"Why don't you move back into your own house," his father wanted to know.

"Dad, I've got a good tenant in there. Besides, it's not in very good shape. I'd rather sell it than invest more money in it. And there are so many places on the market, I can rent something better. Even after a big drop in prices it is still cheaper to rent than it is to buy something."

There are probably millions of homeowners who would like to sell - if they could. This hidden inventory of unsold houses will depress housing prices for a long time.

But there's a crisis coming in commercial real estate too.

"An extreme amount of commercial debt is to mature over the coming years," writes real estate investor George Karahalios in Marc Faber's Gloom, Doom and Boom Report. "And unlike the residential market, there is no safety net (Fannie Mae) for commercial loans. Instead investors must rely on financing through commercial banks, a few insurance companies, and other private lenders who now demand much higher interest rates and more equity for the risk associated with these investments. Thus, not even the Fed's printing presses can save commercial property prices, and I am expecting certain locations to crash, perhaps falling as much as 50-80% from the peak."

So you see, dear reader, there is bad news ahead - a lot of it. Stocks will go down. Gold will go down too - most likely - when people realize that the economy faces a long, deflationary depression...not a period of inflationary growth.

But while stocks are fair weather friends, gold sticks by you in foul weather too. Right now, gold is rising on good news. Eventually, it will soar when the news turns bad. (Though...not necessarily right away...)

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Housing Slump Has Fattened the Inventory of Unsold Homes
• Commercial Real Estate May Be the Next to Fall
• Trends Make Investors Less Afraid of Risk
• Ireland Going Through Same De-leveraging Process as the US
• Housing Prices Follow GDP Growth and Inflation

It's not really...it's just the point where this bounce will equal the bounce following the crash of '29. No reason in particular that this bounce should be the same as the one 80 years ago. But no reason it shouldn't either.

Gold rises with the stock market. The yellow metal hit a new record over $1,100 yesterday. Why is that that important? Well, it's not important either. But gold still has another $1,000 or so to go before it equals the last bubble peak in gold, set in 1980 - on an inflation- adjusted basis.

The point is, there's plenty of room on the upside for gold...and not much room left on the upside for stocks...

Stocks are going to be hit hard when people realize that the recovery is a fraud. When will that happen? We don't know. But another big wave of foreclosures might be the thing that sets it off.

"The Second Wave Begins..."

This was the title of a report over the weekend from John Hussman. The gist of it is that the long-awaited 'second wave' of foreclosures has, perhaps, finally begun.

First, many of the Top 50 metro areas in the US are reporting "sharp increases in foreclosure activity.

"Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation's foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave," said James J. Saccacio, chief executive officer of RealtyTrac. "While toxic subprime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A and Option ARMs are spreading the foreclosure flood to more metro areas in 2009."

Hussman:

"While the news itself is no surprise in the sense that we have expected and written about this situation repeatedly in recent months, the phrase 'sharp increases in foreclosure activity' is notable in the context of widespread views that credit difficulties are abating. Below is a reminder of where we stand in relation to the reset curve. This news of a shift in the character of foreclosure activity comes precisely in tandem with the beginning of the predictable second wave. The pleasant lull in the reset schedule is decidedly behind us.

"The mortgages certainly do not reset at Treasury bill yields or even at standard spreads over LIBOR. Instead, they reset to a 'premium' spread above those rates. That 'yield spread premium' is precisely what the homeowners agreed to in return for the undocumented loan, and is particularly obnoxious at the point of reset if the mortgage itself is underwater (loan amount in excess of home value). Given that these mortgages were written during the last stages of the housing boom, at the highest prices, it is reasonable to assume they now sport very high loan-to-value ratios."

So, there you go.

If Hussman is right, we'll soon see real estate prices take another tumble.

Bill Bonner
for The Daily Reckoning Australia

• New Default Wave Hits Mortgage Industry
• The Interest Only Mortgage Option
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• House Prices in California and Las Vegas Hit Hard by Wave of Foreclosed Properties
• Recovery for the Real Estate Market

They were valuable because they helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry. The chart below shows you the ferocious fish may still have an appetite.

