A Random Walk Down The Path of Asset Deflation

By: Steve Moyer | Wed, Mar 14, 2007
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One of the nice things about our series of Safehaven articles on Asset Deflation is that we have been on such a tiny island compared to the "All Markets Will Continue To Rise Forever and Ever Amen Because It Is Our Birthright And The Fed Will Surely Guarantee It" set, our small legion of open-minded and perceptive readers write in with increasing frequency and say things like, "Yo, Steve, isn't it time for another deflation update?"

In case you missed our initial warnings, here are links to two of our Safehaven articles on asset deflation: the first from May of 2005 (http://www.safehaven.com/showarticle.cfm?id=3009), the other from September of 2006 (http://www.safehaven.com/showarticle.cfm?id=5844). Please take a moment to look them over if you have 1) the time or, 2) the desire to end up with a lot of money when your neighbors are 1) broke and 2) standing in bread lines a couple years from now.

The funny thing is that some people still don't realize that we are already in an asset deflationary environment. If you had taken our advice and sold your real estate, metals and stocks when our series of articles ran and held the cash in something like a T. Rowe Price Treasury Money account (current safe yield: 4.50%), you'd be even more poised to kick some boo-tay in the coming, otherwise-frightening, take-no-prisoners environment. The savvy men and women are already out and have completely sidestepped the coming storm, but when "everyone else" figures out what's going on, it's sayonara to pretty much everything we hold dear (like having money and assets, for instance).

Do not -- I mean, DO NOT -- put your financial fate in the hands of those same CNBC (aka General Electric) cheerleaders, Wall Street pimps, Pollyannaish U.S. policymakers or guys who write articles featuring a bunch of charts as a means of convincing you that they know what the hell they're talking about. Don't listen to Treasury Secretary Henry Paulson when he steps to the podium to say that the "world economy is strong" (What's he going to say? "The world economy is unbelievably precarious and we're all going to hell in a handbasket!"?). In the coming months, quotes from Paulson, Ben Bernanke and George Bush will sound an awful lot like another famous assurance from long ago: "The Titanic is unsinkable, Molly! I tell you -- unsinkable!"

Instead, my friends, use your gut, your instincts, your sense that the economy is slowing down in your own community and that people are pulling in their speculative horns. Turn off the nightly Larry Kudlow sis-boom-bah routine and utilize your own ability to see through the lunacy. Asset values have begun heading down and we are nowhere near "the bottom." More like mid-to-high forehead, if you really want to know.

The jig is now completely up, and Monday's headline from Bloomberg News pretty much seals the deal ("Countrywide Ends No-Money-Down Loans"). There is no going back now. All that remains is for everyone in America to come to the realization that values are not going to go back up any time soon. We are entering the "lack-of-liquidity" phase of our program, more than exacerbated by an unwelcome and untimely credit contraction, as most Americans have no savings and won't want to borrow from lenders who will be increasingly reluctant to lend anyway.

Yes, you could have sold your assets last year (thereby timing it perfectly) but we're willing to forgive you. The inevitable outcome of a six year liquidity/borrowing orgy is, indeed, very difficult to see coming. But I applaud you for being here now, reading my pap, keeping an open mind and putting yourself in position to salvage your family's finances. If so, we will still buy you a beer and give you a hearty and well-deserved pat on the back when the time comes. For you will be one of the true survivors.

Since our call for asset deflation and timing of its onset have proven to be entirely on the money, allow us to humbly walk you through the coming phases so you can do all you can to avoid the landmines scattered around the landscape like so many pennies in a wishing well.

The coming housing and real estate meltdown will be too great a force for the average American's pocketbook to withstand and despite your hope that "they" will be able to do something about it, the market forces of deflation will render the Fed and other policymakers completely impotent, just as it did Japanese policymakers in the 1990's when their own (post-stock market bubble) real estate deflation took hold.

The stock market is in the process of going splat, foretelling a particularly strong economic slowdown brought on in part by the unfolding evaporation of easy-money home loans and the coming banking/lending crisis the media have initially characterized as a "subprime lending meltdown." The cockamamie home loans which provided the fumes for the final run up in housing prices (Steven Pearlstein of the Washington Post categorizes them as "balloon mortgages, liar loans, option ARM loans, piggyback loans, teaser loans and stretch loans") are quickly going away and the rug is thereby in the process of getting yanked from under the United States' housing market.

