.

Tuesday, March 31, 2009

The First Tremors

.

Last week we talked about the looming possibility of inflation and even hyper-inflation with the 'quantatitive easing' policies (ie. printing money) of many Western goverments, particularly the United States.

The danger this represents to Vancouver Real Estate, of course, is we could see a return of the high interest rates of the early 1980s. With the inflated bubble real estate prices of the Lower Mainland, homeowners with with large outstanding mortgages face potential ruin.

[For example: the monthly payment on a $650,000 mortgage at today's five year monthly variable rate of 3.30% would be $2,603.28. If the rates spiked to 11%, the montly payment would be $6,090.22. If rates spiked to the 1981 level of 22%, your monthly payment would be $11,922.46.]

The greatest concern outlined by Peter Schiff was the massive dependance by the United States on foreign countries to continue purchasing US Treasuries. Schiff speculated that if China stops financing US debt, the value of the US dollar will plummet, triggering a hyper-inflationary spiral in the US.

Last week, for a few horrifying moments we saw the possibility of this scenario playing out.

The tremors began in Beijing, where a essay from the governor of the People’s Bank of China favoured the creation of an IMF currency to replace the U.S. dollar as the world’s reserve currency.

Delegates of China’s legislative advisory body suggested that the biggest foreign holder of U.S. debt diversify away from Treasuries into more risky assets. Jesse Wang, executive vice president of China Investment Corp., said that his $200 billion sovereign wealth fund may invest in “undervalued” commodity assets. Zhang Guobao, head of the National Energy Administration, said China should invest more in commodities instead of hoarding the U.S. dollar.


Almost simultaneously, in Europe, the rotating president of the European Union, outgoing Czech Prime Minister Mirek Topolanek, characterized America’s plan to combat the widening global recession as the “road to hell.”

Meanwhile, British Member of the European Parliament Daniel Hannan made headlines with his stinging rebuke of the inflationary and debt-focused policies of the current UK government.

In response to these events, the U.S. dollar suffered a dramatic drubbing on money markets.

Immediatly Treasury secretary Geithner and his ministerial counterparts in Berlin, Paris and London did their best to convince everyone that the world is pulling together as one to combat the economic crisis.

The charm offensive was effective, calm was restored and the dollar leveled... for the time being.

Given the size and scope of the remedies that the Obama Administration is cajoling the world to adopt, it is likely that the unease will grow. Germany and France are now openly refusing to continue with America’s stimulus plans.

Washington insists that North America's economic problems result from a lack of consumer spending. Therefore, the solution is for government spending to pick up the slack. However, if Americans are too broke to spend, then how can government spend for the people? The only money they have is taken from the American people through taxation. To postpone immediate tax hikes (adding interest for good measure), Washington plans to borrow more from abroad.

The US Administration continues to argue that more debt will restore growth which will then allow the repayment of borrowed money.

But the rest of the world is starting to vocally condemn that approach. This week, at the G20 conference, the United States and Canada will hear that to solve our problems we must first come to terms with their source. We borrowed and spent ourselves to the brink of bankruptcy, and now we must save and produce ourselves back to prosperity.

The voices from abroad are insisting that there is simply no way to sustain an economy based on consumer credit.

Nothwithstanding, the Obama Administration will go to London to cajole the world to adopt its stimulus initiatives. Given the size and scope of the remedies they want implimented, it is likely that worldwide unease will grow until many countries emerge in open revolt to America’s plans.

Meanwhile we continue to splash about on the shores of the Village on the Edge of the Rainforest blissfully unaware of it all.

As greater Vancouver home sales continue at a pace of 100 sales per day, I wonder how many real estate agents - supposedly representing the best interests of their clients - have offer a single, cautionary word to their clients making those purchases?

==================

Email: village_whisperer@live.ca

Sunday, March 29, 2009

The Financial Crisis and Washington State

.

It seems that there are daily reports of troubles for the big US financial giants such as Citigroup, Bank of America and AIG. But as the worst banking crisis since the Great Depression grinds on it appears several of Washington State's community banks also face looming problems.

According to the Seattle Times, at least a dozen of the 52 Washington-based banks examined are carrying heavy loads of past-due loans, defaults and foreclosed properties.

While banks big and small have been kneecapped by the collapse of the housing bubble, the crisis has played out differently for the big "money center" banks and the thousands of regional and community banks sprinkled across the country.

The main problem for the big banks and investment firms has been exotic instruments such as collateralized mortgage obligations, structured investment vehicles and credit-default swaps — all tied, one way or another, to pools of residential mortgages that were bought, sold, sliced up and repackaged like so much salami.

But at most community banks, residential mortgages were a relatively small part of their business. Instead, their troubles are tied directly to their heavy dependence on real-estate loans — mainly loans to local builders and developers.

"Many community banks found that (construction and development loans) was an area in which they could compete effectively against the big banks," said Pat Fahey, CEO of Everett-based Frontier Financial.

At Frontier Financial, for example, construction and development loans made up 44.5 percent of all assets at year's end. City Bank had 53.3 percent of its assets in such loans, and at Seattle Bank (until recently Seattle Savings Bank), they constituted a full 54.2 percent of total assets.

Meanwhile more than a third of Bremerton-based Westsound Bank's assets aren't generating any revenue.

Anchor Mutual Savings Bank, of Aberdeen, had $64.2 million in past-due loans at the end of 2008, but just $8.3 million set aside in its bad-loan fund.

Horizon Bank, of Bellingham, charged off $19.6 million in bad loans last year, more than 100 times what it charged off in 2007.

And Friday, the FDIC disclosed that it's given Venture Bank, of Lacey, a deadline to raise new capital or find a buyer.

Those banks whose situations don't soon improve may have to take steps that will hit shareholders, employees and would-be borrowers in the wallet. (Depositors, so long as their accounts are within federal insurance limits, are protected no matter what.)

To bring their capital resources back in line with their outstanding loans, industry analysts say, thinly capitalized banks can slash dividends, lay off staff or call in loans & mortgages.

Four Washington banks — Horizon, Frontier, Westsound and Bank Reale of Pasco — are operating under FDIC "corrective action plans" that place tight restrictions on their lending practices, management and overall operations.

Corrective action plans are often early steps taken by the FDIC before banks fail. It seems our weekly 'Bank Failure Friday' feature may soon take on a regional flavour.

How long before real estate values, a mere 25 minute drive to the south of Vancouver, start to experience a California-style depreciation?

==================

Email: village_whisperer@live.ca

Saturday, March 28, 2009

Various Vancouver Real Estate items


Interesting items on various sites from around the net.

On Real Estate Talks, KopyrightKlepto keeps track of (and posts the results of) the daily R/E sales in Greater Vancouver. After a strong start to the month, sales are once again dropping off and listings are starting to increase.

March sales are averaging 101 per day, which is a decrease of 26% from last March. The number of active listings is at 15,907, an increase of 22% from this time last year. It is taking, on average, about 7.2 months for a property to sell right now.

Meanwhile over at the blog Housing Analysis, Mohican has posted the results of the CMHC Housing Analysis. The number of completed yet unsold units in the Vancouver market has shot up to 2,391 (last year at this time it was 1,384). There are 25,907 units under construction and due to come onto the market as the year moves along.

In the current economic climate, it's sizing up to an explosion of inventory on the market as the year moves along. Most observers expect a rush of promotions similar to the 'Onni Liquidation' last month. Things are expected to really heat up as spring moves along and developers scramble to move product before the market becomes flooded later this summer/fall.

Meanwhile over on Greaterfool.ca, Garth Turner is once again moved to note the entrenched attitude of people across the country who somehow believe that their individual city is 'different' than the rest of the continent. Be it Vancouver, Calgary, Edmonton, Toronto or Halifax, people in each location think that land values in their individual city simply won't decline:

  • "In virtually every city, I hear the same thing when it comes to the one thing people want to throw money at, real estate. 'It’s different here.'

    It’s different in Toronto because that’s where all the immigrants go, so growth will be endless. It’s different in Halifax because of the huge stabilizing influence of the military. It’s different in Edmonton because of oil. It’s different in Ottawa because of the federal government. It’s different in Vancouver because of the sandwiching of mountains and sea.

    Of course, none of this matters. All markets will continue to decline, even after a minor feeding frenzy by unwary first-time buyers. This will happen even as equity markets lurch higher and lower, and then recover some time in the months ahead. It will happen despite billions of dollars in new government spending and tax cuts. It will even happen as mortgage rates dribble down to the lowest point ever."

Maybe it's because we live here, but this attitude is particularly entrenched in Vancouver.

