Real Estate/Credit Deflation 16: The Next Dozen Shoes to Drop
By Steve Moyer

“If the shoe fits, it’s too expensive.” ~ Adrienne Gusoff

I was offered a very nice position with Fisher Investments of Woodside, California last year and, although I passed on the opportunity, I truly respect their money management track record. At the same time, I have noticed from their website that they are comparing the current equity market with the set-up which existed in 1992; they see this as a brief cyclical downturn prior to a multi-year bull market run rather than an unfolding, post-triple-bubble economic downward spiral. In fact, as I look through the site’s archives, the Fisher research team (60 strong, and plenty bright) doesn’t address post-bubble possibilities in any way, shape or form. They have a major blind spot — that being the collapse of real estate values and related securities in the U.S (and beyond) and the economic ramifications thereof. I guess they’re too busy trying to figure out why the stock market isn’t rallying enough based on attractive P/E ratios, favorable bond-to-earnings yields, low interest rates, wanton monetary policy and other irrelevant indicators. The answer is it’s all being trumped by contagious real estate deflation.

This is no cyclical downturn, friends. This is post-bubble-bubble-bubble time in the U.S. (and now we’ve added deflating China and India stock bubbles to the mix). When the happy talkers on CNBC tell you about real estate or investment cycles “since World War II” or yammer on about “typical bear markets,” just know that that’s why bubbles inflate in the first place; few know (or want to know) anything about investment manias, credit implosions or deflationary depressions. Few know that bubbles go bust with frightening consequences, or that housing bubble deflation is the most onerous one of them all (because far more people own houses than stocks). The “don’t worry — values will always go up!” crowd, emboldened by some sense that the Fed will surely “take care” of everything, will be the one turning bitter in the months and years ahead, while asset preservationists rule the roost.

Before I move on, please take a moment to read a signature piece related to our real estate/credit deflation premise. Penned by Michael “Mish” Shedlock, this is the article I’ll be sending from here on out when hyperinflationists write in to say “The Fed will never allow a deflationary depression!” As we’ve maintained from the beginning, the problem is much too big for the Fed to contain, and Mish’s article reflects that. I couldn’t agree more with his conclusions. To wit, please see this article.

While I’m at it, Mish is on fire right now, and he has his finger firmly on the pulse of what is taking place in the U.S. economy. I suggest you bookmark and read his blog each day (or as time allows): http://globaleconomicanalysis.blogspot.com.

Onward: In response to a request from one of our readers, I decided to make like a cobbler and throw out the next dozen shoes to drop as real estate and credit deflation take greater hold. I accept the challenge, and understand that these answers might have some bearing on a 2008-2009 investment decision or two. So here goes:

1. The Fed won’t turn around rapidly developing and contagious “depression psychology.” Can’t, isn’t and won’t. Picture Bernanke, Paulson and the other United States’ Economic Dictators standing around an emptying toilet bowl, frantically using their bare hands to keep water from going down the drain. Such is the case of these Dictators vs. the awesome force that is real estate/credit deflation.

When home values are declining and banks are afraid to lend money (to borrowers AND to each other), it makes no difference what desperate “policymakers” do; Bernanke, Paulson and friends don’t have the power to force people to borrow and banks to lend. The market does that. That confidence is waning, and it’s not coming back until few think it ever will.

2. Nothing will stop real estate values from continuing their decline; they will continue to fall, from coast to coast, category to category, setting up an eventual “crash” when a global systemic event takes the entire market out at the knees. Just laugh in the face of those who say real estate is bottoming now or will bottom “later this year,” in 2009 or any other time in the next five years (at least). Certainly there won’t be a “bottom” until a meltdown of one sort or another comes to pass and until most conclude that buying real estate is a losing proposition. Anyone who says we’ve reached bottom in the meanwhile surely has something to sell you (probably real estate or stocks).

THERE IS ABSOLUTELY NOTHING TO SUGGEST THAT THINGS ARE IMPROVING IN THIS ARENA; IN FACT, as lenders get more skittish, financing gets tougher to find by the day and more cash down is required, THINGS ARE GETTING MARKEDLY WORSE. REAL ESTATE VALUES ARE IN FULL DECLINE, AND THERE IS A LONG WAY TO GO. It’s the top of the second, not the bottom of the eighth.

Credit Suisse projects that by 2012, 12.7% of houses in the United States — roughly 6.5 million homes or ONE IN EIGHT — will have been foreclosed upon (I think it will eventually be worse than that). Regardless, that projection alone is enough to cause significant strain on the U.S. economy, and that strain will only lead to more asset deflation. Suffice to say post-bubble real estate deflation has a long way to go, my friends.

Property sales require a willing buyer, a motivated-enough seller and an agreeable lender and there aren’t now — nor will there be — enough of these folks to go around for possibly a generation. Buyers, in particular, will become ever-harder to come by.