It shows you that we are past the viscous subprime crisis, when that shark chewed through the balance sheets of a number of banks and financial institutions, in some cases devouring them whole. However, it is not yet safe to get back in the water:

There are these other slices of mortgages that are not quite as risky as subprime that reset in the next couple of years. Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.

Making all this worse is the fact that the housing has not yet recovered. The T2 duo made the case that the current "stabilization" of the housing market is a head fake. Mostly, it's due to huge government support of the housing market. But there is still a large inventory of homes out there. And with these resets coming due, we've still got a large amount of foreclosures on the horizon.

All the while, the unemployment numbers are still poor. The T2 duo calls the unemployment situation the "most severe since the Great Depression." The US economy has shed over 8 million jobs in this recession and unemployment - officially - is nearly 10%.

Plus, it's not like the average US consumer is in a good position to sail through this crisis. Household liabilities are still high, as this next chart shows:

US consumers need to save and rebuild their financial strength. This is why the savings rate is on the rise. This is why, for the first time since the 1950s, household credit debt declined.

As investors, it seems clear that any idea that depends on discretionary consumer spending - say, buying trendy new sweaters or watches or expensive shoes - faces some big head winds. Better to the stick with the necessities, I say.

Also, it looks like the bounce in the stock prices of overleveraged banks and financial institutions is premature. Most bank stocks should be sold, not bought. The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones US Home Construction ETF (ITB). By shorting it, you make money when the stock prices of the home builders go down.

They made a compelling case, of which I will highlight a few things. Exhibit A would be the fact that the average new home has been on the market for 12.9 months. Exhibit B is that we have about 2-3 years of existing home sales just to absorb the vacancies that exist. According to T2, about 6% of all homes built this decade are vacant.

Exhibit C is that the home builders themselves have too much debt and too much inventory relative to their thin equity cushions. The home builders are in the position of trying to hold up a bowling ball with a sheet of paper...in the rain.

Lastly, the home builder stocks are almost universally expensive on a price-to-book basis, as this chart shows:

Stocks with lots of debt, too much inventory and an awful market don't deserve premiums over book value. Discounts are more like it.

So there you go. I like the idea of shorting the home builders. At the very least, I wouldn't buy one. I'd also stay away from banks and financial institutions that hold mortgage assets. American real estate is not worth zero, as Dobson said, but it can be worth a lot less than today's price.

I recommend staying with the sorts of companies that own essential assets and/or sell essential items. As I like to say, stick with what keeps civilization a going concern. And avoid any stock that is dependent on regular access to the credit markets. As we saw in 2008, a mortgage crisis can shut down the credit markets. We don't want to be held hostage by lenders in that situation, so stick with excellent financial conditions.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• All Ordinaries Reach 52 Week Low
• The Aussie Dollar as a Measure of Global Risk Appetite
• Looking at WPL and Oil Side by Side
• Commercial Mortgage Backed Securities Are Back
• The Two Pillars of the U.S. Mortgage Market, Fannie Mae and Freddie Mac, Wobbled Again Yesterday

That same house sold again this April. Once again the entire neighbourhood went through the house to have a look and while it had been kept up, nothing extra had been added. It was the same, except that this time the property sold for $1.7 million. In four years property prices, at least so far as this particular property was concerned, had risen by forty percent.

There has subsequently been quite a bit of action in selling houses on our street but the most astonishing moment was last week. This was a house that had not been touched for fifty years. To say that it had "original features" only underscores what a derelict mess it was.

And the price: it went for over $1.4 million with four bidders going beyond the $1.2 million level and two going above 1.4.

That this totally astonished all of us in the street is to put our reaction as mildly as possible. That it depressed my son who was trying to think how he would ever be able to buy a house for himself was perfectly understandable. This is an economy with property prices gone mad.

