Indirectly, a Green Housing Boom

There is one segment of the California economy that apparently has benefited greatly from the cheap home financing and minimal credit checks in the environment fostered by the subprime lenders. In fact, this effect gives a whole new meaning to the term “subprime.” “California is in the midst of a major boom in large-scale marijuana cultivation operations run from inside homes,” according to the LA Times in an article entitled “Busts Point to Boom in Indoor Pot Farms.”

Marijuana seizures have quadrupled in just the last three years, according to officials authorized to speak on behalf of the U.S. Drug Enforcement Administration. Many of the seizures have occurred in what are considered middle-class homes and upscale suburbs of Los Angeles and Sacramento. Gang-related pot growers have taken advantage of cheap financing and the general lack of background documentation of borrowers, receiving loans cynically known in the trade as “liar loans” to acquire homes and then remodel them as indoor greenhouses.

The common practice of these urban plowboys has been for the new homeowners to black out the windows and install ventilation and lighting systems. After settling in, the drug growers use sophisticated growing, watering, and fertilizing equipment to cultivate as many as four crops per year in their otherwise humble, subprime abodes. This output equals or exceeds the yield from traditional outdoor pharmacological agriculture and lacks the danger posed by the discovery of the pot plants via DEA air surveillance or itinerant hikers and campers. “I am not talking about the Cheech and Chong marijuana cultivation of two plants in someone’s closet,” stated DEA agent Gordon Taylor. “I am talking about organized crime groups who are purchasing homes in our communities and creating marijuana factories.”

So as not to attract the attention of neighbors, some drug-growing subprime borrowers have hired gardeners and other employees to perform landscaping work, take out the trash, do maintenance on the houses, turn lights on and off, and otherwise give the indoor pot houses that “lived-in” appearance. And doubtless, of all the subprime borrowers who took out loans to purchase real estate, it is probable that the pot growers are the least likely to miss their mortgage payments and suffer a foreclosure. In that case, their investment might really go up in smoke.

What Is a Laid-off Subprime Lender to Do?

But indeed, if not growing marijuana, what is a laid-off subprime lender to do? Many, not surprisingly, are seeking other employment within the mortgage lending industry. Lending money and getting paid for it, after all, is what they know how to do. Like the steelworkers in Pittsburgh of old, or the autoworkers of Detroit in the past generation, they pray for the return of the familiar old mills and factories in a sort of “cargo cult,” as the anthropologists call it. But then again, who is to say that the real estate market of California will not be good to these hopeful, if unemployed, mortgage brokers if only they wait long enough. Overall, California real estate has been a great investment over the past two centuries or so.

Then again, if the scientific reports of global climate change are to be believed, the U.S. Southwest may be entering a prolonged period of drought, less availability of water in any form, and higher average temperatures. Knowledgeable experts on water availability and use patterns are already discussing California’s “perfect drought” — a combination of low rainfall in the Southland area, long-term dryness in the Colorado River Basin, and far-below-average snowpack in the mountains. The immediate answer, of course, is to divert water supply from California agriculture to California urban and suburban water usage.

Perhaps the California almond growers, for example, should take a page from the playbook of the pot growers. They can take out a subprime mortgage and buy a house in the Los Angeles suburbs and then black out the windows and grow almond trees indoors, under electric illumination, using the water that was diverted from large-scale agriculture. OK, I am just kidding.

But I do happen to know that they are hiring down at Circuit City. According to the LA Times, Circuit City has laid off most of its higher-paid salespeople nationwide in an effort to, as the saying goes, “cut costs” in the face of stiff competition and falling sales. (Makes sense, right? If sales are falling, fire your best salespeople.) The good news for the laid-off Circuit City employees is that they can apply to get their old jobs back, but the bad news is that the work comes with lower rates of pay. One laid-off employee, for example, who is now suing Circuit City for age discrimination under both federal and California law, noted that she was formerly earning $15.13 per hour, but now must compete to get her old job back at a rate of pay that is estimated to be less than $10 per hour. And if she does not want the job, then there are, surely, a bunch of laid-off subprime mortgage processors who will leap at the chance to rake in that kind of subprime dough.

