Contrarian Chronicles
The housing bubble doesn't
add up
Just like stock prices, real estate prices
will not go up forever. We can't all live in million-dollar houses. Thatâs what
scares me and should scare you.
By Bill Fleckenstein
It might be hard for folks to
step back and see a speculative housing environment for what it is -- especially
when the frenzy has furnished a lifestyle beyond their means. But we all can't
live forever in dream homes financed by dangerous debt levels. The "math"
suggests that this tenuous fantasy ultimately will fail.
Last week, I had a chance to read "The Asset
Economy," the most recent
article by Morgan Stanleyâs Stephen Roach. He is probably the lone economist
working on Wall Street who understands what has been going on during Greenspan's
tenure. Kudos to him for standing up tall and telling it like it is amidst the
ocean of dead fish surrounding him.
His latest article really put the current speculative
environment into perspective. Oftentimes, it's just that, perspective, which is
needed. I urge everyone to read the article and think about its
ramifications.
Insanity reigns in real
estate
Roachâs main point is this: Beginning with the big equity
bubble, folks started using their assets to live beyond their means. First, it
was stock-option wampum and other gains that resulted from the insanity. Now
folks use their houses as ATMs. Then, he adds:
Stepping back from the
data flow, it is important to appreciate the consequences of the asset economy.
A more chilling picture emerges. Courtesy of the Great Bubble of the late 1990s,
the American consumer discovered the sheer ecstasy of converting asset holdings
into spending power. Households learned to spend beyond their means -- as those
means are defined by growth in disposable personal income. Yet when the equity
bubble popped, the consumer never skipped a beat. There was a seamless
transition to another asset class -- property. And the joys of asset-driven
consumption continued unabated.
Income-based consumption
had, in effect, become passÃ, and American households went on an unprecedented
debt binge. No one seemed to care that the personal saving rate had fallen from
5.7% in the pre-bubble days of early 1995 to 1.0% in late 2001 (and now stands
at just 2.3%). In the asset economy, who needs to save out of his or her
paychecks? Who needs to worry about debt? Asset markets, goes the argument, had
emerged as a new and presumably permanent source of saving for the American
consumer. . . .
I must confess to being just as suspicious of this new
paradigm as I was of another such scheme back in the late 1990s. As the bursting
of the equity bubble should forever remind us, there is no guarantee of
permanence to asset values and the wealth effects they spawn.
We canât all live in $1-million
houses
One point Steve Roach
doesn't make is that the math for housing simply doesn't work. Not everybody in
this country can live in a $1 million house or some higher-priced mansion. The
income necessary to support the debt service just isn't there.
Housing
got a boost in the stock mania because people rolled their gains into real
estate. That was on shaky ground, as we dealt with the aftermath of the stock
bubble. But then we got on "firmer" ground in the last 15 months or so, via all
the government stimulus and low interest rates that sparked a speculative frenzy
in housing, which continues to this day.
Money coming into the hot
housing market is pushing up prices. This not only allows people to live beyond
their means but also creates the capital gains to advance to the next bigger
house -- or multiple houses. Of course, the total collapse in lending standards
has abetted this process, since folks can take out 100% loans (or more, in some
cases). It's as though every lender feels that every borrower is a triple-A
credit and can't possibly borrow too much.
When
the math does not work
We have seen drunken
lending orgies in the past, and they always end in disaster. Just as the math
hasn't worked for everyone to live in a super-expensive house, no matter their
income, the math doesn't work in lending, either. That's two pieces of the
housing market where the math just does not work.
In the short run, saying
that the math doesn't work doesn't matter. But in the long run, the math does
matter. Let me give you an example: Back in 1980, when gold was $600 an ounce
and interest rates were 12%, I remember thinking, how could anyone buy gold at
that price instead of a Treasury bond? The math made no sense. In fact, for gold
to keep up with the compound rate of return available from a Treasury (assuming
the reinvestment rate was also 12%), the price of gold from 1980 to 2010 would
have had to rise to almost $18,000 an ounce. That seemed impossible to
me.
Often, we see situations where it's clear that things cannot
conceivably work out. What I like to say is that it's completely and totally
knowable that certain events are preordained. However, what's usually not
knowable is the timing, which only can be ascertained as it is actually
occurring. Thus, all we can do as investors is wait and see (and then pounce) if
what we expect to occur actually does.
Bubblenomics: A window into 'home'
economics
Also, you can be very
close to the end of some phenomenon that's completely and totally knowable, and
you can look completely stupid as things get even wilder. Hereâs another
example: In October 1999, I gave what I think is probably the best speech that I
will ever make in my life, âSpinning Financial Illusions: The Story
of Bubblenomics.â (If you believe that the housing bubble will never
end, I encourage you to read the speech and think about what it was like at that
time -- when it seemed the stock mania would never end.)
My observations
in 1999 about what was happening and what would ultimately happen were fairly
accurate. That said, the Nasdaq ($COMPX) doubled in the five
months after my speech, making me look like a complete and total idiot, when, in
fact, I was essentially dead right. This happens all the time. Markets tend to
make you look the silliest just before they're about to change.
My point
in bringing this up is to lend some perspective to the lunacy in housing and the
continued denial/semi-lunacy we see in equities. The Fed and the government have
attempted to bail out the aftermath of our giant stock bubble with a leveraged
real-estate bubble. This will end in disaster, guaranteed -- no ifs, ands, or
buts about it -- though, to repeat, what we cannot know is the
timing.
Paying the piper for Fed
'prosperity'
Meanwhile, the longer the
insanity persists, the greater the frustration on the part of people who've
acted prudently and tried to prepare themselves. I suspect that's what makes
them angry or causes some folks just to whine. But thatâs the nature of markets.
It's not easy to get rich or even make money in the markets, and folks shouldn't
expect it to be easy. After all, if it were, everyone would be rich, which is
another mathematical absurdity.
Back during the stock mania, I
received a legitimate complaint from one sane fellow: The problem with being a
"level head" (his description of folks who didn't believe in the mania), as
opposed to being a "bubble head", is that when the aftermath of the stock mania
played out, even level heads would have to suffer.
That was true then,
and it will be true prospectively. It's one of my complaints about the
irresponsible actions of the Fed. Everybody will be made to suffer, thanks to
the incompetence and sheer arrogance of the Fed. That is one of the reasons why
I have such contempt for Greenspan and the rest of the central planners at the
Fed.
Bill Fleckenstein is president of Fleckenstein Capital, which
manages a hedge fund based in Seattle. He also writes a daily Market Rap column
on his Fleckensteincapital.com site. His investment positions can change at any
time. Under no circumstances does the information in this column represent a
recommendation to buy, sell or hold any security. At the time of publication, he
did not own or control any of the equities mentioned in this column. The views
and opinions expressed in Bill Fleckenstein's columns are his own and not
necessarily those of CNBC on MSN Money.
