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The Daily Reckoning PRESENTS: Christoph Amberger takes a
look at, among other things, the process of prophylactic over-bidding on real estate known in Great Britain as "gazumping." THE PLAGUE OF THE BLACK DEBT by J. Christoph Amberger Grigori Aleksandrovich Potemkin, Russian field marshal and favorite of Catherine II, played an instrumental role in the annexation of the Crimea in 1783. Four years later, as governor of this new province, he was also in charge of Catherine's fabulous Crimean tour. To impress upon the Empress of all the Russias how competent an administrator he was, historical anecdote claims he had sham villages ("Potemkin villages," as they came to be known) built along her route. My guess is that this illusion of prosperity very closely resembled what is going on in America today. If you happen to live in a metropolitan area in the U.S., here's something I want you to do next weekend. Grab the kids and the dog, warm up the car, and head out of town. Take a route you haven't driven in a year or more, and chose a destination you fondly remember as being "rural" the last time you went there. I promise you, the insight you will gain into the New America will be worth more than a library full of financial magazines. That's exactly what I did last weekend. My family and I went to the southern tip of St. Mary's County in Maryland, where friends are hanging on to a 400-acre farm that hugs the shores of the Patuxent River for more than a mile. Back in the 1990s, before the kids came, we used to visit several times a year. But the last time we went was over two years ago. And, honestly, if the trip didn't mostly involve driving in a straight line, I'd have needed a map. Because the countryside was unrecognizable. Where there used to be fields and rolling pastures, there are now compact piles of townhouses so fresh you can smell the vinyl siding from a mile away. What used to be two-lane country roads are now brand-spanking-new 6-lane highways that make Adolf Hitler's original Autobahn - the backbone of East Germany's hard-currency economy until 1989 - look like a game trail. Where there were vacant lots between strip malls and car dealerships, billboards now promise that a new 200,000- square-foot shopping center will be coming soon. And where Mennonites once went rattling by in horse- drawn buggies, tank-topped Bud Lite boobs in souped-up pickup trucks now go screaming by. And these are pickup trucks that will never carry any load heavier than a riding mower or jet skis. Looking beneath the shifting surface, the one thing that struck me most was the radical change in the character of property ownership. You see, ten or even just five years ago, families and individuals actually owned most of the land and the buildings. Accordingly, houses built in earlier development booms tended to be small...mostly brick ranchers and Cape Cods on quarter-acre lots. If you were to add up the total home equity in any given development today, you would probably arrive at a sum sufficient to pay for the front doors and the catalog- ordered resin-cast replica lawn jockeys. Everything else beneath the cathedral ceilings and above the manicured front lawn is debt. Developers went into debt to build their satellite cities of cookie-cutter tract mansions. Homebuyers - lured by "no-money-down" deals - went into hock to buy the houses that Debt built...and are now stuffing their vinyl manors with stuff bought on store and credit-card debt. They drive cars they "bought" with debt, and they shop in businesses that are only in business because they are still (just barely) able to service their ever- increasing debt. In fact, even debt itself has become an asset. Mortgage lenders hawk debt like so many pork bellies...yet that debt is secured by nothing more than paper gains in property values...which are driven mainly by inflated demand that is in turn powered by the availability of further debt to larger groups of clients, with ever more loosely defined creditworthiness. Any cash gains in property values...as manifested in large checks paid out to sellers at settlement...are typically used to buy yet another high-priced ticket to take on more debt (usually in the form of a substantial down payment on another overvalued house). What if this daisy chain of debt ever starts to unravel, Japanese-style? A decade after that country's last real- estate boom, Japanese banks have US$400 billion worth of bad loans on their books. That's four times worse than the S&L crisis in the States, if you account for the different size of the economies. And if the Enron debacle was all about the quicksand you enter once you start obfuscating the fine line between debt and assets, the potential for a far more devastating crisis in the debt "industry" is explosive. And probable. According to JPMorgan, asset-backed security issuance jumped to US$38.7 billion during March, a new all-time record. Home equity deals are charging ahead, with a record US$17.4 billion sold in March. Q1 home equity ABS issuance of US$33.3 billion represents an increase of 62% year-over-year. And keep in mind that 2001's home equity ABS issuance of US$80.2 billion already showed an increase of 36% from 2000. And home prices are supporting the trend. There are counties in Maryland where prospective homebuyers are advised by their own agents to bid upward of US$20,000 above the asking price. The same is going on in Britain...where they call this prophylactic over-bidding "gazumping." In fact, American homeowners can't seem to convert assets into further debt fast enough. Second mortgages...borrowing against what pitiful equity has been established...continue to convert inflated home values into spending money. As I write this, the Mortgage Bankers Association's weekly index of purchase applications jumped 6% from the previous week, and is up almost 13% over two weeks to a level of 349.9. Factor in the substantial increase in average mortgage size, and you can expect Q1 mortgage originations to come in stronger than US$500 billion. With refinancings down nationwide, net new mortgage debt creation is significantly ahead of last year's record pace. According to a Bloomberg study, year-to-date domestic debt issuance stands at US$457 billion. That's terrible news for those among us who are waiting for the other shoe to drop...but music to the ears of those who love making a buck on their fellow man's folly. Cheers, Christoph Amberger for The Daily Reckoning http://www.agora-inc.com/ "Always do sober what you said you'd do drunk. That
will
teach you to keep your mouth shut." --- Ernest Hemingway |