The man who bought the house had just sold up in a more expensive suburb and was locating down, pocketing a net million along the way, although probably half of that will be sunk into renovations. The seller has netted for himself more than a million relative to the price he paid, and was for him on a property he had rented out and not lived in himself. This is, for him, all money in the bank.

And that's the point. It is all money in the bank. There is, according to the press, a difference of opinion between Treasury and the Reserve Bank over interest rates and their proper direction. Treasury cannot see what the rush to raise rates is all about. The economy has barely touched bottom, assuming that it even has. So far as Treasury is concerned, it is madness to be raising rates already when recovery has not truly even begun.

But then there's the RBA. What it sees are house prices rising again and an inflation already becoming entrenched. While the "headline" movement in the CPI was a quite moderate 1.3% across the year, the "underlying" rate the Bank relies on rose by 3.8%, well outside its band of 2-3% per annum over the course of the cycle. And even the headline measure showed an increase of 1.0% for the quarter which of itself is worry enough.

Inflation and What to Do About It

That the economy, particularly the private sector, is still generally moribund is likely. That there is a long way to go before we return to the kinds of momentum we would prefer seems about right. That raising rates right now will slow the economy and delay a return to stronger levels of private sector activity seems almost unanswerable. Yet, with all this liquidity sloshing around, what is a central bank to do?

What makes it worse is that the very aim of the government seems to be to push the private sector out of the way. This is not like an inadvertent error by the Prime Minister to have raised the level of public spending in a panic and therefore to have crowded the private sector out. This seems more deliberate than that, and is in keeping with the notions put forward by the PM in his economically challenged article published in The Monthly at the start of the year in February. At the time, he wrote:

"The magnitude of the crisis and its impact across the world means that minor tweakings of long-established orthodoxies will not do. Two unassailable truths have already been established: that financial markets are not always self-correcting or self-regulating, and that government (nationally and internationally) can never abdicate responsibility for maintaining economic stability. These two truths in themselves destroy new-liberalism's claims to any continuing ideological legitimacy, because they remove the foundations on which the entire neo-liberal system is constructed."

Neo-liberalism, you see, means leaving production decisions to the market to be made by profit-making firms which are trying to work out what consumers would like to buy. This the Prime Minister will not permit given these apparently "unassailable truths". It is his judgement that is going to matter and come what may, he is determined to have the government absorb our national savings for his own purposes rather than for our own.

In a depressing assessment reported in The Australian this week we were told that "the nation's key economic advisory body [the Productivity Commission] says the government has not 'universally applied' its own promise to subject all major infrastructure spending to detailed and transparent cost-benefit analysis." Listed were $66 billion worth of projects that the government does not know, and apparently does not care, whether the money being spent will be repaid in revenues ultimately earned.

I therefore want the RBA to raise rates and keep on raising rates because that may be the only way we are finally going to convince the Prime Minister there are costs to the approach he is taking. Whether raising rates will prevent inflation from taking off is hard to say. It might put a brake on wage movements which are the main feedstock of the inflation process, but governments are the worst industrial relations negotiators so I wouldn't count on them.

But what I am looking for is recognition within the government that they cannot keep pushing their own expenditures upward, crowd out the private sector, and hope to generate real growth. Is there no one within the Government who actually does understand how prosperity comes about? From how they have so far behaved, it really doesn't look that way from here.

The Government is counting on your ignorance to get away with literally destroying billions of dollars of our wealth. If these projects do not repay their costs, they will just make us poorer.

But they will create jobs. And they will lead to a rise in the recorded level of GDP. That other jobs in the private sector will not be created, and that we will actually end up with a lower standard of living because of this tremendous level of public waste, is just how it is.

I now meet people all the time who tell me we had to do something about the Global Financial Crisis. OK I say. Pay the higher interest rates and taxes and be done with it. Such nobility I think! Such self sacrifice! Such idiocy!

These latest expenditures are not being done in the heat of a crisis. They are a matter of deliberate policy. That we let governments direct so much of our resource base to ends of their own choosing is unfortunate. But if we as a community do not know any better, that is just how it is going to be.

