The Booming 51st State

Puerto Rico is experiencing its own property boom…and as it is on the mainland, this boom is fueled mainly by cheap credit. Chris Mayer watches from the sidelines in Toa Alta, Puerto Rico…

"I used to drive out on the island…you could see the ocean and the beautiful views…and you could stop off one of the little restaurants along the way…enjoy a cold beer, a nice steak. Now, you see nothing but housing developments and the traffic is horrible."

My grandfather was telling me about the changes in Puerto Rico over the last several years.

Puerto Rico is a Commonwealth – existing in the gray area of non-statehood, a sort of vassal in America’s empire, a prize in a long-forgotten war with Spain.

Puerto Ricans have voted many times before on the issue of statehood. The voting has been very close. So far, the status quo has won out. But the last election fiasco was eerily similar to the U.S. presidential election in 2000, with the Supreme Court of Puerto Rico casting the deciding votes, along party lines, that sent their man into office. Statehood lost its closest contest yet.

I’m confident that at some point in the not-too-distant future, Puerto Rico will join the Union as the 51st state.

Until then, it will continue to mirror the United States in other ways. Puerto Ricans seem to love SUVs and fancy cars as much as continental Americans. Consumerism is also in vogue, with retail chains such as Walgreen’s, JC Penney and Macy’s enjoying success here. Plus, nearly 70% of the island’s workers are employed in service industries.

Puerto Rico Housing Boom: Dynamic Economy

And Puerto Ricans, too, have their own housing boom.

The economy of Puerto Rico is likely the region’s most dynamic economy. Nearly every major U.S. and European pharmaceutical company has significant operations on the island. Other companies and industries also find the island attractive for a host of reasons: the population is largely bilingual and educated; there are tax incentives to move operations to Puerto Rico; nearly 5 million tourists come here every year and spend more than $3 billion; and it is a bridge to the rest of Latin America.

In order to capitalize more on the island’s appeal, the government has spent more than $13 billion in the last 10 years improving the infrastructure. There is, for example, a new deep-water port, urban train, and coliseum; along with more common amenities like better signage and expressways.

My grandfather notes the passing of sugarcane fields and farming from the landscape. Instead, shopping malls, hotels, condominiums and auto malls are popping up all over the island. And new housing developments, too – sturdy cement houses painted in the pastel colors favored in the tropics, like cotton candy pink, lime green, sunflower yellow and sky blue.

Housing is in short supply and prices are rising. For years, Puerto Rico’s housing market reliably appreciated 5-10% per year. This year, the market is getting hotter. In 2005, the average sales price is about $311,000 – up nearly 16% from 2004.

The demand for residential loans is higher here than in the United States, after adjusting for population differences. Nearly 75% of Puerto Ricans own their own home.

It’s no wonder prices are rising. Population density is among the highest in the world, with nearly four million people living on an island of about 3,500 square miles. By some estimates there is a housing shortage, with 100,000 more units needed.

Still, as in the mainland United States, the housing bubble is also being fueled by cheap credit. Curiously, while late payments occur four times more often than on the mainland, Puerto Ricans are less likely to wind up in foreclosure.

Puerto Rico Housing Boom: Cause for Worry

As in the mainland, there is also cause for worry.

Doral Financial is the dominant mortgage company on the island, with 40 branches and $11 billion in assets.

This, from Doral Financial’s annual report:

"Borrowers use equity build-up as a means to consolidate high-cost consumer debt of credit cards [sic], auto loans and other types of credit."

Basically, the islanders have succumbed to the temptation of using their home as an ATM machine – just like Americans.

Doral, by the way, enjoyed a stellar run over the last 10 years – riding the crest of Puerto Rican prosperity. Its stock price rose more than 8,000% from 1995 to its 2005 peak. That’s an annualized return of about 56%.

In March of this year, the whole enterprise seemed to come apart at the seams. The stock was ripped in half, on news that the company was being overly aggressive with its derivative portfolio and would write off hundreds of millions of dollars.

But the beating was just getting started. Downgrades from various analysts continued to push the stock lower. Then the credit agencies got in on the act, with Fitch downgrading the company as well. Eventually, the stock hit bottom under $10 per share, but has since rallied.

Today, however, I’m inclined to stay on the sidelines with housing – if not actively bet against it. My readers closed out a 53% gain in Countrywide last week, prospering from the mortgage giant’s deflating stock price.

When the housing bubble finally finds its pin, it will be like an ATM machine that no longer dispenses cash. That won’t be good for banks, homebuilders, credit card companies and a slew of other businesses that have, to date, prospered in the credit-induced revelry of the housing boom.

Freeman Tilden, in his book A World in Debt (published in 1935, but still a terrific read), described fortune as a "willful jade" that set about victimizing human beings, "especially debtors."

Credit cycles turn, dear reader, and this one will turn also – both in the mainland United States and in the future 51st – and anywhere else easy money has left her unmistakable footprints.


Chris Mayer
for The Daily Reckoning

October 12, 2005

P.S. Wouldn’t it be nice to have at least one investment in your portfolio that just grows and grows over time? Well, I’ve found one company that’s poised to become the next Berkshire Hathaway that’s hell-bent on one thing only – building real, tangible wealth.

Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since

1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of CrisisPoint Trader and Capital and Crisis – formerly the Fleet Street Letter.

"Will the next 10 years be as nice as the past 10?" asked Britain’s governor of the Bank of England yesterday. "Will the great stability continue?"

Not waiting for an answer, Mervyn King had his own: "That seems rather unlikely."

