Friday, January 30, 2009

We're Broke (It's a Secret)

Most speculative bubbles produce something everyone wants to own that is way out of proportion. Housing was overproduced. This was an extreme misallocation of resources. The problem, the economy can't shift it's focus of production overnight. A second bubble was loaning money to anyone who wanted to buy a house or car. Label this one a misallocation of financial resources.

Now the country has several problems. There is a surplus of homes for sale and a very large amount of failed bank loans that are uncollectable. Each home seller got real cash for the home. The new owner borrowed funds from the bank. Now, most of the major banks are bankrupt and the government is bailing them out.

The US had over 17 trillion dollars worth of savings. The banks probably loaned out 7 trillion that will never be paid back. Someone got that money and saved it or spent it (consider it spent and gone). Now the government wants to borrow 4 trillion dollars (two years worth of taxes) to bail out the system. Add the up the bill, 7 + 4 equals 11 trillion dollars worth of IOU’s.

The FDIC insurance stops people from making a run on the banks. Their money is safe. They have peace of mind. Normally a run on the bank would force liquidation of home loans. This has been accomplished without a run on the bank, the homeowners took a walk.

There is a problem with retirement funds. As long as money coming in, is greater than that going out, the game can continue. What people save on their taxes by contributing to these funds keeps the game in play. Retirement funds and mutual funds look extremely suspicious right now. It seems quite likely that these unregulated institutions should have a good share of bankruptcies, more so than the banks. Bernie Madoff cleaned a plow or two!

It appears likely that between 5 to 15 trillion dollars has been spent on fast cars, homes, and all sorts of toys. Those with money spent it, those who had none, borrowed it.

Congress is going to try and get the economy going by borrowing and spending 4 trillion dollars? Just who is stupid enough to loan the government that amount of money at these pathetic rates? Question two, what if there isn’t 4 trillion dollars available to borrow? Interest rates will have to increase drastically.

Now we have a lot of people being laid off. These people are going to dip into their savings and then into their credit cards. The solution for Joe Sixpack and government is the same “Spend what you don’t have in the hopes that things will get better.” The rational behind the concept is “You have nothing to lose!” This has Barnum and Bailey written all over it, a real circus act!

Monday, January 26, 2009

Common Cents (Reprinted)

This is a reprint from October 30, 2006. Things are pretty much following the suggested script. It seems even more real after two years have passed.

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!!!

Wednesday, January 21, 2009

An Open Letter

The following appeared in the comments section of my last post. I couldn't see any way to edit it to condense it, but it does give you a feel of the times. I have quoted from articles of this sort from the 1930's and it has the same flavor. I apologize for the length, but you might enjoy it.

An Open Letter:

Politicians and Management of the Big 3 are both infected with the same entitlement mentality that has spread like cancerous germs in UAW halls for the last countless decades, and whose plague is now sweeping this nation, awaiting our new 'messiah', Pres-elect Obama, to wave his magic wand and make all our problems go away, while at the same time allowing our once great nation to keep 'living the dream'… Believe me folks, The dream is over!

This dream where we can ignore the consumer for years while management myopically focuses on its personal rewards packages at the same time that our factories have been filled with the worlds most overpaid, arrogant, ignorant and laziest entitlement minded 'laborers' without paying the price for these atrocities…this dream where you still think the masses will line up to buy our products for ever and ever.

Don't even think about telling me I'm wrong. Don't accuse me of not knowing of what I speak. I have called on Ford, GM, Chrysler, TRW, Delphi, Kelsey Hayes, American Axle and countless other automotive OEM's throughout the Midwest during the past 30 years and what I've seen over those years in these union shops can only be described as disgusting. Troy Clarke, President of General Motors North America, states: 'There is widespread sentiment throughout this country, and our government, and especially via the news media, that the current crisis is completely the result of bad management which it certainly is not.'