Dr. Steven Kates
for The Daily Reckoning Australia

• Why I Would Have Raised the Interest Rates
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• BRIC – Brazil, Russia, India and China Suffer High Rates of Inflation
• Falling Interest Rates and Increasingly Accessible Credit

No jobs...

No credit...

No sales...

But look at those stocks!

And oil! And gold! And even London property!

Real estate agents in London say they are sold out...as prices go to records. Well, asking prices...that is. As for sales prices, that is another story.

Still, London is driven by finance...and finance seems to have gotten out of rehab. It's party time again.

The Wall Street Journal is talking about a "full recovery" in luxury goods sales by 2011. And Wall Street itself is pricing stocks as if the record profit margins of '05 and '06 were just around the corner.

In other words...investors' expectations have not changed. They think things will return to the way they were in the Bubble Epoque.

How could that happen? A full recovery implies a number of things...

..that the 'Son of Bubble' will be as big as his dad...

..that all those people without money or jobs will somehow find the wherewithal to spend again...

..and that the baby boomers will stop saving for their retirements and begin to party like it was 2006 again...

Remember, Bubble Epoque spending, sales and profit figures were made possible by borrowing. People spent every penny they earned...and then "took out equity" from their houses in order to spend more.

What they really got was a house with a bigger mortgage - without moving!

At the height of the bubble period, if we recall correctly, Americans were taking out more than $500 billion per year. Now, they're putting back nearly $500 billion a year in savings.

We don't like to be party poopers here at The Daily Reckoning. But there is no way to get a rerun of the Bubble Epoque on those numbers.

What we see happening is a typical post-crisis bounce...powered by easy cash and credit from the feds. How long can it go on? How far can it go? No one knows. But if you want answers, we'll go way out on a limb:

It won't go on forever. And it won't go to the moon.

And most likely...it won't be long before the whole thing comes to a crashing end.

Here's noted analyst John Hussman:

"The stock market has never been this overbought."

Hussman says that the only time stocks were this overbought was on Nov. 28th, 1980. That was the last rebound in the great bear market that had begun in 1966. Afterwards, stocks fell another 30% before finally hitting bottom in August 1982.

That's why we have our Crash Alert flag flying over the headquarters of The Daily Reckoning. We put it up two weeks ago. No crash so far. But it can't be too far in the future.

And more thoughts...

While champagne and caviar is served out in the speculative economy of bankers and hedge fund managers, its bread and branch water for the poor folks stuck in the real economy.

First, we have some figures from the Center for Responsible Lending. Nearly 3 million houses are expected to be foreclosed in 2009. And there are 8 million still to go!

Yes, we've crossed the foothills of sub-prime already. But the Rockies of Alt-A, jumbos, and other salacious mortgage instruments are still ahead.

Bill Bonner
for The Daily Reckoning Australia

• Another Big Wave of Foreclosures
• The Only Thing Really Going Down Right Now is the U.S. Dollar
• La Bubble Epoque
• The New Chinese Era
• Economists Agreed the Stimulus Was Working and the Recession Was Coming to an End

When you get to the bubble phase, few people stop to ask questions. Instead, everyone assumes that the trends in place will remain...and even intensify. So even into 2008, in Phoenix as well as other growing areas - principally in the sand states - the building continued. And now it is 2009. Where are the shoppers? Where are the renters? Alas, they are thinner on the ground than anticipated...and the developers are having trouble paying their mortgages. Commercial mortgage backed securities are carrying 5 times the unpaid balances they had in June '08, says Bloomberg.

Imagine how disappointed lenders will be when these loans default. And then, imagine how American investors will feel when a new wave of mortgage defaults and foreclosures is hits the commercial property market.

A new wave of foreclosures and falling house prices may be approaching the housing market too. Alan Abelson, in this week's Barron's, reports on the outlook as described by Amherst Securities. The research group estimates an overhang of 'hidden inventory' of some 7 million units. These are properties owners would like to sell - if and when the market strengthens. Trouble is, the market may not strengthen soon enough. Then, many of these hidden properties could come right out in the open, as mortgages are reset, marriages break up, and people move on. Amherst says these people are in the "delinquency pipeline" which eventually flushes out the market. And it calculates that another 300,000 properties enter the pipe every month.

