The Daily Reckoning PRESENTS
Puerto Rico is experiencing its own property boom...and as it is on the mainland, this boom is fueled mainly by cheap credit. Chris Mayer watches from the sidelines in Toa Alta, Puerto Rico...

“I used to drive out on the island...you could see the ocean and the beautiful views...and you could stop off one of the little restaurants along the way...enjoy a cold beer, a nice steak. Now, you see nothing but housing developments and the traffic is horrible.”

My grandfather was telling me about the changes in Puerto Rico over the last several years.

Puerto Rico is a Commonwealth - existing in the gray area of non-statehood, a sort of vassal in America’s empire, a prize in a long-forgotten war with Spain.

Puerto Ricans have voted many times before on the issue of statehood. The voting has been very close. So far, the status quo has won out. But the last election fiasco was eerily similar to the U.S. presidential election in 2000, with the Supreme Court of Puerto Rico casting the deciding votes, along party lines, that sent their man into office. Statehood lost its closest contest yet.

I’m confident that at some point in the not-too-distant future, Puerto Rico will join the Union as the 51st state.

Until then, it will continue to mirror the United States in other ways. Puerto Ricans seem to love SUVs and fancy cars as much as continental Americans. Consumerism is also in vogue, with retail chains such as Walgreen’s, J.C. Penney and Macy’s enjoying success here. Plus, nearly 70% of the island’s workers are employed in service industries.

And Puerto Ricans, too, have their own housing boom.

The economy of Puerto Rico is likely the region’s most dynamic economy. Nearly every major U.S. and European pharmaceutical company has significant operations on the island. Other companies and industries also find the island attractive for a host of reasons: the population is largely bilingual and educated; there are tax incentives to move operations to Puerto Rico; nearly 5 million tourists come here every year and spend more than $3 billion; and it is a bridge to the rest of Latin America.

In order to capitalize more on the island’s appeal, the government has spent more than $13 billion in the last 10 years improving the infrastructure. There is, for example, a new deep-water port, urban train, and coliseum; along with more common amenities like better signage and expressways.

My grandfather notes the passing of sugarcane fields and farming from the landscape. Instead, shopping malls, hotels, condominiums and auto malls are popping up all over the island. And new housing developments, too - sturdy cement houses painted in the pastel colors favored in the tropics, like cotton candy pink, lime green, sunflower yellow and sky blue.

Housing is in short supply and prices are rising. For years, Puerto Rico’s housing market reliably appreciated 5-10% per year. This year, the market is getting hotter. In 2005, the average sales price is about $311,000 - up nearly 16% from 2004.

The demand for residential loans is higher here than in the United States, after adjusting for population differences. Nearly 75% of Puerto Ricans own their own home.

It’s no wonder prices are rising. Population density is among the highest in the world, with nearly four million people living on an island of about 3,500 square miles. By some estimates there is a housing shortage, with 100,000 more units needed.

Still, as in the mainland United States, the housing bubble is also being fueled by cheap credit. Curiously, while late payments occur four times more often than on the mainland, Puerto Ricans are less likely to wind up in foreclosure.

As in the mainland, there is also cause for worry.

Doral Financial is the dominant mortgage company on the island, with 40 branches and $11 billion in assets.

This, from Doral Financial’s annual report:

“Borrowers use equity build-up as a means to consolidate high-cost consumer debt of credit cards [sic], auto loans and other types of credit.”

Basically, the islanders have succumbed to the temptation of using their home as an ATM machine - just like Americans.

Doral, by the way, enjoyed a stellar run over the last 10 years - riding the crest of Puerto Rican prosperity. Its stock price rose more than 8,000% from 1995 to its 2005 peak. That's an annualized return of about 56%.

In March of this year, the whole enterprise seemed to come apart at the seams. The stock was ripped in half, on news that the company was being overly aggressive with its derivative portfolio and would write off   hundreds of millions of dollars.

But the beating was just getting started. Downgrades from various analysts continued to push the stock lower. Then the credit agencies got in on the act, with Fitch downgrading the company as well. Eventually, the stock hit bottom under $10 per share, but has since rallied.

Today, however, I’m inclined to stay on the sidelines with housing - if not actively bet against it. My readers closed out a 53% gain in Countrywide last week, prospering from the mortgage giant’s deflating stock price.

When the housing bubble finally finds its pin, it will be like an ATM machine that no longer dispenses cash. That won’t be good for banks, homebuilders, credit card companies and a slew of other businesses that have, to date, prospered in the credit-induced revelry of the housing boom.

Freeman Tilden, in his book A World in Debt (published in 1935, but still a terrific read), described fortune as a “willful jade” that set about victimizing human beings, “especially debtors.”

Credit cycles turn, dear reader, and this one will turn also - both in the mainland United States and in the future 51st - and anywhere else easy money has left her unmistakable footprints.

Regards,

Chris Mayer
for The Daily Reckoning

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© 2005 Christopher W. Mayer
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Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of CrisisPoint Trader and Capital and Crisis - formerly the Fleet Street Letter.