Banker's Nightmare

I have been watching foreclosure.com for about 4 months and have been keeping track of the data for California.

Just for a lark, I decided to plot the data on semi-logarithmic graph paper. My thinking process revolved around the idea of what a banker would do to forecast for the future mortgage delinquency's and this looked like a pretty good start. If you're a banker, this has to be a graph that is hopefully flawed! If not, there is going to be some pain.

This graph plots the increasing foreclosures in the California market and the predicted future foreclosures. Three lines are drawn High, Middle and Low estimates based on data supplied. Double click on the graph for an enlarged view.




A few interesting notes. The total foreclosures for 7/29 was 3,384 (a data point I didn't use) and the figure for 9/1 was 3,060. 324 foreclosures disappeared. What we could be looking at here, are Notices of Default (NOD) being filed and as in say a bankruptcy, the bank accepts the deed in lieu of foreclosure. Bankruptcies do not necessarily generate a NOD but the banks acceptance of the property would probably cure the NOD.

What we cannot see in real time that the banker can, is how many people he has on their way to a NOD that he is aware of. We don't see the figures until the NOD is filed. If it's a bankruptcy, there just might not be a NOD.


So, back to the visual aid here, if you look at the middle of next June, we could be looking at about 23,000 foreclosures. This years total will probably be less than 8,000, but if we "trust" the graph, we are going to be in pain in June of next year.

The real issue here is, if the data assumptions are correct for June of 2007, this implies a banking crisis far greater than the Savings & Loan debacle of the 1990's.

Real Estate Musings

Everybody is familiar with the standard bell curve. That's what this little curve is all about. This is nothing scientific but rather a walk through some constructive thinking. This time, we choose to pick on real estate.

The values don't have to be quite right, its the concept that we are after. Notice that 50% of the real estate is classified as less than nice (ie Crappy to OK).



As a buyer, your interest will lie with the 50% to the right (nice to plush). In just generalizing, half of the market is really non existent. We could define "Real Crap"; as too old and run down, or gang neighborhood or an absurd asking price for say a 700 foot starter home. Nice could be defined as; "better than anything we have been shown before by this realtor," or brand new. Excellent could be defined as something we would like but cannot afford.

Just from reading the other blogs and comments, it looks as if its the "Nice" and the "Excellent homes are selling. My interpretation of this is that these people who are selling, are reducing their prices to accommodate the perspective buyer. Home builders top the list, and anybody that was lucky enough to buy before the tremendous price rise I would also include in this group.

Notice how sales in the right side of the bell curve would skew the "Median Home Sale Price," even higher when the seller is reducing his expected price (ie the sellers house was valued at 700k but they were willing to accept 600k) If the median price was 500k, you see that increase in a declining market.

So what are we looking at? 50% of the sellers on this bell curve have bought high and are stuck, you can't sell low. Considering the numbers, this is an awful lot of stressed real estate!

The banks or financial institutions that are holding the paper can see what has to transpire next, and it looks as if, "Maybe if we give it some more time, "Real estate could come back and save our ass!"

Loan writers are still cranking out the loans, fewer of them, but the game is still being played. Just where is the money coming from? Maybe from some GSE (government sponsored enterprise)--I wonder who could be buying the notes?

Stock Market Quirks

Back in 1987 crash there was a new phenomenon. Everyone that tried to call their discount broker couldn’t get through, the lines were busy. A lot of the new ownership of stock was held in Street Name, not in the buyer’s name. The difference here was that back in time, people took delivery of the stock certificate. The inconvenience of taking delivery meant that you might have to wait up to 4 weeks for receipt of the certificate. In today’s fast market that could be a drawback.

There was no problem walking into a full service broker that October day and handing them a certificate and telling them to sell it. If you were with a discount broker, you couldn’t get in the door, there was a line.

Let’s troll on to the present. A majority of people with a brokerage account today are online through the internet. Ask yourself one question. What would happen today if the market went south and everybody tried to logon and put in a sell order at the same time? I think we all get that question right. The difficult question would be; “What is the real trading price of your stock if everyone that wanted to sell could get on line and sell.” This is what happened in 1929, the market ticker was 6 hours behind actual trades. People were trading blind. The internet lockup might be a good thing, because in 1929 the market came back. So no action makes a lot of sense.

Enter the mutual fund manager with his computer program for trading the market. Let’s figure that between 1,000 and 8,000 mutual funds/Ira/etc decide to play. If you decide to not play, your fund gets valued by the other’s trading. It will be similar to your automatic sprinklers’ kicking on while you’re having an outdoor dinner party. Both events are planned, what happens isn’t.

In theory, 100 shares of IBM sold at market during a panic could have a real bid of 5 cents a share. That would net the seller 5 dollars. Don’t forget the 8 dollar discount brokerage fee. That sure beats the full service commission from a regular broker, doesn’t it!

Bankruptcy Vs Forclosure

If you cruze any of the other sites I have as favorites, you'll observe that a lot of the chatter is about home foreclosure's.

Click on this site Forclosures. Notice the foreclosure statistics and also the bankruptcy stats.

This is where it gets interesting. A reader pointed out something to me that I hadn't known about(his email):

One subject that is not getting covered in the press is the
inaccuracy of foreclosure statistics. This is because there are huge numbers of
"deeds in lieu of foreclosure" being taken in by lenders instead of foreclosures.

In a round about way, we are talking about bankruptcies and how lawyers handle them. It looks as if a bankruptcy lawyer goes to the bank and points out what is going to happen next (with regards to his client) and the Banker has only two options, take the deed in lieu of foreclosure or go the whole 10 yards the hard way. Notice that this circumvents the NOD (Notice of Default).

What we have here is a hell of a lot of bankruptcies, and it looks as if the NOD's will never be filed. The only conclusion you can draw from this, is that the banks are picking up a lot of real estate that is being missed by the bean counters.

Look at how much of what is happening, can be hidden from view. Neat Huh????

Absolute Prices

This is pretty much a non scientific but useful perspective of Price as viewed from the eyes of Joe Six pack.

The price of a new Car --------------1 years wages

The price of a new Home----------- 5 years wages (with two wage earners)

The price of a high end TV---------One months wages

The price of one ounce of Gold---- One weeks wages.



Notice that when you go through the list and try to mentally justify or discredit an item, you have to get to Joe Six pack's perceived level of income. It's different for each area of United States. But, you get the idea; there is a frame of reference for cost.

What we need to figure out is the inflation factor, which is well hidden. The prices that Joe Six pack has to pay seem to be rising. Is it time for gold and housing to drop in price, or is it time for Joe's wages to increase? We are at a point here, where we either get used to the new values or clamp down and say no to the increase in prices.

Is it going to be inflation or deflation? Most of us probably won't know until after the fact, but that table up above that I gave you at the start should still be valid.

The thing to be realized is that there will be a major change. I tend to believe that its deflation that we will be embracing. It will be a time where everyone is trying to sell assets to raise cash. The retail stores will have competition from their customers.

Sadly, it looks like desperation could be the factor that determines price in the new market. You won't be trading two, million dollar homes in Carlsbad for a hotel on the Riviera, it will be two Swiss watches for a tank of gas and 20 pounds of dog food. Louis Carrol mixed reality with dreams and ended up with "Alice in Wonderland," Berneke is going to mix Freddy and Fanny Mae, and end up with "Bankrupt in the US of A." It could be a best "dunner!"

Optimist be Damned

I guess if we examine everything, real estate has to come back, Lucent will rise back to $100 per share. And every one will retire rich and give scads of cash that is left over to the kids. The retiree's won't have to spend their own money, they have Social Security and Medicare/Medicaid to keep them from dipping into their cash reserves.

The Wizard of OZ was a great movie, but reality is a different creature. Something has gone wrong with the system and its probably going to "fix itself."

There are a lot of people out there that are stretched out to the max with one thought, "Hold on things have to get better."

The question that comes to my mind, is what will get better? Crime is down 25% in LA. What's that mean? The cop's aren't any better, there are less young people. So with less young people entering the work force, the unemployment rate drops.

Hey unemployment is low, ergo the economy must be doing good--WRONG! Actually from here in San Marcos, English is a second language at Taco Bell and other establishments. It looks like immigrants are filling the work slots because of the shortage of first time young people entering the work force.

So what happens next? Nobody that's young can afford to buy a house. Nobody American is around to fill the vacant job openings. Who's going to buy these homes priced at one half mill to one mill?

Right, reality is just around the corner, the trouble is, are you standing on the right corner?

The Low Bond Yield Conundrum

The bond market is at a point right now that leaves an awful lot of long bond holders (buyers of the 30 year) very vulnerable.

With the coming vaporization of the second trust deed market, there should be a scarcity of funds. Add to that, marking to market of foreclosed homes adds even more to this up and coming "enterprise." Seventeen interest rate increases by the fed and the long term rate comes out very little changed.

In Greenspans speech to Congress last year June 9, 2005 he is quoted:

Among the biggest surprises of the past year has been the pronounced decline in long-term interest rates on U.S. Treasury securities despite a 2-percentage-point increase in the federal funds rate. This is clearly without recent precedent. The yield on ten-year Treasury notes, currently at about 4 percent, is 80 basis points less than its level of a year ago. Moreover, even after the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period.