For those of you who like to talk about Sunday's football games by the water cooler on Monday morning, the last year or so has gone something like this: First the real estate speculators, fully leveraged and able to buy four and five condos at a time with little or no down payment as long as the prices were going up (does that sound anything like dot.com stocks in 1999-2000?), suddenly started losing money as the speculative soda predictably lost its carbonation. In no time, those speculators exited from the party, stage right.

Market activity then began to slow down substantially and everyone from ordinary home buyers to big land developers started walking away from previously-negotiated purchase contracts. Statistically, "average home prices" have not shown an appreciable drop yet because condo sales have gone dead (thereby artificially raising the average selling price of a "home), but as no-money-down and other goofball loans go the way of Nehru jackets, it is only a matter of time before "declining home value" stories will be headlining the evening news. Every night.

At that point, everyone in America will come to the same realization: That real estate values are headed down and will continue to head down, meaning that it will be virtually impossible to compel people to buy real estate.

Waves of foreclosures (in some cases even entire neighborhoods in newer developments) have already begun to rear their ugly heads. This will only make matters worse as those distressed homes come back on the market to compete with excess inventory already backing up the pipeline while, at the same time, "easy money" becomes ever more difficult to come by. Many housing bubble participants have rationalized the real estate echo-bubble by saying that "supply and demand" has driven the market. Wait until they get a load of a market with crazy, ridiculous excess supply and almost zero demand.

Ordinary Americans -- statistically with zero savings and previously able (and optimistic enough) to borrow whatever they needed not only to buy houses but goods and services -- will be hard-pressed to borrow more and frankly, in a declining market, not at all in the mood to do so. Lenders and mortgage securities players will no longer be so absurd (or solvent enough) to take on increasingly risky loans and the rules of the game will change very substantially. The elimination of subprime (poor-credit) borrowers, nothing-down borrowers and "NINJA" (Pearlstein's "No Income, No Job, No Assets") borrowers will whack the market in a way no one could have ever anticipated.

Folks who used the temporary "equity" from their homes the last few years to buy trinkets and charms and baubles and toys will have no problem completely curtailing those purchases for the foreseeable future. Pocketbooks will snap shut, and people will only buy if the price is so low, they simply can't refuse. A lot of companies will get profit-squeezed right out of business. The entire economy will get smacked the way Albert Pujols addresses a 3-1 fastball.

At that point, all you will hear about will be deflation, deflation, deflation and you'll wonder why you didn't listen to my tiny voice long ago. The psychology will take hold for what will likely be many years to come. You know that $3900 42" Hi-Definition TV you can now buy for $1500? The same thing will happen to real estate values as buyers figure out that "prices will be lower next year" and the year after that and the year after that. With no savings to support the average American's rapidly-evaporating net worth, people will stop spending, stop borrowing and stop hiring as they hunker down for the coming deflationary depression. Stocks will crash and fall completely out of favor for a generation, precious metals will take a liquidity-short nosedive of its own (before, I might add, becoming the investment of the decade). The shockwaves of falling property values, zero savings, credit contraction and liquidity squeeze will resonate throughout the real estate industry as the common perception will shortly become, "Why should I buy real estate when it's obviously going to be worth less next year?"

And while most people will sit there, tapping their fingers on the table, waiting for values to "go back up" and trying to call "the bottom" (who could forget the Talking Heads on General Electric, I mean CNBC, trying to call the bottom of the initial 2000-2002 stock drop -- "OK, THAT was the bottom." "OK, THIS is the bottom." "I'm pretty sure THAT was the bottom." "All right, that DEFINITELY was the bottom." "Jennifer Lopez has a VERY NICE bottom" "I am here to tell you and can almost guarantee you -- the 4th quarter will CERTAINLY POSSIBLY SURELY be the bottom"), our guess is that it will take ten to fifteen years for all of the NASDAQ bubble and post-bubble (and post-bubble-bubble) excesses to be completely rung out of the market.

The all-out collapse of the real estate bubble will mean that anyone left standing with 2005-2006-2007 cash -- you know, gobs and gobs of funny-money cash -- will ultimately be able to buy stocks, property and precious metals at ever more substantial discounts. My wish is that when the time comes you'll be there with me on the courthouse steps, buying distressed property for prices we can't begin to fathom right now.



Steve Moyer

Author: Steve Moyer

Steve Moyer,

Steve Moyer is a columnist and assistant editor of the monthly newsletter, Ponder This.... (www.ponderthis.net). He has been an investment real estate broker since 1982. Contact Steve at StephenLMoyer@aol.com.

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