Tuesday, September 25, 2012

REITS Are the Solution to the Housing Crisis

There were many causes of the housing crisis that hi the US in 2007 and set off the depression that began in 2008. Many of the problems remain but the biggest question is what do we do now? 

When the housing market began to decline many problems were created. Banks that held hundreds of billions in Mortgage backed securities found that what they had thought were low risk securities discovered they were taking huge losses. Home owners could not afford their mortgages anymore and the down real estate market put them “underwater”, that is, they owed more than their homes were worth. Many individuals chose to walk away from their debt to start anew while many others were foreclosed on by the banks. Banks hate foreclosures because they must recognize the loss, begin what can be expensive procedures to remove the occupant, and are stuck with property they don’t have the means to maintain and run a high risk they will be either occupied by squatters or gutted by criminals seeking a quick buck. Clearly, kicking homeowners out is undesirable for both parties. Banks then must sell the home in a declining real estate market bringing down the comps for the remaining neighbors, creating a “death spiral” that put the remaining neighbors under water.

Up to this point, banks have chosen to let many foreclosed homeowners stay in their homes paying nothing. This is known ad foreclosure stuffing. As stated above, this allows banks to put off the recognition of the loss and allows them to put off selling the home in a declining market. Whether banks foreclose or not they face a decline in revenues and accounting losses. A home owner who moves out loses their home and their families lives are put in upheaval. But for a new healthy real estate market to emerge, prices must correct and be allowed to fall to their real value. Only then will new buyers step in at the lower prices because one, homes are more affordable to young people who begin household formations and two, because people still view a home as their biggest investment and want to think the odds are in their favor their investment will increase in value rather than become a “money pit”.

Up to this point the Federal government has tried to help by easing requirements for homeowners to refinance. But this does little for people who are underwater by over one hundred thousand or more. Accounting standards were also suspended to allow banks to “mark to model” rather than “mark to market” making a joke of our accounting system which is a cornerstone of a free market since analysts rely on reasonable accounting to value companies. Meanwhile, the Federal Reserve has in both QE1 and the current QE3 bought mortgage securities to provide liquidity to banks. Certainly this is helpful to banks who get the bad debt off their balance sheet but is does little for the homeowners and worse it socializes the losses from the banks to the US taxpayer who see the value of their dollar reduced by the money printed by the Fed to buy the bank’s mortgage securities. So neither of these programs helps reset the market, rather they both stretch out the time it will take for the real estate market to find its new, lower equilibrium. Neither of these solves the documentation problem where documents on mortgages were incomplete, fraudulently signed or where documents are completely missing. This has clogged our courts with cases of homeowners suing their bank or fighting eviction and no clear indication as to who the real owners is legally.

The solution is REITS

Thursday, September 20, 2012

Money Going Down a Black Hole

For the past four years the Federal Reserve, the President and Congress have operated under the Keynesian notion that we can spend our way through the recession/depression/financial crisis, and that if we did, economic growth would eventually return. Keynes had the idea that during an economic down turn governments should engage in deficit spending as a counter cyclical economic force to speed up a recovery. Keynes even postulated that it didn't matter how the money was spent. A work crew could be hired to dig a hole while another was hired to fill it in and the result would still be economic activity. Of course I'm over simplifying some what. Keynes also thought we should run surpluses when times were good. But it is essentially this theory that both the US government and the Fed have operated under in their attempt to get the economy moving again.

In February 2009 congress passed the American Recovery and Reinvestment Act of 2009. The bill's total cost was  $831 Billion dollars. It was then thought that there would be a "multiplier" effect, that is for example, for every dollar spent on the stimulus, there would be say $1.50 of economic activity generated. This is precisely what Christina Romer (Chair of the Council of Economic Advisers in the Obama Administration) had predicted. So in other words, the $831 Billion spent would generate about $1.2 Trillion in new economic activity. This was the basis of the Obama administration's projections for unemployment shown below:

Obviously the actual results were not what had been expected. Why? According to John Cochrane:

Estimated macro models used for policy evaluation—whether old Keynesian or new Keynesian—have this basic mechanism built into them. However, they differ greatly in their predictions of the policy impact because of different assumptions about expectations, the marginal propensity to consume, the speed of price adjustment, and crowding out of other spending. For example, Christina Romer and Jared Bernstein used old Keynesian models to predict the effect of the stimulus package of 2009 before it was implemented. They predicted large effects of the package with multipliers around 1.5. In contrast, in research with John Cogan, Volker Wieland and Tobias Cwik, I used a new Keynesian model to predict the effects of the 2009 stimulus. We predicted a much smaller effect, with multipliers averaging 0.5, even less when you include transfer payments.