I personally remain convinced we will see a minimum 50% decline in the price of condos from the March 2008 peak and a minimum 40% decline in the price of detached houses.

We should have some sort of online betting pool about when the tipping point will finally come.

According to the Teranet–National Bank National Composite House Price Index™, Vancouver is currently down 8.3% from peak prices. Only Calgary at 11.4% has dropped more.

Below is another excellent clip featuring Peter Schiff in an appearance on MSNBC last Wednesday. He touches on many of the key points we hilighted in our our recent Peter Schiff series. This clip is 8:36 long and as one commentator states towards the end, Schiff's comments are an excellent clinical analysis of the current economic crisis...


==================

Email: village_whisperer@live.ca

Friday, March 27, 2009

Bank Failure Friday (2009/03/27)

.
UPDATE: Bank Failure #21: Omni National Bank, Atlanta
.


Has it been a week already?

As faithful readers know, bank failures in the US always seemed to be delayed until late on Friday afternoons, prompting Friday to be jokingly referred to as 'Bank Failure Friday' in many economic blogs.

2009 is off to a record breaking year with 20 failures so far.

We wait with eager anticipation for today's carnage. Updates from the FDIC as they come in, check back late this afternoon. Click here to read our post: "US Bank Failures - Why Do We Care".

Bank Failure #21: Omni National Bank, Atlanta

From the FDIC: Omni National Bank, Atlanta, Georgia, was closed today by the Office of the Comptroller of the Currency, which then appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into an agreement with SunTrust Bank, Atlanta, Georgia, to act as paying agent for the insured deposits of Omni National Bank.

The cost to the FDIC's Deposit Insurance Fund is estimated to be $290 million. Omni National Bank is the twenty-first bank to fail this year. The last bank failure in Georgia was FirstCity Bank, Stockbridge, on March 20, 2009.

Thursday, March 26, 2009

Peter Schiff 5: Will we do the right thing or will it be Hyper-Inflation?

.
Part 5, the final part, of our series condensed from a speech Peter Schiff’s gave on March 13, 2009 to the Austrian Scholars Conference.

Our problems existed because the government, with their policies, undermined our productive capacity, undermined our ability to save, undermined our ability to manufacture and nurtured and cultivated the consumer bubble. Their policies created this service sector economy. And now it has collapsed.

The government’s plan to deal with the economic crisis? (1) They want to bail people out, and (2) they want to stimulate the economy.

But government bailouts are the worse thing that you can do. They want to bailout companies that should fail, that should be bankrupted. Bankruptcy is a good thing. It's the way the market cleanses the economy of companies that shouldn’t be there.

Why shouldn’t they be there? Because they are not generating profits. They are not effectively utilizing resources. Those resources need to be freed up but right now they’re being held hostage. We need to free them up so that we can use them productively.

They say we can’t let General Motors go bankrupt because some auto workers will be unemployed. Well, we don’t want work just so that someone can have a job. We want work so that we can produce something. We want the value.

Keeping those jobs just to preserve them doesn’t make any sense, not if they’re unproductive or inefficient.

We need to let companies go bankrupt.

And if we let General Motors go bankrupt, does that mean it’s the end for the automotive industry? Does that mean all those plants in Detroit are going to sit idle? That all those skilled workers are just going to sit there and nobody is going to try and hire them?

Of course not.

What would happen if we let GM go bankrupt is that some entrepreneurs would step up and buy up the assets out of bankruptcy. Then they would no longer be encumbered with big labour union contracts and interest on debt. They would be able to buy the assets without the liabilities and organize them in such a way that they could produce cars profitably.

In addition to letting companies go bankrupt, the government is viewing this whole crisis incorrectly.

The President keeps saying we need to restore credit.

He keeps saying credit is the lifeblood of the economy. We need credit so Americans can go out and buy more stuff. But the last thing we need right now is for Americans to buy more stuff. We need to start making things for the rest of the world.

China needs cars. Look at all their people who ride bicycles. They have lots of our money now, let’s start making cars – profitably – for them.

Bailouts are another problem. The government wants to bailout Wall Street investment banks. Why? Let them fail. What do we need them for? Why do we need Goldman-Sachs? Why do we need Morgan Stanley? Let them fail.

Everyone is trying to blame all of our economic problems right now on the fact the government let Lehman Brothers go out of business. Meanwhile they’ve bailed out everyone else and we are still in this gigantic mess.

Maybe it’s not because they let Lehman fail. Maybe it’s because of all the other bailouts!

But no… now they want to make us believe that because they let Lehman’s fail, they can’t let anyone else fail.

The reality is we don’t need all these investment banks. And if they go away it’s not going to mean that brokerages are going to stop, that investment banking is going to stop. All it means is... that work is going to be done by somebody else.

There are many smaller firms out there would could fill the void. But the government is rewarding the incompetent people and punishing all the competent ones.

Meanwhile look at all the bonuses being paid using bailout money. How can these executives be entitled to multi-million dollar salaries when their companies are failing? They should get paid based on what they are doing. Let them fail, let them go out of business.

So what, exactly, is the government trying to do with the stimulus?

The government is trying to recreate the conditions that lead to the crisis.

When they talk about stimulating the economy, they’re not talking about stimulating economic growth... they’re talking about stimulating spending. They want us to go back to the auto showrooms, back to the mall and buy more stuff.

And they want us going deeper into debt to pay for it.

And if we’re not willing to accumulate the debt on our own, well then the government will do it for us. And they sincerely believe this is the secret. If they can just spend enough money, then the economy is going to magically grow again.

That’s all nonsense.

The only reason it worked in 2000 (and it didn’t really work then), is because we were able to borrow the money from the rest of the world and spend it. And we were able to live in the delusion that we were getting richer even when we were getting poorer.

We believed this because we looked at our asset prices (real estate and stocks) and we saw the prices going up and we said “hey, were actually getting wealthier”.

But we weren’t getting richer because we were spending money at the same time instead of saving money. We would borrow on the asset value and spend it consuming.

And as we spent money, the government counted that money as GDP. And as long as our GDP was rising then we thought our economy was growing.

But the whole time our GDP was going up, we weren’t measuring how much our wealth was going up. We were measuring how much our wealth was dissipating. We thought we were okay because some appraiser said that our house was worth more. Or the stock market was still going up.

All that was an illusion. Because when the bubble burst, our real estate wealth disappeared and our stock market wealth disappeared.

And now that those bubbles have burst, there’s no way to go back to it.

We can't go out and borrow any more money against the value of our real estate... because the real estate value is gone, collapsed.

We can't go out and borrow any more money against the value of our stocks... because the stock market value is gone, collapsed.

Restoring credit by bailing out the banks won't work.

And it doesn’t matter that the stock market is rising again. Because you’re going to have ups and downs, but stocks are still too expensive. These rallys are doomed to collapse again because, based on any kind of historic measure of value, the P/E’s are high and the yields are low for our companies.

Stocks are overpriced, even today.

Houses are overpriced, even today.

Our assets are still overpriced despite the fact that they have fallen.

Our whole economy is phony.

Why? Because the malinvestments we have now is this entire service sector economy.

We have built an economy based on the idea that we can borrow and spend in perpetuity. And that’s just as phony as the idea that real estate prices will always rise.

So we have a lot of Americans working in jobs they really shouldn’t be in.

We have a lot of Americans who work in retail, who work in shopping centres, who work in restaurants, who work in financial services. We have a whole lot of Americans working in jobs they really shouldn’t do because we are too broke to patronize their businesses.

We need more Americans making stuff, producing things.

What do we produce right now?

And in order to have American labour available for productive capacity, they have to leave those jobs. Somebody has to loose their job in the service sector in order to get a job in goods production. And to get the jobs in goods production, we need the capital. I mean you can’t produce anything without machines, without tools. And where is that going to come from? You need Americans to have savings. Someone is going to have to borrow the money to make those investments. You need people to save their money.

If no one has any savings to lend, then we are going to have to convince someone in another country to take their savings and lend us that money for our productive purposes (and not just to lend it to us to spend).

It’s not like the 1800s when we ran huge deficits.

Bach then we borrowed money to make investments, to build infrastructure, to build factories, to build farms… to build a productive economy. We invested the money, we didn’t just spend it on stuff. When you borrow money and invest it in productive capacity, then you have a real asset. And the asset can generate real revenue. That’s what we did. We produced things that the British and French could buy, that’s how we made enough money to pay back what they lent us.

We became the world’s wealthiest economy because we borrowed to produce.

What we have done recently is to borrow to consume.

So how can we possibly pay this money back?

