Contrarian Chronicles Notes from a housing bubble's bust When bubbles break, the aftershocks don't just hit the speculators and the fools. They hit everybody. Check what's going on in Australia and could soon happen here.
By Bill Fleckenstein This year is shaping up a lot like 1987. Back then, we saw speculation in commodities and stocks in general (though in a much, much milder form than exists now). We also had a new Fed chairman -- Easy Al Greenspan succeeded Paul Volcker as chairman that summer. And, ultimately, we had a stock-market crash. Longtime readers know that I have been expecting a stock dislocation to mark the end of our long-running mania. I can certainly make the case for that happening this year (though I could also see how it might have happened in a few of the last several years). Just because a dislocation hasn't happened doesn't mean that it won't. (See "The odds of a crash are higher than you think.") To me, in fact, the probability has only ratcheted higher. Taking into account an ugly confluence For such an event to happen, a number of market forces will need to align themselves in a certain way. Given the impossibility of predicting when that alignment will occur, we can only try to position ourselves as it develops -- though, in the very short run, I have almost no shorts, as the path of least resistance seems higher for the moment. (For a detailed explanation of why, please see my Feb. 8 daily column.) Turning to one potential catalyst in that alignment -- the unwinding of the housing bubble -- we have been given hints. Homebuilder Toll Brothers provided one last Tuesday when it cut its forecast for home "deliveries" and said that signed contracts declined 21% in the first quarter from a year ago. Thus, more evidence of what we have been seeing: The housing ATM is slowly creaking to a halt. Certainly, there have been plenty of data points suggesting trouble in various formerly hot markets of the U.S., including Massachusetts, San Diego, Las Vegas and Miami. Housing harbinger from another hemisphere And last week brought evidence of how the problem has affected Australia. This, from "Slump hits home," a story in the Sydney Morning Herald. As writer Matt Wade chronicles, the slow unwinding of that country's housing bubble is starting to hurt a bit, after having been somewhat benign last year: "The casualty list from Sydney's property boom is growing. First, a generation of first-home seekers found itself priced out of the market. Then, as house prices finally sagged, thousands of overstretched investors and owner-occupiers fell into trouble." He goes on to point out the insidious nature of bubbles, which I railed at constantly in our last equity mania -- and which is why I detest the Fed so much, because of its role in aiding and abetting idiotic activities that ultimately harm society: "Now, even vulnerable people who had nothing to do with the fluctuations of property prices could be hurt. As the State Government struggles to repair the holes in the budget caused by stagnant property revenue, the aftermath of the boom could be painful for bystanders like the old, the sick, the disabled and the poor. The suffering would occur if the Government were forced to cut services and lift charges for these groups as it covers the shortfall in property taxes." Unfortunately, that's what governments do. The spending rises to meet the level of the income they receive, and they never recognize that the "windfall" is in the form of ephemeral bubble revenues. We also saw this happen in the wake of our last stock bubble. Continuing on, Wade's article cites last year's record number of mortgage defaults, whose emotional impact is described by attorney Katherine Lane of the Consumer Credit Legal Centre: "Investors are part of this, but in my experience from advising people here at the centre, it's mums and dads as well. The cost to these families is horrendous -- there is great financial loss, there is stress, there is the embarrassment of losing their house and then they have to move out of their community." And, from the director of a social-services organization: "It's a terrible irony. The low- and modest-income earners who were not able to build up the value of their assets through the housing boom, and who have not been able to reap the benefits of more than a decade of growth, are the ones who will experience the pain of cuts." The long arm of ARMs The point being: No one is shocked when speculators and people who acted like fools get hurt in a bubble. But as I have said, the cost to society is far higher. Australia and the United Kingdom are canaries in the coal mine, as they have been raising interest rates longer than we have. We are behind them in the unwinding process because we acted later. We're also behind them because of the lag effect of all the floating-rate mortgages that were used at the end of the boom. But I believe that the prospective pain for us will be far greater, due to the absurdity of our lending practices and the sheer number of people doing the speculating -- which will unfortunately insure a horrendous fallout. Furthermore, if the timing of our real-estate bubble's unwind coincides with other bubbles' unwinding, it doesn't take much imagination to see how the financial environment could get extremely ugly. Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Bill Fleckenstein did not own or control shares of companies mentioned in this column. -- Jim Devine / "There can be no real individual freedom in the presence of economic insecurity." -- Chester Bowles
