Thursday, October 18, 2012

New Home Sales Surge: Is The Mania Back?

As part of the real estate mania series this week first looking at existing home flippers, then the apartment market, we now turn our attention to the new home sales arena.

The following chart shows housing starts for the month of September putting it in context going back to 1968. You can see that starts are still below the trough levels of past real estate recessions when the population was far lower. The dotted line shows the still record high unemployment. Unfortunately, even with today's government sponsored loans you need a job to purchase a new home.

However, turning on the news you would think that home starts are back at 2006 levels with all the excitement. There is cause for some excitement as the trend line has turned up significantly. Annual home starts rose to 872,000 - a 15% rise. New construction on apartments was up 25.1% and single family homes rose 11%. This is up 45% from a year earlier (off of the absolutely depressed levels seen in the bigger picture graph above).

While builder confidence has surged exponentially higher in recent months, actually hiring of residential building employees has remained stagnant (red line in graph below). I find this interesting as the builders are telling us they are believers with their confidence numbers yet have not proven it with new employees. Perhaps there is a surge coming. We will see.

It is worth noting that in order to obtain a FHA loan it requires 2 years from the point someone filed Chapter 7 bankruptcy and 3 years for a foreclosure or a short sale. This means that someone who stopped paying and then walked away from their home during the early stages of the home price declines can now step right back up and get a new loan courtesy of the FHA (paid for by the other responsible tax payers of course - the FHA is a government loan program). This new loan ready supply of buyers, who normally would need to wait much longer to purchase, is significantly helping the new home market.

Just think, if an American closes on a new home they might be able to live in it for close to two years without making a payment (about how long it takes many banks to foreclose on homeowners as they push back the shadow inventory). After those two year have finished the government may now have a program allowing FHA loans after any amount of time someone has come out of foreclosure. Someone could hypothetically live for free, forever.

All in the process of helping their country and putting other people to work through the purchase and building of a home. Home of the brave and the land of the government sponsored free monthly living payments.

Tracking Global Capital Flows: Who Is Buying & Selling US Debt?

It always interests me to watch where money is currently moving around the world, try to understand why it is moving in that manner, and then try to conceptualize how it will move in the future.

This process is similar to someone who watches weather patterns. If you have a fundamental understanding of how and why money is moving, you can almost feel where it will move next. This is why some of the best investment managers in the world are people that have studied the markets day in and day out for a very long time. Like golf and business, it is something you can practice and improve on almost your entire life (a major reason why I love the markets).

An area of capital flow that receives a lot of attention because it is the largest liquid capital market in the world is the United States government debt market. People want to know who is buying, who is selling, and why they are doing it. This market serves as an even greater interest to me because I personally believe the bonds today are priced at extreme bubble levels due to both the price vs. fundamentals behind the investment and the investment community's absolute assured belief that prices "can never fall." No risk models exist at major banks and financial firms that have US treasury bonds (and the US currency) falling in significant value in tandem (just as they did not exist for Russian debt in 1997, US stocks in 2000, US housing in 2008, European debt in 2010). It is the ultimate black swan.

So where is the money moving now as it pertains to this debt market? We can track this through data released by the government on who is buying bonds. The most recent release had some important data:

Japan was a major US buyer of treasuries. Why?

Japan has seen its currency appreciate significantly over the past year as investors have rushed out of European bonds and currency. Think of it as a bomb going off and money running away as quickly as possible. As with the US they have seen capital flow onto their shores looking for safety. As money flows in, euros are sold and the Japanese yen is bought. Then investors make investments within Japan using the yen.

This strengthens the currency, something that Japan does not want as its economy is slowing and they desperately need to boost their export market. To counter this, Japan has sold yen and purchased US dollars (and invested in US treasuries). This artificially manipulates their currency lower and simultaneously makes them a larger owner of US debt. Japan, one of the worst debt offenders in the world, will soon be the second largest owner of US debt (another one of the worst debt offenders in the world). If this process sounds very strange it is because it is. It is also known as a ponzi scheme, but don't get me started - we'll save that story for another day. They will soon overtake China as the second largest US debt holder in the world but still lag the Federal Reserve who recently became the largest.

Switzerland was a major US buyer of treasuries. Why?

Same reason as Japan. Money is flooding into Switzerland as it leaves the Eurozone. The Swiss have pegged their currency against the euro (similar to how China has pegged their currency to the US). This means they must sell a massive amount of Swiss francs into the market in order to keep this peg. The US has once again become a major beneficiary of the temporary selling.

China has continued to sell treasuries. Why?

Great question. Perhaps the most important question of the decade. No one has a definitive answer, although there are is endless amount of speculation on the topic. I believe that since 2008, when it was revealed that the US Emperor actually wore no clothes, China has completely changed their fundamental shift on how they will invest toward the future. Their treasury holdings are down $125 billion year over year after decades of relentless purchases (leading up to 2008).