So if we want to build a viable economy, and we don’t have our own savings, we’re going to have to convince the Chinese and the Japanese to build factories here. But why would they want to do that? With the high regulations we have right now, with the high taxes we have right now, we’re just not competitive.

So the only way we are ever going to rebuild a sound economy in the United States is if we stop all the stimulus and stop all the bailouts and let the free market work.

What we have to understand is that what is going on, the recession, is the solution not the problem.

The problem was the bubble inflating, blowing up. Not the deflation.

We have to allow the pain, no matter how unpleasant it is. We have to understand that anything we do to delay this is going to make it worse.

And Obama and Berananke are making the exact same mistakes as Bush and Greenspan did in 2000, only on a much grander scale. The bailouts are preventing the solution from being allowed to work.

It’s the same philosophy. Nothing has changed. This might as well be the third Bush term because Obama is doing the same exact stuff. They are arguing the economic growth is a function of people spending money and we need our government to stimulate the economy. Therefore we should bailout the people who fail and punish the people who succeed, and that we should have a zero interest rate with the Fed cranking out money.

It’s the wrong direction.

We need to allow these companies to fail, and allow Americans to stop spending (through the pain of recession). The credit crunch is a good thing. The fact that credit is being denied to Americans is a good thing. It’s a good thing because credit is scarce. Credit isn’t unlimited; it’s a function of savings. And if we want to have a real economy, if we want to have production, then savings need to go to producers.

Well they’re not going to go to producers if they’re being squandered by consumers.

They’re not going to go to producers if the government is borrowing all the money.

So what do we need? We need the government to eliminate the deficit and go to a surplus. We need the government to stop spending money and depleting our savings. We need consumers to stop spending money and rebuild their savings.

We need a recession.

We need one badly. And we need to have the government say to us, “Yes. This is the price we pay for years of indulgence and reckless spending, now comes the sacrifice. And there is nothing the government can do about it.”

We also need sound money. Unfortunately the means we need high interest rates.

That’s what we need but Obama and Bernanke is giving us what Bush and Greenspan gave us. And it’s going to fail.

And what is it going to give us? What are going to be the consequences of what we are doing now?

What I think is going to happen is that, ultimately, people like the chinese and the rest of the world - the saudis and the japenese and everyone else, they are going to figure this out. And they are not going to want to play this game anymore.

You know, we have them conned right now.

In my book, crash proof, I compare it to Tom Sawyer. You know there was that passage in Tom Sawyer where Tom gets everyone in the neighbourhood to whitewash his fence. And he gets them to pay for the privilege of doing his chores. When Mark Twain wrote that passage he probably had no idea that it would form the basis of the entire world economy.

We have got the world painting our fences. Like they don't have their own fences that need painting.

But the world is not going to accept this con. You've had Hillary Clinton, when she went over to China, a couple of weeks ago to get them, to beg them to buy our bonds.

She'd tell them, we're all in this together. And basically this is what she tells the Chinese:
"You need to take money away from your citizens and loan it to us, so that we can give it to our citizens, so they can use it to buy products made in your country, to keep your people employed."

That's the deal that we are making with them.

Now what the Chinese should say to Clinton is:

"you know what, I have a better idea. Why don't we just leave our money with our own people, and then they can use the money to buy their own products. That way we get to keep our stuff."

You know, the way it is right now, we get all the stuff and all they get is the jobs.

What good are jobs without stuff?

That's slavery.

So they're gonna figure it out. And what's gonna happen is they're not going to buy our bonds and the Fed is going to start buying all the bonds, and the dollar is going to plunge.

And this crisis is going to end up being a currency crisis. And when it becomes a currency crisis.. then... you're going to have higher consumer prices, and you're going to have higher interest rates.

Right now we are creating a lot of inflation and people are talking, they're saying "it's not inflation, it's deflation".

That's all nonsense.

Real estate prices are falling because they are too high. Stock prices are falling. But that's not deflation.

That's just falling prices.

There is no contraction of the money supply, it's growing like crazy.

But the expansion of the money supply is not immediately showing up in rising prices for commodities and consumer goods because there are other temporary factors pushing prices down at the same time inflation is pushing prices up.

You've got deleveraging, you've got bankruptcies, going out of business sales, you've got a lot of companies liquidating their inventory and you have the dollar strong.

Paradoxically, while this was happening as this crisis began, money flowed into America instead of fleeing America. Ultimately it will flee, but currently it is flowing into America.

Can you imagine? It's as if there was this giant explosion and everyone is running towards the blast... that's what's going on with all this money flowing in.

We caused the explosion. It's our system that has collapsed. And people are plowing their money into our system as a safe haven.

And we are rationalizing to ourselves right now. We look around the world and say, "well people are coming to America because as bad as it is every place else it's so much better here." But that's nonsense. That's just what we justify, just like we tried to justify the real estate bubble. Or the internet bubble. It's all nonsense.

Why is it so bad in the rest of the world right now? It's because they loaned us so much money and we can't pay them back.

And now they're losing, based on their bad loans.

What's really causing the global credit crunch and making things so bad in the rest of the world is that we're borrowing so much money right now that were crowding out everyone else.

The fact that people are loaning us so much money means that private businesses around the world can't get capital.

Why?

Because it's all going to the US government, that's why.


So... the world is suffering. And the world is suffering, not because our economy is collapsing and we can't buy their stuff anymore, but because they are foolishly trying to prop up our economy.

And, when they figure this out, then were really going to get an economic crisis.

Because when they figure this out, they will stop proping our economy up. China and the rest of them will stop buying our treasury bonds. And when the dollar starts to plunge - and it will - then we are going to see prices rising sharply for consumer goods and we will see interest rates rising.

And if we think we have problems now wait till we see how much worse they get when we throw rising consumer prices and rising interest rates into the mix.

And there is nothing the government is going to be able to do about it.

You know, right now, unemployed people are getting the benefit of lower prices. Imagine when you are out of work AND your prices are going up.

Because that's what's going to happen. And then this is going to be a real economic crisis. And we are going to be in for some very, very difficult choices.

And unfortunately, the worse case scenario, is one that is looking increasingly more likely, which is hyper-inflation.

Hyper-inflationwill come when no one will lend us money.

The Fed will have to buy up all the bonds in order to keep interest rates down and to maintain deficit spending. And then the velocity of money will really start to pick up, and no one is going to want our money, not even American citizens will want it.

And they will try to spend it as quickly as they can. I mean the government will try and keep it together a little bit longer, with regulation. Maybe we will have capital controls. Maybe they will make it illegal for Americans to do what I am doing with my clients right now, which is buying foreign currencies, foreign stocks.

Maybe they will make it illegal to buy gold. As prices really start to escalate, private parties will try to make contracts, with payment in gold or other currencies. Maybe the government will make that illegal.

There might be stores where people don't want to accept dollars, because their value is dropping too rapidly.

The government will make that illegal.

And that means we will have a black market. If you want to buy something, you will have to buy it on the black market. Just like they did in the Soviet Union. The only reason you could buy anything there was because you did it illegally.

A lot of these things are going to happen. I think early on, probably in Barack Obama's first term of office, I think were going to have price controls. I think prices will be rising so rapidly, maybe even by next year, that they are going to impose price controls on a number of products. Probably energy, probably gasoline, probably milk, bread. I mean we are repeating all the mistakes of the 1930s, we might as well repeat all the mistakes of the 1970s.

So when the put on price controls, what that's going to lead to? Shortages? Blackouts? Long lines for gas? Long lines for food?

Civil unre... I mean a lot of things are going to happen.

People say we can't repeat the mistakes of the 1930s... well that's exactly what we are doing.

I mean, the popular notion is that we had a depression because Hoover was so irresponsible that he trusted the free market and he did nothing.

And because he did nothing, we had a depression.

And then Roosevelt rode to the rescue and saved the day with big government.

Well, the reality of course is that we had a depression because we had a Federal Reserve that was too easy in the 1920s and created a boom and when the boom bust, Hoover ignored the good advice of his secretary of the treasury (which is maybe the last time the secretary of the treasury ever gave anyone any good advice) and instead of allowing the free market to work, he came up with all kinds of crazy things to bail people out and prop things up and distort prices and fix wages and all kinds of things, that created the depression.

And then Roosevelt came in and proceeded to make it worse. And everything that Roosevelt did exacerbated it and made the depression 'Great'.

And we eventually got out of it after the second world war, but how can anyone say we got out of it because of Roosevelt?

We got out of it despite Roosevelt.

We would have got out of it a lot faster had Roosevelt not just expanded the failed policies of Hoover.

And that is very similar to what is happening now.

You got Bush, who is the Hoover, now, of this generation, who was associated with the free market but was anything like the free market.

