The Bubble Blues

Bubbles – in just about anything you can imagine, from debt to real estate – have taken the country by storm. What will happen when they burst? The Mogambo Guru predicts that the average American’s sense of blissful ignorance will be replaced by misery and heartache…

The fact that mortgage applications keep increasing is not surprising. It would have been surprising to learn they had NOT been increasing. The reason is that so much money has been made in buying and selling real estate since the stock market stopped being profitable in 2000, and since people are so desperate to make some money (now that they have sunk into so much debt), that they are willing to take a desperate gamble and plow a few bucks, and a little time, into the housing market, hoping for that big windfall payday (BWP) that will save their financial butts.

Plus, it involves something they understand (houses) as they all live in one, although I am not such an expert, as I live under a bridge and scream at the cars that go by to shut off that damn radio and think about how the Federal Reserve is destroying our money, and then maybe they will spend a little more time at home, thinking and whimpering and hatching plots of revenge against Alan Greenspan, instead of driving up and down the damn roads, up and down, down and up, back and forth, forth and back, night and day, day and night, until I can’t stand it any more because it is making me crazy with the driving, driving, driving!

Housing Bubbles: Violating the Principle of Supply and Demand

But plowing into real estate they are, as sales of new homes climbed to a record in March. The Commerce Department reported, "Sales unexpectedly increased 12.2 percent to 1.431 million houses at an annual rate." But before you interpret this to mean that house prices are going up in response to this increased activity, the Commerce Department also reported, "The median price fell to $212,300 in March from $234,100 a month earlier." Wow! A ten percent plunge in prices in one lousy month!

Beyond that, another "wow!" is in order when you consider that this means that demand is going up, but prices are coming down, violating the whole principle of the theory of supply and demand!

Kurt Richebächer, everybody’s favorite Austrian school of economics deep-thinker, doesn’t even live in the United States, but in Europe. But even from way over there across the Atlantic ocean he can easily see that there is a housing bubble in the United States, and he writes, "The growth of home mortgages exploded from an annual rate of $368.3 billion in 2000 to an annual rate of $884.9 billion in 2004, compared with a simultaneous increase in residential building from $446.9 billion to $662.3 billion. Altogether, the United States experienced a credit expansion of close to $10 trillion during these four years. This equates with simultaneous nominal GDP growth of $1.9 trillion. America’s financial system is really one gigantic credit-and-debt bubble."

For a moment, the revelation is so startling that it makes time stand still. My brain gasps and reels as it tried to comprehend the concept of ten MORE trillion dollars in debt (which is almost as much as the total value of ALL the goods and services produced in the whole freaking country in a whole year!) in four lousy years!! Note the use of two exclamation points to indicate that my eyes are bugging out in freaking disbelief!! Look! There they are again!

The Financial Times newspapers quote Paul Kasriel, chief economist at Northern Trust, as remarking that, on a nationwide basis, the market value of real estate is now close to 200% of disposable income. The previous high in that ratio was in the late ’80s, when it climbed close to 160%. They note that he thinks, "A ratio close to 200% cannot last more than a few months. It is the equivalent of NASDAQ trading over 5000."

Housing Bubbles: Three Standard Deviations From the Mean

Speaking of houses, Jeremy Grantham, chairman of GMO, in his letter to his investors, notes that prices of houses are going crazy all over the place. He notes that in the United Kingdom, house prices are selling for six times average earnings of the guys buying the houses, a mortgage so huge that it is more than three standard deviations above the earnings norm (3.6 times annual earnings) established during the previous zillion years.

If you can remember what a standard deviation is, then you are not drinking enough beer. For the rest of us, I put on my Mogambo Educator Mortarboard (MEM), and explain that it is a measure of the variability from the average (also called the "mean"). In this case, three standard deviations from the mean, which is a long, long way from the average, means that the chances are about 1-in-10 zillion that the mortgage application is going to be submitted to a loan officer who is so drunk or incompetent that he will loan somebody enough money to buy a house that is 3.6 times as much as the guy makes in a whole year. From a financial standpoint, the reason that mortgage people don’t loan that kind of money to people is that the guy is almost sure to default on the loan, and the mortgage people hate that. Well, I assume that they hate it, as I surmise from the way the guy at the bank goes ballistic when I tell him that I can’t make this month’s mortgage payment again, which is a long, LONG way from actual default. In my case, about three more months, I figure.

