Stuff Of Dreams

Our revels now are ended. These our actors,

As I foretold you, were all spirits and

Are melted into air, into thin air;

And – like the baseless fabric of this vision –

The cloud-capp’d towers, the gorgeous palaces,

The solemn temples, the great globe itself,

Yea, all which it inherit, shall dissolve,

And like this insubstantial pageant faded,

Leave not a rack behind. We are such stuff

As dreams are made on, and our little life

Is rounded with a sleep.

(The Tempest V.i. 148-158)

The more equity you ‘take out’ of your house…the less you have left. While this seems obvious, a fuller awareness of it may lie ahead.

Of course, borrowing against equity is nothing new. Nor is the demand for it constant. Instead, the fashion for ‘taking out equity’ has merely reached a cyclical peak – soon to retreat to more normal levels. At least, that is today’s guess.

For, on or before this coming Thursday, from the cloud- capped towers of Waltham, Massachusetts, the nation will get a small preview – I think – of where borrowing against equity can lead. It is not likely to be pretty.

But let us back up a few years.

In the late ’60s, a group of companies emerged that were known as the ‘Nifty Fifty.’ What was so nifty about these companies? They had everything going for them – brand names, patents, top management, spectacular sales, and solid profits. They were thought to be ‘one decision’ stocks…that is, you could make the decision to buy them just once, and that was all you needed to do. These were the stocks dreams were made of – stocks for the very long run.

They had such a big lead on their competitors that they could afford to hire the best managers and buy the latest technology. What could go wrong?

But popularity is as much a curse on Wall Street as it is in high school. The ‘nifty fifty’ stocks were soon trading at levels not seen again until the late ’90s. And then, in the bear market of ’73 – ’74, they crashed, dropping in the esteem of their peers faster than a prom queen caught at a Bible class.

Prominent among the ‘nifty fifty’ was one company that seemed invulnerable. Polaroid showed up more often at family picnics than ants. For two generations, hardly a birthday, wedding or graduation ceremony was complete without a Polaroid product.

Even today, the company seems like a winner. “Last year,” reports James Grant, “it sold the most instant cameras in its history; 13.1 million. And it sold 1.3 million digital cameras, occupying the No. 1 position…”

Yet, at a recent price of about $2.50 a share, you could buy the entire company for just a little more than $100 million. That is just 7% of sales and not even half of book value.

And on or before July 12, a consortium of bank lenders are expected to decide whether or not to force the company into bankruptcy.

What went wrong?

Here at the Daily Reckoning, we do not attempt to offer managers free advice nor even to critique their performance. Had we been running Polaroid, we have little doubt that the banks would have lowered the boom long ago.

Still, we have an opinion.

In a recent trip to a convenience store, your editor was surprised to find how cheap the disposable cameras had become. In an expansive mood, he bought more than one. While this attack of big spenderism may have helped Polaroid stave off the day of reckoning, it probably wasn’t by much. The disposables must have profit margins as thin as celluloid.

And the digital versions? The competition is fierce. Worse, there are no film sales, hence, no repeat business. In your editor’s experience, a digital camera lasts until it breaks…and then it is replaced with a disposable one.

A debt-free company might have been about to ride out the storm of innovation. Polaroid might have bobbed its way throughout the sea change in the picture-taking industry…and its shareholders might have continued to enjoy dividends for another generation.

Instead, the firm borrowed heavily. Today, Polaroid carries nearly $1 billion in debt. Bond investors have marked the debt down to such a low level that “at 50 cents on the dollar,” according to Grant, “they hold out the hope of a yield to maturity of 193%.”

Whatever bond investors actually end up with, it is likely to be more than the stock buyers. They are buying equity in a company with little or no equity to sell. Polaroid ‘took out the equity’ when taking out equity was in style. Now, there may be nothing left.

Thursday, Polaroid’s bankers may round out its little life…by putting the company to sleep.

Your correspondent, with his mind on this ‘insubstantial pageant’ and his body in hazy, hot, humid Baltimore.

Bill Bonner
Baltimore, Maryland
July 9, 2001

“Borrowing was so heavy in the 1990s,” says a Harvard University study called The State of the Nation’s Housing, “that home equity as a share of home value dropped 10 percent, even as home prices rose sharply.”


If Alan Greenspan wanted to avoid recession in the ‘worst possible way,’ he would encourage people to borrow against their houses. This would put them at risk of not only losing their jobs, but their homes.

Greenspan recently commented that rising home values were adding to the wealth of consumers. He should have added a modifier: rising house prices are adding to the ‘perceived’ wealth of consumers. The house doesn’t change as its price goes up. The real value of the house remains the same. But ‘taking out equity’ gives the homeowner the illusion of spending profits instead of merely borrowing money.

