Saturday, April 11, 2009

Ponzi meets Security

The treasury department announced Friday that our budget deficit increased by $192.3 billion in the month of March.

That means that after collecting all taxes (revenue) , they spent all those taxes, and put $192.3 billion on our nation's credit card.

When Bush finished his last term in office he ended his final year with a total deficit of $454.8 billion. This was a new annual record and considered catastrophic for the direction our country was headed.

Bush ran a $454.8 billion deficit for the entire year.

We just ran a $192.3 billion deficit in a single month.

The deficit right now stands at $956.8 billion for the first six months of this year. The Obama administration predicts we will finish the year at $1.75 trillion in the hole.

It is important to remember that as we progress through the year, taxes (revenue) are falling across the board and spending (expenses) is escalating fast.

There is already talk of a second stimulus program and it is being worked on as we speak.

As the banks continue on with their stress tests, it will become clear that the money needed to save them is going to be a lot larger than anyone thought. The original TARP program of $800 billion this fall is just going to be the overture. Without full nationalization of the banks, you can expect to see TARP 2 and 3 before this year is over. (Nationalization would cost even more)

Also, these deficits we are talking about do not factor in "off balance sheet" costs such as the war, social security, or medicare.

Speaking of social security, we keep hearing in the news that it may be running out of money in the near future. What does that mean?

Every month when people pay taxes they pay toward the social security fund. This means you put in money now that you will receive at some point in the future. To make it simple lets pretend that 100 people put $1 into the fund every month. The government then takes that $100 and pays out $75 to 75 people currently retired.

That means that after paying out that $75 every month, the fund should be saving $25 for the workers currently paying, right? Wrong. The government takes that $25 every month, spends it, then replaces it with an IOU. It is similar to the scene in the movie Dumb and Dumber.

This is what you call a ponzi scheme. You may be familiar with that term and its correlation with Bernie Madoff. The plan works fine as long as there is enough new money coming in to pay out the old investors.

In the year 2012 social security is going to take in less than it gives out. That means out of those 100 workers, lets say that 25 of them retire. This means that the remaining 75 put in their $75 every month, and social security now needs to pay out $100 per month. ($25 for the new people who retired, plus the old $75 that still needs to be paid)

Fortunately, most people think that the money to cover the difference is going to be from the savings the program has aquired over the years. The general public does not yet realize that the government has already spent this money.

The point is, if we were ever able to con the rest of the world into buying our worthless treasury bonds until 2012, then at that point we can then begin the real nightmare.

It is estimated by some that the social security bailout is going to cost $100 trillion.

Tuesday, April 7, 2009

Macro to Micro

Interesting quote from Bloomberg this week:

“The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the VALUE OF EVERYTHING PRODUCED in the country last year.”

$12.8 trillion. In a six month period. Wow.

We talk a lot about the big picture here, and focus on the losses from a global perspective. But where do these losses come from? How is it possible that we are looking at a number that large, that quickly? And if we've done that in six months, where do we go from here? Have we hit a bottom?

Lets take a look at what is happening on the front lines....down on the battlefield.

In the past week I have had conversations in great length with custom home builders, land developers, and commercial real estate property managers.

Let's start with the custom builders:

The Charlotte market was strong up until the summer of 2007 (about two years longer than the rest of the country). Custom home builders were building homes on speculation up until that point, meaning that they would build a home before someone had a contract to buy it. Inventory homes.

The market for homes above $700,000 collapsed here that summer, and any home that had not sold at that point is probably still sitting on the market today. The builders have to carry interest on the mortgages every month on these properties until they sell. The typical range for total inventory homes from the builders I speak with is in the range of 5 to 40 homes.

Here is the problem that builders are facing:

The builders took out a loan from the bank in order to build these houses. Lets say a typical builder took out a loan of $1,000,000 to build a home they were hoping to sell at $1,200,000. Today that home is now worth $850,000. If they take an offer at that value then they have to go to the bank with what is called a short sale. This means the bank can decide if they would like to accept an offer at $850,000. The problem with this scenario is that that when the offer is accepted the bank will then go after the builder for the remaining $150,000.

Remember, most builders are holding multiple homes with this scenario. They are paying interest every month on these homes.

So here is what they do instead:

They take all of their assets: money in the bank, homes, second homes, businesses, etc., and they are moving it all into separate LLC's. They are taking everything they own and taking it out of their name, and the reach of bank. They then walk into the bank's office on Monday morning, and hand them the keys to their 5, 10, or 15 houses, and they walk out.

The banks then foreclose on the properties, but are unable to go after the builders for the losses.

A builder I know said he was in the bank last week and someone came in and dropped off 43 sets of keys. Another builder he knows dropped off 15 the week before.

As the months go by, and builders realize that the market is not returning, they decide that they don't want to play anymore.

Will it hurt their credit? Absolutely. But most of them will just retire. They've made millions over the past 15 years during the housing mania, and they would rather quit the business than give their life savings to the banks.

The developers are in a similar situation, except on a much larger scale. Unknown to most of the population here (and around the country), every developer in the city is taking orders from the bank right now. They are in complete control of their properties.

For example, there is a neighborhood here in Charlotte that developed over 2,000 lots in 2004. 98% of that neighborhood now sits empty, and belongs to the bank. The developer is still the face of the operation and is managing the community, but the bank owns the property. Before giving all their land back to the banks, the developers did the same thing the builders did that I just discussed. They protected all their assets, then walked in and said, "I don't want to play anymore."

This same process is just now beginning in commercial real estate. The owners of these buildings will take the same route as the custom home builders and developers.

All the builders and developers went insolvent on paper, and they transferred the losses to the banks. All the banks then became insolvent on paper and these losses were then transferred to the taxpayer.

But where did they go? Did the losses then just disappear? The average tax payer has not seen an increase in taxes. Obama has not said he will cut back on spending in order to cover the difference? So who will take the losses, where will they appear? Were we able to avoid all pain for our mistakes?

You know the answer by now. The losses will build and build until they are reflected in the value of our currency. They will appear as a loss of purchasing power from every dollar holder. This process will take time to work out, but once it begins to unravel it will be over fairly quickly.

The opportunity to board a lifeboat is still available. Its up to you if you want to risk going back onto the ship for one more drink and dance.