Falling prices have reduced 'owners' equity' - the part of the house the homeowner owns free and clear of a mortgage - to only about 43%. This number includes people who have no mortgage at all - more than 50 million of them. Abelson speculates that the actual equity in the hands of the 'owners' of mortgaged houses must be substantially less. Pushed by joblessness...not to many life's other, normal hazards...many of these people are surely going to default. Of those in the "delinquent pipeline," nearly 10% haven't made a payment in more than two years. Sooner or later, the banks and mortgage holders will be forced to take action...and more houses will come onto the distressed property market.

Eager to put this recession behind us? Hey, don't be in such a hurry. Recessions do good work. Depressions are even better (see essay below....)

More and more people get something from government. Fewer and fewer are net taxpayers. This is the basic formula that bankrupts democracies. The political system becomes skewed towards spending; then, there's no stopping it. Once the majority of voters and special interests has an interest in increasing spending - even by borrowing - rather than in limiting taxes and debt, the game is practically over.

USA Today reports on the number of children whose lunches are furnished partly at taxpayer expense. The figure rose from 24 million in 1990 to 31 million today. That is, the welfare program increased by a third during the biggest boom in history. Think what will happen during the bust.

Bill Bonner
for The Daily Reckoning Australia

• Another Big Wave of Foreclosures
• House Prices in California and Las Vegas Hit Hard by Wave of Foreclosed Properties
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Commercial Real Estate May Be the Next to Fall
• Commercial Mortgage Backed Securities Are Back

Not much happened yesterday. The Dow fell 47 points. The newspapers attributed the reversal to surprisingly low consumer confidence numbers. Apparently, consumers aren't so sure this crisis is over. As we reported yesterday, they're saving money...maybe even at an 8% rate.

Oil didn't move yesterday. Neither did gold.

The Wall Street Journal reported that markets were reacting to "mixed data."

That is to say, some reports were encouraging. Others were not. It was as if one weather forecaster called for a blizzard and the other for sunny skies and warm temperatures. Investors didn't know how to dress.

Among the dark clouds was an item on the falloff in tax revenues. States are having a hard time balancing their books, because their tax receipts are declining. The WSJ reports that they are running 17% below last year. Since states cannot print money, they're forced to make cutbacks - typically reducing hours worked per employee as well as the total number of employees. This is a bad thing, says the report, because it increases unemployment and lowers the wage base, leading to less consumer spending.

Another little cloud appeared yesterday (in addition to the consumer confidence numbers): the vacation timeshare market is collapsing at a record pace.

Well, don't worry about it. We met a guy who explained the timeshare business to us.

"What you're selling is a dream. You bring them to the property. You make sure they have a good time. And then you do to the numbers with them. You show them how much they save by coming to your property rather than on a typical vacation. And then you show them the other properties that they can exchange for. They think they can buy a cheap property and then exchange with an expensive timeshare. But it doesn't work that way. They get stuck in the cheap unit and the dream gets a little faded. And then, they stop coming...and then they try to sell the timeshare. Timeshares are rarely a good investment."

Besides, timeshares are a small, quirky part of the housing picture anyway. The real story is in the regular housing market. There, if you believe the forecasters, it's sunny skies.

House prices seem to be stabilizing. In some areas, they are going up. Of course, in some places you can get a house at half the price it sold for two years ago. That lures buyers back into the market. If we wanted a house to live in, we might be tempted too. That's why we like falling prices in housing; we get more for our money. But most people want a rising housing market. They think it makes them richer.

They're likely to be disappointed. They show up at the beach with their umbrellas and sun tan lotion...just as a winter storm hits the coast.

