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The Coming Real Estate Crash and How You Can Protect Yourself from it

September 28, 2001

By now it is no secret that the much anticipated U.S. equities crash is well underway. But a crash that few are talking about-and almost no one wants to hear-is the impending collapse in U.S. real estate prices. This coming catastrophe will far exceed that of the stock market in terms of economic damage and will devastate the country as no other disaster could. By our calculations, the real estate crash (let's call it the R.E.C.) will have begun by no later than first quarter 2002.

What makes this coming crash particularly onerous is the fact that almost everyone stands to suffer from it, and few can hide from its effects. No single region or real estate sector will be insulated from its effects. Commercial, farm, and residential properties alike will all suffer the same fate. It comes as a tidal wave crashing down upon the inhabitants of an island community, who are powerless to combat the destructive forces of nature but instead are relegated to watching helplessly as the wave descends.

This impending collapse represents the final "domino" in the collapsing U.S. superstructure that began officially in 2000, but in reality began many years before. Since real estate represents the primary form of personal wealth for most Americans, the R.E.C. will have the effect of divorcing Americans from all socio-economic classes of any remaining vestige of prosperity and ownership. Millions across the country will be forced to a devastating form of commonality-an egalitarianism of poverty, if you will-by the time the seismic force has dissipated.

In any secular bull market, real estate prices are always the last asset class to "top out" in terms of price and demand. Already we have witnessed the topping and turnover of the stock market and the economy, but homeowners have been deceived into thinking their property is the one asset that can never be taken away from them in terms of inherent value. How wrong they are! What millions of homeowners are about to experience will be unlike anything they, their parents or even their grandparents have ever before witnessed in this country. U.S. property values will begin dropping like a rock with scarcely a bid to bolster them along the way, and the trip begins in less than five months.

Because the governing force behind real estate prices (and virtually all prices for that matter) is the 55-year Kondratief Wave, or "K-Wave" as it is simply called, is in its final 3-4 years of descent, most of the damage will be inflicted upon property values between now and 2004-2006. Because the preceding boom in real estate prices was so steep and exaggerated, the corresponding drop must of necessity be equally pronounced (by the inevitable laws which govern all prices). We have already seen this principle in effect with regard to stock prices, now it is time to witness it in action with real estate prices.

Preliminary signs of this coming destruction are already beginning to show up in places across the country. Here in coastal North Carolina, where this writer resides, dealers are for the first time in recent memory having trouble selling prime beach-front real estate. Up and down the coasts of this beautiful island one can see reality signs in front of houses for sale such as "Price Reduced." Also, for the first time in over a decade sellers are being met with considerable resistance from potential buyers and beachfront homes are staying on the market for unusual lengths of time. This is a leading indicator since the beach real estate market is always the first to fall into recession.

Lawrence Patterson, editor of Criminal Politics magazine, points out that the latest, and so far the most effective, weapon used by the feds to combat an incipient economic recession is home equity finance. With successive interest rate cuts and federal programs that have pumped as much as $90 billion into the hands of consumers having so far failed, the government is hanging its hat on this last-gasp attempt at staving off depression. Here's how it works:

Supposedly "private sector" companies like Di-Tech.com are given federal support and free advertisement in order to entice consumers into refinancing their mortgages at lower rates. The mechanism to accomplish this has been to push mortgage rates down to exceedingly low levels (below 7% as of this writing), and to do everything within their power to encourage refinancing of home mortgage debt. As Patterson points out, the development of the Internet and Internet lending companies has assisted in this effort.

"It is now a lot easier to get competitive mortgage rates if one does not wish to deal with a local lender where they live," writes Patterson. "The business has become far more competitive than ever before-thus benefiting all home owners. Consumers are met with a constant barrage of mortgage refinance advertising on all mediums, and particularly on television. As a result, home owners have been able to sharply reduce their monthly mortgage payments."

Patterson also points out that in addition to lowering the monthly mortgage payments which allows a loosening of the family budgets, the banking consortium (read Federal Reserve member banks) very quietly arranged to have mortgage lenders offer cash back-directly to the home owners as part of their refinancing package. In other words, while they are reducing their monthly payment, they can pick up an additional $5 or $10 or $25,000 in cash with which to spend as they wish and still end up with a slightly reduced or possibly the same monthly payment that they had before. This has the end effect of instilling a false sense of security among property owners, who are leveraged to the hilt in their ongoing attempt at living the "American Dream" of having their cake and eating it too - even though they don't actually own it!

This mortgage-reducing strategy the bankers have recently embraced actually turns out to their benefit on both ends. For one, it stimulates bank income in the form of mortgage payments since many people will naturally want to take advantage of the lower rates to reduce their principal. Hence, the bankers get an immediate injection of liquidity into their coffers at a time when they need it most (after bailing out several major institutions and businesses over the past couple of years). On the other end, the bankers will own the defaulted properties of multiplied thousands of homes across the country as the real estate deflationary wave wreaks havoc from coast to coast.

"But," someone has objected, "what good will it do the bankers to own defaulted properties in a financial deflation when they will be faced with the trouble of trying to re-sell them at drastically lower prices in a market where bids are few?" This question assumes that lending institutions must turn to the domestic market in order to turn a profit. What few are aware of is that there is a vibrant demand for U.S. housing among well-heeled foreigners who are licking their chops awaiting the moment when real estate prices drop calamitously and housing and property can be had here for pennies on the dollar. We have already witnessed a preview of this coming spectacle as hundreds of wealthy Russians have descended upon Manhattan in the past two years purchasing upscale houses on the Hudson and paying for them in cold cash - and this was when real estate prices were at their peak!

Another source of this foreign demand for U.S. property comes from China, where newly wealthy Chinese await entry into the country to pick through the remains of the U.S. property value collapse. It is no coincidence that the two healthiest stock markets in the world are Russia and China, especially the former. Both are in the midst of impulsive bull markets despite the near universal bear market in most major countries. Ironically, the liquidity necessary to sustain these equity bull markets in Russia and China came from-you guessed it-U.S. banks and the federal government itself. It is easy to see, therefore, how U.S. bankers will clean up in profits made by brokering defaulted properties to a flood of wealthy immigrants.

America, your problems have only just begun. Watching the World Trade Towers being demolished was a symbol of the further destruction-and painful -that is to come.

The only financial solution to this inevitable catastrophe is to shed any and all forms of personal debt as quickly as possible. Take advantage of reduced interest rates and amortize all existing debt immediately. Then park your remaining assets in the safety of gold, the U.S. dollar (which will maintain value for at least another year), and short-term U.S. Treasuries (which also will maintain some value for the time being). A certain portion of your discretionary wealth should also be intermediate-term invested in a top-performing hedge fund, such as the Rydex Ursa or Tempest Fund, or the Prudent Bear Fund. Selective short selling of equities is also a favored strategy. At all costs, avoid "ownership" of a heavily mortgaged house or property. Sell now while prices are still relatively high and the market is still fairly liquid.

The top of the great U.S. real estate cycle has been seen. The great plunge awaits.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.


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