Curiously it triggered over 20 emails about how wrong I was on this issue.
To summarize, I have long viewed the China economic dragon as a paper tiger. China has, on a per capita basis, pumped as much - if not more - stimulus into their economy as America.
And that massive stimulus - source of the infamous 'HAM' we keep hearing about - has created a huge real estate bubble in China.
In recent months the Chinese central government has taken significant steps to cool the market.
And now the Chinese Central Bank has come out with warnings of a 'relatively large' property collapse later this year.
Specifically China Finance, a publication of China's central bank,has warned that there's 'very large pressure' for Chinese property prices to fall in the second half of this year.
Government measures to curb property speculation have had "initial" results and further effects will be evident in the second half, wrote Zhou Jiang, of the housing ministry's research center. The article is in the July 16 edition of the magazine.
Declines in cities where prices previously rose quickly will be "relatively large," Zhou wrote without naming cities.
Imagine if our Central Bank came out with such clear warnings about the bubble they created?
We'll watch with keen interest to see what fallout, if any, is felt in the Village on the Edge of the Rainforest.
Above is part of a Charlie Rose interview with James Chanos, hedge fund manager and founder of Kynikos Associates Ltd.
Chanos talks with Charlie Rose about China's economy, currency policy and the risk that investment will "dry up." He says China'a property bubble will burst as early as this year.
What grabs the attention of those in the Village on the Edge of the Rainforest is his comments at about the 1:30 mark of the interview.
He talks about all the 'hot money' that is going INTO China on this real estate speculation is from Chinese nationals outside the country; in London, Singapore, Vancouver and San Francisco.
It's a take on things that makes one sit up and take note. Pervasive has always held here that the situation was in reverse... that it has been 'hot money' from China inflating our Real Estate bubble.
Could it actually be a symbiotic relationship that is so intertwined that neither side sees it for what it is?
That's what their calling it. A result of he busiest July ever for Vancouver Real Estate, both in Greater Vancouver and in the Fraser Valley.
And according to the Vancouver Sun, first-time homebuyers are driving the market.
Faithful readers will recall several posts I made earlier this year about how all the propaganda being pushed out by the Real Estate Associations was targeting first time homebuyers in a desperate attempt to grease the wheels of a real estate machine that had begun seizing up.
And now?
Paul Penner, president of the Fraser Valley board, notes the effect of luring the first timer's back. “That volume creates a significant ripple effect as the sellers of those homes move up,” Penner said in a news release.
Jake Moldown, president-elect of the Vancouver real estate board, concurred.
He said first-time buyers who entered the market during the boom a couple of years ago now feel comfortable moving up the property ladder.
“They understand what a mortgage is and they’re comfortable with their payments, and now they’re looking to step up,” Moldown said.
So it's Mission Accomplished for the real estate associations.
But I have said it before, and I will say it again... cheap interest rates are the one and only reason real estate is selling.
We have created a mini bubble, which was the whole point of the Bank of Canada flooding the market with 2% and 3% mortgages.
It's as if the nation has completely forgotten about collateralized debt obligations.
This boom you are seeing is the last silver bullet that our central bank and government can fire. It has staved off the wholesale collapse we have seen in the United States.
When we look back at the stock market collapse of 1929, no one could foresee the subsequent collapses of 1932 and 1937.
Investors are banking on the belief that the economic recovery has started. But just because believe something doesn't make it true. People believe that there is a recovery... and that it is the result of stimulus efforts by the feds.
However the results from the second quarter show the economy still contracting... albeit at a slower pace, just -1% annually, rather than the -6.4% recorded in the first quarter. This is heralded throughout the world as proof that the crisis is receding.
It if weren't for stimulus spending, the contraction [in the 2nd quarter] would have been closer to -4%.
It's how the government has been staving off collapse in the general economy.
In 1930 the world had thought the economy had recovered. Seventy-nine years later, most people cannot remotely fathom how a populace couldn't have realized that they were in the grips of 15 years of difficult economic times.
The stage is being set for our generation to understand it... succinctly.
