The Plague of the Black Debt

Christoph Amberger takes a look at, among other things, the process of prophylactic over-bidding on real estate known in Great Britain as "gazumping."

Grigori Aleksandrovich Potemkin, Russian field marshal and favorite of Catherine II, played an instrumental role in the annexation of the Crimea in 1783. Four years later, as governor of this new province, he was also in charge of Catherine’s fabulous Crimean tour.

To impress upon the Empress of all the Russias how competent an administrator he was, historical anecdote claims he had sham villages ("Potemkin villages," as they came to be known) built along her route.

My guess is that this illusion of prosperity very closely resembled what is going on in America today.

If you happen to live in a metropolitan area in the U.S., here’s something I want you to do next weekend. Grab the kids and the dog, warm up the car, and head out of town.

Take a route you haven’t driven in a year or more, and chose a destination you fondly remember as being "rural" the last time you went there.

I promise you, the insight you will gain into the New America will be worth more than a library full of financial magazines.

That’s exactly what I did last weekend. My family and I went to the southern tip of St. Mary’s County in Maryland, where friends are hanging on to a 400-acre farm that hugs the shores of the Patuxent River for more than a mile.

Back in the 1990s, before the kids came, we used to visit several times a year. But the last time we went was over two years ago. And, honestly, if the trip didn’t mostly involve driving in a straight line, I’d have needed a map. Because the countryside was unrecognizable. Where there used to be fields and rolling pastures, there are now compact piles of townhouses so fresh you can smell the vinyl siding from a mile away. What used to be two-lane country roads are now brand-spanking-new 6-lane highways that make Adolf Hitler’s original Autobahn – the backbone of East Germany’s hard-currency economy until 1989 – look like a game trail.

Where there were vacant lots between strip malls and car dealerships, billboards now promise that a new 200,000- square-foot shopping center will be coming soon. And where Mennonites once went rattling by in horse- drawn buggies, tank-topped Bud Lite boobs in souped-up pickup trucks now go screaming by. And these are pickup trucks that will never carry any load heavier than a riding mower or jet skis. Looking beneath the shifting surface, the one thing that struck me most was the radical change in the character of property ownership.

You see, ten or even just five years ago, families and individuals actually owned most of the land and the buildings. Accordingly, houses built in earlier development booms tended to be small…mostly brick ranchers and Cape Cods on quarter-acre lots. If you were to add up the total home equity in any given development today, you would probably arrive at a sum sufficient to pay for the front doors and the catalog- ordered resin-cast replica lawn jockeys.

Everything else beneath the cathedral ceilings and above the manicured front lawn is debt.

Developers went into debt to build their satellite cities of cookie-cutter tract mansions. Homebuyers – lured by "no-money-down" deals – went into hock to buy the houses that Debt built…and are now stuffing their vinyl manors with stuff bought on store and credit-card debt. They drive cars they "bought" with debt, and they shop in businesses that are only in business because they are still (just barely) able to service their ever- increasing debt.

In fact, even debt itself has become an asset. Mortgage lenders hawk debt like so many pork bellies…yet that debt is secured by nothing more than paper gains in property values…which are driven mainly by inflated demand that is in turn powered by the availability of further debt to larger groups of clients, with ever more loosely defined creditworthiness.

Any cash gains in property values…as manifested in large checks paid out to sellers at settlement…are typically used to buy yet another high-priced ticket to take on more debt (usually in the form of a substantial down payment on another overvalued house).

What if this daisy chain of debt ever starts to unravel, Japanese-style? A decade after that country’s last real- estate boom, Japanese banks have US$400 billion worth of bad loans on their books. That’s four times worse than the S&L crisis in the States, if you account for the different size of the economies.

And if the Enron debacle was all about the quicksand you enter once you start obfuscating the fine line between debt and assets, the potential for a far more devastating crisis in the debt "industry" is explosive. And probable.

According to JPMorgan, asset-backed security issuance jumped to US$38.7 billion during March, a new all-time record. Home equity deals are charging ahead, with a record US$17.4 billion sold in March. Q1 home equity ABS issuance of US$33.3 billion represents an increase of 62% year-over-year. And keep in mind that 2001’s home equity ABS issuance of US$80.2 billion already showed an increase of 36% from 2000.

And home prices are supporting the trend. There are counties in Maryland where prospective homebuyers are advised by their own agents to bid upward of US$20,000 above the asking price. The same is going on in Britain…where they call this prophylactic over-bidding "gazumping."

In fact, American homeowners can’t seem to convert assets into further debt fast enough. Second mortgages…borrowing against what pitiful equity has been established…continue to convert inflated home values into spending money.

