Saturday, July 31, 2010

New Second Half Development

My view and outlook since the beginning of the second half of the year was that we would see a period of disinflation where asset prices fell across the board due to surprising economic deterioration.  I felt that both the Federal Reserve and Congress would then put together a combined stimulus to try and push markets upwards into the elections.

The first step has occurred on schedule as the markets have begun to roll over, and the economic data has been a disaster across the board.  The economy is weakening in every possible way.

My surprise has come with the next step.  I assumed that the Federal Reserve would wait until markets fell substantially before announcing their plans for additional stimulus, is essense, "surprising" the markets with good news.

However, before we have even reached the real fall in asset prices, the Federal Reserve has already announced their plans for the second round of Quantitative Easing.  Ben Bernanke did so during his testimony before Congress two weeks ago, and the Federal Reserve President of St. Louis not only wrote a paper this week outlining his desire for additional stimulus, he even sat down with CNBC for two hours and told the world it was coming.

Why would the Federal Reserve play this card so early?  This is the important question.

My guess is that they are looking at the exact data that I am, and they understand the magnitude and swiftness of the economic decline that is taking place.  They want to let the world know before markets fall that they stand ready with an unlimited amount of printed dollars to support the markets.  This is in stark contrast to the way the previous collapse was handled heading into the fall of 2008.  The Fed was always "reactionary."

So what does this mean for the investment outlook?

The investment strategy for the second half of this year was to raise cash and prepare a shopping list of investments that would become attractive as the markets rolled over.  There would be a short window of purchase time before the Federal Reserve stepped back in.

Unfortunately, the Federal Reserve's early announcement has probably put a higher floor under where the most attractive assets will fall.  For example, my personal hope was that silver would fall under $15 during the next decline.  I have been raising cash to prepare to purchase heavily at that level.

With the Fed's announcement early, other investors now understand what is coming, and they most likely will step in early before the Fed declares war on the currency. 

The point of this discussion is to stay focused.  When you live in a world where the government is so heavily involved in all aspects of the markets, and the Federal Reserve stands ready to print money and purchase any asset available, you need to understand their impact on the markets and plan for it.

The free market is long gone, but you still have to play the game that has been presented.

Friday, July 30, 2010


Leonardo Dicaprio is on the cover of Rolling Stone this week.  He spends time discussing his life as well as his new move, "Inception,"  which is by far the best movie of the year, and in the top 5 for movies this century.

If you haven't seen it, go see it.

In the article he also briefly mentions a movie that he recently saw called "Collapse." 

The movie was an independent film that was originally intended to be about a completely different topic.  The film's crew flew in to visit a man named Michael Ruppert to ask him a few political questions.

When they turned the camera on and began asking questions he started to go into mesmerizing detail about events he had recently predicted, and what his vision was for our future.

When the film crew finished asking questions, they abandoned their original premise for the film and they decided to make the entire movie around Michael Ruppert's interview. 

I saw the film last year. It came out on DVD June 15th, and it is worth a night with popcorn if you are looking for a real life horror movie.

This past week he did an interview with Jim Puplava discussing the film and his new book that he decided to write as a follow up to the film's massive response.

The interview can be heard here.  The following is the trailer for the film:

Thursday, July 29, 2010

Through The Looking Glass

The world now assumes that the European debt crisis has passed, due to the stress tests released last Friday which tested nothing.

Unfortunately, in the real world, nothing has been solved.

In the financial markets the cost to borrow in the European banking system has been rising daily.  This indicates that tremendous stress still exists in the financial system as banks still do not trust each other.

Outside of the financial world on the streets of Greece we have another round of rioting this afternoon.  Truck drivers that carry fuel in the country have been on strike for days causing shortages at the pumps.  The government threatened to make arrests if the drivers did not go back to work.

Instead of going back to work, they took to the streets in protests.  The police have begun firing tear gas into the crowds to regain control over the situation.