As we will see it was actually much lower...about .2. Yep, for every $100 spent, we generated $20 of economic activity. Not a very good investment. It is explained rather well in the video below from Charles Biderman:

So we are spending far beyond our means (Over $1 Trillion each year for the past four years) and an extra $831 Billion on a stimulus that has not generated enough economic activity or growth to justify its use.

Its just as bad or even worse at the Fed where they have bought $2.5 Trillion of junk assets from banks and newly created treasury debt. The new QE3 will take us to about $5 Trillion over the next few years but is just as doomed to fail as QE1 & QE2. Why? The Fed operates under some assumptions that are dislocated from reality.

First, is the money multiplier which I've explained before using the example of the Fed's fractional reserve where a bank can take $100 of deposit money and make $900 in loans. QE is partially about getting more money to banks by buying Treasuries from banks in the hope they will make loans. In this way the money multiplier would create new economic activity in the economy. The problem however, is that the banks aren't lending or are being extremely tough with their underwriting of new loans. Anyone trying to get a new mortgage knows what I mean. So the money sits on their balance sheets or is lent back to the Federal reserve where they get paid for their excess reserves or they buy new treasuries paying a risk free rate of return of 2-3%. The result is that there is no money multiplier in the real economy.

The graph below from the St. Louis Fed shows the money multiplier has fallen below 1 since 2008:

The combination of both of these types of multipliers (monetary and fiscal) being essentially between zero and one explains why both monetary and fiscal stimulus have not worked so far.

Wednesday, September 19, 2012

The Romney Comments the Press Didn't Tell You

I'm sure you've heard Romney's comments made at a private fundraising event about the 47% of American's who pay no Federal taxes. Its all over in the press. This is not about that. This is about the comments the press didn't bother to tell you about from the same fundraiser.

From Motherjones:

Romney: Yeah, it's interesting…the former head of Goldman Sachs, John Whitehead, was also the former head of the New York Federal Reserve. And I met with him, and he said as soon as the Fed stops buying all the debt that we're issuing—which they've been doing, the Fed's buying like three-quarters of the debt that America issues. He said, once that's over, he said we're going to have a failed Treasury auction, interest rates are going to have to go up. We're living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who's loaning us the trillion? The Chinese aren't loaning us anymore. The Russians aren't loaning it to us anymore. So who's giving us the trillion? And the answer is we're just making it up. The Federal Reserve is just taking it and saying, "Here, we're giving it.' It's just made up money, and this does not augur well for our economic future.
You know, some of these things are complex enough it's not easy for people to understand, but your point of saying, bankruptcy usually concentrates the mind.
 Click below for more.

Tuesday, September 18, 2012

The Gold Debit Card (Patent Pending)

No, not gold status, gold bullion.

For the past few years I've watched the Fed print money to deal with the economic malaise we've experienced since 2008. It became evident that rather than let markets clear, deleverage and reform the rot in our economic system, that we would "extend and pretend". First it was to get us through the initial crisis that saw our financial system on the brink. Then, as time went by I saw that "pretending" had become the new normal. Congress didn't do any substantial reform. Frank-Dodd was passed essentially as an empty bill with no realistic plans towards its implementation. Even today, the CFTC has delayed implementing position limits on gold and silver futures allowing JP Morgan and HSBC to (allegedly) manipulate the prices by creating naked short positions out of thin air. The Fed, once they had dropped interest rates to zero, seemed to have only one policy tool left: PRINTING DOLLARS.

Once I recognized this, it became clear that the US dollar which had already been devalued under President Bush and Fed Chair Alan Greenspan, would be massively further devalued bu President Obama and current Fed Chair Ben Bernanke. At first I looked to other currencies, primarily the Euro, but soon it became apparent that the rot and dysfunction in the financial markets was not a uniquely American problem, it was the entire western world and Japan.The US, Europe, Japan, Great Britain and even Switzerland (!) have all embarked on quantitative easing (printing) to deal with profligate spending, an excess of debt and faltering economies. No currency, it seems, will be a refuge or preserve purchasing power. Only gold seems to be up to the task.

Click below to continue

Saturday, September 15, 2012

$3,350 Gold & $190 Crude

The consequences of unlimited quantitative easing are just now being contemplated as "endless easing" becomes official policy rather than a thought experiment. One consequence will be the repricing of assets, including gold and silver, in the ever devalued currency of the USD. For now, the US dollar is still the "petrodollar" that oil is primarily priced, so a devaluation of the dollar means the price of oil must go up as the dollar is devalued.

BofA has their own take on it given that the Fed will increase their balance sheet from $2.2 Trillion to $5 Trillion over the next few years. From Zero Hedge:

n other words, for once we actually were shockingly optimistic on the US economy. Assuming BofA is correct, and it probably is, this is how the Fed's balance sheet will look like for the next 2 years:

Or, in terms of US GDP, the Fed's balance sheet will have "LBOed" just shy of 30% of all US goods and services.


