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All of this is possible through the almost infinite leverage available with today's home financing schemes. If you have a pulse, you can get a mortgage or home-equity loan. Some home-equity loans can be for up to 125% of the appraised value of your house (the assumption being that rapidly-rising real-estate prices are outstripping appraised valuations). For the mortgage-borrower, adjustable-rate mortgages with "teaser" introductory rates are available, as are "interest-only" loans (for the first few years... you may never pay off any of the loan before you sell the house!) and, new on the scene, "neg-am" (negative-amortization) mortgages, in which the amount of money you owe the bank increases from year to year.
Times have certainly changed from when I bought my first house, when a standard mortgage was 28% cash payment down and you couldn't borrow more than 2.5 times your annual income. But back then bankers still had memories of the Great Depression, and they remembered how much nonproducing real estate they ended up owning in the 1930s when the hard times hit.
That near-infinite leverage is sweet while home prices continue to rise; but when they go into decline that leverage becomes real ugly real fast.
And even those rising house prices (while the real estate bubble continues to expand) are not sweet for everybody. My wife and I have a good friend in California who is going through a painful divorce after her (soon-to-be-ex-, thank God!) husband had a mid-life crisis and split. (Now there's an oxymoron; what divorce isn't painful?...) California is a community-property state; a divorcing couple (without children) splits everything 50-50, including the house. Now each partner in this dissolving marriage would have sufficient non-retirement liquid assets to (with a modest mortgage) "buy out" the other's share of the house.... if it weren't for the damnable real-estate bubble. San Diego County is one of those "hot" coastal areas of the country where home prices have soared into the stratosphere.... up 140% in the past five years, which is about as long as they've been in the area. Their "modest" three-bedrooms and-den, two-bath home on a smallish lot, which would probably sell around a quarter-million dollars in a non-bubble part of the country, will probably fetch in excess of $800K in her neighborhood.
Our friend might luck out if the divorce-forced sale does pay her almost $400K, then the real-estate bubble pops big-time while she's renting for awhile as she decides what part of the country she really wants to live in. (California was her husband's choice.) But that would be but a happy accident; people do not plan their lives around whatever bubble the Fed happens to be blowing at the moment. They just do their best to deal with the consequences.
Selling your home near the peak of a real-estate bubble might make sense if, say, you were retiring to Belize. But most people typically stay in the same general area (excluding corporate transfers), so selling a high-priced home means replacing it with another high-priced home, with less "bang for the buck" due to transaction costs based on those absurdly-high prices. (A 6% commission on our friend's $800K-plus house is $48K, and that's a serious piece of change, as far as I'm concerned.)
Speaking of bubbles, Nick (you say), when is the real-estate bubble finally going to burst? Well, nobody can predict the exact day of the peak, but it is possible to "take measurements" and make a good guess whether we are very near to (or maybe just past) the peak.
Different areas of the real-estate market will peak at different times, as will different areas of the country and different countries of the world. For example, it is clear that the English bubble has popped, and probably also the Australian bubble. "Triple-decker" (rental real estate) sales here in Worcester, the financial backwater of America, peaked last fall, according to the brokers. Single-family homes here, allowing for seasonal price fluctuations, appear to have plateaued for the last six months. There is some very scanty evidence that in the latter half of May the Worcester single-family-home market suddenly turned soft. (I know that a number of homes in our immediate neighborhood have been sitting unsold for several weeks where, just a few months ago, they would have been snapped up within the month.)
In southern California prices softened over the winter, then firmed up again for a double peak. But central Florida, Bulgaria and Estonia are still red-hot.
So overall, we appear to be generally peaking out now. Certainly the 80% drop in refinancings (2005 versus 2004) and the creative mortgages at which people are grasping indicate the peak is at hand.
There are several recognizable stages of a bubble, and for real estate it seems to me that we have now reached or passed through all but the last three:
1. The bubble begins in a solid market with real demand for the utility of the product (that is, people buy houses to live in them).
