Subprime danger "Only three countries in the world have a serious subprime problem - the U.S., Britain...and Spain. But no country has taken more advantage of low interest rates to build more houses and sell them at prices they don't deserve to more people who can't afford them. They just built too many new houses...

"One building company had gone up 1,000% since it listed only a few months
ago. It got whacked yesterday...so did the other builders."

(Homebuilders have seen the mega-bust on the horizon for quite some time
now...read the full report here:

Building Permit Applications Plummet
http://www1.youreletters.com/t/1234565/1618638/819367/356/

Today our question is, "How much is too much?"

Many people thought you couldn't build too many holiday homes in
Spain...just as you couldn't build too many hotel rooms in Las Vegas...or
pay too much for Chinese stocks...or pay too much to hedge fund
managers...or have too much money in private equity...or too many dollars
at large in the world financial system.

Since the expression 'too much' has been extant in the English language
for a very long time, we assume it must mean something. What we've been
waiting...and waiting...and waiting...to find out is what it means in
financial affairs.

The latest figures show that hedge fund manager Jim Simons earned $1.7
billion last year. Is that too much? He takes an unbelievable 5% of his
clients' assets each year, in payment for his services - plus, and even
more unbelievable, 44% of profit. Is that too much?

Readers will remark that his $6 billion Medallion fund rose 84% last year
(Simons is good with figures). Investors came out ahead more than 40% even
after paying the outrageous fees.

Or what about Ed Lampert or Kenneth Griffin, each of whom also earned more
than $1 billion last year. Was that too much? We don't know. But we came
back from our vacation, opened our eyes, and thought we saw 'too much'
everywhere we looked.

Money streams into new investment funds. Even Brian Hunter, who lost $6
billion trading energy for Amaranth, is starting up a new fund. And John
Arnold, formerly of the Enron energy-trading desk, earned more than $240
million last year - partly by taking the other side of Hunter's trades.

Over on the Las Vegas Strip, Goldman Sachs (NYSE:GS) is buying Carl
Icahn's four casinos...for $1.3 billion. Is that too much? Again, we don't
know; but when it comes to excess, what Las Vegas doesn't already know
probably isn't worth knowing. The place had a total of 35,000 hotel rooms
in the 1970s, which seemed like too many to us. Now, it has five times as
many - 151,000 - which seems like more than enough.

But 'too much' has dropped from the English vocabulary in Nevada...and
perhaps the rest of the world, too. The Venetian alone is adding 3,200 new
rooms. And over at the old Stardust Casino, the owners judged it too
small, so they blew the place up last month...to build a new development,
Echelon Place, with more than 5,000 rooms.

Meanwhile, MGM is spending $7 billion putting up the City Center
development - the most expensive development in Las Vegas history. Isn't
that a little too much, dear reader?

Who knows? All we know is that throughout the world, a great boom is on.

And if you want to count the hotel rooms for yourself, attend this year's
FreedomFest in Vegas. The three-day event will be taking place at the
Bally's/Paris resort July 4-7 and will include an intensive investment
seminar by some of your favorite DR faces. Learn more by calling Tami
Holland, Conference Coordinator, 1-866-266-5101; or go to
www.freedomfest.com.  

The Daily Reckoning PRESENTS: It has become generally accepted that the
bursting housing bubble will have its consequences - but do we fully
understand the effect it will have on the average cash-strapped American
consumer? Tom Au shows how the nation's latest Ponzi scheme could bring
about pullback in living standards not seen since the Great Depression.
Read on...

THE MODERN 1930's

by Tom Au

Richard Suttmeier on Real Money hit the nail on the head when he said
yesterday. that the real estate explosion is about to implode. Like him, I
believe that the subprime lending collapse is not just a speed bump in the
"New Economy." Instead, it is a sign of wider problems in mortgage lending
that threaten the viability of the New Economy itself. That's because the
collapse of the housing bubble means that a major "band-aid" has been
ripped off the country's Achilles heel, the cash-strapped, savings short
American consumer, exposing the scab underneath.

Who would have thought it would come to this? For three decades after
World War II, the average American worker's income grew by 2-3% a year
after inflation, and stateside consumer spending grew apace. But after the
mid-1970s, these income gains slowed to a crawl, while spending growth
continued at the same pace. But Baby Boomers felt that the 2%-3% average
annual real income growth enjoyed by their parents was their birthright.
And when they didn't get it, they settled for "the next best thing," 2%-3%
average annual spending growth financed by artificial means. The result is
that the average American is now spending at a level not sustainable by
income, but only by asset values, specifically in real estate. And when
those asset values collapse, and they're doing so as we speak, so will
U.S. consumer spending and overall economic growth.

