Saturday, January 22, 2011

Bernanke Crime Family

For those that are fans of the Sopranos television show, presented below is the police outline for the Bernanke Crime Syndicate.  It is good for a few laughs now but will not be quite as fun when Americans realize what these men did to our country. (Click for larger image)

Thursday, January 20, 2011

Vellejo, California: Ground Zero

Vellejo, California made major news this week when they announced their plan to exit bankruptcy through reorganization of the debt owed to its largest creditors:

They will be paying unsecured bond holders 5 to 20 cents on the dollar.

To understand what this means, let's say that Vellejo, California needed to raise money to pay for their city expenses because their income did not cover their expenses in 2010.  They pick up the phone and call your home and tell you they would like to sell you $100,000 in bonds.

They agree to pay you 6.5% interest on your bonds every year for the next 10 years, and at the end of 10 years you will receive your $100,000 principle back in full.

This sounds great to you since the bank is paying you less than 1% to hold your money in savings.

You write the check, put it in the mail box, and your interest payments begin to come in. 

Life is good.

Until you pick up the newspaper and find out Vellejo is declaring bankruptcy.  You read they will be paying out 5 to 20 cents on the dollar for the debt they currently owe.

This means they will be sending you a check in the mail for between $5,000 - $20,000 on your $100,000 investment, and hopefully some sort of apology letter.

Municipal bonds are owned by banks, government and private pension funds, foreign governments, and they are laced across 401ks all over America.

Vellejo is the first taste of what is to come, similar to the New Century subprime mortgage office that closed back in 2006.  The mortgage market was $14 trillion in size, while the municipal bond market is less than $3 trillion.  Just like the mortgage market there is "prime" debt, and there is "subprime" debt, so the entire $3 trillion is not going to be wiped away.

However, this will be the main story in America during 2011 (unless the stock market collapse back down to fair value) and investors should be very cautious what loans they currently hold in the bond funds in their 401k's and IRA's.

Wednesday, January 19, 2011

Exponential Growth

International TIC flows yesterday showed that China was a net seller of 11.2 trillion in American treasury debt for the month of November.

As of last month there has been a change in the largest holder of United States treasury debt with China now moving into second place.  The largest holder today?

The Federal Reserve.

As foreign countries continue to move away from our debt, look for the debt chart below to soon mirror the size of the Federal Reserves balance sheet, meaning the amount of printed currency that will be needed to fund our deficit.

And as night follows day, the chart of the price of gold will soon follow.

United States debt growth from 1940 to present:

New Housing Starts December

Tuesday, January 18, 2011

Home Builder Confidence January

Multi-Family Euphoria Is Back

I was churning through the headlines this morning on Globe which reports on commercial real estate activity across the country. 

I noticed a sale this week for an apartment community in Santa Monica, CA that was sold at a cap rate under 4%.

A cap rate means the return an investor is willing to receive to purchase the property.  If a building has an annual net operating income of $40,000, an investor who wants a 4% return (cap rate) would pay $1,000,000 for the property.

The current interest rate on a 30 year treasury bond is 4.56%.  That means that an investor who buys $1,000,000 of 30 year treasury bonds will receive $45,600 a year in interest payments.  At the end of 30 years they will get their $1,000,000 back from the government.

There are risks involved with purchasing an apartment.  Tenants could lose their job and stop paying, someone could fall and sue the building owner, an apartment could flood or catch on fire, or a water main could break bringing an unexpected cost. 

A treasury bond is considered a risk free investment.  An investor is paid every month by the federal government.

The argument against treasury bonds being risk free is that interest rates could rise or inflation could eat away at the value of your bonds.  An apartment owner can raise rents to counter inflation.

This is true.  However, in inflationary times expenses such as heating, cooling, insurance, taxes, and salaries have an impact on the expense column of apartment owners.  Will rents rise at a faster rate to offset rising costs?  Maybe.

What does this mean?

It means investors today are paying non-sensible prices for multi-family properties.  In many areas across the country investors are paying at cap rates in the low 5's. 

As our economy rolls back over and interest rates begin to rise during the next leg down of our current depression, investors buying at these ridiculous prices will be slaughtered once again across the board.

(I believe that 30 year treasury bonds at 4.56% and an apartment building return at 5% are both terrible investments.  I am just trying to show the overvaluation of apartments for the purpose of this discussion.)

Monday, January 17, 2011

Nial Ferguson Part 1 + 2

It is a rainy MLK day here in Charlotte, and the financial markets are closed for the day. I'll let you in on what I'm watching this afternoon: a fantastic discussion with Nial Ferguson on America's future.

