"To restore the wealth lost in the current financial crisis, the Treasury would have to monetize some $30 trillion of toxic assets, almost ten times what the Geithner Treasury is currently contemplating, and twice the size of current U.S. annual GDP. Add to that about $10 trillion of value lost in the collapse of commodity prices and another $10 trillion in real property values, and we have a wealth loss of $50 trillion." ~ Henry Liu, Asia Times via Mike Whitney
Move over Rocky Horror Picture Show, the article we penned in May of 2008 (Real Estate/Credit Bubble Deflation 16: The Next Dozen Shoes to Drop -- http://www.safehaven.com/showarticle.cfm?id=10204) has over time developed its own cult following, as not a week goes by that we don't receive a request or two for an updated version along the same lines. Of course, this may have something to do with the fact that all of our shoes dropped right on schedule in '08, including the initial, shuddering global stock market "crash". Our small contingent of sharp and savvy readers told two friends and they told two friends and so on to the point people started saying, "OK, that was pretty good, Steve; now let's see you make an ocean liner disappear."
The point is that while the clueless corporate media (and our policymakers) acted like this credit bubble implosion and across-the-board asset deflation were shocking and unexpected events, we gave our readers prior written notice several times -- beginning in May of 2005 and straight through to last year. And while our minions sat safely in invisible plastic bubbles with storm windows in place, full rations in the cupboard and a warm, comfortable fire crackling in the hearth, the 2007-2012 global financial hurricane began to howl its way right over us, landing with a vengeance and laying waste to property values and asset portfolios and 401k's from coast to coast.
Talk about mixed emotions. There's nothing like watching your fellow countrymen get sawed off at the knees financially as you make a cold-blooded killing via ultrashort ETF's and put options. What can I say? It's a dog eat dog world out there, indeed.
Anyway, we certainly can't make ocean liners disappear (heck, the economy will take care of that), but we can do our level best to connect the next several dots based on what has transpired to date. Hopefully you're connecting them yourself, without much prodding, and are assuming a more conservative and protective posture going forward. Based on everything I'm observing, reading and hearing from clients, ordinary folks have had just about enough of risk, investment losses and eroding balance sheets. Speculation is soon to be dead, Zed; asset preservation is for the most part the new order of the day. And as to our lead quote from Henry Liu (above), the answer to your next question is no: Fed popgun printing will not keep pace with deflationary wealth destruction, at least not for a good while, especially when people are scared to borrow (other than to refinance what they already owe) and bankers are frightened to lend (except to borrowers who don't really need the money).
So enough with the vamping; let's see which shoes are in style this year.
The current stock market rally will have legs, and will run longer than most expect, confounding the short-sellers. The mother of all bear markets is in session right now, so it stands to reason that bear market rallies have the same potential to impress. The sell-off that took place from October of 2007 to March of 2009 was so relentless and steep, we could be in the midst of a fairly impressive countertrend rally despite utterly atrocious economic prospects worldwide.
Decide for yourself if you want to try to make money, salmon-up-river, on the long side, but remain alert and agile at all times -- calling the top of this technical correction will likely be a difficult proposition. There will probably be a fake-out or three (or not!) as the market climbs the "wall of worry" investment veterans speak of. Before this rally is done, idiotic CNBC cheerleaders will chorus that the worst is over and shell-shocked short-sellers will be the ones using sleep aids. I wouldn't be at all surprised if, as the next monstrous leg down begins, bears are hiding in the forest and the shorts aren't in place to shore up the downdraft.
Make no bones about it, once this countertrend stock rally is over, the next leg down will make the October, 2007 to March, 2009 decline look like child's play. The washout will go down in history as the greatest stock market collapse of all-time, bar none, and it will take real estate and commodity values down right along with it, to an almost shocking degree. Few will be ready for the devastation.
Commentators will say the deflation threat is behind us and you might even begin to believe it but to wait for inflation is to wait for Godot, at least for a few years. We're in the third inning, at best, of asset and credit bubble deflation, and while the Fed and Treasury printing and currency debasement sounds inflationary, it is not close to keeping up with asset value destruction worldwide. We are absolutely nowhere near the deflationary nadir.
The real estate market topped in 2006 (give or take), the S&P in October of 2007 and the Commodities Index (CRB) on July 1 of '08, and any moves up since have been merely technical in nature. The effects on the macroeconomy since all asset markets began to decline in concert, while already pronounced, are all in their early stages, and they will continue to feed one another to the point of creating an awe-inspiring deflationary monster. While we may get a respite here for a few months, courtesy of an oversold stock market, the next leg down will surprise even more, hurt even more and feel even more seismic. I expect many asset values to fall another 30% or more, and within a relatively short timeframe.
