Houses Without Moats

Three years ago, we speculated that the housing bubble had found its pin…now – we’re sure of it. This DR Classique first ran on September 20, 2002…

It is over.

The Golden Age of Central Banking – when giants such as Alan Greenspan, Robert Rubin and Larry Summers walked the earth – has come to an end. Now, day-by-day, Mr. Greenspan shrinks. Before the trend is over, he will be a midget.

We hear the hissing sounds already…other economists carping about his ‘errors’…investors whining about their losses…politicians eager to stick him with the blame.

There is also the hissing from his many bubbles. Stocks leak air almost every day. Bankruptcies reach record levels. Junk bonds get trashed and debts go bad in record numbers. And consumers’ knees grow weak and weary from toting so much debt.

Consumers will be the last to catch on. As recently as a month ago, they thought they could borrow money without worrying about paying it back. Jobs would be no problem. The cash would keep flowing. Stocks may crash, they believed…but the housing sector is still growing and solid.

The Housing Bubble Pin: Starts Fall and Lumber Cracks

But yesterday brought news that the housing bubble may have found its pin. Housing starts fell 2.2%. Lumber cracked – dropping below the $10 limit.

Mortgage delinquencies at a record 5.7%…and foreclosures at the highest rates since they began keeping records…have begun to hammer away at both the builders and the lenders. Kaufman and Broad fell $3.26. Lennar dropped nearly the same amount.

And Fannie Mae – the greatest of the housing bubble stocks – slipped to $67.

Anecdotal evidence is beginning to show up too…and seems to be gathering a crowd. The smart money is selling, not buying:

“I bought this piece of land [near Middleburg, VA] about six years ago. I marked it up to 4 times what I paid for it and sold it before I even had it listed,” reported a friend over dinner last night.

But in other areas, people say it is taking longer to sell houses. Rental rates are said to be falling off. Vacancy rates are increasing.

As reported here earlier, housing prices have risen 30% more than the inflation rate over the last seven years. Why should house prices increase faster than everything else? We have a partial answer: because you cannot import a house. Consumer price inflation has been coming down for two decades. But housing has bucked the trend in most areas. The Chinese are making more and more TV sets. They are making so many of them, so cheaply, that prices have been falling for many years. But the Chinese do not build houses for Americans. Even in America, though, people can still make things – if there’s money in it.

Years ago, your editor recalls that his cousin prepared to go into the construction business:

“What do you know about building houses?” was the question put to him.

“Nothing…what do you need to know?” answered the cousin.

“Don’t you need a lot of tools and equipment?”

“I’ve got a hammer and a saw…what more do you need?”

And so the cousin went into the home construction business in 1972 and did well at it.

The typical American house is hardly a work of beauty or consummate engineering. In a matter of days, it can be hammered together out of pre-fabricated parts. Over the long run, and making no allowances for local conditions, there is no reason for houses to be any different from other consumer items. They can beat the general rate of inflation for a while, but not for long.

The Housing Bubble Pin: Moats

Warren Buffett points out that the only way you can be fairly sure of protecting a profit margin is to own a business with a moat around it – a high cost of entry that makes it difficult for others to compete.

Some places have natural moats – mountain villages, such as Aspen, Colorado, with little available land…or islands, such as Manhattan…or seaside resorts, such as Naples, FL, whose backs are to the ocean. Not surprisingly, these are the places where property prices have risen most quickly. In San Diego, for example, with its huge moat on the west side of town…stretching all the way to China…housing prices have been going up at 20% annually.

But there is no moat around St. Louis. Nor is there one around Baltimore or most other cities. As long as property prices rise faster than the cost of capital, builders will continue putting up marginal houses in marginal areas and selling them to marginal buyers with marginal financing.

That is the thing about a bubble that is almost indescribably wonderful. Things that people might have considered foolish and stupid begin to look reasonable. The housing development, for example, that was a loser at 10% mortgage rates, becomes a winner at 6%. People who could barely afford a doublewide find themselves with a mini-mansion with plastic siding and a maxi mortgage. And gradually the supply of houses catches up to even the most marginal demand.

And then a change begins. “For Sale” signs stay up longer. Foreclosures rise. Builders and lenders begin to lay people off. And suddenly, it begins to look as though the last of Greenspan’s bubbles has popped.