What it really boils down to is; there is a very large demand for long term bonds. More than the market can supply. Otherwise interest rates would rise to attract buyers (this is backwards, the price of the bond drops and that raises the interest rate). The Baby Boomers could be going to less risk in their portfolios. An insurance company locking in rates on an annuity for thirty years is a smart call.

Where it gets kinky, is the fact that everyone is loaning 30 year money at about par for the one year note. lets look at a 30 year bond issued today at say 5%

Value of Face amount-------interest rate--------interest paid
----$1,000,000-----------------5%-----------------$50,000

No problem with the investment, but if the interest rate went to 10%, the dynamics change. Now we have:

Value of face Amount-------interest rate--------interest paid
------$500,000------------------10%-----------------$50,000

What this shows, is that your market portfolio could, if marked to market have a haircut of 50 percent. Notice however, if you hold on to maturity, there is no "real" loss of principle. 30 years is a long time to wait if you are already 60 (I turned 60 yesterday).

The real pure play for the bond market is to buy when the market is at 10% and sell when it goes to 5%. That play, a reverse of the first example, would net a cool half million. This is where the money is made in the bond market.

The only thing that makes today a buying opportunity, is the belief that the interest rate will drop to 2.5%, this would double your bond portfolio's value, and it just ain't going to happen.

Another thing that Greenspan mentioned, that people were willing to accept more risk with less reward. Everything except Delta Airlines Bonds are trading as if they are US Treasury's (admittedly an exaggeration, but the rates commanded are rather unrealistic).

Its only a personal opinion, but I believe that we have a market running on the herd mentality of "If it works, go with the flow." At some point there will be a demand for funds that could raise the interest rate to quite a spectacular level, even if for a short period of time. It is at that point, that cash can buy into the bond market and make a killing.

A stock has to double to double your money. With a bond a 50% drop in the interest rate doubles your return. The thing to remember in a panic, it's like going into a pawn shop with a $10,000 wedding ring, you're not going to get list price or anywhere near it. You're are going to take what you can get according to how desperate you are for cash funds.

What you really have, is a mistake being made by retirement funds, that will take 30 years to come out even. Your clients only have 15 to 35 years to live. They just might need the money before the call date.

Problem? What Problem?

Thank goodness the election is over. I never could completely understand how this government could be run so poorly for 2 to 4 year spurts and nobody complains until a month before the election. And then it's like two kids arguing over whose fault it was. Both sides are blameless.

In the two party system, you are either a Republican or a Democrat. The irritating thing is that the other side is lying by implication. The only thing that a Congressman can't hide, are their alleged improprieties, like groping, fondling, or what ever. They still find the time to give away the candy store.

In the 1930's when Congress passed Social Security, 95% of the population never reached the age of 65. To paraphrase the law, "We're raising your taxes and we're going to spend it before you die at age 65.

Carry forward 50 years and now people are not dying on the old schedule. A while ago, the Congress decided to add Medicare. Now, you open up the paper and see the headline, "77 Million Baby Boomer's to retire in the next 20 years." The largess of Congress has boosted our retirement benefits from non existent to substantial.

Notice in the real world, how many retirement plans have dropped dead. Just pick an airline. General Motors could be next, but I get the feeling that they may have to wait in line.

You really have to marvel at the way our government can accomplish Social Security and Medicare together. Private medical insurance, if you are over 60, can really crimp your life style.

Everybody worries about Social Security going broke and that's a good thing. It keeps your mind off the bigger problem, Medicare and Medicaid. We've finally figured out how to make our children fund our retirement package and that's a good thing. Otherwise, the kids would probably spend their money foolishly, just as we did.

In a book review I was reading, they mention a humorous rhyme written on a bathroom wall in 1931, encountered by Andrew Mellon (Secretary of the Treasury): "Mellon pulled the whistle, Hoover rang the bell, Wall Street gave the signal, and the country went to hell."

Somehow, I get the feeling it will be different this time. Not only will we be able to read about it, we will experience it. Nothing beats a front row seat.

Real Estate, the Deer in the Headlights.

We can all be right in our assumptions. The key to that concept is that something can be true at one moment and false at the next. Notice everyone can be right, it just won't happen at the same moment.

Real estate fits into that concept. Everything you've ever heard about real estate can be true or false, right or wrong at any particular point in time. The bubble bloggers I believe, have correctly diagnosed the bubble, as very real at this point in time. What is not so apparent is the assumed collapse of the price structure of the housing market. Its not happening as fast as most would like it to happen. You hear the words "housing prices are sticky on the down side."

As you drive your car down the highway, due vigilance allows you to avoid accidents. But what happens if you are approaching another car head on in your lane going the wrong way? Both of you will take evasive action and swerve into the empty lane. Bang, you have a head on collision. So the point being, it takes at least two mistakes for a real accident.

The real estate market is not going to collapse on its own. Its a smoking gun. It points to impending issues. "Who financed all of this?" is a valid question, but the answer is really a moot point. The real question that needs to be answered is: "Who's going to pay for the clean up?" The sad part about that question, is that we know the answer to that question, don't we?

So here we get to the second to the last analogy. The real estate seller is like a deer in the headlights, he's not going to move (price wise) and he's probably going to get hurt in a falling market.

The other shoe still has to drop, what it will be I can only guess; Stock Market Crash, Fannie Mae Meltdown, or maybe an Earthquake. At this point, the real estate seller will begin to feel the pangs of panic.

An economics professor Nouriel Roubini got blown away in a 3 way TV interview last week on his assumption that we were in a recession. Here is a Link to his blog. The point being, is that he failed to mention that no one knows that they are in the beginning of a recession or depression until two years after the fact. Thats what really makes the home seller seem so much like the deer in the headlights.

Common Cents

Normally when you make a bad investment, you walk away from it and take the loss. But that can change, if the size of the investment is too big to walk away from. Your common sense thinking gets turned upside down.

When disaster strikes, there is the urgency to raise cash fast. In this sort of decision-making, you end up saving the crap for last. It doesn’t really sound rational, but there is the hope that the “dogs” will come back. So it appears that we have a lot of homeowners in this dilemma right now. Their situation is just now becoming obvious.

If we examine the group that holds the mortgages, it gets a little less visible. Large institutions can hide their problems just by being so big. Second, if the amounts of cash managed are large, the financial institution can use the cash to stall for time. It’s very easy to pretend that nothing is wrong. You will get caught, but probably just not this year.

Another thing that is quite invisible right now is embezzlement. Take an embezzler, he purloins the funds and the person bezzled, is none the wiser. In fact both can be at the same resort spending money, and having fun. The only difference is, the embezzler knows he's spending your money, while at the same time you think your money is safely tucked away. This can go on until the eventful day when cash demanded from the enterprise exceeds what they can cover. It's only at this point that the person embezzled will feel the pain. Knowledge will not only set you free, it can send your blood pressure into the stratosphere.

Notice that the perceive problem is the over extended homeowner. If you carry things forward, the rest of the systemic problems will become apparent. At that point, it will be too late. The assets will be non-existent.

We have yet to see a retirement fund under the stress that will be produced by the baby boomer’s retirement. There has been no real call for funds yet. Common sense suggests that the assumed assets are safely tucked away.

Q.E.D. The Tooth Fairy lives!!!

The Googleiots

Google, here is a company that if you thing about it, its whole infrastructure could be recreated for less than one billion dollars. All of the stock is valued at over 129 billion dollars.

It doesn't really make much money, because if it did, it would pay a dividend.

Creative accounting? Maybe, but where is the income stream? I really don't think that it is there.

What do you call these investors? If you combine the two words google and idiot, you get google-iots. Best spelling I can offer is Googleiots. This would be defined as a person who will buy anything on the hope that it goes up forever. There has to be an end to this outrageous price, it certainly doesn't seem to be in the reality of the present time. So I guess that it can be said that we are in the midsts of Googleiots trying to sell to the greater fool.

What is the stock really worth, about $8 bucks a share. A reality check tells you , that if you are buying toilet paper for $2,000 a roll, you will find a cheaper source for the purchase of toilet paper.

Who are the Sellers?

There are several groups of people that have real estate inventory for sale, contractors, real estate brokers, flippers, home owners and banks.

Who's going to offer you the best price? The builder probably has the most leeway on price, next the bank repo, then the real estate broker (flipper), next the investor (flipper) and then the homeowner.

Builders tend to know the market and if they need to discount, it’s going to be real.

Banks offering repo's would theoretically have a 20% discount of the property to break even, if the loan was an 80/20. The second trust deed would drop off.

Real Estate Brokers especially if they are named “Stretch,” will be more eager to sell you their property. They’re going to give you a good price (hell you already told them your bottom line). Flipping is a realtor's second job (only a 3% commission to pay). There are a lot of realtors holding inventory at this time.

Investment flippers have two areas of concentration: condos and detached houses. The Condo market is between a wish and a prayer and the regular house market isn't doing much better for price appreciation.

