But the investment seasons turn. Today some smart investors are once again saying you should a buy house. John Paulson is one of them.

You may know him as the man who turned the greatest trade of all time. Betting against the housing market, he netted a cool billion dollars for himself in 2007. One fund he managed rose 590% that year. Today, he is one of the richest men in America.

His advice today is very different. “If you don’t own a home, buy one,” Paulson said. “If you own one home, buy another one, and if you own two homes, buy a third and lend your relatives the money to buy a home.”

That’s a strong endorsement. It sounds similar to the advice another investor gave his audience in 1971, at the dawn of another inflationary age. It was Adam Smith (George Goodman) on The Dick Cavett Show. Here is a snippet from that conversation:

Smith: The best investment you can make is a house. That one is easy.

Cavett: A house? We were talking about the stock market. Investments…

Smith: You asked me the best investment. There are always individual stocks that will go up more, but you don’t want to give tips on a television show. For most people, the best investment is a house.

Cavett: I already own a house. Now what?

Smith: Buy another one.

It was good advice. In the 1970s, U.S. stocks returned about 5% annually, which failed to keep pace with inflation. Still, it was an up-and-down ride. In 1974, the stock market fell 49%. But here are the average selling prices for existing homes in the 1970s as inflation heated up:

• 1972   —   $30,000

• 1973   —   $32,900

• 1974   —   $35,800

• 1975   —   $39,000

• 1976   —   $42,200

• 1977   —   $47,900

• 1978   —   $55,500

• 1979   —   $64,200

You can see that housing held up pretty well. And think about the effect of a mortgage on 80% of that house in 1972. That would mean $6,000 in equity, a sum that went up fivefold in eight years. It’s hard to find a better inflation fighter than that. Granted, today’s market is different, but still.

Apart from this, you might also reflect on the fact that it is quite absurd today to think that anyone can buy an average house for any of these prices — and that, too, is the point. The average price today is $257,500 — even after the great collapse in the last few years.

“If you have a 7% mortgage and your house is worth half a million dollars,” Adam Smith writes, “you may gripe about shoes and lamb chops and tuitions like everybody else, but your heart isn’t in it.” Your heart won’t be in it because you’ll be in fine fettle with your house.

Of course, you can do a lot better than 7% today. For the first time, the rate on 30-year mortgages slipped below that on the 30-year Treasury bond. You can get a 30-year mortgage at little more than 4% today.

Factoring in mortgage rates, housing affordability is back to where it was in September 1996. Then mortgage rates were 8% and the average price of a home was $171,600. As Murray Stahl writes: “One can actually buy a home for a monthly payment that is not very many dollars different from the monthly payment one would have needed in September 1996, when rates were significantly higher.”

Adjusted for inflation, Stahl points out that the payment for an average-priced home today is about 30% lower than it was 14 years ago.

The advice of Paulson and Smith starts to make sense now, doesn’t it?

Essentially, real estate is a way to buy now and pay later. It is a way to short (or bet against) the dollar. And the case for housing extends to other property types, too. Owners of quality real estate are getting deals on mortgages that we are unlikely to see for a generation.

Regards,
Chris Mayer
Whiskey & Gunpowder

January 5, 2011

Cheap Houses Hedge Inflation Risk was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

We just had a week in the 70s, with more to come. The grass went from ochre to bright green in about thirty-six hours. The buds are popping like mad. This is usually what the first week of May is like around here, and that fact alone may explain New York state’s relentless population drain over the past forty years.

I was out on my bicycle, naturally, taking it all in — like, why sit inside and sulk because the weather is strange in a pleasant way? — and I ventured into the outlands east of town, where an impressive number of gigantic new houses had landed like alien mother-ships in the former cow pastures and wood lots. Of course, the aesthetics were an issue apart from the socio-economics of it, but nonetheless interesting.

Each new, gigantic house seemed the result of a losing struggle to reinvent basic design principles that did not require re-invention. I doubt the spirit of joyous “creativity” among the star-architects has seeped down to the level of the provincial house-builders, who, after all, are just assemblers of modular materials like dimensional lumber and eight-foot sheet-rock. It’s their inability to assemble these parts coherently that’s really striking, so what you get is an endless variety of mistakes along with a complete absence of anything done really well — which may be the essence of what the “diversity” craze has really meant to us, the ethos of current times.

