The Daily Reckoning - Poor House II (Bill Bonner)

verfasst von Firmian, 11.10.2003, 01:17

-->Poor House II

The Daily Reckoning

Paris, France

Friday, 10 October 2003

-------------------------

*** Stocks up... dollar up... euro down... gold down... It just
gets madder and madder...

*** Russia may begin pricing its oil in euros...

*** When will the bear market end? 2016? Running into
people... and more!

------------------------

The Nasdaq is selling at 8 times SALES... but stocks went up
yesterday.

Even at Wal-Mart, the people who know what they are doing
are selling stock... but the lumpeninvestoriat takes no
notice; the dumb money keeps buying.

Asians work for 1/5th to 1/10th the wages of Americans. And
Asians economies are growing 2 to 3 times faster than the
U.S.. Still, Asian stocks are priced much lower than stocks
on Wall Street.

The U.S. is running a current account deficit of about $1
million PER MINUTE... but the dollar rose yesterday.

The average American is deeper in debt than at any time in
history... but consumer spending just rose at the fastest
pace in 18 months.

The Moscow Times reports that Russia, the world's second-
largest oil exporter, is considering shifting its oil
dealings from the dollar to the euro... but the price of the
euro fell against the dollar yesterday.

As a percentage of family income, house prices have risen
nearly 50% since the early 70s. Houses are selling for such
high prices that fewer and fewer people can afford
them... but the price of the median house continues to rise
five times faster than income.

The U.S. army is the greatest offensive military force the
world has ever seen. But it has been placed in a position
where it is forced to DEFEND itself against desert
tribes... and the price of gold still dropped more than $6
yesterday.

Meanwhile, the world's only super-power seems to be at war
with ITSELF over what to do next, both on the economic
front and in the Iraqi front. It is running a budget
deficit of more than $1 billion per day...

.. and people lend it money as if it were the Eisenhower
years.

The more we think about it, the more we love this
market... this economy... this world! It gets madder and
madder. But imagine how boring it would be if people did
the reasonable thing?

Instead, we are treated to the spectacle of investors,
economists, homeowners and politicians sitting on stacks of
dynamite... and lighting the fuse!

Advice to readers: watch out. Sell the dollar, sell the
Nasdaq, sell Treasuries, sell real estate. Buy gold, the
euro and Asian stocks.

And now over to Addison with more of the madness of crowds:

-------------

Addison Wiggin, writing from Paris...

- Little by little, people are beginning to realize that
reports of growth in the GDP are greatly exaggerated. Last
week, an economist at Merrill Lynch went public with the
story."One economist who's telling the truth," is the
headline in the NY Post.

- According to John Crudele, the column's author, David A.
Rosenberg, Merrill Lynch's chief economist for North America,
has a bone to pick with government statistics. First of all,
Rosenberg"concluded that the money being spent on computers
and other technology by businesses is nowhere near what is
being reported by the government."

- Using what our own Dr. Richebächer calls"hedonic price
indexing" - valuing computers by their computing potential,
rather than dollars spent on them - government number
crunchers pretend that businesses have spent $133 billion on
computers and peripherals since the recession bottomed out.
In fact, according to Rosenberg, the number is closer to $15
billion.

- Crudele:"[Rosenberg] notes that the tech spending
'accounted for 30 percent of the overall increase in GDP, so
the economy ex-computer expenditures has only risen at a 2
percent annual rate.' The government is officially reporting
GDP at nearly twice that rate."

- Secondly, Rosenberg's work suggests the recent report on
job figures - the vaunted 57,000 increase that arrested media
musings on the 'jobless recovery' - was"not a strong report
in and of itself and we shouldn't let the shock factor of a
'+' sign confuse matters... more companies are still cutting
workers than adding them; the drop in hourly wages shows
'income growth is sluggish'; and the number of people who
only have a part-time job because they can't find full-time
work soared last month."

- Yesterday, the market spent the better part of the morning
climbing higher as several bullish pieces of news floated
about the ether. Strong earnings results rolled in from the
New Era holdout Yahoo... and a less-severe-than-expected new
jobless claims report put in an appearance. The major
averages were all up - the Dow climbed 49 points to 9680, the
Nasdaq rose 18 to 1911, and the S&P 500 closed at 1038 after
rising 5 points.

- The mid-cap S&P 400 and small-cap Russell 2000 indices both
put in new 52-week highs.

- We remember our friend John Mauldin asking earlier this
year:"What if they threw a dollar devaluation party, and
nobody came?" Certainly, the dollar has been under pressure
since officials of the G7 met at Dubai, and John Snow & Co.
began gently trying to talk the dollar down from the
precipice off of which it is currently considering a swan
dive. But Snow's sweet nothings have not stopped Japan from
intervening to restrain the yen. According to Reuter's, they
have even enlisted the help of the New York Federal Reserve
to sell yen on its behalf.