2. A long period of rising prices draws people into the bubble who are speculating on even higher prices. (They get them, for awhile.)
3. The government screws up and injects a big wad of dough into the bubble.
4. Creative financing enlarges the pool of participants and drives prices to formerly-unimaginable heights.
5. The existence of the bubble is denied, even while it is picking up steam.
6. The existence of the bubble is admitted, but "this time it's different" - it won't deflate, people tell themselves.
7. The existence of the bubble is recognized by nearly everybody (even the inept mainstream media), but nobody cares; they just enjoy the ride, for they are smart enough to get out at the top. The bubble becomes the butt of jokes.
8. Prices flatten and soften. The bubble has popped.
9. Prices go into decline.
10. Prices plunge as people panic.
11. In despair, people try to unload at any price. Many are ruined.
A look at some charts (courtesy Northern Trust; Federal Reserve data) will give you an idea of the magnitude of the real-estate bubble:
The first chart shows how successful the Fed has been in feeding the bubble through refinancings triggered by lower interest rates. To ameliorate the fallout from the 2000 tech bust, the Fed strove to keep the economy afloat by encouraging people to extract equity from their homes (hence the title of my little essay, "Home Sweet ATM").
Note how refinancings accelerated sharply in 2000 and after as the Fed drove down short-term rates. The chart is a bit deceptive, because the vertical axis (billions of dollars) is logarithmic, so refinancings have not been growing linearly, they have been expanding exponentially.
The second chart shows dramatically the extent to which people have actually "spent" their houses, extracting equity presumably just to meet living expenses.
In the early 1990s people actually built equity in their homes, as is appropriate for baby-boomers approaching retirement who might need to draw on that equity when they are retired. After the popping of the stock bubble in March 2000, it would appear that, since stocks were no longer delivering outsized returns which people could cash in and spend, they started tapping their homes instead..... thanks to Uncle Al and his easy-lending rates.
The third chart shows how the popping of the stock bubble has dramatically altered people's worth. During the 1980s and 90s, as the stock bubble progressed, people still had increasing net worth even as they spent some of their stock gains.... and continued to pay off their mortgages, thereby increasing their equity in their homes even in excess of the modest price appreciation. Since 2000, with stocks out of the picture, people have obviously borrowed on their homes instead, clearly going into the hole to maintain their standards of living in excess of the rapid price appreciation of houses.
The fourth chart shows how the resale housing market has become an increasingly important part of annual GDP as the bubble has progressed. Note that the ratio has about doubled in the past five years (indicating that, historically, "used" homes are currently about 100% overpriced). Even in the inflationary 1970s, when people dumped cash in favor of almost any kind of tangible good, the ratio did not reach its current extreme.
Above is one of my favorite charts, courtesy The Daily Reckoning. It compares the current housing bubble (as reflected by homebuilding stocks) to the NASDAQ tech bubble of the 1990s. (For those of you seeing this in black and white, the "incomplete" homebuilders index line rests above the NASDAQ line.) Of course, positioning the current level of the homebuilders index at the peak of the NASDAQ bubble (implying we're now at the peak of the real estate bubble) is just a guess on their part.... but it's a pretty good guess, I'd say.
Though the popping of a stock-market bubble can be deadly to consumer confidence and the economy, as the 1930s demonstrated, the popping of the 1990s stock bubble did not have the immediate impact of prior bubble-poppings primarily, I think, for three reasons: (1) Much stock wealth is held in defined-contribution retirement plans such as 401(k)s and is not available for immediate spending, so people didn't freak out. They have bought big-time into the "buy and hold" mantra, so they figure it will all average out by the time they're ready to retire. (It will.... heh, heh.)
Also, (2) the Fed has the capability to keep stock prices propped up with futures buying and, in my opinion, has done so on at least a few occasions when it looked like stocks might head south in a big way. As a result, the stock bubble-players were playing with "house money"; their own contributions have not (yet) been impacted.