When “the government” starts bulldozing entire tracts of houses — and they will at some point — in an attempt to do SOMETHING about chronic and persistent housing oversupply and blight, we’ll start talking about “the bottom.” Until then, there is no bottom.

3. “I can’t get financing.” Despite my protestations, a client recently decided to buy a $4 million property direct from an acquaintance of his; a property/price combination he thought was too good to pass up. Tellingly, no lender came close to offering him the loan he expected. They either weren’t interested in the loan at all or wanted a lot more money down and a much higher interest rate, not to mention his first-born male child as collateral. Once he got a sense of what the new rules of the game were, he quickly decided to pass on the “great opportunity.”

A few months from now there might be another buyer, and she’ll need even more cash to make the deal. By then, she’ll be familiar with the financing landscape and will want a correspondingly lower price. Lo and behold, and assuming the seller is motivated enough to reduce the price again, even fewer lenders will want to make the loan. And so on down the deflationary line. It’s part of the process, and happening as we speak. Most buyers don’t realize it until one lender after another says thanks, but no thanks.

Get used to the refrain. Each month will bring additional categories of loans lenders will no longer be willing to make. For example, financing for condominiums (except within mature, well-established projects) is already almost impossible to get, which is sure to knock condo values down another 30-40%.

The Fed may lower short-term rates, but as we’re learning, that doesn’t mean lenders will follow suit. Now that they’re back to imputing risk, they want higher returns, and the only way to achieve that is to raise interest rates, no matter the Fed. Truth is, the Fed has little to do with market interest rates for real estate.

The Catch-22 is that as real estate deflation continues to unfold, those intelligent enough to have 10 or 20% down (or more) plus cash in the bank to back up the purchase won’t be stupid enough to throw good money after bad via buying market real estate. Only complete dunderheads are buying now and the dunderhead contingent grows tinier by the day.

4. Banks will be under more pressure, and bank failures will follow. When the stock market’s countertrend rally is finished and the summer/fall dive in the market takes hold, the cover story will likely be centered around failing financial institutions — large and small — and the “We Don’t Have Enough Fingers for the Dike!” Fed. As one leak is plugged, three more will appear, and market confidence will be shattered as all major asset classes fall in value at roughly the same time. Nothing like a major headline run on the bank (or several) to get Americans heading into full-on depression mode.

5. The “Wealth Effect” will morph into the “Broke Effect.” The U.S. economy boomed and the stock market benefited from artificial, Fed-induced 2003-2007 reflation, mostly because folks felt wealthy due to phony home value “increases.” This meant boomtimes in real estate, a seemingly healthy economy, further expected value increases, little incentive to save and an American cultural rush to “borrow to buy things.” Now that home equity is disappearing by the day, homeowners saddled with too much debt feel ever poorer, not wealthier, and they’ll do what most people do when they feel broke: They’ll watch every penny and say no to more debt.

6. Consumers will spend less with each passing month. The downturn in retail sales will become increasingly pronounced and force scores of bankruptcies in the retail sector. Face it, cash-strapped Americans, getting clobbered each week by the high cost of food and gasoline, forced to buy things with money they don’t have (I’m talking cash, not disappearing credit), and already saddled with too much debt, have no choice but to snap shut their pocketbooks. More importantly, they’re in the process of discovering that almost any discretionary purchase will cost them less next year. Discount retailers might weather the storm, but the more optional the purchase, the worse-off the retailer will be. Not only will retailers be unable to pass along rising costs to their customers, price cuts, discounts, coupons, giveaways, close-outs and going-out-of-business sales will become the only way to attract increasingly tight-fisted consumers in the United States.

Obviously, retailers who opened outlets from coast to coast to take advantage of the borrow-to-buy-things spending spree of 2003-2007 will not be able to withstand such a striking reversal of fortunes. Look for going-out-of-business sales, sudden store closures, an epidemic of empty storefronts and rashes of bankruptcies (including a few “headline” big box names). Shopping mall and shopping center values will quickly get clobbered.

7. The commercial real estate value decline will intensify. The homebuilding index led the way downhill in 2005 and home values soon followed suit; the same is now true in the commercial real estate game. Values on the commercial side have held up fairly well through the 2nd half of 2007 but commercial and office REIT’s are now getting hammered (there’s your fair warning) and the commercial mortgage sector is in the process of joining the growing default party. Seasoned real estate investors are increasingly willing to wait on the sidelines; they see the handwriting on the wall and are happy to look for better deals. They MAY buy, but only at risk-premium discounts (i.e., higher capitalization rates) and that means lower prices.

As real estate deflation takes further hold, no commercial real estate category will be spared. Current investors will have their own problems to deal with (rising vacancies, lack of fresh leasing interest and declining rents) and they’ll lose interest in buying until THEY think the shakeout is complete (best guess: April of, oh, 2018).

