The "Wow" Factor

There is at least one reason to be thankful that the housing bubble is bursting – a slowdown in the build-up of gaudy monstrosities. As in every bubble, people get carried away, and in this case, the "nothing can go wrong" mentality of some homebuilders gave birth to houses that were only meant to "wow" people. Now if only they could sell them…

Tacky, vulgar and trashy…say good riddance to the Great Rubbish Market of 2001-2007.

Driving down Route 4 in Southern Maryland, we passed a sign advertising a new housing development. So many are the new houses weeding up in the greater Washington, D.C. area that one hardly notices another one. But the sign caught our attention:

"The Wow Factor", it said, in large red letters. We looked beyond the sign to see what the ‘wow’ was all about. The houses were just like all the others built in the last 10 years – with large, fraudulent fronts, laid up in brick, some with tall Tara-like columns…and front windows so large you bend down to look for a stone. You think they might be substantial, handsome houses. And then you see the vinyl siding and small, plastic windows on the side. They only look good from the front. And then only if you don’t look too hard. Charmless…soulless…hasty…slick…they are stacked hard up one against one another like Chinese TVs in a discount mall.

"The ‘wow’ has to come at the very beginning," explained a real estate developer from Miami. "You bring someone to a house…he’s got to say ‘wow’ in the very first two minutes…or you won’t make the sale."

A couple years ago, he was building $4 million dollar houses on a golf course in the Boca Raton area. What did you get for $4 million in America those days? A lot more than you got in the United Kingdom…but still nothing a person with a sense of dignity would want. The houses were crowded together and then covered in tropical plants so you couldn’t notice how tiny the lots were. Just as with the houses in Maryland, the facades pretended towards substance, but it was substance they most lacked. The fronts were built of stone and marble. Then, you opened the door and the entryway took your breath away. Wow. You felt as though you were in a Florentine palace…or an abandoned bank. The place had so much marble we thought we were inside a quarry. And the ceiling was a good 24 feet in the air…with wide, curved stairs winding to the upper deck; still there was something cheap about it…fake…like a Hollywood set. It was the kind of staircase Rhett Butler might have carried up a checkout girl.

"Wow," we said. We had never seen a place so extravagantly hideous.

"Yeah…it’s all in the first impression. But so what? That’s what people want. And then it goes up in price…or, at least it used to. I made money. The buyer made money. It was a win-win situation."

Behind the first impression was a rather pathetically extraordinary house, the kind a sports star might build. It had, for example, a huge master bedroom, with a bathroom as big as Penn Station. We looked up to see if there might be mirrors on the ceiling over the bed. No…the new owner would have to put those in himself. Off to the left was a more practical feature – a balcony; as the housing crisis deepens, a mortgage-stretched owner could throw himself off…and drown himself near the 18th hole.

"Are these places still selling?" we wanted to know.

"Nah…nobody can get financing…"

In the heyday of the credit bubble, financing houses became as fraudulent as the facades. A recent study by Fitch’s found hanky panky in practically every one of the 45 subprime files it examined. Between 2000 and 2006, the FBI’s suspicious mortgage reports rose nearly 800%. The gumshoes estimate that mortgage fraud cost lenders as much as $4.3 billion last year alone.

The homeowner lied about how much he earned or how much he had; the appraiser lied about the value of the collateral; or the mortgage company lied about the terms of the loan. Sometimes all of them lied to each other. And then, along came the Wall Street packagers who told more whoppers. Bundling up thousands of fraudulent mortgage contracts they somehow managed to get the stuff rated "investable" grade, a lie so spectacularly in-your-face it practically knocked your nose off.

First impressions were everything. Executives were paid hundreds of millions to perform cosmetic surgery – trimming a little fat here…putting in a little silicon there. Billions poured into hedge funds too – in which managers were paid enormous sums for hocus pocus investments that were no more than "heads, I win; tails, you lose’ bets with other peoples’ money. And private equity was another hot trend. But what were the private equity surgeons doing except nipping and tucking? Balance sheets and earnings were pimped up…until the old girl could be put back on the streets.