I believe that China has decided to re-direct this money to purchasing hard assets and tangible companies around the world (instead of a United States IOU they understand is worth nothing). They are one of the first countries to make this shift and it will pay dividends down the road when both the US currency and debt markets collapse. China, along with every investor in the world (including hopefully readers of this site), have the advantage of purchasing strong companies and hard assets at ultra low prices with over valued US paper while the Federal Reserve pushes the ponzi scheme out as far as possible into the future.

China is preparing for the moment when the global financial system is re-balanced, which will most likely occur with a Japanese, UK, US (or all three simultaneously) sovereign debt crisis.

Or perhaps they will soon join back in and began buying the IOU's from America. Time will tell, and I will continue to monitor the capital flows as they are released here.

The Source Of Income Behind US Government Bonds: The Employed Tax Payer

Earlier today we looked at what it means to purchase a government bond - a bet on the tax payers ability to pay that money back in the future. Now we'll take a quick glimpse at the health of this income source within the the US.

After the miraculous jobless claims number last Thursday, this mornings report surged back up to the recent (and more realistic) data trend line. It rose by 46,000 unemployment filings on the week, bringing the total number back up to 388,000.

The unemployment situation, or the people (not) paying into the income stream of government bonds that investors are now betting on, continues to be mired in depression. The following shows the change we've seen under Obama's regime since he took office. Those that "pay" into the government as employees through taxes (-473,000) and those that "collect" from the government through disability and food stamps (+16,660,000). I'm sure there is some overlap as many that have applied for disability are also collecting food stamps.

There has also been a recent surge in state and local government jobs (those that collect). The problem, as seen below, is that the balance sheets of the state and local governments (blue line = deficits) do not match the strength seen in the hiring (green line = employment change). This means that unless there is some unknown surge of income into these coffers, these recent hirings will soon turn into a mass of layoffs.

The point I'm trying to reinforce is that if you are betting your 401k money in a bond fund, you are betting on both federal + state & local government balance sheets. It is not a CD at the bank where you are storing your money safely. Remember that no government program provides real economic growth - it only takes from the total pie.

Japanese & US Citizens Positioned Perfectly Within The Next Bubble (Again)

Entering the late 1980's Japan was the up-and-comer to challenge the United States as the global economic power. Then the simultaneous bursting of a stock and property bubble in 1990, arguably the largest in history, have set the economy in what has become a permanent malaise of slow growth over the last 22 years and counting.

The United States, still the current owner of the largest economy in the world, has gone through the same process since what can be argued as the peak of US prosperity in March of 2000 when its stock market bubble burst. The US was different from Japan in that its property bubble burst on an a lag; coming 7 years later in 2007.

The connected link between the two economies since these bubbles burst has been the investment response from the citizens within the country. Japanese citizens, terrified of both deflation and losing money in "risky" assets have pumped their hard earned savings into Japanese government bonds to prepare for their retirement. The debt of the country, closing in at close to 240% debt to GDP (the worst in the world), is mostly held within the country by these steady savers. 

This same phenomenon occurred in the US when the most recent property (and second stock market) crash came in 2008. American citizens, which we have been able to track through monthly TIC data, have moved money out of stock related investments in exchange for bond funds at a steady and relentless pace. Most of these bond funds own a significant portion of the funds in government bonds. America is echoing the Japanese blue print step by step.

This movement of money into the trust of the government, one of the most discussed on this website week after week, fascinates me to no end. An investment in a bond, in simple terms, is a bet on the the investment quality of the creditor you are lending money to. Bonds in both countries have been rising in value for a very long time so most people assume that a bond is as good as cash, only it pays a better return. Investors have no concept of losing principle value in bonds.

An investor purchasing bonds of a government are betting on the tax payers of that country being able to pay that money back, with interest, in the future. The government has no money. It is no more complicated than that, only the fundamental thinking behind this rational has been temporarily masked through the central banks of both countries, which now have a "guarantee" on the debt repayment.

Bill Gross, manager of the largest bond fund in the world at PIMCO, re-released his "Ring of Fire" graphic in his most recent newsletter. The graph shows the annual deficit on one column against the structural debt to GDP on the second. By plotting it along this graph it shows the most dangerous government bond markets in the world.

Japan on every possible scale is the worst in the world. Coming in at a close second are the US and the UK. This is why I believe that these three markets will be the next targets in the sovereign debt crisis when we have finished with Europe. I believe we will move from Japan, to the UK, and end with the US but it could come in any order as all three governments are bankrupt.

What has separated these three from the other offenders in the Ring Of Fire (Spain, Greece, France) has been the backstop of a single central bank; the promise to defense their bond markets with "unlimited bond buying."

It is for this reason that I think the next stage of the sovereign debt crisis will be far different than the first (Europe). We will finally see what happens when investors challenge a central bank. In both cases, America and Japan, the public is once again and unfortunately positioned perfectly for maximum pain where they least expect it.