-"Much of the dollars bought in that intervention could well
end up in U.S. assets and will be held by the Fed," Reuter's
reports,"which holds some $786 billion of Treasuries on
behalf of foreign central banks, mostly from Asia." And the
reflation attempt goes on...

- Meanwhile, fearing their own economy may be 'overheating,'
the Chinese have moved to limit foreign direct investment.
According to a piece in London's Financial Times,"China has
stalled the expansion of a scheme to attract foreign
investment funds into its domestic capital markets because of
concerns about its use by investment banks for currency
speculation." The British bank HSBC was shut out of half of a
recent $100m bid... and an informal request from Union Bank of
Switzerland to increase its $300m target was rejected flat
out.

- Singapore, a leading member of the ASEAN trade pact we
talked about yesterday, saw 3rd-quarter GDP come in at an
annualized 15%...

- In his book Tomorrow's Gold, Marc Faber describes the
world's capital markets by way of metaphor. Imagine the
world's investment funding as water filling a large bowl. For
much of the last decade, that bowl has sat squarely over the
corner of Wall and Broad in lower Manhattan. Despite the
combined efforts of all the world's meddling central bankers,
the bowl appears to be steadfastly tipping toward the Asian
markets... waiting for the great inundation to begin.

-------------

Bill Bonner, back in Paris...

*** Stocks have been rising. But it is almost surely just a
normal rally in an extraordinary bear market. How long
might the bear market last?

A message on the Richard Russell website gives a clue:

1910-1929 - Bull market, DJIA peaks at 381
1929-1948 - Bear market, DJIA went as low as 41 in 1933 and
ended in 1948 at 161
1948-1966 - Bull market, DJIA goes from 161-975
1966-1982 - Bear market - DJIA starts at 975, goes to 1000,
bottoms in 1973 at 577 and finishes in 1982 at 974.
1982-2000 - Greatest bull market in history, DJIA goes from
974 - 11,722
2000-???? - Potentially the greatest bear market in history

***"Do you mean to tell me that you paid $200,000 for a
broken-down house in a third-world slum..." asked a
business partner yesterday evening,"... and that you
actually made the deal while a potential revolution was
being whipped up in the town plaza?"

We could not deny it.

"But I thought you were supposed to be a conservative,
risk-averse investor," came the accusation.

"Well," we replied,"we are risk-averse. Like Warren
Buffett, we never buy anything that we would not want to
own for life. And if we're ever on the lam we could hide
out down here. We could sit in a rocking chair drinking rum
and fruit punch until our liver or our money ran out."

*** We just got back in the office after a visit to Latin
America. We hate traveling, but occasionally and literally
bump into interesting people. On this trip, we practically
knocked over a pretty young woman in the Miami airport.

"Do you know who that what was," asked a traveling
companion.

"No idea..."

"Anna Kournikova... the famous tennis player who poses in
men's magazines...?

"Hmmm....she ought to look where she's going."

---------------------

The Daily Reckoning PRESENTS: The miracle of No-Sweat
Equity...


POOR HOUSE II
By Bill Bonner

Today, we return to our courtroom drama.

You will recall, dear reader, we are arguing that the
typical house is not what it appears to be. It pretends to
make its owner rich; instead, it makes him poor.

Practically every sentient being with a U.S. passport
believes the opposite - that buying a house is a nearly
risk-free/reward-guaranteed proposition. Taking the other
side of the argument clearly puts us in a very small
minority. We look around, and we are practically alone. So,
the burden of proof is on us. Last week we carried the load
a short way. Today, we pick it up again and teeter on.

Your editor begins by disclosing a prejudice: he is a
sucker for real estate. He likes the feel of dirt beneath
his feet and under his fingernails. He is comforted by the
notion that - should the world go to Hell as he has been
predicting - at least he would have a place to live. He
even imagines himself living well - eating the fruits of
his own garden. In extremis, he might even slaughter his
wife's obnoxious horses and roast them over an open fire
while swilling his own homemade hooch out of an old jar.
For luxuries and heating oil, he could dig up a gold coin
or two when needed.

On the whole, the end of the world might not be so bad.

Since he is making disclosures, your editor might also
confess a mixed record when it comes to real estate
investing. He has spent the week down in Nicaragua,
scouting real estate investment possibilities. But this is
not the first time he has been a pioneer in the Third
World. Two decades ago, he bought a house in a bad
neighborhood in Baltimore. He paid almost nothing for it
and restored it himself. Back then, he felt he was building
'sweat equity' in the property. Only later did he discover
that his perspiration was not worth very much. He could
improve the house, he discovered. But not the city around
it. When the final tally was made, he found that he had
lost money on an actual cash basis. For all his sweating,
he had earned not a penny.

