We Are All Paris Hilton

Bleech! I can't believe I'm putting a picture of this spoiled, brainless princess (with the dead eyes) on my blog, but I need to in order to make a point.

When it comes to family wealth, it typically follows this path.

Generation 1 is hard working and earns the wealth.

Generation 2 inherits the wealth and feels guilty about it, so they try to compensate by spoiling their children excessively.

Generation 3 is the most entitled and lazy generation and they usually end up pissing the family wealth away and end up broke.

Guess which generation Paris Hilton belongs to? Here's another one to ponder... guess which one George W. Bush belongs to?

Even though I am a member of Generation X, I feel that we are that Third Generation. And even though my generation is bad, Generation Y and the Millennials are even a more amplified version of spoiled and entitled.

We are constantly told that we are the richest and most powerful nation in the world, but if you look at the facts it speaks otherwise.

Americans have had a declining savings rate for decades and for the past 3 years we have had a negative savings rate.

Americans equity in their homes has hit it's lowest point since since the 1940s.

One of the biggest issues in this presidential campaign is National Healthcare. But, like the Medicare Prescription Drug Plan from a few years ago, no one is talking about how to pay for it. The Prescription Drug Plan added $9 trillion in unfunded liabilities for our government. The fact is there is no way it could have passed if the Medicare tax had been increased to pay for it. I feel it's the same for National Health Care, there is no way it will pass if it requires a tax increase because everyone is broke and the voters expect something for nothing.

Here's more insanity. The big $600 tax rebates everyone is going to be getting in a few months is being 100% financed by debt. We are borrowing money from the Chinese so we can go out to Wal Mart and buy some Chinese crap!

The Iraq war is also being 100% financed by China and the Middle Eastern nations buying our debt. If you think the war is unpopular now, just wait until they pass some kind of "war tax" or "gas tax" to help pay for it!

Big American corporations like Citibank, Merrill Lynch and Washington Mutual have had to go begging sovereign wealth funds (again owned by China and Middle Eastern Nations) and hedge funds to give them a cash infusion or else they'll implode. The concessions that the corporations are giving these entities are obscene and essentially loot the companies and screw the shareholders!

Our country requires $2 billion/day in foreign capital inflows in order to function.

Look at the proliferation of gambling in our country over the past 30 years. The poor play the lottery and gamble at the local Indian Casino. The middle class gamble in the stock market and in Las Vegas. The upper class have their hedge funds and gamble in Monte Carlo. The problem with this is that none of this actually creates "wealth", it's all just pushing dollars around while the dealers (the casino, Wall Street and hedge fund managers) skim a percentage off the top.

We actually spent through all our wealth years ago. The past 12 years we've been living in a bubble economy (first tech and then the housing bubble) which gives us the illusion of wealth and allows us to borrow money in order to maintain that illusion. However, like spoiled, 3rd generation heiresses, there will come a time when the banks say "no mas" when you call to get another increase in your credit limit.

We'll kick and scream and cry. We'll say "Do you know who my daddy is?!?" We'll threaten them with lawsuits or worse. However, in the end it won't matter. We'll have to reap what we have sown. It won't be pretty, but it will be necessary.

Maybe our country will learn a very valuable lesson. Nobody owes us a living. We're going to have to figure that out for ourselves the hard way.

Who knows, maybe the next generation (post-Millenials) will know how to build real wealth again.

Excess Capacity

A few years ago I read the following article.

http://dir.salon.com/story/tech/wire/2003/08/29/cars_and_drivers/index.html

In 2003, our country had a major turning point. For the first time in history, there were more automobiles in the United States than there were DRIVERS! What did I read into this article? I read that used car prices were going to plunge. Why? Because in a supply and demand model, if there is more supply than demand – prices go down!