Not All Feel the Troubles

But amidst the economic carnage and human hardship, not all here in SoCal are feeling the troubles. We learned the other day that Ray Irani, chief executive of Occidental Petroleum Corp., headquartered in Westwood, adjacent to pricey Beverly Hills, took home more than $460 million in compensation in 2006. This certainly ranks among the largest paydays in business history for any executive at any publicly traded U.S. company. Mr. Irani’s compensation outdistances even that of Lee Raymond, former CEO of ExxonMobil, who cleared in excess of $300 million in his last year as great helmsman of that well-integrated oil company. I have never been an oil company CEO, but I hear it is nice work if you can get it.

To place Mr. Irani’s pay in perspective, something over $270 million of the $460 million package came from the exercise of 900,000 options on Occidental shares in 2006, with another $93 million accruing due to associated share distributions and dividends. These underlying options were awarded in 1997, when Occidental stock was selling for less than one-fifth its current price and oil was selling for nearly $10 per barrel.

So a rising tide of oil prices certainly has lifted Mr. Irani’s tanker. (Actually, for $460 million, Mr. Irani could buy a few of his own oil tankers, if he could find a shipbuilder who could deliver on the orders.) And to his credit, Mr. Irani was personally instrumental in positioning Occidental and facilitating its entry into the lucrative oil development business in Libya. This is a long-term plus for the company. So maybe the guy is actually worth the $460 million. That is a lot of dinars, but I have no hard feelings. I don’t own any Occidental stock, and it is not my money. And now Mr. Irani gets to pay taxes on it.

Perhaps because Mr. Irani was feeling flush, he used his role as a member of the board of directors at KB Homes (of Westwood, Calif., by the way, just across the street from Occidental’s headquarters building, which certainly saves on travel expenses) to select Stephen Bollenbach as that company’s new chairman. Mr. Bollenbach replaces former KB Homes boss Bruce Karatz. Mr. Karatz was forced out under a cloud, after reports surfaced that he had backdated stock option grant dates to favor himself and other top executives. KB Homes, an upscale home builder, subsequently restated seven years worth of financial results. It is a good thing that people on the KB board, like Mr. Irani, understand that stock option stuff.

Lessons Learned

I began Part 1 of this article with a reference to my Navy days. Another thing that I learned in my time in the Navy was that after every significant operation, you catalog the lessons learned. So what are the lessons to draw from all of this?

First, the wheels are coming off the subprime mortgage business, and things are falling apart for a lot of people in and close to the lending industry. So for future reference, if you are going to be part of a speculative financial venture that loans money to so-called “borrowers” who cannot repay, then be sure to get yourself into the top executive suites. When all else fails, seek bankruptcy protection in Delaware.

Second, as we also noted above, Circuit City is laying off its best salespeople in the face of falling sales. That is what I call the triumph of capitalism. Speaking of capitalist triumphs, it sure is good to be the CEO of a major oil company. And you probably will not do too badly as the CEO of an upscale home building company. Just don’t sell too much of your product to subprime borrowers, who have a high probability of not being able to pay the mortgage. But you might be OK if you sell the houses to subprime buyers for the purposes of growing pot indoors. Those kinds of people will probably pay the mortgage, but if they get caught growing pot, the DEA will apply the forfeiture laws.

And finally, whatever you do, don’t get caught backdating your stock options. Make sure that you have your friends do it for you.

Best wishes from California, where it is dry and getting more so.

Until we meet again…
Byron W. King

April 12, 2007

Subprime Ground Zero, Part II was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

A Real Morale Booster on Jobs?

Reuters is reporting “HP to Slash Work Force by About 10%”:

“ ‘They’ve gotten themselves in fighting shape here,’ said Caris & Co. analyst Mark Stahlman, adding that it dispels uncertainty, which had been frustrating for some in HP’s engineering culture. ‘I think this is going to give a big boost to morale internally,’ he said.”

Enquiring minds might be asking some of the following questions:

1. When was the last time firing 14,500 people boosted morale?

2. Would firing 20,000 have boosted morale even more?

3. Is there a “Laffer Curve” on firing people to boost morale?

Perhaps HP was jealous of the big morale boost at IBM and Sanyo. IBM is cutting about 14,000 jobs, mainly in Europe. Sanyo announced layoffs of 14,000 jobs earlier this month. Is 14,000 the magic number?

