Friday, November 7, 2008

The Rosy Picture is Gloomy

We received the the unemployment numbers this morning that said that we are currently running at 6.5% unemployment and have now lost over 1 million jobs this year in America. What was shocking to me was how incredibly understated these numbers still are. Just like the Consumer Price Index that measures inflation, the unemployment numbers have been changed over the years to represent a much rosier picture. This is not some conspiracy theory, they have come out and told us how they have changed their calculations.

I have discussed the way they do this a few times in previous Tuna's so I'll just give you a glimpse here of where we really are. John Williams of shadow stats compiles economic information the way our government USED to, using real data. The following chart shows true current unemployment in our country. Click below:

The top line shows where we are currently running through the end of September at around 14.5%. The number will be higher when he releases the October information. Anyone who lives in the real world knows that this is the true number, and it is only a matter of time before the country stops paying attention to the government's phony information.

I came across another very interesting chart yesterday. Click below:

It shows the reserves of foreign central banks. Just about every week I have talked about the US economic bubble ending when foreigners stop purchasing our worthless debt. As you can see from about 1971 their accumulation of our debt has increased exponentially month after month. To many people this means that it would go on forever.

Something interesting happened in August of this year. The amount purchased hit a wall and has actually started falling month over month since. Could this mean they have finally figured out our con? That they work hard every month to send us money that we use to buy things?

Maybe. Maybe not. But if they have, that means we will then move to step two of this process, which is monetizing the debt. If foreign countries will not finance our lifestyle then we will have to do it ourselves with printed money. Recent charts I have posted show the Fed's balance sheet exploding upward.

There are two important factors to remember concerning inflation. The first is the supply of currency (dollars) printed into the system. I talk about this relentlessly, but what I talk less about is the demand for those dollars which is equally as important. For example the recent rise in the dollar index has come at a time when dollars are entering the system at a blistering pace. But because of the recent deleveraging, there has been a short term rush toward dollars increasing demand tremendously.

What will eventually happen is that when the foreign countries stop buying our debt, which may be happening right now, the demand for dollars will fall through the floor. This will come at a time when the Fed is monetizing our debt, meaning they are covering all the bad loans with printed money. They will be flooding our system with dollars at the same time foreigners are sending all their dollar reserves back to America. Supply exploding, Demand collapsing.

These steps will combine with the third and final step. Americans are currently saving money because of the economic hardship. (A good thing) When they begin to feel the value of that currency falling, they will begin to purchase items faster because they feel the items will rise in price if they wait. This will flood the market with additional currency creating the final leg of the perfect storm.

I use the term hyperinflation a lot, and these are the steps that will unfold to get us there. The dominoes have been put into place. All it is going to take is a small push to start the process.

Thursday, November 6, 2008

A Familiar Story

News crossed the wires this morning on Bloomberg that for the first time in 15 years the month of October saw no purchases of bonds backed by credit card debt. Zero. How much was purchased last year at this time? $17 Billion.

What does that mean?

In the same fashion as housing loans over the past few years, credit card companies sent credit cards to every American in the country with a pulse. They told them to spend away with almost no limits. When the Americans started to spend, the credit card companies then bundled that debt into bonds and sold them into the market to investors. (Foreigners) This allowed them to continue to increase the amount of debt without keeping it directly on their books, and the amount of debt surged.

Now, the debt is starting to default, just like home loans. This has spooked investors who buy those bonds in the open market. This means if a credit card company wants to offer credit they have to take that risk on their books. Obviously, they will not do that because they know they are lending money to Americans who cannot pay it back. When you send the debt to someone else for it to default on, it is much more attractive.

What you'll begin to see now, as an example, are statements arriving in the mail telling you that your credit limit has been reduced from $5,000 down to $500. You'll begin to see a lot less cards arriving in the mail telling you that you are instantly qualified. This will not happen tomorrow, but gradually over the next few months.

This will be a crushing blow to Americans who now depend on the credit cards to cover the difference in the cost of living every month. More and more loans will begin to default, and the market will continue to tighten.

In response to a tightening of lending standards for home loans to Americans, (the free market working) the government nationalized Fannie Mae and Freddie Mac. Will they do the same with the credit card companies and stand behind all their debt? If they do not then the end of our spending binge may finally be over, and our country can begin it's true economic collapse.

GM announced yesterday that they will know in the next few months if there will be an American car industry at all. The government has the same decision to make with the auto manufacturers to decide if they will stand behind their debt.

Fantastic article written today:

Wednesday, November 5, 2008

A Next Shoe to Drop

There are two ways to make money in commercial real estate. The first is to increase income and decrease expenses. The second is appreciation to your building based on the market's desire to own your property. Seems easy right. It is. But what I've found in my last few years of study is that commercial real estate is very similar to texas hold-em. It is very easy to learn, but it takes a lifetime to master. Similar to a no limit high stakes game of poker, the smallest mistakes can wipe out your stack in an instant.

For example, let's say that the annual income on your building is $200,000 and your expenses are $100,000. That leaves you with $100,000; this is called your Net Operating Income.

$200,000 (Income)
(-)$100,000 (Expenses not including mortgage costs)
=$100,000 (Net Operating Income)

All you have to know at this point to understand what a building is worth is to know what rate of return an investor is willing to pay for that $100,000 in Net Operating Income. If an investor is willing to accept a 10% return on their investment, then your building is worth $1,000,000.

$100,000 / 10% = $1,000,000

The 10% is called a cap rate. Cap rate and Net Operating Income are the two most important terms in commercial real estate. They are similar to "implied pot odds" and "number of outs" in texas hold-em.