Meanwhile, here in the United States where such a thing could never happen, California governor Arnold Schwarzenegger has declared a fiscal state of emergency.

He has ordered 200,000 state employees to now be paid minimum wage, and many more to take 3 days unpaid leave a month.

They are currently faced with a $19 billion budget gap, and they will run out of money by October.

Fortunately, we know Mr. Obama stands ready to fund state level deficits with an unlimited amount of Federal debt issuance.

But who will buy this unlimited amount of Federal debt that continues to skyrocket upward?

We found that answer today in a press release from St. Louis Federal Reserve President, James Bullard, who said he feels the Fed should invoke crisis level measures involving the purchase of additional treasury bonds. (Federal debt) 

Quote from Bullard:

"The FOMC’s extended period language may be increasing the probability of a Japanese-style outcome for the U.S., and on balance, the U.S. quantitative easing program offers the best tool to avoid such an outcome."

This is in concert with Bernanke's recent comments during testimony that he has "not run out of bullets."

The Federal Reserve's next round of Quantitative Easing (money printing) should provide the long awaited catalyst for our coming currency crisis.

Wednesday, July 28, 2010

Long Term Trend Line

The following display shows home prices dating back to 1890.  Throughout history home prices have essentially tracked the rate of inflation. (Until the year 2000)

Now that the (current) government subsidy has passed, the following red line shows the likely direction of home prices needed to revert back to the long term trend.

(This trendline is based on the assumption that the government will continue to nationalize 100% of new mortgages with the Fannie and Freddie tax payer money.  If they were to do the right thing and step away, prices would collapse far further than the red line indicates)

Click on image to enlarge:

Tuesday, July 27, 2010

Commercial Auction Case Study

I receive commercial real estate auctions in my email box on a daily basis.  As you can imagine, the amount of properties I have been receiving continues to pick up week after week.

I spend time running financial simulations on some of the more interesting properties to get an estimate of what I would offer for the asset if I were to attend.  I can then check the tax records to see what the property was acquired for and get a better understanding of where the distressed market is today.

Let's take a look at an apartment community going up for auction down in Orangeburg, SC in August.  The following are their actual income/expenses for 2009:

Total Income: $450,900 (Rent)

Total Expenses: $227,605 (Taxes, Insurance, Management, Supplies, Legal, Advertising, Etc)

Net Operating Income: $223,295 (Income  - Expenses)

This is what an investor would receive every year if he paid cash for the property.  I would not pay cash. (I wouldn't pay cash even if I had it, but that is for another discussion)

I would offer $1,800,000 for this property today. 

Let's say I financed the property 100%.  How much would that cost per year?

70% bank loan at 7% interest: $100,584
30% private loan at 15% interest: $81,000
Total cost to finance: $181,584

So what do I take home after all expenses at the end of the year?

Net Operating Income: 223,295
(-) Cost to finance: $181,584
Yearly Cash Flow: $41,711

I would make $41,711 in passive income with a full time management staff on the property with $0 put into the asset.

I am interested to see what this property sells for in August.  I will update you when the info become available.

Why won't I be at the auction?  Because it is extremely unlikely the winning bid will be $1,800,000. (or below)  Investors are still paying too much for property.  But that will soon change.

Commercial Real Estate Reality

Excellent conversation today on CNBC regarding the outlook for commercial real estate with Scott Rechler, CEO of RXR Realty.

As I've discussed in the past, the commercial real estate crisis has not even begun due to banks marking their loans at 100% value that are currently worth 40-50% of the loan.

The crisis will intensify through 2011 and 2012 as 1.4 trillion in commercial debt will need to be refinanced through 2014.  As Scott discusses, there is no financing available for this rollover due to the collapse of the CMBS market.  (Secondary market that packaged and sold loans during the credit bubble)

The massive mark down in prices will come when banks must finally recognize the losses and sell the assets at true market value.

This period will be the greatest real estate buying opportunity of our lifetime and based on current data will present itself around 2013. 