The regular homeowners are dropping prices in $10,000 increments. They know the rudimentary fundamentals of selling, but they are only a “garage sale retailer.” It’s their price or it isn’t for sale. Can you imagine a super market offering hot dogs on sale regularly $3.95 now only $3.85? They mise well be glued to the shelf. They are not going to move.

So who is really selling houses? The answer has to be the contractor! The machine works very efficiently.

The contractor can finance through limited partnerships. If the land is bought at a reasonable price, the LLP investor can expect a 20 to 50 percent return on the investment. Even in the worst market you can imagine, the contractor can undercut the home owner. There is a limit to that, and it’s around $80 dollars per square foot. I could be a little off on that, my figures are about 6 years old. So when the houses start selling for $80 per square foot and condos for $30 per square foot, the contractors will melt into the sunset as they did in Detroit. Who gets the houses if they don’t sell? Most probably the bank. Who wants the houses at this price, only the uninformed (they're easy to spot; there is no newspaper in their driveway in the morning).

So what do we have? We have home owners wanting to move and sell their house. We have builders building more houses; there is a profit to be made. The supply is increasing, but why buy an old home when you can buy a brand new one? (Colorado is in this scenario right now, the contractors are still building and inventory is going through the roof, and prices are very reasonable).

As long as used housing prices are sticky going down in price, the contractor is going to eat the home seller’s lunch, and laugh all the way to the you-know-what. What makes it interesting is that the banks can play both ends. They loan to the contractor and to the homeowner.

So the banker says “Belly up to the bar, HELOC's for everyone, and if you need money to build, just tell me where to mail the check!”

Then you have the homeowner, he’s already spent the equity in the house, his world of dreams is now a nightmare. His wife is packing up and ready to leave him.

The typical buyer is not going to buy that used house; they’re going to buy a brand new one from that contractor down the street.

The contractor is going to keep on building until housing prices drop to where he has no profit margin. His profits will tend to be real profits. On the other hand, the homeowner's prices tend to be from some dream hoping for a sense of reality. Equity created out of nothing.

The Roller Coaster is approaching the Top

Here's a financial news article from Friday:Link The Guardian Newspaper

20 years after London, NYSE has its Big Bang

Andrew Clark in New York
Friday October 6, 2006
The Guardian


The New York Stock Exchange will take its first step towards London-style electronic dealing today in the face of increasing international competition.

In a gradual transition, the NYSE is introducing a "hybrid market" allowing traders to buy and sell big chunks of stock at the touch of a button.

Its move is comparable to the London exchange's "Big Bang" in 1986 which led to the end of the City's trading floor - except that the Big Apple's changeover will be slower, more considered and, it is hoped, less likely to contribute to a crash akin to Black Monday in 1987.

Technology will vastly increase the NYSE's capacity. In a test on Saturday, more than 6bn shares changed hands in two hours - exceeding the exchange's record of 3.1bn for an entire day.

The changeover is nothing if not cautious. On the first day, just two stocks - American Express and Equity Office Properties Trust - will be traded under the new technology. In a gradual roll-out, all 3,600 listed companies will be included by December.

Previous electronic transactions at the NYSE were limited to small deals of 1,099 shares at a time. The new limit will be a million shares and a restriction of two trades a minute will be lifted.

Its certainly going to speed things up. The human element was like a braking mechanism. So we ought to be at full throttle by December with no emergency brake. The mutual fund traders with their star wars technology buy and sell programs will be matching wits with twits.

This could be as much fun as the automated bathrooms at Washington DC airport when the power went out. You couldn't flush a toilet, wash your hands or get a paper towel. It gives more meaning to the quote; "The road to hell is paved with good intension's."

The Non Existent Banking Crisis

Right now in California, there has been 3,855 houses that have been foreclosed on. Let's just round it up to 4,000 and figure that each loan is $500,000. So it's 4,000 times 500,000. Just count the zeros and multiply the whole numbers together. The answer is 20 with 8 zeros added to it. Two billion dollars of real estate is in default in California so far this year.

Its highly probable, that on the way to foreclosure, the owner has also maxed out their credit cards. Let's figure the amount owed on credit cards, for a family in this predicament, would probably range between $10,000 to $50,000. Here would be a real, on the books, banking loss of between 40 to 200 million dollars.

There have been 23,000 bankruptcies so far this year and about 49,000 pre-foreclosures. Here is a Link to the numbers I am quoting. If we figure that the 23,000 bankruptcy's have between $10,000 and $50,000 in credit card debt, that calculates out to between 230 million and 1.15 billion dollars of bad debt.

Speculate further, that about 4,000 of the 49,000 pre-foreclosures go into foreclosure. That's another two billion of real estate in default and of course another 40 to 200 million of bad credit card debt.

This leaves a range of between 310 million (20+20=230) to 1.5 billion (1.15+.2+.2) in bad credit card debt. If the banks can pull out 80% of their loan value on the 4 billion of real estate in foreclosure, then that would result in a loss of about 800 million.

The most optimistic numbers, would be 310 million in non collectible credit card debt and a zero loss on all real estate foreclosures (the Tooth Fairy lives!). The worse case for the banks would be 1.5 billion in credit card debt and close to 1 billion in real estate write offs.

This is kind of boring stuff, but remember, this is only one state, California. Visualize all 50 states together, now it begins to have some size and body.

One person in bankruptcy or foreclosure is not the end of the world. But a bank, with a couple hundred foreclosures and a lot of bad plastic, knows the reality of their problem right now, at this present time.

The first signs of fire in the movie theater will be after the end of the fiscal year for these banks, when they have to present their profit and loss statements.

As if things couldn't get worse, two trillion in bank loans are due to reset in the next 12 months. Here cometh the Anti-Tooth Fairy. So with the banks Federally insured (and you thought the Tooth Fairy was dead) the New Year could prove very distracting.

Kondratieff Wave Revisited

A while back, in May I covered the Kondratieff wave May8th Link and it seems to be more to the point as time goes by. Here is a link to a history lesson that's well worth reading.

The Kondratieff Wave

This gentleman's theories were published before the great depression in 1925. For those of you that don't click on the link, here is a quote from the above article dealing with the autumn just before the winter labeled Depression.

Excesses of an unpopular war, along with fiscal liberalism, cause popular reaction toward stability or normalcy. A mood of isolationism permeates . The plateau period generally lasts seven to ten years and is characterized by selective industry growth, development of new ideas ( both technological and social ) and a strong feelings of affluence, terminating in a feeling of euphoria. The inflated price structure from the primary recession, along with the desire for consumption, produces a rapid increase in debt. Eventually, wealth consumption expands beyond all practical limits, and economy slips into a severe and protracted depression.

These cycles tend to be about 60 to 70 years long. If you think about it, everyone that was about 30 years old during the last depression is no longer with us. The group memory of the past depression is gone and most of the financial shenanigans going on, are "new" in our mind's eye.

The point about perceiving a depression, is that its only visible in your rear view mirror. The investment trusts that collapsed in the 1930's smell a lot like the hedge funds of today.

The Perpetual Money Machine

Let's see the banks are paying 5 percent interest and our current inflation rate is around 4 percent. That gives us a ONE percent rate of return. That certainly isn't much incentive to save for a rainy day, especially if the inflation rate is higher than what the government states.

Interest rates are an indicator of money in the market looking for a borrower. The rates are high if there is a shortage of money to loan and low if nobody wants to borrow. Obviously the United States is floating in surplus bank funds. The Feds raised the interest rate 17 times and the 30 year bond hiccupped.

Another name for this surplus is DEBT.

Joe Six Pack bought the car, the plasma screen and put it on plastic. Let's say he's on the high side of 30k on his cards and he has no problem making the monthly payments. Here is where the bank can do the Fannie Mae routine.

(The following is pure conjecture on my part and could be way out in left field.)

The bank needs to reimburse the retail outlet in cash for the goods charged. Now bear in mind that the bank is getting 18% minimum on these loan amounts carried over 30 days. What better way to raise money than to package these borrowers like Fannie Mae does and sell them to some mutual fund. This way, everyone gets paid and the game can continue. It seems to me, if this was done right, the bank passes the bag to some other institution like a pension plan wanting 8 to 10 percent on their funds. These notes would be far from FDIC insured.


Everyone that needs to borrow is probably already maxed out and wouldn't qualify for more borrowing using a regular loan. But, if you're a bank, you give them a credit card. As long as the banks can issue credit cards, the game can continue. The minute that they stop issuing cards, the game would be over. The banks have monetized the debt and created a perpetual money machine. The more you charge the better it gets.

Bye for now from Left Field.

The Amaranth Fiasco

Looks like the Amaranth hedge fund is in deeper than it looks. Yesterday their losses were less than 3 billion. Now with their sale to J P Morgan Chase & Co and the hedge fund Citadel Investments, it looks closer to SIX BILLION!

As quoted from the Wall Street Journal:

As part of the deal, J.P. Morgan and Citadel could receive in the neighborhood of $2 billion of collateral that Amaranth had posted as margin on its various trades,

It gets stranger as you dig deeper.

As quoted from the San Diego Union Tribune:

Amaranth severely restricts investors' ability to cash in their holdings. Investors only can withdraw money on the anniversary of their investment and then only with 90 days' notice. If they try to withdraw at any point outside that time frame, they face a 2.5 percent penalty.

