The Chart du Jour

No Inflation?

February 23, 2000

Did I hear Mr. Greenspan correctly today when he said that with the exception of "oil and a few other commoditity prices" that he could not find any signs of inflation in the U.S. economy? Give me a break. Asset price inflation is all around me, and even the leveraged real estate investors that I know are worried sick about it.

"My partners and I bought this little office building in North Jersey as few months ago," one friend explains. "We fixed it up a bit and thought that we could lease it out as office space to Doctors from a nearby hospital. We were about to sign such a lease deal when someone plowed in and offered us double what we paid for the building six months ago. It's crazy. I've never seen anything like it. If this all ends badly, it's going to end really badly."

And this is not a one-off story. I for one can tell the following tale on the residential real estate front. In 1993, I bought a house in Short Hills, NJ for $660,000 -- a princely sum at the time I thought given that the house had zero acreage, was in need of a new heating system, and had a somewhat tacky 1950s kitchen. In 1997 I tried to sell the house for slightly more than I paid for it, and after three months on the market found no takers. I decided to withdraw the house from the market and wait a bit. Just over a year later, by July 1998 New Jersey real estate was on fire again and I got lifted out of the house for $912,000. The buyer worked at Morgan Stanley and put down less than 20% cash. But who was I to care how much leverage he was using. I was out of my house and quite happy about it.

Well that same house, one or two cosmetic changes later, just sold for $1,400,000. If the newest buyer is also financing the house again for 20% down, some mortgage company is now lending a total mortgage amount equal to two times the total value of the house just three years ago. If this is not credit excess and dangerous inflation, what is?

We're sorry Mr. Greenspan but your "aw shucks, what inflation?" line today just does not ring true in suburban New Jersey, nor probably in most other U.S. locales. David Tice's and Jim Grant's ongoing warnings about excess credit creation via entities such as Fannie Mae and Ginnie Mae ring more true than your hollow words of comfort.

It took approximately eight years for one house in New Jersey to increase about 61.8% in value (between 1990 and 1998), and then just two years more to do so again. Shall we go for another 61.8% appreciation in just one year to complete a Fibonacci sequence?

Maybe I should put this all down to the wonders of America, and I obviously know that it has something to do with the ebullience of nearby Wall Street. But if Wall Street ever turns sour and those magic bonus checks stop, I don't want to be near the mortgage portfolio holding that loan origination.

We're sorry for the tirade, and the lack of a chart to go with it, but Wednesday's testimony on inflation just seemed to us a joke, particularly given such anecdotal stories as those above. The fact that people actually bought stocks on the comment is even more amazing.

But oh yes, that's right: Henry Blodgit was speaking as well -- it's time to buy AOL and Time Warner we are told. Get in front of those Merrill funds. One scary thought is that no matter what Mr. Greenspan ended up saying Wednesday, Blodgit's comments might well have still ruled the day. Any excuse for a rally, of course.

But the general naivete and short-sightedness of the investment public is truly amazing. Does AOL at $56 a share really represent that much of a compelling bargain? We think not. The world just hasn't changed that much since October 1998 for us to value AOL at over five times what it was trading for then -- even if the stock just retraced 50% in two months from its all-time 95 13/16 high.

Mr. Greenspan's and the average American investor's perspectives on prices and price changes are clearly very different - and at different ends of the spectrum. Greenspan thinks we have little price inflation; investors believe that almost any price is not too high to take an equity punt or to buy a piece of real estate. Sadly, both Greenspan and investors have lost their perspective. Both will be equally culpable for their lack of vision when the bubble-days end.

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