Interestingly, apartment rents have increased solidly in 2007 and into 2008 as housing sales have come to a standstill and folks choose to rent (or have to), but that trend will reverse itself soon enough. The last time the U.S. experienced a deflationary depression, residential rents fell for 18 consecutive years. Expect the same or worse this time around. The market has held up fairly well for residential income property, but it won’t be immune to deflationary real estate forces. If you don’t sell your residential income property given everything you know now, you’ll have no one to blame but yourself as values decline and management headaches multiply. It’s still a very good time to get out.

8. U.S. real estate deflation is now the world’s real estate deflation. To make matters worse, much of the rest of the Western world is now experiencing the same, steep housing price drop/credit crunch. Real estate deflation has arrived on a worldwide scale and the pressure on the global economy and banking will be too great to hold back the spreading deflationary forces. Central bankers cannot and will not control the outcome, try as they might to slow it down during the plague’s early stages.

9. Yes, your area will be hit, too. It’s just a matter of time. Each passing month brings another state or two — and more counties within each state — afflicted by real estate and credit deflation. Here in the Bay Area, for instance, San Francisco, San Mateo, Palo Alto, Marin County and the Oakland and Berkeley Hills have held up reasonably well in terms of median price, while neighboring communities get pimp-slapped one after another. Alas, it’s only a matter of time until the cancer spreads. First off, the number of sales in less-impacted areas is down substantially (fewer stupid buyers willing to pay last year’s prices). Second, instead of “discounting to sell,” frustrated but well-heeled sellers just take those properties off the market while they “wait for things to rebound and prices to go back up;” so entrenched is their view that values will keep going up, with occasional pauses along the way. In this case, it’ll be like waiting for Godot.

Years from now, those sellers will end up either selling at lower prices (when things are significantly worse), walking away when they find themselves hopelessly underwater, or sitting in rocking chairs, waxing nostalgic about the time their property was worth two, three or four times what it has become.

10. Stock markets around the globe will face ever-more downward pressure, dragged down by real estate and banking woes in the United States and beyond. When the real estate pain becomes bad enough, those markets will crash, too. Will a stock market crash cause a bigger real estate crash, or vice versa? The answer is yes.

It doesn’t really matter which is the chicken and which is the egg. With credit and real estate markets collapsing worldwide, a woeful lack of consumer confidence, ever-greater effects on the consumer and the economy (not to mention employment), people will be in no mood to buy stocks. There might be a countertrend rally or two yet to come, but the late-2007 “top” is in and the post-triple-bubble deflationary drift will be overwhelmingly down. When the majority of people realize that the global economy has no chance of turning itself around, the United States stock market will crash and world markets will follow, causing real estate and other asset values to ratchet down even further.

11. Local and state governments and school districts, already under pressure, will feel the crunch more each day, and deficits, layoffs and bankruptcies will follow. Declining property values + far fewer transactions = significantly less revenue for state and local governments. It will be interesting to watch overtaxed and cash-squeezed citizens battle state and municipal entities as politicians try to float more bonds and work to raise taxes and fees in order to offset huge reductions in revenue. Meanwhile, necessary layoffs and budget cuts in the public sector will just add to the post-bubble, deflationary pressure.

12. One bad thing leads to five others. Falling home prices will affect confidence which will affect buying psychology which will affect home sales which will affect the economy which will affect employment which will affect creditworthiness which will affect availability of credit which will affect earnings which will affect stock values which will affect social mood which will affect employment which will affect consumer spending which will affect home prices which will affect confidence which will affect buying psychology which will affect home sales which will affect…..Ah, hell, you get the picture.

If your neighbors can’t connect the dots by now, there’s really not much hope for them. I’m just glad you’re here, reading stuff like this, taking good care of the eggs in your basket. Risk is everywhere, and something inside of you is telling you to be alert to the possibility. You’re in a very select group, and I applaud you for it.



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1. Mish produces a very nice analysis of government sponsored entity (”GSE”), mortgage backed security packager Fannie Mae and its capital position. Needless to say, given the significant downturn in the housing market, predictable by us, but unpredictable by pie-in-sky financial professionals and government bureaucrats the world over, the mortgage giant is not looking too healthy in terms of capital level. I will be VERY surprised if one of the following two does not take place: 1. Taxpayers are forced to bail out this dubious firm; or, 2. the firm essentially goes under. At this point owning this stock (FNM) does not appear to be the most sound investment.

2. Ron Paul’s brand new book, The Revolution: A Manifesto, is a masterpiece work of common sense political honesty and frankness in an era of massive government foolishness and deception. Fortunately for freedom lovers everywhere, the book is making waves. It has reached the #1 spot on the NY Times best sellers list.

3. Grand Theft Auto IV, the latest release from Take-Two Interactive (TTWO) based on operating a street criminal bent on various forms of career development, sold an amazing 6 million copies in its first week in stores. At $500 million in retail value, this represented a new record, significantly topping Halo 3 from Microsoft, which was released in October 2007. The game is the fourth in the line of the highly addictive series based on the dour social mood activities of the criminal underworld. A very interesting blow out for Take-Two.