But (3) the main reason is that the Fed attempted to "ameliorate" the economic fallout from the popped stock bubble by using the primary weapon available to it, the lowering of short-term interest rates. In hindsight, there can be no question that this has produced a millennium-sized global real-estate bubble which is much more dangerous than the stock bubble because of its immediacy. People can shrug off retirement-plan losses; they don't need that money just now. But overpaying for a house with monthly mortgage payments one really can't afford is a shortcut to bankruptcy when the monthly payment rises with interest rates while your income does not.... and the house drops in value, and you are "underwater". This is not "house money"; it's your money that's at risk.
People try to hang onto their houses no matter how tough times get. But some of them just aren't going to make it. If the housing market only reverts to mean, prices could drop by (a CPI-adjusted) two-thirds in the overheated areas of the country. More seriously, such a loss of real wealth could bring on a depression, or at the very least a decades-long malaise like the one the Japanese have been struggling with. Japan's problems really began about four years after their stock bubble popped, when sinking real-estate prices rendered banks insolvent. Because our Fed was more aggressive, we have had an extra year.... but that does not change the outcome.
So dear Uncle Al thinks he's smart enough, and has
the financial tools, to avoid the "Kondratyev Winter"
following a popped bubble, and we're the guinea
pigs. "We're from the government, and we're here
to help you." We're from the government, and we're
going to ruin your life, is more like it.
Traditional economic thinking assumes that higher consumer spending stimulates businesses to increase their spending on capital investment and employment. This went badly wrong. It has not been realized that excessive consumption, taking up a rising share of GDP, has the exact opposite effect of depressing savings, investment and the trade balance through well-known crowding-out processes. If you think all this over, you will realize that the American economic reality on the macro level is not record wealth creation, but national impoverishment, foreboding a declining living standard. Take the borrowed import surplus away, and U.S. living standards collapse. - Kurt Richebächer
The economic and financial world is changing in ways that we still do not fully comprehend. - Alan Greenspan
I, too, listen carefully to Greenspan, but not for the same reasons as the bulls. I consider just about everything that comes out of his mouth to be monetary diarrhea, but I need to know what he says so I can figure out how the never-met-a-stock-I-didn't-like crowd is going to react. I may gag ... but I listen. - Tony Sagami
The central bank has tried and failed for a year to reverse the trend in long-term rates, the Chairman himself admits that the market has defied the Fed's monetary policy, and states in public that he can't find a "reason" to agree with regarding why... ...And yet, with all those facts (and others) on the record, the media still repeat the fiction that Greenspan's moving lips create market trends. - Robert Folsom
Greenspan, for his part, seems interested only in getting out before all hell breaks loose. And his warnings about the housing bubble - in selected markets, he says - is akin to his "irrational exuberance" speech when the stock market was percolating. It's all butt-covering. And it never works, no matter how many lies you tell. - John Crudele
I worked at Morgan Stanley during the 1970s market collapse and have been through a few since. And lately I'm seeing telltale signs everywhere warning us that despite all the bullish propaganda, a bubble's about to burst. Something will pull the trigger -- real estate, hedge funds, deficits, something. - Paul B. Farrell
All of the bullishness feels like 1999/2000 again or actually more like summer 87. There was a complacency in the air even as the sand was eroding from around your feet. - John Riley
Part of me thinks the intent of those who intervene in markets is benevolent - or is a high practice of economic warfare with an unseen enemy who we will defeat if we just keep on spending and don't notice how the volatility index (^VIX) has gone about as close to flat line as a week-dead corpse. Didn't the intervention seem to get really serious after 9/11? Nevertheless, we wonder deep down inside if a Dow on cruise control is an investment so much as keeping up appearances. - George Ure
Despite the positive hype, it appears probable that the economy is headed for a significant slowdown or recession that has not been discounted by the market. We draw these conclusions from some significant indicators that have shown good lead times in forecasting past economic cycles. The PMI Index, which has been heading down for a number of months, leads industrial production by about five months. In turn, industrial production leads manufacturing employment by four months. Furthermore, rising energy prices tend to lead the economy by about a year, meaning that the increases we have already witnessed are baked in the cake even if oil prices should decline from here. We also note that since the start of the Federal Reserve System in 1913 periods of tight money have almost always been followed by an economic slowdown or recession ‹ most often a recession. The year-over-year decline in money growth as measured by money to zero maturity (MZM) has now dropped to a point that has led to slowdowns or recessions over the past 40 years. Another study reveals a significant high correlation between the growth in real M2 and final domestic sales.... Real M2 has declined from a growth rate of 4.4% in the first quarter of 2004 to only 0.6% in the first quarter of this year. - Charlie Minter
