The REO Auction Heimlich Maneuver

This is our third update using semi logarithmic paper plotting California Foreclosures. It looks like the train to hell, is on schedule. The number of foreclosures is increasing at a steady geometric rate, and we are in the prime buying season for real estate. That gets a little scary when you realize that home purchases taper off after school starts. So that factor could exacerbate the problem. We are presently at 34,000 foreclosures (sounds like a pilot giving and altitude report) and if it keeps up at the present rate, it doesn't look good, come November. Double click on the chart for a larger, more depressing, image


---------------------------Data courtesy of Foreclosure.com-----------

There is a little whisper running around about the hedge fund insurance for these mortgages. They might not have to cover loan fraud. Looks like the underwriters for these loans have found a loophole.

People are slow to realize what is happening (auction wise). The bank takes title to the property at the foreclosure auction. (who's going to bid at that price?) We know that it's not going to move as an REO real estate listing. So what happens next? The banks in an area get together and have an auction to clear out their REO's. They've had two in the last month, one in LA and the other in San Diego I believe.

20,000 to 30,000 foreclosure houses will have to be sold in California in the next year, a majority will be REO bank auctions. No Realtor involved, as is, cash on the barrel head. What's not realized is that this auction party has only just begun. That's a lot of houses to sell in a down market; the price has to be right. The buyer can't do a "No Doc." You might want to write your Congressman and request that they put Realtors on the Endangered Species List. Don't be shocked if you get a letter back saying they will look into it.

Banks are just managing the property for the lien holders, whoever and where ever they are. The real pain for the debt holders has not set in yet. If we have a full year of REO auctions, prices are going to drop off a cliff.

San Diego currently has 21,300 real estate listing. The Realtors claim that's about 9 months of inventory. San Diego banks alone, either have to move their 4,600 REO's at auction or there will be 25,900 real estate listings. If you examine the graph, this is the only solid approach to the problem. They have to keep up with the new stuff coming in.

The lien holder has new problems. The tax based price for the REO is the foreclosure sale amount (full retail if it was a 100% loan). Now as a new land owner, they have property taxes to pay, of 1% per year. The lien holder loaned the money expecting a 6% return, gets no return and is dunned for taxes and maintenance. Talk about feeling used and abused, I thought that only happened when you got married.

The Fairy Tale World of Today

My son turns on the cartoons and there’s an ad for DiTech (GMAC) offering 125% financing (true cartoon thinking). What ever happened to the ads for toys and cereals? I turn to Bloomberg and there’s an ad from Countrywide to refinance at no cost to me. No cost means that they tack 10% onto the loan amount. It might not even be visible if you have paid 10 years on your present loan and refinanced. You start out again at 30 years with lower payments. The guy that writes these loans is often nicknamed “Slick.”

I get on the road to go to work and you hear on the radio about “Get out of bankruptcy dot com.” Or another one, “We will save you thousands on what you owe the IRS.” Where do you get the money to pay the lawyers to get you out of debt?

Then there is the movement to help these struggling home borrowers to escape the clutches of foreclosure (AKA the carrot on the stick solution). Give ‘em hope, but for god’s sake get a payment out of them! (And you thought your banker really cares)

The IRS is now accepting credit cards to pay tax bills (I think there is a 5% fee added on). Is this a new convenience thing? Or has the credit card industry taken another stupidity pill? Since real estate eliminated the “Fog a Mirror” test, the credit card companies have come out with a simpler test called “Lick the Envelope Stupid and Mail It in.”

Then you have a president that gets caught with his pants down, and the next thing you know his wife is a congressman threatening to run for President. Sounds to me like the lead levels are getting a little too high in the drinking water for that state.

The press says the president’s popularity is down to 25%. Sounds horrible, but if you figured only 60 % of people even voted, and he won with about 43% of the vote, that comes out to 25%. I must be missing something here?

Ex President Carter spoke up the other day deriding President Bush’s administration as being one of the worst on record. I have yet to find anyone who will admit to having voted for Carter. Everyone still remembers his brother taking a piss on Pee for View.

The rather odd thing about President Bush’s administration is that the Democrats want to blame everything on him. It’s kind of like one of those old Paul Bunyan tales in reverse. Or is it our Congress confirming indirectly that they really do nothing up there on the Hill? If they are so good at solving all our problems, then what have they been doing for the last 200 years?

When you really examine politics, if two thirds of the Congress could get together and agree on what they want to do, the president could play golf all day or clintonize a secretary or two.