Even more Draconian, if investors redeem more than 7.5 percent of the fund's assets, Amaranth can refuse further withdrawals.

Then an article on the same page of the Tribune:

County pension may have lost millions in fund

The crash of the Amaranth hedge fund could have sizable repercussions for San Diego County's retirement system, which invested $175 million with Anaranth just last year.

The county retirement fund's losses could be as much as $45 million . . .

The retirement association already has terminated its agreement with Amaranth and is recalling its investment.

Here is a link to a previous post of mine on derivatives
Invisible Derivatives Market

The thing that I have been stressing, is that a lot of the money chasing the big returns could be retirement funds. That's where the big money is. If I'm right, its truly a sad time for a lot of people, this could get worse real fast.

A thirty two year old guy at Amaranth in a span of one week lost over 3 to 5 billion dollars.

Do you know who your retirement fund is sleeping with?

Final score: Amaranth ruined, San Diego County retirement caught in a compromising position

Truly an Ex-Lax moment!

The Interest Rate Spike

If you read today's paper, one of the largest hedge funds, Amaranth, took a 35% hit to assets. to the tune of 3 billion dollars. It only took a week. Most nightmares occur while you're asleep, this one is not going away when you wake up in the morning. Amaranth is selling corporate bonds to raise the cash.

What we are looking at here is the smell of smoke and its liable to get worse. Consider this a trial run for a date set in the future. Imagine all of the real estate second trust deeds going to zero and you can see a lot of hedge funds that have "insured" these "fine investments," out in the market trying to raise cash.

Step back for a minute and remember that the Feds sell a thirty year bond that's paying about 5%. Also most people are fully invested in something, house, stock market, gold, bonds. So, there is no liquidity for quick investment if you hold these assets.

Now picture the hedge funds starting to fall apart. Their objective is to raise cash. Sell assets like bonds and stocks. They need cash. Who has cash when the call for cash is quite large? At this point, the interest rate rises only because there are too many bonds at 5% for sale. Nobody wants them at that interest rate. Considering the potential losses in the second trust deed market, interest rates could spike to 20%.

So if interest rates were to hit 20% you could buy 30 year Treasury's at 25 cents on the dollar. $100,000 Treasury bond paying 5% could be bought for $25,000 in the ensuing panic. Remember, you have to have access to cash money to buy.

The damage and destruction would be over in a matter of weeks. From there, the bond market could be back to normal. So if the interest rate dropped back down to 5% the bond you purchased for $25,000 would now be worth $100,000 ---- a chance to quadruple your savings.

Sound far fetched? History doesn't quite repeat itself. Are you ready for the ride? ---The ride that will be "different this time?"

Cash will be King. For how long is anyone's guess. Are you ready for it?

Real Estate, Its Getting Worse

My sister and her husband have been selling real estate in Colorado very successfully for the last 10 years. Now, this year, between the two of them, one sale so far this year, and that's it.

Colorado is not in the big player market, we are talking 150k to 200k per house. Foreclosures are at a record high level.

Now travel to California and look at houses in San Marcos for $800,000. You can rent them from $1800 to $2400 per month. If you bought a house at $800,000, and make $60,000 a year, then you're in a world of hurt. Your problems get worse when filing for bankruptcy and you have to show the documentation for your "No Doc Loan."

Well, all I can say, is that the warm and fuzzy feeling isn't so warm and fuzzy for a lot of people. The fuzzy part is getting fuzzier!

My Neighborhood is Weirding Out!

I was driving home from the supermarket Saturday afternoon. Couldn't believe all of the sign wavers. Here is three in a group on Mission and Las Posas. On the last mile to my house, I must have passed eight sign twirlers on various corners of Las Posas Avenue alone.




There are a lot of for sale signs in our area. This one seemed to go the extra mile. The newspapers stacked in the driveway didn't photograph very well. To be fair, there is a "Sale Pending" on the sign. I can't figure out why the recent addition of the garage banner and the "Reduced" sign if thats the case.





The neighbor a few doors down recently "harvested" his lawn. It could have been winter wheat. He probably cut the lawn so you could see the "For Rent" sign. At first it had $1895 per month, then a week later it went to $2295 per month. Last week it went for $790 for a room (master bedroom with own bath). The signs gone so I guess the owner has someone living in his master bedroom.

Things that go Bump in the Night

These are things that can keep you awake at night.

Ever heard of a big mutual fund going bankrupt? Even if you haven't, do you know the name of the one you own?

What happens when the baby boomers retire and ask for their money, is it there? It doesn't have to be there. They haven't asked for it (yet)! Your fund manager could be on his second tour around the world on his (yours technically) private yacht.

Ever heard of a retirement fund insured by the FDIC? Does it matter? They don't insure investment losses anyway.

After 34 pretty good years, isn't the stock market due for a 5 to 10 year downward slide?

Why would the big boys be buying 30 year bonds for less that the 5 year bonds--how much lower can interest rates go before you say, spend it, inflation will eat it up?

How can a hurricane triple insurance rates in Florida, but yet the threat of a housing collapse has inverted the interest yield curve?

An ad on the radio today advertises 5.9% fixed for 30 years 1.2 million limit, no income verification. Is this your retirement income in action?

How can Fannie Mae package a ton of junk and have no problem selling it? Nobody mentioned that "Risk had left the market."

There is a shoe ready to DROP, not sure what it will be, but it WILL go BUMP in the night.

The Interest Rate Squeeze

There is a lot being said about the real estate bubble and whether or not it has popped. The issue here, is the sellers. They don't want to loose any money on a real estate sales transaction and\or want that dream price they saw last year ("In their hearts, they know they deserve it!")

So if they still have their job and have say 5 credit cards, there is no real problem with the mortgage. $50,000 in credit available ($10,000 per card) gives them one to two years to ride out the popping bubble. Then figure another 9 months for the bank to foreclose in the worst case scenario.

Up to now, people have been refinancing and paying off their credit cards with cheaper home equity line of credit money (HELOC). Here is where it gets interesting. The credit card companies advance more credit to more people. Then, there is a need for additional capital. This call for capital will result in lenders offering more interest for deposit money. Bank credit card loans are currently returning %18. Ever notice how those rates are listed as Prime plus some number? Raising the prime would be considered a "happy event" for the banks. I can see Bernanke biting into that credit bubble--go get 'em Ben, the banks will love you!

I'd like to see Master Card package a million in debt and turn it over to Fannie Mae for cash (the way the banks do with real estate)(my attempt at a very absurd train of thought).

The real estate cash infusion into our markets, spawned by Fannie Mae refunding, is drying up. The need for new additional capital to keep the ball rolling, will be have to be created in part, by increased interest rates. Where this new money is to come from, is the real question, we're all tapped out.

Famous Quotes from the Past

Here is something that I ran across that seems like a parallel to todays mindset.

This is a link to the site: http://www.gold-eagle.com/editorials_01/seymour062001.html

Begin Copied Material:

1927-1933 Chart of Pompous Prognosticators





1. "We will not have any more crashes in our time."
- John Maynard Keynes in 1927

2. "I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future."
- E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928

"There will be no interruption of our permanent prosperity."
- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928


3. "No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment...and the highest record of years of prosperity. In the foreign field there is peace, the goodwill which comes from mutual understanding."
- Calvin Coolidge December 4, 1928

4. "There may be a recession in stock prices, but not anything in the nature of a crash."
- Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929

5. "Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months."
- Irving Fisher, Ph.D. in economics, Oct. 17, 1929

"This crash is not going to have much effect on business."
- Arthur Reynolds, Chairman of Continental Illinois Bank of Chicago, October 24, 1929

"There will be no repetition of the break of yesterday... I have no fear of another comparable decline."
- Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929

"We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices."
- Goodbody and Company market-letter quoted in The New York Times, Friday, October 25, 1929


6. "This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan... that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years."
- R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929

"Buying of sound, seasoned issues now will not be regretted"
- E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

"Some pretty intelligent people are now buying stocks... Unless we are to have a panic -- which no one seriously believes, stocks have hit bottom."
- R. W. McNeal, financial analyst in October 1929


7. "The decline is in paper values, not in tangible goods and services...America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin."
- Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929
"Hysteria has now disappeared from Wall Street."
- The Times of London, November 2, 1929

"The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."
- Business Week, November 2, 1929

"...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation..."
- Harvard Economic Society (HES), November 2, 1929


8. "... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall."
- HES, November 10, 1929

"The end of the decline of the Stock Market will probably not be long, only a few more days at most."
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929

"In most of the cities and towns of this country, this Wall Street panic will have no effect."
- Paul Block (President of the Block newspaper chain), editorial, November 15, 1929

"Financial storm definitely passed."
- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929


9. "I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress."
- Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929
"I am convinced that through these measures we have reestablished confidence."
- Herbert Hoover, December 1929

"[1930 will be] a splendid employment year."
- U.S. Dept. of Labor, New Year's Forecast, December 1929


10. "For the immediate future, at least, the outlook (stocks) is bright."
- Irving Fisher, Ph.D. in Economics, in early 1930

11. "...there are indications that the severest phase of the recession is over..."
- Harvard Economic Society (HES) Jan 18, 1930

12. "There is nothing in the situation to be disturbed about."
- Secretary of the Treasury Andrew Mellon, Feb 1930

13. "The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
- Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930
"... the outlook continues favorable..."
- HES Mar 29, 1930


14 "... the outlook is favorable..."
- HES Apr 19, 1930

15. "While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us."
- Herbert Hoover, President of the United States, May 1, 1930
"...by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..."
- HES May 17, 1930

"Gentleman, you have come sixty days too late. The depression is over."
- Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930


16. "... irregular and conflicting movements of business should soon give way to a sustained recovery..."
- HES June 28, 1930

17. "... the present depression has about spent its force..."
- HES, Aug 30, 1930

18. "We are now near the end of the declining phase of the depression."
- HES Nov 15, 1930

19. "Stabilization at [present] levels is clearly possible."
- HES Oct 31, 1931

20. "All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
- President F.D. Roosevelt, 1933

End Copied Material


Quotes #5 and #8 are very famous remarks by Irving Fisher, who at the time was managing the Yale endowment funds. It didn't go well from there.

