Friday, March 26, 2010

Good Debt Bad Debt

There are two kinds of debt in this world: Good debt and Bad debt.

If a person/company/country borrows money for a productive use it is good debt.  For example, if I go to the bank and ask them to borrow $1,000,000 to buy an apartment complex and the apartment generates enough income to cover the debt every month, that is good debt, also known as an asset.

That apartment will then become a business where people are hired to manage the property and do maintenance on the property.  It generates jobs and grows the economy.

The same goes for a business that borrows money to invest in machine equipment or medical research or software.  The debt will be paid with future cash flow and allows the business to generate additional profits.

It is possible to put a value on the return an entity receives from the debt they borrow. 

The following chart shows the return the Federal Government has received from every dollar they have borrowed going back to 1960:


During the 1960's a dollar borrowed generated almost a full dollar in return.  This means the United States was running an excellent business. 

When looking at where we are today you see a different story.

For every dollar the government borrows today it is now losing 45 cents.  This is staggering.  The United States is running what can be described as an extremely unhealthy business.

This brings us to the present day decisions our leaders are currently making for the country.

Before I go on, let me emphasize that I would love for everyone in our country to experience the world's greatest health care in unlimited amounts.  I think taking care of your health is the most important part of life.

That being said, the new health care bill has to be paid for.  Estimates show that the bill will cost the country $2.4 trillion and it does not go into effect until 2014.  We pay now, and we hope to receive in 2014. 

We are currently spending just under $800 billion per year on defense spending.  It feels as if we have a military base in every city in the world. 

Is that necessary?  Is health care more important than that expense?  I think one day soon we will have to decide.

The following chart provides a great visual to show where our money will be spent in 2010:


Running yearly deficits between $200-$400 billion was never a problem in years past because China always purchased our debt and they always recycled it back into America.  People always said the deficits were future problems when this paradigm ended.

Well, it has now ended.  China has stopped buying, and they are now selling.  The deficits are no longer $200-$400 billion, they are now $2 trillion, every year.

We have now run over the cliff with no parachute.  Social Security will take in less this year than it pays out.  This was not supposed to occur until 2016.

The treasury debt auctions this past week could be described as scary.  Rates are moving up across the board.  Insurance on United States debt now costs more than companies such as Berkshire Hathaway and Exxon. 

Stay focused on what is happening.  The world will be a very different place, very soon.

Wednesday, March 24, 2010

Home Owner Write Downs

One of the tax payer's most recent acquisitions, Bank of America, announced today that it will be writing down the principle on $3 billion in mortgages for 45,000 struggling home owners.  (The tax payer only pays for the losses for Bank of America, it does not share in the profits)

This move will most likely be followed by the other large banks now that they have accumulated $1.2 trillion in interest free cash reserves from the Federal Reserve.

It also takes away the last remaining reason for a homeowner that is underwater to continue making their payments.

In addition, this move provides new incentives for Americans to max out credit cards and not make payments to be in line for the credit card principle write down that will coming next.

Housing "Recovery" Continues

We received new data on the state of the media's housing market recovery this week:

Yesterday's news showed existing home sales falling for the third consecutive month.  The annual sales number fell to 5.02 million, down substantially from the recent high created with the artificial government stimulus.

The inventory on the market soared from a 7.8 month supply, up to 8.6 months.  The supply increase has been due mainly to the foreclosures coming onto the market, a trend that is only just now beginning.  The total inventory, including the shadow homes that banks are holding off the market, is estimated to be double that at around 18 months.

Today we received word that new home sales last month plunged to an all time record low of 308,000 annually.

Once a year my local paper publishes a report showing companies that have not paid their taxes.  The publication is put out to incentivize companies to pay their bills in order to avoid the stigma that their business may be in trouble.

The $43 million in unpaid taxes for my county alone read like an obituary for anything and everything involved with land, building, or real estate.

Fortunately the media has announced the bottom in the housing market so this information should not have an impact on real estate prices.  (Which are also falling every month across the board)

Monday, March 22, 2010

China's Deficit May Uncover The Direct Bidder

The global economy that we have known for the past 30 years has been a similar theme.  The United States has been the global consumer of the goods the world produces.

The largest producer of those goods over the past decade has been China.

This imbalance between the two countries created a large trade surplus for China and a large trade deficit for the United States.  (The US bought more than they sold.  The difference is a deficit)

This meant that China had a large amount of cash coming in month after month.  If that cash was kept on their shores and converted into yuan currency it would have caused high levels of inflation within China. 

Instead, they immediately took that money and recycled it back into American assets.  The bulk of the purchases were in US treasury bonds which has allowed the United States to run incredibly high deficits year after year.

Why is this important?

This morning the China Daily News is reporting that China plans on announcing a deficit of $8 billion for the month of March.  You read that correctly; deficit. 

Our government this year needs to raise an estimated $1.4 trillion in the debt markets to remain solvent.  Over the past four months there has been a mysterious direct bidder at the weekly auctions who many have speculated was China making purchases through the United Kingdom.

This news of a monthly deficit makes that scenario very unlikely.

That leaves one big buyer still out in the market place.  I think you know his name by now: