My New Blog: The Wedge Effect

Believe it or not I am back blogging! This time I have been motivated with the unintended consequences of all of this government intervention. The Wedge Effect is the increase of interest rates and risk premium of all other capital assets. I will be reporting on the effects and also current events that relate to a more intrusive government in our markets. Take a look:

The Wedge Effect Blog

Time permitting I will continue to blog for you mercenaries out there.

The Media Misses the Forest from the Trees with Sub-Prime Scare

Is it me or is the Main Stream Media (MSM) taking the easy way out on the deflating housing bubble. We have finally passed the stage of denial of the falling values and are now approaching acceptance of them. Most likely by the fall of 2007, we'll be moving on to panic stage after a dismal spring-summer peak buying season passes. Currently the easy way out to explain why home prices are falling and our economy is slowing is to blame it on some shady loans in sub-prime. If you came from another planet and began reading today's business news you would think the entire housing bubble could be blamed on the segment of sub-prime and shady loans. However the MSM is completely missing the forest from the trees because it was a convergence of numerous factors that helped spur massive home speculation.

Yes problems with sub-prime are showing up now, but it was only a symptom of the great housing bubble not the disease. Plus the real shady loans, 110% financing, 40-50yr mortgages, neg-ams, and ninja loans (no income-no job-no assets) haven't even reared their ugly head yet! They showed up around 2005. Why did this happen, well I will tell you why. From 2002-04 a massive amount of people were hired to meet the demand for new homes, refinances, and other real estate activities. This just led to a feeding frenzy of increased real estate activity as more and more people fueled the rise of prices and the rise of the Real Estate Industrial Complex. No Dick Cheney and the black helicopters were not behind this, it is just an easy way to describe everyone (REIC: agents, lenders, builders, title, escrow, appraisers, etc) that has vested interest in real estate activity. Continuing: Greed took greater hold with speculators buying 2nd, 3rd, and 4th homes which artificially inflated prices and created jobs for the REIC. While the REIC reciprocated and encouraged more and more speculators and buyers to join in. In economics this is your typical multiplier effect. As values skyrocketed home affordability was falling like a rock. But REIC and the general buying public didn't want the gravy train to stop and that is where the true sub-prime stepped in to extend the bubble for another year and half.

Here is a simple way that the media should be describing the entire situation out there: The housing market got way ahead of itself and now its coming back to earth! The simple economic term says it all: revision to the mean. Or here is yet another way of putting it: the housing bubble was one big bender of a party and now the inevitable hangover is here. Those at the party tried in vain to keep it going with redbull/vodkas, cocaine and on the housing side you had low rates, creative financing, and general propaganda. Now they enter the long and drawn out hangover which for housing means long periods of price declines to high inventory from inactivity, etc. Ahhh, but I digress.

So when somebody tries to blame this housing decline or anything else for that matter on just one factor, take it with a grain of salt. There are a lot factors to this housing hangover and there is a lot of blame to go around: Greenspan & his artificially low rates, Bush's idealistic ownership society, sub-prime, REIC, yen-carry trade, a greedy uneducated public, black helicopters, etc. America and the media need to wake up and take responsibility for this mess that we all had some stake in creating! One tree of this mess is sub-prime, while the forest are all these factors together that created one of the largest bubbles of history, the late and great housing bubble.

Inflation & Ski Resorts

Has anyone noticed the recent proliferation of higher and higher ski pass prices. Within in the last five years I have seen prices in Tahoe go from the high $40's to around $70 a ticket. The worst in my opinion has been the escalation at Mammoth Mountain. In little over 4 years their tickets have gone from $61/day to $80/day. That is an inflation rate of 7% and who knows what the increase in price will be with the new renovations they're doing. I have one of their discount season passes that has gone from $499 to $550 this year alone!

Yes this anecdotal evidence, but this inflation problem is starting to rear it's ugly head in more places. Even more worrisome with inflation is it's a lagging indicator meaning we are getting the hangover from the easy money over the last 5 years. Too much money following too few goods. Now that our economy has slowed down we are left to play in the mess Greenspan made (http://themessthatgreenspanmade.blogspot.com) at the turn of the century. Welcome to Stagflation! Stagnate growth + inflation of the 1970's.

