Where the Next Financial Bubble Is Forming

Here we go…piling more debt on an already huge debt burden.

Another U.S. debt ceiling hike has been formally requested of Congress.

While last fall’s soap opera on increasing the official U.S. debt ceiling still lingers in investors’ minds, last Thursday, President Obama put in his formal request to Congress to raise the U.S. debt ceiling limit by another $1.2 trillion. Congress has 15 days to vote on the request. This would raise the U.S. debt ceiling from the current $15.194 trillion to $16.394 trillion.

(Legislation calls for the President to place his formal request with Congress when the U.S. debt ceiling limit comes within $100 billion of being breached.)


Let’s keep in mind that, although the final figures have yet to be released, U.S. GDP for 2011 will be in the area of $15.0 trillion, less than the current U.S. debt ceiling. This means that the national debt has reached 100% of what our country produces (GDP).

It’s funny how numbers like this are not shocking people. Nothing to worry about; the U.S. debt ceiling keeps increasing each passing year, our national debt now equals our GDP, but everything is fine? In my opinion, the proverbial alarm bell should be ringing when a country’s debt-to-GDP level hits 100%.

We in America are fortunate that, in spite of the ever-increasing U.S. debt ceiling, this land is still perceived as the safe harbor of the world to park one’s money—in U.S. Treasuries—during these uncertain times. Because of this “safe harbor” mentality, the interest rates the U.S. government is paying on its debt are at historically low levels, from almost zero on short-term interest rates to under two percent for longer-term rates.

If rapid inflation rears its ugly head—as I expect it to—then interest rates will move higher, which obviously means that the cost of servicing the country’s debt (the interest payments on the debt) increases…possibly by hundreds of billions! Increases in the U.S. debt ceiling will have to come faster if inflation and higher interests prevail.

And we’re already at 100% of GDP!

The estimated U.S. budget deficit for fiscal 2011 was $1.3 trillion. The Office of Management and Budget is forecasting that, in its current fiscal year, the U.S. budget deficit will reach $956 billion. Let’s put aside the fact that, most of the time, these projections are wrong (that’s why they call them “projections”). Let’s also put aside that this estimate is based on the U.S. economy growing by 2.6% in 2012 and the unemployment rate remaining steady (good luck with that).

Please follow me for a moment…

If we take the $15.194 trillion in current U.S. debt and add $956 billion (the official current year’s U.S. budget deficit estimate), we get a total national debt of $16.15 trillion, which means that the current U.S. debt ceiling request will last roughly until the end of the government’s current fiscal year (September 30, 2012), and will easily pass 105% of GDP.

In 2013, the White House is hoping that the U.S. budget deficit will continue to fall from its $956-billion projection for 2012. This, however, is based on continued growth in GDP and interest rates remaining at historically low levels! What about inflation? Forget that…it was a 1980s issue, right?

Dear reader, please don’t forget that Greece’s problems began when its debt reached 130% of GDP. By my estimates, if government spending isn’t cut or taxes are not raised, the U.S. will hit a national debt equal to 130% of GDP in 2015—that’s three years from now…three consistent years of raising the U.S. debt ceiling!

That’s only if nothing goes wrong: no natural catastrophes, no new wars, no spike in inflation, and no spike in interest rates…things we all know can happen very quickly. And I didn’t even mention a worldwide slowdown in economic activity (see: Economic Slowdown for 2012 Will Be Worldwide).

If someone were to ask me today where I see the next bubble, I would say the bubble is in U.S. Treasuries. We keep increasing the U.S. debt ceiling and we are racing to the same debt/GDP ratio many eurozone countries hit before they faced a debt crisis. The writing is on the wall.

Michael’s Personal Notes:

Despite what the popular media may be preaching now, the U.S. housing market is more than just upside down.

The American dream, at least as I remember it, always included owning one’s own home. It’s where the family would experience their fondest memories.

