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The Most Expensive Property You've Never Heard Of

By Dr. Steve Sjuggerud
Thursday, August 2, 2007

Greetings from the isle of Guernsey... where the average home price for you and me is $2 million.

For that price, you might think this island is all mansions and gated compounds, or that it's ritzy like Monte Carlo. You'd be wrong...

"Quaint" is a better way to describe Guernsey. I've just arrived, and I've enjoyed walking the narrow streets and small shops of St. Peter's Port. When I get the chance, I'll walk out to the impressive Castle Cornet, which has guarded St. Peter's Port since the 1200s. But I haven't seen a fancy home here yet.

So why the heck are homes so expensive on this island? There's no particular reason to be here... Guernsey is simply a speck on the map north of France, under English rule.

Actually, there are three big reasons why home prices have absolutely soared here in the last four years. Of these three reasons, two of them matter for investors...

The first reason is that Guernsey has a two-tiered property market: the "local market" and the "open market." With a limited supply of properties on the open market, prices are naturally driven higher... But that's neither here nor there...

More interesting is that the British pound has soared versus the U.S. dollar. Back in 2003, it took $1.60 to buy a British pound. Today, it takes more than $2. So the pound, along with a lot of other higher-yielding currencies, has strengthened an incredible amount in four years.

The third reason prices are high is that Guernsey is an offshore banking center, and banks have been making a fortune. For the last few years, banks have been taking incredible risks... and making incredible profits. So without a doubt, bank executives here in Guernsey have been getting huge bonuses. And without a doubt, they've been pouring a portion of those bonuses into the property market.

When you add these three reasons to the global property boom, you see why the price in U.S. dollars for a home on the open market here has risen from $800,000 in 2003 to $2 million today.

This is ridiculous. The earth didn't suddenly get more valuable by $1.2 million dollars. So it's clear that the "free money" is already long gone in Guernsey real estate...

But the same conditions that pushed prices through the roof on this tiny island are setting up opportunities for the vigilant investor. Let me explain...

Up until this year, bankers weren't afraid of risk.

Everything – real estate, stocks, commodities – had been soaring for five years. So any self-respecting bank had to take on big risks. You see, the bank had to make big profits to keep both market share and shareholders happy. And the bank had to pay big bonuses out of those big profits, to keep its star employees.

No sense in being prudish. The bankers had to operate this way. If they didn't, the other banks would. But in the last week in particular, all that has changed. Things are getting complicated...

"Some things that might have got done are not going to get done," said Stephen Green, the Chairman of HSBC, England's largest bank by stock market value this week.

In recent years, hotshot bankers at Morgan Stanley and Citibank could get access to all the borrowed money they wanted, either to speculate with or to offer to clients to speculate with. With asset prices going up everywhere, it was like a self-replenishing cookie jar.

Now, the hotshot bankers can't get that money anymore... The spigot is closed. The subprime mess is spreading, and none of the big bankers want to get caught with their pants down. So they've frozen their lending.

Banks are cutting their lines of credit. And not only will banks lend less, wary investors will borrow less, too.

In short, things just moved from overly greedy to overly fearful in a week. While stock prices may recover in the short run, I don't think we've seen the end of the troubles.

When banks get cautious like this, they make fewer loans, and they make loans with smaller profit margins. So much for the huge bonuses for the bankers here in Guernsey this year, and everywhere else around the globe.

I might be wrong about the banks tightening their belts... but I think it's likely that we've seen the end of the loose lending practices of the past few years. Bets on the end of easy money are the surest thing in the market this year.

Good investing,


Market Notes


Jeremy Grantham couldn't have made it any clearer...

This week, the legendary fund manager predicted as many as half of the world's hedge funds – and several large banks – would be wiped out by the risky loans they've made in the past few years to every idiot that has asked for a pile of money to speculate with. If this week is a harbinger of the future, Grantham's prediction will come true before Christmas... and you'll want to own some AFBIX.

We've covered AFBIX before... calling it "the asset that will go up when nothing else will." The fund tracks the price of financial insurance that money mangers buy to protect against a catastrophe. As the price action of the past few months shows, folks are taking Grantham's prediction to heart.

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