It gets worse:
Since the Fed is effectively becoming the marginal player in both the MBS and Treasury markets, a very relevant question is how much private market debt is left to sell. Short answer: not much. According to BofA's calculation, the Fed will own more than 33% of the entire mortgage market by 2014.
 That's half the story.
On the Treasury side, in just over 2 years, "Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014." You read that right: in just over 2 years, the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years (which by then will be part of the Fed's ZIRP commitment, yield 0% and essentially be equivalent to cash).
No wonder that David Rosenberg is worried that the Fed will soon run out of securities to buy (well, there are always equities of course, but the Fed will not monetize those until some time in 2015 when hyperinflation is raging).
And speaking of hyperinflation (and our earlier note that nothing "else is equal") the real question is if indeed the Fed will own $5 trillion in "assets" in 27.5 months, what does that mean for gold and crude? The answer is plotted below:

In case it is unclear, the answer is:
  • $3350 gold
  • $190 oil.

In coming days I'll provide analysis as to why continued QE will not work, except to inflate the price of commodities and (temporarily) the stock market.

Thursday, September 13, 2012

To Infinity and Beyond!

 I was going to write a long post on the effects of QE3 to infinity announced by the Fed when I came across an extremely well written piece that describes both the plus side and coming negative side of endless printing on different asset classes. It supports the goal of this blog to examine the macro economic environment to preserve and grow wealth. You can read it here. I have also shown it below:

The Dark Side Of QE: The Next Chapter In Our Story

I am about to tell a story with a very happy beginning and a very sad end. Unfortunately, it happens to be the story we are living in today, but because we are still in the happy part of the story most people cannot see what is coming ahead. I will provide that for you here.

The immediate knee jerk reaction to the Fed's announcement today is that the Fed printing $40 billion per month and pumping it into the banking system is fundamentally strong for every type of asset in the world. Those that graduated from college in 2009 and have only been watching the market for a few years would believe this is a fact.

In essence: buy everything and just keep on buying.

Now that we know we are on the path of QE to infinity it is very important to understand how an endless running stream of new money fundamentally impacts assets differently. You'll notice a repetition of the word fundamentally because for long periods of time assets can move in the opposite direction of their fundamentals. Think of the 100% par value of subprime mortgage tranches in early 2006 or the multi-billion dollar valuation of in 1999. Over time assets have a tendency, like gravity, to revert back to their fundamental value. This is what causes booms, busts, opportunity, and disaster.

Before we go any further, let's quickly review how QE actually works. The Fed shows up at the doorstep of primary dealer (the largest) banks with a printed bag full of money and asks them if they can come in and buy some mortgage bonds. The banks agree, hand them the bonds, and take the bag full of cash. The banks now have a new lump sum of money to spend or do with what they like. This is also new money that did not exist in the economy before which is how the money supply is increased. In reality, there are no knocking on doors with bags of money, this process takes place electronically with a few key strokes from either side. The outcome, however, is the same.

Click to continue reading

More Money Printing- QE3 Has Arrived

The Fed, in a move that is no surprise at all, has announced indefinite monetary stimulus. Though this blog has focused on wealth preservation that has assumed more QE all along, its still disheartening to see our country continue to move down the road to ruin and a weaker dollar. My readers, of course, are well positioned to profit from the latest move but one wonders, what of the rest of America who will now face higher prices in both food and gas as this depression drags out longer?

I'll have more on the Fed's latest move later.

Wednesday, September 5, 2012

Is Silver About to Explode Upwards?

Bill Murphy on the (possible) end to JP Morgan's silver manipulation.

Pay attention at 17:21. It would seem that Russia too is taking advantage of artificially low prices at the expense of us (Americans).

Monday, September 3, 2012

S&P 500: from 1,400 to 400?

There's a correlation between the  10 year US Treasury and the S&P 500, which represents the 500 largest US companies. Prior to 2008 they moved in tandem when graphed against each other. Take a look at the graph below from 1999 to 2008.

You can see that the orange line tracks the black line very well for much of the last 10 years up until 2008. This was when quantitative easing started. Quantitative easing artificially inflates the price of stocks (along with most everything else) since the stocks are priced to reflect the new, lower valued US dollar.

Since that point the two lines diverge. The question is, when will they re-converge? And will it be because interest rates are rising or because the stock market, represented here by the S&P 500 index, comes down? Its an important question because if rates are held down by the Fed through continued through operation twist, then the index needs to fall from 1,400 to 400!!!

You may recall from my previous post, Three Graphs Explaining When to Dump Gold and Buy Stocks, that I am looking for the Dow/gold ratio to decline to close to 1:1. What these two concepts have in common is that US stocks, whether represented by the broad index of the S&P 500 or the more narrow index of the Dow, will have to decline for these to ration to "revert" back to normal in the case of the US Treasury and to complete an 18 year cycle in the Dow/gold ration.
Click below to read more