On Vancouver Condo Info, there was an interesting comment posted by a mortgage broker:
“I am lender and have first hand knowledge regarding speculators holding out. Most of them have VRM (variable rate mortgages) of 0.75% to 0.90% below Prime. So currently their mortgage rate is between 1.35 to 1.50%. How many of them lock up into 5 year term when the rate was 3.5%? Very few. It is very hard for a person to lock up with a 2.0% rate increase rightaway especially if they are thinking short term to sell. I have none of my clients lock up. So if the Prime goes up next year by big numbers, you will see lots of blood.”
Yesterday we talked about the subprime mortgage mess. So much has been made of the subprime mortgage implosion that you would think it was almost totally responsible for the economic collapse, and that once the subprime problem was fixed then the worst would be over.
Well... the subprime implosion is now mostly behind us and the worst is yet to come.
Over the last few years you have heard all about 'subprime mortgages'. Let's now focus on another type of mortgage: Option ARMs.
An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the note is periodically adjusted based on a variety of indices. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change).
ARMs generally permitted borrowers to lower their initial payments if they were willing to assume the risk of interest rate changes. For the borrower, adjustable rate mortgages may be less expensive, but at the price of bearing higher risk. Many ARMs have 'teaser periods' which are relatively short initial fixed-rate periods. The teaser period may induce some borrowers to view an ARM as more of a bargain than it really represents. A low teaser rate predisposes an ARM to sustain above-average payment increases.
The most important basic features of ARMs are that they have an initial interest rate and then they have an adjustment period (this is the length of time that the interest rate or loan period on an ARM is scheduled to remain unchanged. The rate is reset at the end of this period, and the monthly loan payment is recalculated).
An 'option ARM' is typically a 30-year ARM that initially offers the borrower four monthly payment options: a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment
Option ARMs are often offered with a very low teaser rate (often as low as 1%) which translates into very low minimum payments for the first portion of the ARM.
When evaluating an Option ARM, prudent borrowers will not focus on the teaser rate or initial payment level. Specifically, they need to consider the possibilities that (1) long-term interest rates go up; (2) their home may not appreciate or may even lose value or even (3) that both risks may materialize.
When a borrower makes a Pay-Option ARM payment that is less than the accruing interest, there is 'negative amortization', which means that the unpaid portion of the accruing interest is added to the outstanding principal balance. For example, if the borrower makes a minimum payment of $1,000 and the ARM has accrued monthly interest in arrears of $1,500, $500 will be added to the borrower's loan balance. Moreover, the next month's interest-only payment will be calculated using the new, higher principal balance.
The danger of the Option ARM is nasty feature known as 'payment shock'. This is when the negative amortization and other features of this product can trigger substantial payment increases in short periods of time.
Subprime mortgages had resets of 2-3 years and the bulk of those resets has past us now. The domino effect of failing subprime mortgages has collapsed housing values all over the USA. Millions of American homeowners are now in a negative equity position (the value of their home is now less than the amount of their mortgage).
Compounding this condition is the fact that millions of American homeowners began treating their home equity as some sort of housing ATM, meaning they have taken out loans against the inflated values of their houses and used the money to buy things. Some would refinance to pay off credit cards. Others would take out a home equity line of credit to buy a new car or to fund home repairs or both.
The end result is that subprime isn't the mortgage class in the most danger,Option-ARMs are because there are way more Option-ARM mortgages than there were subprime mortgages. Moreover the housing collapse has left far more Option-ARMs in a negative (underwater) equity position than there were underwater subprime mortgages. (click on image to enlarge)
So while the huge wave of subprime mortgages resettings from 'teaser' rates to market rates has virtually ended, we are still dealing with the aftermath of the resettings. Specifically there is a massive spike in subprime mortgages going into default and foreclosure.
And as the housing market struggles to absorb all these foreclosures, along comes the Option-ARM resets. The resetting of these 'teaser' rate mortgages into market rate mortgages has only just begun.
