Monday, April 30, 2007

The Return of Principle

So lets see, you have a mutual fund or IRA. They know your date of birth.

Most probably, your not ready to retire. You are paying into this account 3 to 4 thousand a year to avoid paying taxes on the income.

Lets look at it from the funds point of view. They know when you will start to draw benefits. The funds are not accountable to anyone. Legally they have broken no laws, it is not illegal to loose money.

What about income statements? "What ever the fund prints on paper and sends to them they will believe." "It doesn't have to be really truthful, it can't be confirmed without information from the fund itself." Can you even read the statement?

The question you need to ask is: How much time do these investment machines have before problems become apparent? Nobody is in any real hurry to retire and the money is still rolling in.

How can these funds be held accountable when there is no perceived problem? This could go on for for a long time.

There are thousands of investment funds and not one of them has had any problems. And yet 63 lending institutions have gone belly up. Something is a little too perfect here. Didn't one rogue trader send Barings Bank to the bottom?

Wednesday, April 25, 2007

The Stock Market Game

The "Dow Jones Industrial Average" sounds impressive. Right now it’s at 13,000. Add up the value of all thirty stocks in the DOW and you get 1,600. Hmmm where does the 13,000 come from?

There is the Dow divisor index which is currently at 0.1248 is a peculiar animal. Here is a cut and paste from Wikipedia

Assume an index comprising on 2 stocks A and B.
A is priced at $100 and B is priced at $200.
Hence the index value in this case is (100+200)/2=150
(where N=2 which is index divisor). So the index value here is 150.

Now assume stock B undergoes 2:1 stock split so its value becomes $100.
Now the index value would become 100 instead of 150.
To correct his irregularity we need to do the index divisor calculation as
(100+100)/N=150 (Since Market Capitalization of the stock is unchanged).
Hence, upon calculation we get the value of N as 1.333.
This shows that a stock split caused the index divisor to be revised
from a value of 2 to 1.33.

Today with the DOW, you would take 1600/.1248=12,820

DOW 30 Stocks---------------Weight %-----Present Value
3M Co.--------------------------4.8746---------77.75
Alcoa Inc-----------------------2.15-------------34.37
Altria Group-------------------4.3605---------69.55
American Express------------3.8245---------61
American International ----4.3593---------69.53
AT&T Inc--------------------- 2.4997---------39.87
Boeing Co. --------------------5.8489---------93.29
Caterpillar Inc. --------------4.5028---------71.82
Citigroup Inc. ----------------3.3492---------53.42
Coca-Cola Co. ----------------3.2659---------52.09
DuPont------------------------ 3.0897---------49.28
Exxon Mobil Corp. ----------5.0007---------79.76
General Electric Co.---------2.2025---------35.13
General Motors Corp.-------1.9862---------31.68
Hewlett-Packard Co.--------2.5937----------41.37
Home Depot Inc.------------2.4583---------39.21
Honeywell-------------------- 3.2226---------51.4
Intel Corp.--------------------1.3894----------22.16
Johnson & Johnson---------4.0828---------65.12
JPMorgan Chase & Co.-----3.2941---------52.54
McDonald's Corp.-----------3.032-----------48.36
Merck & Co. Inc.-------------3.2282---------51.49
Microsoft Corp.--------------1.8194----------29.02
Pfizer Inc.---------------------1.6909---------26.97
Procter & Gamble-----------4-----------------63.8
United Technologies-------4.2307----------67.48
Wal-Mart Stores Inc.------3.1198---------49.76
Walt Disney Co.------------2.2119---------35.28

If you examine the Market Weighted %, this is the actual amount the Dow swings per dollar for each individual stock. Notice that a 5 dollar move in IBM translates into 30 points on the DOW (5 x 5.92). A 5 dollar move in Intel translates into 7 points on the DOW (5 x 1.38).

As boring as all of this is, its rather like doing 20 miles per hour in a car and the Manufacturer decides to add another zero to the speedometer and make it 200. In that scenario, you can go through a hospital zone at 200 mph and not suck the drapes out of the rooms.