Click Here For Full Video.

And if you'd like even more from Ferguson, the following is an incredible presentation he gave a few weeks ago titled "Empires On The Verge Of Chaos." Fast forward 9 minutes for Ferguson's discussion.

Click Here For Full Video.

Jim Rogers CNN Money

One of the greatest of all time in the financial world, Jim Rogers, sits down for some tea with CNN money to discuss China, Europe, and the USA.

Sunday, January 16, 2011

Commercial Real Estate Prices Falling

CoStar released their commercial real estate price index for the month of November this weekend.  The composite index fell 2.57% month over month, and the ever popular investment grade index (the trophy properties) fell 4.07% month over month.

I have churned through countless outlooks from professional companies involved with the commercial real estate market and their forecasts are extremely optimistic across the board.

If they do not feel the bottom is already in place, then they see it occurring in the first half of 2011.

These outlooks factor in job growth, high consumer spending, and a lowering of interest rates.  Basically they see a strong recovery across the board.

With excess inventory, short term under water loans maturing, extremely low interest and cap rates, tremendous pressure from online retailers, and consumers on life support, I see bloodshed ahead for the commercial property market. Look for the graph below to continue its straight line downward. (Red line is composite pricing)

There will be a time to purchase commercial real estate, but that time is not now.

Sunday Thoughts

A topic that seems to be coming up more and more often in the financial media is the concern over the solvency of the Federal Reserve, or if it is possible for them to go bankrupt.

The Fed is a privately owned bank, similar to a J.P. Morgan or Goldman Sacs, that has a special relationship with the federal government in that they are in charge of the money supply and interest rates.

The Fed, like every bank, has a balance sheet.  In normal times, the Federal Reserve will create money by purchasing treasury bonds from either the government or other banks.

When the Fed buys bonds from a bank, they give them cash in exchange.  This allows the banks to have more "reserves" in their bank vaults. (It is all done electronically)  With $10 in new reserves, the bank can then lend out $100 in new loans such as mortgages, credit cards, car loans, etc.

This is how the money supply grows.  When the Fed wishes to reduce the money supply, they will give the banks back the treasury bonds and ask for cash in return.  This reduces the "reserves" on hand for banks and forces them to tighten lending.

This is how the Federal reserve controls interest rates.  They "target" rates using this process. 

But what about the Federal Reserve itself? 

Remember the value of a bond, whether it is a government treasury bond or a mortgage for a home, goes up in down in value based on interest rates. (Most investors don't understand this which is why they are rushing into bonds at the peak of a bubble)

Let's say that the Federal Reserve purchases $1 trillion in mortgages. (They purchased $1.3 trillion last year) 

Let's assume that all the mortgages are 30 year bonds and they all have 30 years remaining on the loan.  The interest rate for each of the bonds is at 5%.

If the interest rates were to rise next year to 10% (interest rates would already be there today if the Fed was not buying bonds) then the value of the bonds would be cut in half, from $1 trillion to $500 billion.

The Federal Reserve, like most banks must keep cash "reserves" in the (electronic) vault to protect themselves from losses. 

If the Fed only had $100 billion in reserves, and they were forced to take write downs or show losses of $500 billion on their mortgage bonds, their balance sheet would show a negative $400 billion.  Meaning they would have to declare bankruptcy.

What would happen at that point is only speculation because we've never seen it before.  The Fed would have to go to Congress and ask them for a bail out.  (Congress could lend them $400 billion and add it to our national deficit, and the Fed could then print more money to purchase the bonds)

Kind of strange to think about isn't it?

What makes this unlikely to happen is that the Federal reserve does not have to follow traditional accounting standards.  If the bonds on their balance sheet were to be cut in half, the Federal Reserve through accounting gimmicks can still show these bonds at full value. 

The Fed says they can hold the bonds for a full 30 years, so the interest rates do not matter.  But what happens if homeowners stop making the 5% interest payments and then default on the loans?

That is where it would get even more tricky.

What most inflationists and deflationists who study this concept in detail don't take into account is that the Federal Reserve and Congress can just change the rules. 

We live in a world of "fiat" money which is backed by nothing.  In a monetary world with no rules, the likelihood of thinking about a Federal Reserve default is a waste of time.

Investors should focus on what happens if the Fed does not default and every asset in the world has the potential to be purchased with printed money.  The riots taking place around the world as food prices skyrocket is only a taste of what is to come.

And someday, maybe soon, the inflation being created today is going to wash back onto the shores of our own country creating a shock wave in the prices of food and energy that we use every day.