So let’s predict the next presidential election (tongue in cheek). I predict that Bill Clinton will be the Republican Nominee for President, with Arnold Schwarzenegger as Vice President. Hillary Clinton will be running on the Democratic ticket with a Vice President candidate that is black, Hispanic, Jewish and gay. Bill Clinton will win the election. Hillary will shoot Bill and President Arnold will pardon Hillary. Talk about a happy ending! Sir Arnold, a Knight from the Kingdom of Kalifornia, will save us!

***** Warning****fractured fairy tale**** Warning*****

Footnote: You have to be born in this country to run for President; the Vice President is not restricted in that respect. Arnold cannot run for President since he was born in Austria, but he can run for Vice President. In this scenario he could become President.*

*For you history buffs, it looks like the 12th amendment closed that loophole. Vice President also has to be born in this country. So, Bill is safe for now, but isn't Dick Cheney looking for a new hunting partner? (I'd better be careful here, I think we are talking about two different types of "quail")

The New American Dime

Here are two coins, an old silver dime and the new Presidential dollar coin. Just for a laugh, which one is worth more? Answer, the silver dime is worth about 9 cents more.

To be a millionaire in the ‘1960’s meant something. In today’s world, a millionaire is a piker with 100K in 1964 dollars. Inflation makes people think that they are getting richer. People are making more money and their house and other investments have appreciated. What could be better?

Inflation is the hidden tax. Government spends a little more each year than they take in, probably about 3%. Over a 20 year period, the decimal point moves over one space to the right (i.e. $1,000,000 becomes $100,000). This worked pretty much OK until they passed Social Security.

When you contrast the silver dime with the new dollar, a new problem becomes visible, inflation taxation vs COLA (cost of living allowance) linked retirement benefits. What is different now, is that most of these retirement items that everyone depends on, were locked into the dime that was made of silver. So now benefits have to pay at the old dollar rate, inflation adjusted. As long as the dollar could inflate without COLA's, there was no problem. Once Congress linked the cost of living into retirement benefits, it created a monster that would bite them in the ass with every COLA increase.

Let's add to this, the health care package for seniors. Imagine, at the age of 55, your health insurance cost is $300 per month. What a relief that at age 65 it will be free. I am still talking BUBBLES and this is bigger than all of the rest. This bubble is not going away. Give it another 15 years before it's visible. The real question to ask; "Is it possible to believe that we, the people (the government) are really going to pay for what, we the people, (as individuals) could not pay?

Well, this kind of gives you an idea of where we are headed. They have super sized the dime and called it a dollar. So size does matter to your Congressman, doesn't everybody deserve a bigger dollar?

The government claims the inflation rate is under 3%, that keeps the COLA's low but kind of ruins their credibility. The real rate is probably closer to 12%, that's if you buy gas, milk, meat and beer. (Who can afford to buy all four at the same time?)

The Mutual Fund Run

There are about 8,000 mutual funds in the United States and 55,000 worldwide. Of those in the US, 4,600 were stock mutual funds. 55% of the money invested in mutual funds is invested in Stock Mutual funds (5 Trillion dollars). 48% of all of the Mutual Funds are in tax deferred accounts. Mutual funds owned 23% of all US publicly traded stocks for the year ending 2005. There is more info on this at
Link.

I am not really picking on all mutual funds just the open ended ones, the closed end ones look OK. The open ended funds are open to anyone and new shares will be issued to the investing buyer. There is a built in flaw with these funds. If the stock market turned bearish and started to drop drastically, things would start to happen. Your mutual fund portfolio would drop in value. At this point you have three choices; withdraw your funds, switch to a non stock portfolio with the fund, or do nothing. With withdrawal, you could face an early withdrawal penalty of 5% or as with the tax deferred accounts, an IRA penalty on top of that.

Notice that 52% of the investors have the option to withdraw without tax penalties. The rest probably have the option to switch from stock to money market funds. Here’s where things start to become unglued. The mutual stock fund facing redemptions has to sell stock for redemptions, and also for the transfers being made to money market funds.

The stock fund manager is sitting in his office wants to buy the market, everything is at a discount. What’s he being ordered to do? Raise cash! So what’s he about to do? Sell into a declining market. I just hope they don't try to sell the whole 23%.

