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  Posted on: Thursday, January 14, 2010
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The Bank Chiefs' Incredible Testimony

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When we saw the esteemed chiefs of the nation's top banks testify that nobody could foresee the coming devastating residential mortgage problem or that home prices could ever come down we stared at our TV sets in disbelief and disgust.  After all, we had only been writing about the problem continuously since as early as 2003, and we obtained all of our information from public sources.  It was all there for anyone who wanted to take the trouble to keep informed.  Unfortunately the bankers were not alone.  Others ignorant of what was taking place around them was the then Chairman of the Federal Reserve Board, the future Chairman of same, the regulators, Congress (both parties), the White House, the media and the vast majority of Wall Street.  Or perhaps a lot of them did know and chose to ignore it for fear of ruining the party while everyone was having a great time.  This attitude was neatly summed up by former Citicorp CEO Charles Prince when he famously said, "as long as the music keeps playing, we'll keep dancing."  At any rate, what follows is just a small sample of our housing comments over the years.     

June 17, 2003___

"Now, take a guess at what segment dominates domestic non-financial debt? What area is over 40% of total domestic non-financial debt? You guessed it---Mortgages! What area now do you think will be the catalyst for the next deflationary period? You guessed it again-Real Estate! Now maybe we are wrong on this, but we are highly confident in the final outcome even if we are early. We believe that just like the farmland that became too expensive relative to the prices received from crops, the price of real estate can't be justified by the amount of rents received. We look at this in the same way as the P/E of a common stock.  If the price of the company's stock is way out of line with earnings, that stock will eventually decline. On our home page in the section titled "Comstock in the News" is an interview with Barron's that touches on the dilemma of real estate and housing. The Center of Economic Policy Research put out a paper comparing the cost of renting a home to the cost of owning a home. They looked at the situation just as we do. They concluded that the gap between the two is now about the largest ever. Comstock was written up in Barron's magazine in 1988 discussing this same theme and the gap was wide then, but it is even wider now! This gap can only be filled by rentals rising or home prices falling. With vacancies increasing in every area of real estate, we doubt that the gap will be filled by rents increasing. There is no other solution to this problem except for housing prices to fall, and that won't be a pretty picture since it seems that every homeowner in America has been borrowing on the equity of their homes."


Sept. 22, 2003__

"One of the amazing aspects of the massive refinancing of homes, which is effectively piling on consumer debt at record levels, is the fact that this is being done with the blessings of our esteemed Federal Reserve Chairman, Alan Greenspan.  In various testimonies he has stated that borrowing the equity in consumers homes is helping the economy and he supports it.  Imagine the head of the Central Bank of the world's largest economy becoming a cheerleader for individuals to continue borrowing on the equity of their homes while they have already incurred a record amount of debt and the homeowners' equity is falling to record lows.  Could the Fed Chairman actually think it is appropriate to use ones' home as an ATM cash machine?...  In summary, we believe that real estate will be the main catalyst for the deflationary environment we expect is inevitable.  This is the result of the tremendous demand for RE since the mid 1990s driving valuations through the roof.  The prime driver of the appreciation was the liberal lending policies of banks and mortgage institutions.  The combination of the lax lending and the demand from homeowners to continue to borrow against the equity in their homes, have placed RE in a vulnerable position.  The rising prices have moderated substantially, while until just recently the borrowing and lending continued at record levels.  This dropped homeowners' equity to record lows.  Since every valuation ratio of real estate is presently at record highs, if the slowdown in appreciation turns into an actual decline in values, the present economic recovery and stock market recovery could reverse and be potentially devastating to the financial environment.

April 1, 2004___

".financial advisor Bridgewater Associates, in a recent report, made a strong case that there really is a U.S. housing bubble. They cited high home prices relative to income, the increasing percentage of adjustable-rate mortgages, and the high level of new home sales. The firm concluded that, "As with any unsustainable market or economic event, it is impossible to pinpoint when the reversal is about to take place, but a pop in this bubble will likely have a larger effect on households than the popping of the Nasdaq did."

