The Big Picture for the Week of February 20, 2005

Yesterday on Cavuto on Business they had a lively discussion about the potential for a real estate crash. I was struck by two lines of thought. One came from Ben Stein who essentially said this time is different (Jim Rogers called him on this by the way) and the other came from Tom Adkins (who may be the Larry Kudlow of the real estate market) who said that if your mortgage is $1500 is you can afford to pay it doesn't matter what prices do.

First, Mr Stein's comment; this time is different isn't as dangerous as having a financial over reliance on this time being different. To put it terms I understand better, equity market terms, there is historical precedence for bad things to happen to sectors that grow to become 30% of the S+P 500, tech in 2000 and energy in 1981. The next time a sector grows to be 30% of the market may not spell doom but you would be wise to be underweight when it happens. If it turns out not to result in a crash great, but an overweight position could be disastrous.

As for Mr. Adkin's comments; I believe he stopped short in his statement about affording your mortgage. I would add that you can afford your payment and the loan is amortizing. A lot of the loan products people buy these days don't pay down principle so you don't build equity from your payments. They only way to build equity in these instances is through price appreciation.

Interest only loans can be great things when used properly. My take on proper use is to, at a minimum, include the same amount of principle in your payment as if it were a normal loan. If the house is otherwise unaffordable other than by only paying interest, too much leverage is a problem.

There has been more devastation by mis-using leverage in capital markets from buying stocks on margin or from trading too many options.

I think over leverage is a function of speculation. The crowd tends to get most excited closer to the end than the beginning. Maybe this is happening in real estate.

I read something this weekend that got me to thinking about why Alan Greenspan feels the bond market is a conundrum. The US has not issued a 30 year treasury bond since 2001. I wonder if less supply of longer dated paper is contributing to the flatter yield curve. That would not, I believe, change any of the economic implications of a flatter curve. The slope of the curve impacts the way capital is accessed. The reason for the change in slope does not matter.