Friday, February 04, 2005

The Super Bowl Indicator

by Kevin Duffy

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In the "Can you top this?" category, several creative football fans in Philadelphia are apparently financing trips to the Super Bowl by tapping into the equity in their homes. To the typical European or Asian consumer, octogenarian, or hospital patient just awakening from a 10-year coma, such behavior must seem bizarre. To the average post-millennial American, this is barely one degree of separation from normalcy.

Alone, most people act rationally. Put them in a crowd and entertain them? They shave their heads, paint their faces, expose their over-hopped bellies to sub-freezing temperatures, shout obscenities at well-intended referees, and generally lose their minds. (In the City of Brotherly Love, they sometimes toss snowballs at these same officials.)

When everyone is thinking alike, no one is thinking. Worse, the collective level of intelligence drops to the lowest common denominator. What is sure to whip people into a frenzy? Nothing beats an easily discernable uptrend and a simple explanation for its perpetual continuation, i.e. all the ingredients for everyone to get rich. The longer the trend goes on, the smarter, more invincible, and more daring the mob becomes.

Five years ago, the crowd thought technology stocks paved the way to early retirement. Their rationale was simple: the future would be high-tech, highly productive, and highly profitable for those "New Economy" companies who "got it." Never mind that the Nasdaq 100 had vaulted 10 times in just the past five years or that Cisco Systems’ $500 billion market capitalization dwarfed its sales of $19 billion. They sold their stodgy old-line stocks (often to insiders) just to buy more.

In hindsight, the signs of excess were all there. What the consumer craves, Madison Avenue, Wall Street, and the mass media supply. Ubiquitous TV ads encouraging day trading reached the sublime, one showing a successful teenager with his own personal helicopter. Half of 2000’s Super Bowl ads were for dot-coms, many hastily produced. CNBC (a.k.a. "Bubblevision") told its audience what they wanted to hear: the future is bright, technology (e.g. the Internet) is bringing information to the individual investor, and the real risk is missing the ride. Analysts and strategists were mostly bullish, and those who didn’t give the consumer what he wanted were replaced. Investment bankers packaged new product and insiders – especially those fortunate enough to own stock in New Economy companies – generously sold from existing inventory.

Predictably, it all ended badly, but did we learn anything? Has human nature really changed? Has the mob dissipated, kicked its gambling addiction, and gone back to work?

For starters, CNBC is still in business, Las Vegas is undergoing a construction boom, TV shows about casinos are hot, and stock market speculation is back. A recent headline reads, "Google Heads For the Moon." With a market cap of $57 billion, sales of $3.2 billion, and its two founders in their early 30s worth north of $7 billion each, one could argue Google has already reached its destination.

The real crowd pleaser these days, however, seems to be cheap credit. Everywhere one turns there is a billboard, TV ad, or phone solicitation offering once-in-a-generation low rates to the marginally creditworthy, as long as the collateral has four walls and a front door. The formula is simple: interest rates will remain low, credit will stay abundant, and real estate always goes up. A logical conclusion follows: Buy as much house as possible and borrow as much as the lenders allow.

Over the last 5 years household real estate gained $6.3 trillion (62%) in value, yet homeowners piled on another $2.8 trillion in mortgage debt, or 44% of this new found "wealth." (Keep in mind, these are averages which include the 20% or so who own their homes outright, mostly retirees. Home equity extraction is certainly much higher for those with mortgages.) At the margin, many are literally betting the ranch that the easy credit stars stay aligned indefinitely. Like a compulsive gambler, the home buyer on margin is opting for higher-octane fuel, moving from fixed mortgages to ARMs, and now to interest-only mortgages and "piggy back loans" which cater to the buyer who is challenged to come up with a down payment. Despite the lowest interest rates in 46 years, the average American pays over 13% of his disposable personal income just to service his debts, a record.

It is not just borrowers who are optimistic. Mortgage lenders are in a generous mood these days and why wouldn’t they be? Borrowing at 2% and lending at 5% is good work if you can get it, especially if your collateral keeps rising in value. Not only do they want this virtuous credit cycle to continue, they expect it.

On conference call after conference call, we find executives with remarkably similar forecasts: the good times will continue. The CEO of subprime lender New Century Financial, Robert Cole, admitted, "We’re all competing aggressively for market share," without a thought that the consensus might be wrong. CFO Patti Dodge projected minimal loan losses over the next 18 months based on their "historical experience" of the "last 7 to 8 years." Countrywide Financial, the nation’s #2 subprime lender and prodigious advertiser, plans to double its assets by 2008. CEO Angelo Mozilo recently boasted, "Shareholders’ total annual return the past 10 years averaged 30% per year and 45% the past 5 years… This is the real Countrywide story." (We think the real story might be Mozilo "divesting" himself of $157 million in company stock over the past two years.)

As the housing beat goes on, who can fault those who, from time to time, hook up an ATM to their house in order to take the wife to Paris or the kids to Disneyworld? Or if they happen to be Eagles fans, why not use some of the proceeds to buy tickets to Super Bowl XXXIX?

We understand the Super Bowl’s half-time show this year will be sponsored by Ameriquest Mortgage, this country’s #1 supplier of subprime home loans. Five years ago online broker E*trade secured this dubious distinction. This time, like the last, we’ll let the fanatics have their fun. We’d rather watch this spectacle unfold in the comforts of our own home.