You're right Mr. Clarke, it's not JUST management…how about the electricians who walk around the plants like lords in feudal times, making people wait on them for countless hours while they drag ass…so they can come in on the weekend and make double and triple time…for a job they easily could have done within their normal 40 hour work week. How about the line workers who threaten newbies with all kinds of scare tactics…for putting out too many parts on a shift…and for being too productive (We certainly must not expose those lazy bums who have been getting overpaid for decades for their horrific underproduction, must we?!?)

Do you folks really not know about this stuff?!? How about this great sentiment abridged from Mr. Clarke's sad plea: 'over the last few years …we have closed the quality and efficiency gaps with our competitors.' What the hell has Detroit been doing for the last 40 years?!? Did we really JUST wake up to the gaps in quality and efficiency between us and them? The K car vs. the Accord? The Pinto vs. the Civic?!? Do I need to go on? What a joke!

We are living through the inevitable outcome of the actions of the United States auto industry for decades. It's time to pay for your sins, Detroit.

I attended an economic summit last week where brilliant economist, Alan Beaulieu, from the Institute of Trend Research, surprised the crowd when he said he would not have given the banks a penny of 'bailout money'. 'Yes,' he said, 'this would cause short term problems,' but despite what people like politicians and corporate magnates would have us believe, the sun would in fact rise the next day… and the following very important thing would happen…where there had been greedy and sloppy banks, new efficient ones would pop up…that is how a free market system works…it does work…if we would only let it work…

But for some nondescript reason we are now deciding that the rest of the world is right and that capitalism doesn't work - that we need the government to step in and "save us..." Save us my ass. Hell - we're nationalizing…and unfortunately too many of our once fine nation's citizens don't even have a clue that this is what is really happening…But, they sure can tell you the stats on their favorite sports teams…yeah - THAT'S really important, isn't it…

Does it ever occur to ANYONE that the "competition" has been producing vehicles, EXTREMELY PROFITABLY, for decades in this country?… How can that be??? Let's see… Fuel efficient… Listening to customers… Investing in the proper tooling and automation for the long haul…

Not being too complacent or arrogant to listen to Dr. W. Edwards Deming four decades ago when he taught that by adopting appropriate principles of management, organizations could increase quality and simultaneously reduce costs. Ever increased productivity through quality and intelligent planning… Treating vendors like strategic partners, rather than like 'the enemy'… Efficient front and back offices… Non union environment…

Again, I could go on and on, but I really wouldn't be telling anyone anything they really don't already know down deep in their hearts. I have six children, so I am not unfamiliar with the concept of wanting someone to bail you out of a mess that you have gotten yourself into - my children do this on a weekly, if not daily basis, as I did when I was their age. I do for them what my parents did for me (one of their greatest gifts, by the way) - I make them stand on their own two feet and accept the consequences of their actions and work through it. Radical concept, huh… Am I there for them in the wings? Of course - but only until such time as they need to be fully on their own as adults.

I don't want to oversimplify a complex situation, but there certainly are unmistakable parallels here between the proper role of parenting and government. Detroit and the United States need to pay for their sins. Bad news people - it's coming whether we like it or not. The newly elected Messiah really doesn't have a magic wand big enough to 'make it all go away.' I laughed as I heard Obama 'reeling it back in' almost immediately after the final vote count was tallied…'we really might not do it in a year…or in four…' Where the Hell was that kind of talk when he was RUNNING for office.

Stop trying to put off the inevitable folks … That house in Florida really isn't worth $750,000… People who jump across a border really don't deserve free health care benefits… That job driving that forklift for the Big 3 really isn't worth $85,000 a year… We really shouldn't allow Wal-Mart to stock their shelves with products acquired from a country that unfairly manipulates their currency and has the most atrocious human rights infractions on the face of the globe…

That couple whose combined income is less than $50,000 really shouldn't be living in that $485,000 home… Let the market correct itself folks - it will. Yes it will be painful, but it's gonna' be painful either way, and the bright side of my proposal is that on the other side of it all, is a nation that appreciates what it has…and doesn't live beyond its means…and gets back to basics…and redevelops the patriotic work ethic that made it the greatest nation in the history of the world… and probably turns back to God.