The abiding quality of all these houses was grandiosity (by which I do not mean grand-ness). That, too, is a signature of these times in America — the nation too big to fail and tragically destined to do just that on account of its too big to fail-ness. And, of course, one could not fail to wonder, cruising by these hideously ponderous houses, whether as a matter of fact they were failing in terms of the owners’ ability to keep up with the payments, for instance. One after another, I pictured a husband and wife within sitting in the sunny breakfast room on Easter morning humped in tears as they sorted through stacks of bills and bank statements… and I imagined the yellow foreclosure tape a few weeks hence atop the weird split-block portico treatments and misbegotten arrays of concrete balusters, and the colossal Palladianesque windows with their pathetic snap-in muntins (and the fantastic solar heat-gain, not figured-in by the designer-builder, that would turn the lawyer-foyer into something like a crematorium by two p.m.)… and the pension fund in Wisconsin or Norway that was sitting on the booby-trapped CDO that contained this sketchy mortgage and thousands of others just like it… and, well, this choo-choo of thoughts led to envisioning the train-wreck of economies and nations that lies in wait just around the bend….

One also could not fail to reflect on the recklessness of a nation that placed untold million-dollar bets on the idea that it would be possible to travel anywhere in an automobile from houses like these a few scant years from now. This far along in the tribulations of our time, most Americans still have not heard of peak oil, and the few who have regard it as some figment that Ralph Nader or Al Gore conjured up on an acid trip in a sweat lodge.  The more sophisticated among the mentally unwashed are certain that the earth has a creamy nougat center of low-sulfer light crude oil, or they heard that the Bakken formation in Dakota holds more oil than Saudi Arabia, or that the whole US car and truck fleet will be electrified in a year or two, or that we can drill-baby-drill our way to permanent oil abundance, or just that the American can-do spirit will come up with something to keep Happy Motoring alive because we’re the greatest! Such grandiosity!

Personally, I look at these houses scattered around what was only recently a dedicated farm landscape and I am quite sure that the denizens within will be marooned in their great rooms, and that very probably many of them will have no job to go to — in the conventional sense of what we think a job is, in some corporation or institution — and that in a surprisingly short span of years these buildings will be ruins or squats. I think these thoughts after struggling up a rather steep hill more than half-a-mile (and many others previously). A trip anywhere from here, to do anything, and the return trip, would occupy an entire day even for someone in decent physical condition. Somebody accustomed to rations of Cheez Doodles and Mountain Dew would be dead by then. There will be lots of dead.

On the macro level, the feeling spreads across the USA that our troubles are behind us. Employment is ticking up. The S & P index only goes up now. The banks have stabilized and those “toxic assets” (which I call “frauds” and “swindles”) have been disarmed and safely buried under Yucca Mountain. Housing starts may still be weak, but the “gaming” industry is making great strides in places like the old Puritan commonwealth of Massachusetts, so soon we’ll have a virtually automatic economy of leisure-and-entertainment paid for by creaming off a small percentage of the quarters pumped into video slot stations. No doubt the Chinese will be jealous and try to imitate us.

All these lovely mild days, I was not unconscious of the eeriness of the weather and the possible insidious effects of it on the local ecosystem in everything from the added generations of deer ticks carrying Lyme disease and the death of the honeybees to the fate of this year’s apple crop. I confess: it made me very nervous. Something is happening… out there.

Regards,
James Howard Kunstler
Whiskey & Gunpowder

April 6, 2010

P.S.: Click here to listen to my new play Big Slide about life as the long emergency gains traction.

Peak Oil and Unpaid Mortgages Will Kill Suburbia was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

My interest in Andy was due to the fact that he has been singularly successful in pretty much all aspects of the real estate market, including financing and developing large projects — such as shopping centers, apartment communities, office buildings, and warehouses — from one end of the country to the other. His expertise has also allowed him to build an impressive business providing assistance to large financial institutions that need help in dealing with problem commercial real estate loans. As you might suspect, business is booming.

Back in 2007, however, what most intrigued me about Andy was that he had been almost alone among his peer group in foreseeing the coming end of the real estate bubble, and in liquidating essentially all of his considerable portfolio of projects near the top. There are people that think they know what’s going on, and those who actually know — Andy very much belongs in the latter category.