But it is not just in the United Kingdom, but also in Sydney, Australia, where mortgages are routinely made at "about 4.8 times annual earnings." Here in the United States, he notes, "In Boston, a whopping 6.5 times annual earnings (over 2 standard deviations), and for the United States as a whole, about 4.3 times annual income, versus an historical average of 3.4 times income, and is three standard deviations above the mean."

Housing Bubbles: Bubbles Break

Germany remains about the only place where people did not go crazy with this silly house-buying crap, and so they will be rewarded in the end.

I have lost the author of "What do we really know?" and if you are the person who wrote it, I apologize, but if you send me a few bucks maybe I will be more careful next time, but probably not. But whoever it is has also looked at things from this standard deviation thing, although they refer to a standard deviation as a "sigma."

They have looked specifically at economic/financial indices that are, or were, at the 2-sigma level, which are pretty rare occurrences. I can see you are on the edge of your seat, and you want to know, "What happened?"

They say that ALL bubbles (which they define as anything where the average prices are in the range of 2-sigma events) broke and ended badly. So how many bubbles did they find? They found 28 bubbles around the world, including stock markets, currencies, and commodities, and including our stock market bubble here, although they did not, as far as I can tell, include our bond bubble and our housing bubbles in their analysis. And all of them broke, which they characterize as "all the identified bubbles did indeed move all the way back to (or below) the trend that existed prior to those bubbles forming." What they did NOT mention was that the reversion back down to the mean left bankruptcy, heartache and misery strewn all over everything.

And they perfectly sum up The Mogambo’s stupid opinion that there is nothing that can be done with bubbles except try and prevent them from forming, and, failing that, suffer from them. They write, "Bad monetarist policy may have caused the Great Depression, and good policy may have let us down gently after 2000 (we shall see), but both were clear asset bubbles and both broke. The monetary environment was different for all 28 bubbles, but all of them broke."


The Mogambo Guru
for The Daily Reckoning

May 09, 2005

P.S. The Mogambo Sez: The Federal Reserve and the government, in cahoots with their cronies on Wall Street, are going to pull every trick in the book to keep the markets up. How else to explain that the stock market ended up after the Fed raised interest rates today, for the eighth time in a row?

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter, an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

Uh-oh…the last British-owned automaker went bust last month. This month, our own GM and Ford seem headed in the same direction. The two companies’ bonds have been downgraded to junk. Many pension funds, insurance companies, and other conservative financial institutions will not be allowed to own them – they’re too risky. The 30-year bonds of both firms have sunk to the point where GM’s bonds maturing in 2033 yield 11.7% and Ford’s bonds that mature in 2031 yield 10.2%. Both look like good investments – as long as the automakers can make the payments.

Britain seems to be ahead of the United States in several ways.

House prices in the United Kingdom shot up before those in the United States – and even further. Compared to London, houses throughout the United States are still cheap. The English come to Florida and California in search of bargains. But last summer, house prices suddenly stopped going up in the U.K. Analysts are still debating what might happen next; is it a pause in the property boom…or the end of it?

But so many Englishmen depended on rising property prices that even a pause is devastating. Bankruptcy rates in England and Wales are hitting new records, reports the weekend news.

In the homeland, meanwhile, prices are still going up – especially in that Mecca of the absurd and extravagant, Las Vegas. Prices of residential real estate rose 47% last year. And Donald Trump reports that every one of the 1,282 units in his 64-story hotel/condo are already reserved by buyers – despite the fact that not a single shovel has yet hit the sand. So many other high-rise projects are being discussed that builders are talking of the "Manhattanization" of the desert city – with skyscrapers full of luxury condos all up and down The Strip. If anyone knows why people would want to live in Las Vegas, he does not work here at The Daily Reckoning headquarters. Still, the city attracts 5,000 new residents every month.