June 16, 2005___

"The Fed's current dilemma is a direct result of its policy, instituted in early 2001, of trying to avert the potential damage of the bursting stock market bubble by spurring a rapid increase in housing prices.  The policy worked in two ways.  First, the soaring home prices were converted to ready cash by means of hundreds of billions of dollars of cash-outs on mortgage refinancings.  These cash-outs along with plunging savings rates and soaring household debt enabled consumers to maintain their spending patterns despite far below average gains in conventional wages and salaries.  Second, since the recovery began in November 2001 a full 43% of the increase in private-sector employment has occurred in housing and housing-related industries.  However, while the policy worked in the short-run, the long-term damage may be far greater than if the Fed had let the normal economic corrective cycle run its course."

June 23, 2005___

"In our view a housing bubble with national implications definitely exists, and the risks to the economy are enormous.  The Fed and other depositories are acutely aware of the situation leaving them with the dilemma of what to do about it.  If they tighten enough to really halt the rapid rise in home prices the economy could very well go into a nosedive, a particularly scary situation, considering that all the debt still remains on the books.  On the other hand if they do little or nothing, the boom could get even further out of hand, making the eventual economic and financial unraveling even worse.  So far the Fed is raising the fed funds rate at the so-called "measured pace", and, along with other agencies, recently started a policy of moral suasion.  If this doesn't work the question is whether the Fed will follow through with more actual tightening.  If Paul Volcker was still heading the Fed we would know the answer, but given Greenspan's consistent reluctance to pull away the "punchbowl" we just don't know.  Either way the outcome is likely to be extremely unpleasant for the economy and for stocks."


Sept. 22, 2005___

"The reasons that we feel that this strong growth of earnings will not continue are fourfold.  One, we don't believe the profit margins that have reached their historical peaks will be able to sustain those levels.  You can see from the attached chart that once they reach these historic peaks they revert back to the mean and below.  You can also see that the profit margins were at these same extremes in 2000.  Secondly, the consumer has leveraged their consumption relative to wealth and income to extreme levels which cannot be sustained.  Thirdly, the housing bubble which has supported consumption in the past few years is close to bursting and will leave in its wake a reverse wealth effect and a severe reduction in the ability to use one's home as an ATM machine."

Oct. 27, 2005__

"Yes, Bernanke has an excellent resume, and, yes, the Greenspan era was marked by low inflation, decent economic growth and only two mild recessions.  This economic record, however, was achieved by the creation of a record stock market bubble that ultimately burst, followed by a huge housing bubble that mitigated the damage, but led to a fragile, unbalanced economic recovery fueled by cash raised from soaring home prices.  The result is record household debt, negative consumer savings rates, a huge trade deficit and a dangerous federal budget deficit."

Feb. 2, 2006__

"In the current cycle the results of monetary tightening can be even more damaging than usual because of the unique role that housing played in the economic expansion.  In the absence of normal increases in wage and salary income consumers have used the soaring value of houses to maintain their rate of spending and drastically lower their savings rate.  The home values have been turned into cash through home turnover, mortgage refinancing cash-outs and home equity loans.  A recent Federal Reserve staff study-significantly co-authored by Greenspan himself-estimated that "discretionary extraction of home equity accounts for about four-fifths of the rise in home equity mortgage debt".  They further estimated that about ¼ to 1/3 of the so-called mortgage equity withdrawals (MEW) directly financed personal consumption expenditures.  Other estimates run as high as 50 or 60%."

June 22, 2006___

"Housing weakness is reflected in the lowest housing affordability rate in 15 years, the lowest NAHB index in 12 years, soaring inventories of both new and existing homes and reports of the leading home builders.The problem is that after allowing a late 1990s stock market bubble and a 2003-2006 housing bubble, the Fed has basically lost control."

Aug. 10, 2006___

"Housing weakness is reflected in the lowest housing affordability rate in 15 years, the lowest NAHB index in 12 years, soaring inventories of both new and existing homes and the reports of the nation's largest home builders.  Yesterday, Toll Brothers said that signed contracts fell by a whopping 46 % with all regions of the country weakening.  The company's housing backlog dropped 17% and cancellation rates were significantly higher.  Since the housing boom has been by far the main growth factor behind the current economic expansion cycle in the absence of normal gains in employment, disposable income and business spending, any bursting of the housing boom has serious implications."

