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A Letter I Wrote To My Friends In September 2007

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I hope this is ok to post here. I have learned so much from this site, however this letter was sent to some of my friends before I joined; in truth I found this site whilst writing this.

One day I might post some of the replies.

LINK

Kind regards,

James

EDIT - typo

Dear All,

Towards the end of an evening out with friends last week, I decided to go to the casino. One friend commented, 'I hate casinos; gambling is so wrong, and so working class.' I chose not to respond to him, and rather chuckled to myself as I made my way to my den of vice.

Hypocrisy is a word we often use incorrectly, yet it is so apt here. I am bored of dining with Londoners these days because pleasant conversation has been lost to long and often heated discussions about the property market. Good food, and fine wine, should not be muddied by talk of money, and referring to our pursuit of wealth as an investment does not fool me; it is all about money, and greed. As Wilde said, there is only one class more obsessed with money than the rich, and that is the poor. How true that is. London used to inhabit the crème de le crème of our workforce, but Brown's boom and boom economy has lured the greedy to London that were once put off by the hard work required to survive in a boom and bust economy.

Before I get side-tracked, my friend's summary of the ills associated with gambling may have been correct, but coming from a man that had spent most of the evening telling us about his property portfolio, they were also hypocritical. The housing market is a glorified casino with the largest stakes in the world. My friend's parting comment to me the other evening was wise, 'James don't bet more than you can afford.' Under my breath I said, 'Google negative equity.' At least at my den of vice they will not lend me money that I do not have in my search for riches. I might lose £100 at the Black Jack table, and then call it a night. That would be a loss to most people, but hardly one with long term ramifications. On the other hand, his local high street bank might advance him 6 times his salary to buy a flat and should the market fall 50% his loss might be very hard to live with, especially if interest rates double in the process. So if he borrows £500,000 at a borrowing rate of 6% to buy a flat tomorrow, and a year later his flat is worth £250,000 and he is paying 12% interest on it 12% of £500,000, not £250,000, you tell me which is worse, and which is a greater gamble? Whilst we choose to ignore the fact that whatever rises must fall, we fool ourselves into a false sense of security with the opposite notion, that whatever falls must rise. If you believe the latter, I would suggest you take a quick look at the property market in Tokyo it is still 40% lower today than it was at the end of its last boom in the early nineties. Excuse the pun, but borrowing from the previous example, my friend would most likely have to finance that debt for a very long time, especially if he jumps on the latest bandwagon of taking out an interest only mortgage.

But perhaps there is another word better to describe the collective attitude of the people that I dined with the other evening; ignorant. In their desperate attempt not to appear nouveau riche, the thing they hope will mask their love of money, they have also neglected to learn how money works on the most basic level; supply and demand is a theory they learned to pass an economics GCSE. I wonder if they know about how goldsmiths were the original banks and instigators of the promissory note? If you are going to borrow, does it not make sense to understand how it works? So when 'A' deposited his £10 worth of gold at the goldsmith, he received a £10 promissory note. But the goldsmiths were not stupid, and when 'B' arrives asking to borrow £10 of gold, they too gave him a note worth £10, and crucially not the actual gold. Put simply the £10 worth of gold that is sitting in the goldsmith is now circulating as £20 worth of promissory notes. In the US the deposit to loan rate is about 9-1 or for every $10 deposited the bank will lend $90. Perhaps a better example is this: imagine you write a cheque for £10 and give it to your friend, but she does not cash it, and instead passes it onto another friend of yours who knows you are good for the money. Imagine that process being repeated over and over – how great would that be for us? Our cheque would never actually be cashed, it would just exchange hands that is how paper money works, and more recently electronic money.

Now back to my friend's hypothetical mortgage; when he borrows that money, all the bank does is create a mortgage account for him and deduct the £500,000 from it nothing actually happens in terms of a trade. The debt is created out of nothing, and he would pay them the agreed amount each month. I will get onto the Subprime lending collapse in the US in a moment, but let's go back to basic economics supply and demand. As Keynes argued, does demand create its own supply? Who knows, but what is without a doubt is that without the supply of debt provided by banks, we'd not have a bubble at the moment. The value of anything is meaningless if no one is willing to pay that price for it now. I hope I don't need to get into liquidity here! As I hope we all know the supply of debt is controlled through interest rates, and as I have demonstrated already, the realised demand for houses that lead to their supply, is reliant on the supply of debt. If the banks do not make the money needed available to purchase houses the demand for them would also disappear. We have all heard of first time buyers, but it is not because the markets, soulless by their very nature, care about them personally; it is because they are essential to keep this bubble alive. To join the property market all of us had to be first time buyers at one point the market is made up of a food chain, and with no one at the bottom for the middle tier to feed off, the whole market would collapse. In other words if a buyer wants to upgrade their property that is at the lower end of the market, and purchase a more valuable one, if there is no one to buy the property they need to sell in order to buy the more expensive one, then the food chain comes to a halt. So the so-called Subprime lending market that has collapsed in the US has in turn culled the borrowers at the bottom of the food chain that the whole market relies on for its nourishment. Perhaps of more concern for us Europeans is when these loses will trickle through to us... or worse; do we have our Subprime situation about to be realised?

