The Rude Awakening
Wall Street, New York
Tuesday, June 28, 2005
------------------------- - Why your "home ATM" might be about to run out of
crisp, high denomination bills,
- Will you be stuck cleaning up after the enormous
house party and,
- Storming Capital Hill with reason and sturdy aplomb,
your chance to join the "awakening of the
politicians." And plenty more…
------------------------- Eric Fry, reporting from somewhere near the housing
bubble… A good friend of mine has a beautiful home for sale at what
would seem to be the going price…but it's not going
anywhere. Everyone who looks at this charming residence
seems to love it, but no one is buying it. Suddenly, in my neighborhood, cautious "home-lookers" seem
to greatly outnumber eager home-buyers. Is this the
beginning of the end of the housing boom? Is this, as many
of us have been dreading, the end of the house party?
If it is, we might be cleaning up the after-party mess for
a very long time. That's because the precarious state of the U.S. housing
market is not simply a result of leveraged speculation; it
is a result of NAÏVE leveraged speculation. Very few
homebuyers seem to appreciate the risks they are assuming.
Because prices have been rising for so long, many home-
buyers believe prices will continue to rise. And because
they believe prices will continue to rise, they devise
ever-more-creative ways to control as much real estate as
possible with as little starting equity as possible. And
even after buying, they continue to suck equity out of
their homes. In such an environment…Prudence seems idiotic, while
idiocy masquerades as prudence. "If you paid your mortgage off, it means you probably did
not manage your funds efficiently over the years," said
David Lereah, chief economist of the National Association
of Realtors and author of "Are You Missing the Real Estate
Boom?" "It's as if you had 500,000 dollar bills stuffed in
your mattress." Lereah scorns such fiscal conservatism as "very
unsophisticated." "If you own your own home free and clear," another
mortgage-industry executive related, "people will often
refer to you as a fool. All that money sitting there, doing
nothing." Call us old-fashioned (and "unsophisticated"), but we
suspect that paying off debts is much more prudent than
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By Eric J. Fry Asset bubbles are never merely financial; they are the
love-children of leveraged speculation and warped
perception. Sadly, even though these offspring seem so full
of life in the flower of their youth, they cannot survive
adversity…especially the sort of adversity that includes
rising interest rates. That's why the U.S. housing bubble will very soon perish.
Rising interest rates will claim the housing bubble,
promises Bill Gross, the nation's preeminent bond fund
manager, just like rising interest rates have claimed
nearly every bubble that has gone before it. No mortal may ever know death's appointed hour, but Gross
believes a few specific telltale signs will portend the
last days of the housing bubble. Indeed, he believes the
first of these telltale signs may already have come to
pass: A 300-basis point jump in short-term interest rates. "I think it's pretty clear," Gross relates, "that real
housing prices have peaked on average four to six quarters
after the central bank first raises interest rates and
following what appears to be 200 basis points of short-term
rate hikes. The tightening then continues (too much
exuberance!) another two quarters thereafter for what looks
like a total cyclical increase of 300 basis points or so." Guess what? The Fed's rate hike last Wednesday brought the
"total cyclical increase" in short-term rates to 300 basis
points since June of 2004. (In other words, the Fed has
hiked the fed funds rate from 1% to 4%). "That's dead on
the average point where real housing prices have peaked
over the past 35 years," Gross notes. Americans are enjoying a growing economy, says Gross, "but
one which is acutely dependent on housing continuing to go
up, equity continuing to be extracted, and consumption
continuing to be motivated by what seems to be an endless
chain of paper prosperity. "Wiser and more experienced counsel know that such a
foundation for wealth generation is really a castle built
on sand instead of granite, and the only question is when
the tide will rush in to wash it away…let me summarize my
sequence for house bubble popping or froth skimming: 1) Housing prices will cool/stop going up very much/even
go down in some cities, WHEN… a. Interest rates rise to a high enough level to
make the purchase of a new home a burden
instead of a boon for first time buyers. b. Mild regulatory pressure begins to reduce the
amount of funny-money lending.
c. Speculators sniff the beginning of the end.
2) Home equitization should retreat shortly thereafter. 3) Consumption/the U.S. economy will then weaken when
the house ATM starts running out of fresh new
$25,000/$50,000/$100,000 home equity loan dollar
bills. 4) The Fed will cut interest rates in order to start
the game all over again. "Make no mistake about it," Gross ominously concludes, "the
froth in the U.S. housing market is about to lose its
effervescence; the bubble is about to become less bubbly.
If real housing prices decline in the U.S. in 2006 or 2007,
a recession is nearly inevitable." Gross fears a recession…we fear a catastrophe. Because
the housing boom seems more bubble-like than not, the
effects could be much more devastating than most
prognosticators, including Gross, would anticipate. "Operating in bubble markets, many people lose their
bearings," observes James Grant, editor of Grant's Interest
Rate Observer. "They become disoriented, financially and
morally. As most investors shrugged off the preposterous
high-tech valuations of early 2000 (they had become used to
them), so they are prepared to explain away the risk-
fraught mortgage-lending practices of 2005 (they have grown
used to them to)." Sign Up For The Daily Reckoning Written by the authors of the New York Times business #1 bestseller Financial Reckoning Day, The Daily Reckoning has the most innovative way of weaving valuable information about investing and living into a format that is not only educational but also entertaining. To sign up for this FREE service enter your e-mail address below. | |
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