The After-Life

Financial bubbles are mortal organisms. Even though they
might seem immortal for a time, they never live forever.
The housing bubble will be no different. It will

Are we ready for the after-life? Are we prepared to cross
over into that netherworld where home prices tumble from
the heavens like falling angels, and where property
speculators weep and gnash their teeth and where the U.S.
economy itself abides in the outer darkness of excess debt
and inadequate savings?

Based on America’s limited capacity to absorb a substantial
bear market in housing, we fear that very few homeowners
will find salvation in the afterlife of the bubble. A
select few of us might achieve a partial salvation,
provided we have not committed the mortal sins of borrowing
too much or saving too little.

"US economic growth depends entirely on the continuation of
the frenetic housing bubble," warns Dr. Kurt Richebacher,
editor of the Richebacher Letter.

Dr. Kurt may be wrong, of course. But what if he isn’t? Is
America prepared for the end of the bubble? Are any of us
prepared? Most macroeconomic indications do not inspire

Real Estate, both as an asset class and as an industry, has
assumed such an outsized share of US economic activity,
that the entire economy would mourn the passing of the
housing boom.

Let’s consider a few surprising – if not alarming – facts.

Since the end of 2001, housing-related industries have
produced a whopping 43% of the nation’s total net private
sector employment growth. Obviously, therefore, any
slackening of real estate activity would slow employment
growth in the industry. Indeed, this massive job-creator
could become a job-destroyer.

The nation’s banking operations have also become heavily
reliant on the real estate sector. Mortgage-related assets
at U.S. banks have swelled to more than 60% of total
assets. As the chart below illustrates, mortgage lending
used to comprise a much smaller share of total bank

Back in the days of Eisenhower, Kennedy and Johnson, U.S.
banks would lend to businesses for the purpose of investing
in plant and equipment. Today, banks lend to homeowners for
the purpose of buying garden plants and stereo equipment.
Additionally, the American homeowners of 40 years ago were
far more likely to pay off their mortgage debts than to
increase them.

Net-net, the U.S. economy has become increasingly reliant
on real estate transactions. The proceeds of used home
sales as a percentage of nominal GDP have soared to new
all-time highs. "At 10.36% of nominal GDP, the dollar
volume of trading in existing homes is nothing to sneeze
at," notes Northern Trust economist, Paul Kasriel.

"Of course, the principal direct contribution to GDP from
existing home sales comes from commissions paid to real
estate brokers, mortgage brokers and Wall Street securities
houses which ‘securitize’ mortgages," Kasriel notes. "[But]
if this housing frenzy were to slow down, it likely would
have a major ripple effect on the economy as a whole."

Clearly, therefore, any prolonged slackening in the real
estate market would directly imperil job growth and GDP. In
addition, the adverse "knock-on" effects could be

"All bubbles essentially end painfully, housing bubbles in
particular," warns Richebacher. "They are an especially
dangerous sort of asset bubble, because of their
extraordinary debt intensity. The debt numbers speak for
themselves: In 1996, U.S., private households borrowed
$332.2 billion…With the housing bubble in full force, it
hit $1 trillion in 2004.

"This debt intensity has its compelling reason in the
particular way that accruing ‘wealth’ has to be converted
into cash," Richebacher continues. "In the case of an
equity bubble, in general, the owner realizes capital gains
simply through selling a part of his stock holdings. No
bank and no debt are involved…In this respect, a property
bubble is a totally different animal. Since homeowners
normally want to stay in their house, ‘wealth effects’ have
to be extracted through additional borrowing against the
inflating property value; that is, through mortgage
refinancing. In essence, twofold borrowing is needed:
FIRST, to boost housing prices; and SECOND, to withdraw

"Yet," Richebacher notes, "there is a second, even more
dangerous, aspect to housing bubbles: 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…"

Clearly, a post-bubble economy would be no friend to the
debt-heavy, savings-lite U.S. consumer. Throughout the
1960s, 70s and 80s, we Americans would save about 10% of
our income each year. But today, the national savings rate
has tumbled to zero – We don’t save nuthin’!

"In 2004," Richebacher observes, "household debt increased
more than twice as fast as disposable income." As we never
tire of mentioning, therefore, American households have
never before dared to face the future with so much debt and
so little savings.

"For consumer spending to slump in the wake of a fading
housing bubble," Richebacher warns, "house prices do not
need to fall at all. It is sufficient that the stop rising,
thereby depriving households of new wealth effects…"

The housing bubble has not crossed over the after-life, but
that day approaches.

Are you ready?

Did You Notice…?
By Eric J. Fry

"Dr. Copper," often called "the commodity with a PhD in
economics," hit a new multi-year high yesterday near $1.60
a pound. Apparently the "doctor" believes the global
economy is expanding briskly. On the other hand, the ISM
survey of US manufacturing activity has been slumping for
more than a year. Traditionally, the copper price and the
ISM Index track one another fairly closely.

Their diverging trends, therefore, present something of an
enigma. Who’s got it right; the ISM survey or "Dr. Copper?"
We wish we knew. Perhaps Dr. Copper suffers from dementia.
Or maybe, instead, he’s as sharp as a tack. It could be
that he’s teaching a brand, new economics course – one that
includes the vibrant economies of China, India and other
emerging nations.

The U.S. economy may be slowing, but Dr. Copper insists the
global economy remains robust…for now.

And the Markets…



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