Agora Financial’s Rude Awakening

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Laguna Beach, California

Looking back to the future housing collapse – Dissecting the “coming crisis,”

A tale of anemic post-war recovery,

Where there’s smoke, there’s meltdowns a comin’ and plenty more…

Eric Fry, offering a few parting words about Dr. Richebacher…

In today’s edition of the Rude Awakening, we come to praise Dr. Kurt Richebacher, not to bury him. Although this brilliant financial mind passed away two weeks ago, his legacy endures within all those who relished his insights – a legacy of intellectual honesty.

He was a man who would always “tell it like it is,” even when the “is” that he was telling was very unpopular. Richebacher rigorously pursued the truths and insights that nurtured prudence, while also scorning the deceptions propagated by Wall Street and Washington.

His honesty often forced him to become a lonely voice of reason, and thus, a very valuable voice. Richebacher did not hesitate to yell, “Fire!” whenever he smelled smoke. More than that, he continuously scoured the underbrush of arcane macro-economic data to identify the smoldering embers of future crises.

Truth-seekers lost one of their leading lights two weeks ago…the task now falls to the rest of us. Every investor would do well to emulate Richebacher’s unwavering pursuit of insight, as well as his resolute determination to examine the risks that other ignore.

To honor Dr. Richebacher’s memory, your editors would like to reprise one of the last columns he wrote for the Rude Awakening – a column entitled: “When the Roof Caves In.” Although this column is now seven months old, its observations are as timely as tomorrow’s Wall Street Journal.

Dr. Richebacher, we will miss you.

The following column is a Rude Awakening “Classique,” which first appeared January 30, 2007:

Eric Fry, reporting from Laguna Beach, California…

About fifteen months ago, I spent two days with Dr. Richebacher, soliciting his views about the debt-heavy U.S. economy and its booming housing market.

About fifteen months ago, I sat on a balcony in Cannes, France, discussing the probable fate of the American housing market. The balcony belonged to Dr. Kurt Richebacher, as did the prescient predictions I heard that day.

“The American housing market is in serious trouble,” Dr, Richebacher insisted at the time. “It is one the verge of a major collapse.”

The date was October 14, 2005, and the view from the balcony was the one depicted in the nearby photo. At that time, the housing boom was still booming…and almost no one imagined that the good times would end very soon. But Richebacher did not refrain from predicting imminent disaster. Read on below…

THE “SUBPRIME” TIME BOMB TICKING UNDER WALL STREET

Thought you were “done” with the property bust?

Think again — then get ready as a deadly subprime lending time bomb ticking under Wall Street sparks the worst property-led recession of the last 76 years!

This triple-edged “housing hedge” strategy could shelter both you and your money against the fallout IF you let me rush it to you FREE, as soon as possible…Read On Here

When the Roof Caves In
By Dr. Kurt Richebacher

America’s income-short, consumer-led recovery is the aberration - not the norm - in this Brave New World. It is all about ever-declining saving rates, ever-widening current account deficits, mounting debt burdens and increasingly wealth-dependent consumers. It personifies what I believe is one of the most precarious macro models that has ever existed for a major economic power.
- Stephen Roach, Morgan Stanley Economist, April 4, 2005

Private households in the United States have embarked on their greatest borrowing binge of all time, fostered and facilitated by the rampant house price inflation and a most aggressive financial system. What has been developing in the balance sheets of private households, therefore, is a race between booming “wealth creation” through rising house prices and soaring indebtedness.

It appears that indebtedness will win this race and wealth creation will lose.

Over the five recovery years since the end of 2001, the overall indebtedness of private households surged by 66%. Even though overall indebtedness soared, rising home prices still provided the private households with the biggest wealth gains of all time. The housing bubble, therefore, has been the single most important economic event of the last few years. Homeowners used the sharply rising market values to embark on their greatest borrowing-and-spending binge of all time, financing higher consumer spending through soaring equity withdrawals, even though personal savings were negative in the aggregate.

The bursting housing bubble, therefore, should be the single most important economic event of the next few years.

In a recent speech in Atlanta, Donald L. Kohn, vice chairman of the Federal Reserve Board, remarked:

“Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed.”

Please note his explicit remark on “our uncertainty about what pushed home prices and sales to those elevated levels.” The Fed slashed its federal funds rate with unprecedented speed to 1% and accommodated America’s greatest credit inflation, yet Mr. Bernanke stresses the uncertainties in the Fed about what truly pushed homes and sales of housing to those elevated levels.

There never was a secret about what exactly has been fueling the U.S. asset-inflation bubbles - above all, equities, bonds and the boom in housing. First of all, the Federal Reserve - with Messrs. Greenspan and Bernanke at its helm - played a key role in the late 1990s both with extremely loose monetary policies and highly encouraging public remarks to foster the stock market boom.

Nevertheless, the stock market boom went bust in 2000 and the following years. While the government and the Federal Reserve opened their fiscal and monetary spigots as never before, the economy started its most anemic postwar recovery. The main support for economic growth came from the developing residential housing bubble, which offset the stock market bust of 2000 to 2002 and provided homeowners with soaring collateral for borrowing through home mortgage refinancing.

