FJ Prediction: $4/gallon gas by Memorial Day

Please note, I am not giving any investment advice. You need to do your own due diligence in regards to investing.

We’ve got a perfect storm brewing in the energy markets right now. Oil has recently hit, and for the first time closed at, over $100/barrel this past week. On top of that, the springtime has many refineries switching from winter blends to summer blends. Alongside both of these issues is the fact that Memorial Day kicks off the summer driving season when gasoline consumption tends to peak.

All three of these trends lead me to believe we are going to see a major uptick in the price of a gallon of gas starting now. Here in Santa Fe we’ve already seen gas jump up by about $0.50/gallon in the past month, to about $3.09/gallon (and I have seen some stations at $3.19 for regular unleaded).

I know that oil also was hovering around $100/barrel oil in November and December of last year. For some reason we didn’t see a big bump in the price of a gallon of gas. Here in Santa Fe, prices remained in the $2.60 - $2.80/gallon range during that time. I’m not sure why prices stayed so low (although my conspiracy theorist has lots of ideas about government manipulation to keep prices down over the critical Holiday shopping season).

Regardless, we didn’t face the other two issues back at the end of last year. Refineries are already stretched to their limit trying to keep up with our energy consumption. When they start to switch over in the next few months, expect major increases in the price of gas. Last year, even though oil was in the $60/barrel range, gas prices jumped over $3/gallon because of the refinery bottleneck.

I’d be interested in finding out if they’ve been shipping extra number fours (for the signs) to local gas stations in anticipation of the $4/gallon being breached. For the record, I also thought this was going to happen last year, but that never materialized. Nevertheless, everything seems much more likely this summer.

The only thing that could change this prediction is a sudden and dramatic slowing of the economy in the next 3 months. Even though this is a possibility, and the economy is slowing right now, I doubt this is going to have much of an impact on oil prices. There is a real bull market happening in energy right now and I expect that to continue in the short term.

However, longer term I’m positive that prices will be falling rapidly starting in Winter, 2008. I think by that time you are going to see real recessionary indicators on both the American and world economy. If worldwide oil consumption drops by only 10%, that could result in a 50% drop in the price of oil (back to $50/barrel and probably under $2/gallon gas). I hate calling this good news because it only happens if the recession is stronger and deeper than anyone thinks right now.

I will follow up with this on Memorial Day to see if my prediction comes through.

Sorry I've been so sporadic with my posts. This month has been crazy, but I've got lots of stuff to talk about going forward. I'm going to try to post some more real soon!

Old School Housing Truisms

Amid the housing frenzy of the past few years, there was a lot of conventional wisdom which got ignored. I want to remind all of you that it was not that long ago that all of these rules were rigidly followed (and had been followed successfully for 50 years).

When I bought my first house in 1998, all of these rules were still being followed.

1. YOU NEED A 20% DOWN PAYMENT. This shows the bank that you have discipline and are able to live below your means. It also means the buyer has some "skin in the game" and will be less likely to walk away from this debt. If you didn't have 20%, you have to pay Private Mortgage Insurance (PMI). PMI was a very expensive penalty, it would usually add another $100 - $200/month to your mortgage payment, which further reduces how much home you can afford.

2. GET A 30 YEAR FIXED MORTGAGE. If you couldn't afford a 30 year fixed, you couldn't afford the house. Adjustable rate mortgages, interest only mortgages, subprime mortgages made up a very small percentage of all mortgages and were reserved for very special cases.

3. IF YOU NEED TO SELL YOUR HOME WITHIN 3 YEARS OF BUYING IT, YOU WILL PROBABLY LOSE MONEY. This is why when you took a job in a new city you rented! If you weren't sure if you were going to be in a place for at least 3 years, you didn't buy a house! Remember, when you sell there's a 6% commission plus closing costs (about 1.5%). You needed about 3 years of appreciation in order to cover those costs, and even that wasn't a guarantee.