Everybody wanted a piece of the action. The gaudy, sensational, trendy, hollow, superficial – it all moved up in price – from the suburban ghettos of Calvert County, Maryland, to the A shares on the Shanghai stock market. And there was no point in arguing with the people who were buying this garbage; they were geniuses and had the money to prove it! Towards the end, you had to be a moron to make money, because it was the worst investments that moved up most.

In the art world, for example, the Great Rubbish Market swelled up prices on corrugated tin and dead animals. The idea was to make a big impression – fast. And nothing made a bigger impression than big money. Damien Hirst’s diamond encrusted skull was just a silly gimmick. But it wasn’t so much that the oeuvre itself caused the wow…it was that some numbskull had paid $100 million for it.

What did the IPO come out at? How big was his bonus this year? How much did that house down the block sell for? How much is the stock up? Wow.

What a surprise it must be when it comes to an end…and the headline numbers go down.

Until next week,

Bill Bonner
The Daily Reckoning
December 21, 2007

Well, it doesn’t seem like winter down here. That’s because it’s not winter; it’s the first day of summer in the Southern Hemisphere.

Here at The Daily Reckoning, we tend to be skeptical. Someone tells us something; we don’t quite believe it. There’s always a different angle…and always more to the story.

Since we were little, we’ve been told that the earth was round and that the people on the bottom don’t fall off because of ‘gravity.’ Well, now we can report that it is true. Or, at least it seems to be true. Newton and Copernicus were right…the celestial system works just as they said it did…more below…

But first let us turn to what makes the world go ’round – money. What’s new in the world of money?

The tide of cash and credit is receding…credit is drying up…and credit-driven markets are falling.

Housing hit its high water mark last year. It’s been going down ever since.

Stocks, too, reached a level that was equivalent to a 40-year flood this year. The larger story on stocks is that they hit a flood-tide high three times in the last century – in ’29, again in ’66, and finally in ’99/’00. What we’ve seen this year was merely a follow-on gush of liquidity. In terms of gold, the euro, or real dollars (adjusted to consumer price inflation), stocks were actually down from their January ’00 level.

Of course, we’ve also seen high water records set in markets all over the world. Many emerging markets hit all-time highs. Many stock markets are still near all-time highs. So are many peripheral markets. Shares in Sothebys, the celebrated auction house, ran up 600% from 2003 to 2007. A tide of liquidity floats heavy boats…as well as a lot of light, trivial trash. Nothing is more unsubstantial than contemporary art. Now it too seems to be coming down; the art market itself reached a peak this year.

Likewise, gold is near an all-time high. Oil seems to have hit its high at almost $100…and has since eased off. The commodity index is in record territory still. But there are different types of commodities. Industrial commodities – copper, iron, tin – peaked out back in May. Agricultural commodities are a different story…about which, more in a minute.

Certain marginal tidal basins and low-lying marshes have already been left high and dry by the receding waters. House builders, house financers, and financing generally have dried up. Big financial stocks – such as Merrill (NYSE:MER) and KKR (AMS:KPE) – are down nearly 50%. Here is where the story has been most exciting…and most alarming. Because investors and lenders don’t know how much liquidity these outfits have left. Often, they don’t know themselves. Many of the derivative contracts they sold to others, and sold to themselves, were never ‘marked to market.’ Instead, they were ‘marked to model,’ mathematical models with deep, obvious flaws. Worse, many were ‘marked to make-believe’ in a way similar to subprime mortgages themselves. The borrower lied about his income, his assets, his age, his employment, his marital status and how many points were on his driver’s license. The appraiser lied about the value of the collateral. The lender lied about the terms and conditions of the loan. And then Merrill, or Citigroup (NYSE:C), or Goldman (NYSE:GS) lied about the quality of loans generally…and Moody’s backed them up!

As we noted yesterday, in the heyday of the credit bubble, bank robbers set aside their handguns and ski masks; it was easier just to borrow the money like everyone else, and not pay it back.

