SEPTEMBER 2005

MANIA !

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California-details

by Don Stott

Last week I took California to the cleaners, and spared nothing. I got not a single objection from anyone, but rather a few e-mails from Californians who agreed. Perusing my library, I came across a book, which I had bought and read way back in 1998. This, of course, was before the stock market melt-down, when it is estimated that $7 trillion was lost. The stock market was a bubble, and especially the NASDAQ. The Dow suffered as well, but not as much. None have recovered. In my diatribe about California, I allowed as it could apply to a lot of other places with real estate bubbles, but I picked on California, because of its heavy dependence on fuel to navigate and park on its freeways. This book, "Contrarian Investing," beginning on page 71, discusses manias. Below, I am quoting the exact words of the text, with a few left out because of brevity.

"We've observed that all manias have certain characteristics in common. Watch for these signs."

1. "Speculative manias always come during periods of prosperity. That makes intuitive sense. It's only during periods of prosperity that people have idle money to speculate with. Prosperity alone does not signal the start of speculation; after all, prosperity is an important ingredient for a healthy bull market in stocks, real estate, precious metals, or tax-free bonds." (The author points out that Japan's real estate market and stock market collapsed amidst prosperity. The Nikkei had reached a bit under 40,000, and is still, many years later, about 12,000.)
2. "Most speculative manias are fueled by easy money and easy credit. An easy money atmosphere breeds speculation. In Japan, savings accounts paid less than 1 percent, spurring investors to go out and play the market in pursuit of higher returns. As investments bought using easy credit rise in value, lenders let down their guard, making it progressively easier to borrow more. Only when the storm hits do the lenders tighten credit, exacerbating the collapse."
3. "All speculative manias are characterized by ever-widening acceptance. In every case we studied, the seeds of a market mania are planted by the wealthy and by professional investors. It was only after the masses jumped in and tried to emulate the market makers that prices really seemed to rocket beyond any semblance of fair value."
4. "Speculative manias are always supported by authoritative opinion that reassures speculators. There will be experts who will justify a mania as merely the proper actions of informed investors. These people usually believe strongly in what they say. They are as blinded by the mania as everyone else."
5. "Participants ignore the voices of doom, which really are only the voices of reason."
6. "It is impossible to forecast the top in a speculative mania, just as it is impossible to predict a top, or bottom, in normal markets. In a mania, investors lose the ability to think rationally. Any attempt to rationally forecast a price peak can be deadly. All manias are characterized by prices that, in retrospect, are irrational. Prices, having risen wildly, can keep doing so, doubling, tripling, or more. Since the market has lost any semblance of rational value, contrarians must remember that irrationality has no limit."
7. "It is impossible to invest successfully in a speculative mania. A mania is a lot like a speeding freight train. It accelerates, rockets along, and slows at some points, only to speed up again. Getting on and off at just the right time is near to impossible."
8. Speculative manias all end with a crash so destructive that its pain is felt for years, even decades, that follow. This may be the easiest way to identify whether or not a mania is playing out. Simply ask yourself if the end of the suspect mania would spell true disaster." (Decades later, Japan has still not recovered.)
9. "As the mania progresses, and the demand for stocks or other investments burgeons, so does the supply. But those newer offerings are always of increasingly questionable quality."
10. "All manias end abruptly, and with little warning. No matter how much we believe we can avoid a mania, the fact is that manias are most obvious only in retrospect. The happy and successful speculator in August 1929 had no clue the market was about to lose all but 10 percent of its value. What few warnings exist are usually ignored."

In Florida, the land boom and bust made history. The population of the state in 1920 was 986,470. By 1925, it was 1,263,540. That's an increase of about 60,000 per year. At the turn of the century, Miami didn't exist, and the state was largely undeveloped. A visionary named Henry Flagler, who had made a fortune in Standard Oil Stock, took a liking to Florida, and thought it must have a lot of possibilities with all that sunshine. Flagler opened the first hotel in Miami, the Royal Palm. He later opened the magnificent "Breakers," which still stands. We had lunch at the Breakers a couple of years ago, and it is splendid. Flagler decided to build a railroad down Florida's east-coast, to help with tourism. He later built one all the way to Key West, over a series of bridges. Those bridges now hold US 1. The railroad failed after a hurricane took many of them out.

Miami Beach was an island, and a bridge was needed to access it. Carl Fisher and Thomas Pancoast built a bridge, and began selling lots in the new town called "Miami Beach." Between the railroad, warm climate, and the fact that due to WW I, the wealthy had been sunning themselves in Florida rather than Europe, things seem to mesh. A boom was born. Slowly at first, but by 1922 land prices began to skyrocket. It didn't hurt things that Miami was a jumping off place for Cuba and Bimini either. Why? Whiskey. Prohibition was running then, and in order to drink legally, one had to go offshore, or buy it from smugglers. Cuba was 90 miles away. Smugglers could get rich quick, buying a case of Scotch for $24, and re-selling it to tourists in Florida for $120.

Karl Fisher began selling lots. $3 million in 1923, $8 million in 1924, and $12 million in 1925. Change that to billion, and you have 2005 dollars. The advertising was wild, as was the speculation. Most thought it would never stop. It did. It came to a shuddering halt on September 18, 1926 when a major hurricane hit. The first one since 1910. 3990 died and 5,000 injured. $80 million damage to property. In 1928 another hurricane hit and that finished the Florida land boom. Prices went down like an elevator. Many millions were lost, and the prices didn't recover for many decades. Charles Ponzi scammed more than a few, selling underwater lots in Florida.

Last week, in Crested Butte Colorado, a new batch of condos went on sale, and were all sold in a matter of minutes for the $600,000 and up range each. Construction isn't even finished, and the 'lucky' buyers are now re-selling their contracts at a profit. Pensacola Florida thought it would never happen to it. No hurricane had ever hit and done any damage. "It can't happen here." It did and hit hard, even though everyone thought they were immune. "Real estate will go up forever," some wags say, and people keep buying…it seems. Except a lot are selling, and a friend of mine in California, in San Diego, is in business placing "for sale" signs for real estate outfits. Last Saturday, he put up 255, which was more than he had ever put up by several multiples.

So you Californians, Bostonians, and New Yorkers, plus those of you who live anywhere where prices of real estate have gone up to ridiculous levels, I ask you to re-read the first part of this, and read it carefully. Then tell me if real estate is a boom, bubble, or mania. Then, if you believe it is, make up your minds about what to do with it. Buy? Sell? Sell and rent? Move? Do nothing? I can't advise. I can only give you my observations and historical aspects. I am not selling my home, and plan to die in it. I paid $150,000, and it is now worth perhaps $750,000 because of its uniqueness and age, but it isn't for sale. Should you save in Dollars? Are dollars a bubble? You bet! They're worth 2% of their value a hundred years ago. Is real estate a bubble? My parents bought a 6 bedroom, three storey, four bath home in D.C. in 1935 for $3500. It couldn't be bought for $750,000 today. I went there last year and checked. Knocked on the door at 1811 Kenyon St N.W. introduced myself, and renewed acquaintance with my childhood home. Not for sale, but if it were…over $750,000. My parents sold it in 1960 for $16,500. You decide. Protect yourself.

August 25, 2005

Don Stott has been a precious metals broker since 1977, has written five books, hundreds of columns, and his web site is www.coloradogold.com