Saturday, November 14, 2009

Real Estate Agents to the Left; Goldbugs to the Right; Here I Am...Stuck in the Middle

This is a quick update on the insanity that passes for financial advice in our popular culture.

The Institute for Economic Reality, Kitsap County’s original economic think tank, has recently relocated its campus to Western Poulsbo, due to the previous landlord expecting me to stay in a house on a month-to-month basis, only to leave if she ever found an economic illiterate from California to bail her out of her jam. The price has been dropped 17% with only one bona-fide looker, despite monthly open houses.

It's waterfront and as we are all told by most RE agents, waterfront is always desirable.

Anyway...back to the relocation. One annoying aspect of relocating is all the hucksters find your new number and try to sell you everything under the sun (or in the our case, everything under the gloomy marine overcast). One such phone call was placed by a RE agent at one of Poulsbo's two big RE brokerages. I took the phone call and endured the standard "it's never been a better time to buy. INTEREST RATES ARE AT HISTORIC LOWS. So buy now, or miss out on the low interest rates forever..."

Really, she said that. This sounds an awful lot like the "buy now or be priced out forever" nonsense that was peddled in the early part of this decade.

Let's see a show of hands, class. Does anyone know how that advice worked out? If you bought your Bainbridgeislanddreamhome in 2006-7, and prevented being “priced out forever,” how are you doing? Median price has dropped from $840K in Oct 2007, to somewhere in the mid-high $500s today. Ouchie. If you put a quarter of a million down on that Bainbridgeislanddreamhome, you have lost everything.

Now, to be fair to our "licensed professional," I will say that she is probably dead-on accurate that interest rates will probably go up from here. After all, that's what "historic lows" usually implies - a retrace (and overshoot) of the median is becoming an increasingly likely scenario.

So, why am I all in a tizzy about a RE agent calling me up and pointing out the incontrovertible truth that interest rates are at freakishly low levels and that if I want to take advantage of it, now is the time?

One might think that I have an axe to grind concerning RE agents. That is patently false. Our community needs people to play matchmaker between homes and buyers. Granted, we are probably overstocked in the field, but we need them and I am glad to have several I count as friends. Where I get my undies in a twist is when they start peddling financial advice and playing "gatekeeper of the American Dream." As evidenced by the "buy now or be priced out forever" pap that we all were force-fed into the 2008 financial rout, RE agents should stick to the specialty their license enumerates and not delve into areas they are not suited to discuss.

I'm not saying that just because you are a licensed RE agent that you are incapable of grasping the intricacies of basic personal finance, but judging from the prevailing sales script, one could be easily forgiven for thinking such. I do know several RE agents that have a very deep, mature, and thorough understanding of the broader credit markets and how manic buying causes epic panics. These agents are people I can recommend and would like to see survive the coming RE crackup in Kitsap County.

Let's put to rest this nonsense that today represents a good time to buy.

If interest rates are at historic lows, let's just assume, for our discussion, that rates ARE at the low tick, as "historical lows" would seem to imply is a relatively high probability.

In order for this to be a good time to buy, we would assume that price would also have to be at a relative low, otherwise we would lose on our capital outlay and demonstrate that today was NOT a good time to buy. If we check prices, we do find that we are paying a lot less for our Bainbridgeislanddreamhome than we were two years ago, so our triple-threat RE agent (sales, financial adviser, and economic soothsayer) seems to be hitting on something very plausible. If we buy now, we get low prices (compared to a multi-generational, credit-gone-wild peak), and low interest rates (in a highly manipulated bond market).

Where do I sign?

Not so fast...we first need to understand the basics of fixed income instruments, which boils down to the more "fixed" the income, the stronger the inverse correlation between interest rates (yield) and principal (price).

Go back and read that out loud a dozen times until you understand it. If you spaced-out on that, you will be licking your wounds in a couple of years and cursing your RE agent/Financial Advisor/Economic Soothsayer.

