The problem with a bubble of any kind is the speculative excesses that take place in and around the bubble and ramifications of unwinding these excesses.

Do you remember the good old days when you could buy any stock related to the internet and have it go up from 100% to 300% or more in less than a year. Remember stocks that had no real business but still traded at over 100 dollars per share and continued to move higher. You didn't seem to need investment advice in those days.

The stock market moved mostly higher for two decades and everything was fine until the extreme speculation began in the late 90’s. During this period, the stock market broke from reality and took investors, institutions, and the world right along with it. Investors only thought stocks could go up and many of my friends left their careers to make a living investing in stocks. ONLY to be back in their careers a few short years later.

Institutions (which should know better) began taking companies public that had no more than a business plan because investors would buy it. Hey if the investor wants “crack cocaine” just give it to them. Even the financial institutions that spent years building investors trust, threw it all out of the window to profit from the bubble that we all came to know as the “Internet or Tech Bubble of the 90’s.”

Although the fall out from the Tech Bubble was bad it was not catastrophic. The economy went into a multi-year recession and the stock market went into the worst bear market in over 70 years. Many retired people had to go back to work because they invested their entire retirement plans in tech and internet stocks. Pensions were lost and younger investors lost most if not all of their savings. The GOOD NEWS was that for most investors (even those that went out and traded on margin) only lost the money they had to invest and when it was gone the game was over. It does hurt to lose money but when all of their money was finally gone but at least they did have outstanding loans to that funded their stock purchases. Some people did take out home equity loans to invest but those instants were rare. They DID NOT have to pay a note with increasing payments for their stock losses.

This little walk through the past was just a quick reminder of what happened just a few short years ago. But more importantly, it leads me to what I would like to talk about today. The Real Estate community has a vested interest in being sure that you believe real estate to be the only safe investment, and that using other investment systems such as stock trading systems from investment newsletters is "too risky". The only investment advice they give is "buy more real estate."

WHAT IS GOING ON TODAY IN THE REAL ESTATE MARKET IS MUCH SCARIER THAN THE INTERNET BUBBLE THAT BROUGHT OUR ECONOMY AND STOCK MARKET TO ITS KNEES.

The problem with the much publicized bubble in real estate is that it involves a tremendous amount of leverage and borrowing to enter the game. And just like with stocks, everyone is getting into the game because prices are moving higher. Everyone is now a real estate expert.

I knew trouble was brewing in the real estate bubble because I ran into two friends in the last 30 days that I have not seen in years and both have left good professions to get into the real estate game. One gentleman had managed a BMW dealership for the last 9 years and the other friend I saw at my 25 year class reunion left a government job he held for the past 20 years to sell real estate.

Why is this bubble so much more dangerous than others that we have seen? Good question!

Let me answer it with an example. If you buy a piece of property for $300,000 and you put 5% down (in many cases now you have to put nothing down) you then have $15,000 invested but are responsible for paying the note on $285,000. Sounds simple enough…

Most people who are playing this game are also using adjustable rate or interest only loans because they just know they are going to sell this property at a huge profit in a short period of time and find another and do it again.

As long as prices keep moving higher everything is fine. Just like the tech bubble…it is the “greater fool theory.” As long as the next investor was willing to pay more than you paid prices continued to move higher.

Even though most real estate investors do not think prices can go down, what happens if they do? The other problem is all of the borrowed money. If an investor cannot sell the property quickly and the rates on the loan starting moving higher (which they will) they are forced to pay more on their monthly payment.

In our example…let’s say prices begin to drop. They only have to drop 5% before the investor loses the entire investment of $15,000 that was put up. Lets say real estate prices drop 10%, now the investor has not only lost the original $15,000 invested but will owe $15,000 when the property finally sells.

The next problem is that most investors will not sell at a loss. So now they are stuck with a property they cannot sell for the price they want and now they have a mortgage with increasing payments they cannot afford.

Remember that millions of people are playing this game in the United States. It is the single reason our economy has done so well over the last few years. It is also the single reason that consumers continue to spend and take on more debt because of the increased value of their own houses. It is time that these people learn more about the reality of the market condition, and look to other investment systems. We hope to see more investment advice offer some safe haven to those who have put too many eggs in one investment basket, real estate.