And now we have Barack Obama, like Roosevelt, coming in to save the economy with big government.

Of course, the government is already huge, maybe he hasn't figured that out.

When Hoover left office, I think the federal budget was about four billion dollars.

That was the whole thing.

And Roosevelt doubled it to about 8 Billion.

Now we're 3 Trillion. That means the government is huge.

Of course when Roosevelt came in, we had a sound economy beneath the surface. I mean we had a productive economy, we saved, we made stuff, we exported, we didn't have a huge social welfare state, no body got cheques from the government. We were in much better shape.

If they did that much damage to a sound economy, imagine what they can do with the one we got now?

Plus back then we had real money, we were on the gold standard.

Now look at us.

I mean, look at the problems we had in the 1970s. Still we had a fundamentally sound economy then.

We had a bubble in the 60s, the same stock market bubble, we printed too much money, we went to Vietnam, we went to the moon, we had the war on poverty, the government created too much money... and they gave us the 1970s.

That was the payback for the 1960s.

But then in the 1980s, we got some sensible government. We shrank goverment and we raised interest rates.

We went for sound money and smaller government.

But what do we have today?

We have a huge trade deficit but we have no domestic savings. And we're already loaded up with debt. And the only hope we have of artificially stimulating our economy is that we borrow the money from the rest of the world.

We don't have it, on our own.

So, when the world stops financing this, and it's gonna come to an end. And we're gonna have to make some hard choices. Is it going to be hyper-inflation or are we gonna do the right thing?

But the rest of the world, and a lot of people think this is never going to happen - and I've had a lot of arguments, and people call it decoupling - they say "this is never gonna happen"... or "when America stops consuming, the whole world is finished".

They're not finished. We're not the engine of the world's economy. We're the caboose. And if you decouple the caboose, the cars move faster.

Ya know, were not doing the world any favours consuming their stuff. It's vendor financing. But people say 'we're their best customer'. We're not. We're the worst customer because we don't pay.

Your good customer pays you.

And in the world of trade, you pay for imports with exports. And if you don't have anything to export you, you don't pay. And that's what we have, we issue an IOU.

And when the world finally lets the dollar collapse, and they will, our purchasing power isn't going to vanish, it's going to be re-distributed.

Other currencies are going to rise. And people in other countries, people who are working in factories right now in China, people who are making products and just shipping them abroad and waving goodbye, all of a sudden... they will be able to afford them.

The Chinese will be able to turn in their bicycles and buy automobiles. Because steel will be cheaper, because cars will be cheaper, because the value of their wages will rise, because their currency will gain purchasing power.

It's Americans who will be buying the bicycles. Because, all of a sudden, cars will be too expensive for us. Gasoline will be too expensive for us. Because we will be bidding with currency of much less value.

And that's what's gonna happen. The world is not going to suffer because we don't buy their stuff, they're gonna benefit because now theirs going to be more stuff for them.

I mean, right now, because the world lends us so much money, there's a capital shortage.

Wouldn't the world be better off investing their savings productively in their own countries? Rather than just giving their savings to us?

Wouldn't they be better off enjoying the fruits of their own labour rather than labouring while we enjoy the fruits?

It's obvious and wery shortly now they are going to realize that.

And when they do hyper-inflation, and all that comes with it, is gonna happen.

Wednesday, March 25, 2009

Peter Schiff 4: The Dominos fall

Laurel Magri: lying deceptive, manipulative whore.
Part 4 of our series condensed from a speech Peter Schiff’s gave on March 13, 2009 to the Austrian Scholars Conference.

By 2006 everyone thought Real Estate couldn’t go anywhere but up and nobody questioned the Triple A ratings that Wall Street had given these extremely high risk mortgages when they were packaged up and ‘securitized’.

Then, in early 2006, prices in America started to fall when some potential US homebuyers concluded that home prices were becoming fundamentally overvalued. As a result you had falling demand in a few bubbly cities such as San Diego and Miami.

The falling demand created relatively high levels of housing supply. This high supply/low demand triggered a modest drop in prices.

And that’s all it took. A modest drop in prices in a few bubble centres.

Had house prices actually continued to rise, many subprime mortgages could have been reset at higher rates without much damage. But when this modest drop in housing prices got going, it started a domino effect that has been catastrophic. Modestly lower prices, along with higher reset rates on the exotic mortgages resulted in a substantial wave of foreclosures.

Suddenly a bloated housing inventory started to overwhelm itself.

As the housing inventory rose, the more downward pressure was reinforced on house prices – a typical supply and demand situation.

When more and more subprime mortgages came up for reset, the reduced value of the property made renewal impossible. And a vicious, perpetuating cycle began.

And that’s all it took. And the entire system collapsed from there.

For years housing prices rose only slightly year over year. Suddenly, in the last five years, they shoot drastically higher. If you plot it on a graph you have a straight line moving upward at a slight angle and then, it curves straight upward.

I used to go on television and talk about housing prices going to fall. And people would say, “that’s not going to happen. That had never happened, certainly not since the Great Depression.” Which was true, but housing prices had never shot straight up like they had in the past five years. That had never happened either. For the first time housing prices were not supportable by rents and incomes. But everyone seems to think it is going to stay up high that it should somehow plateau there.

In many ways it’s kind of funny. Everyone now recognizes that we had lending practices that were too lax, the lack of a downpayment, too many people buying houses and credit was too cheap.

Everyone knows all these things that we did wrong which caused people who shouldn’t have been buying houses, to be able to go out and buy a house. And everyone knows that this artificially drove up the value of houses.

And everyone can agree that we need to go back to a prudent mortgage lending process.

But nobody wants to go back to prudent pricing.

Everyone wants to go back to sound lending principles but leave the bubble prices intact. But that’s impossible. Nobody can afford to pay these high prices without all these lending gimmicks.

The reality is that the best thing that can happen to the lending industry is for these high prices to come down. It used to be that the mission of Freddie/Fannie (before they went broke) was to try and make home ownership affordable. Now their mission is to keep home prices high.

And this is where the government is making a huge mistake.

This keeps homes unaffordable. It makes sure that we have to mortgage ourselves to the hilt to buy a house.

The government’s solution is high prices with low mortgage payments subsidized by the government. The free market solution is low prices. Because if real estate prices go down, you don’t need to borrow that much money to buy a house. And if they do, it doesn’t matter that interest rates go up a bit, because your payment will be lower anyway.

So now we get into the foundation of our current financial crisis. The government still looks at the problem as being one of falling real estate prices. That’s not the problem, that’s the solution.

The problem is that they went up.

Now that the housing bubble has burst and the stock market has collapsed on the backs of this real estate collapse, we are having this massive – necessary – recession which is just getting started. And it has just started, we have barely gotten a taste of it.

Unfortunately all the blame is on the free market. All the blame is on capitalism. People are running around saying “it’s because there wasn’t enough regulation, there was too much greed.” President Bush summarized it by saying “Wall Street got drunk.” And he was right, they were drunk. But so was Main Street. The whole country was drunk.

But what he doesn’t point out is… where did they get the alcohol? Why were they drunk? What was the root of the problem?

Obviously Federal Reserve Chairman Greenspan poured the alcohol, the Fed got everyone drunk and the government helped out with their moral hazards, the tax code, all their programs, the incentives, the disincentives, the way they interfered with the free market. It removed the necessary balances that would have existed, that would have kept all this from happening.

But now that it has happened, we have to deal with it.

So we are back to where we were in 2000 after the dot.com bust, only this time the recession we are facing is far more severe.

Tomorrow: The Threat of Hyper-Inflation

==================

Email: village_whisperer@live.ca

Tuesday, March 24, 2009

Peter Schiff 3: A Financial House of Cards is Constructed

.

Part 3 in our series condensed from a speech Peter Schiff’s gave on March 13, 2009 to the Austrian Scholars Conference.

The Real Estate Bubble morphs into a Financial House of Cards

When the Bush Administration came to power, they tried to combat the recession and the after affects of the 2001 terrorist attacks with deficit spending. They cut taxes, increased government spending and Federal Reserve Chairman Alan Greenspan slashed interest rates down to 1%.

So we had a flood of money and fiscal stimulus.

And what was the result? Americans borrowed massively to fund the biggest spending spree in history and our trade deficit just skyrocketed. More importantly it acted as a leverage for huge amounts of real estate and consumer purchases.

It was all borrowed money.

Very few people used their own money. In fact many of the people who were buying real estate were buying it with nothing down. Is it any surprise that people gambled when they had nothing to lose? Especially when they had so much to gain? Real Estate prices were rising and everyone believed it was a never-ending gravy train.