Negative equity is profoundly affecting these mortgage classes even before their teaser rates have expired. While most subprime mortgages had teaser rates lasting 2 or 3 years. Option-ARM mortgages (and a third class of mortgages called Alt-A) usually have teaser rates of 5 to 7 years. All these Option-ARM and Alt-A mortgages are only now just coming due for reset.
Worse, most Option-ARM mortgages have 'triggers' in their contracts that mandates that they automatically amortize once they've reached a certain level of negative equity, usually around 110%.
Alt-A and Option-ARM mortgages are only just now starting to implode with these 'resets' and 'triggers'.
It may be several year before many of these mortgages have to reset, yet we are already seeing defaults skyrocketing because of these 'triggers'.
T2 Partners report titled "An Overview of the Housing/Credit Crisis and Why There is More Pain to Come" outlines all of these coming mortgage problems (see report here).
If this trend continues Alt-A and Option-ARM will easily become the worst mortgage class of them all and they will dwarf the carnage created by the subprime meltdown.
A chilling report was issued yesterday by T2 Partners titled "An Overview of the Housing/Credit Crisis and Why There is More Pain to Come". If you want to see the actual report, click here.
Tomorrow I am going to hilight the key points of the report, but before I do let's cover some background leading up to the current situation. I had several questions about the whole subprime issue and how it came about so let's look at it.
So much has been made of the subprime mortgage implosion that you would think it was almost totally responsible for the economic collapse, and that once the subprime problem was fixed then the worst would be over.
Unfortunately nothing could be further from the truth. But what was 'subprime' all about?
After the dot-com collapse of 2000/2001, a dramatic wave of inducements entered the financial markets to resusitate the economy. Led by the US Federal Reserve under Allan Greenspan, interest rates were dropped making money cheap to borrow at the highest levels of the finance world. Thus began the greatest campaign in American history to get you - the consumer - to borrow money.
When you opened your mailbox in the United States in 2004, 2005, you could barely go a day without all kinds of people pressing on you all matters of schemes in which to expand your personal debt and mortgage debt.
Perhaps the most amazing aspect of this was that you could borrow more than 100% of the price of a house under these schemes with the most fragile of financial bonafides.
One of the mortgage products offered in this atmosphere was something called subprime loans, meaning less than prime quality.
The borrowers that were targeted by these products often had sketchy credit, were financially strapped or lacked sufficient income to qualify for a standard mortgage. The key component of these loans was that after a year of artificially low payments, the interest rates on subprime loans jumped all the way to 10 or 11%.
So why would anyone in the right mind take one of these loans?
Two reasons, primarily. The first (incredibly) was you could actually MAKE money taking out a loan. Yes, you could actually get paid to buy a house!
In many cases people were getting loans in excess of 100% of the value of their property. In this way people were actually putting a little bit of money in their own pocket at close of escrow. You bought the house with nothing down and then were given extra money on top of that for buying the house.
To understand how this was possible, you have to understand what Wall Street was doing with mortgages.
Almost all of the people involved in a mortgage transactions made huge amounts of money arranging the loan, then they passed the risk on to somebody else.
Instead of keeping dicey loans in their own portfolios, the big banks and giant mortgage companies that originally underwrote them resold the mortgages to big New York investment houses.
Firms like Bear Stearns and Merrill Lynch then sliced the loans into little pieces and packaged them up with other investments, then sold them to their best customers around the world as high-yield mortgage-backed securities, turning sows' ears into silk purses, all with the blessing of rating agencies like Standard & Poor’s.
And at every step of the way, somebody has his or her hand out, getting paid.
The broker who arranged the mortgage got paid. He or she was happy. The lending officer, ditto. The rating agencies who assessed home values and the worthiness of the mortgage got paid for passing judgment on these securities. They, too, were pleased, and their stockholders were happy. And on and on.
Because of this 'securitization process', those who instigated the loans were eager to make the loans happen. Therefore whatever a buyer wanted to state for their income, the bank would accepted that at face value and made the loan based on that ficticious income.