Typically, our experience was at odds with the rest of the
world. In a sea of rising property prices, your editor
managed to find a leaky boat.

But the real tidal increase in property prices began
later... about 8 years ago. In that period, house prices
rose 3 times faster than rents. Not since The Flood has
there been such a lift. Prices rose nearly 50% in nominal
terms, almost 30% more than the increase in inflation.
Without lifting a finger, the nation's homeowners found
themselves $2.7 trillion richer - about $35,000 extra for
every one of them. Where did the money come from, we
wondered last week?

In almost every community, the story was much the same. You
could toss a congressman out of a helicopter almost
anywhere in the country; it was very unlikely he'd fall
upon a house that had not gone up in price.

But we contend that houses have not really made people
wealthy at all. In fact, they've made them poor. How can
that be?

Last week, we established an important point: that the
house itself - the physical thing - couldn't possibly
increase in value. All its components deteriorate,
depreciate, fade and decay - just like everything else.

And now we call our star witness.

"Mr. Alan Greenspan, would you step up to the witness
stand, please?

"Mr. Greenspan, you have sworn to tell the truth, the whole
truth and nothing but the truth, isn't that right?

"Of course, you wouldn't tell lies, we just wanted to make
sure...

"Now, isn't it true you have said many times that your
lower interest rates were a big help to consumers? In fact,
wasn't it as recently as a few weeks ago that you testified
before Congress that consumers were in 'better shape,'
since they had been able to refinance their debts at lower
rates?

"Now, to tell you the truth, you might as well have gotten
down on all fours and barked... it would have made as much
sense to us. As near as we can tell, consumers have never
been in worse shape.

"Of course, as chief of the Federal Reserve system, you are
well aware of the numbers. The old rule was that lenders
insisted that monthly mortgage payments not exceed 28% of
gross income. They called that the 'back-end ratio.' But as
people came to believe that real estate always goes up,
both borrowers and lenders began to loosen up. Now, in
expensive markets such as Boston and San Diego, the
percentage of income devoted to mortgage payments has risen
to more than 43%. In San Francisco, the average family
spends 47% of its pre-tax income on mortgage payments.

"San Francisco must be the Nasdaq of real-estate markets,
wouldn't you agree? The median house there sells for
$515,000. Only 14% of the people in the area can qualify to
buy a house... and those who do spend 5 to 6 times their
annual income on it. Thirty years ago, the median house
cost 2.1 times median income.

"Much of the reason for the increase in real estate prices
must simply be that it is easier to borrow money, wouldn't
you guess? Even very poor credit risks are routinely
cleared for mortgages these days, aren't they? Because
everyone is so sure house prices will keep going up. As
long as prices are rising, why worry? If the homeowner runs
into trouble, he can always sell his house for a higher
price. Or, the bank can resell it for him.

"But isn't it true, too, that lending to the marginal
credit risk is a little like introducing your daughter to a
marginal sports star? If you make it too easy for him,
there is almost sure to be trouble.

"Thanks to your policies, and the innovations of the
financial industry, credit has never been easier to come
by. As a consequence, debt has increased for the last 30
years... and it has continued to increase even through the
recession of 2001... and right up to the present. In
absolute terms, as well as by most relative measures,
Americans are more in debt than at any time in history. And
after record levels of mortgage refinancing, never before
have they owned so little of their own homes.

"In light of all that, would you care to explain what you
meant by consumers being in 'better shape'?"

[Unintelligible response.]

"Well, let's approach it in another way.

"Do you read the papers, Mr. Chairman?

"You do?

"Good. Well, have you seen an advertisement offering an
equity line of credit? It has a drawing of a house with
bags of money under it. 'Go ahead... it's yours... you have a
right to it... take it out... spend it... ' the ad says, or
something like that.

"Well, now... there wouldn't be any ads like that if rates
hadn't been cut so dramatically, would there?

"Of course not.

"And there wouldn't be a refinancing boom, either, right?
And if there were no refinancing boom, consumers wouldn't
have been able to keep spending, could they?

"Now we understand that you regard all this as a good
thing. If consumers had not been able to keep taking the
'equity' out of their houses... the whole world economy
would have fallen into recession, wouldn't it? Americans
wouldn't have had any money to spend. Foreigners wouldn't
have been able to sell their products. Nor would they have
been able to accumulate hundreds of billions of dollars or
to reinvest them in U.S. Treasury bonds. There wouldn't be
such a huge trade deficit... and no way to finance the
federal deficit or the war against Iraq... at least not at
current interest rates.

"Wouldn't you agree?

"You would? Good.