Forbes lists eight reasons to "remain worried about housing":

• The federal tax credit, worth $8,000, is set to expire at the end of November. That will make housing $8,000 more expensive for first-time buyers.
• The Fed is also ending its $1.45 trillion shopping spree. It has been supporting housing by buying mortgage-backed derivatives. What will happen when it stops?
• Mortgage lending standards are tightening up generally.
• Houses are still not cheap. Forbes cites Shiller's numbers, putting the average house 41% higher than it was in 2000. Incomes did not increase during that period; ergo, houses are still too expensive.
• Damaged psychology. It will take time for potential homeowners to get over the shock of a bear market.
• The end of summer has arrived. Housing sales always go up in the summer. People relocate in summer, when school is out. Then, sales fall with the autumn leaves.
• There are still huge numbers of houses that will be foreclosed. Forbes says only 12% of option ARMs have been reset. More foreclosures will increase the supply of desperate sellers and decrease prices.
• There's a 'shadow inventory' hanging over the housing market; it could be vast. Everyone knew it would be hard to sell a house in 2009. Many potential sellers held back, waiting for the market to stabilize. As they put their houses up for sale, that too will hold prices down.

Some wiseacre economist has probably already come up with eight reasons why housing prices will go up. But the key thing to recall is that this is a depression...a major restructuring of the economy, not a standard post-war recession. After 64 years, the consumer has finally rung a bell. He has reached his limit. He cannot borrow more. He cannot spend more. He is finally cutting back. That fact will echo through the entire world economy...and through the US housing market...for many years.

Houses, like stocks and corpses, may bounce. But they will not begin a real bull market again for a long, long time.

Bill Bonner
for The Daily Reckoning Australia

• Housing Market is Becoming More Affordable but That’s Not Necessarily a Good Thing
• Property Spruikers Claim Australia Suffers from a ‘Chronic Housing Shortage’
• When Will Housing Stop Falling in Price?
• Underlying Demand During a Housing Shortage
• The Kitchen is the Place to Be

Let's take the earnings recovery story first. Tomorrow we're going to have a look at the outlook for Aussie bank earnings. But for now, is there a case to be made for stocks as an asset class? Are they really recovering?

Well, the S&P 500 closed down in New York. But it's up 57% from its low. That's impressive. It's also expensive. The index now sells for 20 times operating profits, which is pretty optimistic, given how crappy the world economy has been in the last year.

"But that was last year," you say. In the future, things can't help but be better! And relatively speaking, that's probably true. Our friend Dan Ferris writes, that, "Last year, the S&P 500 lost $23.25 per share for the fourth quarter. In the second quarter of 2009, 369 out of 478 companies, representing perhaps 97% or 98% of the total market cap, reported negative earnings over the previous year."

Compared to last year, this year HAS to be better. You can't get much worse than negative earnings. And with trillions in credit backstopping the financial system and making it possible to generate profits on paper assets, you'd expect to see at least some engineered earnings in the next two quarters that look absolutely dazzling when compared to last year's numbers.

"So," says Dan, "for the next two or three quarters, you can expect plenty of reports of vastly improved earnings, even if those results aren't really so great. As you parse the news and evaluate your own investment goals, keep your head about you and don't be afraid to spend extra time getting deeper into a company's numbers, its market, its history, and its future prospects than you normally would. And for Newfoundland's sake, don't buy anything that isn't dirt-cheap."

Absolutely speaking, the popping of the credit bubble fatally undermined the business models of a lot of heavily leveraged companies, including many, many banks (both big and small). We reckon that the capital cushions of those banks are still in danger from further falls in asset values. Yes, that's not a popular or even common view. But we'll expand on it tomorrow.

In the meantime, you can always tell when stocks are out of favour in Australia. Everyone starts talking about what a good investment property is. But Australian housing is not exactly a cheap asset. The Governor of the Reserve Bank, Glenn Stevens, said as much earlier this week.

And this morning, we peeled our eyes over this paper on Aussie houses by RBA man Tony Richards. Richard's inadvertently made a lot of interesting points. One was that the so-called improvement in affordability over the last year is, "mainly due to movements in interest rates rather than in house."