You would literaly apply to a bank, or a mortgage broker for a loan. When you filled outthe loan form, you would say, "I have an income of, oh, $150,000 a year." They say, "You do? Fine. Just sign right there." And they would nod, and because they were being paid, not by the veracity of the information, but by the consummation of the deal, not further investigation was necessary.
Next the lending office would say, "Ah. You have verified this?" And the bank would say, "Why, yes, we have." And the lending officer would say, "Great. So do I." Then they would get paid.
Next it was passed on to Wall Street to be bundled up and sold in packages, with Wall Street reaping huge commissions for those sales.
This 'easy money' created a housing frenzy from 2002-2008 unlike anything ever seen.
Easy money started bidding wars for properties and housing values skyrocketed. As the frenzy intensified, Wall Street's hunger for more and more mortgages to securitize grew by leaps and bounds.
Enter the subprime mortgages.
In it's gluttonous lust for more and more mortgages, products were crafted to offer loans to borrowers with sketchy credit (or to offer to those who lacked sufficient income to qualify for a standard mortgage). These subprime mortgages came with artificially low monthly payments in the first year of the mortgage, but then the interest rates jumped after that all the way to 10 or 11%.
People would take these loans because they didn't have to put any downpayment on the house. Then, by getting false assesments about the true value of the house, they would pocket the extra money from the mortgage immediatly (thus getting paid to buy the house).
These false assesments about the true value of the houses were rationalized within the real estate frenzy. Property values were climbing by 10-20% every year. If the house wasn't really worth that now, it would be in a matter of months.
Meanwhile borrowers didn't worry about the interest rate resets after a year because they could afford the initial payments and planned to refinance the mortgage before the interest rate jumped to 11%. Home values would have risen and the mortgage would now represent a smaller percentage of the assessed value of the house. Plus borrowers would have equity in the property (based on the new 'value' after a year of prices booming) and would therefore qualify for a standard mortgage instead of a subprime mortgage.
Real Estate ownership was a licence to print money.
That is... until the bubble began to burst in the most bubbly cities in Florida and California.
It wasn't a big drop. But it didn't matter, a small drop is all it took. When the value of some of these homes dropped in 2007, a ticking time bomb was activated.
And the subprimer's were the first hit.
When the subprimers went to refinance their mortgages after one year, they couldn't do it because the value of the house had fallen below what they owed on the mortgage. So when those 11% interest resets kicked in, it was game over - and the defaults/foreclosures started.
The first wave of defaults triggered a greater drop in housing values as foreclosed properties started to flood the market.
A small drop became a sizable drop. And the dominos began falling.
To the subprime mortgage holders, it really wasn't a big deal.
The subprimer's were never really invested. Most of the people who lost the houses didn’t lose any money because they never put any money down. Though their credit is damaged, and they could face legal action in some circumstances, they got to live in a new house for a couple of years, and some of them even managed to get some money with home equity loans or by refinancing.
And when the crush came, people just said, "Take the house. Good-bye. I'm leaving." And the cascade of foreclosed homes really began flooding the market (furthing driving values down).
Prior to this housing boom, loans were made by your local banker or building and loan associations or savings and loan. They had a stake in the risk of the loan. But as mortgages became securitized and Wall Street became involved, mortgages became very transactional and there was no relationship built with the borrower and the lender.
Lenders failed to act to make loans to credit worthy borrowers, and borrowers were willing to simply walk away from their obligations to a face-less Wall Street entity.
It was greed on both sides of the table, lenders and borrowers with everyone was gaming the system. Warnings were issued, and ignored, by the likes of Nathan Roubini, Schiller, Peter Schiff and Ron Paul.
This hitler inspired parody of the crash lampoons all these factors and has become a classic comic representation of the entire housing crisis...
Ultimately subprime was a very small fraction of the overall mortgage market. But the impact of subprime on the market was like a giant, first domino that triggered a cascading effect.
And with home values plummeting, and the housing sector - one of the largest and most vital parts of the American economy - grinding to a standstill, America was pushed towards recession.