Sorry - don't cut my head off, I'm just the messenger sharing with you the 'bad news'. I hope you take it to heart.


Gregory J. Knox,
President, Knox Machinery, Inc. Franklin, Ohio

Thursday, January 15, 2009

We Can't Go Back

When one member of a family looses their job, the household cuts down on expenditures to accommodate for the loss of income. Or they could decide that since it is only temporary; maintain the current lifestyle using the credit card. Using the credit card only allows you to continue the current lifestyle for an undefined time limit. It doesn’t solve the family’s problems. In fact, it makes them worse if the employment situation deteriorates.

Our government works the same way. There is a limit to the amount of debt a nation can carry, just like a family. The government cannot put these failed disasters on a credit card for long. You need real money to do anything. Real money is proof that something was produced for consumption. Savings are the surrender of present gratification for future consumption.

Our government has spent one trillion dollars (that no one earned yet) and is expecting someone in the future to forgo that large amount of consumption (savings) so they can spend it. It’s not very likely. The suggestion that the increase in the national debt will be passed on to our kids is ridiculous. We didn’t pay what was passed on to us, so don’t figure that human nature is going to undergo some metamorphic change.

We have to look at is the total amount of the national debt. The issue we need to be concerned with is the interest rate on that debt that we have to service. As long as the rate is 3%, there is not much of a problem. If the interest rates were to increase to say 10 or 15 percent, things could become very awkward. The total debt is a known; the service on the debt (interest) could get to a level where the government revenues would not be enough to cover it.

The interesting issue here is that interest rates relate to risk. The government spends what it doesn’t have and then expects us to fund it. This will be done by taxing everyone’s savings through a government program called inflation. The catch here is that you may want more of a return on your money since it is losing value. This would mean that interest rates would have to rise.

The other thing to consider, people might want gold and silver and would be dumping currency. The only solution to that is to ban gold ownership by individuals. FDR did it, to save the currency. I don’t see anyone wanting a currency where the incoming President claims that we may have trillion dollar deficits for many years in the future.

The net result is the government (by way of inflation) will confiscate personal savings to pay off the national debt. You get to keep your house, your car, your gold and silver and the government goes broke and issues a new currency to replace the old one. If you worked hard all of your life and saved for retirement, it will be comforting to know that it’s all gone, you have lost everything. You are at a point in life where you are too old to kick ass and make someone pay. Kind of sucks doesn’t it!

Obama is going to save us? Not to put the guy down, but to look at things a little more realistically. Printing money is not going to solve the problem. Congress is in charge of spending. The thought that this new President can somehow keep this spending orgy going is just a wish of the Hoi Polloi. It’s a little like pimping your wife and daughter to make the house payment. It shows that you gave serious thought to the situation and concluded that using your family “very pragmatically” was your salvation. The neat thing about this is that their customers will provide free “On the job training.” What a deal! It has government stamped all over it.

Tuesday, January 06, 2009

90 Day T Bills, Smoke and Mirrors

The interest rate on 90 day T-bills is effectively Zero. The absurdity of it boggles the mind. To carry it one step further and suggest that the people buying them are scared to death over the return of their money is crazy. It sounds logical and financially preposterous at the same time. Investing in government treasuries doesn't guarantee future buying power.

I would even go so far as to suggest that the people doing the investing are banks. If there weren't enough bidders at the T-Bill auction, rates would climb. This would make the housing mess even worse and at the same time increase the interest on the national debt. We are only talking 20 billion a week on 3 month T-bills, so the net investment is only 200 billion (if you roll over the first 20 billion on the third month). Bid zero and keep the rates low. Lets face it, if the are banks bidding these T-Bills to nothing, it’s probably TARP (Trouble Asset Relief Program) money that they haven’t been able to loan out yet.