4. The “D.C. Madam”, who reportedly committed suicide to avoid a potentially lengthy prison term, and potentially had some serious clients on her list, had her suicide notes released this week. Reportedly, one of the notes quoted her as saying suicide was the only “exit strategy” she could think of. To me, language like that in a woman’s suicide note is kind of a strange thing. Maybe it’s just me, who knows?

5. Vallejo, CA, a city of roughly 100,000 residents, declared bankruptcy. The city seems to have been wracked by huge civil servant salaries and was facing a large decrease in property tax revenues due to the housing decline and an increase in foreclosures. Could municipal bonds be the next shoe to drop as many cities, counties and states struggle to pay the bills amidst a slowing economy?

6. The Republican Party, which foolishly trashed Ron Paul and his energetic supporters, looks ready to get thrashed come November. There is a significant liberty-supporting void in the two major parties. This will have to be rectified as liberty-lovers in America are a large contingent and growing daily. This is the home of liberty and if the Republicans do not take the mantle, there will be changes. With all the corruption, greed, war-mongering and general disregard for the Constitution and the rule of law, it is very little surprise that the Republican Party is bracing for a very tough November 2008.

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Many chicken-hawks, war-mongers and those who may potentially profit from endless war and the military-industrial complex (politicians included…) have tried to smear Ron Paul as somehow not supporting the troops because he is not a gung-ho Iraq War supporter. The facts say, however, that Paul’s positions - protect and defend America first, do not police the world, do not nation build, and be generally friendly with the world at large - are drawing a well of support from those individuals whose work it is to defend our country and uphold our Constitution via arms.

Air Force Times analyzes the numbers.

It has been very harrying for a pro-peace, pro-sanity, anti-death, anti-wealth-down-the-drain, anti-corruption individual like myself observe the war parties and the corporate mouthpiece media defame Paul and generally ignore and smear him over the course of this campaign. These people should realize that by doing so, they are, in part, sending the same defamations towards our fighting men and women, as they long for the same goals - defending liberty and maintaining the Constitution and its limited government principles in America through the 21st Century.

Minus principled defense of liberty, peaceful coexistence and self-determined prosperity, these ideals will not be passed on to future generations. I solute Dr. Paul for his efforts in defending liberty and putting the American idea and the American people first. I sincerely call on any and all political leaders (not politicians) to uphold the same principled defense of the inalienable rights that I will be passing on to my children.

Come hell or high water will America succumb to outright tyranny. We must be vigilant in its defense at this time, because there has been a long period of laziness on the part of the people.

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The chart speaks for itself.

Click the picture to enlarge:

Read what caused this turn of events here.

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This is a very solid interview. Props to Bloomberg for producing it.

Part 1:



Part 2:



Part 3:



Filed under: Politics, Social Mood, Economics, Current Events | 1 Comment »

Mish presents an extraordinary analysis of Bernanke’s Federal Reserve auction facilities and why they are really just reshuffling the chairs on the deck of the titanic. One of his best points is that the Fed is not “King Midas” - just because it is willing to hold crappy bonds, such as mortgage backed securities, does not make those securities worth any more.

The fact of the matter is that too much folly was undertaken during the credit bubble years. You can not make up for excess folly by encouraging further folly. Yet that is essentially the policy of the current Federal Reserve Board led by “Helicopter” Ben Bernanke. Living in his Ivory Tower Academic World (”ITAW”) for so long, he has been zapped of any noticeable common sense. Traditionally, those who inhabit the ITAW are filled with undue hubris and are given far too much credit by the lay individual. The reality is, the emperor has no clothes. If Bernanke continues down his foolish path, he will likely kill the US$ and therefore destroy the foundation of the American economy. So far, he hasn’t shown too much concern as the Dollar has crashed non-stop since he has been Fed Chairman. ITAW syndrome has been known to cause unintended consequencces. Hopefully a deceased US$ and totally obliterated U.S. economic system is not one of those.

At this time, it is important to realize that people who made poor decisions should be the ones to suffer the consequences and society as a whole should not be pulled into the Bernanke ITAW black hole.

Click here for more on the societal ills of a falling dollar.

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1. Amidst the housing bust portion of the boom-bust cycle, brought on by extremely loose monetary policy engineered by “Easy” Al Greenspan and continued by “Helicopter” Ben Bernanke, underwater home “owners” are now setting fire to their houses (and even cars) to attempt to gain insurance settlements on an impaired asset. This sort of activity by clearly spoiled folks who made bad decisions, is another indication that no one should be bailed out by taxpayers in the housing “crisis”. Let the market play out and let those who lived within their means secure the fruit of their well reasoned decisions. Don’t punish good choices at the expense of everybody.

2. A friend of mine, Adam Yamauchi, turned my attention to this very solid interview in the Rich Dad, Poor Dad series. The video encompasses metals, real estate, Federal Reserve policy and other critical issues. It is a definite good watch.