At one point in California, I believe it was 2005, they took a survey and the average homeowner believed his property was going to appreciate by 20% each and every year for the next 10 years.

That is what was expected.

At the time the average California home was selling for about $500,000, which was about 10 times what the average household actually earned. But these guys actually believed if they bought that house they would make $3 million dollars over the next 10 years.

That’s what they sincerely believed!

Now is it any wonder they lied on their mortgage in order to get that appreciating asset? Is it any wonder that they signed up for a teaser rate mortgage? Do you think they cared what happened to the loan two or three or five years from now? They didn’t care what the reset was, they were gonna be rich. All they had to do was buy the house and they were going to be rich. It didn’t matter what the mortgage payment was going to be because the house would take care of it.

In fact if you calculate what the average Californian expected to earn from house appreciation, it exceeded what he expected to earn from his job. It used to be you worked hard to earn money and be able to buy a house. Now it was if you buy a house, you don’t need a job.

And for a few years, it worked. The people who bought houses were getting rich. And the banks made it very easy to monetize that gain. You didn’t even have to sell your house, all you had to do to realize that gain was remortgage and you could borrow the money out of all the appreciation. Instant equity and money in your pocket. Plus you could still live there.

It was like the goose that laid the golden eggs. No one would sell their house, because it would just keep going up. In fact people went out and got second houses with nothing down to keep it going and then borrowed the appreciating equity to fund more consumer purchases.

Part of the problem here was that realtors redefined the American Dream. The American Dream was always you save your money, you work hard and anybody can succeed. You don’t have to be born to a royal family, you don’t have to be an aristocrat… anybody of modest means can grow up to be a captain of industry or be President of the United States… that was the American Dream.

Somehow the realtors turned it into home ownership and buying a home and just getting rich. That was the American Dream they were selling: that you didn’t have to work.

Well that dream is now dying.

So we had this gigantic bubble. And the bigger problem here was the lenders. I knew that when the real estate bubble finally burst, it was going to spell huge trouble for the financial industry – and thus the stock market – because I knew that the banks and the financial institutions had, as the bedrock of their assets, all these IOU’s, all these mortgages.

It’s simple. If the mortgage holders don’t pay, then the assets aren’t worth what everyone thinks they are. Which means the banks are undercapitalized.

And I knew just by looking at it that Fannie and Freddie were going to have to go bankrupt. They had guaranteed 50% of the mortgages and those mortgages weren’t worth anywhere near what Fannie and Freddie thought they were. People were borrowing to buy these houses so I knew that when people couldn’t pay those companies, they were going to have to go under.

Compounding this looming potential disaster was the securitization process.

At the time I was helping a client set up a hedge fund in 2005 that was shorting sub-prime mortgages and I learned about the whole securitization process.

First it started with Freddie and Fannie. If it wasn’t for Freddie Mac and Fannie Mae, Americans couldn’t have borrowed all this money to buy houses. The only reason they could do it was because the American government was co-signing their mortgages. And they knew if you lent someone money to buy their house and they can’t pay you back, then the government will pay you back.

So people were able to borrow more money than the free market would allow because the government was there to co-sign the mortgage. But there were some mortgages the government wouldn’t co-sign. These were the ones known as the sub-prime mortgages.

But Wall Street figured out that they could ‘securitize’ these mortgages. The government won’t guarantee them, but we will buy them all up, put them into these structured products and by structuring them like this we will be reducing their risk.

And it was crazy. After they sliced and diced them,better than two/thirds of these sub-prime mortgages were rated 'Triple A'. And these were mortgages where people have put nothing down, have lousy FICO scores, were in jail or don’t have jobs, whatever it was, two/thirds of them were rated ‘Triple A ‘

‘Triple A’!

I mean, how could that be? How can you take all these lousy mortgages, bundle them up, and they're rated Triple A?

But a lot of people owned structured products, which was one of the main reasons that there was a market for them, and a lot of people were looking for high yield products, so no one quesitoned it. Buyers just ate it up confident that these were high quality investment products.

And because Wall Street had ‘securitized’ all these new mortgage bonds, and gave them Triple A ratings, they were able to sell them to the Japanese, sell them to the Chinese and sell them to the hedge funds…there was demand.

And why was there so much demand for high yielding assets? Because the Fed had interest rates too low. Everyone needed yield and they were willing to take risks to get it.

And where did all these foreign Central Banks get all this money that they recycled back into these bonds? Because of our trade deficits. Because interest rates were too low and we were buying too much stuff on credit.

And as the market was flooded with more and more money from these Triple A products, it became even easier for people to borrow more money and buy more houses.

It was because of securitization.

So you had the government perpetuating this crisis and you had the attitude that real estate prices couldn’t fall.

How bad was this attitude? In 2005 I had a booth in Phoenix, Arizona at an investment conference. And the person next to me had a real estate company that specialized in hooking up people with bad credit, who couldn’t buy homes, with people with good credit. And the people with good credit co-signed the loans of the people with bad credit. Now this guy with bad credit can get a house and the other guy would get some extra payments or something.

Now there was one flaw in his argument. I said, “what if the guy, this deadbeat person who can’t get a loan, what if he can’t pay? What happens to your client who co-signed?” And the reply was, “well… then we will just sell the house”. I said, “Okay, but what if the value of the house goes down?” And he looked at me like I was from Mars. He said, “this is Phoenix. Real Estate prices don’t go down in Phoenix.”

Everyone had this idea that housing prices would never go down. So nobody questioned these faulty Triple A ratings. And it didn’t matter anyways because if someone defaulted on a mortgage within the package - which, of course, was always supposed to be apreciating, so you had the house to sell.

But I knew that housing prices were going to fall. And when I went on television they told me, “that’s not going to happen, it hasn’t happened since the Great Depression, that’s impossible.”

But it was possible. All you had to do was look at the way the system was constructed.

And if housing prices started to fall in any one area, the resets on the subprime mortgages would trigger a massive unravelling of the system because of the way everything had been 'securitized'.

So guess what happened?

Tomorrow: The Dominos Start to Fall

==================

Email: village_whisperer@live.ca

Monday, March 23, 2009

Peter Schiff 2: The Real Estate Bubble

.

Peter Schiff is the President of Euro Pacific Capital and is famed for being the most vocal financial critic who accurately predicted the real estate crash of 2006 and the stock market crash of 2008.

In Schiff's view, mainstream economists still do not understand the fundamentals of the current crisis. He believes that the government's stimulus and bailout policies are misguided and are "sowing the seeds for economic devastation."

What follows is the second in our series which is condensed from a speech he gave on March 13, 2009 to the Austrian Scholars Conference.

The Real Estate Bubble

The internet bubble burst because you had all these companies that were tremendously overvalued. None of these dot.com stocks were paying dividends because none of the companies had a realistic chance of making money. So why would their value go up?

Basically what had happened was the Federal Reserve had been too easy and loose with money in the 1990s. Interest rates were too low and we created too much money. And that facilitated massive investments in the stock market.

So we had all these companies that were able to flourish despite the fact that they weren’t able to make any money. The same thing started to happen in the real estate bubble.

When it comes to real estate, if a property’s asking price or current market valuation bears an unrealistic relationship to what it can be rented for, well, it’s probably not worth what the vendor is asking. If there is no positive cash flow, it’s overvalued.

People began buying property as an investment when rent for the property couldn’t cover the mortgage payments on what was paid for the unit.

Why? Because people were sold on the idea that it didn’t matter that there was negative equity, the property would appreciate in value and that’s where the real money was to be made. Everyone bought into the idea that a property would double in value in a couple of years.

And it made no sense. You couldn’t cash flow the property positive at the value it is currently sitting at now, how is it going to go up in value? It defied the basic law of commerce that says Real Estate is a function of rents.

During the Internet Bubble, if you questioned the wisdom of what was happening, the reply was always, ‘you don’t understand the stock market’.

Now, when anyone questioned the wisdom of what was happening in real estate, the reply was, ‘you don’t understand the real estate market’.

Well... no... I do understand the Real Estate Market, and the values of these properties was grossly overvalued.

People were told rents don’t matter to real estate in the same way they said dividends don’t matter to stocks. What evolved was a rationalization that said all real estate would appreciate, year after year, for no other reason than a belief that real estate appreciates.

Everyone bought into the idea that it was going to go up… year after year… just because.

And it made no sense. Were incomes going up each year? Would you be able to charge 10, 20, 30 percent higher rents each year? No? Then why is the value going to go up 10, 20, 30 percent?

And the answer was… ‘it just will’.