To quote Stephen Roach of Morgan Stanley: “The Fed, in effect, had become a serial bubble blower.” By the time the equity bubble popped in early 2000, consumers had moved on to a new strain of wealth effects - taking advantage of possible equity withdrawals from rising housing values to extract newfound purchasing power.

But now that home values are falling, this purchasing power is moving in reverse. According to the Fed’s Flow of Funds Accounts of the United States, new mortgage borrowing by private households peaked in the third quarter of 2005 to an annual rate of $1,223.6 billion. One year later, its growth sharply slumped to $672.7 billion, marking a decline by 45% within just one year. Retrenchment in mortgage borrowing and lending over this brief period has been dramatic.

Without rising home values, and continuing access to new credit, the American economy will slide into recession.

The U.S. economy is one of the very cases in the world in which all three main sectors - government, businesses and private households - keep borrowing and spending heavily in excess of their current income growth. In 2005, they together borrowed $3.35 trillion, of which the nonfinancial sector borrowed $2.3 trillion and the financial sector another $1 trillion. This compared with a total credit expansion by $1.6 trillion in 2000. This coincided with a collapse in national saving from $582.7 billion to $7.2 billion.

Therefore, arguments between bulls and bears about the further prospects of the economy and the financial markets are focused more than ever before on one aggregate: excess liquidity and credit growth. Long ago, until the late 1960s, credit growth was closely tied to economic growth, as measured by gross national product. But this formerly close relationship between the two aggregates went completely bust in the 1980s. Ever since, credit has been expanding in excess of GDP growth.

During 2005, total credit grew in that single year by $3.35 trillion. Compared with nominal GDP growth by $0.74 billion. In other words, it required $4.50 of new credit to add $1 to GDP. Clearly, this is excessive liquidity and credit growth.

It is a fact that each major economic and financial crisis was preceded by “excess” liquidity. Just think of America’s New Era during the 1920s and of Japan’s famous bubble years in the late 1980s. In both cases, prior excess liquidity vanished in no time when the existing asset bubbles began to burst. If growing asset bubbles are the channels to excess liquidity, bursting asset bubbles are the channels to liquidity destruction and excess debt.

Therefore, we observe with a very critical eye the balance sheets of private households. According to the consensus of economists, American balance sheets are in excellent shape because asset values, mainly equity and housing, have soared in value for years, altogether by about $19 trillion - or almost 40% - since recession year 2001.

But the bulk of these gains has been entirely in illiquid assets, mainly equity and housing. Liquidity, measuring existing cash against overall liabilities, is at its lowest ratio in postwar history. To us, consumer balance sheets in the aggregate look more like a house of cards.

The great question is whether there is anything in the pipeline that might shake this house of cards. Clearly, we do not want to be standing near this house of cards when the macro-economic trembler finally arrives.

Joel’s Note: Mike “Mish” Shedlock has been keeping a close eye on the collapsing house of cards. First the subprimes felt the pinch, then the punch…and now that the true magnitude of the credit crisis is bubbling to the surface, it appears the effects will be more far-reaching than most had expected.

Mish’s Housing Survival Report details the causes and effects of the crisis as well as a triple-edged housing hedge you can employ to protect your greatest asset. Even if you believe you are in the “safe-zone” it pays to be aware of exactly what’s going on. Read the full report here.

Rude Endnote: Here in Kuwait City, the temperature is a currently hovering at a relatively mild 109 degrees. People around here don’t bother complaining until it gets to 122 degrees. That’s 50 degrees Celsius…officially hot. 

So, what is one to do in this kind of heat? Strip down and head to the beach? Guzzle water and icy cocktails by the pool? ‘fraid not…

Today is the first day of Ramadan, the holiest month on the Islamic calendar. 1.2 billion Muslims around the world (and anyone who is living in a Muslim country) began fasting this morning. That means no water, no food and no sexual activity between suhur (the last meal before sunrise) and iftah (breaking of the fast the moment the sun sets).

This year’s Ramadan begins very early - the dates depend on the lunar calendar. That means longer, hotter days for anyone participating.

But while Muslims around the world fast in the name of religious ritual, many others are going without for another reason: The price of food.

Sugar, lean hogs, cattle feeder, live cattle and wheat all finished up again in yesterday’s trading as markets responded to panic about growing demand from the voraciously industrializing nations of China and India and massive shortfalls in production from major exporting countries - notably Australia and Canada.
 
What does that mean for you? More at the grocery store, for a start.

“In the U.S., food prices have risen more than 4 percent from a year ago, as producers pay more for wheat, corn and soybeans to feed livestock and for gasoline to move products,” said David Wyss, chief economist with Standard & Poor’s.

Our own Kevin Kerr, editor of the Recourse Trader Alert, is watching every movement in the explosive ags sector, ready to alert his readers to the very next profit opportunity. Ensure you receive his next mailing here: The Resource Trader’s Secret Logic

We’re off to find a shady place for a while, but your 5 will be along from our Baltimore desk momentarily.

Cheers,
Joel Bowman
Rude Awakening