Saturday, June 12, 2010

The "Future" Social Security Problem Has Arrived

Every time you pick up your paycheck on Friday morning there is a deduction called "social security" payments.  This has been deducted every Friday from paychecks across the country for many decades.

As you know when a person reaches a set retirement age in our country they become eligible for a monthly social security check.

Every month up until this year there has been a surplus in social security income (money collected from pay checks) compared to what has been paid out. (the monthly checks people receive)

The government has always told us that this surplus is savings that they will use in the future when the baby boomers retire and there is far less income coming in and far greater payments going out.

What many people do not know is that every year the government spends this surplus.  They take the money, use it, then replace it with an I.O.U.  There is a drawer in the White House that is the social security fund.  It is a file full of pieces of paper that say I.O.U.

Jim Carey explains this situation here.

This was not originally anticipated as a problem until 2027.  Then estimates were moved up to the year 2016.  That was until we received word that, surprise!, this year, 2010, the surplus has run out.  The chart below shows the income and expenses crossing.

Not only has the government lost their make believe surplus account which they used to buy other fun things, they have to borrow every month now just to make the payments.

Some analysts now estimate the coming social security bail out at over $100 trillion.  This will not be in the year 2027.  This bail out is needed now, and it will grow exponentially every year as baby boomers continue to retire in mass.

The United States as a country is bankrupt.  It currently owes $13 trillion and the deficit now grows by $2 trillion every year.

The money used to pay this entitlement spending will come from the Federal Reserve.  It will come from a printing press. 

Commercial Real Estate Destruction

We received the most recent commercial real estate data from Moody's this week.  The overall delinquency rate for the sector has risen to 7.5% in the month of May.  Delinquent means a commercial loan is not currently being paid.

They have upped their target for year end delinquency to 9-11% from their original 8-9%.  Their target was moved due to ongoing unemployment and deterioration in the economy.

I expect them to move the target higher as the economy moves from "deterioration" back into "total destruction."

The following shows the delinquency rates and price charts for each individual commercial real estate sector.

All properties: 7.5% delinquent.

Apartments: 13.13% delinquent

Industrial (Warehouse): 5.59% delinquent

Office: 5.59% delinquent

Retail: 6.10% delinquent

The apartment and hotel sector (13.25%) have significantly higher delinquency rates than industrial, office, and retail.  This is due to the long term leases that are signed in the latter three.  Under the surface, however, office and retail are crumbling quickly.  The supply of open space and inability for new tenants to acquire financing for small business continues to lower their income drastically.

The apartment and hotel sector should be the first to bottom in a few years.  Another 30-40% decline in prices, along with a rising interest rate environment and the coming loan resets should annihilate anyone who is still involved in the commercial real estate business.

It will then be buying season for new investors, the ones who wait patiently today in the shadows. When people look back many years from now they will not believe the buying opportunities that became available between 2012-2014.

Thursday, June 10, 2010

Nassim Taleb On The Next Black Swan

I keep CNBC on my screen either at home or at work pretty much from 6:00 AM to 8:00 PM.  However, very rarely does the TV come off mute as 99% of the audio information is garbage.

Last night they had a guest on by the name of Nassim Teleb.  He is the author of the bestseller "The Black Swan" which became legendary after predicting the financial crisis before it appeared.

He is also one of the greatest minds of our time and an example of one of the rare times I will press unmute.

Of particular interest to me during his discussion was not if the US will have a failed Treasury auction, but when.  "That is the black swan."

We all hope that he is wrong and that foreign countries will continue to sacrifice the prosperity of their own citizens to support our ridiculous government spending.

Part I:

Part II:

Moving Out Of The Shadows

Realty Trac reported this morning that foreclosure filings were above 300,000 in May for the 15th consecutive month, coming in at 321,920.

No news here as the coming real estate collapse is real and approaching.  The more important question is when this shadow supply will begin to hammer prices downward?  When will banks actually take possession of the properties?

The bigger story from Realty Trac this morning was that bank repossessions (REO's) hit a record monthly high for the second month in a row at 93,777.

When banks finally take ownership of the properties in foreclosure they will begin to put them on the market for sale.  It is at that point the shadow inventory will become the real inventory.

It appears that process is finally beginning.

As mortgage applications, existing sales, and new homes sales continue to drop off a cliff after the expiration of the home buyer tax credit, the shadow inventory should be another welcome boost to the real estate recovery.

