Stock Market Collapse Holds Brutal Shock for Bears, Too

These are surely giddy times for bears.

And why not? For most of them the summer's stock market crash came on with a warning that had all the subtlety of a brass band parading down Main Street.

For technical analysts in particular the indicators were as clear and spine-tingling as the trill of piccolos above a Sousa march.

By June, the analysts' most trusted runes were in rare harmony, all clearly signaling a decrescendo to the bull market that began in 1982.

Even the geopolitical world seemed poised to acquiesce: Japan and most of Asia were slipping into the mire of depression, Russia was about to kiss off Western bankers, and Bill Clinton was precipitating a quintessentially American crisis of recrimination and self-doubt.

All of which looked like money in the bank to those dour realists of a practical bent who were paying close attention.

Indeed, if the boasts of bears on the Internet are to be believed, many heeded the signs and bet heavily against equities just before stock averages began to tank in late July.

One need look no further than the bank stocks to appreciate the source of their professed glee -- and profits. Citicorp dropped 54% from peak to trough, and Chase Manhattan fell by nearly half. Banker's Trust, perhaps the most notorious and inventive crapshooter of them all, shed 56% of its capitalization.

A timely $200 wager against any one of them in July could have produced gains exceeding $7,000 in just six weeks.

And that, ironically, is what so far is most troubling about this bear market. For if its end is to break the spirit of speculators and annihilate the greedy, its means is to visit pain and suffering on bulls and bears alike.

Which is to suggest that, among investors, neither the optimists nor even the most astute pessimists should have anything to brag about once this bear market has run its course.

We are therefore impelled to ask, What terrible surprise might await both?

I am firmly convinced the answer lies in that seeming bedrock of savings and investment, residential real estate.

Pumped by profits from the bull market in stocks, housing prices have reached unsustainable levels, especially in or around such heady financial centers as New York, San Francisco and Los Angeles.

Ordinarily a bear market could be expected to deflate the real estate market, or at least cause it to level off somewhat. This has happened regularly in the past.

But this time the bear market is global, and its cause is not merely a downturn in the business cycle but the bursting of a credit bubble that has engulfed us all.

Much has been written about the bubble, and its destructive potential has been tacitly acknowledged by the world's most influential banker, Fed Chairman Alan Greenspan.

But if Mr. Greenspan truly understands whence the bubble's power comes, he is most skillful in hiding his fear of it.

For here is the bottom line: Every penny of every debt eventually must be paid -- if not by the borrower, then by the lender.

C.V. Myers, the late economist, formulated that maxim in his prescient book of 1977, "The Coming Deflation," and it will always hold true. He was attempting to dispel the notion that we can simply "walk away" from our debts.

The collapse of the banking stocks because of loans gone sour in faraway places is ample proof that ultimately, someone -- in this instance bank shareholders -- will have to shoulder the debts on which someone else has reneged.

Globally debt has grown to incalculable size. Some sources attempt to measure it in relation to the derivatives market, a realm of financial prestidigitation that has helped to create credit money three to four times the size of dollar trade in worldwide goods and services.

Others simply look at Uncle Sam's books and see $5 trillion in on-the-books debt, $9 trillion in off-the-books debt, and who-knows-how-much in way-off-the-books debt.

Applying Myers' rule, the amount that we collectively owe must eventually settle against what we own -- essentially, the homes, stocks and bonds in which nearly all of America's savings are vested.

This explains the mechanism that has been deflating Asia's economies. In effect, corporate borrowers can't produce enough cars, or cut enough timber, or sell enough silicon wafers, to service their debt.

The implication for the homeowner is sobering. When deflation spreads to these shores, as it must, asset values and income will fall, and even a modest drop will be enough to bury most mortgage borrowers.

Try to imagine being yoked to a 6.8% mortgage on a $300,000 house after it has been reassessed at $150,000. Now reweigh your relative burden when the highest rate of return available to you in T-bills or a passbooks account has fallen to less than 0.5%, as occurred during the Great Depression.

Toss in a delinquent home equity loan and a touch of joblessness, and the picture is complete. The "silver lining"? Houses aren't as liquid as stocks, and the banks therefore won't be able to repossess them all.

But their shares will adjust to misfortune by falling precipitously. I've forecast that Citicorp, currently trading for around 105 per share, will drop to under $10 at the trough of this bear market.

Since there is no way to profit by selling the housing market short, bears, too, will be dealt a stunning blow.