DOW 13,000 sounds super, but when you add it up you begin to realize that the perspective is a little misleading. The DJIA 30 stocks are worth $1600. The real validity of the DOW hitting 13,000 has more to do with someone who bought into the market in about the year 1910.

The next picture is a logarithmic rendering of the DJIA over the last 100 years. The slope of the graph is linear. On logarithmic paper that's not a good thing. It could indicate a bubble, or the last step before hyperinflation (slope equals inflation rate). (Click on the graph for a larger picture)

The area under the graph line could be considered the measure of value paid for all stocks in the market. For that reason I have included the next graph which is linear. The crash of 1929 and 1987 are not very noticeable. This one, puts in perspective the large amount of money moving into the market. (Click for a larger picture)

---------------Picture from

The DJIA broke through 13,000 today or $1,600 (if you do the math my way). Both graphs tells a story. One is logarithmic because it was too big to fit on a page without losing detail. The other suggests that 1929 and 1987 were non events (that should raise an eyebrow or two).

On the positive side, the Dow's a lot more liquid than the housing market. Stockmarkets are not sticky on the down side! At one time Wall Street offered "Cradle to Grave Service." There was a nursery at one end of the street and a grave yard at the other. The grave yard is still there.

Friday, April 20, 2007

The Chinese Fire Drill

Maybe there are a few of you that still remember the “Chinese Fire Drill.” That’s where you are driving around with about 3 other people in the car and stop at a red light. All 4 doors open and everyone, gets out and runs around the car, gets in a different door and you drive off just as the light turns green.

With real estate right now, we have the owner, the bank, the appraiser, the RE agent and the note holder involved in salvaging this foreclosed real estate. Their goal is to market the property, and sell it. They want it off of their books and the light is about to turn red.

From my limited experience, there were only two organizations that were set up to handle this sort of fire drill, the VA and HUD. The VA was excellent and knew what they were doing,. HUD on the other hand was pathetic, the word "Worthless," comes to mind.

What does this have to do with today’s foreclosure market? It displays what I call “The Disconnect phenomenon.” The note holder is removed from the local market, and fixates on the loan value and its' recovery.

We have a local bank managing the property, and a real estate agent trying to sell it. The question arises, how do you aggressively market an item remotely from a thousand miles away, let alone evaluate it realistically? What you’re probably looking at is another 6 months of a listing that doesn’t sell. So you have: from last payment received, 6 months to foreclosure, and 6 months on your first expired listing. Total 1 year no income.

It doesn’t take much to realize that if the foreclosures don’t sell the first year, because of improper evaluations of the properties, there will be twice as many the next year if you project it out.

Notice, what you will be looking at, is the failure of management to agree on a price that would move the house. It will stay in inventory. It’s the inventory buildup shock that will kill them. These note holders could lose more than 50%, in the San Diego market.

The essence of a Chinese fire drill, is to display action, as if to solve the problem, but what is done accomplishes nothing, kind of like our Congress at work!

Tuesday, April 17, 2007

Sallie Mae, College Salivation Shotgun Style

They just announced that the GSE (Government Sponsored Entity) Sally Mae, the writer of a majority of student loans, is being taken private. The full article is in the San Diego Union Tribune April 16, 2007.

There is kind of a hidden money machine here.

“To start, nearly $69 billion of the current $86 billion in student loans is backed by the U. S. Treasury, meaning that even if the loans go into default, the lenders are protected. These loans are subsidized by the government in order to keep interest rates low for borrowers and guarantee profits for lenders.

Between 1992 and 2004, the cumulative subsidy cost was 39 billion . . . . .

….the Supreme Court ruled in 2005 that lenders have the right to garnish even Social Security income from those who are delinquent on their student loans.

In 1971 I graduated from college with a student loan of $3,500. I was just an innocent kid. I started making payments right away and was two months ahead on payments. Then I received a promissory note in the mail to sign, for my student loan.

I started reading the note. It had a phrase in there, “If the government fails, you are still liable for full payment.” There was another that stated, “Even if you file for bankruptcy, you will still pay this note in full.” And one other statement that eludes me. Anyways, I took a pen and crossed out the three offending items.