3. Across the country, reckless speculation based on easy money helped spur a ridiculous housing bubble. Now that the false boom has led to its inevitable bust, ghost towns are sprouting up across the country related to a huge increase in foreclosures.

4. I will state right now: establishing Fannie Mae and Freddie Mac was a TERRIBLE idea on the part of the out-of-control federal government. These market disrupting organizations, which are assumed to have an “implied government backing” helped significantly lower the cost of capital in relation to purchasing homes in the U.S. The problem is, most people now cannot afford the average home in their area. And to add total insult to injury, there is growing speculation that the American taxpayer may indeed be bludgeoned yet again to bail out these nonsensical entities. The nonsense and blatant plunder-filled nature of such activity is so morally reprehensible that it is hard for me not to cuss out loud at the prospect. Socializing losses is one of the greatest paths to societal failure known to man.

5. People are walking away from contracts to buy new homes at an amazing rate, nearly one third of all contracts signed. Desperate builders are doing everything in their power to keep as much money from the walk-aways as possible.

6. Mish analyzes one of the most pressing debates in the environment of diligent market observers: can there be a deflation in a fiat money environment?

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The economy is undoubtedly at a critical turning point. Let’s take some time to make a reasonable attempt to understand what has happened and what is happening now, and try, humbly and sincerely, to decipher what is next on tap for the economy and markets.

First, for a little macro background:

1. In 2007, the United States represented the largest economy on the globe, with an estimated $13.8 trillion gross domestic product (”GDP”) for 2007. While the total Euro Zone represented an estimated $16.8 trillion GDP economy, surpassing the U.S., the next individual countries behind the U.S. were Japan at $4.4 trillion (roughly 32% of the size of the U.S. economy), Germany at $3.3 trillion (24% of U.S. GDP size), China at just under $3.3 trillion (24%), the United Kingdom at $2.8 trillion (20%), France at $2.6 trillion (19%) and Italy at $2.1 trillion (15%). These represented the only other countries with GDPs in excess of $2 trillion for 2007. Interestingly, only 17 countries had official GDPs above $500 billion in 2007.

It must be noted, however, that in many developing countries, there exists much more barter and unregistered (free?) exchange, which may not be counted in official figures, therefore potentially under-recording these nations’ GDP estimates. That being said, this figure is likely not of huge significance, but bears reflection.

To provide further context, the graph below (click to enlarge) illustrates GDP growth rate estimates for 2007, indicating which developing regions of the globe are fueling significant global growth. Growth in North American GDP is indicated to have been very slow for 2007. Chinese and surrounding economies, in contrast, showed tremendous growth.

2. The U.S. economy has grown consistently through its history, with occasional road blocks, with growth due primarily to its foundation as a generally free society as laid out in the Declaration of Independence and U.S. Constitution. Additional factors that have played a significant role include an ethic of individual determination and effort, innovative and independent thinking and product development, a general reliance on free market concepts (hindered by more than occasional government regulation and tinkering), a strong historical respect for, and defense of, individual personal property rights and the rule of relatively just law, as well as a cultural desire for education and personal betterment on the path towards individual happiness. These concepts have underlain the economic growth of the U.S. over its time but have been applied/defended/upheld to varying degrees over the history of the nation.

At the current moment in history, there exist questions as to whether the U.S. economy, deeply infected by, most prominently, “Keynesian Economics”, whereby the government feels compelled to consistently enter into the economic realm to “engineer” desired economic outcomes, will survive in the form we currently know it. Keynesian thinking, which was fully embraced under the Nixon Administration (”We are all Keynesians now”), has been thoroughly debunked by Ludwig von Mises and the Austrian (Free Market) Economists, and is a significant threat to the idea of personal freedom via its rationalization for consistent government intervention into the free economy. This “crack in the door” has helped create the idea that it is totally natural for the government to “do something” every time there is a hiccup in the economy. Combined with the U.S. (and generally global) belief in fiat currency and fractional reserve lending, these forces have led to a situation of very dangerous malinvestment brought on by the body of force altering economic terms in an unnatural manner.

3. Now that we have some general context as to the global economy and the economic history of the United States, let’s look at the history of the past 30-40 years (bear in mind, this is the period that has witnessed the “Globalization” of the world economy):

- In 1971 Nixon broke the Bretton Woods Agreement that had linked the U.S. Dollar to a fixed price of gold on international exchanges and also had tied global currencies to fixed values. The cause of the break was the excessive spending on both war and social programs (”Guns and Butter”) of the 1960s, heavily administered by Lyndon Johnson and continued by Nixon. This can be seen as a “bankruptcy” of the U.S. Federal Government as it defaulted on its obligation to exchange dollars with gold at the rate it had promised previously.

