Lies, Deceits, and Misapprehensions

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We turn to Bloomberg for another update on the California residential real estate bubble. Prices on "used" houses rose 20% in the last quarter of 2004, says the article. It doesn’t say "annual rate," but we presume that is what it meant. The median house price in Southern California is now $451,333. This is more than twice the price in the rest of the nation, and a lot more than the typical Southern Californian can afford to pay. Recent reports put the median house out of reach of all but one out of ten potential buyers.

The gap between what people can afford and what they pay is made up by "creative finance." What makes America great, say the flag wavers, is our talent for innovation and flexibility. But in the present case, it is like praising a man who shot himself in the head for his good aim.

We tried to explain the "neg am" mortgage to a friend from Latin America yesterday. "How could that possibly work," he asked. "How would the lender make any money offering loans below the going rate of interest? Why would anyone do such a crazy thing?"

We wondered too. But then we realized — it was just another little stitch in the vast web of mutual deceit that is America’s empire of debt. The buyer has no intention of ever paying off his loan out of his own pocket. The lender has no expectation of ever getting paid. The buyer thinks he will resell a year… two years… five years… later, at a profit, of course. Then, he’ll move on to the next mortgage. The lender could care less; he’s already sold the credit to Fannie Mae.

A man with a negative amortization mortgage owes more and more money as time goes by. If his income does not rise, his house better; otherwise, he will be in a jam. Still, the house buyer expects to make money without working for it. The lender expects to make money without taking any risk. And nobody expects any significant disruption or surprise.

And yet, the longer house prices rise faster than GDP, inflation, and incomes, the closer we must come to the end of the trend. Already, at $450,000, the carrying cost of a 6% mortgage is $27,000 per year. Hmmm… the median household income is only $43,000 per year. It is clear that the buyers are not really buyers, but speculators. And that the moment prices fail to rise they must fall. Because the marginal buyer depends on rising prices just to stay even — paying his mortgage, taxes and upkeep.

When that moment arrives we don’t know. And we won’t know until after — perhaps well after — it has come and gone. The latest figures show that inventories are building up. Where it took 23 days to sell a typical house last year, this year the figure is 28 days.

If you are planning to sell, dear reader, don’t wait too long.

• An editorial in the International Herald Tribune reveals the mainstream world’s attitudes to gold. The editorial urges the IMF to sell its gold horde in order to finance various programs for poor. If the programs were worthwhile, the world-improvers could get money from many different sources. But the editorialist seems to think that the gold is simply a dead asset. Selling the stuff would be a way to put it to work.

In some sense, it is true, in the sense that a cord of firewood has no value in the summertime. Nor do you need health insurance when you’re feeling fine, or an umbrella when the weather is clement. The hidden conceit is that the present generation of international economists is so competent that monetary insurance — gold — is no longer needed.

We hold onto our umbrellas and we buy gold.

We began urging readers to buy gold almost as soon as we began writing these daily reckonings. The price of the yellow metal was still well below $300 — so that is where we set our first buying target. Since then we have been forced to raise the target price… under $350, under $375, under $400, and most recently under $425. We have had an opportunity to buy under $425 for the last week or two. But this weekend, the price rose to our target. This morning, it is just above $425.

Buying gold is a bet that the worlds’ central bankers are no smarter today than they were in the time of Caesar, Louis 15th, or the Weimar Republic. We’ll take that wager any day.

• Our guess is that the economy is slowing down. Bonds rose again on Friday. And the employment numbers came out showing only half as many new jobs as expected. The report did not mention it, but a large percentage of those jobs were related to the real estate bubble, which must be nearing a sharp nail.

And here we offer some advice. For while the last bubble — in tech stocks — blew up without much collateral damage, we suspect that when this one goes there could be a lot of debris flying around. Too many people now stake their standards of living on lies, deceits, and misapprehensions. The collapse of the housing bubble will force a slowdown throughout the economy. Real estate—related jobs will disappear. Consumer spending will go down. People will have trouble keeping up with their payments. Credits and assets will be marked down. Our advice is: neither borrower nor lender be. Hold cash. Cut expenses. Rick up firewood and plant tomatoes. Practice saying "I told you so," to friends and neighbors, so you’ll be ready when the time comes.

Thrift has been out of style for a long time. Perhaps it is ready for a comeback.

• We attended Jules’ graduation from the American School of Paris on Sunday. Details tomorrow… after we’ve had time to think about it.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century.

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