Bonds are a FIXED income instrument, which is to say that at the time of the issuance, the income is predetermined and DOES NOT CHANGE over the life of the bond. A bond is a contract stating what schedule the borrower has to repay the lender and in what amounts. Once it is issued, the lender can sell that instrument on the open market, and the buyer is BUYING A STREAM OF INCOME, which depending on what he paid for it, determines his interest rate. In reality, he determines what interest rate he wants and bids accordingly for it. If he is the high bidder (the seeker of lowest yield) he purchases the bond.

Right now, the "true believers" in the Real Estate wealth paradigm are screaming at the top of their lungs, "Homes are not bonds!!!"

Very true, but the amount of money that can be set against a real estate investment is trending downward as credit vanishes (ask your favorite RE agent about the pool of available buyers and lending products), and will soon be supported by incomes more so than credit.

Check out the spread on Kitsap County incomes. It isn't very large due to the monolithic employment opportunities available to us. Yes, Seattle offers a more diversified employment field, but it also isn't as rich as it once was. Take out many of the jobs in the Real Estate Industrial Complex (REIC), and there really isn't much "there" there in the employment picture.

The amount of money we can throw at housing is more fixed than you think, and that number is shrinking.

As interest rates rise, UNLESS WE GET A RISE IN INCOMES or CREDIT, we WILL have a highly correlated drop in price. This is a mathematical fact; it is not an opinion, theory, or desire. Credit is tightening, and rising rates, by definition, is prima-facie evidence of this. Just as we got credit expansion during the "Bankers Gone Wild" extravaganza of the early part of the 21st Century with falling rates, we get credit contraction with rates rising.

If you take out the suicidal actions by the US monetary authorities of borrowing money in the short term to keep an artificial bid under the problematic mortgage backed securities market, rates would be steadily and forcefully rising.

They can’t do it forever, and when that juggling act ends, it will end with little warning and a backbreaking rise in interest rates across the credit spectrum.

Incomes also drop during deflationary credit contractions/collapses, as the money supply is choked off by a glacial freeze in the velocity. There simply isn't the money available to expand businesses and salaries.

The worst part is how the underlying math destroys the principal in a leveraged fashion. Rather than reprise the math in this entry, I refer you to some IER gems of yesteryear for examples. Since leverage works in reverse, just as well as it does in drive, using the amortization formula with rising interest rates and steady to declining incomes, principal gets smashed.

That's why low interest rates are highly likely to be the primary indicator of THE WORST time to buy real estate. Unless you can forecast higher incomes or easier credit (a mathematical impossibility in a rising rate environment), telling people that this is the best time (as based upon interest rates) is dispensing economic hemlock to your customers, just as they did in 2004-07 with "buy now or be priced out forever." (It is a mission statement of the IER to constantly remind people of that gem.)

In reality, the best time to buy is when you have massive forced selling (foreclosures), high interest rates, and a job market that is bottoming. None of those are in play, or even close, in 2009 - NONE. The government and banking system are holding foreclosures off the market; FHA is underwriting just about everything and is about to detonate what is left of the housing market. (Yes, the FHA is really levered-up over 188:1) It is pointless to have a meaningful discussion of a “bottom” in real estate until the bond market crashes – and, yes, it WILL crash.

The job market won’t turn until business profits have a meaningful recovery, margins rise significantly, and that almost certainly won’t happen until the interest rate complex crests and starts heading downward.

This is why jobs are a “lagging” indicator of business health, but a leading, or real-time indicator of consumer activity.

Wall Street’s economic hit men are telling us that the bottom is here, or even past (they have assets to sell you); some economists are starting to predict 2014 as the extent of the pain.

The IER is forecasting that the pain to continue until either the BabyBoomers are largely dead, or we get a meaningful war, where we have a similar outcome to 1945. Yes, when KQED runs its “WOODSTOCK AT 60” commemorative series, it might be time to go long.

