When we wrote a piece in 2005 about the housing bubble–calling it the biggest bubble in the history of mankind–we based that statement on our thesis that the availability of liquidity driven leverage in combination with society’s willingness to use that leverage is what creates monster bubbles. The demand for an asset, whether it be a tulip, or stock, or art, or a house, or a baseball card, or a beanie-baby, is irrelevant as far as we can tell. If leverage is extended to the masses and if the masses are in a psychological mindset conducive to accepting elevated levels of risk through greater and greater amounts of leverage, the leverage itself is enough to create the bubble because the leverage will eventually be dumped into whatever the “hot” investment of the day happens to be. The proof in this assertion, we believe, is that once a huge bubble bursts and people are wiped out, the desire to use leverage seems to disappear for a couple of generations and that’s what makes the downturns so brutal. If you don’t believe me just think about how survivors of the Great Depression focused on paying off their homes as soon as was humanly possible and how, after seventy years, they still lean down to pick up a penny off the street and are reluctant to leave a scrap of food on their plates. Cycles of gambling and risk taking come and go and with lotteries and casinos sprouting up like tulips, it’s pretty easy to see which part of the cycle we’re in now and what will come next. The deceiving part about the current bubbles is that the housing bulls think prices cannot decline, because they assume that people will be more reluctant to sell a house than they were to sell a tulip or stock, or beanie-baby. The problem, we believe, is that sooner or later, they’ll be forced to sell. And as for the other bubbles, we also believe that when the various carry trades unwind, the coincident short-covering of foreign currencies will also result in “forced selling” in other markets.
-During the 1600’s the rich used cash to buy tulips and the common man used land, livestock and houses as collateral.
-During the 1920’s stock investors used cash—albeit a fairly miniscule 10-20%, to buy securities.
-Even in the wild world of commodities, at least a small portion of money must be set aside in order to control the contract.
-During 2001 through 2005 individuals and investors used ZERO (0%) TO BUY REAL ESTATE and just 2-3% (interest only) carrying costs!
-We continue to believe that this is a disaster waiting to unfold.
Full report coming soon