Quantitative Easing Sucks

The term Quantitative Easing is familiar to everyone. It is now referred to as QE followed by a number. What is it? It is printing money! It’s a little like the euphemism, “Used Dog Food.” It doesn’t sound bad until you give it some thought.

Did gold jump 100 dollars, or did the Bernanke dollar lose value? We have a President that thinks that the banks, Wall Street, and the rich people of this world are responsible for the current mess we are in. And by God we will make them pay Rah! Rah! A President chooses to tax the rich as a way out of this mess? I don’t follow it.

Congress has always taxed the rich; no need to wave a flag while doing it.

No cost of living increase this year, just like last year, for Social Security recipients. That could make for an interesting election next month. The checks don’t go as far as they use to, especially when the government removed food and energy from the cost of living index. The only things still left in the index are Denture-Grip, Preparation-H and Desenex Foot Powder and that pretty much covers everyone from head to toe (from a government perspective).

This quantitative easing by the government is keeping interest rates artificially low. Even the retirement funds which depend on interest rates for their income are being hurt by these unrealistic low returns on bonds. (Double click on image below for a larger view)

Notice that the CALIPERS figures above are a few years stale and the present discount rate is nowhere near 4 percent. These figures suggest that they are still trying to lock the barn doors after the barn has burned to the ground.

Gold and silver use to be a very poor investment (they still are). They pay no interest but they tend to keep up with inflation. Cash is getting no interest in the banks (if you count in inflation). Of course that light bulb goes off in your head saying "borrow cash and by gold." Do you run with the herd? Caution could be the word that wins the day. A buying frenzy here, could result in government intervention.

Gold and silver are increasing in price. Is this the last bubble in town? Or maybe it’s just a reflection of the true value of the dollar. Quantitative Easing is the name of the game and everyone with paper dollars gets to play (shh ---it’s only a tax on our savings).

The Freddie and Fannie Scam

So you want to buy a home. Where do you get the financing? Aren’t Banks just dying to loan short term funds at long term interest rates? Remember back to the Savings and Loan Crisis of the 1990’s, the Savings and Loan companies loaned short term funds at low long term rates. It worked great, until interest rates rose. It’s pretty hard to believe that banks today would venture to write 30 year paper at the lowest interest rates of the last 50 years. So from here, we can pretty well deduce that they won’t even attempt it.

Say you want to sell your home, the question arises, “sell it to whom?” There is no bank financing out there. What bank is going to do a home loan at 4 percent for 30 years when they can do a car loan for 7 to 9 percent for 5 years? Home loans are a lost cause. Of course, the car market isn’t on fire either, but on the other hand,  Freddie and Fannie are obligated to guarantee new home loans.

But wait one moment; it is different if you want to buy a home. Fannie and Freddie have a home for you with financing. Now how is that possible? They offer very low interest rates, with little or nothing down. The only catch, you have to buy one of their homes. The Federal government doesn’t have to write any new paper, they already own the homes, they guaranteed the loans.


The government people in charge of selling these Freddie and Fannie homes are unloading them onto anyone that can “qualify.” Remember way back in 2006, everyone was fogging a mirror, I guess this time it’s different. They even get to take it off their books once a payment is received. Of course, you have to remind yourself, all they’ve done is gotten someone else to take over the payments on a non-performing loan. Notice each sale reduces Fannie and Freddie's inventory. It’s kind of like selling life insurance in the suicide ward of a mental hospital—there is no problem with sales, but can you afford to stay in business?


Basically what we have here is a government program/scam that keeps prices artificially high by providing government financing at very low interest rates at prices close to what the home originally sold for. This way the government limits its losses on the GSE’s at the expense of the new home purchaser. The trouble with buying a Fannie or Freddie home is the fact that there is no real market, it is all artificial. The new owners have no skin in the game. These GSE’s are  praying for a miracle and increasing unemployment, is not the miracle they had in mind.

The quality of these new buyers is suspect, not to mention the price’s of the homes or the very low interest rates. And then there is that invisible inventory, I guess that’s the stuff that Fanny and Freddie don't own.

What would happen if the Congress tossed those two hookers (Fannie and Freddie) out in the cold? The taxpayers wouldn’t be buying any more homes in Detroit to bulldoze down. The present setup, is a little like charging a $1000 massage on your Visa card -- When your wife sees the bill, you get to pay for your mistake twice.

Disasters Without Damage

Take an earthquake or hurricane, homes are destroyed and the infrastructure is broken. No lights, no gas, no food deliveries. Transportation cannot move and services are disrupted. A person could be stuck in their home for several days to a week. Emergency hospital care would be limited. Food and supplies pour in from unaffected areas.

Let’s picture an "Invisible" disaster. Suppose the value of our currency fell to zero. Money became worthless. At this point, is there any reason for a grocery store to stay open? Would the employees work on faith? Would gas stations feel the need to sell gas for the old dollars? Would the truck transporting toilet paper from Georgia to Los Angeles feel obligated to deliver it, if he couldn’t buy diesel fuel in Kansas? The supply of necessities to a  city would be a major problem. No cash, no product. Plus what would consumers use for currency to pay for it with, even if it was delivered?

In a real disaster, everyone is prevented from doing their job because of barriers created by the disaster. In a financial meltdown, it is a little different. Food and gasoline deliveries to major cities would stop. Why go to work, they can’t pay you. Since money would not buy anything, there would be looting. If you can’t buy it, steal it. The banks would be hit and your safety deposit box trashed. Figure that after two weeks of fires and looting, the National Guard would have a handle on it. There will be no fire department, police or ambulance service.