I went to the bank and turned in the note and they sat there for over an hour yelling at me saying you can’t do this! I pointed out to them that I had already spent the money and that, what I couldn’t do, I had done. End result, they defaulted my loan, even though I was not even close to being delinquent on the loan.

This company provides a seemingly legitimate service to students. What’s not realized is that this is more of a machine that supplies money to help Schools fill slots on their campus that would otherwise remain empty. Notice it’s the school and loan provider that have a symbiotic relationship. The victim is the borrower. High hopes, dreams, all of the stuff that every kid wants in their youth.

Advise your kids to be careful with student loans. These people will loan you enough to make you regret ever borrowing it. Just remember when that promissory note arrives, you might not want to sign it.

I still paid off my student loan, never filed bankruptcy, and the government didn’t fall. The company provides a valid service, but beware when you graduate with your degree in “whatever,” there may be no jobs available. The college didn’t mention that did they? So when it comes to blame, is it the loan company or the college or the student? We know who the winner is, do you?

Thursday, April 12, 2007

An Email from “Concerned Appraiser”

This was emailed to me the other day. It lends insight into the housing problems from the appraisal side (printed with permission of the writer).

I enjoyed your recent articles on sub prime loans. I thought you may be interested in another aspect of this lending picture. Many people are critical of the lack of requirements imposed to qualify someone for a loan. I surely agree that stated income, no down payment, low credit scores, etc. lead to potential loss. However there is another side to this problem that is not being discussed. That side is collateral.

The federal government created The Appraisal Foundation after the savings & Loan bailout of the 1980's. This resulted in the creation of the Appraisal Standards Board and ultimately the licensing and certification of real estate appraisers requiring the use of Uniform Standards of Professional Appraisal Practice (USPAP). These USPAP requirements are required when an appraiser prepares an appraisal of real property and appraisals are required for federally related transactions. However this requirement became a "burden" to the lenders and the federal government instituted a de minimus threshold of $250,000. Appraisals are not required for loans under $250,000. The banks and others used opinions of value given by real estate licensees, AVM's (automated valuation models), tax assessments or loan officer opinions to make those loans. While one or two of these of loans do not put the economy at risk I think there is a great potential of risk when this is multiplied many times over the entire banking industry for the 50 states.

I live in East Texas and the local appraisal districts do not have a single licensed or certified appraiser on their staff. The appraisal review boards have no licensed/certified appraisers on their board either. However real estate loans are being made based on the valuation assigned by these groups. Many banks make loans on real estate based on the opinion of a real estate broker or loan officer. Many real estate brokers have never taken an appraisal course in their life. Their opinions are used because they are cheaper and faster than a "real" appraisal. And, of course, everyone knows that real estate agents know everything about real estate. Then there is the AVM's. Just give the size and zip code of your home and a computer will spill out the value. The computer will not know about the foundation problems or leaky roof.

Sorry this is so long. But it only describes a small part of the valuation side of the problem. The lenders think they have problems now with the inability of borrower to pay. Just wait until they find out that their collateral is worth a whole lot less than they thought!

I wonder if they used for their appraisals (tongue in cheek)?

Tuesday, April 10, 2007

REO a Hot Potato

Here is a little bit of info on REO’s. This is what I picked up while trying to get a few to list at the Real Estate firm I use to work for.

When a house is foreclosed on (in California) the note holder is probably 1,000 miles away in a different city. This cash money lender picks a bank that is close to the failed property (he needs feet in the street). After the trustee sale (assuming there are no bidders) the loan holder’s debt plus expenses, is the bid that wins the trustee sale. The appointed bank becomes the manager of the REO. The bank, as a financial fiduciary, has the responsibility of managing the property and getting it sold. The first thing the note holder will want from the bank is an evaluation of the property. What’s it worth, does it need repair? They will need a property appraisal. The banks duty is to insure that the house is sold for a fair price, thus protecting the foreclosed home owner’s rights. Most likely the homeowner is going to get a 1099 after the mess unwinds.