Wednesday, June 9, 2010

The Good, The Bad, And The Bubble

How does an investor decide if debt is good or bad? 12 months ago the government debt in the country of Greece was considered one of the safest investments in the world. It held a debt rating of AAA. It was perceived by the investment community as not only good, but great debt. A few weeks ago the country was on the verge of bankruptcy with the debt trading at a fraction of its former value. Its debt became bad debt that was only saved with a bail out.

During the spring of 2007 a form of debt called subprime became the darling of the investment world. It held a debt rating of AAA. 12 months later during 2008, subprime debt could not even find a price in the open market because its value was plunging so rapidly. Many investors holding what they perceived as good debt ended up getting wiped out. Once again these investors holding bad debt were only saved by a bail out.

Today the United States government debt, the Treasury bond market, is the darling of the investment world. The treasury debt of our country holds a rating of AAA. Investors around the world have become spooked by the Euro debt crisis and have rushed into American treasuries, pushing the prices to historically record levels. (Low interest rates)

Many investors believe that the “good” United States debt today will soon turn “bad.” Some have even called it a bubble. Is it possible the United States good debt could turn bad? Looking at bubbles throughout history, investors have learned that they arrive with two main characteristics:

1. There is a record new supply coming onto the market at the same time investors are willing to pay record high prices.

For example: At the end of 1998 the NASDAQ crossed 1500. Over the next 18 months there was an onslaught of new technology IPO’s that poured in to the market. A record amount of new stock was issued at a time when stock prices were rocketing higher every month, until they peaked. Then the new supply became unsustainable, and prices collapsed.

The same situation occurred in the summer of 2005 as builders flooded the market with an endless supply of new homes. The more homes they built, the higher the prices rose. Then the new supply became unsustainable, and prices collapsed.

Last week our United States treasury debt crossed $13 trillion. Our debt to GDP level has now reached 90%. New debt supply continues to grow every month as tax receipts fall and spending continues to rise. In 2009 we added $1.9 trillion to the deficit, which is close to four times the record annual supply seen in 2007. This new massive amount of supply comes at a time when investors are willing to pay the highest prices in history to purchase the debt, similar to technology stock investors in 2000 and real estate investors in 2005.

At some point the new supply will become unsustainable……

2. The public is rushing into the market.

Similar to the NASDAQ bubble in 2000 and the real estate bubble in 2005, the bond market has seen the public, the every day investor, rush in with full steam. When investors left the stock market in 2000, they bought into real estate which they perceived as the ultimate form of safety.

In 2010, the average investor has left what they perceive as risk in stocks and real estate, and they have again rushed into what they perceive as safe. Bonds in their mind are as good as cash. What most of the public does not know is that bonds lose value just as stocks do. In the 1970’s bond investors were pummeled for a full decade as interest rates rose.

Today the average investor is buying bonds at record high prices, the second major sign of a bubble forming.

So what is the key determinant of what makes debt good or bad? It is a word found continuously throughout this discussion: perception. Fundamentally bad debt can be traded at a price in the open market that is far above its true value, only because investors mistakenly perceive its value at a higher price.

However, when that perception changes it usually comes in the form of a rapid collapse as seen recently in the country of Greece.

Why Real Estate Prices Should Fall

There is nothing more important to the price of your home, the office you work at, or the building where you do your shopping than leverage. Leverage can be defined as credit, debt, or the ability and cost at which to finance real estate.

While many books and articles have been written to show how an increase in leverage and credit caused the price of real estate in our country to skyrocket to bubble levels, very few seem to understand that the coming lack of leverage will in return bring real estate prices far lower.

If more buyers are able to secure mortgages due to relaxed qualification standards such as credit scores, down payments, and income requirements then the demand for housing will increase as there is a larger pool of potential home buyers.

The exact opposite is true when credit contracts. As lending restrictions tighten, the pool of potential home buyers becomes smaller and demand will in turn be far lower.

In a normal real estate cycle home prices will then correct downward until they reach a level where buyers can once again afford a home with realistic qualifications.

However, this downturn in the real estate cycle has been different from those seen in the past. Our government has stepped in and now provides or guarantees close to 100% of new mortgage loans currently being made.

This has temporarily stemmed the price fall for homes that fall under the FHA maximum loan limit. In the Charlotte area this loan limit is currently at $303,750. Under an FHA loan a buyer needs no cash reserves (savings), 3.5% down payment, and lower credit scores than a conventional loans.

What this means is that the American tax payer has become the credit market for residential real estate. They have become the leverage, and they stand ready to pay for any losses incurred as a result of lending with these relaxed qualification standards.

So they question is, how long can the government continue to provide leverage to keep the real estate market artificially afloat?

That question needs to be determined by looking at the strength of the Federal government itself. Is it good debt, or bad debt?