Wall Street and foreign investors were stuck with millions of distressed properties. The unsold condos in Miami, the unfinished apartments on the Vegas Strip, the developments in Atlanta, and the collapsing California dream, it was all interlocked in a giant real estate ponzi scheme.
That’s the fascinating part of this whole debacle. Mortgages are sold in mortgage backed securities, so they’re pooled. The pools are part and parcel of those high-yield mortgage backed securities everyone gobbled up a few years ago, and are now stuck in the windpipe of the world's financial system.
No one wants to buy them, so no one can sell them.
Bonds marked triple-A are now quoted at 50 cents to the dollar, 40 cents on the dollar. Some of them, much less. Some are worth nothing on the dollar. And nothing on the dollar is the worst thing that has happened to Wall Street in a long time.
How many of these securities are out there? A trillion with a T-plus.
But the worst of the subprime fiasco is past, as you can see by this graph (click on image to enlarge)...As you can see, the huge wave of subprime mortgages resettings from "teaser" rates to market rates has virtually ended.
The problem is that subprime mortgages were never a significant part of the mortgage industry.
Looming on the horizon is a gigantic wave of regular mortgages whose terms reset after 5-7 years. With the value of real estate having plummeted over 40% in many areas of the United States, these homeowners represent a catastrophic mass of mortgages that cannot be renewed because of their current negative equity position.
Tomorrow we will look at that and the impact it will have on the economy.
Bank Failure #22: Cape Fear Bank in Wilmington, N.C. Bank Failure #23: New Frontier Bank of Greeley, Colo.
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Way back in September, Vancouverites smugly looked out at the evolving economic crisis spreading across the United States with a bit of bemusment. We 'tsk-tsked' the subprime mortgage mess. It was an American problem and we were not directly affected.
When the stock market crashed, we shrugged our shoulders. Canada was economically sound and BC was even better off than the rest of the country.
The attitude bordered on arrogance.
From a July 22, 2008 Vancouver Sun article:
Finance Minister Colin Hansen looked The Vancouver Sun's editorial board in the eye late last week and maintained that, despite all the economic gloom and doom that's going around these days, the B.C. economy is doing pretty well.
From a October 20th, 2008 CTV story:
Finance Minister Colin Hansen introduced his Liberal government's economic relief package in the legislature, saying the province will avoid recession. "None of the leading economists that I have heard from have indicated a forecast of a recession," Hansen said. "Relatively speaking, British Columbia is doing remarkably well."
Oh how the times have changed.
The StatsCan data now puts B.C. at the epicentre of a massive Canadian recession. Gone is the talk of no provincial budget deficits. And the Real Estate industry - its folding in on itself.
For hidden in the job loss numbers is the real impact of what is happening.
Last month, the B.C. economy shed 22,600 jobs. But those numbers hide the full measure of the drastic downturn in B.C.'s construction/real estate sector.
The were actually job gains last month. B.C.'s service sector (the accommodation and food services sector) saw employment grow by 7,200 jobs.
7,200 jobs gained!!!
And these job ADDITIONS disguise the profound devestation that hit the Real Estate sector.
Last month not only did 16,000 construction jobs disappear; but there were 8,500 lost positions in the financial, insurance, real estate and leasing sectors - the support system for the housing industry. And the tally in those areas alone is greater than the overall number of net lost positions in the B.C. economy.
For any newly unemployed journeyman or real estate agent who has been longing to become a waiter, that's great news.
For anyone else, it's a sign of an economy that is shedding high-paying, full-time work for low-wage, part-time employment.
With the American and European economy in full retreat, look for BC's service sector industry to take in on the chin this summer. Which means the job loss hit parade will continue throughout the spring/summer months.
And as we have said before, people who substitute low paying part time jobs for high paying full time ones... and people without jobs... well they simply can't pay mortgages or buy new condos.
The blueprint for fall and winter in BC Real Estate is being drawn now. And it doesn't look pretty.
Part 4 of our series condensed from a speech Peter Schiff’s gave on March 13, 2009 to the Austrian Scholars Conference.