The United States Vs. China

U.S. vs China: Superpower Showdown
Source: Master of Finance Degrees

Wednesday, October 17, 2012

The Mania Is Back: Apartment Prices Cross Back Above Pre-Bubble Peak

Moody's Real Capital Analytics just released their most recent October issue on commercial real estate prices across the country. They divide up the apartment market into two sectors: major and non-major markets.

The major markets include New York, Boston, Chicago, San Francisco, Washington DC, and Los Angeles. The non-major markets represent everything else.

The major headline from the research report: the prices paid for apartments in these major markets have now crossed back above the all time peak at the top of the real estate bubble in December 2007. That's right, less than five years later, the bubble has not only reflated - it has pushed above the peak of the mania.

Prices in non-major markets are still 12% below the peak bubble/mania prices, but they are closing in fast. 

Many of these investors are now purchasing buildings at cap rates lower than 2007. For a review on cap rates and how building prices are determined see 2012 Commercial Real Estate Outlook: How Prices Are Determined.

This is due directly to the current low interest rate environment we find America in today. As the Fed continues to artificially push all rates lower with all their might, it pushes investors further and further out onto the risk curve to try an obtain any form of yield. This has more money chasing available properties, bringing back the exact same artificial environment we saw during the 2004 - 2007 years.

This time, just as with residential homes, the financing comes from the government through Fannie Mae and Freddie Mac who finance (only) apartment buildings in the commercial real estate space. This is part of the reason why apartment prices have surged relative to other forms of commercial real estate (retail, office, industrial). 

Where do we go from here?

When interest rates begin to rise off the current 0% levels, and I can only promise you that they will not go below 0% and keep falling, not only will investors be slaughtered this time around; tax payers will be on the hook as well.

A discussion of this sort will never be found during a presidential debate nor will it be found in any Congressional meeting. Fannie and Freddie are the elephant in the room that no one wants to even think about. 

For a thorough review on the coming buying opportunity in commercial real estate (after the coming next leg down which will be truly horrific) see 2012 Outlook: Commercial Real Estate.

Tuesday, October 16, 2012

Real Estate Mania: Remember The Flippers?

We're going to take a look back today at an article written in the Washington Post. The title is "Flipping Homes Is A Booming Business." Here is a subsection from the article:

Not long ago, John Irvin was selling women’s shoes in the ­Nordstrom at the Pentagon City mall, pulling down about $20 an hour.
Now he flips houses in Northern Virginia — scooping up short sales, rehabbing them and aiming for a quick sell. He has sold three homes and says he netted more than $30,000 in profit each time.
“If I do one house every quarter, I’m making $125,000 a year — at 25 years old,” Irvin said. “All my other friends, they have a 9-to-5 job. They make probably half of what I’m making right now. It’s kind of like hitting the lottery.”

Irvin, the 25-year-old flipper in Virginia, carefully researched each of his three properties — one in Dale City and a pair in Manassas — before buying. He said he spent tens of thousands of dollars improving the houses, refinishing hardwood floors, updating bathrooms, installing new kitchen cabinets and appliances, and landscaping yards but stuck to a tight budget to maximize his profit.
Irvin, who has a business management degree from George Mason University, plans to close on his fourth short sale this month, a home in Fairfax County that is larger and pricier than any he has flipped so far. With low interest rates, scarce inventory, rising home prices and willing buyers around Washington, he doesn’t plan on selling shoes again anytime soon.
“There’s always somebody who’s going to want to buy your house,” he said. “As long as there are short sales or foreclosures, I’m definitely going to want to be doing this.”

Now, can you guess what year this article was written? 2005, 2006, 2007?


This article was published yesterday. October 15, 2012. Yes, folks, the insanity is back. Let's rewind the last quote just for fun:

"There's always somebody who's going to want to buy your house."

The actual title of the article is Flipping Houses Is Once Again A Booming Business. Is it possible that everyone has forgotten what took place only 5 years ago? Can we really already be back to the point where people are quitting their jobs to flip homes?

For more on how this story will end, although readers of this site have a crystal clear understanding, please see US Housing - How Long Can Shadow Inventory Stay Hidden?

What Can We Cut To Balance The Budget?

A simple two minute walk through in the video below that hopefully helps some people see that America's "Greek moment" is already built in. There is not even a discussion to make changes in what you see here, never mind the actual will to do something.

What holds the US debt markets in place, currently resting at prices that will soon be understood to be at the greatest bubble in history, is confidence. Nothing more.

As always there will be a select few that are on the correct side of this coming change, a wealth transfer, while most will be caught off guard and lose almost everything.

Monday, October 15, 2012

The Inspiration For Our Present Money

See any parallels to the game of Monopoly that you played growing up?

Bernanke, after all, is only following the rules he learned as a child as well.

The following chart shows the real life application of rule number 11 - the M2 money supply. It recently crossed $10 trillion and is now picking up speed.

h/t Zero Hedge, JS Mineset, FRED