Reports like these are bound to be good news for Wal-Mart:

1. There are another 14,500 potential Wal-Mart greeters searching for jobs.

2. This will keep up the price pressures on Wal-Mart wages.

3. Some of those fired engineers will start shopping at Wal-Mart, instead of The Sharper Image.

Seriously, mergers, outsourcing, and other consolidations are costing the United States hundreds of thousands of jobs. Massive amounts of announced layoffs in the banking and telecom industries will start kicking in the second half of the year. Eventually, this will spill over and affect housing just as it has in the United Kingdom and Australia.

Some consumer discretionary spending is already taking a huge hit. It will be affecting even more jobs as we go forward. 

Let’s Take a Look at the RV Glut. Coachmen will eliminate 12.5% of its salaried positions and 10% of its hourly work force, according to this article in the South Bend Tribune:

“The announcement marks a sharp departure from rosy projections offered at the start of the year by the Elkhart-based recreational vehicle and systems-built home manufacturer.

“‘The RV industry has been pretty slow and the housing market in the Midwest has been slow,’ said Jeff Tryka, Coachmen’s director of investor relations.

“Michiana RV, which calls itself the largest Midwest dealer of Coachmen recreational vehicles, has an unusually high inventory. High dealer inventories forced Coachmen to implement a cost-cutting program that eliminated more than 10% of the company’s work force.

“‘This is a dip, and it was predicted,’ [general manager Lenny] Martynowicz said. ‘But did anybody listen? No, everybody built more plants, and dealers took on more inventory.’

“‘We’re confident the market will turn around,’ Tryka said.”

I am very confident that it won’t.

Caddman on The Motley Fool had this commentary to offer: “RVs are one of the first discretionary items to not buy when reducing spending. Notice how movie and concert ticket sales are also down this summer. Totally discretionary…”

I agree. Let’s see how discretionary spending holds up in the second half of the year. I bet not well.

Unfortunately, the article failed to mention the big boost in morale Coachmen will get by slashing 10% of its work force.

Let’s now look ahead and see what data there are to support home renovation jobs.

Creative Outsourcing: I See a Renovators’ Nightmare

Conventional wisdom says that trade jobs related to housing will remain strong even if new home construction takes a tumble. I guess the theory is that people will have to maintain their houses and will be putting more into them, as opposed to buying new houses. These things are hard to debate with the “housing will never die” crowd, so sometimes you just have to wait for a practical example. I just found one.

The Sydney Morning Herald is reporting a “Renovators’ Nightmare for Builders”:

“Sydney’s infatuation with home improvements has abruptly ended, as evidence grows that the end of the housing boom is hitting the city’s economy.

“The value of home renovations in NSW has plunged $120 million in just three months, or more than 20% — the largest fall in dollar terms since the Bureau of Statistics began collecting records in 1974.

“The number of home building starts in the state also fell, as did the total value of building work in the March quarter.

“Architects, seen as bellwethers for the building industry and the broader economy, said yesterday that their workloads had held up nationally but fallen by a third in Sydney since the peak of the boom two years ago.”

We have already seen consumer spending and home sales drop like a rock in both the United Kingdom and Australia. One argument currently floating around in the United States is that we aren’t making any more land. The last time I checked, they were not making land in London anymore either. Japan has not made any land recently, but that did not stop prices from falling for 18 consecutive years.

The United Kingdom has just about finished year one of a housing bust, and Australia is well into year two. Already, U.K. retailers are clamoring for lower interest rates to prop up consumer spending. The first of probably many rates cuts in the United Kingdom is likely in August. I doubt it will do any good. Consumers are just plain tapped out, and job losses are mounting.

The U.K. “Consumer Spending Express Train” has left the station. It is now heading south. It may be years before it heads back north.

Look for Sydney to lead. I suspect we will soon be hearing about “Renovators’ Nightmares” in the United Kingdom, followed by the United States, of course. A liquidity trap is coming your way soon.

Meanwhile, back in the United States, consumers merrily go about their business buying homes sight unseen. Check out this article in Newsweek Business:

“In the last year Stocker…has also bought rentals in Alabama and Florida; he hopes to buy at least 10 altogether. ‘Next year I plan to buy a motorcycle and take a tour of my properties,’ he says, since he’s never seen any of them.”