Columnist Alex Brummer comments in the Daily Mail:

"A sharp deterioration in the nation’s international trade together with the catastrophic slide on the high street [translation into the American tongue: A fall in retail sales] could mean that a period of 52 quarters of consecutive growth is drawing to a close."

Last night, at a restaurant in South Kensington, there was no sign of it. Every table was taken at Lundum’s – a fashionable eatery with a Danish motif. Diners put down trendy portions of gravlax, beef stroganoff and other Baltic specialties, apparently unaware that their world of money shuffling from nine to five during the week, and then weekends off to Spain or Scotland was beginning to wobble. House prices are going down in London. And according to recent figures from the British Retail Consortium, shoppers are either running out of money, or having a temporary bout of sanity.

Britain has always been ahead of America. The Industrial Revolution began in England before making its way over to New England. England took the lead in empire, too – extending its control over much of the world, while America still minded its own business. Unionization began in Britain, and social welfare legislation, too.

We Americans have always admired the English. We lived in plain wood houses out on the prairies or backwoods; imagine how our heads turned when we saw Westminster or Buckingham Palace! We butchered savage tribes out on the frontier; imagine how we envied Wellington! We ruled from sea to shining sea; Britannia ruled the ocean waves themselves, and almost everything they touched!

American statesmanship – certainly under Wilson and Roosevelt – was often nothing more than a fawning imitation of the British. Where the English went, Americans followed. And when Roosevelt went to create his New Deal, all he had to do was to look over his shoulder at his English cousins. Neville Chamberlain began picking taxpayers pockets with his "Widows, Orphans and Old Age Contributory Pensions Act" in 1925.

A property bubble began in Britain in the late ’90s. America’s property price bubble did not begin until five years later, but house prices on the sceptered isle have been on a gentle decline for several months. And now the threat of recession is making its way to the lips of the Dr. Mervyn King and the pages of the Daily Mail.

Can the Wall Street Journal be far behind?

Average house sales prices in Manhattan fell in the last quarter by 13%, explains a news item. At the top end, the decline was 36%. On the other coast, sales in San Diego fell 4%.

Could this be the beginning of something big?

We don’t know, but we will find out.

More news from The Rude Awakening…


Dan Denning, reporting from Colorado:

"Last week, I paid a visit to Royal Dutch Shell’s oil shale project in Colorado. The visit left me with more questions than answers, but I came away from the place with the sense that this opportunity is very real…or, at least, it soon will be."


Bill Bonner, back in London with more views…

*** So we return to Dr. King’s question: Will the next 10 years be as stable and as nice as the last 10?

We have no sure answer, but we have a guess. The world advances by fits and starts; in endless cycles of growth, correction, boom, bust, innovation and destruction. One success leads not to more successes, but ultimately to more failures, since life cannot follow life. Death follows life, and then life again. One business has to go broke so that a new industry can flourish. One tree has to fall so that the small seedlings beneath it will get the sun. Everything in nature – including markets – are self-limiting, and self-correcting.

Mr. Greenspan seemed to have this natural cycle in mind when he cautioned central bankers at Jackson Hole last month. The silver lining he drew out by successfully stabilizing financial markets for so long seemed to have a cloud wrapped around it. Investors, and homeowners, took stability as a fact of life, and current market conditions as permanent. Why not borrow, they said to themselves? There will always be jobs, plentiful credit at lower rates, and higher asset prices. You’d have to be a fool not to buy a house on these terms.

On a website this morning, we saw an advertisement: "$150,000 Mortgage – Just $483 per month!" A man with $1,500 of free cash flow available could borrow $450,000 – about the average cost of a house in California in 2003. A year later, he had about $100,000 in "equity". What was his investment? He had to live somewhere. He had merely "rented" a $450,000 house for $1,500 a month. His investment was zero.

Thus has the entire nation been lured into debt like a teenager into a free strip show, knowing that it can’t help but be interesting.

But why cannot the next 10 years be just the same? Because once the man has committed his $1,500 – he can buy no more. Sales grow sluggish. Inventories build up. Eventually, prices fall…as fellows decide to take their winnings off the table.

*** Some $88 billion of corporate debt is "on the brink," says a Bloomberg report. Hertz, Clear Channel and 616 other U.S. companies are in danger of having their corporate bonds downgraded to "junk" status. Of course, they will be in good company. Many of America’s largest and most prestigious brand names are now junk – Sears, G.M., Kodak. G.M. bonds are rated BB, meaning they are two levels below investment grade.

"Business bankruptcies to rise 30% in third quarter," adds a headline from the L.A. TIMES. Not since the Great Depression has so much corporate debt been such poor quality.

*** "Thanks for your daily email, repetitive though it may be from time to time. There’s nothing like reading ideas to which you already subscribe to increase ones conviction of being right," writes one DR reader.

"Anyway, I thought I’d send you a note to tell you about a letter I found in a magazine published during the midst of the Civil War. I recalled this because it ties in with your comments today about the glorious practice of using others to fight your battles.

"The letter was written by a founding member of the religious organization I belong to when that man was traveling in Virginia seeking exemptions for his brethren from military conscriptions from the Confederate Army on the grounds of conscience.

"Interestingly, the author (Dr. John Thomas) writes a rather scathing observation of the agents of northern U.S. towns who had been sent south to buy the freedom of black slaves in order that they could then be conscripted into the Union armies to fight against the South in place of their new white ‘owners’. Ingenious.

"What is rather humorous about the letter is that Dr. Thomas tells about a poor agent from a northern, more western state that was sent with only $30,000 or so and was unfortunately outbid by an agent from Boston with over $400,000, who managed to buy up all the available slaves in the area.

"The only improvement the current government has made to this process is that it is able to do the same without using gold, but rather paper."

The Daily Reckoning