It is time for the employment charade to end. The Labor Department padded its May employment figures with an extraordinary 207,000 positions that probably don't exist - and it still could get only very modest job growth for the month. The only conclusion can be that the real economy - outside the government's guesstimate for companies it hopes and prays are being created - is beginning to sour. The worst part of this game is that Washington is making dangerous assumptions that disguise from policy makers - not to mention you and me - what is really going on with the economy. Other economic statistics, as well as corporate anecdotes, are already pointing to a slowdown. - John Crudele
Where would the world be if Americans did not live out their proclivity to consume everything that looks good, feels good, sounds good, tastes good? We provide a service for the rest of the world. If we were running a current account surplus or trade surplus, what would happen to economic growth worldwide, and what would be the economic consequences? - Richard Fisher [President, Federal Reserve Bank of Dallas. Nick's comment: And these idiots control our money supply?]
Contented American consumers matched against delighted foreign producers. Happy borrowers matched against willing lenders. The difficulty is, the seemingly comfortable pattern can't go on indefinitely.... At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb markets.... - Paul Volcker
But not to worry, we know by now that the US economy is a service economy and does not need to produce anything to prosper except printing machines to keep increasing the supply of money (most printing machines are probably imported too).... and - according to the Census Bureau's Economic Census - with the fastest growth being registered not in "mundane" businesses such as biotechnology, nanotechnology and high tech industries but in high-value-added and intellectually highly-demanding sectors such as lawn care, childcare providers, janitorial services and nail and hair salons! - Marc Faber
Real interest rates - both short and long - are still far too low for sustainable growth in the global economy and for stable conditions in world financial markets. Yet central banks - especially America's - have been reluctant to lead the charge in normalizing the rate structure. The best we have gotten from the Fed is a policy rate that has gone from negative to zero in real terms over the past year. I continue to believe this is ultimately a recipe for disaster. - Stephen Roach
It is really starting to look like Japan's situation in the early 90s. Rates will probably move towards zero but economic growth will still be stagnant. We may have already seen the inflationary phase in the form of the stock and housing bubbles. The traditional signs of inflation may not show up this time around and that is what has people fooled into thinking that all is well. We may not get an inflationary spike, but we may end up with a long period of subpar growth. Keep in mind that despite the insane expansion of credit and liquidity, the current recovery is still nothing to write home about. - Marc Sexton
Greenspan has never demonstrated an ability to foresee a recession before the economy was already in a recession. Why would it be otherwise this time? Start warming up to the Deflationary Depression. The single best market signal of this is that the long-term US Treasury bonds continue to out-perform stocks. From the current level of household debt, no mortal can save the US economy from depression. And deflation is an overwhelming favorite, 20:1, in the race between deflation and inflation because the demand will plunge. - Jas Jain
The U.S. economic ship of state is going to sink. As the problems with her hull are structural, current efforts by government officials and central bankers to plug up the holes will not keep her afloat. Though I remain hopeful that she may one day be salvaged and returned to a sea-worthy condition, there is nothing collectively that we can do to alter her fate, or that of the millions of Americans, ignorantly dancing the night away on the lido deck. However, individually we can take defensive action to protect ourselves and our families by getting off the ship. - Peter Schiff
Mark my words. When the USA economy goes down, it will take the social structure down with it. What do you think all these people are going to do when the status quo implodes and the checks stop? Answer me that when you say all this economic stuff doesn't matter and I am just a negative, cynical crank. I live in a major city and I KNOW what will happen even if you do not. Perhaps, that denial, of what the economic consequences will be, is the greatest illusion in the USA today. - Doug McIntosh
