Comstock Partners Predict More Trouble for Housing

Wealthy investors pay Michael Aronstein and each of his two colleagues more than $1 million a year to keep their eyes open. Right now, the partners see a number of trends that could mean big troubles for bankers.

Among them:

* Americans will be turned off by debt.

"In five years, people will view debt the way Russians currently view Communism," says Mr. Aronstein, a contrarian strategist. Such a shift would challenge current banking orthodoxy, which holds that mass marketing of credit is a key to profitability. Consumer banks would have to focus on transaction services and savings accounts instead of credit cards.

* The big slide in housing prices is just getting started.

Though residential markets in Texas and Colorado are close to a bottom, markets will fall out of bed in other areas that have huge concentrations of capital in residential real estate. "It will be over when New York and Los Angeles go through the same process," Mr. Aronstein says.

Will the average guy lose his shirt?

Values "won't go down any more than your car, assuming you bought a car in the last five years," he says, with a straight face. He adds that, if you bought your house as an investment as opposed to a residence, "it will be the most disappointing investment you've ever made."

* Bankers will be swamped with mortgage defaults.

So many defaults, in fact, that they'll probably declare a moratorium on foreclosures to reflect reality, he says. "If I were a bank examiner right now, the one area I'd really, really be concerned with would be second mortgages.

"On the rest of them, the cat is out of the bag. You don't need a bank examiner to tell you to assign more risk to a strip-center loan or an LBO loan."

Impressive Track Record

Is this man a kook?

Economists pretty much thought so four years ago when when Mr. Aronstein and his two colleagues at Comstock Partners - Stanley Salvigsen and Charles Minter - predicted a Texas-style real estate collapse in the then robust Northeast.

They look prescient now, but conventional prognosticators greeted their prediction with the same disdain heaped on Galileo when he embraced the theory that the planets revolve around the Sun. "There's very little chance of a housing collapse in the New York area," pooh-poohed one economist in August 1987. "We have a housing shortage, and a vibrant economy continues to attract people."

Mr. Aronstein and Mr. Salvigsen also aroused skepticism in 1981 and early 1982 when, as Merrill Lynch strategies, they urged investors to go heavily into bonds. Money market rates were hovering near 20% at the time, and many investors were expecting rates to go even higher.

The pair also predicted a collapse in oil prices, which was considered a hoot down in Texas. The Aronstein-Salvigsen team proved right, however.

Noted for their provocative and entertaining style of writing, the duo also predicted in a July 1988 tract titled "The Briar Patch Effect" that, at the end of the 1990s, high-quality, long-term bonds will be in short supply.

"We have visions of packs of white-haired retirees roaming the edges of Florida golf courses with snorkels and flippers, hoping to pull a few stray balls from the water hazards to supplement their 3 1/2 CD incomes," they wrote.

Credit Price Inflation

Another tract from the 1980s, "Revenge of the Nerds," predicted the eventual triumph of savers over borrowers as the price of credit became inflated. That's when they first began to focus on housing as the asset that would be hurt most as a result of the trend.

Comstock Partners' current bearish real estate forecast provokes the same hostility from noncustomers as the earlier works.

"I get the same response here as the people in Tokyo who attack protections for rice farmers," says Mr. Aronstein, 38. "They are accused of undermining ancestral traditions. That's the way Wall Street views our outlook on home prices."

The red-haired money manager said that, if asked, he would have told bankers this year to sell their mortgage securities and invest in corporate debt in Brazil and Argentina instead. That's where he put some of the money he manages.

"The mortgage securities were overpriced in relationship to Latin American debt," he explains. "But no one would have listened."

That's excessively modest of the genial Mr. Aronstein. Plenty of people listen. The partners manage $2 billion for 10 major investors and two mutual funds - a Dreyfus fund and one of their own. They also sell their research to other money managers.

Less Short-Term Success

Though they are adept at spotting long-range trends, they are less successful as market timers. They were out of the stock market most of the summer, claiming it was ridiculously overvalued, which many other experts also conceded. But their absence cost clients short-term profits because the market proved stubbornly resilient.

Mr. Aronstein professes not to be a forecaster, guru, or doomsday prophet.

"Forecasting implies a certain specificity we really reject," he says. Rather, he and his colleagues are "investors who try and take a very broad macroeconomic perspective.

"... What we try to do is discern what the causal factors are behind events that are unusual or market-moving or unique to the era."

The process doesn't involve piles of printouts or intensive polls. Rather, it requires a heightened awareness of everyday events. For example, Mr. Salvigsen's experience in the early 1980s with an apartment building he built in 1974 convinced the men that commercial real estate was heading for a fall.

"He was coming into the office and telling us what he was selling apartments for compared to what they cost to build [and] what they cost to rent," Mr. Aronstein recalls, "Both of us shook our heads and said it was ridiculous."

Their technique comes down to discovering where banks are lending the most money and steering clear of that particular market. Like art. Last year, Mr. Aronstein says, the personal trust departments of most New York banks decided art was great collateral. They even bought some for their own portfolios.

"They financed stuff that will never sell. I have friends whose clients sold a painting to one bank at an enormous profit. They had to look out the window as the papers were being signed to avoid collapsing in laughter."

The Lemming Factor

"Banking is a form of investing, but all its principles run contrary to good investing," Mr. Aronstein says. He faults bankers for being too collegial.

"There's almost a sense of fraternal decision-making. Banking is a business where the image and the notion of acting in consonance with your peers is very important."

In the case of fine art, banks jumped in at the top of the market in 1989 and 1990. Their willingness to funnel credit into the sector just insured that it would inflate a while longer. But appreciation has nothing to do with real value. That sets the stage for a bursting of the bubble exactly as happened in commercial real estate and will happen in residential real estate, he says.

The Literate Golfer

The walnut-stain bookshelves that line Mr. Aronstein's office in New York's financial district are not populated by works you'd expect an investment expert to read. There are antique, leather-bound volumes of Shakespeare and paperback versions of "The Tibetan Book of the Dead," "Bhagavad Gita," and "The Upanishads."

He was graduated from Yale, where he studied literature and philosophy, and later was instructional editor at Golf magazine. He says he is club champion at Westchester Golf Club.

Later Mr. Aronstein joined Merrill Lynch as a retail salesman, a result of a lifelong fascination with the stock market. He didn't enjoy selling, however, so much as giving advice.

Robert Farrell, Merrill Lynch's best known forecaster, heard Mr. Aronstein give a speech to some clients and was impressed with his insights and knowledge of economic history. He hired him as an associate in 1980. Mr. Farrell also hired Mr. Salvigsen away from C.J. Lawrence. He later teamed them on investment strategy.

After several successful years at Merrill, they struck out on their own in 1986, adding Mr. Minter, a Merrill Lynch bond trader, to their roster.

Though Mr. Farrell says he believes residential real estate will lose its luster as an investment, he is not so pessimistic as Mr. Aronstein.

"I hear the hard-sell mortgage ads on the radio driving to work," says Mr. Aronstein, a confirmed renter. (Mr. Salvigsen and Mr. Minter own their homes.) "I guarantee that rationale for extending credit on this basis is exactly the same rationale for extending credit for all the other sectors that have blown up in the last five years."

PHOTO : MICHAEL ARONSTEIN hasn't made himself popular with his views.

PHOTO : THE VIEW IS DARK for bankers from where Michael Aronstein sits.

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