As I write this, the Mortgage Bankers Association’s weekly index of purchase applications jumped 6% from the previous week, and is up almost 13% over two weeks to a level of 349.9. Factor in the substantial increase in average mortgage size, and you can expect Q1 mortgage originations to come in stronger than US$500 billion. With refinancings down nationwide, net new mortgage debt creation is significantly ahead of last year’s record pace. According to a Bloomberg study, year-to-date domestic debt issuance stands at US$457 billion.

That’s terrible news for those among us who are waiting for the other shoe to drop…but music to the ears of those who love making a buck on their fellow man’s folly.


Christoph Amberger
for The Daily Reckoning
April 17, 2002

P.S. The Taipan group’s top mortgage play is now yielding an annualized dividend of 17%+. In late March, the company announced plans to issue dividends of US$0.40 a share for each remaining quarter of the year. This yield is on top of the nifty stock price appreciation: when we recommended the stock last summer, you could have picked it up for US$7 and change.

The rest of Taipan’s real estate-based "Conservative Portfolio" is no slouch, either. These plays can boast some nice YTD gains: our first is up 10.46% so far this year, and 16.6% over our initial recommendation of January 2, 2001. Our second has appreciated an impressive 87% gain since our initial coverage. And our last, which is actually a health care play, is up 49% since last year.

As publisher of the Taipan Group of publications and President of, J. Christoph Amberger’s role can be compared to that of a spider in the middle of the web. He is constantly in touch with all of our inside sources, contacts, and correspondents, directs their research, and identifies new and promising subjects.

J. Christoph Amberger grew up in what used to be West Berlin, Germany. Educated at Berlin and Gottingen, Aberdeen (Scotland) and St. John’s Graduate Institute in Annapolis, Maryland, his work and travel have given him firsthand experience of Eastern and Western Europe, as well as North and Central America.

A frequent speaker at international conferences, he is the author of several books and scores of articles and special reports.

"The Treasury," writes the Mogambo Guru, "like the favorite uncle who’s always good for a few bucks, let loose another billion in new fiat cash [last week]."

"The coordinated explosive monetary growth in the developed countries continues blazing along. We are in the midst of an historic experiment, and will answer the burning question: if every country rapidly expands their monetary base beyond growth in GDP or inflation, what will happen?"

The CPI numbers released yesterday suggest…what’s this? Inflation?…The median CPI is running at 4.2%. If that ain’t inflation, what is it?

Meanwhile, Office of Management and Budget Director Mitchell Daniels, referring to the new, much bigger budget, said "If we are not prepared to roll back spending" once the current crisis is over, "we will make a fundamental mistake."

"This makes the stupid assumption’" the Guru continues, "that there will not be a crisis of one sort or another. Congress is ALWAYS finding some crisis that needs gobs of money to be spent. Tell me about one single moment in your whole life where the government, any government, was NOT addressing some crisis, either real or imagined.

"That this crisis-spending is just to ameliorate the malignant, unintended consequences of the sheer tonnage of decades of previous crisis interventions, one monstrously expensive-yet-utter failure piled on top of another, is what makes the whole exercise into farce. It guarantees yet more crisis interventions. And that will require more and bigger Congressional interventions and bold, decisive actions! Money! Power! Passing new laws! And photos photos photos!"

Well, Eric…what crisis is developing in the market?


Eric Fry from New York…

– "Upbeat earnings news from a gaggle of companies lit a fire under stocks Tuesday," reports CBSMarketwatch. While it is true that gaggles rarely light fires, this was no ordinary gaggle.

– "Good news from Texas Instruments and Novellus Systems propelled Intel, which propelled the Dow," the author of the mixed metaphor explains. "Further, better-than- expected results from the likes of General Motors and Johnson & Johnson gave Dow investors another reason to cheer."

– By the time these birds came home to roost, the Dow had gained 208 points to 10,301. The Nasdaq soared 3.6% on high-tech wings to 1,817.

– Meanwhile, out in the field of economic dreams, (and not too far from where the gaggle waddle about) yesterday’s favorable statistics seemed to indicate that economic growth is standing as high as elephant’s eye. March industrial production jumped 0.7 percent – the largest monthly increase in nearly two years. Capacity utilization also firmed nicely – to 75.4% in March from 74.9% in February.

– The only blights on the landscape were some poor data from the housing sector. Housing starts in the month of March tanked 7.8% and building permits plummeted 10%. But the bulls confidently cast aside these "aberrations" and got down to the business of buying stocks… especially semiconductor stocks.