These were very intelligent people back in their time. Their thoughts on what would happen next were way off the mark. What was said, sounded good and was reassuring.

It leaves a lot of doubt about what you can take for granted in todays newspapers

Note, quote 20 refers to the fact that it became illegal to own gold as an American citizen. The government was making sure no one was holding out on them. You had to trade your gold in for currency. This was FDR's way of keeping everyone honest--government excluded.

Deflation or Inflation?

Right now our government is balanced on a swords edge, fall one way and its a major depression. Fall the other way, and its hyperinflation.

The motivating force to hyper inflation, is that the Congress wants to get reelected. It has to deliver more and it is in a bind to do so, so they have to cheat. Its very easy to pay for health care costs with printed money, its very hard to tax and raise it at this time, the amount needed is more than is being taken in.

The fixed cost for social security is increasing and if you figure in medical costs, you get numbers that are out of whack. A heart bypass is $50,000. How many people have contributed over $50,000 total into social security?

Now if you figure that there is a 12 trillion dollar real estate bubble out there and it is funded by private institutions (Mutual Funds or what ever you call your retirement fund), you now begin to see the size of the problem.

The losses cannot be guaranteed to be paid by Congress, I fear they are way too large. The problem at this point in time is, that we are looking into a dilemma, which way will it go?

The Man who lived through 1929

Let's go back and picture a man from the 1929 era. He would have been born about 1890 and been about 40 at the time. His world had gone from horse and buggy to the automobile. Between 1908 and 1927 Ford had produced 15,000,000 model T's. In 1904 there were three million telephones, by 1915 you could call coast to coast (the cost was prohibitive). By 1906, the electric light bulb was commercially feasible to produce. Radio came into its own in the 1920's. By 1924 there were 3 million radios in use in the US. The airplane had come on line. It was used to speed up mail delivery; commercial aviation was still a few years away. Technology had turned his life into something new and different.

The banks were loaning money out, 100% financing, interest only, 5 year loans that had to be refinanced at the end of the term. Also, you could borrow any amount you desired from your stock broker just pay the interest. Buying stocks on margin (10% down) was the name of the game.

Another thing to come of age, was installment buying. GMAC was created in 1919 to help sell more cars, and it did just that. There had been a stigma attached to not paying cash and through advertising, it became more acceptable. By the eve of the great depression, it had become a way to acquire the American Dream. You didn't have to wait and save up for what you wanted, you could have it now.

From 1915 to 1930 we had been transitioning from an agrarian economy to a more industrialized economy. Technology had changed our way of life without any perceived realization of it by the general population. A farmer was 10 times more productive with modern machinery. Agricultural prices were dropping because of this over supply. The speculation that had been going on in farm land was unsustainable. A bigger farm did not increase your return on investment, just the opposite.

Things started to go bad in 1926 with the Florida Hurricane, land speculation lost its appeal (severe understatement). Then in June of 1928 there was a mini stock market crash, a precursor to the big one. In October of 1929 the big crash came and "rearranged" the financial markets. In 1930 Congress passed The Smoot-Hawley Tariff Act, which some claim was responsible for the unemployment rate climbing to 25% (over the next two years). Bank failures started to be a problem in 1929 only to get worse in 1930, 1,352 banks failed. In 1931, 2,294 banks bit the dust.

So what happened to our gentleman? If he had a 5 year I/O loan that was due for renewal, it wasn't renewed; the bank wanted and needed the cash. Result, the bank got the house. He stood a 1 in 4 chance of being unemployed. If his bank had failed, he might have no savings left. Anything bought on installment might have to be returned or a payment made on it.

He probably survived with memories of the rough times he had. People from that generation were seasoned with these memories. They acted differently as so to avoid making the same mistakes over again.

Today, in the world of 2006, the "group memory" of these people is no longer with us. Are we destined to make the same mistakes as they did so long ago?

The evolution of the Internet is comparable to Radio of that time. And Google stock isn't quite as high as RCA's stock got to, before the crash. Then, there was the installment buying and interest only loans of the 1920's, verses the credit card of today and the same old loan formula (use their money not mine).

Almost sounds like an eerie episode of The Twilight Zone, doesn't it?

What Happens Next?

Let’s say housing hits 50,000 units for sale in San Diego. What happens next?

At some point, we have second trust deed holders going ga ga. Then we have the trust deed market increasing in trustee sales. At that point, we will see REO's with 20% drops in purchase price offered for sale.

This is where things get dicey in stage two. You want to sell your house because you can't make the payment and there is an REO down the block $150,000 less that what you are selling for. Well it isn’t going to sell! So you go to the bank and get a "been there, done that, routine."

What happens next? The buyer walks or declares bankruptcy. If you walk, that means that other than the house, your financial state is not bad.

From here, its conjecture on my part. Bankruptcy should give you a few more months in the house, but from what I’ve read, that’s a false assumption. But either way, credit card consumption would continue, and lets face it, if you are going down, go down in style. Get the root canal done, the crown, dental bridge, tummy tuck and breast augmentation. Use your imagination; your card has instant pleasure at your beck and call.

Ask yourself one question, “Why would a lender loan money to just about anyone?” Could it be the easy monthly payment? It couldn’t be the FICO score under 400 could it? The answer to that question could be yes—hey we can charge 26% interest on this turkey, go for it.

So let’s see if we’ve got this right, the strapped homeowner needs something, he has to use his credit card at 26% interest because of a missed house payment. The question arises, at what point is the individuals credit card balance so far out of whack that the lending institution has to throw in the towel. I personally think that they keep raising the bar. Otherwise, as a lender you would have to confront the issue

Credit Bubble? Not on your life (if you issue credit cards).

“Hold on tight, it’s only a bump,” said a crew member of the Titanic.

I personally think that its the retirement assets of a nation that will go down the drain. I sincerely hope that I am wrong.

The Unseen Bubble

All the media is now talking about the housing bubble. They've got it wrong, it's really not the big issue. But if you want to miss the forest because of the trees, you're about to become a victim.

I was listening to a radio ad yesterday, "Have bad credit, a bankruptcy coming up or a FICO score under 500 and need to refinance, call 1-800-***-loan." They were offering up to 1/2 million at 7.4 APR, with a real nice intro rate for 2 years.

Let's combine the two ideas and elaborate a little. Housing bubble, the homeowners ATM machine has bit the dust, no more free money from equity. So you have bad credit, no problem here's a 1/2 million dollar loan, sign on the bottom line. What we have is a Credit Bubble of monster proportions.

The bubble is starting to unwind. Ford is cutting back production 25%. Boeing is going to lay off 6,000 workers. GM did it all already. Housing bubble you say, it doesn't really matter if you have lost your job. It makes the Realtors statement ring so hollow, "The house interest is deductible from your taxable income." Subtract it from what, when you're unemployed.

See the post from last week Life is Becoming more Difficult

It seems as if credit consumption has kept the economy moving with the appearance of growth. It is this credit consumption that has to be paid for in the future.

The credit bubble is still growing, just go to your mail box and count the credit card applications. The housing bubble points directly at the Credit Bubble. If you can fog a mirror and can sign your name, you can have it NOW!

If people start tightening their belts, consumption will fall faster than it normally would. Unemployment will make it worse. The major gripe of people about to be laid off at Boeing, was, "I'm too old to find another job that pays this good." I didn't even touch on the loss of health insurance.

It's all downhill from heeeeeeeeeeeeeeerrrrrrreeeee. Set back and enjoy the ride, your neighbor's credit fling paid for it (using your retirement savings).

Credit Card Debt

Let's go back to 1971 when I was young. Just out of college and I did not have a credit card. I also had no credit experience as far a Master Card and Visa was concerned so they wouldn't issue me a card. I had always paid cash. The only way to build your credit was to go out and buy something on the installment plan at some local store charging 18-36% interest. So I financed a microwave oven for $400--easy monthly payments of $60 per month. After 8 months of paying, I qualified for a Master Card. The card arrived two weeks after I was laid off from my job. Admittedly I used it as a tool and it got me through some rough times where I need 30 or 60 days until my unemployment check came. At that point in my life I took a risk and purchased a lawn mower with the card and started a successful lawn care business.