He added that, "Mortgage rates are particularly low at present and, as the Bank has noted on a number of occasions, it is not reasonable to expect that interest rates will stay at the current low levels indefinitely. When they do rise towards more normal levels, discussions on housing affordability will again focus more on the level of housing prices relative to incomes."

That is clever to suggest that when rates rise people will have to find another way to say that houses are affordable. But we reckon when rates rise, as they eventually must, a lot of new home buyers will find out that access to cheap credit does not make a house affordable. It just makes the amount of debt you owe to the bank a lot larger.

The most interesting part of the paper, for our twenty minutes, was the discussion of 'underlying demand'. 'Underlying demand' is the phrase that gets trotted out when the banks and real estate brokers tell you there's a housing shortage, or when the RBA tells you not to worry about a house price crash in Australia. But what does it really mean?

Richards says the four components of 'underlying demand' are population growth, household size, new houses to replaced demolished homes, and demand for "second or vacant homes." Note that none of these are like the Ten Commandments. They aren't carved in stone. They are changeable.

By the way, who on earth can afford to own a home they neither live in, nor rent? "Honey we're going to buy a third home. But we're not going to generate any rental income from it. And we're certainly not going to live in it. We're just going to pay the mortgage on it."

"But why would we do that dear?"

"Because we can. To show how rich we are. We can afford it. And to support underlying housing demand. What else are we going to do with that money, buy stocks?

Returning to reality, Richards says that a preference for smaller household sizes, along with rising incomes and a rising population all factor in to strong "underlying demand." But if you spend exactly forty two seconds scrutinising this claim, you'll find that it simply doesn't hold up. "Underlying demand" as a bullish factor in Australian housing is a fiction propagated by property spruikers and money lenders.

Take rising incomes. Rising incomes are a function of a growing economy. But in a prolonged recession—or just a period of slower growth, or a world in which wages in the Western world are gradually deflated as the global work force grows (especially in manufacturing)—income growth is going to be harder to achieve across the economy.

And rising populations? Well, it's always possible for the government to reduce legal immigration if it's concerned about too many people competing for too few jobs. That knocks another plank out of underlying demand.

And then there's the preference for smaller households. Of course there's a preference for having your own castle and being your own King, if you can afford it. But the RBA's own data show that after many years of smaller and smaller household sizes, the trend is now swinging to larger households.

This could be by preference. After all, living alone has its benefits, but it can be awfully lonely. Or it could be by necessity—children living at home longer to save money or taking on flatmates to ease the pain of higher rates.

But whatever is behind the trend in rising household sizes, the main point is that the elements that go into "underlying demand" don't automatically suggest a level of demand for houses that will always rise. Quite the contrary, in fact.

And of course one of the biggest factors in demand for housing is the availability of credit via low interest rates. We reckon that when you add a couple of hundred basis points to the current cash rate, you'd take quite a bit of momentum away from "underlying demand" for housing.

How about some reader mail?

Dear DR,

Phil Cantrill

Intriguing scenario. Politically, it's a mess. Financially, we reckon the big issue is the value of toxic CDOs to banks and financial firms. Regardless of what happens to homeowners, those CDOs are due for a haircut. And when that happens, watch out for more bank failures and a second buffeting of the financial system.

Hi Dan,

Peter H

Dan Denning
for The Daily Reckoning Australia

• Aussie Housing Market Actually Leads the U.S. by Three Years
• Property Spruikers Claim Australia Suffers from a ‘Chronic Housing Shortage’
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• The Mother of All Housing Booms
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We're still working on our short summary of how three-life leases led to a huge generational transfer of wealth and capital in 17th and 18th century England. Landholders who were content with steady, predictable returns in the form of money and livestock from their land holdings didn't think twice about leasing their most productive assets to those who worked the land.

Bill tells us that in France, this arrangement was designed to look out for the interests of farmers so they would not be at the mercy of unscrupulous land holders. It also recognised that farms were long term capital investments, and it was better for everyone to remove them from the volatility of shorter-term leases. Losing the productivity of farmers meant less food, and there was not as much surplus to go around before the advent of fiat money and cheap credit.