4. HOMES ONLY APPRECIATE AT THE RATE OF INFLATION. This goes back to point #3, you could only count on about 3%/year appreciation on your house. That means a $100,000 house should only increase in value by about $3,000/year. After 3 years, a $100,000 house would be worth about $109,272. If you needed to sell and paid 7.5% (commission and closing costs) you would net out about $101,000.

5. YOUR LIFE WILL BE THOROUGHLY DOCUMENTED, TOP TO BOTTOM, BEFORE A BANK WILL GIVE YOU A MORTGAGE. They want to see two years of steady employment (pay stubs, W-2s and tax returns). They also want to see your investment and savings accounts, and no more than 25% of your down payment can be a gift from your family. They check your credit report to see if there are any judgements against you, and if there are - you need to pay them off. This is a grueling process and they basically find out everything about you before they end up loaning you money.

6. HOUSING PRICES CAN AND DO GO DOWN. Despite what Realtors tell you, every housing market - at some time - has gone down. Even some of the biggest and most expensive housing markets, including San Francisco, Honolulu and New York, went through periods of sustained housing declines. These declines take years before the losses are recovered. The bank wants to be sure you will stick it out and keep making your payments and that's why they wanted a large down payment and a full documentation of your financial situation in the first place.

All of these rules are slowly being reinstated in the wake of this massive housing bust currently in effect.

For 50 years the homeownership rate in this country held steady at 65%. In the past 10 years they've been able to push that up to 70% but only by repealing every one of these rules. The entry of approximately 15 million homeowners over that time caused the average price of a home to double. Now those 15 million fake homeowners who never put any money down, who used no documentation loans and Option ARM or subprime mortgages will lose their homes and prices will go back to their inflation adjusted norms.

And there's nothing that the Republicans or the Democrats can do about it.

Demergophobia

Demergophobia - The Fear of Debt, The fear of falling into debt.

AMERICA, YOU HAVE BEEN TAMED!

There was a time not so long ago when Americans feared debt. When you bought something, you paid cash.

If we go back 100 years, the use of credit was actually considered a moral weakness on the part of the user. It was typically extended to desperate people who couldn't pay their bills.

When people did go into debt, it was used for an extremely large purchase, like a home. And when you did go into debt, you worked your butt off to pay it off and pay it off quickly. Did you know that back in the early part of the 20th century, mortgages used to be paid off in 10 years?

Back in the day, there was something called "mortgage burning parties". No kidding, people would throw a big party and invite all their friends over when they finally paid their mortgage off! They would light that mortgage note on fire and everyone would cheer. The symbolism of the burning mortgage note was the homeowner was now released from servitude to the bank.

Now, compare that to our modern ideas about the use of credit and debt. Debt is no longer feared, it is embraced. Debt is not shunned, it is encouraged at all levels of our society. In fact, our culture has become so twisted by the use of debt, in many ways your level of "success" is directly correlated with the use of debt. People who are up to their eyeballs in debt are typically viewed as the most successful. They have the nicest and most expensive houses, cars, clothes, electronics, etc.

The problem with this widespread use of debt to finance a lifestyle is that it warps society's perception of what is successful. When you see Joe Blow driving around in an tricked out H2 and your tooling around in a 10 year old Toyota, even though you have a good job and make a decent income, you're going to start questioning your own self worth.

The use of debt also twists the actual value of what you buy. The use of debt creates an artificial demand for items. Remember in basic economics, when demand increases for any particular item - so does it's price. Look at what happened to housing over the past 5 years. The banks and Wall Street created products that allowed people to buy homes with no money down, no income verification and no assets. Shoot, you could get a mortgage that actually had negative amortization, that means the amount you could pay each month was less than the interest owed on what you borrowed (so every month you would end up owing more as that unpaid interest was added onto your mortgage balance).

This caused a large segment of people to enter the housing market that, in more sane times, would never had been able to buy a house. Their entry into the housing market caused a massive bubble. However, the lending was so loose and fraudulent that there is now a massive wave of defaults happening across the country. Banks and Financial instituations have responded by tightening up requirements. They now require you to verify your income and employment, they now want a down payment. This has removed a huge segment of the population from being able to buy a house. The predictable response is that the price of housing is now coming back down (right now the estimated losses in housing is 10% or $2 trillion, and we have a long way to go).