The situation is clarified for him, like so many other things, in a genuine recession. The poor schmuck finds that the part that he still owns is worth less than before – while his debt has become, relatively, more important. What can he do? Forget about spending more…he struggles to make ends meet, until he loses his job…

“The continuing jobless claims are at levels that we haven’t seen since November of 1992,” said Wayne Angell, chief economist at Bear, Stearns & Co., “so there is no evidence that the employment recession is ameliorating.” U.S. companies cut 124,852 jobs in June, 56% more than in May. In the first half of the year, 777,362 jobs were lost, almost 31/2 times as many as the same period last year.

Here’s Eric’s report from Wall Street:


– Ouch! It’s starting to look an awful lot like a classic bear market on Wall Street – a long, grinding decline punctuated by sharp, short rallies.

– Last Friday, the Nasdaq plunged 76 points and the Dow dropped 227 points. The technology sector topped the list of casualties, as the Philadephia Stock Exchange Semiconductor Index tumbled 9%.

– All of a sudden, the losses are starting to add up. With last week’s sell-off, the Dow has now given back more than one-half of the 1,900 points it had gained between April 4th and its May 21st peak

– The dolorous global refrain of vanishing orders and collapsing profits in the technology sector is hardly the sweet music one expects to hear leading up to a bull market. One standout loser last week was Manhattan’s own The online provider of investment research suffered a “stock market stock split.” In other words, it lost about half its value by falling from $16.01 to $8.22. The culprit: lower-than-expected earnings that will necessitate pay cuts and job layoffs.

– Nor do the officers of America’s public companies see any fast-approaching economic rebound, at least judging from their actions. “In recent weeks, U.S. corporate executives have been dumping the shares of the companies they work for,” the Bank Credit Analyst (BCA) reports. Among companies listed on the NYSE or Amex, BCA calculates that over the last eight weeks, three insiders sold stock for every one that purchased. This 3-to-1 sell-to-buy ratio reflects a high level of bearishness in the boardrooms.

– A weak employment report contributed to the pervasive sense of gloom on Wall Street last Friday. June non-farm payrolls fell 114,000 jobs. As Addison noted over the weekend, “The Dept. of much-Labored Statistics said the nation’s unemployment rate has risen to 4.5% [from 4.4% in May]. Significantly, demand for workers in ‘service industries’ – often cited as the savior of the new US economy – dropped to its lowest level in 10 months.” The number of people on unemployment rolls has now passed the 3-million mark for the first time since 1992.

– Moody’s John Lonski points out, “From 2001’s first to the second quarter, initial state unemployment claims might surge higher by a troubling 76% annualized. Be it quarter-to-quarter or year-to-year, initial state unemployment claims have been piling up in a manner that is ordinarily associated with a recession.”

– Deflation seems to be the order of the day. Lumber, one of the most “knowing” of all commodities, has fallen 24% from its recent peak in May. “The ‘standard beef bowl’ in Tokyo fell 30% last week,” Greg Weldon tells us, by way of the Blue Team’s Dan Denning. “Deflation – falling prices due to overcapacity – is wracking the economy.”

– Are we about to learn the hard way what Japan has known through experience for over a decade? Interest rate cuts are no substitute for economic vitality. Most American corporations have neither the means nor the desire to increase – much less maintain – their current levels of capital spending. Cutbacks and deferrals have become the norm. As Lonski observes, “From the first to the second quarter of 2001, real business investment may contract by roughly 9% annualized for its steepest such slide since the 9.7% drop of 1991’s recessionary first quarter.”

– About the only spending that has been going on all year is that of consumers, using money they don’t really have for things they don’t really need. But given the rising unemployment rate and the falling stock market, even America’s heroic consumer may be starting to turn tail and run.

– Many retailers will report June sales this week and the news will likely not be pretty. Already, Federated Department Stores and Neiman Marcus have warned that sales are waning. If Federated is slashing its sales forecasts, can Nordstrom, Dillards and May Department Stores be far behind?


Bill from Baltimore:

*** “Where’s Henry?” I asked Elizabeth on Friday

“He’s visiting with his friend, Ethan,” was the

“Where’s Jules?”

“He’s visiting his friend, Andy.”

“Well, where’s Maria?”

“She’s down with Aunt Margaret.”

“How about Edward?”

“He’s staying with Benjamin and Lynn tonight.”

“What kind of family vacation is this – everyone is gone,” I observed rhetorically…

“Don’t worry,” comes the reply, “they’ll all be back tomorrow. Now, I’m going out with Liddy. See you later.”

The Daily Reckoning