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:
- Panic early and drive out before the freeways turned into a parking lot.
- Fly out of the storm's path entirely.
- Panic late after the crowd had dissipated and the storm's track became more predictable (taking a page out of Walter Block's book).
- 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