Remember, the carnage of the onset of The Great Depression wasn’t made whole until the mid-1950s (where we were a unipolar military power and unscathed from WW2), and Japan has yet to recover from its fiscal idiocy from the 1980s (where it has been a net saving nation, peaceful, with a fat, loud, lazy and stupid customer mindlessly inhaling all its products.)

After a few minutes of trying to educate this RE agent, she wanted no part of any math, or any discussion of how, exactly, will people be able to fork over higher monthly payments when they can't even make their present payments. She hung up and presumably went on to bamboozle someone else. I wish her luck, but would like for her to drop the unsolicited financial adviser role.

Buyer beware. Scratch that; if you are buying today, you had better be in love with your house and mortgage, and I mean really in love, because you are going to be married to it. Rent now, or be locked in forever.


As if RE agents hawking financial snake oil isn't enough, we have the incessant goldbugs becoming the 2009 annoyance on AM radio that "cash-out REFI" hucksters were in 2006.

The sad part is this is really just a warmed over version of "buy now or be priced out forever" that Cooki and Candi were peddling in the Real Estate blowoff, but now, we have the AM radio talk show hosts telling their listeners to buy gold AT HISTORICAL HIGHS to protect themselves against "a falling dollar" and "inflation." It made sense back in the early part of the decade when gold could be had for under $300/toz, but after a massive run that is closing in on $1200, I'm not so sure gold is where you want to park your money.

Funny how gold wasn't a buy back then. Just sayin'...

Gold is obviously very pleasant to view and hold. Women dig it, especially when it is wrapped around their necks, wrists and fingers, but is it a good hedge against a falling dollar?

It is a decent hedge against a falling dollar, but not necessarily a good hedge.

Let's dispense with a myth that goldbugs propagate.

Gold IS NOT money with mystical qualities. Gold is a commodity, just like rubber, aluminum, glass, steel, wheat, liquor, granite, bamboo, stainless, coffee and even Beanie Babies. Hedging with gold is no different than hedging with aluminum. Gold has production costs, just like aluminum. Gold trades on the world market at a constantly moving spot price, just like aluminum. Gold has some industrial uses, just like aluminum.

Gold, like aluminum, is only worth what the highest bidder for the commodity will pay, as there is (normally) no contractual or legal obligation to trade in gold for things other than gold related products and gold contracts (i.e. gold futures). Yes, for millenia, men have put a premium on gold and it has been a store of value. That doesn't give it any mystical properties, just that it was a rare, attractive, durable, and relatively useless metal that served this purpose. Bits of crystallized carbon are also exceedingly valuable for their size, and women REALLY swoon over that stuff, but there is no mystical value to diamonds, other than they can suggest marriage and cut glass. In the end, diamonds are worth what someone is willing to pay.

In early 2008, oil, copper, aluminum, and wheat were all rallying hard in price. Why were there no commercials for hoarding this stuff? Surely, you can hoard copper and sell it to recyclers to protect against inflation. Bags of sugar would have sufficed for 2009. Why don't we make coins out of sugar to hedge? Think of Halloween as a tax day with children dressed up as ghoulish IRS agents (oops, that's redundant).

The answer does not lie in the commodity, as most commodities can be used as a hedge against a falling dollar, but in the dollar itself. As the dollar sells off (and it has been), gold has been on a rampage. Gold has run higher and faster than the dollar has fallen, so it seems like a great idea to get on board this train before we "get priced out forever."

Is anyone starting to suspect that this is a really bad remake of the insanity we have chronicled in the housing market?

Remember, nothing can sustain itself at a price high enough where people cannot afford it. With no buyers, there is no volume and no sales. To get sales, price have to drop to meet the demand or the commodity isn't produced.

You are going to look pretty silly trying to sell gold for $3000 per coin while people are trying to find a few grams of protein to eat and enough gas to get to and from their jobs.

I'm not saying that gold is a definite sell at this price, but that gold isn't necessarily the money of last resort. If you are nimble enough, you could turn $1150 gold into a profit, but remember, it has had quite a run and the path of least resistance is down.