Common sense suggests that a bank in trouble has to pay more for investor’s deposits. This enables them to stay in business. What happens when they are propped up by a TARP/CRAP loan? They don’t have to raise interest rates.

Here is a recent email I received. This missive suggests that there is some opportunity here on loans that have gone sour. You may be tempted to buy this package. Just don't sue me for showing you what the rich and stupid might be buying. Double click for a bigger pic if you're tempted.

Here is just 30 of the properties on that list. The housing crisis is only one year old and there are problems that are beyond comprehension? Just look at these prices!

Alt A paper is paying as high as 50% interest a year. That is the discount that you are looking at here. Right now, first trust deeds in the Detroit area are not even marketable. Do you even wonder why?

We are looking at a conundrum, invest your money with a possible 50% return or for zero interest with Treasury's. The conclusion that people are interested in preserving their principle sounds great, but think about it. It makes no cents/sense. Even one percent interest, using the rule of 72, means that your money might not double in your life time. On a tax test basis, I could offer my son a rate like that and even the IRS would question it. Why would any one in their right mind give our government an interest free loan?

The new government is going to SAVE us. I have no idea what that will mean from a financial perspective. But figure it this way, you will pay more for less. Perception is the name of the game.

Friday, January 02, 2009

The Zero Percent Solution

At what point does a bank go out of business or when does it cease to have a purpose? As interest rates approach zero, the money to be made loaning it out disappears. Why keep it in a bank if the inflation rate is higher than the interest rate? Keep it in a shoe box.

Remember back to the Savings & Loan mess of the 1990’s? They loaned money long at low interest rates (home loans) and when short term interest rates went up, these institutions went broke. There sure is a lot of refinancing going on right now. Bill Seidman get ready, we may need you again.

Let’s say you want to buy a car and get it financed. If you have lousy credit, you’ll be looking at 10% interest. But if you are a car manufacturer, the leasing aspect looks real nice. Joe6pack gets to lease it at full book with a roll in of 12 % interest. God Bless GMAC.

The only places getting a realistic return on their money are the credit card companies. And they give you money back for spending money, go figure.

Stock broker loans with stock as collateral are in vogue; the current rate is about 1.5% plus the yield on the 10 year treasury, for a million dollars or more (4.5%). Add two points if you’re a piker and want to borrow less than 50k (6.5%). Hop on; the DOW will hit 30,000 (yea right!).

If you are retired, living off the interest on your investments, I would suggest getting a seed catalogue and carefully pick out what you want to eat/grow a lot of, in the coming years. Step two, chickens are low maintenance, but the local CC&R’s might not allow for it, check first. You’ll be living on straight principle within months. The stress of retirement, isn't it fun?

Something is severely wrong with the current interest rates. The Alt-A paper has been discounted to 18%, of face amount, that equates to an interest rate range between 25% to 50% interest; using an original issue interest rate range of 6% to 12%. A bid of 12 million might buy the whole city of Detroit (the back taxes will kill you)

Figure inflation is 9% and a fair interest rate would be 3% added on, to get a 30 year T bond rate of 12%. The rate is currently at less than 3%. So if an investor went out and bought a million dollar 30 year treasury bond with a 3% rate (paying 30K in interest), what would it be worth if interest rates suddenly went to 12%? The purchaser would have a loss of 3/4th of a million dollars (if they needed to convert it to cash now). They could wait 30 years and get the full million back. Visualize it this way. What amount of money at 12% interest pays 30K per year in interest, answer 225K? That’s how you value a bond if it has a long maturity.

If the real interest rate jumped to 12%, the interest on the national debt would double in size twice. Instead of 412 billion dollars it would be 1.648 trillion dollars PER YEAR(824 billion at 6% and 1.648 trillion at 12%).

Common sense says something is wrong. The government can borrow and print massive amounts of money and the interest rates remains at historic lows? It’s kind of like using grease to wax the floors in a hospital; it keeps your patient count high for all the wrong reasons.

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