Before you go play hopscotch on the freeway, remember domestic company balance sheets are in great position and are economy is more efficient then ever. The effects of the past monetary binge and now the housing crash are going to test our economy. So far the economy is with standing the onslaught....

The Truth about Executive Compensation

I am getting a little off track, but this is something I have wanted to blog about for a long time. Thanks to Keith over at Housing Panic, "The Housing Bubble Blog with Attitude" I have been inspired to write about this subject. Here is the link to his post and to one of my favorite blogs:

http://housingpanic.blogspot.com/2006/10/petscom-all-over-again-as-reic-starts.html

His post is in response to the Countrywide CEO Mozilo, who was compensated $160 mil last year. Now I am no friend of the Real Estate Industrial Complex (REIC). I am almost positive there will be Enron like hearings in the near future in regards to fradulent real estate practices. My post however is in regards to all executive compensation and how populist regulation can have the opposite effect. The problem with over compensation is a result of the proliferation of stock options. However this is only a symptom of the real disease which was the cause and effect of liberal "tinkering". The main source of the problem is a law that was passed by President Clinton & his Democratic congress in 1993. As with most liberal policy it sounds good on the surface and means well, but of course had the opposite effect. Did you know that currently companies are prohibitted from deducting any salary of $1 mil or more? Well in 1993 congress passed the law, which is now part of section 162(m) of Internal Revenue Code, in response to the public uproar of compensation paid to top execs. This effectively created a boom of stock options for execs & employees (mostly execs). Plus congress exempted incentive-based pay from this law and the IRS ruled that option grants was incentive-based pay. This is why there is more excessive compensation than ever because companies can pay them for "free", by just issuing out more stock. Most executive compensation is well over 80% stock options. Big fund companies and fellow executive stockholders rarely complain about these options. Now if the liberals didn't tinker & regulate then most of the compensation would be in the form of salary and be put on the balance sheet for everyone to see. Leave it to the government to screw it up.

The countrywide CEO is a prime example of what is wrong with the system. Pump up the stock or ride a bubble and then cash out and let some other poor sucker deal with it. Coincidence with the internet boom, you bet. That is why congress needs to abolish the law on executive compensation. It seems ass backwards, but it's the obvious solution.

Why Real Estate Investing is Just Hype

This post is a counter to all of the hype surrounding the real estate “investing” world. It is now almost commonplace to hear ordinary Americans looking at real estate as an investment instead of a place to live. What they don’t realize is the deck is stacked against them in regards to costs & returns. Real Estate has suddenly turned into a one stop shop for all things including an ATM/Bank, children’s college savings, retirement account, etc. Well here are my problems with single family home dwellings as an investment properties (multiple properties) for most Americans.

• Operating/maintenance costs are high: This is probably the most significant overlooked cost for investors. Yes there are interest & tax expenses and yes they are tax deductible, but it costs money. Plus your interest rates are going to be higher because the home is non-owner occupied. Then you have the choice of having a management company or yourself taking responsibility of your tenants and their needs. There is a cost which can range from 15-30% of your rental income. Or you can utilize your time and liability risk to do it yourself. Remember not all tenants are created equal and a horrible tenant can become an absolute nightmare and sap your time. If you bought an older property, be prepared to dole out some cash for major repairs.
• Buying costs you time and money: This is also underestimated because most folks believe the costs are taken care of by the seller. Guess again they are some hidden ones. Most notably an agent will have a conflict of interest to only show their broker/companies listing. This can lead to paying more for a property. Also there is the costs of your loan which can range anywhere to 1-3% of the sale. The time spent buying house can be substantial when considering: looking at all properties, haggling with the seller on price & contingencies, and getting all of the inspections & paperwork done.
• Selling costs you time and money: Here is what really gets you when you decide to finally sell your investment property. You will be looking at an agent’s fee of close to 4-6% off the sale to get listed and marketed. God forbid you have to sell in a market like 2006-‘07 or you can add closing costs to that fee too. Then of course there is the time and energy to get your house in shape and to show it constantly. Another little known issue is your house just got a couple years older, while newer and better houses are entering the market.
• No capital gains tax breaks for non-owner occupied homes: This is the most glaring issue, especially for flippers. This will literally eat what ever profits you have left after the aforementioned costs. Your capital gain is going to be taxed at ordinary income rates. This means you’re going to be taxed at federal & state level from 25-46% on your gain depending on how much you income and if your state taxes you.
• The returns are mostly based on extraordinarily high amounts of leverage: For almost everybody you have to be leveraged with a down payment of around 20%. In an up market that can turn a 5% home value increase to a rate of return of 20%. Well guess what happens if the home value goes down 5% when you want to sell? Now you have a 20% loss. Hmmm your value goes down 10% and you’re looking at 50% loss on your money. But housing always goes up right? According to Yale Professor Robert Shiller prices have only increased at rate of under inflation of 3%/yr. (the long term data is very difficult get a reading on because houses were much smaller in the 1950’s compared to now)

