Alan, We Have a Problem

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confidence is generally described as a bursting bubble, an event
incontrovertibly evident only in retrospect.”

recovering short seller

There are about
90 references to "housing bubble" on and
you've read practically every article and blog. You sold your house,
filled two safe deposit boxes with Krugerrands, and bought put options
on the HGX (Housing Index). You even named your three bloodhounds
Bonner, Corrigan, and North. Let's face it, you're every bit as
obsessed as the condo flippers, twenty-something leveraged landlords,
and Trump seminar faithful. Your wife is questioning your sanity
and you are beginning to wonder if she's on to something.

Sure, bust
follows bubble as predictably as concussion follows a swan dive
into the shallow end of a pool, but when? Can the powers-that-be
keep the party going indefinitely? Can the HGX double, rendering
your option strategy an exercise in futility and grounds for divorce?
Can any mere mortal really know the timing of a bubble?

The honest
answer is that recognizing folly is much easier than knowing its
natural limits. As Sir Isaac Newton lamented in 1721 after losing
his shirt in the South Sea bubble, "I can calculate the motions
of heavenly bodies, but not the madness of people."

Although history
rhymes, the great bubbles of at least the past century have followed
a remarkably similar script right before they popped. As absurdly
high valuations weigh on relentless injections of liquidity, the
advance narrows. Former favorites are treated like lepers while
the remaining beauty queens become the focus of intense adoration
and pursuit. Eventually, even the central bank bubble blowers get
cold feet and begin posting speed limit signs by raising rates.
Initially the crowd runs right through the signs, taking their speculative
vehicles on a reckless, parabolic joyride. As higher rates slow
liquidity, speculators sell their losers in one last desperate attempt
to get their hands on more fuel. The jig is finally, mercifully,

The Roaring
’20s ended with the Dow peaking in August, 1929, well after
the broad market, as represented by the NYSE advance-decline line,
was in full retreat. In 1972, growth stocks like Coke, Polaroid,
Xerox, and IBM were all the rage during a two-tiered "Nifty
Fifty" market that ushered in the 1973–74 collapse — rivaling
its 1929–32 cousin in inflation-adjusted terms. The March,
2000 Nasdaq peak was a similarly bifurcated affair, as the performance-chasing
masses unloaded their Old Economy laggards in order to make room
for more Internet, telecom, and technology stocks. The Nasdaq Composite
proceeded to lose 78% of its value in 2 years.

Before we fast
forward the tape to today's market, a word of clarification is in
order. The bubble du joir is not so much in housing as it is in
credit. We are hard-pressed to know who is crazier, the borrower
swimming without a bathing suit or his Pollyannish lender. Not all
regional housing markets are in bubble territory, but credit availability,
rates, and standards are clearly detached from reality.

stocks, as measured by the Bearing Credit Bubble Index, rose ten-fold
from 1995 through the end of 2004. Its eight sub-indexes (banks,
brokers, subprime lenders, etc.) were all in sync until mid-2003
when the government-sponsored enterprises began to lag. The speculative
darlings of the past 2 years have clearly been the homebuilders
(+170%) and subprime lenders (+107%). This year the subprime lenders
hit the wall, leaving the homebuilders alone to carry the speculative
torch. The remaining credit providers and facilitators (especially
those weighed by heavy market capitalizations) are now either stalled
or joining the GSEs in full retreat:



Market Cap












billion (GE)

center banks











billion (FNM, FRE)

the stocks of the country's largest credit engines – Citigroup,
JPMorgan Chase, and Fannie Mae — shutting down and nearing 2-year
lows, this credit rocket is sputtering on fumes. Mr. Greenspan,
we have a problem.

2, 2005

Duffy [send him mail]
is a principal of Bearing Asset Management.

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