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U.S. Economic Bubbles

Three Sectors Ready to Swan Dive

Written by Brian Hicks
Posted July 28, 2009

It's every investor''s dream — buy into a theme before any one else has caught on. . . ride it all the way up until it gets bubbly. . . and sell to the suckers who bought at the top.

It's like buying housing names in 2004 (as we did), only to sell and go short in 2007 (as we did). . . or oil prior to the rise to $147 (again, as we did). . . or even dot-coms before the bubble burst.

Yep, we've become all to familiar with the term "bubble" in recent years; that unsustainable phenomenon pumped full of irrationality and over-valuation only to burst and trigger monumental downturns that'll continue with Option ARM resets.

We've seen it happen in Treasuries, financials, commercial real estate, autos, and credit. We watched in tortured silence, as an over-extended housing bubble popped, triggering a seismic credit meltdown.

And pretty soon we'll have bubble bubbles, where our heads explode over the financial chaos.

And now, unbeknownst to many, as we deal with banking and housing issues. . . are three more bubbles that'll pop. . . and soon.

#1: Higher education will be next

So say Joseph Marr Cronin, secretary of education in Massachusetts, and Howard E. Horton, president of Boston's New England College of Business and Finance.

And we agree. The next bubble to burst will be higher education. No doubt about it.

You see, higher education is big money for institutions and lenders alike. . . and they're in big trouble. What most people who are not directly involved with higher ed fail to understand is that these institutions and lenders are in the same sinking boat that banks and other financial companies are in. Assets are drowning. And debt and costs are rising.

Under-capitalized colleges are staring down threats to solvency, as penny-pinching students and parents go for cheaper alternatives (community college, online colleges, etc.) and sources of funds dry up.  Colleges are facing the same obstacles as banks, but the difference is. . . 

In the end it's the students that'll suffer, along with the colleges and universities. And that's not all. 

Lenders are about to take a hit, too. . . thanks to the Administration

As President Obama urges an end to government subsidies for student loan providers, a number of education stocks could swan dive.

Putting the kabash on these subsidies, according to Education Secretary Arne Duncan, could save the U.S. billions every year. The only roadblock is congressional approval. . . but this one looks imminent.

Here's an excerpt from a recent New York Times editorial...

The [new administration's] budget rightly calls for phasing out the wasteful and all-too-corruptible portion of the student program that relies on private lenders. And it calls for expanding the less-expensive and more-efficient program that allows students to borrow directly from the federal government. That means doing away with the Federal Family Education Loan Program, under which private lenders receive unnecessary subsidies to make risk-free student loans that are guaranteed by taxpayers.

Worse for lenders, a bill that cleared a House Committee could remove private lenders from the federal student loan industry. It's a move that could generate $87 billion in savings over ten years to fund more government grants and loans.

#2: Commercial Real Estate

A crisis in the $6.7 trillion commercial real estate market looks like the next obstacle for the recession-weary. . . just as Steve Christ and I have been alerting readers.

We're talking about $400 billion in commercial real estate loans that will mature this year and the billions more following. On top of that, banks could lose as much as $140 billion from construction loans that involve commercial real estate.

And it's not likely to get any better any time soon.

In fact, real estate experts and regulators just finished warning a U.S. Congressional committee that commercial real estate is headed for a crash that "could eclipse the devastating slump of the early 1990s."


Worse, banks have been charing off "soured commercial mortgages at the fastest pace in nearly 20 years," according to the Wall Street Journal: "At that rate, losses on loans used to finance offices, shopping malls, hotels, apartments and other commercial property could reach about $30 billion by the end of 2009."

In what's mirroring the residential real estate meltdown, the commercial market's bottom has been falling out.

Delinquencies are beginning to rise. The meltdowns at some of the biggest commercial REITs could be another blow to a financial system teetering on the brink of disaster.

Trust me, the Fed's shaking nervously over the prospect of a commercial real estate sector deteriorating sharply in the months ahead. That's because a large number of commercial real estate mortgages will come due at a time when:

  • Banks likely will still be facing balance sheet constraints;

  • The ability to securitize commercial real estate mortgages may remain severely restricted;

  • Vacancy rates in commercial properties could well be climbing.

Things are bad. . . and they'll only get worse before we see sustainable improvement.

#3: Option ARM Bubbles

The next phase of the disaster is upon us. . . and millions of investors are going to get wiped out, as more than $750 billion worth of Option ARMs (Adjustable Rate Mortgage) begin resetting later this year.

But don't take it from me. The Wall Street Journal believes Option ARMs' "worst troubles may yet lie ahead. . . since the bulk are due to reset over the next three years or even earlier."

And, says Goldman Sachs, which also just foolishly predicted 10% upside for the S&P 500, says that nearly half of all outstanding option adjustable rate mortgages — more than $375 billion worth — will eventually default.

That's crazy.

What should scare you to act quickly is this. . .

Defaults on those loans will skyrocket as unemployment spikes. And it'll devastate the economy and the banking system. . . yet again.

Really. . . how much more of this can we take, as economists predict that the U.S. unemployment rate could spike to 12% or higher?

It's now at 9.5%. The Fed is even predicting that we're likely headed over 10%.

Yep, just as 2007 and 2008 were the years of subprime woes, this one will go down as the year of Option ARM resets. With billions in Option ARM resets in 2009 and 2010, this crisis is about to unleash a fury no one's prepared for.

It won't be as bad as subprime, of course.

It'll be worse.

That's because lenders created these ARMs with "teaser" features for borrowers, which included making lower minimal payments for the first few years before the loan reset to a higher payment schedule. And if that weren't bad enough, there was another feature called "negative amortization," which meant you weren't paying back any principal.

What will happen is this: many borrowers, if they haven't already, will start throwing in the towel as they realize just how far under water they really are. And the likes of JP Morgan (JPM) could be heavily and negatively impacted.

But two things are for certain. . . One, we'll be paying for someone else's mistake, yet again.

And two, consumers could slow spending more than they already have.

It's a Virtual Hit List of Real Estate, Education, and Housing

Despite blind optimism on the economy that you're seeing throughout the financial press — especially CNBC — these three sectors are due for major downturns. . . and there are many way to profit from them.

We're preparing a full analysis of these sectors and the companies to short for maximum gains in the next few days. But you can get a head start by becoming an Options Trading Pit member today.

Good Investing,

Ian L. Cooper


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