- This Shock to the system led to heavy price increases (commonly known as inflation) in the 1970s. The well publicized oil shock of the 1970s actually was simply a rational reaction on the part of oil producers that the U.S. Dollar (Federal Reserve Note) was no longer backed by anything but government force (no gold, silver, etc.). This shock to the system sent gold and silver (real money) to unprecedented heights in rapid fashion through the 1970s, significantly destabilizing the economy, and reflecting the new reality of a totally floating fiat currency system on a global basis. Needless to say, this was a significantly important development in the history of modern American economics and finance. Fiat currencies have been known to go bust throughout history. (In a funny side note, many people I come across both online and off-line seem to think that a “Gold Standard” is some 19th Century historical relic, essentially announcing their ignorance of economic history in an unashamed manner. Most of the 20th Century reflected at least the perception of gold-backed currency.)

- To save the Dollar from complete destruction, Paul Volcker, the Federal Reserve Chairman of the era, raised short term interest rates to a peak of nearly 20% (Effective Federal Funds Rate “EFF”) in April 1980 and working to contain the growth in monetary aggregates. Compare this figure to the current EFF of 2.35% as of April 16, 2008.

- By offering such a significant return for dollar-based fixed income assets, the high rates blunted the public infatuation with non-interest-bearing precious metals holdings. Meanwhile, the economy tanked in the early ’80s. A “double dip” recession occurred in the 1980-1982 period. This period is widely considered the worst recession in the U.S. in the Post-Great-Depression era. The monetary breaks needed to save the dollar from spiraling to irrelevancy had caused the economy to contract significantly.

- The 1980s brought the early development of the biggest tool in the modern economy: the personal computer. Additionally, the dollar and the belief in fiat currencies stabilized, destructive war spending related to the Vietnam War was a thing of the past, President Ronald Reagan brought a semi-rebirth in classical liberal economics, limited government and free markets, and the era of structured Wall Street finance began. The 1980s witnessed the foundation of late-20th Century growth, a rebound from the shock of the 1970s and early 1980s. The decade also provided some foreshadowing to fiat currency and fractional reserve lending financial instability with the Savings and Loan (”S&L”) Crisis and the significant crash in the stock market in October 1987. During each event the fiscal and monetary authorities significantly stepped in to “backstop the system”. In the S&L crisis, large bail outs were passed, while the stock market crash brought a surge of monetary liquidity via newly appointed Federal Reserve Chairman Alan Greenspan.

- The early 1990s witnessed a return to a mildly destructive war (Iraq I) as well as the most recent (until the current) case of a national housing market decline. Again, to remedy the problem, Alan Greenspan surged the system with “liquidity”, which turned out to be his trademark as Fed Chairman.

- With the establishment of the computer as a significant productivity tool and the introduction of the unquestionably important social/economic tool of the Internet, the late 1990s witnessed a significant economic expansion. With belief in fiat currencies and fractional reserve banking at an all time high, a period of general peace and stability, rapid innovation in the global economy, and significant downward pressures on prices of goods and labor coming from developing regions (most notably China) further providing fuel for belief in fiat currency, the U.S. economy reached its 20th Century peak just as the century turned. It must also be noted that this period witnessed a significant expansion in credit for a broad range of organizations, most notably in the Tech/Telecom sectors as well as on a general level.

- The turn of the millennium brought a change in mood. Greater fools in the stock market began to disappear as the Tech/Telecom boom went completely bust, reflecting some rotten valuations in many publicly traded companies (see Nasdaq chart below).

- As the bubble burst and the financial economy also teetered due to bad debt related to the bust, the U.S. economy slid into recession in 2001. Just as the economy got head long into the depths of the recession, the September 11, 2001 attacks on the World Trade Center and, amazingly, the U.S. Pentagon, forced a complete transition in short and intermediate term thinking in the U.S.

- Fearful of a collapse in the system, Alan Greenspan pushed EFF interest rates extraordinarily low and held them there for an extended period of time. The EFF found its nadir in August 2003 at a paltry 0.86% and drifted below 1% off-and-on thereafter, with the EFF equaling 0.97% as late as June 2004 when it was already blatantly obvious to any reasonable observer that the U.S. housing market was significantly bubbling unnaturally (click to expand below).

- The lack of wisdom on Alan Greenspan’s part allowed credit to stay ridiculously loose for a number of years beyond when it was advisable from a rational perspective. First, Greenspan fumbled the gift he had been given of a pervasive social belief in the validity of fiat currencies.

Secondly, Greenspan created a completely destabilized housing market while overseeing a massive growth in credit products. Sadly, the largest credit bubble in American history occurred during this period, sowing the seeds for significant economic instability. The amazingly loose credit also sowed the seeds of serious weakening of the U.S. Dollar. Please see Steve Moyer’s commentary Real Estate/Credit Deflation 14: Anatomy of a Murder for a more thorough break down of the factors relating to the boom/bust cycle we have been witness to (and are still experiencing).