Why is that? How can an enduring metal, that women love, be crushed by slips of green linen that the government is blowing around like autumn leaves?

As we have already noted twice, women (as well as Mr T) dig gold . This accounts for over 80% of the retail use of gold. Sure, gold is also useful for reusable coffee filters, dental crowns, certain electronics, but the largest use is adornments. Everything else, is speculation - you want to buy it and sell it at a higher price to someone else who has the same idea.

Just like Bainbridgeislanddreamhomes, eventually you run out of greater fools, and the price reverts (or likely overshoots) its support level as adornment.

A thorough discussion of how the dollar is getting clubbed by manipulation in the credit markets, foreign exchange "carry trade," and debt redemption would also be in order to show how the dollar will rally and crush a lopsided long position in gold. I'm going to save that for another discussion, as this Clearcut Bainbridge entry has enough for everyone to digest. I'll wait to see how questions and comments might go to steer the discussion (provided anyone even reads this anymore).

I do apologize for the anemic second half of this entry. I'm at the end of a long day and most of this was written at the San Francisco Airport while waiting for a flight home. (No, it wasn't written while I was actually working a flight.) I do intend to throw up a rather meaty discussion of how the dollar is getting manipulated and how the exit from that trade will crush commodities, especially gold, housing, oil, and all the other speculative playthings of Wall Street bankers. Until then, stay solvent, keep your head down and your wallet shut.

Monday, August 31, 2009

The Joke Is On Us

The IER attended the Inslee Town Hall at NKHS on Saturday, and was amazed at the widespread economic idiocy that passes for governance.

Sunday, August 23, 2009

The Deadbeat Next Door

I have good news and bad news.

The good news is that foreclosure rates on subprime ARM mortgages fell last quarter. Wall Street is rejoicing with a 50% rocket-shot in the S&P since the March lows and everyone believes that the "all clear" has been sounded with the window-lickers on CNBC yammering about "green shoots" nonstop since that time. Yes, the biggest financial calamity in world history was sidestepped by a $700 billion ransom paid to the 22 largest banks in the world. It's a new day and a glorious morning for homeowners on MLK Blvd.

The bad news is the improvement in subprime ARMs was more than offset by fixed rate PRIME mortgages going into default and foreclosure at a steeper pace than the subprime improvement. Now, almost 1 in 7 mortgages in the US are in trouble, with the bulk of that coming in areas known to be financially well-to-do. Sunrise Drive is the new MLK Blvd (but without all the trendy diversity).

What is happening? Well...folks who gambled in the housing bubble used various vehicles to stake themselves at the table. Some folks used subprime instruments with shorter fuses, and other folks had the luxury of gambling instruments with longer fuses. The longer fuses are now going off.

Those longer fuses are attached to MUCH larger explosive charges, and the bankers didn't properly prepare for this eventuality.

Let's go to the charts:
We are between peaks on mortgage resets. This explains why some real estate agents are crowing about how the market has improved over last year. I certainly hope so, but as we can plainly see, the subprime debacle is largely behind us and we are staring at the face of an enormous tidal wave of mortgage resets in the higher quality loans and properties.

Bainbridge Island, this means you.

Put another way...subprime was the trigger charge, and prime/option ARM/ALT-A is the main charge. Subprime killed the banks. Yes, it KILLED the banks. We have stunned them back to life with the bailouts, but the coup-de-grace is coming when Joe Hippen and Mary Trendy of Rolling Bay, Washington default on their 2 acres of Heaven.

The banks have zero chance of surviving this and the bailouts will not work to shock them through this next wave. This one is for real.

Many moons ago, I posited the idea that Bainbridge Island was not immune to the coming crack-up in housing prices. I said that median income is in the low-mid $70K range, but people were living a big, expensive, suburban lifestyle in spite of meager means. How did they do it?