Most people don't realize that there was another massive housing bubble back in the 20s. After the great depression began the supply of credit almost completely dried up. Because there was no credit, no one could afford to pay the going prices for homes. The end result is that by 1933 (the worst year of the depression) house prices crashed 70 - 80% across the country!

You need to develop a fear of debt again. Don't trust the smiling bankers or the friendly "pre approved" credit card offers that come in the mail every day. Know your limits as to how much debt you can afford and refuse their offers to give you more than you can handle. Keep a tight lid on the amount of debt you have because it is so very, very hard to get rid of it once you take that debt on.

Debt Negotiation - UPDATED

Did you know that most debt is highly negotiable?

If you are having a problem paying your debt, call your lender and talk to them. Most lenders are highly motivated to have you to continue making your payments.

Think your interest rate is too high? You can get that lowered usually with a call. Likewise, if you want to just make an interest only payment for a month or two, the lender will usually allow that. If you need to renegotiate the term of your loan (that's extending the time you make payments on a loan) they can adjust that as well. Finally, if you are able to make good faith payments toward your debts, you can also get penalties reduced or eliminated. All of these items can help in lowering your monthly payment and helping you if you're facing a short term cash crunch.

However, this negotiation does have its limits, and that's the debt trap. The bank wants two things from you: they want you to pay your interest due each month and they want the balance due. Of course, lowering your interest rate reduces the interest they collect - but they still collect interest from you.

Most people are so afraid of their lender, they never try to negotiate with them and just accept usurious levels of interest and penalties on their debt. When I hear about credit cards charging 30% interest, I am floored that anyone would even pay that. The banks only charge that because they feel they can milk that out of the populace.

Believe me, the lenders DO NOT want you to default! As long as you're making payments, they make money - never forget that. If you're having problems with your debt, or even if you're not and just want some better terms, call them today and see what they can do for you. If you get a lot of stonewalling from the first rep that comes on the phone, ask to talk to their manager. Move on up the line until you get satisfaction. Keep names and numbers of the people you talk too.

You do need to understand your limits, though. If you call your lender and ask them to reduce your credit card balance from $3,000 to $2,000 they will laugh at you. The companies can't do that. The only thing that discharges debt (that is releases you from the obligation of your debt) is bankruptcy or foreclosure.

UPDATE - On February 13th, Henry Paulson came out with another mortgage rescue plan that is more of the same. Six of the biggest mortgage lenders in the country (that make up about 50% of the outstanding mortgages right now) are going to freeze the foreclosure process for 30 days in order to do some "work outs" with these heavily indebted homeowners. This is basically the same plan as the "Hope Now" alliance that hasn't done jack squat since it was instituted back in the fall (Hope Now has helped a total of 10,000 homeowners since it was instituted - as a comparison we had 2 million foreclosures in 2007). The reason is because the work outs don't address the real problem, people took on too much debt. They're going to try to refinance these homedebtors into a fixed rate, lower the interest rate, remove penalties, extend the term of the mortgage, etc. However, this doesn't solve the problem of too many people took on too much debt that they couldn't afford.

This is problem that's happening in the housing market right now. When the government and the lenders talk about negotiating with homeowners, they're talking about interest rates, loan terms and penalties assessed. The problem is that most homeowners in trouble paid too much for their homes, they took on too much debt. It doesn't matter how you change the terms on the debt, you're never going to be able to get a person who makes $50,000/year able to pay a $500,000 mortgage.

That's it, game over.

The banks won't voluntarily discharge that debt. Those loans have to be defaulted on those homes have to be foreclosed on for that debt to be released from the system.

So, don't pay a penny more than you have to in interest or penalties. Remember that those expenses are a direct tax on your wealth. Don't be afraid to talk to your lender and get those expenses minimized as much as possible.