I reckon it's only a matter of time till some portion of the sheeple (the sleeple?) wake up to the idea that if they are investing in 401-K plans with a planned withdrawal date anything much past the end of this week, they are taking on a huge - and undisclosed - systemic risk. Why? Because my friend, if the best pension brains in the world can't keep a fund solvent, why should the part-time investor relying on a commission-based system expect to beat the rest of the pack? Yeah, I know, the mantra is "Buy and hold"." But the odds seem to lengthen daily that you'll have to hold till you've been dead another lifetime before the markets will come back after what we see on the horizon. - George Ure
Bretton Woods II, by linking mercantilist emerging market countries, notably China, into a de facto monetary union with the United States, represents a positive shock to global aggregate supply relative to global aggregate demand. Consequently, it is America's global civic duty to live beyond its means. And it is the Federal Reserve's global civic duty to facilitate American hedonism, because in the face of a positive structural shock to global aggregate supply, notably labor, American hedonism is not inflationary. - Bill Gross
Mortgage rates are determined by the yield on 10-year treasury bonds in the United States. Therefore, if foreign central bank buying drives down the yield on treasury bonds, it will also push down mortgage rates, which in turn will cause the rate of increase in US property prices, already the fastest in 25 years during 2004 (and the fastest ever in real, inflation-adjusted terms), to accelerate still further. Higher property prices will allow yet more equity extraction which, in turn, will stimulate US consumption further. Additional consumption will pull in more imports and exacerbate the US current account deficit. And, a larger current account deficit will put yet more dollars in the hands of foreign central banks, who, then, will look for still more dollar-denominated assets in which to invest them. At the same time, rising house prices and booming consumption will lift US tax revenues, causing the US budget deficit to shrink much more than currently expected. In other words, if the US current account continues widening faster than the US budget deficit, it could drive down yields on government bonds and therefore the interest rates on mortgages so low that it creates an asset bubble in the United States that the Fed could not control. - Richard Duncan
Contrary to government and Wall Street propaganda, the real reason for America's trade deficit is our noncompetitive economy, which results mainly from excessive taxation and regulation and lack of domestic savings. Since nothing is being done to improve this situation, and since American consumers continue to convert house price appreciation into current consumption, expect America's trade balance to continue to deteriorate, until either the housing bubble bursts or the rest of the world comes to its senses at stops financing it. - Peter Schiff
Interest-only mortgages are enslavement! - Phil Spicer
For while the last bubble - in tech stocks - blew up without much collateral damage, we suspect that when this one [real estate] goes there could be a lot of debris flying around. Too many people now stake their standards of living on lies, deceits, and misapprehensions. The collapse of the housing bubble will force a slowdown throughout the economy. Real estate related jobs will disappear. Consumer spending will go down. People will have trouble keeping up with their payments. Credits and assets will be marked down. Our advice is: neither borrower nor lender be. Hold cash. Cut expenses. Rick up firewood and plant tomatoes. Practice saying "I told you so," to friends and neighbors, so you'll be ready when the time comes. Thrift has been out of style for a long time. Perhaps it is ready for a comeback. - Bill Bonner
As the housing market reaches its saturation asymptote and falters in a plateau state of overproduction and overcapacity, the relatively high paying financial, construction, and real estate jobs that have proliferated in the last few years will.... suddenly and dramatically decline. Just like the equity markets in 2000 had the bubble concentrated primarily in the tech sector, i.e., the NASDAQ, the housing bubble is likewise primarily concentrated in the sunbelt and coastal areas. It is, unequivocally, a major bubble, nevertheless.... Five years after the NASDAQ peak the tech bubble's valuation is 60 percent less than its 2000 peak. What would happen to the US GDP if the real estate market in five years is 60 percent less than its current value? - Gary Lammert
Given that 43% of all jobs created since 2001 are housing (bubble)-related, a decline in housing-related payrolls can be expected to reinforce housing price declines in the bust part of the cycle. - Eric Janszen
Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications. Nationwide banking and widespread securitization of mortgages make it less likely that financial intermediation would be impaired than was the case in prior episodes of regional house price corrections. Moreover, a substantial rise in bankruptcies would require a quite-significant overall reduction in the national housing price level because the vast majority of homeowners have built up substantial equity in their homes despite large home equity withdrawals in recent years financed by the mortgage market. - Alan Greenspan [Nick's comment: Less likely?]
