Denial is always the first stage that marks the beginning of a Bear Market: There is no better example than the one that can be seen when observing today’s real estate market. What else would you call it besides DENIAL when every real estate guru is calling for a bottoming of the market after only a year and a 5 to 10% (that is assuming you accept the published numbers) or so price correction of the biggest real estate bubble in American history?   If you want to see what a real correction or Bear Market looks like, just take a look at Japanese real estate: It topped out in 1990 and here we are seventeen years later and it’s only now beginning to see some life.




Before going any further, let me point out that 70% of the population owns their own home (actually the banks own most of them) so although the real estate business only represents 20% of the economy, it is really much larger than that. Everything the analysts, media and politicians report as news is really ancient history, spun to make it look like it’s what’s happening today. But even yesterday’s news is not news, but really history. Looking in the rear view mirror will only tell you where you have been; you better look out the front (forward) window if you want to know where you’re going so you don’t crash into a brick wall.


Stages of a Bear Market in Real Estate

1st Stage is the almost complete drying up of sales as buyers refuse to pay up and as the number of real buyers (as apart from shoppers) dwindles. At the same time sellers, still caught up in the rising expectation hype, not only refuse to lower their prices but actually raise them, having gotten used to houses being sold above their asking price.


2nd Stage  There is a dramatic increase in the number of foreclosures. This begins in the last stages of the boom, but dramatically increases as the homeowners who cannot meet their obligations, can no longer refinance at lower interest rates while extracting money to meet their obligations.  As prices begin to first stabilize and then turn down, they can no longer sell their home for any price that even remotely approaches their outstanding mortgages and are left with no other choice but to mail their keys back to the mortgage holders.


3rd Stage One by one, the sub-prime mortgage brokers shut their doors and go bankrupt, but that is not the end of it.  The brokers and banks that have packaged these junk mortgages and sold them off to the public and institutions such as insurance companies and pension funds have also securitized them and thus far, we have not yet seen the carnage that will occur as $1.3 trillion of junk bonds comes home to roost. As in every bubble that bursts (as they all must eventually do), the BANKS are always left holding the bag. At least until the Government (read Public) bails them out.


The banks are also in denial as they attempt to cover up $ trillions in bad loans, using financial trickery such as giving new fixed payment negative amortization loans to defaulted borrowers in order to avoid realizing the losses while booking refinancing profits instead. During the last real Bear Market (1973–1974), it was the Trumps and the Memorex’s that they loaned additional funds to in order to bring their payments up to date, so that they would not be forced to write off their huge losses and damage their balance sheets.  Here is how it works today: Suppose we take a $400,000, 6% interest only mortgage, which comes to $2,000 per month, add another $1000 for taxes and $1,000 for insurance and maintenance, for a total of $4,000/month. The borrower is 6 months in arrears, so instead of foreclosing the bank loans an additional $27,500 is loaned to them so that the arrearage and refinancing charges can be paid, with a # year fixed payment negative amortization loan costing $2,000/month because that is all the borrower can pay. The result is that by the end of three years, the outstanding mortgage stands at $499,500. ($400,000 +$27,500 + $72,000 {3 years at $2,000/mo negative amortization}): All done in the hope that prices will increase 35% so that both the bank and individual can get out whole in three years. Wishful thinking? But in the meantime, the bank books a $3,500 profit instead of writing off a bad loan of $400,000 but they will most likely write-off  $500,000 in 3 years. Federal bank regulators using their Moral Suasion” have asked lenders to be more cautious when making the high-risk loans and scrutinizing borrower’s ability to repay them; thus marking the end to undocumented loans. The banks have now “locked the barn door” after all the horses (read Money) have gone, drastically tightening up lending standards, making sure that their wishful game plan can’t possibly materialize.  The final nail in the coffin came last Tuesday when giant Freddie Mac said it will no longer buy sub-prime home mortgages it deems most vulnerable to default or foreclosure. Where will all the new buyers come from to support a resumed housing boom and more importantly, where will they get their financing from?


ON ANOTHER SCORE- what is the difference between sub-prime and Alt-A lending, some arbitrary difference in FICO scores? Can we not liken the mortgage bubble to the dot-com craze in the late 1990s in which most investors ignored the failure of the smaller Internet companies as a harbinger of things to come. One of the main reasons that real estate prices were so elevated is at least two-fold. Firstly, a whole class of people came into the market, who under normal credit terms could not have been homebuyers and secondly, the degree of speculation became wildly overblown. What is going to happen to overall demand when you take away the ability of these two sets of people to buy homes?


4th Stage  Layoffs and drastically reduced earnings and salaries; first due to the sharply reduced construction followed closely by a reduction in all of the auxiliary industries, ranging from real estate agents and mortgage brokers to furniture and landscaping. So far, this stage remains hidden as it is masked by the backward looking unemployment and economic numbers being reported. I expect that it will be a shocker when next quarter’s numbers are reported..


5th Stage Economic recession (if we are lucky). By next quarter, as the economic numbers begin to reveal the truth as to what is really going on in the economy is the time when we will be facing our greatest danger. What type of legislation will Congress propose and will the President have the guts to veto it?  There is no question that Bernanke, like Greenspan before him, will rush to the rescue with the FED’s liquidity hose, but this time it won’t work. There is already too much liquidity in the system and the tightened lending standards brings us to another old truism “you can lead a horse to water but you can’t make him drink.” Especially under conditions of tightened lending standards. What happens to all that take-over money under the new lending standards?