Where will it all end?

We don’t know. But it seems a safe gamble that sometime after this flourish of concrete is over; the English might want to look in Nevada for bargains. There are bound to be some in Las Vegas.

More news, from our currency counselor:


Chuck Butler, reporting from the EverBank trading desk in St. Louis…

"So, why was the dollar bought? This isn’t dollar friendly news? Just another one of those ‘dolt mentalities’ that resides in the markets. And when this all gets unwound, and it will in my opinion, these buyers of dollars will be sorry…"


Bill Bonner, back in Paris:

*** Jonathan Kolber, with more information on the company that has been busy developing a whole new world of miracle drugs for the deadliest and most costly diseases on Earth…

"Now, I know what you might be thinking: Why haven’t I already heard about this company anywhere? If this is such a great opportunity, why isn’t USA TODAY or Yahoo! all over it?

"First off, you will hear about it in mainstream sources. And soon – especially once its revolutionary new heart attack drug passes its final stage of FDA approval. But let’s face it; by the time any investment reaches The Wall Street Journal, the chance to buy it at its peak potential is long past. And with this stock, I fully expect to see its name in lights any day now.

"But just because this company hasn’t made the front page of the Journal yet doesn’t mean nobody’s scooping up (or holding onto) shares of this Nordic wonder. Quite the contrary. has already mentioned the firm’s heart attack drug as one of the New Drugs to Watch, projecting up to $1 billion a year in sales. Soon the cat will be out of the bag, big time. Keep reading…"

*** The weekend’s VE-day remembrances brought a novel angle on WWII: The Germans were victims too!

Of course, it is true. The average German had no more control over the course of the war than the average American. He may even have voted for Herr Hitler. He probably liked the idea of Germany’s recovery from the humiliation of the Treaty of Versailles. He probably approved Germany’s economic recovery too – and the new spirit of patriotism, nationalism and energy. Only a few years before, the Germans were pariahs in Europe – cursed by every paper and crushed under every heel. Now, they could hold their heads up. Everything seemed to be heading in the right direction. How could he know that it would turn out so badly?

That is the difference between the public and the private…between economic means and political ones. In investing, you get what you deserve. In politics, you get what someone else deserves.

*** The price of gold has slipped to $426 – just a dollar above our current buying target. We hope it slips some more today – we’ll buy some. If inflation was a growing problem – the gold market doesn’t see it. The price is in no hurry to go up. We don’t buy gold because we think it is going up. We buy it because we think – over the long run – it won’t go down. And we fear that almost every other asset will go down – stocks, bonds, the dollar, real estate, collectibles. We buy gold. We watch. We wait. We are happy…enjoying the spectacle.

*** You know, dear reader, we are very susceptible to what Orwell called the "lure of the profound." We give in to it as readily as an alcoholic gives in to Jim Beam. And…now, we feel a binge coming on. We have been studying empires. Our first reaction to the imperial purple was disgust. Like most Americans, we harbor a sentimental attachment to the modest old republic that was the U.S.of A. But the more we read about empires, the more we grow to like them. They are much more entertaining that humble nation states…simply because they are so much more vain, pompous, and delusional. More to come…

*** Henry spent the weekend in Germany, staying with friends. He enjoyed his visit, but he was annoyed to discover that he could not speak German. He’s been studying it in school for four years.

"I went to school with [my German friends]," he told us. "But I couldn’t understand much of what was going on – except in English class. And they all speak English so much better than I speak German, so we spoke English most of the time."

"What did you think of the school…are they about on the same level as you are in France?" we wanted to know.

"I couldn’t tell. I couldn’t understand what they were saying. Well, on the second day, I could understand more. But I don’t know how advanced the studies were. But I liked the school better than our school in Paris."

"Why is that?"

"Because they get out earlier."

What seemed to impress Henry most was a trip to the Haribo candy factory. He came back with bags of the stuff.

"You could scoop out as much as you wanted. They charged by the weight. It was very cheap."

The Daily Reckoning