But this is not happening on our doorstep so why should we care? Well we are in the midst of a global speculative bubble, and the word we should be most concerned with there is not bubble, but speculative. The mode of speculation means that property is no longer being valued by its true worth today, but instead by what it might be worth in the future, yes, a little like gambling. It has become so irrational, with some commentators using the phrase irrational exuberance (Robert J. Shiller) to describe the current trend, that reality in terms of what people might pay has been replaced by another valuation based on the Greater Fool theory. In other words many investors knowingly pay an exaggerated price believing that a 'greater fool' will eventually pay more than they did.

The saddest truth about the 'greater fool' is they are in fact frequently the most sensible amongst us. The 'greater fool' tends to be the last person to enter a clearly unsustainable market, and their delay is usually spurned by sound economic principles. If having spotted the bubble many years ago an investor declines to gamble, and subsequently he is subjected to witnessing the real 'fools' that rushed in making money, at some point he might start to doubt his own thought, admit his error, and jump in too. The sense he once employed will also be the thing that will cost him ultimately.

Speculative bubbles are not hard to spot in money markets. The next time someone asks for your opinion of the market, tell them you think it is about to crash they'll interrupt you before you have begun to explain your reasons. Why? Speculation relies on faith, or at the very least hope, and anyone that doubts the market is a threat to it. The chances are your opinion was not sought for any other reason except to bolster the irrational belief of the questioner. Some might call it a mob mentality; I prefer to call it the madness of crowds (Charles Mackey).

Conspiracy theories aside, it is not hard to see who benefits from a growing property market. Borrowing on ones property creates more disposable income, and with more money, everyone is happier, and businesses enjoy more demand.

We'll have to see what happens, but for now this punter is sticking to his petite flutters. If you own one property the market is unlikely to affect you, unless you have a large mortgage that's repayments are determined by interest rates. If the market crashes your one home will still buy you the same valued home elsewhere; it makes little difference when everyone needs at least one roof over their head.

...

James - Sept 2007

Edited by Socialhacker.co.uk

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I don't really know why I decided to post this now but I have felt recently that the terrible crash I once imagined happening is not going to occur. In some respects I suppose I am admitting I was wrong - not about overvalued properties, but just about how bad all this was going to get. As much as I love this site I do feel as though it has fed my pessimism - assuming we have experienced the worst. I am beginning to feel as though the powers that be have somehow managed to avoid a crash and instead have ‘saved’ us with a soft landing.

I have been very outspoken with my views on house prices as well as the economy, including devoting much of my website to the subject, but it has to be said I should have read not only the opinions on here (with which I often agree/d) but also those that did not sit so comfortably.

Back in September 2008 when Lehman’s failed it was all too easy to say, “I told you so.”

Kind regards,

James

I hope this is ok to post here. I have learned so much from this site, however this letter was sent to some of my friends before I joined; in truth I found this site whilst writing this.

One day I might post some of the replies.

LINK

Kind regards,

James

EDIT - typo

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I don't really know why I decided to post this now but I have felt recently that the terrible crash I once imagined happening is not going to occur. In some respects I suppose I am admitting I was wrong - not about overvalued properties, but just about how bad all this was going to get. As much as I love this site I do feel as though it has fed my pessimism - assuming we have experienced the worst. I am beginning to feel as though the powers that be have somehow managed to avoid a crash and instead have ‘saved’ us with a soft landing.

I have been very outspoken with my views on house prices as well as the economy, including devoting much of my website to the subject, but it has to be said I should have read not only the opinions on here (with which I often agree/d) but also those that did not sit so comfortably.

Back in September 2008 when Lehman’s failed it was all too easy to say, “I told you so.”

Kind regards,

James

Keep the faith- it's only just started. The one million plus unemployed (Poor b*stards) will drive the next leg down. Cheap credit and securitisation of mortgage debt are not returning any time soon. House prices won't bottom out until 2012-2013- at the moment the situation in America looks to be going from bad to worse. We are lagging them by about 18 months.

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I am beginning to feel as though the powers that be have somehow managed to avoid a crash and instead have ‘saved’ us with a soft landing.

Yeah, that'll be the crash that is currently the biggest and fastest in history. Please note I use the word currently, as it has a long way to go yet. But even in its early stages it is momentous.

You sir, act like a bear but speak like a bull. Something ain't right here. Please correct me if I'm wrong.

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You sir, act like a bear but speak like a bull. Something ain't right here. Please correct me if I'm wrong.

Scott,

Thanks for replying - I understand what you are saying but honestly I have been a bear from day one; you only have to look at my site (and the videos I have made) to see that, but I have to say that recently, despite my bearishness, I am beginning to question many things.

Thanks.

James

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I don't really know why I decided to post this now but I have felt recently that the terrible crash I once imagined happening is not going to occur.

