The Housing Chronicles Blog: There, there -- everything may not be all better

Friday, February 15, 2008

There, there -- everything may not be all better

Hedge fund manager Bill Fleckenstein writes a regular column called Contrarian Chronicles for the site, and he called the housing bust in advance several years ago. He also thinks that Fed Chair Ben Bernanke is waaay over his head and that there's simply not much the government can do regarding the mortgage and credit issues.

First, from an interview in Business Week:

In Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve, William A. Fleckenstein takes tough shots at the former Fed chairman. The hedge fund manager and writer of the online column Contrarian Chronicles studied transcripts of Fed meetings and Greenspan's congressional testimony, and tracked the market's moves. That is the basis for the critique he co-authored with Frederick Sheehan, published by a unit of McGraw-Hill (MHP), BusinessWeek's corporate parent. Contributing editor Christopher Farrell asked Fleckenstein how investors will fare during Ben Bernanke's regime.

Chapter headings like "How Wrong Can One Man Be?" make your opinion of Greenspan clear. What about Bernanke?

Bernanke is just a pure academic. He was almost predestined to be in over his head. When I looked at what he was saying on the Federal Open Market Committee, before he became chairman, it was clear he didn't understand what was going on. But then he was handed the big real estate bubble as chairman. He was doomed.

Many people believed Greenspan could be relied on to cut rates and bail out the financial markets when they ran into trouble. Is that the case with Bernanke?

I think the Bernanke Fed wanted to free itself from that at first. But it caved in pretty quickly. The belief is that the Fed can't let the stock market trade down. In the Greenspan era, markets could go up as much as they wanted, but they couldn't go down.... There was no penalty for taking excess risks.

Given your views on the Fed, what should an investor do?

A lot of investors think everything will be O.K. They don't understand how shaky an edifice has been created. I don't think it's possible for the Fed to solve the unwinding of credit. It's going to get worse.Paragraph This is a moment to take less risk. To race into stocks because they're down 20% from their highs—I don't think so.

The product investors should load up on is cash. You put yourself in a position to take advantage of things when the risk has been squeezed out. You might lose a little, but you put yourself in a position to win big. Let's say you get a 3% return on cash, and inflation is running 5%. But [eventually] say I can find stocks down 30% to 60%, and in two years they'll double in value.

What about betting against the dollar?

For the past four to five years, I have owned several foreign currencies. I have a core position in precious metals. You have to have a hedge against the markets' going bad.... My favorite [currency] at the moment is the Canadian dollar. They have a budget surplus, a balance-of-payments surplus, all the resources the world wants. I'm not sure I'd buy it at 99 cents to the U.S. dollar, but I feel more comfortable holding Canadian dollars than U.S. dollars.

Gold has a place in a portfolio as downside insurance. It's around $900 an ounce, up threefold in a few years. That price is a product of what the Fed has done. The Fed will print money no matter what, until the foreign currency market and the bond market say, "No more."

And, from his latest column:

The problem in this country is that too many people have houses they can't afford and debts they can't service. Many financial institutions are owed those debts, which are impaired.

If we had just one financial institution and one consumer and we put them in a room together, we could probably get the financial institution to write off the value of the mortgage to where the debt could be serviced and the housing market could clear its inventory. That might be 25% or 30% lower.

We could cobble together a deal whereby that consumer could afford to live in his house, be able to make the monthly payments and, in effect, do a short sale to himself. (A short sale, in real-estate terms, is when a house is sold for less than what the owner still owes on the mortgage.)

The financial institution could then write down the loss over the life of the mortgage, or, if the house were to rise in value, it could capture the gain.

That would probably allow the consumer to move forward with less angst, assuming the economy managed to stay OK in the absence of the housing ATM -- something that might not be possible. Nevertheless, in this manner, the problem could be worked out in a couple of years.

The financial institution would have time and be given an accounting mechanism by which to write off the problem slowly. During that period, the economy would be only sort of crummy.

However, in the case before us, mortgages have been sliced and diced. Hardly a mortgage is left in the place it was originated. Conceivably, any given mortgage could be held by 50 or 100 financial institutions rather than just one. And every community has unique problems to deal with.

As for those folks who think still-lower interest rates would reinvigorate demand, Bob Campbell of the San Diego Real Estate Timing newsletter counters with this undeniable fact: "When an asset like real estate becomes overvalued, even if you drop interest rates to zero, you can't force consumers to borrow more, because they've already borrowed too much. Nor can you force lenders to lend, because they're already puking on 'bad paper.' It's called a liquidity trap."

I don't believe there's any way to get the genie back into the bottle or to solve not just the size but the complexity of the fundamental mortgage problem: Too many people are involved with too many different agendas to make these credit problems go away quickly and easily.

Arguably, our country has experienced the biggest bubble ever: the real-estate bubble induced by easy credit. I cannot believe that Wall Street will escape with only the recent damage in stocks or that the economy will suffer no more than a modest downturn.

Folks would be wise to hope for the best but to plan for the worst.

Thanks, Bill! And Happy Belated Valentine's Day to you, too!

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