Suffice to say that when it comes to real estate, asset and credit bubble deflation, well, you ain't seen nothin' yet.
(Meanwhile, Mike Whitney -- a fellow who gets it -- adds a bit more to the deflation discussion: www.marketoracle.co.uk/Article9962.html).
It's all about the O's: Overcapacity, overbuilding and oversupply. It's as simple as this: Credit bubbles create excesses. The 2003-2007 reflation was an economic house of cards, built on loose monetary policy, leverage and debt. As "money" and credit seemed plentiful, people borrowed, spent and "invested" like crazy, while projecting out rising income and asset values for many years to come. Unfortunately, when credit bubbles burst, it's as if a rug's been pulled out from under the economy. In no time there is too much of everything, and the unanticipated reversal quickly clobbers demand.
Worse yet, each contraction begets more contraction. There are simply too many goods and services to offer, too many retailers to offer them, too many cars and houses to sell, too many restaurants and golf courses to frequent, too many commercial properties to occupy, too many consumers happy to leave the party. Overcapacity, overbuilding and oversupply all contribute to the problem, and to a greater degree each month. Each job loss, each decline in home value, each debt gone bad, each stock market hammering, each knock on consumer confidence, each consumer retrenchment, each bankruptcy, each foreclosure, each loan rejected, each budget reduced, each tax raised -- they all feed the deflationary monster. Eventually all sorts of things get boarded up, shut down, torn down and sold for a loss. Those who used leverage to make money or to further previous trend growth become the first of many to go out of business.
It's literally your last chance to sell real estate at values that will look nostalgic even a year or two from now. While good deals are indeed starting to pop up (a client of mine just "stole" a 21,000 square foot office building here in the San Francisco Bay Area), this last stock market rally -- coupled with historically low interest rates -- will convince others that the worst is over, prompting the suckers with money to lose to make more assertive offers on real estate. If you still own investment property, take advantage. Sell to the last few dunderheads now, even though such buyers are scarce, financing is difficult to procure and the sales price will almost certainly disappoint you. The next leg down in the stock market will DESTROY real estate buying psychology and further inhibit lending, while even farther down the road looms the piece de resistance: A bond crisis (based on a fairly sudden market recognition that U.S. tax revenue cannot service out-of-control national debt) which will prompt out-of-control financial markets to suddenly push interest rates up to 20% (or higher) at the worst conceivable time, courtesy of our slapstick Treasury and Fed, inept Bush and Obama administrations, and laughingstock Congress. At that point, few will be in the mood to buy real estate, and values will be in the dumper.
{While we're at it, when interest rates skyrocket and governments everywhere are tearing down houses (and, in some cases, entire neighborhoods) in an attempt to ameliorate the effects of oversupply and blight, smart investors will start buying real estate -- hopefully with safely set-aside, 2006-2007 cash}.
Rents will fall in every property category as the commercial and investment real estate decline intensifies. Rents are dropping and vacancy is rising rapidly throughout most real estate sectors (office, retail, industrial, warehousing, distribution, manufacturing, and so on), but the next leg down will find apartment rents joining the party, as well. Be prepared for ALL rents to continue their decline for more than a decade. Once the current stock rally is complete and worldwide economic problems intensify, more and more people will declare bankruptcy, share housing, and move in with parents and grandparents, making apartment investing much less profitable and more management intensive. The market will quickly price that trend reversal in (and then some), so it's your last chance to sell and avoid the coming "haircuts" and headaches.
Need more than my word that the markets are pricing in the next leg down in real estate? On April 7th, relatively dependable real estate investment trusts (REITs) offered a foreshadowing of what's to come. In one day of trading, as the S&P 500 fell a mere 2.4%, industrial REITs lost 13.2%, diversified REITs fell 11.5%, and residential REITs sank 10.5%. Property values in those categories are set to get hammered over the next few years, and nosediving REITs will make it all fairly quantifiable.
Bankruptcy? Foreclosure? No problem! I'm being just a bit facetious but when "the system" (i.e. hard-earned taxpayer money) so readily bails the biggest U.S. banks, investment bankers and even insurance companies out of their financial transgressions, why should its citizenry hold itself to a higher standard? I greatly doubt the stigma previously attached to bankruptcy will be applied this time around. "Filing" is likely to be more popular than the Macarena ever was.