What if you could increase your expenses by $10,000 by raising rents, and what if you could decrease your expenses by $10,000 by having more efficient management on your property? This gives you:

$210,000 (Income)
(-) $90,000 (Expenses not including mortgage costs)
= $120,000 (Net Operating Income)

If the cap rate is still at 10%, then your building is now worth $1,200,000.

$120,000 / 10% = $1,200,000

This means you just created $200,000 in value into your building with a small change in operations. Now here's the fun part. What if you didn't even change anything in your building, but investors were willing to take a lower return for your $100,000 Net Operating Income? (Original Example) What if the cap rates in the area were lowered to 9% because commercial real estate is a hot investment in your area/country?

$100,000 (Net Operating Income) / 9% (Cap rate) = $1,110,000

Your building just increased in value by $110,000 just because investors were willing to take a lower return. This is what happened between 2002-2007 as commercial real estate was smoking hot. Investors were paying a 2-3% return for the Net Operating Income, which created huge paper gains on the buildings.

I only take the time to explain this because over the next six months you are going to begin hearing about commercial real estate as one of the next major problems in the market. Right now cap rates are rising, which is causing building values to fall. Investors over the past five years purchased buildings with short term debt just like homeowners. They are now going back to the banks to refinance only to find out that they cannot. (Because of something called a debt cover ratio that would take too long to explain)

Over the next 48 months commercial buildings are going to flood the market in a manner not seen since 1990, only this time I believe it will be much worse. There is no Fannie Mae or Freddie Mac that the government can socialize to create new loans for commercial real estate. Lending restrictions will severely tighten up, creating massive losses for banks that purchased these mortgages, and enormous bargains for investors entering the market.

I prepare every day for this coming opportunity. To prepare I work on my ability to increase income/lower expenses on a building, understand the direction of cap rates/capital movement, and align myself with investors who will have the capital to make purchases when the time is correct.

A Change Is Coming

We have a new president America. He has promised you a change, and I assure you a change is coming. Let's talk about what we can look forward to.

Obama enters his presidency at a historic moment in time. Our entire country has experienced a 25 year economic boom fueled by credit and debt. Every year it seemed things could only get better, and every year the debt grew larger for Americans and the country as a whole.

Unfortunately, what goes up must also come down. A boom fueled by credit is what can be described as phony, for lack of a better word. The country experienced a glimpse of what our economy truly is in October, when the stock market fell over 20% in a single month. Many people who do not watch their accounts week by week will be opening up their statements in the mail this month to an unpleasant surprise. A change.

While the phony inflated stock market values of American's 401Ks can be ripped away in the blink of an eye, the real estate market works in a different manor. Astonishing surveys taken over the past few months show that about 75% of Americans think that their home has stayed equal or gone up in value over the past year. Many still feel that their homes will sell at 2006 prices, only to find out what their home is really worth when they put it on the market. I know this because I see it every day in my business. The true prices of homes right now are what they are selling at in foreclosure.

Coupled with this decrease in asset wealth will be mass layoffs over the next 18 months. These appear to be coming across the board in every industry, but real estate and finance in general are the true slaughterhouse. Unfortunately, those two industries were the main growth of employment over the past ten years. Where will those employees work when they're out of business and they realize that the housing and financial industry will not be back for many years? Very good question. They will feel the change as well.

As assets and wages fall, the real pain will come from the other side in the cost of living. The temporary pull back in oil has comforted Americans with the fact that the oil "bubble" has finally burst. Unfortunately, no one has told them truth about supply and demand. The global demand for oil this year will grow by about 1% and the supply is falling. To counter that punch, the number of dollars entering the system is surging at a rate almost unfathomable as the supply of oil falls. As I've said before, prepare yourself for some remarkable prices for oil over the next 18 months. A change if you will.

Oil will be teamed with its partner agriculture(food pricing) which will follow a similar pattern of supply and demand, only possibly more severe in the short term. The cost of food and gas will take away any available "free" spending money for additional goods. Our lifestyle will be put first onto the credit card as it is now, and as that is taken away it will leave nothing left for consumption, which makes up 72% of our economy. Remember, our economic model is foreign countries working hard to send us money so we can buy things. That will end after this crisis. A change in living standards is coming.

This will all have a snowball effect as home loans, credit cards, auto, commercial real estate, and business loans are all defaulting at the same time. It will begin to overwhelm the financial system with defaults. For these reasons, over the past few weeks all the banks have essentially been nationalized to prepare for this coming storm. If this had not taken place, the credit default swap market would be a weekly time bomb set to explode, which would have the effect of shutting down all the major banks who send billions to our politicians. This is obviously not acceptable and a change was needed fast.

So the banks will be saved and the cost will be sent to the already decimated American public. It will be sent to them weekly in the form of inflation. Every week they will be taxed with a higher gas price, food price, clothing price, ect. Obama will stand ready to send them additional stimulus checks to cover these costs. Of course, these additional stimulus checks will only increase the cost of living thus cancelling out any positive effect. They will send more, and more, and more. Then you can expect price controls, and then you can expect tax hikes, the two most destructive things any country can do to its people.

What will ensue will feel like a hyperinflationary depression. All remaining wealth will be transferred from the hands of the poor and middle class to the wealthy and foreign countries as our currency collapses in value. The wealthy will be holding assets that will keep their value, and foreigners will be holding currencies that have increased in value. All the cars, televisions, and homes that they lent to us on borrowed money will then be returned to them at incredible pricing. We will just be left with the debt for those products. Obama stands ready to take the fire that blazes across our country and send air crafts to dump gasoline. Yes sir, get ready for a change.

(I am not a McCain fan, and I believe that no one can stop the pain that is coming. A recession must always follow a credit boom to cleanse the system. Certain people, however, could positively affect how quickly we could recover, mostly by standing out of the way and letting the free market correct the mal investments)