In
the "Can you top this?" category, several creative football
fans in Philadelphia are apparently financing trips to the Super
Bowl by tapping into the equity in their homes. To the typical European
or Asian consumer, octogenarian, or hospital patient just awakening
from a 10-year coma, such behavior must seem bizarre. To the average
post-millennial American, this is barely one degree of separation
from normalcy.

Alone,
most people act rationally. Put them in a crowd and entertain them?
They shave their heads, paint their faces, expose their over-hopped
bellies to sub-freezing temperatures, shout obscenities at well-intended
referees, and generally lose their minds. (In the City of Brotherly
Love, they sometimes toss snowballs at these same officials.)

When
everyone is thinking alike, no one is thinking. Worse, the collective
level of intelligence drops to the lowest common denominator. What
is sure to whip people into a frenzy? Nothing beats an easily discernable
uptrend and a simple explanation for its perpetual continuation,
i.e. all the ingredients for everyone to get rich. The longer the
trend goes on, the smarter, more invincible, and more daring the
mob becomes.

Five
years ago, the crowd thought technology stocks paved the way to
early retirement. Their rationale was simple: the future would be
high-tech, highly productive, and highly profitable for those "New
Economy" companies who "got it." Never mind that
the Nasdaq 100 had vaulted 10 times in just the past five years
or that Cisco Systems' $500 billion market capitalization dwarfed
its sales of $19 billion. They sold their stodgy old-line stocks
(often to insiders) just to buy more.

In
hindsight, the signs of excess were all there. What the consumer
craves, Madison Avenue, Wall Street, and the mass media supply.
Ubiquitous TV ads encouraging day trading reached the sublime, one
showing a successful teenager with his own personal helicopter.
Half of 2000's Super Bowl ads were for dot-coms, many hastily produced.
CNBC (a.k.a. "Bubblevision") told its audience what they
wanted to hear: the future is bright, technology (e.g. the Internet)
is bringing information to the individual investor, and the real
risk is missing the ride. Analysts and strategists were mostly bullish,
and those who didn't give the consumer what he wanted were replaced.
Investment bankers packaged new product and insiders — especially
those fortunate enough to own stock in New Economy companies — generously
sold from existing inventory.

Predictably,
it all ended badly, but did we learn anything? Has human nature
really changed? Has the mob dissipated, kicked its gambling addiction,
and gone back to work?

For
starters, CNBC is still in business, Las Vegas is undergoing a construction
boom, TV shows about casinos are hot, and stock market speculation
is back. A recent headline reads, "Google Heads For the Moon."
With a market cap of $57 billion, sales of $3.2 billion, and its
two founders in their early 30s worth north of $7 billion each,
one could argue Google has already reached its destination.

The
real crowd pleaser these days, however, seems to be cheap credit.
Everywhere one turns there is a billboard, TV ad, or phone solicitation
offering once-in-a-generation low rates to the marginally creditworthy,
as long as the collateral has four walls and a front door. The formula
is simple: interest rates will remain low, credit will stay abundant,
and real estate always goes up. A logical conclusion follows: Buy
as much house as possible and borrow as much as the lenders allow.

Over
the last 5 years household real estate gained $6.3 trillion (62%)
in value, yet homeowners piled on another $2.8 trillion in mortgage
debt, or 44% of this new found "wealth." (Keep in mind,
these are averages which include the 20% or so who own their homes
outright, mostly retirees. Home equity extraction is certainly much
higher for those with mortgages.) At the margin, many are literally
betting the ranch that the easy credit stars stay aligned indefinitely.
Like a compulsive gambler, the home buyer on margin is opting for
higher-octane fuel, moving from fixed mortgages to ARMs, and now
to interest-only mortgages and "piggy back loans" which
cater to the buyer who is challenged to come up with a down payment.
Despite the lowest interest rates in 46 years, the average American
pays over 13% of his disposable personal income just to service
his debts, a record.

It
is not just borrowers who are optimistic. Mortgage lenders are in
a generous mood these days and why wouldn't they be? Borrowing at
2% and lending at 5% is good work if you can get it, especially
if your collateral keeps rising in value. Not only do they want
this virtuous credit cycle to continue, they expect it.

On
conference call after conference call, we find executives with remarkably
similar forecasts: the good times will continue. The CEO of subprime
lender New Century Financial, Robert Cole, admitted, "We're
all competing aggressively for market share," without a thought
that the consensus might be wrong. CFO Patti Dodge projected minimal
loan losses over the next 18 months based on their "historical
experience" of the "last 7 to 8 years." Countrywide
Financial, the nation's #2 subprime lender and prodigious advertiser,
plans to double its assets by 2008. CEO Angelo Mozilo recently boasted,
"Shareholders' total annual return the past 10 years averaged
30% per year and 45% the past 5 years… This is the real Countrywide
story." (We think the real story might be Mozilo "divesting"
himself of $157 million in company stock over the past two years.)

As
the housing beat goes on, who can fault those who, from time to
time, hook up an ATM to their house in order to take the wife to
Paris or the kids to Disneyworld? Or if they happen to be Eagles
fans, why not use some of the proceeds to buy tickets to Super Bowl
XXXIX?

We
understand the Super Bowl's half-time show this year will be sponsored
by Ameriquest Mortgage, this country's #1 supplier of subprime home
loans. Five years ago online broker E*trade secured this dubious
distinction. This time, like the last, we'll let the fanatics have
their fun. We'd rather watch this spectacle unfold in the comforts
of our own home.

February
5, 2005

Kevin
Duffy [send him mail]
is a principal of Bearing Asset Management. Special thanks to Bill
Laggner, the other principal, for his considerable contribution
to this article.