But that can't be so, some might say. The country is much wealthier today
than in the 1970s, which would support much higher consumer spending. That
much may be true for the country as a whole, but it's not for the whole
country by any means. The reason is that while (President) John F.
Kennedy's "rising tide lifted all boats" through the 1960s, most of the
gains since then have accrued to the top 20% of the population. For
instance, as late as 1980, the average CEO made only about 40 times as
much as the average worker, now it's more like 400 times. On the other
hand, antipoverty programs and removal of lingering discrimination have
greatly reduced the number of the truly poor. So the person in top decile
(90th percentile and higher) of the economic ladder (where thestreet.com
subscribers are overrepresented), is decidedly better off than the
equivalent thirty years ago, and someone in the bottom decile (10th
percentile and lower) is somewhat better off. But the average person (the
one at the 50th percentile, and 30 percentiles on either side) is the one
who has gained very little real income in the past three decades.
Nevertheless, it has been in the interest of U.S. economic policy to
pacify this person by allowing him/her to maintain spending growth at
historical (post World War II) levels, even though income growth hadn't
been keeping up.

The housing bubble was a good a tool as any for this purpose. At first the
gap was plugged by reduced savings. But as savings rates plummeted in the
1980s, this fuel could not last for long. So credit card debt took up the
slack. But that soon played out, especially when the deduction for credit
card interest (but not mortgage interest) was removed in the 1986 tax
reform. The ray of hope was the fact that interest rates were falling
through the 1980s, and periodic refinancings meant that homeowners could
save money by capturing progressively lower rates on their mortgages, and
using the difference for spending. What's more, interest on this
mortgage-related spending could qualify for the tax deduction denied
credit card interest.

But if falling interest rates meant that constant mortgages required
progressively lower monthly payments, they also meant that a homeowner
could choose to "invest" by maintaining constant payments, taking out
larger mortgages, and buying more house. And if a synchronized housing
boom was underway, or at least could be orchestrated, many might be
persuaded to do so. And so it was done, which is why housing values
doubled in real terms between 1996-2006, an unprecedented rise in American
history. Now the consumer had a house (or two) that could also double as
an ATM, i.e., the best of both worlds (a framework that could serve as
both a place to live, and a source of "income" for other consumer
spending).  Using this twisted logic, going over one's head (taking out a
mortgage that consumed 50% or more of income) was a smart thing to do
because it meant a more valuable asset and more spendable income down the
line.

Thus housing became the nation's latest Ponzi scheme, one that could work
only if more and more people were sucked into it. But even if the housing
market was on fire, as it was in the past decade, it needed firewood to
burn. And if there was a growing shortage of "firewood," to feed this
boom, there was always "kindling" (soft materials such as leaves and hay
that burn for only a short period of time), in the form of such
monstrosities as interest only and negative amortization loans to subprime
borrowers. From a financial point of view, however, such borrowers were
placed in the position analogous to "tearing down their (financial) house
for firewood" (pun intended), i.e. being forced create a problem of less
house for tomorrow because today's problem of freezing to death was so
severe.

The collapse of the housing bubble is bringing about an end to this game,
and will soon face average American consumers with the fact that their
consumption standards of the mid-2000s, were way out of whack with income
levels that had reached only a mid-1980s trendline (given perhaps ten, not
thirty, iterations of 2%-3% growth off the mid-1970s base). To bring
income and consumption back into balance, average Americans will have to
fall back two decades in terms of standard of living, which would still
put them back at Western European levels of today. But such a pullback
would represent "the modern 1930s."

That's because the original 1930s took American consumption back to 1910s
levels, which then represented "prosperity" by prevailing global
standards. But that was a big comedown for an American public that had
just experienced the 1920s, which gave a glimpse of a prosperity that
would be experienced in the 1950s by their children, but not by
themselves.

Likewise, the Internet Boom of the 1990s gave adult Americans of the time
a glimpse of the world that their children will inherit for their middle
age - in the 2020s - as the Boomers get ready to shuffle off this mortal
coil. Like the peers of Moses, who saw the Promised Land but never got to
enter it, Americans will wander the desert for two generations until their
children are ready to take the big step. (And yes, I believe that those
children will fight the modern "battle of Jericho" to get there.) But
getting from here to there will not be a pleasant experience.

Regards,

Tom Au, CFA
for The Daily Reckoning

P.S. Not only is the most dramatic property asset bubble of modern times
clearly over... but the slip in real estate prices we've seen so far is
not even close to being the beginning of the real devastation to come...
not just in property, or even Wall Street, but across the entire U.S.
economy, now and for at least the next three-four years, if not longer.

Read more here:

The Next Wave of Falling Property Prices
http://www1.youreletters.com/t/1234565/1618638/818169/356/

Editor's Note: Thomas P. Au, CFA, is a principal with R. W. Wentworth, a
financial services firm in New York City. Earlier he was an emerging
markets portfolio manager for the investment arm of Cigna Corp. and an
analyst with Unifund, S.A. of Switzerland and Value Line. He graduated cum
laude with a B.A. in Economics and History from Yale University and an
M.B.A. in Finance from New York University. Mr. Au is the author of "A
Modern Approach to Graham and Dodd Investing."

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