"So, you would say that the whole world economy depends on
the rate cuts and on consumers' willingness to continue
taking out 'equity' from their houses, right?

"Yes, it is fairly obvious. But now a more difficult
question. Are you ready for this, Mr. Chairman? Here goes:

"What exactly is this 'equity'? We understand money you
make from working. Or profits you make in your business. Or
money you've saved up. But this no-sweat equity is
something different, isn't it? It seems to come out of
nowhere, almost magically. Houses are supposed to provide a
sort of dividend for their owners; they give them a roof
over their heads. But isn't it a bit peculiar that they
should produce extra cash, too?

"What is this money? We've put the question to others. No
one has had a good answer. We were counting on you, Mr.
Chairman. As the best-known central banker since John Law,
we thought you might be able to tell us what this money -
this money that the world relies upon so heavily - really
is.

"Well, let us jog your brain a bit.

"Isn't it possible that there really is no money there? A
house is a house is a house, after all. It is a consumer
item, not a capital asset. What is really happening is that
the house owner is merely borrowing against the inflated
value of it. And isn't it possible that the house is
subject to the same fits of 'irrational exuberance' - as
you put it - as the stock market? Isn't it true that the
mortgage industry is merely acting like the brokerage
industry in a bubble market - lending money on the inflated
value of the asset? And isn't it correct to say that this
lending is itself contributing to the bubble in prices?

"You know how it works; you watched the same thing in
stocks three years ago. You said you couldn't tell it was a
bubble back then. But now that you've seen one up close,
maybe you are better able to see the next one? A fellow
sees his house going up at 10% per year. He figures he'll
buy another one. How can he resist? It's easy money, isn't
it? Especially since, as everyone knows, house prices never
go down.

"But you remember Hyman Minsky? He pointed out that
'stability produces instability,' didn't he? The idea was
that the more people come to believe something is sure, the
less sure it becomes. As everyone came to believe that
house prices only go up, lenders lent more freely and
buyers spent more freely. Naturally, prices rose. This
convinced other buyers that they should get in while the
getting was good. Before you knew it, real estate prices
had taken off, rising far faster than the incomes of the
people who were to buy them.

"And isn't that exactly what has happened in America? The
average after-tax, after-inflation income is barely rising
at all. And yet, house prices are going up at 10% per year
and more. Yesterday, we read that house prices in Minnesota
have risen 50% in the last 4 years. And last year alone, in
places as diverse as Topeka, KS, and Providence, RI, they
were up nearly 20%. In Nassau County, NY, they were
reported rising at an unbelievable 26%. How long can that
last?

"You don't know? Well, we don't know either, but it
definitely can't last forever, can it? There must come a
time when the average person can no longer afford the
average house and when some people need to sell. Then what?

"Of course, we're not blaming you, Mr. Chairman, we're just
trying to get to the bottom of it... to understand what is
going on.

"Now let me ask you another question. If house prices can
stop rising, they can also go down... isn't that correct?
And isn't it also correct to say that, in fact, sooner or
later, they will go down? Isn't this exactly what happened
following every stock market bubble of the last 70 years -
in Japan, Korea, Hong Kong, the Philippines, Thailand,
Indonesia, Mexico and Brazil?

"And what do you think will happen to homeowners who have
taken out the equity in their houses? They will still have
to pay interest on it, won't they? In fact, at some point
they will even have to put the equity back in... right? When
they sell, for example?

"And now, here's something interesting. Even in a bad
economy, most people will be all right, of course. Most
won't have to sell. So, you might assume that property
prices will stay fairly stable. But that's not really true,
is it? In Japan, residential properties have fallen 23%
since 1991.

"Prices are set by the properties that sell, not by those
that don't change hands. In a crunch, all it will take is a
few desperate neighbors and your house could decline in
value by 10%... 20%... or even more.

"Yes, but? What but?

"We're not asking you to predict the future. We are talking
about the present. We just want you to admit that a
homeowner who takes 'equity' out of his house is actually
poorer than the one who does not. And since low interest
rates and rising real estate prices are an invitation to
'take out' this 'equity,' it might also be correct to say
that the boom in the real estate market has actually made
the marginal homeowner poorer. Am I wrong about that?"

[Unintelligible response.]

"You may step down, Mr. Greenspan, we have no further
questions for you..."

And now, let us call our final witness: you, dear reader.

Let us begin with the same question we've posed to our
other witnesses. What is this no-sweat 'equity' people take
out of their homes? Is it really any different from any
other promise of something for nothing?

And like every other promise of something for nothing,
won't it more than likely end in more nothing than
something?

And won't millions of homeowners end up sweating their
equity after all?


Bill Bonner

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• The Daily Reckoning - Poor House II (Bill Bonner) - Firmian, 11.10.2003, 01:17