In fact, this past week Yahoo had an article on the fastest depreciating automobiles. One item that stuck out on me was they were talking about the Kio Optima Minivan. This is a car that retails in the Mid $20k range if you buy new. It’s also one of the fastest depreciating autos in the country, losing more than 80% of it’s value over 5 years!!! To put it another way, the driver of the Kia Optima is paying about $416/month in depreciation costs just to drive that vehicle (that's on top of fuel, insurance and maintenance costs).

Even the "best" vehicles that maintain the highest resale value (think Honda and Toyota) lose approximate half their value in 5 years. That is a huge cost incurred by drivers of new cars, but if you are a buyer of used cars - this is to your advantage because you are able to keep more of your wealth.

I talked about autos in detail in my post “The Depreciation Monster” back in December (check it out).

I don’t want to sound like a broken record, but excess capacity is the problem with housing right now. There are simply too many houses/condos/lofts out there when compared to current demand.

It is very, very hard for me to pay full price for anything anymore. The big reason is that I know there are hundreds, if not thousands of people who I know bought something at full price, have never used it (or used it once or twice), and now want to sell it for pennies on the dollar.

Here’s another example. I am currently renting a house (I sold my house last year) which has a very dated kitchen. When we moved in, both the dishwasher and the refrigerator were original appliances and somewhere near 30 years old. Our landlord, who is a very old gentleman, was very resistant to replacing these artifacts. So my wife and I took it upon ourselves to find suitable replacements. Last year we found a 10 year old dishwasher in great shape at a garage sale. What did we pay for this dishwasher? It only cost us $25. We then went to our landlord and said we would give them the dishwasher if they would pay to install it. It was a done deal.

Then we set our sites on the refrigerator. Our landlord didn’t want to buy a new one. So we negotiated that we would replace the refrigerator if he gave us a break on the rent. He agreed, so this past weekend we finally found a suitable replacement. Someone in our neighborhood was selling their 5 year old refrigerator for $200. I went to see it and it was in great shape, I offered $175 and he accepted. This is a fridge that would easily cost about $600 if it was bought new.

Did you know that most retailers do have a policy that allow you to negotiate on the prices of what you purchase? Even big national chains like Best Buy allow it!

http://www.nytimes.com/2008/03/23/business/23haggle.html?ref=todayspaper
Excess capacity is everywhere. Remember how hard you work for your money and use every tool at your disposal to get the best price.

"...since the Great Depression."

Maybe it's just me, but I've been seeing this comparison more and more in the media when it comes to our economy.

Here's some examples:

"Savings Rate Lowest Since Great Depression"

http://www.breitbart.com/article.php?id=D8FF6D700&show_article=1

"Lawrence Yun, the Realtor's chief economist, said it was likely the country has not experienced a decline in home prices for an entire year since the Great Depression."

http://biz.yahoo.com/ap/080124/economy.html

"Fed takes boldest action since the Depression to rescue US mortgage industry"

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/03/12/cnfed112.xml

In fact, if you Google the words "...since the Great Depression" you get 2.1 million hits! Apparently this is becoming a popular phrase.

I'm pretty sure that it's going to get even more popular as we move forward.

Bill Fleckenstein is my hero! FJ Quote of the Day

"Congress and the White House are now attempting to right past wrongs with bailout schemes -- some aimed at lenders and others at borrowers. And of course, the Fed is being called on -- and has willingly obliged -- to provide more easy money in the hope that more of what created the problem can solve it.

The latest example by the Fed: Handing JPMorgan Chase a $30 billion credit guarantee to get it to buy Bear Stearns.

The insidious and dangerous unspoken corollary to all this: Financial pain is now unacceptable. Those in trouble demand to be rescued, and the government seems to agree that the "creative destruction" component of capitalism must not be allowed to do its work. It's a sad irony that as former communist countries embrace capitalism, we seem to be headed in the other direction."

- Bill Fleckenstein, "Contrarian Chronicles"

March 21, 2008

Here's the link to the article:

http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/CateringToTheBailoutNation.aspx?page=1

FJ Challenges the Conventional Wisdom: High Housing Prices are BAD for the economy and consumers!