After the note holder gets the appraisal, they would determine a suitable sales price and advise the bank. The bank if it doesn’t have a real estate section, goes out and selects a real estate broker to list the place.

Now if we travel to the note holder’s work place, the guy doing the paperwork is probably working on REO’s in all 50 states at the same time. In the past, his performance was gauged on getting full value on the loan amounts. This wasn’t hard in a rising market. Ask yourself, is he going to slash prices to the bone, to move them? Probably not, it could get him fired. The appraisal he got is probably stale by now and the conditions for each part of the country are different. The sales price he is comfortable with might be a tad high relative to the local conditions.

The note holder's inventory will start to increase. No need to panic, they have been able to handle it in the past. If it doesn’t sell after 6 months, change realtors and lower the price. There is some time involved in selling an REO. I know from experience with the VA Repo’s that there was about a 9 month black out period from Trustee sale to the VA listing date, and this was when repo’s were a hot item. Not quite sure why, but it must involve paperwork of some sort.

It looks like a lot of these REO’s are going to mature for about 3-12 months before they get placed on the market. In a very poor market, these foreclosures could become more over priced, due to the stale appraisal and would fail to sell. If you add to that, the vandalism, theft and neglected maintenance, things could go down hill quite fast.

Since REO’s are local, and the guy calling the shots is 1,000 miles away, you are not going to move inventory in a timely fashion. The thing not fully appreciated, is that if it takes you 9 to 12 months to move inventory in good times, this could get out of hand real fast.

Sunday, April 08, 2007

DOW 2000

I started trading stocks back in 1972. I had about $6,000 in the market. My grandfather and my dad traded stocks so it was pretty easy to pick up all the ins and outs of the market. It didn’t mean for one minute that you would make any money, hardly anybody did back then. My stock broker was a real agreeable guy. If you had a stock you liked and weren’t sure about buying it, he had about 10 good reasons why it was a good buy. He was a very good listener and let you do most of the talking. He knew that you came into buy something, otherwise you’d be some place else.

He had a plaque on his desk that had engraved on it “DOW 2000.” You’d look at the sign and then at him and wonder out loud, “Do you think it will ever happen.” We’d kind of laugh and chuckle and reflect that the DOW had been at 1,000 for a hell of a long time, and the concept of it going to 2000 was a pipe dream. The plaque was a good conversation piece even if it was a little ridiculous.

Anyway, I was reminiscing old times and began to think about that plaque with “DOW 2000” on it. I remembered the absurdity of the DOW hitting 2000 back in 1972. Not a chance. Then, looking at today’s market with the DOW at 12,000 that same plaque looks just as absurd, the same exact feeling as I had in 1972, it can't happen.

I guess what I have learned, is that the future is not rational or logical, when it comes to what’s going to happen next. We just take that concept for granted and that’s our biggest mistake.

Saturday, April 07, 2007

Credit Cards, the Big Black Hole

It was “Fog a mirror,” to qualify for a home loan. Now it’s “Have an address,” to get a credit card (the number of cards you want to apply for is optional). The housing market ran amok so why can’t the credit card market? The credit card fiasco will come to an end, just like real estate.

From our previous model suggesting the collapse of Loan Companies, we figured that they would be working for nothing the minute defaults hit 8%. It only took 6% to take them out. Let’s project that model out for a credit card collapse. Interest charged 20% less interest paid to cash suppliers 7% equals’ 13% interest on the float for the credit card companies. So in theory, 13% of their credit card loans defaulting puts them in a zero earnings scenario. From there it’s a reverse burn.

There is the question on the $9,200 credit card debt owed “per household.” Is that per “card” or per “client?” Does Visa tell Master Card? From a computer point of view; J. Doe, John Doe, and John D. Doe are three different people. How many of these households have the same address?

My dad before he died at the age of 81 (in 2001) had 10 cards and owed over $45,000 which they (you know who) had to write off. How can the banks issue cards to people that old? In 1987 he lost everything in the stock market crash and walked away bankrupt. So he had to wait 10 years to get these cards. These had to of been issued when he was 77 years old. To top it off he was using the cards to buy Florida real estate (he wasn’t doing that bad with it either).

