Panic Now and Beat the Rush

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After
watching the tragedy of Katrina unfold from the safety of southeast
Pennsylvania, I returned to my home office in Houston despite ideal
hurricane conditions in the Gulf of Mexico. Big mistake. Monday
morning, tropical storm Rita was threatening the Florida Keys and
projected to pick up a head of steam and ram into the Texas coast.
My partner and I needed to formulate contingency plans and realized
the importance of acting quickly before the crowd. We came up with
several options:

  1. Panic
    early and drive out before the freeways turned into a parking
    lot.
  2. Fly out
    of the storm's path entirely.
  3. Panic
    late after the crowd had dissipated and the storm's track became
    more predictable (taking a page out of Walter Block's book).
  4. Ride out
    the storm, buying provisions early.

We
eliminated the first option figuring the cost of lost productivity
was too high. Grocery store shelves were noticeably sparser by Tuesday,
especially for bottled water. Gasoline was scarce by Wednesday,
the same day Houstonians started heading for the exits en masse.
Rita was upgraded to Category 5 about 3:00 that afternoon and the
authorities were urging residents to evacuate. By Thursday, the
arteries leaving Houston were clogged, cars running out of gas,
temperatures reaching the high 90s, and tensions running high. It
took one reporter an hour to drive 2 miles on I-45 right through
the heart of Houston. People were passing out from heat stroke and
requiring medical attention. Others were turning around and taking
their chances with the hurricane. A human disaster was building
before the natural disaster had even occurred.

Is
there a lesson here? Are large population centers becoming intractable
and reaching the limits of growth? Is our just-in-time distribution
system like a pool of water a mile wide and an inch deep?

We
see two lessons: crowds are inherently dangerous and the system's
points of greatest vulnerability are where government is in charge.
In New Orleans, the weak link was the levees (the U.S. Army Corp
of Engineer's responsibility); in Houston it was the government-maintained
highways that buckled under the added weight. Both times government
authorities provided assurances that proved hollow.

Can
these lessons be applied to financial disasters? Earlier this week
Treasury John Snow dismissed a housing bust as "improbable
at best." President Bush continues to promote "homeownership,"
now at record levels approaching 70%. Even the Maestro himself,
Fed chairman Greenspan, is more worried about regional bubbles than
a systemic failure.

The
public, assuaged by the authorities, has not exactly prepared for
a rainy day. In the last three years, residential mortgage debt
climbed 45% to $8.2 trillion. Household liabilities grew from 105%
of disposable personal income to 122%. Lending standards collapsed
while speculation in homes and condos soared. In 2002, 6% of mortgage
activity was subprime; today the level is over 20%. 31% of new mortgages
are now interest-only versus 6% three years ago.

Meanwhile,
a parabolic blow-off in homebuilding stocks (more than tripling
in 3 years) has obscured the shutting down of key credit engines
powering the urge to super-size consumption. Fannie Mae is contracting
its balance sheet at double-digit rates and its stock is nearing
an 8-year low; Citigroup, JPMorgan Chase, and Bank of America are
quietly hitting 2-year lows. An estimated $1.4 trillion in adjustable-rate
mortgage debt will be reset in the next two years at considerably
higher rates, adding to already swelling unsold home inventories.
In short, the marginal U.S. consumer and his charitable lender are
facing a financial version of the perfect storm.

We
just got word that our flight out of Houston was cancelled. We're
down to our last two options: panic late or ride out the storm.
As for our nation's mania for credit, our advice? Panic now and
beat the rush.

September
24, 2005

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

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