We had the internet bubble because the Fed was too easy with money. And eventually, Alan Greenspan started to raise interest rates, and he burst the stock market bubble. He had seen what had been happening. In 1996 he talked about irrational exuberance and they took him to the woodshed for saying something negative. But he still went ahead and raised interest rates to correct the imbalance.

And, of course, when the stock market bubble burst, a lot of the malinvestments were exposed. A lot of the people working at the dot.com’s had to find real jobs. Because they were wasting their time. Because they were destroying wealth. They weren’t creating anything of value. And so we had a lot of companies who were given a lot of capital who shouldn’t have been given capital and a lot of investors who invested foolishly who were going to loose a lot of money.

It meant that we were going to go through a painful recession, certainly, as we digested and worked off those malinvestments and allowed capital to be reallocated to where it could be productively used: labour, land capital, what ever was involved in these dot.com businesses.

And it would be a necessary recession. As painful as it might be, it is the free market's way of correcting the imbalances.

And, of course, with all the wealth that was squandered from investors who lost real money, real savings, people were going to have to come to terms with the fact they lost money. People were going to have to try and save and replace that money.

That's part of the way recessions and the free market correct imbalances.

So there was going to have to be a big, painful, difficult recession when the dot.com bubble burst and George Bush came to power in 2000.

But rather than admit that the Clinton era had been a fantasy, that it was a boom and now we had to live through a bust, President Bush squandered a chance to correct the economy. It would have been a perfect opportunity to repudiate what had happened under Clinton, to expose that we had a bubble and to have taken the necessary steps clean up the mess.

And it had to be cleaned up. It wouldn’t be easy but Bush could have taken the chance make sure the economy faces the consequences that come after a boom.

But instead of doing that, the Bush Administration came out and said ‘we need to stimulate the economy’. We need to fight off this recession.

Sounds familiar, right?

So he wanted an economic stimulus. And what was the economic stimulus we got out of Bush? Deficit spending. Cut the taxes and increase government spending. And Alan Greenspan cooperated and slashed interest rates down to 1%. So we had massive money and fiscal stimulus. Massive inflation, this time in Real Estate.

And what was the result? Well… we blew up another bubble that was bigger than the one that was just burst. And not only was it bigger, it was worse.

And during that shallow recession that we had – and Bush was so proud of that – we also had record car/auto sales.

But where did Americans get all the money for all these car sales and all these home sales?

It didn't come from savings... they didn't have any. There hadn't been any time to set aside any savings after the dot.com bust.

So... what did they do? Well... Americans borrowed it all. And why wouldn't they? The Bush Administration monetary policy that was designed to lure Americans into borrowing.

And they did.

And we went into debt. Massive debt which was used to fund a massive spending spree, the biggest spending spree in history. We borrowed Trillions which we used to built houses, remodel houses, we bought cars, appliances, furniture, gadgets, ipods, cell phones and plasma TVs. All sorts of things.

That massive amount of easy credit also further fueled the irrational real estate market.

Making it all worse was the fact that we didn’t make any of this stuff we were buying... we didn't produce any of it. We just borrowed money to buy it all.

And our trade deficit skyrocketed. We started running $60 Billion a month trade deficits for years. And our savings rate went negative. And it went negative even after the government doctored the books and recalculated how we assess savings.

So we had this huge bubble that was much bigger than the Internet stock market bubble. And of course, the major difference was the leverage involved.

When people bought stocks in the dot.com bubble, they pretty much used their own money. Maybe they had a leverage account, but they still had to put up 50% of their own money down.

So when the bubble burst, the losses were pretty much confined to the people that made the bad bets.

That wasn't going to be the case with the Real Estate Bubble because of the amount of leverage involved with all this real estate and consumer debt.

And you could see it all building through 2002, 2003, 2004 & 2005. It was all so obvious. But like I have said, when you are living in a bubble, sometimes it is hard to see reality for what it is.

Tomorrow: The Real Estate Bubble morphs into a Financial Bubble.

==================

Email: village_whisperer@live.ca

Sunday, March 22, 2009

Peter Schiff: The Internet Bubble

.
Peter Schiff is the President of Euro Pacific Capital and is famed for being the most vocal financial critic who accurately predicted the real estate crash of 2006 and the stock market crash of 2008.

He writes for the New York Time, the Financial Post and makes numerous appearances on all the US television networks. Currently he is predicting serious inflationary consequences as a result of the massive amount of bailout money being pumped into the economy by governments.

His passionate arguments have proven to be highly prescient and are worth taking a look at.

In understanding the current state of the financial and real estate crisis, it is important to look at how it all got started. So I am going to break up his views and start with the Internet Bubble. From that we will move to the Real Estate Bubble, the crash of the stock market, the bailouts and, finally, to his views on what will happen next.

What follows is condensed from a speech he gave on March 13, 2009 to the Austrian Scholars Conference.

The Internet Bubble

When you are living in a bubble, sometimes it is hard to see reality for what it is.

In 1997, 1998 and 1999 we had the NASDAQ bubble and nobody seemed to be able to figure out that these companies that everyone was touting were not worth what people claimed.

They said we were living in a new era and that the internet had captured everyone’s attention. People were saying that everyone was going to buy everything on the internet.

But hang on a second. There was no difference between the internet (and the potential for commerce) and that of a catalogue or a telephone. If worldwide commerce hadn't shifted to catalogue sales or telephone sales, why were they now going to magically shift to internet sales?

What was going to make the internet different?

Yet the valuations coming out for these new companies were huge (and grossly unrealistic). You would have some new company… say doorknobs.com… and they would start up. Now even if they sold every doorknob in the world, they couldn’t possibly be worth the multiples that the company suggested in their prospectus.

Yet once they went public, their value shot up and there was no possible way they could be worth the multiples that the company was now trading at on the stock market.

Somehow it didn’t matter.

And company after company took flight this way. They would come out with a concept. Draw up a prospectus. Go out and get $5 million in start up funding, not because they were worth anything, but on the promise that investors would reap a huge return when they went ‘public’ and listed on the exchange.

It was crazy. Why would people invest in a company that had no land, no assets, nothing!

And the reply was always, ‘you don’t understand the stock market’.

It wasn't about what a company could produce, it was all about the promotion of the stock.

People were sold the malarkey that this was the way the stock market worked with internet startups. And company after company was like this. Many of these companies never made any money at all.

And how could that come as a surprise?

The central premise of most of these internet companies was that somehow it was more cost effective to Fedex every single item currently for sale in the marketplace to a consumer rather than having the consumer come in, buy it and take it home himself.

That’s crazy.

But it didn’t matter. People were getting rich when these companies were listed on the stock market. And they were getting rich, not because the companies were successful; people were getting rich because investors were buying their stock.

And after the bubble burst, everyone realized how stupid it all was.

But within a year of the collapse of the Internet Bubble, we moved seamlessly into the Real Estate Bubble.

Nobody could see that there were any similarities.

But the exact thing that had happened with the Internet Bubble… now starts to happened with real estate.

And we moved so quickly from the unwinding of one bubble and into another that we simply postponed the unwinding of the consequences until now. And we are still trying to postpone it today with all the bailout money being thrown around.

But this time the damage is so great and the problems so huge that I don’t think there is another economic rabbit they can pull out of their hat at this point. We are just going to have to face it now.

Tomorrow: The Real Estate Bubble.

Whisperer Summary: The key point that Schiff is making is that the internet bubble developed because the fundamental law of commerce was ignored. In the bubble, the value of these companies rose due to irrational speculation. The value did not rise because these companies were producing something and providing a return. And when these companies were promoted, they were promoted on flawed and irrational values. It was a giant gamble because they lacked a real 'value-based' foundation. It was gambling. And when the gambling stopped, the values crashed.

==================

Email: village_whisperer@live.ca

Saturday, March 21, 2009

Inflation or Deflation?: A firestorm of debate erupts

.

Last Monday I wrote about the possibility that the US Federal Reserve was opening Pandora's box and unleashing a destructive wave of monetary inflation with their policy moves to deal with the financial crisis.

Through programs known as quantitative easing, the Fed was basically printing money in an attempt to buy up toxic assets.

On Wednesday March 18th, Fed Chairman Ben Bernanke raised the ante with a move that has shocked the financial community. In announcing that they were printing an additional $1 Trillion dollars, the Fed embarked on a course that has NEVER been utilized... they began buying their own treasury bills.

This has touched off a firestorm of debate around the world as to whether it is deflation or inflation that looms on the horizon.

But who is right?

In the Vancouver Sun the debate is hi-lighted in an article titled "Will it be inflation or deflation? Observers are split: U.S. government's injection of new money could overheat the world's biggest economy".