Bill Bonner
The Daily Reckoning

September 02, 2005 — Bill Bonner

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

“There’s no question that in the past year, the ability to monetize shareholder ignorance has never been exceeded.”

Warren Buffett, Shareholders Meeting, April 2000.

Now it is homebuyers who are most ignorant. Five years ago, tech stock buyers thought something that wasn’t true – that tech stocks would go up forever. Now, it is the homebuyers (speculators) who think something that isn’t true – that houses go up in price forever.

But how to “monetize” their ignorance?


There’s the rub. Who wants to sell his own house just to monetize the ignorance of house speculators? Not many people. Besides, you have to live somewhere. If you’re already living where you want to live, what’s the point?

Latest reports, however, tell us that house builders are monetizing householder ignorance in a big way. They’re selling their own stock as if they expected a crash.

Our advice: follow the insiders. Sell the builders.

Meanwhile, the builders are looking to the bayous for another big payday. Hundreds of thousands of homes need to be rebuilt or renovated. They’re expecting some easy money from Washington to help pay for it. Alan Greenspan is meeting with President Bush today. They will probably hatch a plan to use the hurricane as cover for another big dose of credit.

The maestro has been slowly “normalizing” interest rates – that is, edging them back above the inflation rate! He is also warning the nation against too much debt. But the only way things could be normalized is by raising rates so that consumers stopped borrowing and spending so much money, which would mean – almost certainly – a recession. Neither Bush nor Greenspan want a recession. They’d much rather put the whole country under water. Heck, let the next administration and the next generation worry about drying things out. So, the little steps towards higher Fed funds rates are likely to stop.

Our guess is that this will send the dollar down another few notches. It dropped yesterday to $1.25 to the euro…gold shot up $8.

Chuck Butler had this to say from the EverBank trading desk in St. Louis…

“One day into September and we already saw a huge move of over 2-cents in the euro yesterday.

“This move was fueled by the ongoing situation in the gulf, and the thoughts that the Fed will pause rate increases beginning Sept. 30th.

“The selling of the dollar was fast and furious, with no pauses, and no bouts of profit taking in the euro and other currencies. As I said yesterday, the dollar had finally cracked under the pressure, and in my opinion, that will continue to be the case…”

And that is all we have to say this morning…we have to drive back to Paris…

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street…

“The feeding (and fattening) of China will provide opportunities for innumerable companies. The appetite of 1.3 billion individuals is not easily satisfied.”


Bill Bonner, with a few more thoughts…

*** Today is a monumental day. Addison is finally ready to unveil what he is dubbing “his finest service ever” – the Agora Financial Reserve.

Until now, the Reserve was available only to Agora Financial “insiders” – editors, analysts and publishers (including Addison himself).

Other members include Eric Fry, Kevin Kerr, Steve Sarnoff, Chris Mayer, Carl Waynberg, Dan Denning and Justice Litle.

These guys are the best and brightest in the business. And for the first time in Agora Financial’s history, you are invited to join this high-rolling band of investment analysts. Their goal is simple: save money, make money and have a lot of fun in the process.

*** We went last week to visit an old chateau. The place was built in the 13th or 14th century. No one knows for sure. It is owned by a friend who is fixing the place up.

What is interesting about it is what is underneath it.

“The chateau is perched on a huge granite rock,” explained the owner. “The people who built it also chipped huge caverns in the rock. It was a rough and dangerous time. There were bands of brigands…and different towns fighting each other…and then English. They had several lines of defense. There was a moat around the whole place. Much of it is still there. Then, there is an outer wall…about six feet thick…and then the castle itself…with walls more than six feet thick. And when all that failed to stop the enemy…the people in the castle would go down into the caves.”

We went down to look. The passageways were very narrow. It would be almost impossible for an invader to get in. He would stick his head in and it would be cut off. Once through the passages, there were several connected rooms, where grain, water, and maybe wine were stored. Then, there was another tiny passage, leading to another room.”

“There is no way you could fight your way in,” said our host. “The owners would retreat into the caves and stay there with food and water to last for weeks. They would just wait until the enemy left.”

The Daily Reckoning