there is a large, liquid
market in such options, and there are good economic reasons why
someone might want to sell puts on any given security. In short, your
counterparty can know and can hedge his risk.

But if you're going to buy the house at 123 Spruce Street in Anywhere,
California, there is only ONE such property in all the universe. You
want to buy a put on that specific, unique property -- but who could
possibly want to sell a put on that property? How could that person
possibly hedge such a risk?

One non-securitized way of doing what you want to do comes to mind:
You buy the property with as small a downpayment as possible. If the
value of the property later drops too far for your comfort, you
"walk": you voluntarily allow your lender to repossess the property.
Granted, you will have a really hard time borrowing any more money
from anyone for the rest of your life.