In fact, he initially refused to speak at our event, only agreeing very reluctantly after I had hounded him for several months. The reason for his refusal, I later found out, was that he had spoken at several industry events before the real estate collapse and had been all but booed off the stage for his dire outlook.

The happy ending of this story is that Andy’s speech at our Summit was a rousing success, and he enjoyed it so much that he has now spoken at several, and has kindly agreed to sit for periodic interviews to keep our readers up to date on the latest developments in this critical sector. So far, Andy’s real estate forecasts continue to come true. 

As you’ll read in the following excerpt from my latest interview with Andy, who now spends considerable time each day helping the nation’s biggest banks cope with growing stacks of problem loans, he remains deeply concerned about the outlook for real estate.

David Galland

No one has been more right on the housing market in recent years. So, what’s coming next? Some of the housing numbers in the last few months look a little less ugly. Could housing be getting ready to get well?

MILLER: I don’t think so.

For all intents and purposes, the United States home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the U.S. were made with federal assistance, either through Fannie Mae and the implied guarantee, or Freddie Mac, or through the FHA.

If it’s true that most of the financing in the single-family home market is being facilitated by government guarantees, that should make everybody very, very concerned. If government support goes away, and it will go away, where will that leave the home market? It leaves you with a catastrophe, because private lenders for single-family homes are nervous. Lenders that are still lending are reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage. So when the supply of government-facilitated loans dries up, it’s going to put the home market in a very, very bad place. 

Why am I so certain that the federal government will have to cut back on its lending? Because most of the financing is done via the bond market, through Ginnie Mae or other government agencies. And the numbers are so big that eventually the bond market is going to gag on the government-sponsored paper.

The public doesn’t have any idea of the scale of the guarantees the government is taking on through Fannie, Freddie, and FHA. It’s huge. If people understood what the federal government has done and subjected the taxpayers to, there would be a public outrage. But you can’t get people to focus on it, and it’s very esoteric, it’s very hard to understand. But it’s not something the bond market won’t notice. The government can’t keep doing what it has been doing to support mortgage lending without pushing interest rates way up.

Refinancings of single-family homes are very interest-rate sensitive. Consumers have their backs against the wall. They have too much debt. Refinancing their maturing mortgages or their adjustable-rate mortgages is very problematic if rates go up, but that’s exactly where they’re headed. So anyone who’s comforted by current statistics on single-family homes should look beyond the data and into the dynamics of the market. What they’ll find is very alarming.   

On that topic, recent data I saw was that something like 24% of the loans FHA backed in 2007 are now in default, and for those generated in 2008, 20% are in default, and the FHA is out of money.

MILLER: Fannie Mae had a $19 billion loss for the third quarter of 2009, and they are now drawing on their facility with the U.S. Treasury. We have all forgotten that Fannie and Freddie are still being operated under a federal conservatorship. On Christmas Eve, the agency announced that they were going to remove all the caps on the agencies.

So what about commercial real estate?

MILLER: When I saw what was happening in the housing market, I liquidated all my multifamily apartments, shopping centers, and office buildings. I liquidated all my loan portfolios, and I’m happy I did.

Then it occurred to me in 2005 and 2006 that the commercial world had to follow suit. Why? Because it’s a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value. And when consumers hit the wall with spending and debt, that’s going to have an impact on retailers that pay for commercial space.

Furthermore, the financing for retail properties had gotten ludicrous. The conduits were making loans that they advertised as 80% of property value when they originated them, but in reality the loan-to-value ratios were well over 100%. And I say that to you with absolute, categorical certainty, because I was a seller and nobody knew the value of the properties that I was selling better than I did. I had operated some of them for 20 years, so I knew exactly what they were bringing in. I knew what the operating expenses were, and I knew what the cap rates were. And, you know, the underwriting on the loan side and the purchasing side of these assets was completely insane. It was ludicrous. It did not reflect at all what the conduits thought they were doing. They were valuing the properties way too aggressively.

I became very bearish about the commercial business starting in late ‘05. In fact, I think I was in Argentina with Doug Casey, sitting on a veranda at one of the estancias, and he and I were lamenting what was going on in the real estate business, and I said there was going to be a huge adjustment in the commercial market.