Our policymakers' stated (and once again misguided) goal is to try to get people to borrow to spend again and they can't effect that awful plan unless you have access to credit, so it's not difficult to see some sort of free "credit pass" on the horizon. Methinks they'll need you more than you'll need them.
So if you're upside down or close to it, don't hesitate to play by the new rules of the game: Consult with a bankruptcy attorney, then allow the system to pick up the tab. Not only is it a prudent thing to consider when caught with negative net worth in a deflationary spiral; based on the shining example of our leaders and policymakers, it has quickly become The American Way.
The only thing "pent-up" is frustration. I call it the "Make-Do" Economy; my hero Mike "Mish" Shedlock (http://globaleconomicanalysis.blogspot.com -- a mandatory daily read) dubs this developing era, "The Age of Frugality". Call it what you want, but when the trend reverses and easy credit and escalating home values go away, debt looks mountainous, and asset value and good jobs disappear, it's the easiest door in the world to slam shut. Cars, clothes, furniture, toys, baubles -- after a four-year spending orgy, there's little any of us need; consumers can make do with what they have.
You know a consumer-driven economy's in trouble when the national refrain becomes, "Hey, honey -- let's stop buying stuff and pay down these credit cards!" Not only that, even solvent Americans are discovering that cutting back is no great hardship. It feels GOOD to put money in the bank, wait for better deals to come along, and conserve. Surely it's in our blood somewhere; in eras gone by, Americans were terrific savers.
Conspicuous consumption, Rest in Peace. A penny saved is once again a penny earned. Sorry, Wall Street, although if you really want to know -- a lot of this was your fault.
Get ready for taxpayer revolts and social unrest. I live in California, where the cost of living is sky-high, home values are plummeting and unemployment already hovers above 10%. What better time for state legislators to deal with bloated budget shortfalls by enacting across-the-board tax increases, thereby dumping an additional $1100 a year tax burden onto the average California family?
A taxpayer revolt is surely on its way, as the Howard Jarvis Taxpayers Association is back to running ads on the radio (Jarvis was the original sponsor of the famous 1978 Prop. 13 tax initiative, which radically lowered property tax assessments throughout the state). Most residents here consider state-run operations to be wasteful at best, so expect the tax-revolt movement ("War on Taxes"?) to start with a bang in California and spread like wildfire.
Along with that level of frustration, the next leg down will erupt in social unrest, protest, demonstration, vandalism, violence, white-collar and street crime, sabotage, suicide, murder-suicide, workplace homicide, hijacking, hostage-taking, occasional rioting and terrorism and other manifestations of a disillusioned society's anger, frustration and despair. Sadly, for the first time in my 51 years, I'm arranging to purchase a shotgun and a handgun for my family's eventual protection. I guess I'd be a fool not to at this point, knowing what lies ahead.
Certainly it's a striking reversal of fortunes; the ultimate headfake. When people go from feeling artificially wealthy in 2006 to broke and without prospects in 2010, a visceral societal response -- while not ever condoned -- must be expected. When ALL institutions disappoint you in every measurable way -- from Republican and Democratic administrations to government and Congress to complicit treasury secretaries and Federal Reserve chairmen to Wall Street crony capitalists to corporations and so on down the line -- there really are two ways for disillusioned people to go: They can either sit down on the curb and mope, while accepting their fate, or they can express their anger and frustration and desperation by lashing out in every imaginable way. No doubt we're several months from observing a whole lot of both.
As Sgt. Phil Esterhaus used to say on Hill Street Blues, years ahead of his time, "Hey, and -- be careful out there."
The good news is: For those of us not inclined to act out and shoot people, I hope for a return to traditional American roots. The age of materialism is over; it is time to savor and appreciate family, good friends, relationships, neighborhood and community. The next ten years are going to be tough; we don't need to waste money and buy things and run up debt to be happy. We can appreciate those around us, engage in meaningful and enjoyable conversation, watch after each other, instill proper values in our children, volunteer, coach little league, play board games, plant vegetable gardens, expand our horizons, further ourselves. We can take this time to become more enlightened, to read more, to speak out, to question our "leaders", to say hell-no to bailouts, crony capitalism, federal deficits and backroom monetary policy shenanigans. We can "vote the rascals out" and work to elect people like Ron Paul to lead us back from the precipice.
As painful as this process is going to be, at some point America will have no choice but to pull itself up by its bootstraps. I must be an optimist; I think we can do it.
We've always been up to the task.