Although history always repeats, it never does so in an identical fashion, thus it only ends up being recognizable long after the fact.  The current rally that began in Aug. 2003 in the general equity markets is really only a B Wave of an Irregular Top of the Bear Market that began in 2000; all of which is based on record low interest rates, several tax cuts as well as the FED and BOJ flooding the world with fiat money! Soon the Fed will be forced to continue to raise interest rates in an attempt to save the dollar and stop inflation from exploding. The first causality will be to exacerbate the crash of the real estate market; then comes the imploding of the stock and bond markets, followed closely by the credit markets as the take-over and privatizing craze comes to an abrupt end. We are about to witness the Laws of Supply & Demand in action. Balance of payment deficits of an unprecedented magnitude have resulted in credit induced economic over heating on a global scale. There is a limit to how much money created out of thin air can keep the US and world economy going.


We are about to vote on the first NEW DEAL type legislation: Elimination of the Secret Ballot when it comes to voting for unions. The passing of this bill would drastically shift the power in favor of the unions; exactly the same thing as what happened in the 30’s. If this bill passes, we will shortly thereafter find out what outsourcing is really all about.  There are already 83 Protectionist Bills floating around in Congress, similar in kind to the Smooth Holly Bill; shades of the 30’s? Start a Trade War and you will also start the next world wide depression, with a capital “D”.


Another shot across the bow was last Wednesday’s Letter from Hillary Clinton to both the President and Secretary Paulson on our country’s financings and its reliance on foreign loans. Great idea – lets piss-off our bankers; that will surely solve our problems. One thing for sure is, as the economy slides into recession, tax revenues will fall and the deficits will explode, just in time for the tax cuts to expire.  In the 30’s, marginal tax rates were gradually raised to 93% in their attempt to cut the Federal deficits, turning what should have been no more than a 3-year recession into a Depression that lasted 17 years. Will we now, 65 years later, once again turn what should be at most a 2 year recession into a world wide depression and a Mideast skirmish into a world war? Just how closely does history have to repeat?




Brings to mind another old axiom, “UNITED WE STAND DIVIDED WE FALL.” As individuals, there is not much that we can do besides call our representatives and demand that they stop their partisan bickering and start working together for the good of our country OR ELSE we will throw them all out come the next election.

On a more realistic and personal basis, we can start protecting ourselves and especially our finances by firstly reducing the risks that we are taking with our investments. Secondly, reduce our outstanding debt as much as possible and thirdly start to live BELOW our means, so we will be prepared when the S  hits the fan. And last but far from least, BUY GOLD.



Have you all been stunned by the recent action in Gold and Silver? Well you shouldn’t be! If you have been reading my missives since last June, then you should have noticed that Gold has been behaving, if not exactly, pretty close to what we have been expecting.

# 1, A 500% five year Bull Run cannot be corrected in one month even though it was a 36% correction, which could be a sufficient correction price wise, but not time wise.

#2   An 85 month Bull move requires a minimum of a 10% or 8 ˝ month time wise consolidation taking us into the end of February – mid March to complete the “ABCDE” sideways consolidation. Normally this type of consolidation is in the form of a downward sloping triangle. But with all the hot money sloshing around the Hedge Funds; in conjunction with the sharpness of the Market’s Sell-off last week, we got exactly what should have been expected: Instead of selling out losers and letting profits run, panic sets in and the winners get sold, fearing that they will turn into losers and naturally hang on to the losers as the losses worsen. The sharp increase in volatility is providing a heretofore only dreamed of opportunity. In my last letter, I called for a downside objective bordering around $600 Gold. Don’t Blow it by “looking a gift horse in the mouth”

# 3   Has paralysis set in, so that even though there is a great build up of cash, when it comes time to buy the bargains, they can’t move because they are frozen by a portfolio full of losers. By becoming aware of what is happening, you can try to make sure that this doesn’t happen to you.

# 4   We are now into the top of my $650 - $550 downside target area. It’s time to start scaling IN.




# 1 Take your pick either (A) This Goldilocks economy will continue on with no recession in sight for at least two years and the FED will sooner or later be forced to raise interest rates OR  (B)   We are headed for a slow down and the FED will be forced to lower Interest Rates and pump up the money supply to stave off inflation. The short answer to either scenario is BUY GOLD.


# 2  The GRAND DADDY of all IRRATIONAL EXUBERANCES is the credit spread between Junk and Treasury Bonds which, before last week, was  standing at an unbelievable 278 basis points, down from highs above 1500 basis points. Who in their right mind would only demand 2.75% more to buy a Junk Bond over a Treasury. That is telling me that the investment community thinks there is absolutely no risk anywhere in the world: They have had it so good for far too long that I would bet my last nickel that they are about to get their ass handed to them on a platter. It is too bad that the Barclay’s Junk Bond ETF is not trading yet or I would be putting on long treasuries short junk ETF’s spreads until the cows came home. Since this trade is not available to the average investor, you will have to ask your broker to check with his research and margin departments to advise on the best way to institute this spread.



The best opportunities present themselves during periods oh high volatility, so do your homework and be prepared to take advantage of the opportunities as they present themselves. Most importantly, you must have the courage of your convictions and be prepared to stand alone if you are to reap the rewards due you.




Aubie Baltin  CFA, CTA, CFP, PhD                                             March 4, 2007

Palm Beach Gardens, FL