But what the English landholders did not anticipate was a large, one in a three-generation inflation in land prices during the term of the leases they had granted. Land prices in Europe surged, partially because the money supply surged with the opening of gold and silver mines in the new world. Meanwhile, the land owners were receiving fixed rental payments, just as the three-life lease holders were fully benefiting from an historic appreciation in land prices.

Getting into an asset class at the right time is the single best thing you can do to increase you investment returns. It's really the most important factor - more important than stock selection or individual security analysis. The lease holders got historically lucky, and their good fortune literally generated much of the capital that would finance the industrial revolution.

We're only belabouring the point because we think a similar opportunity exists today. The world's productive assets are changing hands. Debtors are losing out to creditor. And for investors, avoiding the assets that will lose the most from debt deflation is job one. Finding the assets that will benefit the most from inflation is task number two. More on that tomorrow.

Also, we spent dinner tonight talking with a Graham and Dodd style investor from India. More on what we learned tomorrow. Until then...

Dan Denning
for The Daily Reckoning Australia

• The Dollar Left Behind
• Farmers Feel Consumers Blame Them for High Food Costs
• Aquaculture: Soybeans and Corn Under Water
• Topsoil Crisis: The Race to Secure Fertile Farmland
• Life After the Credit Depression

How did Australia get caught up losing money in commercial U.S. real estate? In yesterday's Age, Bwembya Chikolwa, a lecturer in the School of Urban Development at Queensland University of Technology, says Aussie super funds had money to burn and listed property trusts, with their large portfolios of U.S. assets, were liquid enough to do the trick.

"Unfortunately they were caught up in circumstances to do with the financial crisis," she says. "Moving into the US wasn't a problem because it had more or less the same settings...It was driven by large investment inflows into the super funds...The super funds needed new investment avenues and the trusts were a good avenue. So they invested through the listed property trusts. They had the funds and had no choice but to move offshore and the US market because of its size."

No choice? A portfolio manager always has a choice. It's the retail investor who is forced into compulsory super that has less choice. But this does highlight the obvious fact that fund managers are not paid to put clients into cash. Self managed super investors can do this easily enough, and many did (whether by design or indifference), thus avoiding the share market wipeout. But big fund managers have to buy big stocks. They are too big to buy small stocks, by the way, which creates a niche for Kris Sayce at the Australian Small Cap Investigator.

But now we have yet another seemingly external threat to your cozy domestic retirement: U.S. commercial real estate. Yesterday's Wall Street Journal reports that the $700 billion U.S. commercial mortgage backed securities market saw a delinquency rate of 3.14% in July. That was up six times from the year before.

The Journal reckons that over $153 billion in loans need to be refinanced by 2012. Of that amount, at least $100 billion could be in trouble. Why? The underwriting on the original commercial real estate loans was dodgy (as it always is in a credit bubble). But more importantly, with property values on commercial real estate down by 50% in some areas, refinancing at the same loan to value ratio as before just isn't going to happen.

Cash flows are fine for debt service and principal repayment now, according to the Journal story. It's the write down in property values that will scupper the refinancing. What's more, because the loans were securitised, it's often hard to figure out who you should be renegotiating with. This is reminiscent of the residential mortgage backed securities market where Deutsche Bank couldn't proved it owned the properties it wanted to foreclose on.

Mortgage servicers, banks, and investors would all prefer the problem to go away so no one has to take a write down on their asset values or a loss on their securities. But Aussie firms already know better. The only question now is if a pear-shaped U.S. commercial real estate market will do as much (or more) damage to the global financial system as the residential housing market. Stay tuned....

Dan Denning
for The Daily Reckoning Australia

• Property Sector Has Seen the Value of its Assets Wiped Out
• Commercial Mortgage Backed Securities Are Back
• A Look at Debt and Super
• Paying Attention to the Risk from Deleveraging in Commercial Real Estate
• Your Average Australian Super Fund