Beyond the obvious, that the real estate market has taken pretty significant hits and some banks have been dragged under by their bad loans, what has really changed in real estate since the crash? 

MILLER: I think the first thing that changed was that people learned that prices don’t go up forever. Lenders also saw that underwriting guidelines for commercial real estate loans, especially in the securitization markets, were erroneous. They realized that some of their properties had been financed too aggressively, but still, I don’t think even at the fall of Lehman, anybody was predicting a wholesale collapse in commercial real estate.

But they did see they should be more circumspect with loan underwritings. In fact, after the fall of Lehman, they completely stopped lending. I think they realized we had been living in fantasy land for 10 years. And that was the first change — a mental adjustment from Alice in Wonderland to reality. 

Today it’s clear that commercial properties are not performing and that values have gone down, although I’ve got to tell you, the denial is still widespread, particularly in the United States and on the part of lenders sitting on and servicing all these real estate portfolios. People still do not understand how grave this is.

Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you’ve been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?

MILLER: It’s an educated guess, and it hasn’t changed. I still think that it’s second quarter 2010.

The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there’s some alternative in place, it’s going to be a very hideous picture for the bond market and the banking system.

The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well – not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I’ll give you an example.

In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn’t have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.

That’s very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they’ll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that’s horribly destructive.

Just to be clear on this, let’s say I own an apartment building and I’ve been making my payments, but I’m having trouble and the value of the property has fallen by half. I go to the bank and say, “Look, I’ve got a problem,” and the bank says, “Okay, let’s work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we’ll shake hands and smile.” Then, even though the property’s value has dropped, as long as we keep smiling and I’m still making payments, then the bank won’t have to reserve anything against the risk that I’ll give the building back and it will be worth a whole lot less than the mortgage.

MILLER: I think what you just described is accurate. And it’s exactly a Japanese-style solution. This is what Japan did in ‘89 and ‘90 because they didn’t want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses. 

And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it’s not going to sell them. 

Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.

Wouldn’t banks know that ultimately the piper must be paid, and so they’d be trying to build cash — trying to build capital to deal with the problem when it comes home to roost?

MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it’s digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it’s going to be. I can tell you that because I’m out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices — all the foot-dragging allows the fundamental problem to get worse. 

In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you’re clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?

Or a borrower who is sitting on a suburban office property — he’s got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don’t think so. So the problems get bigger.

Why would the owner bother going through a workout with the bank if he knows he’s so deep underwater he’s below snorkel depth?

MILLER: It’s always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you’re a borrower who’s guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there’s always a little hope that values will turn around. So there is no reason to hurry into a default. None.

So that’s from the borrower’s standpoint. But wouldn’t the banks want to clear these loans off their balance sheets? 

MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone. 

So here we are, we’ve got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They’ve taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?

MILLER: Well, obviously nobody knows, but I can guess at what’s coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.

I think they’re going to contrive something to help assist commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. It’ll resemble what they did with housing.

They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire U.S. residential mortgage market has in effect been nationalized, but there wasn’t any act of Congress, no screaming and shouting, no headlines in the Wall Street Journal or the New York Times about “Should we nationalize the home loan market in America.” No. It happened right under our noses and with no hue and cry. That’s a template for what they could do with the commercial loan market. 

And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.

But it won’t really be a solution. In fact, it will make the problems much more intense. 

Don’t these properties have to be allowed to go to their intrinsic value before the market can start working again?

MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We’re going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem. 

Do you think the U.S. will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?

MILLER: I know this is going to make you laugh, but I’m actually an optimist about this. I’m not optimistic about the short run, and I’m not optimistic about the severity of the problem, but I’m totally optimistic as it relates to the United States of America.

This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.

Regards,
David Galland
The Casey Report
 
Andy Miller is the co-founder of the Miller Frishman Group (MillerFrishman.com), which includes three companies serving different sectors of the real estate market – from mortgage brokerage and banking, to the building, management, and marketing of commercial real estate across the United States. His firm is currently deeply involved in the distressed real estate business, assisting lenders across the nation with their growing portfolios of non-performing loans.