Fast forward to today, I still use a credit card. Its an easy way to purchase on line. Its also very nice if your doubtful of the stores return policy. If I Visa and item and they won't refund my money, it costs them $40 to dispute my claim. Notice one thing, its used as a tool not as an extension of my future earning power. I pay it off every month.

From here, it is only a short step to start using it as a creature comfort I-need-it-now card. There are many things at work here with this mind set. First the person has been trained to look at the paycheck and how much they can afford in monthly payments. If the house payment is $1500 and they have $600 left over, then the $300 dollar car payment fits in, $200 insurance and $75 utilities. No sweat on the $2,000 Visa card payment--send them $25. Second, they are living from month to month. Anybody doing that needs to sit down and figure a way out of that, you are at a dead end. Third if you are married, its a very uncomfortable life to live, arguing over what to purchase with what little money you have left, with your spouse.

I get very irritated by a TV ad on the radio every day about some worker meant to sound uneducated, telling how this company was able to sell him a $2000 flat screen and not charge him the $500 to mount it to his wall. This is a well rehearsed ad not something spontaneous--its two people reading a script--great acting. Its meant to get you down there and sign on the bottom line. If you are breathing, they want to sell you a flat screen TV. They don't give a damn about what it will do to your family and finances.

Of course it can be played the other way, my stepmother who is about 75 has about 6 credit cards that she got while my dad was still alive. I imagine that she is into the banks for over $100,000. She use to do a phone cash advance transfer from one account to another to make a minimum payment without having to pay a late penalty (its an extra $27 to do a phone transfer). I wish her well.

So where are we? We are between Visa and Master card, at the corner of Walk and Don't Walk. I don't see either credit card company surviving this mess. Chase Manhattan Bank is the bank that my step mother loves so we know who's first in line.

Go ahead buy the flat panel wide screen, YOU DESERVE IT!--miss one payment and PAY FOR THE REST OF YOUR LIFE. Sign on the dotted line. Its painless (I'm lying).

Taxation and Our Government

Every day you hear some Congressman talking about taxing the rich, and more welfare reform for the poor. If we go back in history to the times of Rome and Greece, every male owed one month of labor to the state. The state did not classify people as poor. You either came up with someone to work for you or you did the month of labor.

Now lets advance several thousand years. Today in the US, we have the rich, the middle class, and the poor. We know the poor don't pay much in taxes. The middle class is the real bread winner for the government. Then we have the rich. They don't really have to pay taxes either. Once you make the money, you can't be taxed on it a second time. We do have people that make over $100,000 a year working two and three jobs with the wife's wages added in, and these people are considered the rich that need to be taxed, neat huh?

Now here is where we get into the tax structure with an item called real estate taxes. Real Estate is visible wealth and is taxed as such. So if your house value triples in price, your house taxes also jump--California is an exception. Prop 13 limited the increase to a small yearly amount based on purchase price.Thats little consolation if you bought in the last two years. Notice that it is the Want-To-Be-Rich group of home owners that pay a disproportional part of their income in real estate taxes. And hey its all tax deductible. But loose your job and have no income, deduct it from what?

Now let the economic slowdown begin. Back in the 1920's local governments had been spending their new found wealth. Then in the 30's with the collapse of housing, the tax base for local communities collapsed. Schools closed because they couldn't meet the payroll. Here is a quote from The Great Depression pg. 93 by David Shannon

People never enjoy paying taxes. With the lower incomes of the depression came widespread demand for retrenchment and lower local taxes. Indeed, many citizens and property owners were quite unable to pay their taxes at all.
Since a large part of the revenues of local government is spent for public education, it was perhaps inevitable that the tax crisis should produce cutbacks in the schools. Many communities decreased their school spending severely. In effect, they passed the burden on to the teachers, the students, or both.

So we have the rich, the middle class, and the poor. The only ones that have lost their way, are the middle class. These are the people about to enter a new world, called bankruptcy.

Another compounding factor back in the 1930's was the legislative stupidity that figured "If you raise taxes and fees, it will bring in more income." Well, to their surprise it brought in less. I see examples of this same mentality in California today all around. Can you imagine a young driver running a photo street light having to pay $380 fine--Why not skip town and leave the State? My wife got caught, and she paid the fine, but there are a lot of people out there that this could result in a major change in their way of life.

Remember Economics 101. If you double the tax rate, you don't double the amount of taxes collected. The amount collected will be considerably less than what you previously collected before you doubled them. Unfortunately, intelligence is not a prerequisite when running for public office.

Life is becoming more Difficult.

Its not hard to realize that the economy is starting to deteriorate at a more pronounced level. People are being laid off around the country, companies are downsizing, and the cost of energy is rising to stressful levels.

Right now we have hundreds of analogies about the state of the economy that relate to canaries in coal mines. All I can surmise is that they are selling a lot of imaginary canary gas masks.

What we have to look at here, is the "credit card looting" going on. If you know that you are about to loose your house to the bank, it makes sense to run up the credit cards--bankruptcy then foreclosure and you start over.

What is really laughable, is the credit card CEO's thinking that this is just an anomaly. Lets look back at 1930's

"The average person began to spend less for consumer goods, although for a while this fact was hidden by an increase in buying on the installment plan. When hard times came, this merely aggravated the situation since families could not find the money to pay the installment collector.

Quoted from "The Thirties" by Fon W. Boardman Jr 1967

I shredded two more credit card applications that I received in the mail this week, so I guess that the party isn't over yet. Let the good times roll.

Bernanke, The Mouse that Couldn't Roar

There is another interesting interest rate hike coming up this week and all of the pundit's are discussing its ramifications. The argument revolves around whether it will be bad or good for the economy.

What we are talking about is the Federal funds rate on overnight loans to banks. When the Fed funds rate was 1%, banks lined up at the window for almost free money loans. Now with the rate at 5.25 there are no lines at that window.

They have raised this rate 17 times and the 30 year bond has yet to jump a full point. In fact the 3 year bond dropped to a 4.85% interest rate. The three month treasury is at 5.13% interest and the 30 year is at 5%.



Every financial want-to-be or is-a-be floats around waiting for what Bernanke is about to do or say. The fact is, that when the Fed rate exceeded the bond rate, it no longer mattered how high they raise the rates. If the cheapest price is at Walmart, you buy at Walmart and the Fed right now is no Walmart.

The Fed figures that they have some sort of John Wayne swagger effect. Its just not there. If Bernanke walks into the bar, China is going to tell him to raise his hand for permission if he wants to use the bathroom.

What we are looking at here is an entity that at one time was very powerful. But in the computer age, a mouse click can circumvent anything that Berneke can attempt to control. With everything computerized, the overnight Fed funds rate doesn't really come in to play much. The banks have it pretty well sorted out.

What we are really looking at is a man going through the motions of, "I am in control, have faith and I will get you through this mess." No one out there will challenge his ability to push on a string. With that said, I believe that everyone in Wall Street will ride the ride, on his say so.
So what happens from here? Bernanke either raises the rates or he doesn't and the people on Wall Street will salute this guy as the new god of finance.

Doesn't really make much cents does it? If Bernanke raised rates to an absurd level of say 20% it wouldn't change the 30 year bond rate, but at that point, it would be very obvious that the Fed was no longer in the loop. The reason that they are no longer as effective, is because they are just a small part the very large global market.

Where does Bernenke fit in? He is being groomed to be the scape goat for the coming mess. Its pretty obvious that one is going to be needed soon.

Mortgage Market Meltdown

Lets look at an organization named Fannie Mae. Picture it as a 4 x 4 x 4 foot black box with the words Fanny Mae printed in white on it. Envision Mr. or Ms. "Mortgage Market" dropping into the box all of their 80% finance loans and when the box gets to $1 million it spits out an investment certificate for 1 million paying 5%, face amount guaranteed, which is purchased by Mr. or Ms. "Unknown Entity," AKA "mark" or "sucker."

The little black box is a great transformer and redistributer of debt. Nobody wanted to touch that crap until they built the little black box. By God everyone is entitled to the American dream of home ownership rah! rah! rah!

So we have this box and the question arises, "What the hell do they do inside that box?" My guess--absolutely nothing.

There is really no problem with the design model aspect of the black box. It will perform within its parameters. After all its rather absurd to have a market drop 20% isn't it? (Believe that, and I have a bridge to sell you). What is not realized is that the market can drop 50 to 70 percent. In this scenario, the little black box fails to function as expected. It doesn't have the funds necessary to back the claims it made in the past. What funds does it have for back up of bad loans? My guess, is none. Say you need one or two trillion dollars to back up the investors who bought these certificates---total tax collections for the US of A is about 1 trillion a year. Sounds like someone is going to get short sheeted!

The question arises who's holding all of the crap and who is going to get burned?

My guess is mutual funds and IRA's and I could be wrong.

Investing for Success

The word "Investing," is thrown around by everyone and more or less implies some form of sophistication on the part of the user. Invest in gold, invest in real estate, invest in the stock market, you hear these phrases every day.