By 2006 everyone thought Real Estate couldn’t go anywhere but up and nobody questioned the Triple A ratings that Wall Street had given these extremely high risk mortgages when they were packaged up and ‘securitized’.
Then, in early 2006, prices in America started to fall when some potential US homebuyers concluded that home prices were becoming fundamentally overvalued. As a result you had falling demand in a few bubbly cities such as San Diego and Miami.
The falling demand created relatively high levels of housing supply. This high supply/low demand triggered a modest drop in prices.
And that’s all it took. A modest drop in prices in a few bubble centres.
Had house prices actually continued to rise, many subprime mortgages could have been reset at higher rates without much damage. But when this modest drop in housing prices got going, it started a domino effect that has been catastrophic. Modestly lower prices, along with higher reset rates on the exotic mortgages resulted in a substantial wave of foreclosures.
Suddenly a bloated housing inventory started to overwhelm itself.
As the housing inventory rose, the more downward pressure was reinforced on house prices – a typical supply and demand situation.
When more and more subprime mortgages came up for reset, the reduced value of the property made renewal impossible. And a vicious, perpetuating cycle began.
And that’s all it took. And the entire system collapsed from there.
For years housing prices rose only slightly year over year. Suddenly, in the last five years, they shoot drastically higher. If you plot it on a graph you have a straight line moving upward at a slight angle and then, it curves straight upward.
I used to go on television and talk about housing prices going to fall. And people would say, “that’s not going to happen. That had never happened, certainly not since the Great Depression.” Which was true, but housing prices had never shot straight up like they had in the past five years. That had never happened either. For the first time housing prices were not supportable by rents and incomes. But everyone seems to think it is going to stay up high that it should somehow plateau there.
In many ways it’s kind of funny. Everyone now recognizes that we had lending practices that were too lax, the lack of a downpayment, too many people buying houses and credit was too cheap.
Everyone knows all these things that we did wrong which caused people who shouldn’t have been buying houses, to be able to go out and buy a house. And everyone knows that this artificially drove up the value of houses.
And everyone can agree that we need to go back to a prudent mortgage lending process.
But nobody wants to go back to prudent pricing.
Everyone wants to go back to sound lending principles but leave the bubble prices intact. But that’s impossible. Nobody can afford to pay these high prices without all these lending gimmicks.
The reality is that the best thing that can happen to the lending industry is for these high prices to come down. It used to be that the mission of Freddie/Fannie (before they went broke) was to try and make home ownership affordable. Now their mission is to keep home prices high.
And this is where the government is making a huge mistake.
This keeps homes unaffordable. It makes sure that we have to mortgage ourselves to the hilt to buy a house.
The government’s solution is high prices with low mortgage payments subsidized by the government. The free market solution is low prices. Because if real estate prices go down, you don’t need to borrow that much money to buy a house. And if they do, it doesn’t matter that interest rates go up a bit, because your payment will be lower anyway.
So now we get into the foundation of our current financial crisis. The government still looks at the problem as being one of falling real estate prices. That’s not the problem, that’s the solution.
The problem is that they went up.
Now that the housing bubble has burst and the stock market has collapsed on the backs of this real estate collapse, we are having this massive – necessary – recession which is just getting started. And it has just started, we have barely gotten a taste of it.
Unfortunately all the blame is on the free market. All the blame is on capitalism. People are running around saying “it’s because there wasn’t enough regulation, there was too much greed.” President Bush summarized it by saying “Wall Street got drunk.” And he was right, they were drunk. But so was Main Street. The whole country was drunk.
But what he doesn’t point out is… where did they get the alcohol? Why were they drunk? What was the root of the problem?
Obviously Federal Reserve Chairman Greenspan poured the alcohol, the Fed got everyone drunk and the government helped out with their moral hazards, the tax code, all their programs, the incentives, the disincentives, the way they interfered with the free market. It removed the necessary balances that would have existed, that would have kept all this from happening.
But now that it has happened, we have to deal with it.