Aug. 31, 2006__

"Although the conventional wisdom has only recently caught onto the fact that the housing boom is over, a spate of recent company announcements indicate that the problems are rapidly spreading to the companies involved in mortgages.  H&R Block's sub-prime lending subsidiary had to set aside $60 million due to borrowers falling behind in payments.  Countrywide Financial stated that customers were slow in paying their loans.  Similar statements were made by Impac Mortgage and Accredited Home Lenders.  First Horizon National said it would miss its earnings targets because of declining mortgage volume.The problem is that the housing decline has just started and the above revelations are most likely only the tip of the iceberg.  With home prices likely to move lower, a lot of homeowners are going to be in real danger of defaulting with widespread foreclosures a distinct possibility.  This is in addition to the coming diminution of mortgage equity withdrawals that have been so pivotal in spurring recovery from the 2001-2002 recession.  The great danger is the potential unwinding of the massive debt that has built up over the past decade and the accompanying threat of damaging deflation that was averted after 2002 only with the help of the housing boom that is now definitely over."

February 8, 2007-


"Contrary to those who assert that that the housing decline is over, the worst is yet to come and the ripple effects are becoming increasingly evident. A significant tightening of mortgage lending rules is likely to lead to a dangerous rise in foreclosures.  Over the past few years the banking system has sold off hundreds of billions of dollars of mortgage loans and these have been sliced, diced, distributed and resold to a point where nobody knows who is actually at risk and by what amounts.   This could result in a major financial crisis for the banks and anyone else in the intricate financial system holding these risks.  Today, strategists, economists and bubble TV went to great lengths explaining how the HSBC and related sub-prime problems are isolated events and that the macro economy looks great.  We wish that things were really that simple."

February 15, 2007-

"Major banks and Wall Street firms are trying to force mortgage originators to take back loans that they purchased in the past few years.  It is likely that many of these firms cannot take back all of these loans without going under.  In addition the banks and Wall Street firms made loans to the sub-primes that are in great danger of not being paid back.  Much of the loans were chopped up and sold to various investors throughout the world.  All of this is probably only the tip of the iceberg, and has the potential to develop into a full-fledged financial crisis comparable to some we've witnessed in the past."


April 5, 2007-

"Although the consensus of strategists and economists vigorously insist the subprime woes are just a headline scare story that will quickly be forgotten by the stock market, we think their case is weak.  In our view they fail to explain to why the substantial drop in housing starts combined with the sublime lending problem will be isolated this one time, when a major housing decline alone was enough to cause a recession in the overwhelming majority of past cycles. The subprime lending problem is not an isolated event, but merely the first crack in an unprecedented boom that is in the process of becoming a bust."


June 21, 2007__


"The near-collapse of two big Bear Stearns hedge funds heavily invested in highly-speculative packages of subprime mortgages indicates that the severe housing recession is spreading to the financial arena and is threatening the occurrence of systemic fallout. There are undoubtedly a large number of other hedge funds with portfolios similar to those of Bear Stearns, and it appears that, in the vast majority of cases, the securities have not been marked to market.  The big fear is that any auction of the Bear Stearns holdings will expose the true price of all these holdings and result in immense losses with an unknown, but potentially dangerous chain reaction throughout the financial system."


 August 16, 2007___

"The carnage is far from over.  Amazingly, one guest on bubble TV today casually referred to the recent market turmoil as "financial gamesmanship" as opposed to what he termed "solid economic fundamentals."  This is a widely-held view that has minimized the market decline so far and has prevented widespread capitulation.  The implication is that the credit problems and stock market decline is merely a tempest in as teapot caused by some panicky investors who can't see a great buying opportunity.  In our view, nothing could be further from the truth.  Some studies indicate that as much as one-half to two-thirds of the increase in output and employment since the last recession bottom were a result of housing, housing-related activities and MEW.  That support is now gone and the so-called "financial gamesmanship" is in reality the dismantling of the rickety debt structure built up over a period of years.  As the house of cards come tumbling down the economy, which has already been slowing down, seems inexorably headed for a hard landing and severe earnings disappointment.  We also point out that housing starts in July were down 39.6% from the peak.  Over the past 47 years housing starts have declined 35% or more six times and each time was associated with a recession.  The credit and asset bubble today is much larger than in any of the previous instances."

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