WHAT HAPPENS WHEN THE BILLS COME DUE???

Thanks to rock-bottom interest rates and easy ways to borrow, consumers have been on an all-out spending spree for the last several years. Now, though, there are signs that the bill may be piling up too high. And what is really scary, interest rates haven’t really started to move higher yet!

U.S. consumers are more vulnerable than ever to rising interest rates. Nearly half of all consumer debt and 26% of all mortgage debt are now adjustable.

When all of these adjustable rate mortgages begin to reset soon, some of these people are going to see their monthly payments rise by a several hundred dollars a month. That is a real significant for all of those people complaining now that gas prices have risen to over $2.40 a gallon.

The consumer, which is the engine to our economy, has been living on borrowed time. They have overloaded themselves with adjustable-rate debt on mortgages, home equity lines and credit cards. If housing prices stop increasing, which is eventually going to happen, they will be less able to tap into home equity to help cover the bills. In severe cases, if consumers can no longer afford their monthly payments, there will be more defaults and foreclosures.

Our investment newsletters focus on properly diversified investment portfolios, as this is protection against "Burst Bubbles".

SO WHY IS THIS PARTICULAR BUBBLE A PROBLEM???

Because our entire economy is currently being supported by higher real estate prices! Consumer spending is being supported by higher real estate prices.

The stock market is being driven by all of the companies that support the real estate industry and all of the companies that sell to consumers. They give single focus investment advice, because of their vested interest in maintaining the bubble.

And now higher real estate prices are coming from pure unadulterated speculation.

And the speculators are so leveraged that they will not have the funds to stay in the game once price appreciation stops.

Once the price appreciation stops and the monthly mortgage payments increase, many of today’s new wood-be real estate moguls are going to be forced to sell at any price. This leads me to believe that when the current speculation does eventually unwind that prices could drop a lot further than anyone believes.

FACTS:
1) 40% of new home purchases are done by speculators

2) 27% of all new mortgages so far this year are interest only…this compares to 1.6% in 2001. In the more expensive markets they account for over 40% of mortgages.

3) U.S. consumers now owe over 11 trillion, nearly double what they owed a decade ago

4) The volume of subprime (high risk) mortgages has soared from $35 billion a decade ago to $530 billion last year…more than 20% of all new mortgages in 2004.

Just like the old internet bubble days when institutions sold billions of dollars of worthless .com IPO’s to the naïve public that could not get enough, today banks and mortgage companies are doing whatever they can to lend money to anyone and everyone regardless of whether they are qualified or not.

Here is a quote for you that sums up the absurdity:

“We don’t want to stifle financial innovation.”

This came from the associate director for Risk Management at the FDIC in response to a question asking why no actions have been taken toward tightening mortgage lending standards.

MUSICAL CHAIRS

What happens when the last idiot pays the highest price for a piece of property and real estate appreciation engine that is keeping our economy going comes to a screeching halt?

The ramifications could to be a lot worse than anyone ever imagined.

The consumer will become so overextended with debt and debt payments that they will be forced to finally stop spending. Defaults, foreclosures, and bankruptcies will eventually cause problems for our banking system (remember the old SAVINGS AND LOAN DEBACLE…this is eerily similar). The housing sector which has been an engine for the US economy will begin to slow.

All of these things will have a negative affect on the stock market.

I am sharing my views of what is currently happening in the real estate market and with the consumer with the hopes that you will be prepared and not fall into the same trap that some many other smart people are getting sucked into.

Adversity creates opportunity…

For investors who have the ability to look ahead. Try to be Debt free and try to build you cash. There will be a tremendous opportunity in the stock market and real estate once the correction is complete. It may take a few years but if you have been able to avoid the carnage and build your cash you will be in a position to make huge profits in the future.

Look at how many great companies in the stock market fell to unimaginable prices in the bear market that followed the tech bubble. We have bought many of these “fallen angles” in the MainScale portfolios and they have gone on to be tremendous winners. We have seen no other investment newsletters who's investment systems come close to producing results on par with this portfolio. Check the commonsenseinvestor.com frequently for investment information we have featured in our investment newsletters.

Just like a good boy scout…BE PREPARED. A day of reckoning is coming and if we are ready… major profits will follow.

Have a profitable day,

MARC BARHONOVICH