HELOC money. It was all debt. When you make $6000/mo at the daily grind, but your house goes up $5000/mo, you have the potential to spend loads of money on the usual stuff. His/hers Prius, trips to Burning Man, ski trips to St. Moritz, fully stocked wine cellars, fresh prosciutto in every meal, private school, not to mention the perfunctory stainless/granite/bamboo that adorns every home over $500K.
It is probably harder for someone who has lost a $100,000 job to find one quickly than it is for someone making $25,000. The universe of jobs gets smaller as people move up the compensation ladder. Added to that is the fact that prime borrowers had fairly valuable homes, at least at one point. That may have allowed them to borrow relatively significant amounts of money though home equity loans. Many of those loans are underwater, further pressuring owners.
Access to credit, via the never-ending mechanism of the Housing Bubble ATM, allowed the illusion to pass for reality - until now. Homeowners are now two years this side of the peak, the banks have cut them off from further refinancing, and the paltry savings they had (outside of their stocks and housing portfolios) has been depleted. They are now in the unfortunate position of sitting on too much house, fending off too much debt, and working extra hard to keep the pink slips at a safe distance. The more fortunate ones are lucky enough to have one house that they rode up and down the real estate roller coaster, and have a good story to tell along with a semi-uncomfortable, but manageable mortgage.

The rest hit the Housing ATM every few months on the way up and have found that the ATM has not been restocked by California equity locusts. The ones with the worst timing were those that upgraded homes two years ago (at the peak) and have suddenly realized that they can not sell either home, both of which they really can not afford.

Anecdotally, the Institute For Economic Reality, Kitsap County's One Man Economic Think Tank, has found that many of these folks with bad timing are now attempting to both sell and lease their vacant homes. The IER has recommended renting for several years, and takes its own advice. In almost every case the IER has explored this summer, the story is the same: the owner got caught on the wrong side of the trade at the peak, denied what was happening, believed the local RE agent (because they are the best source of macro-economic trends and financial advice) and held on for a better market. Now, they are all trying to rent out their home that couldn't sell in this "improved market" in hopes that next Spring will be more favorable to them.

It isn't going to happen. Next year will be an unqualified disaster.

Many will point to the rapidly rising stock market and claim that a 50% improvement in the indicies means that good times are just around the corner. After all, everyone knows that the stock market leads the real economy by 9 months. Right? Just like it did in October 2007, and every bounce along the way.

Let's take a quick look at the S&P.

That's what's called a "Dead Cat Bounce." The giveaway is rising price off a "V" bottom coupled with falling volume. That means this rally was oversold, got goosed (in this case the banks forecasting profits on being staked at the casino by taxpayers), and fewer and fewer people are participating in the rally as it grows. Eventually, we get a passel of bagholders at the peak and not enough interest in new money to keep the rally moving.

Dead Cat Bounces are exactly that - bounces. The term is derived from the idea that if you throw a cat hard enough at the ground, it will bounce. It will be dead, but it will bounce. We will certainly revisit S%P 666 once again, and probably a lot sooner than people think. Where did the money come from to fuel this rally? It came out of your home value. Yes, the money was swept into the equity markets from fixed-income markets, and this happened even as the FED was buying down the yield.

Not convinced?

This is the epic fail of the Federal Reserve's "Quantitative Easing," which is a fancy-schmancy term for "paying your VISA off with your MasterCard." The US Treasury is borrowing money at a rate unparalleled in all of human history (seriously) in a failed attempt to keep a bid under its own debt. This, in theory, is supposed to keep interest rates low and all the banks and Boomers in the country will have their asset values high enough to keep Operation Enduring Bubble alive.

As you can see, after the initial announcement of the FED buying bonds, the US Treasury market has sold off from a 2.464% yield on the 10 year bond, to a peak of 4.014% and now is hovering at 3.556%. This would be impressive, but interest rates ARE HIGHER than they were the day before the FED announced that they would be buying down the yield. Throughout this "green shoots" rally, interest rates have risen for all but a short period, which happened to coincide with equity market selling.