The Fed's current dilemma is a direct result of its policy, instituted in early 2001, of trying to avert the potential damage of the bursting stock market bubble by spurring a rapid increase in housing prices.... In our view the increased Fed concern about a severe problem that they themselves created indicates that the Fed is finally starting to aim policy at soaring asset values, unlike the policy they followed during the late 1990s stock market boom, when they felt rising asset values were none of their business. The big difference this time is that an out-of-control housing market propelled by heavy bank lending is a direct threat to the health of the entire banking system in a way that the stock market was not. Therefore the Fed's focus is no longer only on inflation, but on soaring asset values as well, meaning that the tightening policy may last longer than the majority think. The problem is that even a mere cooling of the housing market, let alone a decline, kills the major impetus to the entire recovery since November 2001, and highly increases the probability of a recession and falling stock market with all of the associated risks to the fragile consumer debt structure. - Charlie Minter
US economic growth depends entirely on the continuation of the frenetic housing bubble.... All bubbles essentially end painfully, housing bubbles in particular. They are an especially dangerous sort of asset bubble, because of their extraordinary debt intensity.... they heavily entangle banks and the whole financial system as lenders. For this reason, as a matter of fact, property bubbles have historically been the regular main causes of major financial crises. During its bubble years in the late 1980s, Japan had rampant bubbles in both stocks and property. While the focus is always on the more spectacular equity bubble, hindsight leaves no doubt that the following economic disaster was mainly rooted in the property bubble. Both bubbles burst in the end, but the property deflation has continued for 13 years now, with calamitous effects on the banking system.... For consumer spending to slump in the wake of a fading housing bubble, house prices do not need to fall at all. It is sufficient that the stop rising, thereby depriving households of new wealth effects and the associated borrowing facilities. Therefore, major housing bubbles imperatively end in a hard landing. A second major adverse influence on economic growth implicitly arises from the sudden cessation of the building boom. Yet the worst looming problem is always the potential damage to the banking system through escalating bad loans. - Kurt Richebächer
As of the latest numbers, home sales as a percent of the economy are at 17%. For the statisticians out there, that's 3.4 standard deviations from the mean. For the non-statisticians out there, speculation in home buying is literally off the charts.... if you buy a house hoping to flip it within a year, you're hoping for miracles... as you have to sell the house at a profit of greater than 15% more than you paid for it, just to cover the expenses incurred along the way (commissions, property taxes, taxes on the transaction, the interest incurred from holding it a year, maintenance, etc.) It's hard to be a short-term trader of real estate, when every flip has a 15% hole in the bucket. But.... these days, people are lining up to give it a try. - Steve Sjuggerud
A frightening reality was revealed to me by a friend in the banking industry.... He tells me that unfortunately it is too easy to walk away, or default, on a home loan.... Depending on the state, certain deeds of trust allow for or require what is called a judicial foreclosure, in which the lender can get a deficiency judgment against the borrower for the balance of the loan after the property is foreclosed upon. From what I am told, that is an extremely rare occurrence in those states that do not require it. Banks are not in the real estate business, they are in the money business, and are just not willing to put forth the time and expense involved in a judicial foreclosure if they do not have to. In most cases when a borrower walks away from a mortgage loan, the lender performs the trustee sale method allowed in many states, also called a non-judicial foreclosure. In a trustee sale, the home is foreclosed upon and auctioned through the courthouse, usually at a big market value loss.... once the lender performs this trustee sale, the borrower has no further liability to the lender. If someone were to walk away from their home loan, all it would seem to hurt personally is their credit, and that's it.... When a trustee sale occurs in a declining market, the lender will most likely not recover the original loan amount, taking a loss on its books. Enough losses and the lender becomes insolvent, just like what happened in the S&L crisis years back. A banking crisis may or may not become a reality, but if an increasing number of homeowners start to default on their loans, the economic repercussions will be alarming. - Scott Wright