Until the credit bubble began in 2001-2002, the U.S. housing market was also a stable place to invest money, as it appreciated in the low single digits on average annually over the prior decades. Like owning a long-term government bond: consistent and reliable.

Since the now infamous housing bust of 2007, things have changed dramatically. With the U.S. housing market, the persistent environment of falling prices and home foreclosures has shifted people over to renting instead.

The apartment vacancy rate in the U.S. fell to 5.2% in the fourth quarter of 2011, a 10-year low, and the lowest level in 10 years! This in turn sent the average monthly rent up 2.3% in 2011, to an average of $1,009 nationally (source: Reis Inc.).

Rising home foreclosures have forced families into renting, and stricter mortgage-lending standards have forced those who would rather have a home, to rent as well. No one wants to experience home foreclosure.

Some private-equity and hedge-fund money has found its way to the courthouse steps of the home foreclosures auctions. These companies buy these homes on the cheap, contact the owner of the foreclosed home, and negotiate a rental agreement with the family. In most cases, it’s a win-win for everyone involved. The firm makes money and the family remains in the home, albeit as a renter instead of an owner. This is one way to stabilize the U.S. housing market.

The idea has gained traction. In the first week of the New Year, the Federal Reserve outlined how such a program could work for Fannie Mae and Freddie Mac. Considering that the Federal Reserve Bank estimates that home foreclosures in the U.S. could rise to 1.8 million homes in each of the next two years, Fannie and Freddie could launch pilot programs as early as February in order to help stabilize the U.S. housing market.

For the second year in a row, the stocks of the self-storage companies were the best performing sector of the real-estate investment trusts (REIT). According to the Dow Jones All REIT Equity Index, which was up eight percent for 2011, the self-storage stocks climbed 35.4% in 2011.

Companies like Extra Space Storage, Inc. (NYSE/EXR) and Public Storage (NYSE/PSA) increased their rental rates and experienced few empty storage units. The increase in business over the last two years was due to the rise in home foreclosures in the U.S. housing market, which has forced families to downsize into smaller rental housing.

I believe the U.S.real estate market will continue to be a very difficult place to be in 2012, save possibly for the self-storage companies. However, you should be careful; they’ve had a tremendous run already.

Who would have thought, even 10 years ago, that the American Dream would be reduced to renting your home and stuffing the balance of your memories in a storage locker?

My personal opinion is that the U.S. housing market is dead for years to come. Why don’t I believe it’s bottoming out? My concern—and what no one is talking about—is rising interest rates.

The mass home foreclosures in the U.S. to this point are the result of home prices declining and the mortgages on those homes being worth more than the homes. My concern is that, after a 25-to-30-year down cycle on interest rates, inflation will push interest rates higher in the next cycle. We are at the bottom of the interest rate cycle. The next multi-year cycle of interest rates is in the opposite direction—up. This will devastate any recovery in the fragile U.S. housing market. (See also: 2012 U.S. Housing Market Price Forecast.)

Where the Market Stands; Where it’s Headed:

For stock traders, 2012 has started off terribly. The Dow Jones Industrial Average is up 1.7% for the year so far. If we look at the stock market’s action during January, we note that the Dow Jones Industrial Average has been confined to a trading range of 200 points since the beginning of the year. Traders make money during big market swings, not during narrow trading ranges like we have experienced so far this year.

For average investors like myself and my readers, thus far, it’s been mediocre for 2012; the bear market rally lingers on, although tired.  A massive top is being put in for stocks. But the bear market rally that started in March of 2009 still has some leg left.

What He Said:

“Even the most novice investor can now read the chart of the Dow Jones U.S. Home Construction Index and see that it is trading at its lowest level in five years. If, like me, you believe that stocks are an indication of what lies ahead, this important index is telling us that housing prices are headed to 2002 levels! What would that do to the economy? Such an event would devastate the U.S.” Michael Lombardi in PROFIT CONFIDENTIAL, December 4, 2007. That devastation started happening in the first quarter of 2008.