Investors knocked MBIA (NYSE:MBI) shares down 25% yesterday, after the big lender disclosed that it had $8.1 billion in exposure to subprime debt.

Investors are now reluctant to put money into lenders. And lenders are reluctant to lend. This is the basis of the ‘credit crunch’ you read about. And it is what is worrying central bankers. It is why the Fed cut rates again this month…and why, this week, the European Central Bank put up an extraordinary half a trillion dollars to try to get cash moving.

Here is where we find the dramatic tension in our story…the War of the Titans…the Clash between Unstoppable and Immoveable Forces…the Battle of the Market and the Manipulators…

Will we get the widespread correction the market seems to want? Or will the feds manage to get enough liquidity in the system to keep things wet and slippery? Inflation…or deflation?

Our stock answer is ‘yes.’ We will get them both. Everything in due course…

*** "Food prices soar in America," says one headline. The price of milk, we discover, has gone up nearly 25% since the beginning of the year.

We can see the cold, miserable crowds gathering in front of the White House already.

"Our children have no milk," say the impoverished ones.

"Then, let them drink Diet Coke," comes the answer from the West Wing.

No, that is a scene you are not likely to see. Today’s politicians always have a soft word for the lonely, the poor, and the disheartened. And then they have a solution! Right this minute there is probably some nerdy staff worker figuring out a bill that will end the ‘milk crisis.’ But ending all this nonsense about ethanol has never crossed anyone’s mind.

Nope, in the energy bill passed by Bush yesterday, he "mandated a sixfold increase in ethanol production, including up to a 150% increase in corn-based ethanol production. Oh yeah… and you’ve got to find a way to make energy out of dead hunks of wood and grass, and make it nearly twice as big as the whole ethanol market," quips Addison.

Ethanol is fraud. That’s our story and we’re sticking to it. 

You see, dear reader, in this age of Win-Win Capitalism politicians cannot permit real capitalism to work. They cannot leave bad enough alone. Got a problem? They will figure out a solution…so we all come out winners.

The trouble is that the government’s solution to one problem is the cause of two more. The feds man the pumps 24/7 to try to keep the consumer economy from drying up. But the extra liquidity drives up consumer prices!

(Here we pose the problem in philosophical terms: if you could really solve problems by passing laws and printing money…wouldn’t we all be rich and happy by now?)

Meanwhile, in China, food prices are rising at 18% per year. Officials fear ‘social unrest.’ But what can they do? Well, they can take a page of Richard Nixon’s playbook; they can put on price controls. And they can put up interest rates too; now at a 9-year high.

But where’s the Paul Volcker of Beijing? And how can the Chinese stop the flood of money coming from their main customer – the United States of America? It is that very cash coming from North America that is the source of China’s rising food prices. It is also the source of China’s rising wealth. When the money stops flowing, it will as if the Yangtze had dried up…and the Good Earth is no longer quite as bountiful as it had been.

(We would like to note that Short Fuse and Addison are in New York City this morning, interviewing Mr. Volcker. Expect a full report on that interview and the interview that Addison did with Dr. Laffer on Monday.)

Of course, when the money stops flowing from the U.S. consumer the whole world economy is likely to feel a little dry and thirsty.

*** We’ve crossed the equator five times in the last three weeks, going back and forth to South Africa, Australia and now here. In each place, people walk around just as they do north of the equator. Trees grow up. Balls bounce. We’re no experts, but it looks like Copernicus and Newton were right.

And yes, it is summer down here. The sun is almost directly overhead at noon. It is hot. The leaves are out on the trees. People dress in light, summery clothes and run air-conditioners to keep cool. Again, we don’t know what really happened, but the southern hemisphere seems to have titled towards the sun, while back in the northern hemisphere, it is cold with the sun’s rays low in the sky. In London, when it is not raining, the sun barely clears the tops of the houses. You have to go out into parks and open spaces to see it at all. So, yes, the whole story hangs together. The earth goes around the sun…is tilted on its axis…and gravity makes it feel like up is over your head, no matter where you are on the planet.