Now lets examine another word; "speculation." Speculation is like betting on the horse races, and pays well if you are right. You stand to loose it all if you're wrong.

Now when you invest, you get "a" return on your money and "the" return of your money over a certain time span.

The thing you need to consider about an investment is the rule of 72. Divide the interest rate into 72. A bank paying 5% interest would result in your money doubling every 14.4 years. Not a very good return, but you have fast access to your funds.

Investment real estate is and even better one if you can purchase the rental for 100 times the monthly rent payment (very unlikely here in San Marcos). So if the rent is $800 per month, a purchase price of $80,000 would be a moneymaker. In this example the bank would give you a loan if you put down 20%. Your original investment of $20,000 after you pay off the mortgage would give you $10,000 a year in retirement income. Not to mention a hedge on inflation a tax deduction, and 5 to 1 leverage with bank money.

Stocks used to be a good investment; they paid a 3% to 6% dividend. Its hard to find one that even pays a dividend today. Which brings up a pivotal point an asset can change from an investment to a form of speculation. Housing in our area is purely speculation, nobody is buying rental real estate.

You could start a business or whatever, "Invest in yourself," is a great credo.

The true test of your investment is that it provides a consistent yearly return. So if someone comes up to me and says they are investing in the stock market or real estate, I know what they expect to accomplish but in reality, they are at the two dollar window betting on the daily double.

My portfolio has 10% in pure speculation. I buy what everyone else is selling. Also at the other end of being conservative, I have 10% in gold and silver and I don't even consider it an investment. It is an emergency form of cash. I bought $1,000 worth of 50 cent pieces back in 1985 for $3,500--it probably worth $12,000 today. Trying to store 63 pounds of silver in a safety deposit box is a real joke and a certified pain in the butt especially if you change banks. Gold is a little easier to store. Neither one of them returns any interest, so all you get in return, is true purchasing value in the future. That leaves 80% of your assets to be invested.

And at this point you need to stop and ask yourself one question, do I have the time to research and invest for my future? If you answer "no" you don't have the time, you are in a world of hurt. Your last few years in a rest home with the words running through your mind, "if I had only spent more time managing my money," is a hell of a way to review your life.

Right now real estate is a very poor investment. Stocks don't pay any dividend, it like giving an interest free loan to the kids--you might get it back. The banks are paying 5% which is not something to really get excited about. So where to we go from here?

As a 10% value of your portfolio investment, I suggest gold and silver. Gold could be fairly valued at $13,000 an ounce if valued at 1932 prices and as backing of the US dollar (we know that is not going to happen). Silver, the 100 oz Englehart bars make very decorative door stops. Just don't go whacko--10% and stop there.

From here, you ask the question what's a good investment at this time? The answer is, there aren't any. It sounds strange, but with real estate collapsing, the stock market paying no dividends and the interest rate so low, we have to wait. Something is about to happen, what it will be is anybody's guess. A little patience, say a year wait, should see opportunity knocking. Patience is a virtue

Are We There Yet?

If you study the depression of the 1930's, you will find it defined by events like the stock market crash of 1929. But the realization of the concept "This is a depression," didn't become apparent until late 1930 and 1931.

The truth was, foreign commerce was taking away American jobs in the farm sector as early as 1922, the Smoot Hawley Tariff got passed June of 1930 was addressing those problems.

Add to that, the housing boom had started to fizzle in 1928 after the hurricane in Sept 1928 that wrecked Florida's real estate market.

These were major items, but the individual investor had no idea of his perspective to all of these irrelevant events.

Here is a quote from a book on the depression; Quoted from “The Thirties America and the Great Depression” c1967,by Fon W. Boardman, Jr. page 26

Perhaps most ominous of all was the increase in bank failures. In 1929, 659 American banks had failed: in 1930 the number rose to 1,352, and in 1931 to 2,294. Just before Christmas, 1930, the Bank of the United States in New York City collapsed. It had 400,000 depositors, many of them recent immigrants, and its failure, the worst in the country’s history, affected a third of all the people of the city. A bank panic in the Middle South closed 129 banks. As usual, people began to withdraw their money and it is estimated that by 1931 they had taken $1,000,000,000 from the care of the bankers and had hidden it away in everything from safe deposit boxes to old mattresses. And just at the time when the people were losing jobs and money, states and other governmental units imposed new taxes to make up for declining revenues from other sources. Thus the depression was chiefly responsible for the introduction of the sales tax, Kentucky being the first state to have one, in 1930. Other states and cities followed suit.

Whats the prognosis? I believe that there are still two years to go before there is a consensus of opinions that we are in a major depression. Its not that we cannot read the road signs. Everyone in the lifeboat must feel the burden of doom before the perspective of reality hits home and survival mode kicks in.

The people that survive this up and coming event, will be marching to a different drummer.

San Marcos Real Estate Statistics are off!

I normally don't cut and paste other peoples current new stories, but this one deserves merit. It's a better worded summary of what I've been suggesting about the current state of the housing market.

Link to web site: Prleap.com

Begin Article

Top San Diego real estate broker says San Diego's home prices are off FIVE TIMES the offical data!

(PRLEAP.COM) Bob Schwartz, a Certified Residential Specialist with www.brokerforyou.com in San Diego California says the recently released ‘official’ 1% drop in June home prices for San Diego is in reality approximately five times that figure! Bob explains his findings as follows:

Reviewing the recently released real estate sales data for San Diego, the lay person might conclude that the June home appreciation figures were down approximately 1% as compared to June 2005. The reality is the decline is probably much closer to three or five times the published figures!

The reasons for this are really quite apparent when one considers the following facts:

1. The appreciation figures cited are the MEDIAN sales prices. The upper-end, luxury home market has been extremely strong in Southern California and is relatively immune to increasing interest rates. It operates totally apart from the rest of the real estate market. The sales of these upper-end luxury estates skew the MEDIAN appreciation sales data.

A far more accurate figure would be the AVERAGE sales price. Alternatively, data should exclude, or make million dollar plus sales a separate category.

2. The reported sales data does NOT take into consideration incentives used by not only major builders, but, in today’s market the majority of home sellers, to entice scarce buyers to purchase their properties.

Just open up the Sunday real estate section of your local paper and the magnitude of these incentives becomes quite apparent. Just a few incentives I noted in my July 23, 2005 paper: $15,000 closing cost credit and $25,000 towards an interest rate buy down or upgrades; $50K to help pay your mortgage; seller pays interest portion of your new loan payment for first 6 months, all non-recurring closing costs, plus 12 months of HOA fees. I could go on, but, you must understand that the builders are not being altruistic. No, they just want to move standing inventory, and move it now before any further declines!

While on the subject of builder incentives, it was just a little over a year ago that the majority of builders were not even co-operating with real estate agents. Now, the builder/agent cooperation has gone 180 degrees plus! Typically, builders offer two or 2.5% co-op commissions. Now, agents are being invited to catered brunches and offered co-op commissions up to 5%, as advertised in the July 23, 2006, Union-Tribune!

The purchase incentive phenomenon is not by any means the exclusive domain of new home builders. Actually, I would say the majority of individual homeowners are also being forced into the incentive game. Though not many are offering incentives from the start of their marketing, after six to eight weeks on the market the idea becomes more appealing. Even without offering any incentives, the majority of offers are now being presented with buyer incentives built-in as a condition of sale!

A year ago one would be hard pressed to find any individual home seller or major new home builder offering incentives. Now, it is just these incentives that also skew the appreciation data. A $500,000 home sale with a $25,000 interest rate buy-down/closing costs package incentive will be recorded as a $500,000 sale. Yet, the $500,000 sale, in reality was only $475,000 or 5% BELOW the reported sales data!

So if the $500,000 sale was just 1% below the June 2005 median appreciation, you can see that the ‘real’ difference was 6% below last year!

Other factors not being mentioned in the press that are important to our market direction are:

Typically the period from late March through September is the strongest for real estate sales. What does both a huge and continuing month over month sales decline and now a home appreciation drop, during this ‘hot’ time, portend for the market as it enters the weaker Fall/Winter period? Lastly, the bulk of the interest only, 100% loans used to prop up our market for the last few years, has two or three year time periods until the re-amortization (at the current prevailing interest rates) of the loan balances. The majority of these interest rate adjustments will occur in 2007 and 2008.

In my opinion, this is no ‘return to normal’ or ‘slight correction’ to the San Diego real estate market. By year’s end there will be no denying we will experience a double digit appreciation decline. A decline that will take years, not months, to work itself out.

End Article

Buying a Forclosure

Back in 1997 I started selling real estate in Vista, California. I specialized in selling VA Repo's to investors. Condos went from 28k to 65k, and houses were going from 71k up to about 165k.

The VA repo is a special animal. You don't have to be a Veteran to qualify for VA financing, and if you were an investor it was 20% down. That was 10k down on a 50k condo that would rent for $800/month. You only needed to write a check for 1K in order to bid. If your bid was the winner, they cashed your check. Otherwise it was returned to you uncashed.