The Government Debt Flow Chart

Click For Larger Image:

Keep an eye on the tiny expense called "interest on government debt" as we move forward.  The interest rate on government debt is currently at all time historical lows.

Because the majority of government debt is financed with short term bonds that need to be rolled over, as interest rates rise this expense will mushroom in size.

Think of a large adjustable rate mortgage.

Monday, July 26, 2010

New Homes Sales Surge

Ah, what a classic day for the propaganda machine in full force.

I opened this morning to check the new home sales numbers for the previous month and I was hit with the banner headline right across the top:

"New US Home Sales Surge In June, Inventory at 42 Year Low."

Article: Here

Wow.  Now that is some good news.  But just in case the news may have been spun just a tad, I decided to take a deeper look at the numbers.  Here's what I found:

Last month (data for May) we received the lowest new home sales number in history.  It was beyond horrifying.  We found out this morning that the number was revised down! By 33,000 sales to 267,000.

The US Homes Sales "Surge" was a month over month increase up to 330,000.  This was the lowest June sales number in history.

Please remember this comes with the gift of the lowest mortgage interest rates in US history.  Here is where the monthly sales number stands on a long term chart:

The "42 year low" inventory number is due to home builders having no access to credit to build spec houses.  I continue to confirm this with multiple people I know selling new homes, who say their builder would love to build inventory homes but have no access to financing.

Those same sources are telling me to brace myself for the July numbers that will be released next month.

If you want a real discussion on real estate inventory please see The True Supply Of Homes.

Sunday, July 25, 2010

Stress Tests Results: Recovery Will Never Come

The news of the day Friday and throughout the weekend has been the "successful" results of the European stress test. 

The worry in the European banking sector has been with debt the banks hold on their balance sheets of other European countries.  If a bank holds x amount of Greek debt for example, and those bonds become worth only a fraction of their original purchase value then the bank has to take a write down.  If banks are forced to write down a large enough amount of bad debt they will have to close their doors.

If another bank is worried that this bank may go out of business then they do not want to lend them money.  The banking system is a liquid market that relies on banks lending to each other.  Otherwise you have a freeze up, which causes tremendous stress in the financial system.

(The same exact scenario took place in our banking system in the fall of 2008 with subprime debt)

The Europeans decided to "stress" test all the banks to determine their level of risk.  Their hope was that when this became available to the public then banks would then trust the strong banks, and the weak ones would close.  The term for this is transparency.

Here is the catch:

The only assets that were stress tested on the balance sheets were the ones held on the "tradable" accounts.  This means bonds that banks are holding in a specific account that they are planning on selling.

There is another location that banks can hold bonds; in an account called "held to maturity."  This location on the balance sheet was not tested.

So guess where banks put their bad debt?  On the held to maturity location!  Doing this means they have to raise no capital to cover the loss of value on the bonds.  They can count the bond value as the same price they originally paid for it.

Does this sound familiar?

It should.  The same exact scenario took place in March of 2009 in the United States.  Our government leaders changed the way banks could value their assets with an accounting change called FASB 157.

The banks simply took the real estate that was only worth a fraction of its original value, and by putting it into the "held to maturity" location they could now count the asset as the price they paid for it.

For example; a commercial building purchased in 2007 for $10 million is most likely worth $6 million or less today.  This new accounting rule allows banks to value the asset at $10 million.

The is the reason why the banks are sitting on a trillion dollars of cash and not lending it to the public or businesses.  The losses are still sitting on their books, they now just lurk in the shadows.

Because the system cannot cleanse itself, it can never recover.  Japan pursued the same exact strategy after their real estate and stock market bubbles burst in 1990.  They have had two lost decades, and both their real estate market and stock market are still over 70% lower than where they were 20 years ago.

We received word on Friday with the European stress tests that they plan on making the same terrible mistakes as Japan and the USA.  There will be no real recovery until the system is allowed to cleanse itself of the bad debt and the prices for assets fall to free market levels.