Are high housing prices a good thing?

If you listen to the media, the politicians and the financial industry when asked about the housing crisis - overall you'd come away with the impression that this is true. And all of their "solutions" come down to finding a way to maintain those high prices no matter what!

However, if we delve into the pre-bubble mentality. High housing prices are often seen as a liability for a community.

I live in Santa Fe, NM, which has always had a certain cache - it's considered a highly desirable place to live (and retire to). Because of this, it's always had high housing prices. There are other places like this including Aspen, Colorado and Jackson Hole, Wyoming.

1. The biggest problem with high housing prices is that it makes it very difficult to attract businesses and develop the local economy. Employers aren't that eager to have to pay above market wages to compensate for the high cost of living. In Santa Fe's case, we are the state capital, so there are lots of government jobs. Likewise, we have a large tourist economy that is highly dependent upon the economy. Housing is the third biggest employer in the city (and we know how that's going right now). We have no major employers outside of these sectors (Thornburg Investments and Thornburg Mortgage are probably the single largest private employers in the city, but Thornburg Mortgage is on the verge of going bankrupt because of margin calls and that could result in 400+ high paying jobs evaporating and further damage a struggling housing market).

Because we have no industry, wages in Santa Fe are not good. We often have a problem with teachers, policemen and firemen being able to afford houses in the city where they work. If you want to find "affordable housing" in Santa Fe you have to go to the ghetto-like southwest side (where, according to an article in the paper today, affordable is $250,000+), buy a mobile home and live in a trailer park, or buy an affordable house in Albuquerque and commute 60 miles each way to work.

Likewise, we have a brain drain where the smartest kids in our city can't wait to leave because the opportunities in this city are so limited. We are also saddled with a high dropout rate amongst the disenfranchised kids and minorities.

2. Another big negative for high housing prices is high property taxes. One good thing about New Mexico is that we have very, very low property taxes (most of our school funding is paid for by our "gross receipts tax" which is like a sales tax on everything except medical care and food). On the house I owned until last year, my annual taxes were only about $1,200 on a home that I eventually sold for $345,000. However, in most parts of the country, property taxes come to about 1% of assessed value. That means that over the past 5 years the average person's tax burden on their home doubled or more, even if they didn't do anything to the property. When you talk about someone paying $3,000/year in property taxes on their home when a few years ago their taxes were only $1,500/year - that creates financial pressure on homeowners, especially when wages have been stagnant like they have been this past decade.

3. Then there's the whole maintenance issue. If you have all your money going toward a high house payment with high property taxes, how are you going to be able to afford to pay for the upkeep of your property? When it comes to budgeting for the purchase of a home, they say that you will spend about 1% of the cost of your house on maintenance and upkeep each year. Then, every 10-15 years expect a major repair, like a new roof or the house needs to be restuccoed. Major repairs can set you back $10,000 or more. High housing prices hurt the homeowner's ability to properly maintain their property.

So, that's what you get with inflated housing prices:
Communities can't attract businesses
Brain Drain and high dropout rates
People who work in the community can't afford to live in the community.
Depressed wage base
High property taxes

On the flip side, lower housing prices aren't the end of the world. People will be able to afford houses again without having to take on a toxic mortgage. Property taxes will come down. People won't have to commute hundreds of miles a week to their job. Maintenance issues will be a minor nuisance as opposed to a financial crisis. Finally, you and your partner won't have to work 80 hours a week at multiple jobs in order to afford a home.

That doesn't seem so bad to me.

Banks ask Congress to fill a $3 Trillion Hole

"Watch that first step, Doc. It's a lu-lu!" - Bugs Bunny

How much trouble are the banks and financial companies in relation to this housing bust?

In my previous post I demonstrated how they essentially milked out all of the equity Americans have in their homes through their fruadulent and corrupt lending practices.