"That's one of the great debates right now," said Douglas Porter, deputy chief economist at BMO Capital Markets. "What is the greater medium-term risk to the global economy -- deflation or an outbreak of inflation?"

Yesterday I wrote that Garth Turner had come out decidedly against the inflation scenario. Today he has somewhat tempered his outlook. In the latest post on his blog, Turner concedes the point I have been trying to make - that the policies of today will lead to an inflationary spiral that contains a poison pill for anyone buying real estate in today's markets.

While Turner envisions a longer time-line, the end result is the same. Dramatically higher interest rates are on the horizon. Anyone buying now and financing at today's incredibly low mortgages rates face a devestating prospect.

The normal fixed-rate mortgage term here is five years, and increasingly borrowers have opted for shorter periods of time, gambling that interest rates will be lower when the loan comes due.

But as Turner notes, "Rates can only move in one direction. Up. Over the course of the next five years, possibly way up. In fact, I’d say it’s a certainty. Central banks around the world have been printing a flood of money to try and stall deflation and revive economic growth. Public debt has exploded, governments have plunged headlong into deficit spending, countries are buying back their own bonds with tax money and banks have been nationalized while the money supply increases. In this are sown the seeds of inflation, once economic expansion continues."

Turner then summarizes the looming catastrophe, "So, if 3% mortgages in 2009 become 11% mortgages in 2014 (that is the historic norm over the last few decades), just imagine the consequences for someone buying a house today. After all, a $400,000 mortgage at 3% costs less than $1,900 a month to carry. But the same loan at 11% has double the payments - $3,850 a month."

The inflation vs deflation debate rages on right now. But even staunch inflation discounters like Garth Turner now concede that dark storm clouds loom on the horizon, storm clouds that could bring economic ruin to anyone holding a large mortgage or who jumps into the market with a large home purchase.

Check out this CNBC roundtable debate on the issue featuring Peter Schiff. Its a complex issue but it is imperative that everyone understand what is going on.

Tomorrow I will try to post a summary outlining Schiff's position.


==================

Email: village_whisperer@live.ca

Friday, March 20, 2009

Inflation: The Case Against It

.
Bank Failure Friday Update: 3 Bank Failures and 2 Credit Union Failures (see bottom of post)


As faithful readers already know, Garth Turner is the author of After the Crash, web blogger at Greater Fool and one of the early Canadian soothsayers who acurately predicted the downturn in Canadian Real Estate.

He steadfastly stood up against critics and warned Canadians about the real estate crash and how it would spread to Canada.

So I asked Garth. What does he think about my concerns of inpending inflation worries?

"Not a credible position", he told me matter-of-factly.

"We are trying to escape the jaws of deflation. There will be no threatening inflation and no rate increses in 2010."

Garth elaborated yesterday on his blog. He thinks the market reaction to Bernanke's decision to dump another $1 Trillion dollars is the manic over-reaction of bullionist's who don't understand the process.

While we may teeter on the cusp of Depression, Garth says that Governments will spend whatever it takes to stave it off, borrowing massive wealth from the future disregarding how the Boomers and their kids in the process. Interest rates will continue to race to zero and stay there.

"GDP will likely be rising marginally a year from now, but that does not mean ugly days will be passing. Far from it. Recession in the real economy – where we work, buy houses and shop – will last for several years. Real estate prices will be lower at Christmas than they are now, will stabilize in 2010, and then flatline for years after that. Jobs will start to reappear by next Spring, but they will come back in dozens after being lost in hundreds and thousands."

"Most significantly, however, is the certainty that what governments are doing to stave off depression will only cause another problem of equal size in the future. And, no, I am not talking about hyper-inflation in a year or two because of the new American trillions. Instead, we are guaranteeing a future of higher taxes, debt-shackled governments, a far less competitive North America and the end of the US empire."


Turner summarizes the bullionist's position as opportunists who are betting that the US Federal Reserve (and other central banks, like the Bank of Canada and the European Central Bank) will buy up government securities and create a honking big pot of money to scare off the deflation demons. The bullionist's, Garth says, are convinced we are just months away from the collapse of paper money as crazed central banks overdose on creating cash.

"Under their scenario, hard assets inflate wildly as paper money deflates. The US dollar collapses, causing the likely demise of major banks. In this world, smart wealth rushes into the only global currency alternative – bullion – sending it skyward, as the rest of us use hundred-dollar bills to buy bread and watch as our life savings are destroyed in a matter of months. Others see real estate, oil, two-by-fours and chickens soaring in value. As that happens, debt fixed in dollars fades as fast as your RRSP, which means mortgages slip away into nothingness, at the same time as interest rates hit 20% or 40% or higher."

And then Garth Turner dismisses the argument. He says, "this is exactly why it ain’t gonna happen. No depression. No hyper-inflation. Both are toxic to human society and would inflict irreparable damage. There is not a sane government in the world (sorry. Zimbabwe) which will allow either to take place. If we tip either way, it will be totally by accident."

Impressive argument. But it begs the question... would any sane goverment have allowed the current crisis situation we find ourselves in, to have taken place to begin with?

Yet it happened and all government can do is react.

As we wait on the FDIC to give us our Bank Failure Friday fix, I invite you to check another oracle who predicted not only the 2006 subprime mortgage disaster in the United States, but also predicted the 2008 stock market crash.

His name is Peter Schiff and he started making the real estate predictions in 2002. Check out this compilation of his interviews on the major American business networks. Co-panelists openly laugh at him, audibly scoffing and gasping at his claims about pending real estate and stock market crashes.

He holds a viewpoint on inflation that is diametrically opposed to that of Garth Turner.

Schiff is adament that rapid inflation will happen and it won't be by accident, leaving govement nothing to do but react.

His views tomorrow.



Bank Failure Friday

Bank Failure #18: FirstCity Bank, Stockbridge, Georgia

From the FDIC: The Federal Deposit Insurance Corporation (FDIC) approved the payout of the insured deposits of FirstCity Bank, Stockbridge, Georgia. The bank was closed today by the Georgia Department of Banking and Finance, which appointed the FDIC as receiver.

The FDIC estimates the cost of the failure to its Deposit Insurance Fund to be approximately $100 million. FirstCity Bank is the eighteenth FDIC-insured institution to fail this year. The last bank to fail in Georgia was Freedom Bank of Georgia, Commerce, on March 6, 2009.

Bank Failure #19: Teambank, National Association, Paola, Kansas

From the FDIC:Teambank, National Association, Paola, Kansas, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Great Southern Bank, Springfield, Missouri, to assume all of the deposits of Teambank.

The FDIC estimates that the cost to the Deposit Insurance Fund will be $98 million. Great Southern Bank's acquisition of all the deposits was the "least costly" resolution for the FDIC's Deposit Insurance Fund compared to alternatives. Teambank is the twentieth FDIC-insured institution to fail in the nation this year and the first in the state. The last FDIC-insured institution closed in Kansas was The Columbian Bank and Trust Company, Topeka, on August 22, 2008.

Bank Failure #20: Colorado National Bank, Colorado Springs, Colorado

From the FDIC: Colorado National Bank, Colorado Springs, Colorado, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with Herring Bank, Amarillo, Texas, to assume all of the deposits of Colorado National.

The FDIC estimates that the cost to the Deposit Insurance Fund will be $9 million. Herring Bank's acquisition of all the deposits was the "least costly" resolution for the FDIC's Deposit Insurance Fund compared to alternatives. Colorado National is the nineteenth FDIC-insured institution to fail in the nation this year and the first in the state. The last FDIC-insured institution closed in Colorado was BestBank, Boulder, on July 23, 1998.

Credit Unions

In addition to the three bank failures, two large Corporate Credit Unions were seized today by the National Credit Union Administration (NCUA): U.S. Central and WesCorp. These two credit unions had a combined $57 billion in assets. The affected institutions don't serve the general public. They provide critical financing, check clearing and other tasks for the retail institutions. These wholesale credit unions, known in industry parlance as corporate credit unions, are owned by their retail credit-union members.

==================

Email: village_whisperer@live.ca

Thursday, March 19, 2009

The Central Issue for Vancouver Real Estate

.

Well, faithful reader. You no doubt tuned in this morning and wondered where the latest blog update was.

What can I say?

I had several real estate items to post, but I have set them aside. In it’s place, a late posting on everyone’s favorite topic… the economy.

Late yesterday morning (2:00pm Eastern time) the US Federal Reserve Chairman dropped a bombshell which had an immediate impact on the stock markets.

How immediate? Check out this graph profiling the performance of a Canadian silver exchange traded fund on March 18th. Look at what happened at 2:00pm.