How much is this costing us? Well, Bainbridge Island's president just announced that the federal deficit for the next 10 years is going to be somewhere in the neighborhood of $9 trillion. Yes, that is correct. The deficit for the next decade is going to be $30,000 for each man, woman, child, and illegal alien within our borders. That's $120,000 for a family of four. Bainbridge Island's median gross household income is $75,000.

That's not including tax revenues or interest. That's just the amount of principal each breathing human will have to pony-up just for the shortfall in government spending versus revenues. That's provided you actually believe the government can be that fiscally "responsible." At the current borrow rate, we could get that in one year.

Think real hard about that. Think real #$%^ing hard.

Why not? The US Treasury is going to market to borrow (not "print") almost $240 billion per week. As anyone with a brain that hasn't been clogged by 40 years of bong resin would understand, that isn't anywhere remotely sustainable. Private bidders of government debt are getting harder and harder to come by, which means that the "Primary Dealers" (FED's wholesalers of US debt) have to buy. Lately, they have been buying about 3-4X what they normally do and at interest rates around 1/7th of a percent. That means they are either being exorted to buy at those prices, or they (the big bailed out banks) believe that 0.14% is going to be a hell of a deal over the next few months.*

This will end in tears.

20 cents on the dollar by 2010. It's coming. It's unavoidable.

More later when I get my head around this insanity.

-Ernst Stavro Bloviator,
Senior Fellow
Institute for Economic Reality

*My thanks to Karl Denninger of "The Market Ticker," 8/19/09 for the information on the latest Primary Dealer activity at last week's auction.

Wednesday, May 27, 2009

Yelling "FIRE!" In A Crowded Bond Market

What happens when you are holding a trainload of ALT-A mortgage paper, and 40% (+/-) of the mortgages in those securities are 60 days delinquent? (Think every Money Market fund in the USA)

You sell.

What happens when you are holding 10year US Treasury notes and the government keeps "stimulating" itself at a $trillion per pop, and tax revenues are only 50% of total expenditures? (Think every business in America that holds US Treasury notes as a store of cash)

You sell.

What happens when you are holding massive amounts of debt in a insanely foolish "vendor financing" scheme and your customer just lost his job? (Think China buying US debt to keep interest rates low to spur further buying of Chinese dreck)

You sell.

What happens when your income stream gets clipped and you have a bunch of bonds that can sell to raise cash? (Think export nations that sell to the US)

You sell.

What happens when you are running an insane amount of spending, but you can't tax enough to make ends meet? (Think US government)
You sell.

What happens when you foolishly chased the latest bubble in bonds, and now see that it has clearly topped and is heading down? (Think Money Market/Retirement funds)

You sell.

What happens when some fool from Princeton offers to buy mortgage dreck and US Treasury notes at above market rates? (Think....well, you know who I am talking about)

You sell as much as you can.

What happens when you have spent three straight months convincing people that the bottom is in, houses are cheap, inflation is coming, and the government saved the day, but you know the opposite is true and have a bunch of massively overpriced bonds? (Think large New York investment banks and hedge funds)

You sell.

What happens when the selling pressure overwhelms the bid in the bond pits?

Prices drop.

What happens when bond prices drop?

Interest rates rise.

What happens when mortgage rates jump by 30% in a half-day's worth of trading?

Pending contracts, lots and lots of pending contracts (appx. 50% by one estimate), blow high and wide.

What happens when a house sale "falls through?"

It goes back on the market.

What is the mindset of the owner in a depressed market that just lost a sale?


If the next few weeks see followthrough on this trend, the amount of selling in real estate will simply overwhelm the bids and the entire real estate market will be frozen, until the owners capitulate and lose their homes to auction. The bond market is the "end game" and is why The FED has been buying bonds.

Just as you can't get out of debt by paying your VISA with your MasterCard, we can't keep our asset values high by borrowing money to pay off debt.

It's a global dash for cash. Everything is being sold to raise cash, and that includes trendy real estate.