In summary, back in the 90s Americans had $10 trillion in housing wealth against $5 trillion in mortgage debt. During the height of the bubble both numbers swelled to $20 trillion and $10 trillion respectively. We are now on the downslope and it will end with $10 trillion in housing wealth being backed with $10 trillion in mortgage debt.

However, it's even worse for the banks. Because 30% of the houses in this country are owned outright. This means that the endgame, is that there is $10 trillion in debt held against $7 trillion in housing wealth. The fact that the mortgaged housing stock is still "valued" at $14 trillion doesn't matter because it's shrinking every day (last month national housing prices fell almost 2%, that's $400 billion in housing wealth up in smoke).

This is what is making the banks and financial companies crap their pants. They know that $3 trillion of what they are holding is almost certain to default. Once people have lost all their equity, they'll have very little incentive to stay in the house (especially if rents are cheaper). When you also throw in the fact that we have millions of "homeowners" who never put a penny down on their homes and the debt slaves who HELOCed and Refied all of the equity out of their house these past 5 years, you have a very, very big problem.

But wait! The problem is even bigger. You see many of these banks and financial institutions went out and used this debt as collateral to leverage up their portfolio by 20 or 30 times! So one bank could have $100 million in mortgage debt receivables on their books, but they could have used that to borrow $20 - $30 BILLION more. What did they do with that money? Well they bought more debt instruments: like CDOs or US Treasuries, or Agency debt.

It was all supposed to be very safe. But when you have leveraged yourself to the hilt, a tiny move in the wrong direction (if you're leveraged up 20 to 1, it only takes a 5% move to WIPE YOU OUT!) can send you to bankruptcy very quickly.

If you want an example, look at the Carlyle group and Thornburg Mortgage. They both overleveraged their positions, the value of their collateral dropped by a small amount and generated huge margin calls. Both of these companies have been unable to sell their debt securities (because the debt markets have been frozen for months and they continue to deteriorate), so both of these companies are both going to evaporate.

Poof! Like magic, they will disappear forever.

So now these big and powerful financial firms, who made hundreds of billions of dollars on the way up are now begging the government to fix this.

The only problem is, the hole is too big!

Both the Government and the Federal Reserve are doing everything they can to try to fix and unfixable situation. In the entire history of our country (that's 232 years) we've only now been able to accumulate $9.4 trillion in debt. Now the bankers and financiers are looking for a $3 trillion handout to bail them out of their own greedy stupid mess that THEY CREATED! Shoot, the annual Federal Budget is $3 trillion!

Look at some of the crazy proposals out there right now:

• Ben Bernake wants lenders to REDUCE THE PRINCIPAL of mortgage balances for people that are underwater. I talked about this in a previous post on Debt Negotiation - THEY WOULD NEVER EVEN CONSIDER THIS UNLESS THE SITUATION WAS BEYOND GRAVE AND THE ALTERNATIVE (MEANING LET THE HOMES GET FORECLOSED ON AND TRY TO RESELL THEM IN THE OPEN MARKET) WOULD END UP COSTING MUCH, MUCH MORE!


• Congress is proposing tax credits of $5,000 to $15,000 for people to buy a home. Personally, I'm waiting for a bigger tax credit before I would buy.


• The Federal Funds rate has been reduced from 5.25% to 3% in less than 6 months and it will probably be dropped another 0.75% next week, even with inflation and commodity prices soaring and the dollar depreciating more than 10% since they started cutting interest rates!


• Fannie Mae, Freddie Mac and the FHLB have all had the limits raised on conforming mortgages. So now a conforming mortgage can be up to $729,000 in some parts of the country (so much for helping the poor afford homes).

Sorry, banks. You created a problem that's too big to fix. Everyone sees that all of these proposals don't help homeowners, they help the banks and financial institutions that created this mess.