February 10, 2010

An Insider’s View of the Real Estate Train Wreck was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

– Hazel Bedingfield, 79, who now travels 24 miles for her Social Security payment at her new bank

You deposit your paycheck on Friday and can’t get money out on Saturday.

But don’t worry, the FDIC will cut you a check on Monday morning.

Your county commissioner tells the evening news: “The bank failure opens up an opportunity for another bank to set up here. Until then, customers will have to find another bank in a surrounding county.”

Your bank might have been built in 1905. It may have survived two world wars and a Great Depression. It was sold in 2000 and rebranded when the new owners moved headquarters to Atlanta…you can guess the rest.

This happened to citizens in Gibson, Georgia. And it could happen to you tomorrow.

The Feds raid your bank on Friday…They escort the CEO out. Then they empty the vault.

Right now, aren’t you wondering how much longer will this go on? The short answer: about $13 billion worth of FDIC intervention. I’m wondering if that’ll be enough.

Gargantuan, unfounded suburban growth ringing ’round the Peach State’s metropolis Hotlanta takes the brunt of the blame for bank collapses left and right. Especially those construction loans. A typical example of why these failed, according to FDIC investigation: Over 75% of the loan money was handed out before a single day of on-site construction began.

But here’s a big reason: Banks invest in other banks. Some banks never see nice depositors walk up to their ATMs or get lollipops at the counter. The wholesale bank’s only clients are other banks. If some of those big-ticket clients fold, well, there goes the bank. Silverton was just such a bank, with about 1,500 client banks in 44 of the 50 states. This earned Silverton the nickname “the Mini-Federal Reserve.”

The trouble came from the chunks of real estate loans Silverton sold to other banks in “low-growth” areas: deposit-rich regions that are “loan poor.” Guess that means places that aren’t Nevada, California or Georgia. It didn’t stop Florida Community Bank from adding a stake in the now-defunct Silverton bank to its $978 million dollar asset base. And the FCB ranks among the weakest financial institutions in Florida. We are not surprised.

Even Atlanta’s Federal Home Loan Bank, as 2009 dawned, was straddling the mere 3% capital ratio that would set a regulator’s teeth on edge. (The culprit there was the unwinding private-label mortgage-backed securities.)

Now get this. The Georgia banks facing FDIC conservatorship often depend on loan advances from the Federal Home Loan Bank of Atlanta to stay afloat, and the FHLB gets paid first, before depositors — costing the FDIC even more millions — even if the collateral isn’t there to do it.

Georgia regulators OK’d any fly-by-night bank startup. After all, who didn’t want a cut from making loans to real estate developers? At the start of the housing collapse, Georgia had 334 banks. That’s more than in California, which has four times Georgia’s population. Dan Amoss, the editor of Strategic Short Report, points a finger at this failed bank and offers some advice:

“A perfect example is Integrity Bank in Georgia, which should have been shut down long before it was allowed to attract new deposits with high CD rates.

“Also, note to Whiskey readers: If your CD rates seem too good to be true, your bank may not be healthy, and you may have to deal with the hassle of not accessing your money while the bank is resolved.”

All last week, Dan and I fired e-mails back and forth about the next U.S. bank to fail: The Great Southern behemoth: Colonial BancGroup. Then, on Friday Aug. 14, it finally happened…

BB&T to Swallow Colonial Whole: What Bones Will It Spit Out?

Colonial tapped the FDIC’s matchmaking skills to shack up with BB&T. Expect this marriage to look like the 20-something who marries the wealthy old man because she can’t wait to max out his credit cards. Dan bet me last Friday that dilutive stock offerings were on the way.

Sure enough, come Monday, BB&T offered 26.6 million brand-new shares to some willing dupes.

Like the other Southern banks we’ve been talking about, Alabama-based Colonial’s arms stretched into bad places like Georgia and Florida. And here’s what helped shake Colonial’s foundation. They call it warehouse lending. That’s short-term financing that independent mortgage bankers relied on to do business. Fannie, Freddie or Ginnie did not guarantee these loans.

Back in the 2007’s warehouse-lending heyday, the market was a $200 billion business. Lately, of course, the rich well dried up, to just $25 billion in lending. Colonial held the big 25% chunk of it. So now that it has dropped out of the race, who’s left?

