The global housing ponzi scheme, and the best laid plans of rodents that think they are men...

I always get fairly serious pushback from baby boomers and basically anybody else who rode the housing bubble that we blew for 25 years globally when i describe it as a carefully constructed ponzi scheme.  The financial literacy tends to decline massively with the personal portfolio size basically.  I guess it was ever thus in all asset classes.  Being a know-something investor is quite different to being a determine and socially-sponsored risk seeker in all economic seasons and regimes.  Read that twice baby boomer readers, for your own good...

That stereotypical baby boomer secretary or flight attendant you know with 20 rental flats is not an investment genius.  She is just an early stage ponzi scheme participant, and she entered on her media-stimulated risk-seeking preferences rather than any real nouse...  If she had any real nouse she would be capable of working out a monthly repayment a typical median wage earned could afford and type it into a mortgage calculator at rates before this tightening cycle and after it to understand the impact on housing prices.  

It is not rocket science folks.  The economic negotiation takes place on the monthly payment.  She would be selling those properties hard and fast and putting a liquidity discount on them to get them gone.  Those with even the faintest nouse about the fundamental price and risk factors know the gig is up, and actually knew it was up the moment central banks were making loud noises about transitory inflation that clearly was not after fiscal cannons got fired in a panic for covid.  The smart money is all sold up and desperately selling any residual portfolio with marketability and liquidity discounts being considered seriously.

While the flight attendant/secretary intellectual standard investment genius sails on blithely watching re-runs of Barbara Corcoran and her ilk boost housing, let's talk about what ponzi schemes really are for a bit...

We all understand what an equities-based ponzi scheme is.  Mr Ponzi first made himself immortal in the wrong way by collecting funds, promising returns that he could not meet, and paying original investors that carry out of the new funds being received from new investors.  Yes, it is criminal fraud of course, once the regulators act, which they basically never do until far too late when massive frauds have already occurred, and often they do not act decisively then.  You have been warned...

But what is a credit ponzi scheme...?  Well a credit ponzi scheme is constructed in two stages.  First, you allow a borrower to borrow money to buy an asset, and then you inflate the value of the asset artificially, by policy relaxation of the borrowing rate or relaxing lending constraints via deregulation or failure to apply underwriting regulations to the next round of borrowers.  Basically, the first stage is to offer universal credit and blow a leverage bubble at the same time with policy and regulatory over-relaxation continuously.  The second stage is to generate a carry for the early investors by allowing them to borrow at leverage against the assets they now hold in a funded position, or to cash out the price gains without realising them through an actual asset transaction, permitting cash realisation of unrealised gains.  Does that sound familiar to anybody looking back in hindsight over the past 30 years.  Let anybody borrow, dead or alive, blow a huge leverage bubble by dropping interest rates no matter what the economy did, and let the borrowers estimate the value of their home and take cash out of it like an ATM machine.  It certainly should...  

Deregulation and some fairly irresponsible policy rate setting coming out of the 2001 dot com bust to save the banking system from a market meltdown re-capitalisation event in 2001-3 (those pesky central bankers right?) led to an explosive leverage bubble and ponzi carousel in housing.  By 2007 the ponzi gig was blowing apart badly, but central bankers doubled down on saving the banking system from a massive re-capitalisation event, this time a leverage and credit ponzi bust, and dropped interest rates to 0 and printed trillions, as well as taking all the structured mortgage note toxic stuff onto their books, thus re-capitalising the commercial banking system directly.  The result was merely another 15 years of ponzi housing.  You will note that interest rates had never been sent to 0 nor had we printed trillions in all of recorded economic history.  Yes, baby boomer politicans are quite serious about financial ponzi schemes for baby boomers.

The astute reader will have noticed already that the fundamental inevitable death blow for ponzi schemes, the thing that defines them as ponzi schemes and not economic growth processes, is exhaustion of the ability to keep paying the carry to the early investors.  In order to keep paying the carry you need to keep the leverage bubble primed with ever-lower policy rates, ever looser money, full employment, thus providing a fresh supply of new naiive investors with the cash to let you do it, and they need to believe your shinola.  

Amazingly, most ponzi schemes do not fail because of the financially literate population refusing to believe the shinola any longer.  They fail because the ponzi operator gets too greedy, the ponzi scheme gets too large, there are too many early investors drawing carry, and not enough new participants to keep the carry flowing.  That is what happened in the GFC.  A credit ponzi scheme fell over and got reflated pretty desperately.  Ponzi schemes fail under the gravity of their own economic size, not through human wisdom.  It is sad right?  The social predators amongst us win again.  Score 0 for social justice.