– Both Texas Instruments and Novellus Systems reported surprisingly "strong" first-quarter results – which, by the way, still amounted to losses for both companies. Nevertheless, both companies dutifully upped their second-quarter earnings projections and, in the process, kicked off a sharp rally in the semiconductor sector. The Philadelphia Semiconductor Index (SOX) jumped 5 1/2 percent.

– The merrymaking continued after-hours when Intel reported first-quarter earnings that were in line with those all-important "analyst expectations." Meanwhile, out in the real world, the prognosis continues to be gloomy for the semiconductor sector.

– "According to the Semiconductor Industry Association (SIA)," writes Fred Hickey, editor of the High Tech Strategist, "global semiconductor sales in the first two months of the year came in at $10 billion each month…That’s an [annual] run rate of $120 billion – nearly $20 billion less than the industry recorded in 2001." By contrast, Hickey notes, "Eight years ago, worldwide semiconductor sales were nearly $150 billion." Some growth industry!

– But while Wall Street celebrates a recovery, for one day at least, evidence of non-recovery abounds. A real recovery that produces a meaningful increase in corporate profits would be expected to boost ad spending as well. But that’s not happening.

– The first clue that all is not well in Ad-Land is the meager attendance this week at the annual meeting of the American Association of Advertising Agencies (AAAA). Advertising executives from across the country are convening at the posh Ritz-Carlton resort in Dana Point, California. But only 300 bigwigs are scheduled to show up, compared to the 450 ad execs who simply HAD to attend the 2000 conference in Southampton, Bermuda.

– This year’s confab is optimistically entitled, "Looking Forward." Unfortunately, those in attendance might need binoculars to look far enough forward to spot a recovery in ad spending.

– The conference’s own brochure states candidly, "Pundits say an economic recovery is in sight, but who knows? About the only thing that’s certain is that managing an ad agency has probably never been more difficult or challenging than it is right now."

– "Hopes for a quick advertising recovery may have been wishful thinking," the Wall Street Journal muses. "New figures by leading forecaster Zenith Optimedia Group suggest that no upturn is likely until the fourth quarter, and global spending on advertising is likely to fall significantly for the second year in a row."

– Meanwhile, over in the public relations industry – which, as bad luck would have it, is owned almost entirely by the advertising industry – conditions are also grim. "The average size of a client’s PR budget plunged 21% last year to $3.8 million from $4.8 million a year earlier," the Journal observed.

– But through it all, observes Dr. Kurt Richebacher, "Irrational exuberance about the U.S. economy lives on. An up-blip in real GDP growth during the fourth quarter…kindled wild fantasies about an economic recovery. There is no sense of how such a recovery would be sustained…Tax cuts and some rebuilding of inventories may produce one or two new up-blips, but a sustainable, sufficiently strong rebound depends ultimately on double-digit upturns in the various categories of capital spending which, in turn, depend on sharply improving profit prospects."

Unfortunately, says Richebacher, "we identify overwhelming risks for profits to the downside."


From London…

*** A prime short? Full-time friend, part-time nemesis Porter Stansberry thinks so. Porter: "After ten years without missing its earnings figures, IBM missed its first quarter revenue estimate by $1 billion. That’s a big miss. Reason? The new CEO can’t play the kind of asset sales/share buyback games that outgoing CEO Lou Gerstner could get away with. No more earnings trickery.

"That’s well known and in the news. But what hasn’t yet made the headlines is Lou’s role in the Bristol-Myers debacle. BMY was the only pharma rated AAA by both Moody’s and S&P – it was the IBM of pharma. No more. The company’s new CEO has goofed big time, blowing $2 billion on a bad drug aquisition (C-225) and BMY hasn’t developed a substantial new drug since 1999. Meanwhile its top four money makers all went off patent last year. The main problem with the company is that over the last five years – much like IBM – it has been spending more on share buy backs than R&D.

"I’ve been short BMY for the last three months and I’ve been short IBM off and on for three years. But I just realized: Lou Gerstner is a director of Bristol-Myers and he’s on both the executive committee and the corporate governance committee. That should make him the poster boy for short-term managers who use the corporate treasury to keep their own options in the money, until they sell right before retirement. Having Lou on the board of directors of BMY is letting the fox guard the hen house.

"Lou has sold 2.1 million shares of IBM stock in the last two years and 13,000 shares of BMY (half his stake in BMY). Lou didn’t buy any of these shares at retail price, of course."

Bill is on the Eurostar this morning headed for London…I’m already here. The whole gang is coming to town for a writing conference. We’ll be joined by participants from Germany, Poland, Romania, France, South Africa, Britain, of course…and the US. It promises to be a heckuva soiree. More tomorrow…

Addison Wiggin

The Daily Reckoning