Just look at how Agency debt from Freddie Mac and Fannie Mae have been tanking since they raised the loan limits. Everyone knows that this is just a ploy to allow companies like Merrill Lynch and Citibank to pawn off their toxic debt onto the government (meaning, us taxpayers). No one wants to come within 100 yards of this toxic debt! In the meantime we have to suffer with higher gas and food prices (along with everything else) just so they can keep their game going until at least after the election in November.

It won't work, and I don't think they can hold this thing together for another 9 months, but that's just my opinion.

Pump and Dump

Here's the Headline on Yahoo today:

Homeowner Equity Is Lowest Since 1945
Thursday March 6, 2:15 pm ET By J.W. Elphinstone, AP Business Writer
Federal Reserve Report Shows Homeowner Equity Dipping Below 50 Percent, the Lowest on Record

http://biz.yahoo.com/ap/080306/home_equity.html

How is this possible? Haven't we just experienced the greatest decade ever
for housing appreciation? Didn't the average price of a home in the United
States double during this time?


But wait, the news is actually worse than what's reported. Right now the value of housing in America is about $20 trillion. There is a total of about $10 trillion in mortgage debt held against this equity.
Everything looks pretty good so far, right?



However, about 30% of the housing stock is owned outright ($6
trillion). So that leaves only $14 trillion in housing equity against $10 trillion in debt - all of a sudden that cushion doesn't look as big as
it did.


In the past year, the Case-Shiller Home Price Index has said that
housing values across the country have plunged by almost 10%! Take away 10% from $14 trillion and you're down to $12.6 trillion in equity. Uh oh, all it's going to take is another 20% drop to WIPE OUT ALL OF THE HOME EQUITY IN 70% OF THE HOUSES IN THIS COUNTRY!


This, my friends, is a classic pump and dump of the housing
market. If you understand economics you will know that all pricing
power happens at the margins. Housing is a product that has very small margins. At any given time, only about 1%-2% of the existing housing stock is for sale (there is about 100 million housing units in this country).

Because of easy financing (no down payment, no documentation, liar loans, option ARMs, etc., etc.) you had a large number of people enter the housing market. Anyone knows that when you increase demand without a corresponding increase of supply (housing supply takes about 2-3 years to catch up) the price goes up. In this case, the price went up substantially.

Now we have about 4% of the homes in America for sale and you would think it was the end of the world! However, at the margin prices need to come down substantially in order to clear out this excess inventory. The fact that sales are also slowing substantially is another problem because it puts even more pressure on prices to come down.

So where are house prices going? To answer this question I want to take you back to the last bubble, the tech bubble. From 1996 to 2000 the Nasdaq went from 1052 to 5048. Then the bubble burst and the Nasdaq fell all the way to 1142 in October of 2002.


ALL OF THE GAINS OF THE BUBBLE WERE WASHED AWAY ONCE IT POPPED!


Even today, 8 years after the Nasdaq reached that lofty high, the
Nasdaq closed at 2220. That's almost 60% off it's all time high. If you add in inflation (3%/year), the Nasdaq is still down OVER 80%.


In my opinion, the same thing is going to happen to the housing
market. ALL OF THE GAINS IN THE PAST 10 YEARS WILL BE LOST! That means the average price of a home in America is going back to around $100,000. Also, because the housing market is not nearly as liquid as the stock market, it will take longer to deflate than the Nasdaq did. The peak of the housing market was in the fall of 2005, so we're 2.5 years in right now and prices are only down 10% (and all of that loss occured in 2007).


Equity is a phantom, but Debt is permanent!


In the end we'll have $10 trillion in housing stock backed by $10
trillion in debt. That means Americans will have, on average, NO EQUITY in their homes when this is all done!


That means the end result is that we, as a nation, have become poorer due
to the housing bubble. Not to mention we now have to live through the massive housing led recession that we are entering right now.


We've been played, America! We were the Mark and we fell for it, and now we have to suffer the consequences. The scam artists are laughing all the way to the bank!