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.


Haybaler said...

Good to read you again. When you get rested up and feel up to it, I would like to see your explanation of how this Carry Trade will unwind. Haven't seen anybody take a stab at that yet.

Eleua said...

That's exactly what I plan to tackle in my next entry. I doubt there is a way to nail the cause of the unwind in advance, but the aftermath should be pretty easy to pick. Quick version: my "20 cents on the dollar by 2010" will probably be met.

Thanks for the encouragement to rest up. I've let CCB slide as I have been busy with a bunch of other things. Sitting around airports, or Tulsa hotel rooms, is a good opportunity to update the CCB.

I find that after I get home, I am absolutely wiped out for 24 hours. I have a very hard rule: No power tools until I have slept two times after I return from a trip. Updating the blog would be tough without the use of all ten of my digits.

Anonymous said...

I'm glad to see you back.

I agree with most of your analysis, including that about gold, but I have a slightly different opinion.

Gold is not an investment; it is a hedge. There is plenty of unmined gold in the world, and in North America it costs about $300/ounce to get it. So the gold miners are quite busy now.

As you noted, gold has had a terrific run. The difference between the cost of new gold (see above) and its current market price is unsustainable; there has to be a correction.

The question is, what will be the correction?

It all depends upon what happens with inflation. That is a big question mark. So far, most world currencies have moved more or less with sympathy to the dollar. Thus, it is the cost of gold in dollars that has ballooned, and that is what will deflate.

But suppose that this time, the gold bugs are right, and the dollar breaks free of other world currencies and starts a downward spiral? After all, even a stopped clock is right twice a day.

If that happens, will the government repeat its confiscation of gold of 75 years ago?

My conclusions: if you are long in gold now, this is not a good time to make a major increase in your investment. Under no circumstance should you have more gold than you are comfortable holding if it plummets to $300/ounce. This is not a good time to go short on gold either.

Thus, my suggestion is either hold, or sell to reduce holdings to the $300 comfort level.

Anonymous said...

PS: I will be very interested to read your discussion on how, why, and when the dollar will rally.

My reading of makes me wonder if the dollar really can rally, or if it's teetering on the brink.

The best-case scenario is probably if the three Ponzi schemes (Social Security, Medicare, and prescription drugs) are allowed to collapse, since the alternative seems to be hyperinflation once the boomers start retiring.

Anonymous said...

Been reading "hints" that large speculators are borrowing USD at 0 interest, and then speculating in commodities...and other currencies. If this is true (and it sounds plausible) OMG....

Anonymous said...

I doubt that we'll see much change in interest rates between now and the 2010 elections. The currency needs to be tightened up, desperately, but doing so will quash the (imaginary) "rally" on Wall Street. A new plunge of the roller coaster would be pinned directly on the Democrats; it won't work to blame Bush any more.

Right after the 2010 elections comes January 1, 2011 when the Bush tax cuts expire...including the cut on the capital gains tax. Before that happens, investors will dump their stocks in order to book their capital gains.

So, one way or another, stocks are heading down next year.

It's going to be a wild ride. YEEHAH!

Eleua said...

@Anon 1334pm,

There is no "hint." That IS what is happening and is central to my thesis of the USD carry trade that is pumping asset classes at the expense of the USD in the FX markets.

Retail investors ARE NOT in on this. This is just institutions throwing (government) money back and forth trying to entice retail suckers to take the bet.

Words fail me to describe what happens when the world's reserve currency is the carry currency and it starts to unwind.

It will be uglier than the mutant offspring of Janet Reno, Hillary Clinton, and the NYT editorial staff all rolled into one.

Eleua said...

@Anon 1439,

Interest rates are only being capped by an artificial bid in the various MBS and UST debt markets. When the bid disappears, interest rates will skyrocket.

The FED has said that it wants to withdraw the QE funds by 1Q10. I think they are lying (as usual), but it is food for thought.

My guess is another liquidity program is being hatched to keep the QE funds in place. That's pure speculation on my part.

Eleua said...

BTW, interest rates are not set by the FED or Treasury Dept. Yes, those two entities can influence rates, but they do not set them.

Interest rates are set by the open market. The only way the FED/Treas influence them is by manipulating the debt market, as they are now doing.

Anything that isn't sustainable will fail, and the current manipulation is no exception.

People will be caught by surprise when they realize the FED can't save them. Panic will be epic as that reality sets in. The panic will be expressed in interest rates being several times higher than it is now.

Anonymous said...

So, given the looming disaster, where to invest?

Eleua said...

IMHO, you invest in the dollar and some means of viable production.

I have no idea what that may be. One thing that I keep thinking about is how we are now past the inflection point and are heading down. Whatever worked in the previous paradigm will likely be a good short in the next phase.

Do the opposite of what has worked over the past few decades.

Haybaler said...

Do the opposite.
It's interesting to read that. I have been discussing the economy and the various business activities that I am involved in with family. My statements have been that "All of the rules have been changed" I told my parents who want to put an addition onto their house (and marble countertops) "because it will add value to the property when it comes time to sell"

Today we need to use it up, repair it and patch it like our Depression era relatives did. Preserve cash. There is no "adding value" to realestate today. 20 years from now all of our homes should look like the Clampetts lived in them.

I suggested they acquire Tools of Production, Machines, Equipment,...things that can be used to grow food and provide needed services to those around them....for rent or in order to employ the desperate unemployed.

Yesterday, I was eating lunch in my favorite bar/restaurant. I noticed, again, that I was the sole customer. Two young men came in to apply for jobs....I overheard them state that they were 17 and 18. They had been applying for work "everywhere". They offered to do janitorial work for $20/ evening. I have a tenant in a rental house who had a good job...just got laid off. When tenants lose their jobs that is bad for landlords. It used to be that an adverisement brought hordes of new qualified applicants for you have hordes of "stories".
We need to figure out the new rules.

mannfm11 said...

Absolutely excellent writing. I think you could write better what I would like to. You might visit my blog, as I have a lot of the same opinions, but I don't write so pretty. My mother grilled me tonight about my brother telling her to buy gold at $700. I told her about 6 years ago to put $400,000 in gold when I realized it had gotten out of the bottom. We are in a deflation and having cash is going to become very important. Especially if depositors are forced to take a haircut. Also, pension funds are not going to survive this mess. There will be a lot of family jewelry on the market before all of this is done and the "We buy gold" outfits will all be broke. A dirty old man like me could find me a nice young girl with a bargain basement diamond ring.


I love intro to the post. I should say the title very creative indeed.