These Johnny-come-latelys accumulating condos and houses sight unseen will soon be in for a rude awakening. Professional investors are for the most part gone, but amateurs are still bidding up properties even with inventories of unsold homes skyrocketing in Boston, California, Las Vegas, and other places. Eighty percent of the condos in Florida are now being sold to “investors.” The writing’s on the wall, if anyone would bother to stop and read it.

Mish, What’s the Very Latest in “Creative Morale Boosting”?

That is a very good question. Thanks for asking.

For those that think outsourcing has reached its pinnacle, think again. There are still plenty of ways that prove that anything that can be outsourced will be outsourced.

For the very latest in Creative Outsourcing, please take a look at SeaCode, from a Computerworld article “For SeaCode, Offshoring Means 3 Miles off the Coast,” sutitled “Founders Promise ‘the Price of India With the Proximity of the United States’”:

“What San Diego-based startup SeaCode Inc. plans to do is nothing if not novel: anchor a cruise ship three miles off the coast of Los Angeles, fill it with up to 600 programmers from around the world, eliminate visa restrictions, and make it easy for customers to visit the site via water taxi. The two men behind the venture — Roger Green, who describes himself as an IT and outsourcing veteran, and IT consultant David Cook, whose job history includes a stint as a ship captain — recently discussed their plan in an interview with Computerworld.”

PAST on my board on Silicon Investor had this to say: “Ten years ago, while in Washington State and after observing logs being loaded on an oceangoing barge, I was told that the logs were destined for a Japanese factory ship that was located 3 miles at sea, where Japanese labor would turn the logs into plywood for immediate return to American markets at American prices. Very profitable way of doing business.”

The question I am pondering right now is this: How much more “morale boosting” can this economy take?

Creative Outsourcing: Investment Demand for Gold

According to this article in The Economic Times (of India), “It’s Official: Indians Simply Love Gold.” Let’s take a look:

“India’s share of global gold demand is about 1 1/2 times that of the United States, though its GDP is only 1/20 that of the United States. ‘With its high rate of gold consumption, India accounts for 18% of the annual global gold demand, while its share of global GDP on nominal dollar GDP is only 1.6%,’ market watchers add.

No! The real question is why nearly every analyst is impressed by financial assets in a slowing worldwide economy, enormous debt overhangs, and tremendous overcapacity to boot. That is the real question.

Looking ahead, I can’t say I blame them. Let’s consider some of the choices:

“As per World Gold Council estimates, Indian households own about 15,000 tonnes of gold, accounting for about 10% of the worldwide stock. At current market values, gold accounts for 10-15% of the Indian household balance sheet.

“The real question is why isn’t the average Indian household impressed by financial assets? Analysts say it points toward gaps in broader policy framework, including the government’s expenditure mix.”

*U.S. dollars
*U.S. equities
*Equities generally after this worldwide ramp job
*Barrels of crude oil (not exactly easy to store)
*Productive business assets
*Gold and silver.

It sure seems to me that they made a reasonable choice. Perhaps it is not the best, but at least it is a reasonable one. Not so, according to the author:

“Gold holdings among Indian households at current market value is about 2.5 times the current equity stock holding of $80 billion. While the share of gold in household savings declined during 2000-02 to 5%, it has been on the rise once again during the past two years, and stood at 8-10% during the quarter ended March ’05.

Gee, let’s invest in “productive business assets” so we can add to the worldwide glut of goods that no one really needs. Doesn’t anyone see the enormous overcapacity and lack of pricing power in almost all manufactured goods?

According to an article by the Australasian Investment Review, China is now the world’s fourth largest consumer of gold.

However, the article “GOLDEN Moment” by China Daily claims that China is the world’s third biggest gold consumer, after India and the United States:

“‘Consumption on the mainland is expected to maintain the growth momentum this year as a result of China’s steady economic growth and bullish gold prices,’ says [the World Gold Council’s Albert Cheng. .”

“The WGC forecasts that growth in China’s total consumption to be around 30-35% in the next five years, with growth in retail investment expected to outstrip institutional investment and jewelry consumption

Gold.org highlights consumer demand trends in individual countries as follows:

“But this love for bling bling comes at a pretty steep cost. If instead of investing its annual savings in gold, India were to invest this in productive business assets, its annual GDP growth would be higher by about 0.3-0.4%

“‘The cumulative GDP value lost by parking $200 billion worth savings over the years in this unproductive asset is huge,’ say industry experts. ‘With no domestic gold mining, the purchase of gold also means spending precious foreign exchange earnings.’”