By now, you will all have realised that actually what we have all lived through for the past 30 years was a massive ponzi scheme in housing.  It was originally blown out of poor interest rate policies (too low and too loose) at exactly the wrong moment in 2001 when the housing market was already catching fire, in order to save banks from an equity market meltdown.  After that catastrophic policy error, the doubling down in 2008 was just completely unconscionable.  It is a serious problem, of a nation destroying size now.  

It has swallowed the two demographic cohorts after baby boomers almost whole on their lifecycle economics.  That may only be obvious in retrospect.  It has swallowed the rational investor with its duration against his lifecycle (30 years for young adults when it started), and will swallow the irrational true believer with the large scale losses he holds when it goes boom this decade.  Boomers will sail on through with the gains on the whole.  On average, you had to be a boomer to have enough collateral to turn one home into a portfolio early enough in the process.  

It really was just baby boomers enriching themselves and slaving the kids for decades.  It just was, very deliberate, very organised and quite quite socially vicious.  I am not a big fan of baby boomer group think about their sagesse in property investment.  It is not a great secret in this world that it is much easier to get socially vicious in government than to work and invest rationally for wealth.  Ask anybody who grew up tough in the third world if you have any doubts about that...  Sigh.

That decision to floor interest rates and print trillions as the GFC took form just absolutely scrap-heaped two generations instead of cleaning up the bad debt.  It was a political decision in the end, and it put those two generations on the hook for the ponzi debt instead.  Thank you baby boomers...  

How did this really happen...  Where were the checks and controls? Well, on both occasions the wishes of politicians to save generation Baby Boomer from its out-of-control speculative habit with money it did not earn and could not afford to lose correlated nicely with central bankers' primary wish to stop the banking system from self-immolating pretty much instantly.  When politicians and central bankers are looking for the same victims in a financial crisis, you do not want to be that guy.  If you are silent generation or gen X you are actually just generation Patsie.  

They do not want you to know it.  That is all.  They want you to go to work, rent a cockroach mansion, or better yet, buy one of their ponzi debacles and pay it off for them.  It is a pretty cute, highly effective  inter-generational scam really.  Not much better than street protection run by the mob.  Baby boomers are very committed to it.  They got away with it for decades.  That bring belief.  It takes people time to grow up politically and economically.  It does not arrive at 22 as you leave college.  What trailing generations should do is vote en bloque to remove baby boomer age politicians.  They are simply too dangerous for non-baby boomers to be allowed to take seats, in my opinion.  When you act like that for 30 years, you get tossed out. That is the final check and balance.

Your author saw it for exactly what is was at the time, and simply threw up his hands in horror and frustration at the charlatans that govern us, and took a few years on third world beaches.  Why work when the game is rigged for one generation and against the next?  He was not of a mind to capitalise the 60% losses that generation baby boomer were being insured against by political and central banker action.  He believes moral hazard is not just an euphemism.  Listen up central banking crowd, because without a labor force your policy posing ain't worth much, and we will not be getting airports or dams or electrical supplies or medical care out of you fine examples of professional contribution to society will we now?  We will just get another ponzi scheme as soon as you can.

Now, after that rather alarming showcase rant of common sense and extreme negativity about the pandering morons we allow to make serious economic decisions nationally, let's look at why this ponzi scheme must fail, and how an astute financial frolicker deals with it

Well, this ponzi scheme like all of them, has the fundamental limitation of size.  In this case, the size of the debt demographic flow it has impacted.  We have now displaced so many first time buyers demographically from their mid to late 20s into their early 50s at the leading edge and trailing back fully 30 years from there that this demographic displacement to the funding flow in long term debt taken for housing is a collapse mechanism starting now.  Demographics are not policy variant folks.  No baby boomer politician can make me 25 again.  I wish he could.  Pretty soon, he is going to wish he could a lot more.  He is going to exhort and issue a bit of rhetoric about how it is all my fault and how i should buy a home off him.  Good luck with that.  

We now have a 15-20 year broad cohort that are absolutely destroyed by the housing ponzi scheme on their lifecycle economics, aged roughly 35-55 today with a bit of fan around those numbers.  They are going to dislocate geographically over time as a response to their dislocation from that debt demographic flow that simply went on for too long.  You can see it in second world countries already.  Huge influxes of early retirees in their 50s.  This is just going to grow and grow for the next 20 years.  It is fixed by the past and policy invariant.  It is demographics in action.  ... and it is going to tear that ponzi scheme apart this decade because 30 years later, the elder kids were in their 50s and they were done with the game, and it just keeps going.  You can run a ponzi scheme in houing for 10-15 years.  You cannot run it for 30.  Those debt dynamics intersect with demography and give you a diaspora and a collapse on demographic fundamentals.

Let's talk about how a financial frolicker deals with credit ponzis effectively.  