Many people think California home buyers are crazy for spending so much on homes, but they may not be as crazy as you think. If a homeowner in California defaults on a loan secured by a first mortgage on a single family residence, the only remedy available to the bank is to foreclose the home. There is no deficiency judgment allowed in those circumstances. In other words, the California law simply lets a defaulting buyer turn in the keys and walk away... So Californians have the best of all worlds - they get to speculate on the real estate market, and if they are wrong, they get to walk away with no consequences. It's the banks that eat the loss in California. Under these circumstances, why not speculate on real estate appreciation if you live in California? - Internet reader
A friend of ours put her apartment in central London up for sale last fall - hoping to get out at the top. In two months, she says, only one person looked at it - a crazy woman from the same building. So, she gave up and took the place off the market. Her failed sale is almost invisible. Sellers are reluctant to mark down prices. They can't believe that the market has changed direction. Instead, they expect buyers to come back. Prices don't fall quickly. But the inventory of unsold properties builds up. Houses are unlike stocks in that it costs something to own them - taxes, insurance, heat, and maintenance. As the slump continues, owners must keep digging into their pockets to pay the monthly costs. And they are still unsure what is going on. Then, stories begin to circulate. Marginal owners become desperate; they cut their asking prices sharply to unload properties. But people still do not expect a prolonged bear market. - Bill Bonner
I live in a controlled development where houses begin in the low $400,000s. Our neighborhoods are like ghost towns during the day due to the fleecing of the American worker in taxes, forcing the mothers of America into the workplace. A sight becoming more common around here: tow trucks loaded with a Lexus, or Honda. After checking with security - who were also concerned about auto theft - these aren't broken cars, they're bank repos. - Devvy Kidd
We visited friends in northern New Jersey and got to talking about real estate. My host told me that in neighborhoods across the region, homebuyers and small builders have started to purchase older small houses (2/1 or 2/2 homes) that sell in the $300,000 to $350,000 range and demolished them -- not refurbish or upgrade the homes, but demolish them -- and built much larger ones on the property. Driving around I saw several such new (or under construction) homes myself, looking completely out of place with other homes nearby; my host figured that hundreds of such "replacements" must have gone up during the past year or two. Obviously this account is anecdotal, but it's my first-hand perspective of what the real estate bubble looks like within a 30-45 minute drive of the New Jersey side of the George Washington Bridge. - Robert Folsom
Investors represented over 25% of the homes sold during 2004. Foreclosures are up in the first quarter, and now speculators have cut down on buying, and are cashing out. - Alexis McGee [president, Foreclosure.com]
We are clearly seeing a spike in foreclosures in a number of our major urban areas. If we are not careful, the American dream can quickly turn into the American nightmare. - Julie L. Williams [US Comptroller of the Currency, June 6, 2005]
The mainstays of the US bond market, China and Japan, aren't buying. Hedge funds are. But their support for the dollar, which has the effect of keeping interest rates down, is merely a trade, not a policy. When the hedge funds sell, or quit buying, who will pick up the slack? No one. Interest rates will go up. Puff goes the American housing market. Down goes the dollar. - Dan Denning
History shows that no government, after going on a fiat monetary system, ever reverses course until its paper
currency is destroyed. There is no reason to believe this time will be any different. - Paul Kasriel
And my answer is: Definitely not as much as I used to be, partly because now that I am in retirement mode my retirement assets are all tied up in TIAA-CREF rather than in individual stocks, so The Contrarian's View is now more of a mutual-fund timing service. Also, some of the really interesting (and profitable) stuff I did 20 years ago, such as "Regulation T" shorts of common stock against warrants held long, very few people were doing then, but today a gazillion hedge funds are doing it, which has all but eliminated any meaningful profits (and replaced them with a field of financial land mines).