The other warehouse-lending trendsetters already lie in the grave. The biggest tombstones: Countrywide and WaMu. And there’s a fresh hole dug for a new occupant: Guaranty Bank of Texas, which issued the FDIC red alert last month. Finally, we have National City (acquired by PNC).

What does this tell us? If all the big enablers for these loans are shutting up shop under duress, it makes you think there could be something wrong with the product. Instead of letting the free market eat the gross error of overexuberance, the industry is lobbying Washington to give government-backed Fannie Mae, Freddie Mac and Ginnie Mae a bigger role in warehouse lending.

Don’t Let the GSEs Take Over

Let’s flash back to a nice piece of advice that still holds true for Fannie, Freddie and fast-growing Ginnie. Back in March 2002, the prescient Chris Mayer (before he joined the Agora family) wrote a missive for Mises.org called “Mortgage Market Socialization.” Take a look at this bit of prophecy:

Forgotten is the truism that periods of prosperity necessarily precede periods of crisis. Thus, caution becomes heresy and optimism becomes the new religion.

The only way to correct this problem is the same way all socialistic practices are corrected — the government’s involvement must be severed completely. Just because the GSEs have led a charmed life so far is no reason to infer that their future will always be so bright. Socialism is not dead; it is alive in institutions like the GSEs.

The longer the GSEs are able to expand as they have, the more certain it becomes that someday taxpayers will have to bear the cost of such excess. Like Russian roulette, the longer you play, the more certain it becomes that you will bear the risk for playing.

I don’t know about Congress, but I think you Shooters would be eager to put down this particular gun. We’ve already paid about $86 billion in bailouts and what’s it gotten us? But since Fannie and Freddie backs or owns more than half of the single-family mortgages — probably yours — how about we just don’t load any more bullets?

Here’s the directionless drivel from Tim Geithner, recently before the Senate Banking Committee, as reported by Bloomberg:

“Fannie Mae and Freddie Mac will remain in limbo, as the U.S. Treasury secretary said the government doesn’t have time now to deal with the future of the two mortgage-finance companies it seized in September.

“We did not believe that we could at this time — in this time frame — lay out a sensible set of reforms to guide, to determine what their future role should be. We’re going to begin a process of looking at broader options for what their future should be…

“We just didn’t think it’s an essential thing to do just now, but it is an essential thing to do.”

Doesn’t this fill you with confidence? You see, Shooters, this whole mess began at an exclusive resort island off the coast of Georgia…The ol’ Jekyll Island Club set the foundation for sopping up and propping up incompetence in 1913.

Regards,
Samantha Buker

August 21, 2009

Who Killed 21 Georgia Banks? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Even the UK’s small, tightly packed mainland, floating off the edge of Europe, includes disparate and distinct real-estate markets. Glasgow is as different from London as Cornwall from Cheshire. But in the main (and the mania), and with a peak of 185,000 new dwellings under construction in 2006, the broad sweep of house-price inflation…followed by an inevitable slump lasting six years or so…tends to apply across the nation.

In the United States, in contrast, new housing starts at the peak of what pundits, economists and investment bankers clearly felt was a coast-to-coast boom in 2006 approached 1.63 million amid a total housing market of 128 million units spread across 3.5 million square miles.

By necessity, that makes the idea of an “average” home price more slippery. But let’s not let such quibbles clog up our spreadsheet! Not after math PhDs, applied to mortgage-backed zeroes, clicked and dragged the answer “AAA” whenever asked. And not before we contend with the data itself.

This first chart’s solid enough, thanks to the certainty with which the Census Bureau dispenses its data.

It shows the median price of new US housing, at sale, divided by the ounce-price of gold, monthly average. And as you can see, new housing has swung wildly – measured in ounces – over the last 45 years. Quite clearly, one made a better home for investment than the other over distinct periods, as the mid-way price of new homes (half the market paid less, the other half more) was rocked and rolled by booms, bubbles and busts in both bricks and bars.

Second up, existing homes bought on the secondary market – and the same picture, but only on an annualized basis (and with the National Association of Realtors thrown in as a source) for the Census Bureau’s less lengthy, less detailed data.

You can see, between the two charts, how new housing during this last real-estate boom (2000-2006 in nominal prices) began and topped out much sooner when priced in terms of gold. New units also reached further above existing-home prices too, peaking at $243,000 in 2006 – then 550 ounces of metal – or some 10% higher than the secondary market.