Again I am not advocating that nobody should invest in real estate, but that people need to realize that there are better investments out there instead of a 2nd or 3rd home. I believe real estate investing becomes more attractive if you are a real estate agent, mortgage broker, contractor, etc. because you are able to get some rebates into your investment. Also if this is your primary job, you do it on a daily basis, and you have the time to invest. Most folks are not able to dedicate adequate time to real estate because they have a regular job. A house is a place to live and homeownership is great for that. So lets all keep that in prospective.

Public Debt vs. Personal Debt

The idea behind a democratic nation, is that it should be reflective of its people. This is the case in regards to the United States and her people. However when it comes to American spending habits this is definitely an unwanted correlation. Why? Well for one thing the monthly US household savings rate have been negative multiple times over this last year (savings rate of -0.4%). This data is tracked over at the Commerce Department's Bureau of Economic Analysis. The worrisome issue is that our Federal Government is on the same path. However how can you blame one without blaming the other for financial mismanagement. Here are some statistics on the US public debt in terms of Gross Domestic Product or GDP , according to the CIA Factbook.

• The United States Public Debt: 64.7% GDP (2005)
• French Public Debt: 66.2% GDP (2005)
• British Public Debt: 43.1% (2005)
• Swedish Public Debt: 50.4% (2005)
• Chinese Public Debt: 24.4% (2005)
• Japanese Public Debt: 158% GDP (2005)
• Bangladeshi Public Debt: 44.5% GDP (2005)

What do these statistics tell us? For one our debt level is the same or worst then some of the major European nanny states. We have 3x the public debt of that of China one of the emerging super powers. Japan on the other hand has 1.5x more public debt then we do in the US. Forshadowing??? Well Japan was put into difficult economic times in the early 1990's with a stock market crash followed by a major housing crash and then subsequent deflation. Remember they went into deflation with massive governmental expenditures & a central bank cutting interest rates to effectively zero! What can we learn from this is that Japan went to a more socialists slant with heavy deficit spending on social & government programs. They have been in a 15 year slump and only when former prime minister Koizumi put forward real reforms aimed at pro-business and the break up of the giant governmental institutions have they shown signs of life.

We are most likely in for some troubling economic times due to a variety reasons including a debtor society. The government in our case is really representative of its people. However usually people in rough economic times cut spending and so should the government. Government rarely cuts spending and either cuts taxes or raises them. Why is it so wrong for them to cut frivolous spending? American consumers will likely cut its frivolous spending on Hummer's, plasma TVs, and granite countertops. SO I would hope the government will cut its frothy bureaucracy and little used social programs. This investment mercenary isn't holding his breath....

Stock buybacks & what it might mean

Here is an excerpt from the Wall Street Journal 8/27 by Scott Patterson:

"If businesses move to pay out more of their earnings, investors will reap a windfall. But corporations have increasingly been either hoarding their cash or using it to buy back shares. The rate of dividend increases has recently shown signs of slowing down, while share buybacks are surging, says Mr. Silverblatt of S&P.

In the second quarter, companies in the S&P 500 put more than $116 billion into buybacks, up 43% from a year ago. Dividend payouts were up 11.1% from last year, to $54.5 billion. "

Be afraid, very afraid. Look at all the stock buybacks from a lot of the major US companies. Most recently the $3 Billion buyback from Boeing. That is an important signal because it shows that companies don't want to invest, take on risk, or extra capacity. Why? Because they feel there is going to be a major economic slow down and are preparing accordingly. They are hunkering down for the winter my friends and so should you.

On the flip side this why being a shareholder of a stock can be advantageous. Buybacks & dividends are the benefit of being one and is the company's way of giving back and rewarding your investment.

Source: wsj.com, 8/27/2006