There is an exception to this model and it is called a Closed End Mutual Fund. The managers of these funds don’t have to do anything when things get rough. Their fund’s shares trade like stocks. In a panic, you could sell your shares to another investor. It would not be uncommon for a closed end fund to trade for a 20% discount to the book value of the stocks it held in its portfolio. A great little shopping item, if you spot a panic. In this case you are buying a portfolio of stocks that has a fund manager without calls to raise cash to meet withdrawals.

The real disconnect that I see in the mutual fund market is the interest in the foreign funds. The Asian markets are touted as a "New Frontier." My jaw can't drop that low, I'm just too old. When Templeton suggested that market, the absurdity of the idea boggled my mind. Don't go there!

Foreign mutual funds in a panic could be dead meat. The natural instinct in foreign countries, in a panic, is to dump the local currency for U.S. dollars. The first thing that their government would do to stem the tide is to pass laws against repatriating the currency. In this case, you could cash in the foreign stock fund into local currency, but what good will that do, you can't convert it to US dollars? I'm not even touching on the corruption in third world Asian markets, Japan included.

So what happens if the stock market drops like a rock? The investors in these stock mutual funds are going to pull out of the fund or wish they had. This will force the money managers to sell into the abyss. In the 1930’s they called it “A run on the bank.” In 2001 it was called a 50% haircut. Get ready for the Mutual Fund Run and by the way, it's not a marathon!

Let’s Define “A Depression”

It’s a drop in economic productivity for a length of time. Speculation comes to a standstill, and bubbles cannot exist. There is a tremendous contraction in the wealth of the whole country. The great money making machines (plural) will collapse.

People are beginning to see the housing bubble. The machine that is cranking out new houses, is still making a profit. Building contractors can easily undercut home sellers, no reason to stop yet. Sticky housing prices are a plus (to the builder).

The stock market has Google at $500 and no dividend. It will probably still go higher. I still laugh about the AOL Time-Warner take over. It was like John Paul Jones with the Bon Homme Richard against the H.M.S. Serapis all over again. Then there are hedge funds who hypothecate the whole mess. They seem to be making big returns. When money enters the market faster than the creation of new issues, then prices rise—-forever???

The IRA’s and Mutual funds are increasing in value because of the increase in share price. What you are looking at is not a return on equity, but an increase in the prices of the equity. For example if Google rises to $600 you have a market perception of its new worth. But if IBM doubles its dividend, this is a real return on an investment. A money manager would probably invest in Google over IBM, because the apparent gains from that investment strategy would bring more investors to his fold. (I could be shot for this oversimplification)

If you look at Detroit, houses are so cheap, that you can't build a new one at those prices. The builders are leaving. The stock market could go to the same extreme. In a crash, Investors would demand a dividend of $4 to warrant a price of $100. Otherwise why not put it in the bank. What we would be looking at, is a return to more realistic values for assets. Some comedian during the Great Depression quipped, "I'm not interested in the return on my money, but rather, the return of my money."

The collapse will be a massive redistribution of wealth, hitting the rich, not the poor. All of this hypothecated wealth would disappear. The million dollar cats, dogs and tulips would be marked to market. Paper millionaires would go up in a puff of smoke.

Decreased consumption, would lead to layoffs. This would expose the credit card bubble and threaten the banking industry, or who ever holds all of this credit debt. Liquidation would then be the final game.

If that isn’t enough, Congress will rise up and try to save us. That's the scary part! It's kind of like getting on an airplane and having an election, to see who's going to be the pilot.

Where are the VA Foreclosures?

I was just dusting off my real estate license and wondering how many VA repos were for sale in San Diego. It's kind of weird, only 3 for the whole state of California. Florida had 20 and Arizona had 1. The nice thing about VA Repos as a real estate agent, you get both sides of the commission. You get the full 6%.

Back in 1999 it was normal to see anywhere from 20 to 50 properties listed every two weeks for the San Diego area alone. The big thing about VA Repos, was that they could set the comps for a particular area in a fast way.

From the looks of the present figures, there is a couple of years of agony in this market before it even gets to the 1999 figures. The peculiar thing is that Realtytrac has 6,100 houses listed as REO's in the San Diego area. You'd kind of guess that maybe about 50 of them ought to be VA.

Here's a neat site for California readers. It lists the REO's, NOT's, and NOD's for an area (you only get 20 in an 8 mile radius unless you want to pay for the service) Foreclosure Radar. My wife went through our whole address book on this web site, and it does not look good anywhere in LA or San Diego (at least for the people we know).