What if the major credit card companies sorted their cards issued by address. I wonder how many cards would pop up with the same address? My Dad’s address would have been good for 20 (his girlfriend also had 10). An acquaintance of mine who is a building contractor would be good for 30.

We are not even discussing fraud. Times were good to us and the party was great. The credit card companies are functional units right now holding 2 trillion of unsecured debt. Once the credit card investor (whoever it is) realizes that he can’t just pick up his toys and walk away, it’s over. The money’s been spent. It’s gone. Whose money was it? That’s a question without an answer for the present.

This is going to be a fun year--- Charge it!! Getting 20 gallons of gasoline is painless with plastic.

Got REO?

“Real estate always goes up in value” and “Real estate prices are sticky on the way down.” Either one, if repeated by enough people, becomes sort of an implied truth. You just can't assume that it will still be true tomorrow.

Notice how belief in the first statement has gotten an awful lot of people true financial misery. Belief in the second statement gives those home owners hope. Maybe there is a way out, if they just wait a while. If you’ve ever owned a stock that went up like a rocket, you probably rode it all the way down to the ground thinking that it has to go back up. A little greed can go a long way. Real estate could indeed become sticky, kind of like "Fly Paper."

In San Marcos, one fourth of all house sales are probably from trustee sales (an educated guess on my part). No new real owner, but the selling price is real. The lender gets the house for the amount owed (assuming no other bids). The sales price is recorded. If that doesn’t screw up the average resale price, then you must be a Realtor.

Notice all the bankruptcies? What do you think happens here? You walk up to the lender with your lawyer and explain to them that they can have the house now, if they don’t file a NOD and mess up your credit (what’s left of it). Otherwise, you’ll sublet the place to your son’s motorcycle gang for nine months (the time it takes for it to go to trustee sale). Of course you’ll then demand the $2,000 move out fee to help you get a new place(because you’re broke). You’ll probably get it. The lender receives a clean title and can hand it over to a broker to list immediately. This speeds up the process by 3-9 months.

The Bankruptcy and the Trustee Sale transaction each add one to inventory as well as one to sales totals for the month. The bank in most cases is just a middle man, managing the lender's house loan for a fee. They’re really not in any hurry to unload the REO’s. The more the merrier! I would guess that the management fee for an REO is more than that of a performing loan.

Property taxes are due this month. Its nice to know that at least the lenders are paying their taxes on the REO's. The meter is still ticking. A 1% tax on a loan portfolio is painful.

Real estate is only part of a bigger problem. 50 lenders have bit the dust in 100 days. It doesn’t seem to have set off any bells or whistles, kind of makes you wonder if anybody really understands what is happening. The answer is “Not yet.” It’s kind of like hearing the whistling noise an arrow makes as it is released at a target.

Tuesday, April 03, 2007

Banker's Nightmare Revisited

My graphics need some help, I'm sure it shows! This is the same graph about California foreclosures with additions from December 21, 2006. Today we hit 20,010, thats a doubling from February 1, 2007.

What you want to glean from this graph is the fact that the foreclosure rate is "accelerating at a predictable rate." What does that mean? Things are going to get a lot worse, even faster! (Double click on the graph for a picture that you can read)

Examine this graph without thinking "real estate" and visualize credit card debt that the banks have on the books. That graph would have to be similar and thats hidden from view; "You're going to live on your credit cards until they take the house." So the banks probably have a similar problem with increasing credit card debt.

Implode-O-Meter and Bakersfield Bubble have been following the death spiral of real estate financiers. There is a question that arises; "Has ANYONE lost any money on what has happened?" Here are billions going down the drain, and "Hey it ain't our money." Whose money was it then????

This thing is getting worse, and there doesn't seem to be anyone that has lost money except stock holders of the companies that closed. That to me sounds rather odd.

Real Estate lenders going out of business is one thing, but Mutual Funds and Ira's having financial problems? Hmmmmmm