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Thursday, October 13, 2005


templeton and kondratieff

a conversation relating to the housing/debt bubble at reason reminded me again of sir john templeton's famous 2003 interview with equities magazine. the interview itself is proprietary, but the direction of templeton's comments as summarized by bill fleckenstein is crystalline.

Moving on to housing prices, Sir John comments: "Every previous major bear market has been accompanied by a bear market in home prices. . . . This time, home prices have gone up 20%, and this represents a very dangerous situation. When home prices do start down, they will fall remarkably far. In Japan, home prices are down to less than half what they were at the stock market peak." Sir John adds, "A home price decline of as little as 20% would put a lot of people in bankruptcy."

Sir John also had a few words about debt -- a four-letter word that folks seem not to care about: "Emphasize in your magazine how big the debt is. . . . The total debt of America is now $31 trillion. That is three times the GNP of the U.S. That is unprecedented in a major nation. No nation has ever had such a big debt as America has, and it's bigger than it was at the peak of the stock market boom. Think of the dangers involved. Almost everyone has a home mortgage, and some are 89% of the value of the home (and yes, some are more). If home prices start down, there will be bankruptcies, and in bankruptcy, houses are sold at lower prices, pushing home prices down further." On that note, he has a word of advice: "After home prices go down to one-tenth of the highest price homeowners paid, then buy."

it's hard for many to fathom either the boggling extent of the credit bubble in which western economies are now mired or the economic devastation that is in our near future as it resolves itself. the yawning chasm before us reminds me of kondratieff modeling, long waves and the prediction of an eventual economic winter. while social sciences of the kind kondratieff worked in are only charitably called sciences in my estimation, the possibilities of a sort of confirmation of this long-wave theory are disturbing.

though his string of interviews with john flaherty has ended with the onset of old age, equities magazine reports that templeton has begun shorting the american and japanese markets, while remaining committed to high-growth, low-multiple developing markets in china, russia and india.


Because of my ignorance can you explain how the decline in house values directly causes bankruptcy?

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in the individual case of a high debt-to-equity ratio, declining nominal asset value will fall under the amount owed on the loan. when this happens to a significant degree, the capacity for homeowner bankruptcy exists.

bankruptcies will be forced then when such homeowners then, due to other exigencies, cannot make payments and are forced into foreclosure and personal bankruptcy. the assets are then placed on the market by the foreclosing bank, driving prices down further. eventually, as prices fall, many homeowners, who owe vastly more on their house than the house is worth, can and will simply walk away from the property in despair. this process generally means bank failures.

this is a phenomena that has been observed on local scales (see texas in the s&l bailout) before; now we'd be facing something much larger.

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so being upside down on the house itself is not really a problem as long as the home owner is patient and waits for the value to appreciate again instead of claiming bankruptcy and walking away.

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if one keeps making payments, mr sulla, i think one would be fine.

but many won't. such is the nature of recessions -- people get laid off, lose jobs, can't find work.

but one should be prepared for the possibility that house prices may remain depressed for a decade or more. japan's r/e market is still down by more than half, 11 years removed from their property bubble.

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the difficulty is that the crtedit bubble is much larger than simply housing -- the banking system, under the duress of constant foreclosure losses, will be forced to raise assets and stop lending. this will of course damage the economy severely, putting large numbers out of work -- and putting them into foreclosure, feeding the cycle.

it's easy to believe, now sitting on the tail end of over two decades of expansion, that one can simply keep making the payments and be fine. but a lot of normal folks who think they will be fine, won't be.

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