Asia

India
* Gold jewelry demand in Q1’05 up 72% in tonnage terms year on year
Let’s separate out the gold investment figures from the above text and look at year-over-year trends:

India +100%
China +36%
Japan +12%
Turkey +31%
U.S. +5%

It sure seems to me that the United States has a lot of potential catching up to do when it comes to investment demand.

* Jewelry promotion, such as the World Gold Council’s Speak Gold campaign, coupled with a strong economy, the positive impact on rural incomes of high agricultural prices for key crops and a good winter harvest, and an increase in the number of dealers and retail outlets, were the driving factors for the increase in demand

* Net retail investment more than double that of the same period in 2004, helped by investors looking for alternative investments to place gains from the stock market rally of 2004.

China
* Consumer demand for gold up 14% year on year

* Jewelry demand up 13% on Q1’04 with both the traditional 24-carat chuk kam and the more modern K-gold (18 carat) enjoying strong increases

* Demand for chuk kam, to which there is a strong investment element, benefited from the slight decrease in the gold price

* Demand for K-gold remained strong, resisting the usual winter dip, helped in part by Valentine’s Day promotions

* Net retail investment was 36% higher in tonnage terms than a year earlier, due to the impact of the deregulation of the retail investment market as well as concerns over the poor performance of the Shanghai stock market and perceptions of an overheated property market.

Japan
* Demand for investment products up 12% on year-earlier levels, with strong investment buying in January that retreated slightly in February and March when a weaker yen caused a rise in the local price of gold

* The economic climate remains favorable toward gold investment, with an undercurrent of concern over the level of public debt and its inflationary implications, as well as the pension crisis. The limits applied to bank deposit insurance guarantees from April 2005 are an additional positive factor for gold

* Jewelry demand was stagnant, partly due to limited promotion.

Middle East and Turkey

UAE
* Consumer demand for gold up 11% in tonnage terms compared to Q1’04

* Demand growth spurred by a strong economy, rising tourist numbers, and sharply increased promotional spending

* Offtake during the Dubai Shopping Festival rose 30%, helped by a doubling in promotional spending on gold compared to 2004.

Saudi Arabia
* Consumer demand for gold up 10% on the same period the previous year

* Government measures, including a reduction in customs duty and the easing of the Saudisation program, announced in March will help boost jewelry demand in the future.

Turkey
* The boom in gold demand continued, establishing new records for both jewelry and investment

* Jewelry demand rose 28% from Q1’04, itself a Q1 record

* Demand partly driven by promotion, with 2005 seeing new companies beginning gold jewelry promotion, both in conjunction with, and independently of, the World Gold Council

* Exceptional 31% year-on-year rise in investment, with 9 tonnes sold in March alone

* Jewelry exports from Turkey have been 26% higher in Q1’05 than Q1’04, with January seeing Turkish exports to the U.S. temporarily exceed those from Italy for the first time.

United States and Europe

U.S.
* Jewelry demand increased 3% year on year, a positive result given the economic background and weaker consumer confidence and spending

* Jewelry demand partly driven by the Speak Gold campaign and fashion shifts toward yellow gold

* Net retail investment rose 5% on 2004 figures.

Europe
* Trends in Europe remained poor, in contrast to the rest of the world

* In Italy, poor economic conditions resulted in consumer spending cutbacks, thus the climate for luxury goods remained heavily adverse, with jewelry demand falling 6% compared to a year earlier

* More innovative and stylish pieces are continuing to sell well in both the domestic and export markets throughout Europe, continuing the ‘two-trend’ market with more fashionable design beefing up demand

* The U.K. market suffered from slow retail sales growth. Hallmarking of 18 carat pieces was 2.5% higher than a year earlier on a fine weight basis, indicating that even though trends for gold consumption as a whole are negative, the high-quality and more stylish end of the market continued to be robust.

Regards,

Mike Shedlock – “Mish”
August 9, 2005

Creative Outsourcing: A Real Morale Booster on Jobs was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.