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.
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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.