Wot! You'll need more stamina than that to survive on this site.

We've only just begun. It's going to be like the early '60s - incredible opportunities for those willing to work, amazing squalor for the layabouts.

Edited by okaycuckoo

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Thanks for replying

It is a surreal feeling at the moment, but you just need to wait a little longer to see this has a long, long way to go yet.

I remember the early 90's when everyone thought the bottom had been reached, only for it all to carry on crashing at a rapid rate within a few months. Property was a dirty word back then and it will be again in another 12-18 months. The general election will reveal many things.

Regards

Scott

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Quarterly unemployment has just risen by the biggest amount since 1981, we are in for a bloodbath.

Basically just ask yourself "How much could I afford to pay out of wages for my living space?"

Then do the back-calculation, and that's how much your house will cost.

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Scott,

Thanks for replying - I understand what you are saying but honestly I have been a bear from day one; you only have to look at my site (and the videos I have made) to see that, but I have to say that recently, despite my bearishness, I am beginning to question many things.

Thanks.

James

James - You should re-read your own letter and not question your own logic, if that is what you meant. The point you made was that there is always someone who enters last, and it is he who is left holding the debt. Don't be that fool now and question your logic late in the game, as the crash has just begun.

As for Casinos and the housing market. Extend the analogy to include the fact that the only people who make money from gambling (at least consistently) are bookies and casinos. They take their cut and do so because the odds always favour them. I wonder who the equivalent in the housing market would be. The banks seem to be taking a hit (losing more than they made), so probably not them. Intersting to work that one out. Anyone got any ideas?

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James - You should re-read your own letter and not question your own logic, if that is what you meant. The point you made was that there is always someone who enters last, and it is he who is left holding the debt. Don't be that fool now and question your logic late in the game, as the crash has just begun.

As for Casinos and the housing market. Extend the analogy to include the fact that the only people who make money from gambling (at least consistently) are bookies and casinos. They take their cut and do so because the odds always favour them. I wonder who the equivalent in the housing market would be. The banks seem to be taking a hit (losing more than they made), so probably not them. Intersting to work that one out. Anyone got any ideas?

The analogy is not really apt because a casino is a business and the housing market has been a Ponzi scheme ... very different beasts.

In a casino the house wins; in a Ponzi scheme those who get in (and out) early enough win.

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I hope this is ok to post here. I have learned so much from this site, however this letter was sent to some of my friends before I joined; in truth I found this site whilst writing this.

One day I might post some of the replies.

LINK

Kind regards,

James

EDIT - typo

Thanks SH. From your post you understood the situation a couple of years back, went to the trouble of articulating it to your conservative (small c) orthodox friends and received the normal abuse in return. I had similar conversations at about the same time, as I suspect have many people here.

Those same "normal" people are now starting to bemoan the upcoming financial disaster. The joke is the disaster has already happened: a generation of people have grossly overpaid for their houses. It's that simple.

Good luck over the next several years. I think we'll all need it, but if things pan out the way we hope then try to be more graitious than those "friends" of yours.

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James - You should re-read your own letter and not question your own logic, if that is what you meant. The point you made was that there is always someone who enters last, and it is he who is left holding the debt. Don't be that fool now and question your logic late in the game, as the crash has just begun.

As for Casinos and the housing market. Extend the analogy to include the fact that the only people who make money from gambling (at least consistently) are bookies and casinos. They take their cut and do so because the odds always favour them. I wonder who the equivalent in the housing market would be. The banks seem to be taking a hit (losing more than they made), so probably not them. Intersting to work that one out. Anyone got any ideas?

You actually may be on to something there, about the bookies. Wonder would Paddy Power give me odds on size of HPC?

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Those same "normal" people are now starting to bemoan the upcoming financial disaster. The joke is the disaster has already happened: a generation of people have grossly overpaid for their houses. It's that simple.

Don't forget that for those that have overpaid, and are now in negative equity, they haven't currently got a problem. Only if they have to or want to sell their house will this be an issue. As long as you can afford the commercial agreement you made with your bank your home will be safe.

Whilst there are many who see houses merely as cash machines to MEW out what they can, there are many others who see houses for what they are -- places to live. If you fall into the latter camp then as I say as long as you have built in some contingency for rising interest rates (they must surely go up, they can't go down!), and you feel your job is safe, then you should have nothing to worry about.

What does make things far more interesting is the fast-evolving political events that are now unfurling. That may yet add another ingredient to the stew. If the election is delayed until the autumn or spring next year as seems likely, and the intervening time is given over to a constitutional reform (eg proportional representation), then the political mix may well change sufficiently that we could see parties/individuals with policies strongly supported by the public that offer substantive help to those people with significant debts.

Or you might see a radical rebuilding policy for social housing, as the Lib Dems are proposing. That could increase the supply of public housing stock significantly enough over two or three years that people just walk away from their loans, houses start to flood the market, and the collapse in house prices is precipitous.

So the hurricane that is the economic downturn could be aided by the tsunami of political upheaval.

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