Bubble Markets Abound

Let’s see we have a housing bubble, a credit card bubble, and now I suggest a stock market bubble. Notice that I am not whipping out a bunch of charts to prove my points, just some thinking that suggests that there are discrepancies in the widely held mind set.

If you were in the market back in the 1970’s, it didn’t matter what you bought, it didn’t go up or down. It was like watching paint dry. Now the dividend was another story. This was where the money was made.

Let’s fast forward to today. If you bring to market a stock for "Cosmetic Dentistry for Dogs," a lot of investors’ will buy it. There is no concern as to the dividend rate; “Hell that’s taxable, give me growth!”

If you go back to the housing bubble there was a similar situation. The cost of ownership became financially impractical when considering the cost of renting the same property. This same problem occurs with stocks. If they go up forever, there is no problem. But if they stop appreciating, then the only thing that sets them apart from an interest bearing bank account is the dividend.

Using Big Blue as an example, IBM is at $102 and paying $1.60 per share. Let’s figure over a 10 year period it doesn’t budge in price. In this scenario, the return from a saving’s account would return three times more than the IBM investment. Looking back to 1984, IBM was at 124 and paid $4.20 in dividends.

Notice how the logic of the last paragraph falls apart, if stocks take off and go up another gazillion points. Notice also, the mind set of the investors that bought into the real estate market. “Real estate always goes up.” We know where that thinking could lead in the end.

The stock market has been going up since 1982 and has not had a 5,10 or 20 year bear market in the interim. Very few people can remember back to when the market was a cruel master.

You could argue that the market is fairly priced, (if you figure for inflation) and I would have no argument with that. But, if you consider the lack of reasonable dividends to support the present prices, and the absurd prices for stocks that have no dividend or earnings, you have to realize the market is not functioning on a rational level.

The baby boomers are not going to be interested in growth when they retire, only interest and dividends. They will be trying to preserve their principle and live off of the interest.

Something is wrong. Everyone seems to be a professional trader. It defies logic, that every household using a discount broker, knows what they are doing. People are placing bets and making money. They must be doing something right. This has no grasp on reality, if you compare it to the investment environment of the 1970’s.

The contraction of the money supply has started. Housing foreclosures nation wide are a good indication of that. Marking all of this housing to market, is enough to give the note holders spasms of the lower colon.

The housing bubble is obvious, the credit card bubble is a little hidden, and the stock market bubble—who knows. If gas goes to $40 per gallon, then we know that there is no bubble, just your ordinary hyperinflation. That concept is the one I don't want to entertain.

Did Gas Prices Go Up?

Gas right now is $3.50 a gallon. The price of gold has doubled. This can’t be inflation, because our wages should have doubled also (or so the scenario implies).

Lets look a it from a different perspective. Gas and gold have not changed in price. Then what has changed? Could it be the value of the dollar?

What are we really viewing here is perspective. Perspective is an interpretation of events. There is no real right answer, either could be right at any point in time.

Take two different people one retired and one just entering the workforce. The retired guy on a fixed income just had his buying power slashed in half.

The guy entering the work force will not have enough experience to sort out his place in the realm of economics 101 yet. He just got on the ride.

Add to this, an economic downturn, and a Congress that can be depended upon to grease the chute to hell, you have the beginning of a real mess. If its deflation, the governments tax base decreases. If its inflation, the landholders ability to pay taxes decreases. Either way the government is locked into decreasing revenue. In the 1930’s government raised the tax rate because of falling tax receipts. This exploded in their face. More, meant less in the end (pun intended).

The general public's perception of this “inflation” could become more apparent by necessity. It costs 60 bucks for a tank of gas, that pretty much shoots a 100 dollar bill. What if the Treasury started printing $1,000 bills? Wouldn't that set off warning bells? Kind of like seeing a rat trap in your favorite restaurant.

What scares me is the idea of a guy walking around with a $1,000 bill in his wallet thinking that he’s never had this much money before.

Here's hoping that its deflation instead. You never know whats going to happen next with this Congress passing bills that have already been pre-vetoed. Is that a mule or a jackass that they have for an icon?

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?

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
IBM----------------------------5.9298---------94.58
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
Verizon-----------------------2.3768----------37.91
Wal-Mart Stores Inc.------3.1198---------49.76
Walt Disney Co.------------2.2119---------35.28
Total------------------------99.9998------1594.99


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 http://visualizingeconomics.com

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.