- The housing bubble peaked in the Untied States in roughly Summer of 2005. The following magazine cover from Time Magazine provided a perfect moment to realize the crest of the housing wave was nigh:

Over the past nearly three years, the U.S. housing and financial markets have been struggling to not fall completely apart after years of unnatural credit expansion, terrible borrowing and lending decisions, and vastly complacent market participation.

Notably, publicly-traded organizations such as banking behemoth Citigroup (C), significant broker-dealer Merril Lynch (MER), savings and loan Washington Mutual (WM), major homebuilders such as Lennar (LEN), and mortgage behemoths like Fannie Mae (FNM) significantly crashed in terms of market value, reflecting their poisoned market positions and imprudent financial activity.

Additionally, numerous other banking, home building, finance, broker-dealer, and other related entities have seen as bad or worse. mortgage insurers such as MBIA (MBI), whose insurance has underpinned ratings on vast swaths of bonds in the marketplace, are at risk of going under and further destabilizing the financial economy.

Although the housing market generally peaked in mid/late-2005, and the first signs of the crisis hit financial entities in Summer 2007, the broad stock markets held up through October 2007. From that point through Mid-March of 2008, the broad equity markets lost roughly 20% of their value, with the S&P 500 dropping from about 1,575 to just under 1,260 over five months.

Over this period of time, the reports of economic growth showed significant declines. While in the third quarter of 2007, real GDP growth came in at an estimated robust 4.9% annual rate, the fourth quarter showed rapid deceleration to 0.6% annualized growth. With an increasing crisis-like mood environment in the first quarter of 2008, it is relatively safe to say that growth was negative during the period, in spite of the heavy action of current Fed Chairman Ben Bernanke in lowering rates, providing novel short-term (?) lending facilities to commercial and investment banks, as well as the brokered and backstopped deal for JP Morgan to acquire collapsed broker-dealer Bear Stearns, in a highly questionable move. This was justified as needed to “save the economy”, which clearly is not a good indicator of long-run economic stability.

Since the more panic lows of mid-March 2008, the equity markets have posted a moderate rebound. The S&P 500 has rallied off of its roughly 1,260 lows to today’s closing price of 1,390, a 10% gain in a month.

The most recent news, coinciding with the latest leg in the short-term rebound, is the above-market financial results of key enterprises IBM (IBM), Google (GOOG), Caterpillar (CAT) and Coca-Cola (KO). Additionally, this week brought poor results from Citigroup and Merril Lynch (billions in additional write downs), but the results exceeded the extremely beaten down expectations in the market, thereby helping to provide more fuel for the rally.

Analyzing the companies that have been showing strength:

1. IBM, a $172 billion company by market cap, appears to me to be an integral portion of the total global economy at this point. Through significant merger and acquisition activity, extensive technology development, a focus on core business features, and a relatively traditional blue chip perspective, they have held up well. Due to their global nature, earnings have been boosted by the extremely weak dollar. While U.S. consumers struggle, international firms are boosted. IBM appears to be sidestepping the turmoil in the U.S. markets at this time. It will be telling to see whether they hold up or succumb to broad economic difficulties. IBM currently trades at a price/earnings (”P/E”) multiple of 16.3 based on the latest twelve months (”LTM”) reported results. Current estimates for 2008 and 2009 pin IBM at forward P/E multiples of 14.6 and 13.0, respectively.

2. Google, a $170 billion company by market cap, was beaten down significantly from nearly $750 per share in November 2007, to roughly $415 per share in mid-March. This represents an approximate 45% decline in value from peak to trough. This was definitely a significant change in perception of the company and represents investors becoming wary of the sustainability of growth in Internet advertising during an economic slowdown. This is the first major cycle Google has been a major play in, so it is unproven in relation to business cycle abilities. At $539 per share, Google sports a P/E of 32.2 based on LTM earnings, 27.6 based on 2008 projections, and 22.4 based on 2009 projections. It will be very interesting to see if Google can continue to hit revenue targets in a recessionary economic environment.

3. Caterpillar, a $53 billion company by market cap, has surprisingly to me, held up very strongly through the housing bust. Caterpillar produces heavy machinery for construction. My suspicion is that global infrastructure development is providing a nice revenue stream for CAT and the tardiness of the commercial real estate market to the decline has kept the market going for big construction machines. Again, a company prospering off of the weak dollar appears to be the case here. Again, consumers and savers are the ones bearing the brunt. At $85 per share, CAT trades at a P/E of 15.8 based on the LTM, 14.4 based on 2008 projections, and 12.8 based on 2009 projections.

4. Finally, Coca-Cola, a $140 billion company by market cap, has really avoided weakness to this point due to international sales of their beverages and products. Coke has reported robust sales in South America and calls those markets as dynamic as they have seen. Again, foreign sales are “worth more” in dollar terms as the dollar is WEAK due to questions of the Fed’s desire to restrain its own risk taking. At $60 per share, Coca-Cola trades at a P/E of 21.4 based on the LTM, 19.5 based on 2008 projections, and 17.9 based on 2009 projections. The primary risk, in my mind, to Coke in the coming months/years is a compression in its standard P/E multiples to ratios closer to the low teens along with general market weakness.