As you can see, the price of silver was declining, steady. Then Bernanke made his announcement and BANG! The price of a share in the silver fund shot from $14.23 to $15.00… instantly. And it kept going up from there.

This pattern repeated itself in gold, silver and commodities stocks everywhere. And today, the price of Gold shot up over $70 an ounce over and above yesterday's spike.

Bernanke’s announcement?

From the Los Angeles Times, “Chairman Ben S. Bernanke and his peers at the central bank stunned financial markets by announcing two huge steps aimed at driving down long-term interest rates, including mortgage rates: The Fed said it would buy up to $300 billion of longer-term Treasury securities for its own portfolio and that it would expand its purchases of mortgage-backed bonds to $1.25 trillion from the previously announced $500 billion.”

And why did the markets explode?

“As the Fed effectively pumps another $1 trillion-plus into the financial system, critics say it's setting a time bomb for a future surge in inflation -- the classic case of too much money chasing a limited supply of goods and services.”

As predicted last week, inflation is set to become the central story of these times.

And while Bernanke has said he intends to control the threat of inflation by pulling this money back once the economy is on solid footing, there are many investors who don’t trust the Fed, or who don’t feel the Fed will be able to control it.

In 1981, in an attempt to wrestle inflation to the ground, the prime lending rate in this country soared to 22% and the backs of US Federal Reserve policy. If you were to renew your $650,000 mortgage at that sort of rate today (22%), your monthly payment would be $11,412.24.

That’s makes this THE central story about Vancouver Real Estate right now.

Tomorrow a closer look behind the Inflation debate.

==================

Email: village_whisperer@live.ca

Wednesday, March 18, 2009

Semantics?

.

They say advertising can sell anything.

And as we have discussed recently, the media blitz by the R/E Industry is in full swing to convince you that 'now... is a great time to buy'.

And although current statistics for March are still showing sales down by almost 30% from March last year, active listings up almost 25%, and months of inventory up an astonishing 71%; it appears there is a bit of resurgence in the Lower Mainland real estate market.

Some R/E Pollyanna's are even declaring that the bottom of the market has arrived and we are back on an upswing.

The cheerleaders point out that despite the ongoing and dire negative news about the economy and job losses, daily housing sales in the Village on the Edge of the Rainforest average about 100 sales per day.

And in the midsts of those sales come reports that some of those sales are closing with offers higher than the original asking price!

But before we go out and declare a new R/E 'bull run', let's temper the enthusiasm with a reminder that sales are still DOWN 30% from this time last year and months of inventory has shot up 71%.

Perhaps a more poignant reality check for the real estate cheerleaders is the announcement yesterday by MAC Marketing Solutions of a new marketing campaign for the Yaletown condo development 'The Beasley'.

In an initiative called the 'pass it on' campaign, Amacon Development is offering reductions on the prices of their condos ranging, on average, from $100,000 - $250,000 off the initial purchase price.

Remarkably Amacon is also offering the same reductions to the pre-sale buyers of 'The Beasley' who have already committed to the original purchase price.

According to their press release, Amacon reviewed the construction costs they were saving in this down market and readjusted their prices to pass on the savings to the consumer.

"We are in a very different market than a year ago; when we negotiated our construction costs and realized the savings we made, we were happy to pass on that savings to our purchasers. We're putting everything out into the open as we see it's a win-win-win situation," says Cameron McNeill, president of MAC.

It's a shrewd campaign.

But let's face it, if the real estate market was truly rebounding, would Amacon be cutting prices by $100,000 - $250,000?

Do you think - with losses hitting every developer in the city - that Amacon would flush away a profit margin like that just to project an aura of altruism?

The cold, hard reality of the business world is that months of inventory is up over 70% in the Vancouver Real Estate market. Furthermore there is a plethora of new condos coming onto the downtown market this summer & fall.

Competition for the condo sales dollar is going to be intense.

And in the ever-upbeat world of positism that is real estate, a 'pass it on' sale is far more palpable than an 'inventory liquidation' sale.

Doesn't quite project the same stench of desperation that way.

==================

Email: village_whisperer@live.ca

Monday, March 16, 2009

The Great Gamble

Laurel Magri explains her 'other' profession, click to hear.
Yesterday, at Sunday Brunch, the topic of this blog came up, specifically my contention about the coming onslaught of inflation.

Close friends question my 'alarmist claims' that the central banks of so many nations are actually 'printing money' in an effort to deal with the financial crisis.

Fortuitously Fed Chairman Ben Bernanke provided an unprecedented media interview on Sunday night with the CBS newsmagazine '60 Minutes'.

From the interview...

  • "In the crisis, Bernanke had freedom to act immediately - he doesn't need permission from Congress or the president. While they debated on Capitol Hill, Bernanke cut interest rates nearly to zero; then he used Depression-era emergency powers to launch a dozen rescue programs of his own. There was support for money market funds, mortgages, short term lending to small business, and support for auto loans, student loans and small business loans - commitments of a trillion dollars, doubling the size of the Fed's balance sheet.

    Asked if it's tax money the Fed is spending, Bernanke said, 'It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing.'

    'You've been printing money?' Pelley asked.

    'Well, effectively,' Bernanke said. 'And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.'

    He's not kidding about printing money: the Fed issues U.S. currency, which is why it says 'Federal Reserve Note' on all the bills in your wallet. The Treasury Department's Bureau of Engraving and Printing is just a few blocks from Bernanke's office. It prints the money at the Fed's request.

    The Fed's mandate from Congress is to put enough money in the system for maximum employment, but not so much that it sets off inflation."

The reason Bernanke has embarked on this course is clear. As he told 60 Minutes, we were close to a second Depression and addressing it required emergency measures.

In a sense, Bernanke has been preparing for this emergency his whole professional life. He got a PhD in economics from MIT. He chaired the economics department at Princeton, where his specialty was the Great Depression.

He's among many economists who now believe it was the Federal Reserve itself that helped turn the recession in 1929 into a global calamity.

  • "They made two mistakes, basically. One was they let the money supply contract very sharply. Prices fell. Deflation. So monetary policy was, in fact, very contractionary. Very tight during that period. And then the second mistake they made was they let the banks fail. They didn't make any strong effort to prevent the failure of thousands of banks. And that failure had terrible effects on credit and on the ability of the economy to right itself," Bernanke explained.

So there you have it, right from the horses mouth. The Fed's intention is to print more and more money knowing that it will trigger inflation and stave off the deflationary cycle we were plunging headlong into.

So is Bernanke worried about unleashing the inflation genie?

No. As Bernanke says in the interview, he believes he can control it. When the economy begins to recover, the Fed will wrestle inflation to the ground by unwinding those programs, raising interest rates, and reducing the money supply.

It's a huge gamble because despite Bernanke's confidence, the inflation genie is an economic Pandora's box.

According to greek myth, Pandora had been given a large jar and instruction by Zeus to keep it closed. But Pandora ultimately opened it. When she opened it, all of the evils, ills, diseases, and burdensome labor that mankind had not known previously, escaped from the jar, but it is said, that at the very bottom of her box, there lay hope.

In their desperation to find that hope, the central banks of the United States, Canada, Britain, Japan, China and Switzerland have opened that box.

We have been down this road before. In the late 1970s the inflation genie was unleashed and it ravaged the economy by inflating consumer prices at an annual rate of 13.5%.

While the circumstances and causes were different from today, the fact is that when when the Fed finally took decisive action... interest rates rose dramatically.

The US Federal Reserve Chairman of the day, Paul Volcker, is widely credited with ending that inflation crisis of by employing the proposed measures Bernake is now talking about - particularly by raising the federal funds rate.

The federal funds rate shot up to an average 11.2% in 1979, was raised by Volcker to a peak of 20% in June 1981. That year the prime rate for banks shot to 21.5%.

Paul Volcker is now Chair of the President's Economic Recovery Advisory Board.

It doesn't take a rocket scientist to see what advice Bernanke is receiving on this crisis. Bernanke believes he can quickly shut off the tap and reign it in before it becomes a problem.

Beware the law of unintended consequences.

Even in a perfect world, when inflation takes off, you will see a dramatic hike in the interest rate in an attempt to immediately wrestle it to the ground.

And if the genie doesn't go back into the bottle right away, that rate could well shoot up higher than it did in 1981.

That's what is scaring the pants off of savvy investors right now.

Oh btw... if you were to renew your $650,000 mortgage at an inflation period rate of 22%... your monthly payment would be $11,412.24.

Like the Real Estate Industry says, "It's a great time to buy", isn't it?

They best pray Bernanke doesn't burn all of us as he plays with fire.

==================

Email: village_whisperer@live.ca