Perhaps that extra cash paid for new homes’ expanding foot-print. But it’s also worth noting, turning aside from Gold Investment for a moment, that new US home prices this decade also saw the mean outstripping the median as never before. The gap between average and mid-point prices, in fact, gaped from one-fifth or less (1975-1999) to as wide as 30% during the summer of 2006. Which might show, we guess, a growing number of super-priced units way up at the top-end of the market…bought and paid for, perhaps, with bonuses skimmed off mortgage-backed bonds sold against the sub-median half.

Finally, the money shot…

True long-run figures for housing, like the concept of “average” itself, are more sketchy than Mel Gibson after a night on the sauce.

We’ve used Robert Shiller’s invaluable numbers, of course, but they only come as an index, itself built from five sources stretching back to 1890. Rolling those numbers back from today’s current average ($175,000 according to the NAR) only throws up big gaps with the Census Bureau prices collated and published every 10 years starting with 1940. It also puts the price of US housing above $4,000 in 1900 – and in 1900 dollars, too – when average wages were just $2 per day.

Okay, so home-buying was yet to meet democracy through that great 20th century liberator, the securitized mortgage loan. And yes, two-thirds of US homes had yet to gain running water, let alone electricity. But as in the UK data, Gold Bullion regained its Great Depression value in housing as the Great Inflation of the 1970s peaked out, suggesting (to us, at least) that its utility as a store of value was little diminished by new bath fittings and copper wiring.

The broad sweep – smoothed out to fix those anomalies which our quick desk-bound research, a mere 5,000 miles from the Library of Congress throws up – remains as broad and as sweeping as either gold bulls or bears might hope to spy.

From here, the bottom in housing may still be to come, at least priced in gold. Broad-sweeping investors are invited to draw their own conclusions.

Regards,
Adrian Ash
BullionVault

May 6, 2009

U.S. House Prices in Gold was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Inertia weighs on an investor, trapping him in a state of paralysis and freezing his portfolio, almost forcing him to hold on to whatever he already owns – for no better reason than that he already owns it. He hopes that every one of his old shoes will go up, even if the reason for the purchase is long forgotten or the environment in which the investment might have prospered has vanished. People who substitute hope for cold-blooded analysis almost inevitably wind up losing money.

So, for the sake of argument, let’s look at where you might best put your money for the rest of the year 2007. To keep things simple, let’s assume you start by liquidating all the cats and dogs populating your portfolio, so that you have just a pile of cash. No, let’s not phrase it that way… because then you’re going to start wondering which of the securities you own really are cats and dogs. You might get bogged down. And then inertia will creep back in, and you’ll throw your hands up and do nothing. So let’s assume you sell everything, in true going-out-of-business style.

Now, what’s the smartest place to put that money? Let’s look at the alternatives.

Bonds? A disastrous sucker bet. Bonds, at the moment, are a triple threat to your capital. First, you have a huge risk with interest rates, which are still near historic lows; as they go up, the market value of your bonds drops proportionately. Second, no matter which of the fiat currencies you choose, you have a big currency risk; while the US dollar is on the fast train to zero, virtually every other currency in the world is being inflated along with it and is heading toward eventual oblivion. Third, you have credit risk; General Motors isn’t the only large company whose bonds may go into default.

Stocks? The general market is yielding less than 2% in dividends, less than 1/3 of what you typically see at major market bottoms. And selling for more than 18 times earnings—more than 25% higher than its norm. Worse, for those who might be buyers, the bull market of the century started in 1982 and, in inflation-adjusted terms, ended in 2000. You might not want to hear it, but stocks are almost certainly early into a bear market that could last another 5 or 10 years. By all traditional measures, chances are much better that stocks will drop 50% from here than gain 50%.

Cash? You could always just stay in T-bills. But they currently yield only 5%, before taxes. And inflation (notwithstanding the highly imaginary official figures) is probably running around 6% and likely to head higher.

Real Estate? At the present, at least in the U.S., this is probably the worst choice of all. The speculative boom crested last year, and the market, burdened by an immense amount of debt and overleveraged speculation, is likely to head down for years to come. Of course, there are places in the world, two of our favorites being Argentina and Uruguay, where there isn’t much of a mortgage market, so the properties aren’t overleveraged and values are still available. But unless you are looking to pick up cheap land in undeveloped, exotic countries that have avoided the credit-driven bubble, real estate should be last on your list of investments.

