Saturday, November 07, 2020

Problems in Paradise

Right now, everyone is refinancing their homes at the new 2 ¼ loan rate for 30 years.  Everyone with a job that is.  A lot of people are behind in their mortgage payments 6 or more months.  No problem everything is okay.  The majority of workers have a 401K retirement fund that is probably heavily invested in the stock market.  As long as it goes up, no problem.  A lot of businesses are or will be closed forever due to the Corona virus.  When the government says it is okay to open, quite a few will not be able to.

 A majority of people envision a rich businessman, as a person with gobs of money.  However, in most cases, the person is highly leveraged and knows how to manage his finances.  So, if this average rich man had to liquidate his businesses to raise cash, he might find himself broke.    It can be very hard to sell a 500-million-dollar company with 400 million in debts in a bad economy let alone shut down for 8 months.

 During the Great Depression many cities increased tax rates to make up for the shortfall from taxes collected. Their tax base had shrunk considerably.  A lot of wage earners had no taxable income, they were unemployed. The net result of the tax increases, owners let their homes go into foreclosure.  The cities found themselves owning the real estate.  The logic to raise taxes to increase tax receipts, backfired.  Notice that politicians don’t go to jail for incompetence, they usually just fade away. Their decisions during that era ruined many a family.

 In the 1929 crash, the stock market was owned by individual investors who thought they knew what they were doing. In the present market, huge mutual funds manage the market.  They are too big to get out of the market. The stock market is very vulnerable to a drastic reset, there is no reason for some of the prices, they are absurd.  It won’t be quick; it will be slow probably over three months. Everyone in the market knows what they are doing, wink, wink; they will go broke buying the dips.  Actually, in a long bull market it is very hard to lose money even if you are incredibly stupid. In the 70’s and 80’s I can remember a market, where whatever you bought, it went down.  The present investment advisors have never experienced a bear market.  Imagine what the taxes on your 401 k would be, if you tried to withdraw the whole amount at once from the market.  The government and your investment advisor are banking you won’t even consider it.  Any losses are not tax deductible.

 As the government’s rate of borrowing increases, interest rates will have to rise.    With rates rising and delinquent real estate hitting the markets, look for dropping home prices.  The monthly payment will remain the same (the price drops 50% and the interest rate doubles).  A bank offering a higher interest rates will see funds transfer overnight to their bank, reminiscent of the Savings and Loan fiasco of the 1990’s. Banks deposits are short term and they lend that money long term. The low long-term loans bankrupted the Saving and Loans when interest rates rose and depositors fled in search of higher rates.

 With a 2 percent interest rate, it takes about 33 years for your money to double.  At 5 percent interest rate, it takes about 14.4 years to double.  A thing to be aware of is that historically, interest rates reflected the risk of the investment.  That appears to be overlooked in the market of today. With the government “insuring” mortgage loans, most investors falsely perceive that there is no risk in the market. Two percent interest does not even cover the current rate of inflation of 7 percent.  If interest rates were to rise higher than 5 percent, the government would be insolvent; unable to pay the interest on the national debt or for that fact be able to finance Social Security and Medicare. What that would do to the bond market, which is 10 times bigger than the stock market, is hard to imagine or describe.

 In the present market, the best investments may be your home or precious metals. The caveat here, is do you have a job? I you don’t, there is no reason to buy either. If the Corona virus lockdown lasts much longer, things could get very difficult.  Most parts of our economic structure are stressed to the limit.  The only real sources of taxation for the government is earnings and visible assets; real estate, vehicles and retirement savings. If you are not working, you’re not paying taxes or your mortgage.

 The saving grace for our market under President Trump was the cut in business tax rates, this brought jobs back to the US and gave the rest of the world higher unemployment. After WWII the US economy surged supplying goods to the rest of the world.  Since then, the rest of the world has been making goods for the US.  This turn around of the US producing goods for itself, is a stimulus that was beginning to show results.  I’m not sure if the next administration will continue this policy.

 It looks like Congress is going to try to print its way out of the current economic instability.  At some point it has to fail. The current consensus is that it should work, because it has always worked in the past.  It’s a little like a mouse going back to the trap one more time for that last morsel of cheese.

 

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