Naked Swimming Lessons

"You don't know who's swimming naked 'til the tide goes out," says Warren Buffett. Well, now we know.

The subprime tide has carried the ocean back to its ancestral home. Up and down the coast are the beached naked corpses of the real estate bust, looking downright unpleasant without their clothes. There are: the drowned shaky lenders, like New Century, who lent money to those who could never repay it; the once lean and mean hedge funds, whose risk modeling gave as much cover as Britney's skirts; and the whales, like Countrywide who now look silly in a bikini, having protested all along they had on a wet suit up to their ears.

There won't be any lessons learned from this debacle because regulators always fight the last war -- and investors do, too. Instead of looking out for the next bubble and avoiding the inevitable denial that will surround it, these players will end up retching at the phrase "real estate" without ever understanding the enemy was not an asset class, but themselves. I saw the same psychological phenomenon after the Internet collapse when investors renounced all stocks, never learning that the problem was speculating in the wrong ones. These same people went headlong into real estate taking out adjustable rate mortgages on overvalued property, never realizing that in a game of musical chairs, the music always stops.

If I were trying to give a one-word lesson for swimming naked, it would be the following: don't. Don't leverage your investments without understanding the worst case scenario (the real one, not the one modeled by your "risk manager" or your mortgage broker); don't invest in bad speculative derivative pieces of nonsense like CDO's, CLO's or any other acronym that sounds like a government agency; and try to use common sense to avoid your neighbor's fate, since we all know how uncommon such sense is.

If you must do something just because your neighbor did it (or because you saw an ad promoting it), then try to get a second opinion. If you run a hedge fund, give up modeling your risk based on flawed superficial bits like beta and start actually understanding what you own. And if you can't do any of the above, then just move to an ashram and give away your worldly possessions -- since you'll end up doing it anyway, just without the inner peace.

If the tone of this entry sounds vindictive and self-righteous, that's because it is. This is the main recourse left to us stodgy, conservative investors after we suffer through the excesses when the swashbuckling speculators made us look stupid. I suppose having oodles of cash on hand when everyone else is filing for bankruptcy is good reward too. But there's nothing like the cheap indulgence of saying "I told you so."

Then again, there's nothing more intrinsically depressing than seeing human nature fail and fail. Even when the failure creates large investment opportunities for scavengers like me, I am often asking why, even as I understand the excesses of fear and greed that created this whole mess.

The most interesting question is where the next bubble will form. Since I started managing money in 1996, it has hit small stocks, then big stocks, then tech and then small stocks again and then real estate. The ever-growing money supply has spawned numerous bubbles and the Fed's easy money policy has made sure that another always replaced the one that had just burst. It's possible that in cutting the discount rate instead of the Fed Funds target, the central bank was finally saying: Enough, we will no longer enable your addictions. If so, we may not have a bubble for awhile as the tide runs out even further. The question you should now ask yourself is: will I feel embarrassed, ruined or just plain naked if high tide doesn't return soon? If so, grab a towel -- quickly.

Comments

[montemalone]

I predict a new industry catering to those who have abysmal credit scores.
A lot of poeple are going to say "screw you" when they get notices that their mortgage payments are going to go up by 25-50%.
All those homes will then be REOs.
They will then be sold, cheap, because there will be a lot of them.
The former owners will need a place to live.
We know they can pay "X" per month, but not "Y".
The rent on the house will most likely be "X".
The cash on cash return will be better than what the banks are paying.

[afgail]

It was during the Reagan administration that we had the savings and loans lootings. Now under the Bush administration we have the subprime mortgage implosion. Both financial debacles have the same root. Legislation passed during Republican adminstrations that enabled both of these disasters to be foisted on the public. It's not that people in congress didn't see both of these coming they just voted and waited for the disasters to unfold. They rightfully concluded the public wouldn't notice who aided and abetted these greed fueled financial crises.

[Desiderata]

And the people in congress made sure no underprivleged man nor woman can free themselves from the BigCredit vultures by passing the Bankruptcy Reform Bill of 2005.

Special thanks to Joe Biden, Senator and Presidential candidate from the land of BigCreditCard (Delaware) for his vote to eliminate this last safetynet of the swindled American worker/consumer.

[twgbonehead]

"The question you should now ask yourself is: will I feel embarrassed, ruined or just plain naked if high tide doesn't return soon? If so, grab a towel -- quickly."

The question you "investors" should ask now is "How will my victims feel? Cold? Hungry? Numb? Poor? Dead?" How will their children feel?

Damn you for comparing the housing bubble to the .com bubble. For you cozy, but perhaps embarassed investors, they probably feel about the same.

But while these "savvy" investors and lenders were pumping up the RE bubble as hard and fast as they could, it left the people who actually could USE that "real estate" (FKA a "house") scrambling to find something they could afford, before it got snatched up by "flipping-out" psycho nuts.

Nobody HAD to invest in the .com's. LOTS of people HAD to find someplace to live.

But don't worry about them. I'm sure all those who were really "hurt" by the subprime debacle have a spare gucci towel in their dresser; that'll do until the government bails them out.

[Mutex]

Why stop there? Why not explain the inevitable conclusion of our balance of trade deficit and growing national debt? Talk about your pyramid schemes...­wait until this music stops!

The mother of all bubbles is on the horizon and even the most intrepid of economic reporters apparently wants to pretend the emperor is wearing clothes.

Stir in the conclusion of the baby boom and peak oil and it all reminds me of a purported ancient Chinese curse:

May you live in interesting times!