Mutual funds? Any mutual fund you’re likely to pick is just a way of buying one of the investments we’ve already dismissed. And paying all those fees and expenses that come with a mutual fund just makes the bet that much worse.

So What Should You Do?

Since 2001, we’ve been in a natural resources bull market. If you were one of the few who positioned yourself in gold, silver or pretty much any of the metals or energy commodities – either directly or through the shares in smaller resource companies, which is the preferred vehicle we have been recommending to subscribers of our International Speculator — you’ve already made the easy money.

At least to us, before the bull market kicked off, the opportunity in the sector seemed obvious, with many resource companies selling for less than the cash they had in the bank. Few people even knew the sector existed, and most of them thought it was a dead duck after the 20-year-long bear market it had suffered since 1980.

The easy-money stage of the resource bull ended in 2003, at which time we entered the second stage, where the market climbs a “wall of worry.” In even the most formidable of bull markets, this phase comes with inevitable corrections and scary downdrafts. Per its moniker, with each short-term setback in price, investors who were shrewd enough to get positioned early on into the long bull market fret that they might be wrong. Some are shaken out, but the smart ones buy even more on the dips.

But now, in my opinion, we are about to enter the third, and most important, stage of the classic bull market: the mania stage. This will resemble the tail-end of the Internet stock bull market. It’s hard to predict exactly what catalyst will set it off, but it will very likely be rising expectations for inflation. Fear will drive the foreigners who hold about $6 trillion to sell the greenback, and they’ll be joined by savvy Americans. Some will buy other paper currencies, like the euro or the yen. But those units are just backed by U.S. dollars themselves, so they really aren’t much in the way of an escape pod. Inevitably, much of the money now sloshing through the world will try to get into gold. While no one can say with certainty, I expect the metal to hit $1,000 within the next 12 months and go much, much higher by the end of the decade.

Is this an unreasonable prediction? No.

Most casual investors mistakenly look at gold and think it’s been a leader in this bull market when, in actual fact, it’s a laggard compared to the industrial metals that have been bidden up to extraordinary highs by soaring demand from China, India and other emerging markets.

To give you just a few examples, in the last five years, copper has been up 330%, nickel 560%, uranium 1,150%, zinc up 460%, molybdenum up 450%, and even lowly lead, the most basic of base metals, is up 425%. By comparison, gold is up only 100%.

That will change, however, because although gold has many and growing industrial uses, it’s main use is as money. It will dawn on the herd that the world is drowning in a flood of increasingly worthless paper currency, and they’re going to stampede toward the high ground of gold.

The metal isn’t just going through the roof. It’s going to the moon.

Gold Good, Gold Shares Better

When gold really starts to move, the mining exploration stocks are going to howl. That’s because gold exploration stocks are not just highly leveraged plays on the price of gold. They are capable of providing you with triple-digit gains based on exploration success alone.

Case in point, the last mining share boom from 1993-96, which occurred at the tail-end of gold’s 20-year bear market and carried hundreds of stocks with it, was driven entirely by a handful of discoveries. Since gold prices turned up, starting in 2001, a lot of money has been spent on exploration, and that work will inevitably lead to major discoveries and market excitement. Several of the companies we follow in our International Speculator are already drilling into what look to be monster deposits. Confirmation of a major discovery could well ignite a mania in the market.

While most other investments, such as bonds, industrial stocks, real estate and broad mutual funds are likely to be serious losers over the coming years, the bull market in gold and gold exploration stocks has still barely entered the public’s consciousness. Although the easy money has been made, the big money is waiting to be picked up.

Nothing in the investing world is ever a sure thing, but today the exploration stocks look to be as close as it gets. As for the inevitable corrections during this “wall of worry” phase, remember that the time to be timid is when everyone else is bold, and the time to be bold is when everyone else is timid. Sell-offs in the gold and gold mining sector are, to our way of thinking, gift-wrapped opportunities to buy.

Regards,
Doug Casey
June 15, 2007

Your Cash is Trash, and So Are Most of Your Investments was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.