A Barn-full of Problems

By DAVID MOON, Moon Capital Management
March 5, 2006

When I decided to build a barn, I called my buddy Glenn to help. I wasn't going to pay someone else to build a simple shed. Glenn and I, both amateur, would-be, pretend carpenters, started digging holes and sticking 20-foot poles into concrete.

We had almost all of our poles in the ground and most of our banding boards nailed up when a real carpenter with a couple of his real carpenter friends came by to do some work for my wife.

They were as polite as they could be, but they just couldn't help giggling at our construction job. With one look, the professional carpenter could tell that our 3,000-square-foot amateur structure was out of square by 'at least three or four inches.'

Not only could I not tell that we were out of square by a measly three inches, I didn't care. That seemed close enough to me.

The carpenters remained polite, even if I couldn't see something that was painfully obvious to them. They didn't need a string to determine that the building wasn't square and they didn't need a tape measure to make a good estimate of the size of the flaw.

They could also look ahead and see what would be the ultimate results of that flaw: a waving roofline, crooked walls, awkward board cuts ' a difficult and poorly constructed barn.

I shouldn't be surprised that it's possible to miss obvious signs of future problems. It happens on Wall Street all the time. I hope we're not about to be surprised by a crooked economic barn that should be obvious to anyone who bothers to look at the foundation.

David Rosenberg, a Merrill Lynch economist, has calculated that in the last three years, cash-outs from home equity loans have been responsible for 40 percent of the increase in household spending. These cash-outs are possible as a result of continued low interest rates and years of increasing home prices.

Increases in household spending usually come from increases in household income, which occur in most years. But how often will consumers be able to refinance their homes and take cash away from the closing? Rarely, unless mortgage rates remain low and home prices continue to soar.

If either of those conditions fails to persist, folks aren't going to keep having that easy money to take out of their houses and spend on TV sets, restaurant dining and a new Xbox each year.

People are buying consumer items and financing them with 30-year mortgage debt. Without this spending, Rosenberg figures that the GDP would have been 25 percent lower in the last three years. Retail sales would be 20 percent lower. And there would be a million more people out of work.

When refinancing boom slows, the ripple effect in the economy will extend well beyond the mortgage market. It's just like seeing problems early in a construction project and knowing the ultimate outcome.

Is it so difficult to see that a part of our economy is out of square?

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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