But more to the point is my suspicion that the "Plunge Protection Team" is active in propping up stock prices with futures buying. A rigged market isn't very enticing. It encourages hedge funds to move in and arbitrage what little action there is, sucking out any remaining profit for the poor schmucks who are trying to sock away retirement money. The 2% or less dividends one collects while stocks drift aimlessly barely cover mutual-fund expenses and management fees, and you're in the hole after taxes if your money isn't in a tax-deferred plan.
The "technical" indicators of the market aren't all that bad (which is why I've been calling for a choppy but essentially neutral stock market). The problem is, I think the usual traditional technical indicators don't measure much any more, at least as far as anticipating the future direction of stock prices goes. What they do measure is the extent to which the Fed has control of the market and, as a corollary, the economy.
When the Fed's machinations are producing the desired outcomes, stocks, the technical indicators and (for the time being) the economy are behaving the way our government masters wish. When the Fed starts losing control, as it did for a time in 2002 in spite of its interest-rate cuts and money-printing, then the indicators, the market and the economy will head south. But this is likely to be coincident behavior, without predictive value, rather than giving us the usual six months' lead-time warning that markets of the past did.
You can see this in the current action. The economy is clearly headed for at least a soft spot, if not something more serious.... a recession or depression.... as the housing bubble deflates. But you'd never know it from looking at the stock market or its technical indicators.
Stocks won't ignore economic reality forever.... they'll catch up. So I expect the next major downleg of this decade-plus bear market to pick up steam in the fall and extend to about mid-2006 (maybe longer) when the Fed again loses control to a lesser or greater degree as the asset deflation sets in. Just don't expect stocks to give any advance warning. They're only along for the ride.
The risk of systemic failure is currently at about
20% as hedge funds unwind their "carry trades". In
about two weeks it will revert to 15% until stocks go
bananas in the fall, when I'll take another look at it.
A. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG":
Original cost: $10,699.00
Present value: $17,821.49
Increase: $ 7,122.49 [+66.57%]
COMMENT on "PIG": There is no change from the last issue.
TIAA/CREF 403(b) retirement plan; I switch between indexed stock/bond/money funds:
(No transactions since June 30, 2004 due to my retired status. Update soon, I hope!)
Values, 29Jun2005: stock, 192.57; equity-index, 78.55; MM, 22.28; bond, 76.42; inflation-indexed bond, 46.45; real estate, 222.09; TIAA current yield
in SRA, about 5.2%. Current money-market yield is 2.85%.
Gain, 1988: 18.91%; 1989: 14.48%; 1990: 8.28%; 1991: 27.93%; 1992: 10.20%; 1993:
3.08%; 1994: 4.07%; 1995: 4.80%; 1996: 5.28%; 1997: 5.38%; 1998: 5.72%; 1999: 5.12%;
2000: 9.99%; 2001: 1.11%
Gain, January 1 through March 31, 2002: 0.97% (3.86% annual rate of return)
Total gain since January 1, 1988 (14.25 years): 223.43%
Compound annual rate of return: 8.59%
Gain shown excludes the impact of additional monthly cash contributions.
(Please note that I have not had the time to calculate my rate of return beyond March 2002, and
may not get the time until 2005)
Buying CREF stock on January 1, 1988 and holding it gained 422.38%, for a compound annual rate of
return of 11.46%.
COMMENT on NYSE "Timer's Trend": We are currently on a BUY signal of May 17, 2005 (whipsawing!).
COMMENT on NASDAQ "Timer's Trend": We're on a SELL signal given June 23, 2005.
NEXT ISSUE - will appear near the end of July.