Well, the first thing any investor should have is a pretty fair idea of the price risk in an asset he holds  Return and risk are two sides of a coin.  Believing you might make 10% this year is only half of the deal.  You need to have an estimate of how much you could lose if things get messy.  Things do get messy periodically.  We all know it.

My rough educated estimate is that we carry about 60% price risk and possibly more in western global capital real estate markets and their regional and dormitory centre equivalents.  I do not really care if it is 50% or 70%.  It makes no difference to my investment process.  Medium term downside price risk of 50-70% is simply not an asset class characteristic that i would ever go near.  I leave that kind of stupidity to that bunch best known for the HODL acronym as they bet their lives on 'digital gold' which is basically a computer program that generates a unique number and a work trace that anybody on the planet with a bit of tech nouse can replicate and issue their own form of 'digital' gold on their home computer on a weekend.  'Digital Gold' - yeah, right....  Digital dutch tulip fantasies more like...

Now might be time for that sage warning about negative leverage.  People buy homes in their youth and hope for the best because a home loan will leverage their wages and they hope their wages will rise.  It is a classic leveraged bet.  It is all winsome until the tale of negative leverage gets told.  The price effect on equity magnifies to the downside just as it does to the upside.  It is a linear bet at a high multiple of your wages 10-12 times these days.  Historically it was 3-4 times.  It is a big big bet, and it is a big big bet very late in a very long ponzi scheme.

To make out like a bandit, the wage-leveraged bet on housing depends largely on a short sequence of ponzi regulatory and policy behavior as outlined above for success, because the business cycle and short term interest rate policy cycles are actually shorter than the average period of time people own their homes.  Without a bit of ponzi behavior from the policy setter or regulator - nothing doing on average and housing is actually pretty boring.  I have read the studies.  It is part of what i do.  Pretty much every claim about housing as a hedge of inflation always going up, an unenviable natural store of wealth etc, is completely not borne out by long term studies.  Evidence is muted and mixed, over the very long run.  We live in independent housing for about 60 years of our lifecycle.  That is the very long run.

However, policy setter and regulators are very very motivated to ensure that financial assets appear to grow at rates well above gdp growth nationally.  Just ask your pension broker for the details of those winsome and unwise risky asset return estimates in the long run.  You have all heard them right.  Let's start with 8% and then tell you that if you move out of balanced funds and chase growth a bit it might be 10 or even 12%.  Yeah right.  The anchor folks is economic growth at 2% in the long run.  Clearly the entire economy is now tiny compared to the risky asset valuation 30 years down the line.  It is garbage.  It is garbage.  Please stick that under your hats and hold onto it throughout life.  Policy setters and regulators are endlessly tempted to ponzi support manouvers for exactly this reason.  It is one of the greatest managed charades of democratic capitalism.  it is pure chicanery and tom-foolery of the most damaging variety.  ... and it is where Depressions find their source.

Fortunately, there is an alternative to buying a home, and that is to rent one, which enhances your labor mobility in your youth too.  It is a fact that society leans againt the labor flexibility interests of youth telling them to buy a home in order to ramp housing prices for the elder cohorts.  Just as you would not buy into an equity ponzi scheme once you had identified it, you should not buy into a housing ponzi scheme once you see it for what it really is.  Just like equity ponzi schemes it is the last entrants that take the full weight of the fraud.  The early entrants had their carry and have often left the scheme behind by then.

Smart astute financial frolickers are looking at a 25 year dedicated housing ponzi scheme, promising themselves never to vote for a baby boomer politician again, because that chap has just been too injurious to their lifecycle, and letting somebody else hold the membership in the ponzi scheme that is going to lose 60% levered on wages.  That is not smart investing folks.  Really not.  That is a life destroying economic event if you get caught in that collapse.  There are periods when the risk in asset classses are actually as significant as there past records of excetpional returns.  It is the general case, in fact, and it is exactly because of the past record of exceptional returns.  The FOMO is actually the MOJO, the moronity of jubilant operators, the adle-witted prayers of the faithful no less, and this is one case where you do not want to have your mojo and you do want your wits sharp.

Astute frolickers are renting, and waiting it out.  They know what is coming.  What is coming frolickers is a serious global housing meltdown.  That is not a statement of opinion.  That is fact.  Ponzi schemes end badly - always.  The timing is uncertain. the large losses are not.  ... and the little inflationary surge we just had pushed a near term tightening cycle in with an edge on that was absolutely the end of this ponzi scheme.  Your author will go on the record and tell you that the UK will be in absolute flames on its residential housing market by the end of 2024.  That is already locked in.   It will take longer in countries with fixed mortgage rates like the USA but the losses will be more significant in those countries.  

In the next episode i am going to explain to you frolickers why crashes in global tightening cycles always happen faster in countries with variable mortgage rates, but always crash deeper in countries with fixed mortgage rates.  Stay tuned!