Given the above four stock stories, one could be led to believe that the U.S. economy is not doing bad at all. This sort of relief has permeated the investment world over the last week or two as bulls have breathed a sigh of relief after a number of months of general market swooning. The problem with this analysis, in my mind, is that the companies showing strength are those who are more intertwined with the global economy and are able to grow earnings outside of the US$ environment.

Meanwhile, those organizations that are more reliant on the U.S. economy are taking a more broadside hit. Housing-related companies have been decimated for a number of years now and earnings are, by and large, negative at this point. Further, continued asset impairments on writes downs of previously over-valued land will continue to make balance sheets unattractive for investors to buy into. Concurrently, commercial banks, investment banks, and broker-dealers have been feeling the blow of increased write offs associated with ill-advised loans and debt instruments, a decrease in financial and trading activity on a whole, and a growing mistrust of the organizations by both the international financial community as well as a growing contingent of domestic critics. Politically, the bail out of the leveraged “system” via the Bear Stearns-JP Morgan-Fed deal really shot a lot of the Federal Reserve’s ammo. It will become difficult for the Fed to take as aggressive steps if further crises erupt.

Furthermore, twin mini-bubbles that have grown up around U.S. consumer retail and U.S. commercial/retail real estate are currently in the early stages of what will likely be significant busts. With the U.S. consumer getting hit on all sides - declining house values, the end of the housing ATM, impaired consumer balance sheets, growing high interest consumer debt, surging oil and food prices, and a diminishing pool of high value employment opportunities in a number of high volume fields - there exists a massive head wind facing the retail sector. If retail, which grew to a ridiculous portion of the economy during the housing bubble and cheap Chinese goods years, takes a legitimate hit in this very difficult environment (hint: very likely), the commercial real estate that holds the retail businesses will take an associated major hit. As the economy chugged along and consumers dove head long into mortgage and revolving debt, commercial real estate could do no wrong as subdivisions sprung up everywhere. Now, however, this tide is turning. From what I see, 2008 will not be even a decent year for either retail or commercial real estate.

As we head further into this relief rally of Spring 2008, it will pay to be aware of the underlying intermediate and long term trends affecting the investment world. With the credit bubble environment having been clearly realigned to a more prudent/risk-averse framework, the excesses that built the rally of 2003-2007 will no longer be a part of the equation. This will continue to affect the U.S. economy as consumers will get hit very hard. The stimulus package will provide a small boost to some, but will mainly just help middle and working class folks buy gas and groceries and pay down credit card bills. It will be no panacea with gas at about $4 per gallon and grocery bills doubling from a few years back. The CPI measures don’t account for the fact that most people spend most of their conscious spending awareness on goods that are moving northward in price due to the weakness in the U.S. dollar and the continued growth in international food and energy demand. One major question that exists is, will the international markets slow significantly along with the major world consumer, the U.S.? Or will they be able to transfer production towards domestic consumption? We may simply be witnessing a crash of the American consumer. In many ways, this has been a predictable trend.

In my opinion, strategically seeking highly American-consumer-dependent sectors and individual equities and looking to short/buy puts on those names will provide a potentially high-value strategy in the coming 6 months to 2 years. I see a late-April-to-May peak in this corrective rally and a further negative run in equity values in the summer through the second half of the year. As always, with numerous head winds building up (including gold moving above $1,000 per ounce in March, threatening the popular ignorance of fiat currency inherent weakness as a store of value), the U.S. economy, $13.8 trillion in GDP in 2007, will have a hard time illustrating any growth whatsoever in that figure in 2008. Will the global economy hold up and will multi-nationals provide enough boost to keep things up? We will have to wait and see. Stay tuned…

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There is absolutely no reason why, if our executive branch of government has a government continuity plan for major disasters, that this information should not be shared with the key committees in the House of Representatives. Why would Bush and Co. deny access to such information to our elected representatives? The only answers are not good (hint: stupidity or evil).

Check out the video from the House floor:



More analysis on the subject:



Anyone who considers themselves a responsible citizen should be very aware of these sorts of issues and should not allow rogue elements of one of the branches of government to act outside of their Constitutional authority in ominous ways. One reason I suspect the congressional approval rating is so low is that they have been essentially neutered with fear since 9/11. What I have seen in our legislative body is a group being moved by fear. Congress wake up! Your job is to oversee and DIRECT the executive branch, not the other way around.

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Check out this site: angryrenter.com.

With prudent renters having realized that housing was in a bubble and avoiding the madness, they are now being double wammied by irresponsible Federal government officials who want to levy taxes to bail out those who got in over their head.

To put it simply: NO ONE DESERVES A TAXPAYER FUNDED BAIL OUT.

Renters and taxpayers should be angry witnessing the lunacy emanating from Washington DC in this day and age. Speak out.

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