So we are back to where we were in 2000 after the dot.com bust, only this time the recession we are facing is far more severe.
Peter Schiff is the President of Euro Pacific Capital and is famed for being the most vocal financial critic who accurately predicted the real estate crash of 2006 and the stock market crash of 2008.
He writes for the New York Time, the Financial Post and makes numerous appearances on all the US television networks. Currently he is predicting serious inflationary consequences as a result of the massive amount of bailout money being pumped into the economy by governments.
His passionate arguments have proven to be highly prescient and are worth taking a look at.
In understanding the current state of the financial and real estate crisis, it is important to look at how it all got started. So I am going to break up his views and start with the Internet Bubble. From that we will move to the Real Estate Bubble, the crash of the stock market, the bailouts and, finally, to his views on what will happen next.
What follows is condensed from a speech he gave on March 13, 2009 to the Austrian Scholars Conference.
The Internet Bubble
When you are living in a bubble, sometimes it is hard to see reality for what it is.
In 1997, 1998 and 1999 we had the NASDAQ bubble and nobody seemed to be able to figure out that these companies that everyone was touting were not worth what people claimed.
They said we were living in a new era and that the internet had captured everyone’s attention. People were saying that everyone was going to buy everything on the internet.
But hang on a second. There was no difference between the internet (and the potential for commerce) and that of a catalogue or a telephone. If worldwide commerce hadn't shifted to catalogue sales or telephone sales, why were they now going to magically shift to internet sales?
What was going to make the internet different?
Yet the valuations coming out for these new companies were huge (and grossly unrealistic). You would have some new company… say doorknobs.com… and they would start up. Now even if they sold every doorknob in the world, they couldn’t possibly be worth the multiples that the company suggested in their prospectus.
Yet once they went public, their value shot up and there was no possible way they could be worth the multiples that the company was now trading at on the stock market.
Somehow it didn’t matter.
And company after company took flight this way. They would come out with a concept. Draw up a prospectus. Go out and get $5 million in start up funding, not because they were worth anything, but on the promise that investors would reap a huge return when they went ‘public’ and listed on the exchange.
It was crazy. Why would people invest in a company that had no land, no assets, nothing!
And the reply was always, ‘you don’t understand the stock market’.
It wasn't about what a company could produce, it was all about the promotion of the stock.
People were sold the malarkey that this was the way the stock market worked with internet startups. And company after company was like this. Many of these companies never made any money at all.
And how could that come as a surprise?
The central premise of most of these internet companies was that somehow it was more cost effective to Fedex every single item currently for sale in the marketplace to a consumer rather than having the consumer come in, buy it and take it home himself.
That’s crazy.
But it didn’t matter. People were getting rich when these companies were listed on the stock market. And they were getting rich, not because the companies were successful; people were getting rich because investors were buying their stock.
And after the bubble burst, everyone realized how stupid it all was.
But within a year of the collapse of the Internet Bubble, we moved seamlessly into the Real Estate Bubble.
Nobody could see that there were any similarities.
But the exact thing that had happened with the Internet Bubble… now starts to happened with real estate.
And we moved so quickly from the unwinding of one bubble and into another that we simply postponed the unwinding of the consequences until now. And we are still trying to postpone it today with all the bailout money being thrown around.
But this time the damage is so great and the problems so huge that I don’t think there is another economic rabbit they can pull out of their hat at this point. We are just going to have to face it now.
Tomorrow: The Real Estate Bubble.
Whisperer Summary: The key point that Schiff is making is that the internet bubble developed because the fundamental law of commerce was ignored. In the bubble, the value of these companies rose due to irrational speculation. The value did not rise because these companies were producing something and providing a return. And when these companies were promoted, they were promoted on flawed and irrational values. It was a giant gamble because they lacked a real 'value-based' foundation. It was gambling. And when the gambling stopped, the values crashed.
“The Federal Reserve is now a government within a government. It is totally out of control. Congress doesn't control it. It's funded by the banks and we either have constitutional government or we don't."
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