Owner occupied was 10% down. Either way, the real estate agent got both sides of the sale, the full 6%. It was deducted from the sales price of the house and from the resulting assumable loan amount.

A buyer of mine who had a bankruptcy, two divorces, child support, a separation in progress. Won the bid on one of these and qualified for VA financing. We low balled the house Christmas weekend and from what I can guess, we must have been the only bidder.

All of this was happening back after the slump in 1996. It wasn't uncommon to see 20 Repos each week for my area. Condos that they gave away for 28k in 1997 are now selling for 220k--800 sq ft 1 &1/2 baths. By the year 2000 the VA Repo market dried up and I got out of real estate.

Now we are into 2006 and the real estate inventory is still climbing. I notice a lot of forums discussing how to buy foreclosures and REO's. It strikes me as a little absurd to be looking for a deal so close to the top of the market. It s probably going to take about 4 years for the market to become attractive to the investor.

As an investment guide, multiply the monthly rent times 100 and that gives you a purchase price that will provide an excellent return. Right now, we are not even within driving distance of such a concept.

Like I've mentioned before, while studying the last great depression (circa 1929), I couldn't figure out why almost every homeowner had a 5 year interest only renewable loan (I'll bet you thought this was a new banking concept). When the money supply dried up, the loans were not renewed, they were called for payment. From there the banking collapse got worse. I don't think that Congress ever passed a law against interest only loans, the banks just refused to write them after that.

Today, the news is citing a 25% drop in housing sales from June of last year. What happens when it jumps to 50%? My guess, not much. The homeowner can't sell his house so he had better keep his job and hold tight.

At some point between the 25% drop and 50% drop, unemployment has got to increase. And to repeat myself, this meltdown is not going to be a one item (real estate) event. Financial loan markets, real estate, banks, mutual funds and the stock market are all intertwined.

To sum it up, I still have a current real estate license. I am waiting for when the VA Repo lists drop about 80% in price, and I'll be out there bidding---when the price is right.

My Vacation in Las Vegas

My wife and I went to Vegas over the weekend and unlike everyone else I know, we lost money.

When we went last year, The Tropicana still had $2 blackjack tables and most of the other places had $5 and $10 tables.

This year, its a little more expensive. Tropicana had $5 dollar tables and the rest of the strip was running $10 and $15 tables. The dealer now hits on soft seventeen.

If you are a good money manager, you can walk away from the table up 15 units of play or down 15 at any point in time, its an even money game. If you're a tourist thats never gambled, this place can now get into your pocket at a rather fast rate. Two dollars a hand is a not-too-fast a way to enjoy learning how to play. $15 per hand is a rather "doomsday" way to deplete your vacation spending money (IE you're going to remember that vacation for the wrong reasons).

The real question to ask about Las Vegas, is what is happening? Are we looking at inflation? On the surface it appears that way, but it could be misleading. My wife (who likes to gamble) had three comped rooms for the weekend, one at the Trop, one at the Flamingo, and one at Harris. We stayed in the Trop, relatives stayed in the other two hotels, all my wife did was go to each and register.

In 2000 they list 124,270 rooms total for Las Vegas, this year 310 hotels have 149,846 rooms. The increase in rooms is getting up there. I noticed that the drive from the Trop to the Flamingo is about 30 minutes in the evening---a pure traffic jam---the migraine you were not counting on. Its faster to walk if you count the time it takes to park your car.

Things are not as they appear. My wife's slot machine malfunctioned and a tech came to fix it. Come to find out, he's a laid off LA Northrup Grumman worker that came to Las Vegas, hates the place but he needs the job. Our waiter (at one of our 4 complementary meals for the free slot tournament), was a real estate agent that works for Liberty Realty, real nice guy named Nick. He said the real estate business was good, but you have to wonder about "how good."

So on the last day, we get in the car, I'm grumbling because the wife lost $1,000 at the tables. She tells me, "Where else can you get 3 free rooms, each for 3 nights and all the food you can eat for free?" (She was rationalizing the loss). I kind of had to agree.

Then we started the drive out of town. To my surprise every major contractor had at least one billboard up for condos or homes for sale, some starting in the low 100's. I don't think that I would be exaggerating if I said that I counted 20 full size billboards in one mile on the strip out of town.

Since we also got a free Las Vegas paper, I was reading that on the way home and had to chuckle over the headline that read, "Mountain Falls homeowners enjoy scenic commute--Couple makes 40 mile drive from Pahrump Valley to Las Vegas jobs." I was mentally thinking that if it was this hot in San Marcos, our air conditioning bill would be about $400 a month!

To sum it all up, Las Vegas has changed. No more 2 dollar tables, $15 is the norm. Traffic on the Strip is horrible. The rooms are free if you can prove you like to gamble. I predict several casinos will file bankruptcy in the coming year--the pie is sliced too thin to survive. There are just too many people that I have talked to, that want to leave Las Vegas rather than stay, that makes me so pessimistic about this place. And as for how it ties to The Great Depression of 2006, the party is not over, just yet, enjoy--your HELOC (home equity line of credit) It probably isn't maxed out yet. Reality is lurking right around the corner.

Perception: Your Point of View Verses Mine

After cruising a lot of blogs, I've noticed something that I wasn't really aware of. Ever notice that after you buy that new car, you seem to spot a lot of them on the highway, whereas before the purchase you didn't? The thing that I noticed was, the fact that our minds are sharpened to recognize stimulus that we accept into the model of our perceived world.

The real estate bubble bloggers, see the real estate market falling off of a cliff. The real estate agent sees a return to a more normal market. It's not really a matter of who is right, but rather one of timing. Real Estate has been trying to fall off of that cliff for several years, and yet some real estate agents are making a decent living.

I do believe in the example I have cited with real estate, it will fall off a cliff. The "when" part I am not sure about. What needs to be pointed out is that what you expect to happen, colors how you perceive the markets. It's kind of like the cartoon of two men on a very small island. One puts oar locks to the left and right and puts in two oars and starts to row to the west, the other guy on the island throws his hands up and says "you're rowing the wrong way!"

What needs to be realized is that what we want or expect to see, is far more observable than that what we care little about. Captain Ahab harpooning the great white whale nailed the whale, but the rope was wrapped around his leg--he didn't see it coming.

Our faulty perception of the world can harm us. Real estate could be collapsing and you laugh at the guy that looses his house. With 100% financing, don't laugh at him he's home free. It's the bank that gets hung. And when you trace it back far enough; your retirement fund probably took the big hit.

My point is this, what you want to see, you will be able to see, only because your mind is selective. It will notice what you are more receptive to. Therefore my premise: what you want to perceive, you will find a way to perceive, not because it is actual, but rather because it is expected by you to be that way.

If you accept this theory, then you might just question more critically your observations of the world about you. Reality for the individual is all about perceived perception. It is a real reality to each individual. To the group, it may not be. Hence the reality, "I could be wrong!"

It sure feels nice not to have to be right all of the time!

Two Tiered Housing

Almost every article written lately, looks at the housing market inventory problem, as if it was grouped all together. Lets separate it into two different groups; newly built contractor housing and consumer owned housing.

Forget about the cost of the house, and reflect, upon the idea that contractors have been building houses and making a living at it for centuries.

Our house was built by a contractor in 1994 for $191,000 2,400 sq ft. The contractor made a profit. The same house built up the street this year by a contractor sold for about $650,000 and the contractor again made a profit. The only difference between then and now, is that there are more contractors building houses.

Notice, as the used housing market appreciates, the builders inventory also appreciates with no real investment. Figure the return on investment between 15% on up to 50% for the contractor (no real figures here, a rate of 15% is better than giving it to a bank, and a return of 50% or better would explain the sudden increase in building contractors.) I've been in two limited partnerships that returned 50% on condo construction.

Look at the homeowner that gets ready to sell. In a rising market, no problem. In a dropping market, there is realtor fees and competition from newly built houses. The owners selling price is set in stone. His whole future can depend on the outcome of the sale of the house.

Contrast this with a machine that is invested with money that spits out houses, and returns a tidy profit.

The contractor can probably take $150,000 loss in San Marco's on each piece of inventory and still break even and continue on in the world of house building or he could go broke (the investors would take it in the shorts).

As long as the homeowners hold out for a better price, the contractor does not have to mark his inventory lower to move it. At the same time, while looking for raw land to develop, he can demand and get lower land acquisition prices per parcel for new construction.

At this point the contractor is making money at the homeowners expense. More used inventory accumulates.

Now lets look at two different markets. Denver Colorado and San Marcos California. In San Marcos, the housing prices have tripled. In Denver, they have done nothing. Both areas show an oversupply of used housing on the market. Here is where the hair begins to stand up on you neck. This machine that makes houses and the financial institutions that feed it, have created something that is destined to fail in the near future. We are producing housing capacity that is not needed, but it is still very profitable to produce. This is the truest definition of "miss-allocation of resources," AKA "A Bubble." A basic ingredient of any "mind expanding, wallet reducing" recession or depression.

Something will stop this cycle, but at the present, its not clear what its going to be. Stock markets world wide seem to be pointed for a downward plunge. This could lead to a credit contraction that could bring the home construction industry to a halt.