We take for granted the aspect of plastic credit cards and the concept of what is cash. An IOU is not cash. A credit card is a promise to pay. If the financial system collapses, it doesn’t matter how sincere your promise is to pay, it just won’t happen and it is no fault of the sincerity of the user. Of course this just can’t happen—can it?

With the collapse of the dollar, the government would have to print a new currency. Credit cards would be non functional. Banks would have title to assets like cars and homes, so not all depositors’ dollars would be lost. How fast the new currency could be deployed is a real question. Could people work at their present jobs without pay for two weeks? Without gasoline sales, most people couldn’t do it.

The only good thing about a currency collapse is that the nation debt would also be vaporized (If you are owed money, you get to cry). From there, it would be no big deal for the new government to hand out five thousand dollars to everyone to help kick start the economy and the country. The only trouble would be how to value this new currency. It would have to have a perceived value, otherwise how would one determine a fair price for a gallon of gas or a pack of smokes? At this point the government is going to have to pick a commodity or basket of commodities as a reference point of value. Gold and silver come to mind. Would the new dollar be worth an ounce of silver? Would your weekly paycheck equal an ounce of gold? [insert your guess here]

The thing not realized so far, is the fact that this whole discussion has been structured under the assumption that everything will be orderly. What happens if it is not? Social Security, all retirement benefits, and bank savings would be gone. A lot of people would be very upset to say the least! Bastille Day comes to mind for some odd reason. Would we still have a Democracy?

This article might seem like a lot of gloom and doom, but the scenario above, could be the reason Congress decided to spend a trillion dollars of nonexistent TARP money to keep the game going. What the hey, it's only paper money.

When you think about it, a financial collapse can be worse than any event ever thought up by mother nature,  it doesn't do any physical damage. It doesn't try to kill you, but rather just ruin your retirement and that just might kill you or make you mad enough to [fill in the blank/blanks].

Unintended Consequences (Reprinted)

Here is a reprint from April 10th, 2008 that I added a few paragraphs to that still hits home.

In 1939 we had “Appeasement” to keep from fighting a war with Germany. It kind of worked for a couple of years; we still had a war, but if we had nipped it in the bud, it would have been small. World wars tend to be large.

Congress gave a subsidy for growing corn to make ethanol, and the price of beef went up. Turning food into fuel is pure lunacy (IMHO). The funny part is the subsidies more than make up for the unprofitably of the venture. God bless Congress for their infinite wisdom, their group stupidity will kill us (if their kindness doesn’t). I would like to see the gas stations give you the quart of ethanol instead of mixing it in your gas. You’d be able to fill your tank and get tanked. The DUI would be an unintended consequence.



The Fed dropped the interest rate when the stock market took a dive in 2001 and the real estate market took off. The solution to one problem created a new problem; of course everyone knows that real estate has hit “bottom.” The Fed bailed out Bear Stearns and God knows where that is going yet. Ben’s 30 billion dollar loan will buy a lot of “Blue Sky” (assets with intangible value). B of A is about to throw away the sucked out dry carcass of Countrywide. I guess they get to keep CW’s loan servicing department. This outcome however, was far from unintended.

Congress a few years back passed a law that allowed farmers to depreciate heavy farm equipment over five years. Every business in the US bought a Hummer as a 50K write off! A great business expense when gas was $1.50.

Three paragraphs following, added September 26, 2010

Congress enacted a fine on airlines that could cost them a couple of million if they left a plane waiting the the tarmac for 3 hours. The net result,The airlines eliminate the possibility of a fine by canceling the flight. It's very upsetting to fly into Chicago and find out your flight to DC has been canceled--I remember it well!

Obamacare prevents insurers from putting caps on medical payments for children. The net effect, insurers will stop offering coverage for kids.

A few years back the Georgia legislature passed a bill against abusive loans by banks. The net result, you couldn't find a bank to borrow money from to buy a home, in the state of Georgia. That got fixed rather fast.

We need to accept the idea that the solution to one problem creates a new problem. If that wasn’t the case, we would have solved all of humanity’s problems hundreds of years ago. Once you realize this, you begin to understand politics. The problems are real, but the solutions are only trade offs. The whole mess will sort itself out with or without any intervention. Intervention will not change the final outcome.

It reminds me of the saying “give a man a fish and you feed him for a day, Teach a man to fish and you feed him for a lifetime. The unintended consequence here is you have a couple of guys in a boat drinking beer all day. The additional unintended consequence is a mad wife with a frying pan waiting for her drunk husband to crawl home. Ouch!

The Tax Cut, a Carrot on a Stick

Obama wants to raise taxes on the rich but not the middle class. Is it really a bright idea, to piss off the rich by singling them out? It is kind of like a pick-pocket walking up to you and telling you he is going to steal your wallet; at that point he has little chance of success. It sounds like a great statement to the masses, but when you look at the Health care bill that just passed, whose going to get the bill for that (I give you one guess)? So if you are rich, what do you do? Hop on your jet and move to the Bahamas where tax laws are nonexistent? Hmmm Of course I will have to admit, people who get rich quick assume it’s because they are more intelligent than those around them. That mistake can cost a lot if you buy the multi-million dollar homes and the toys that go with it. There is high tax maintenance on all of that stuff. The “Look at me, I’m Rich,” game cost money to play--- I’m just glad there are people out there that enjoy playing that game.

Obama’s idea that we are coddling millionaires is ludicrous. When I was a kid, the average wage earner might earn a quarter of a million dollars in a life time. Millionaires today are a dime a dozen now. Many people I have bumped into have matter a factly mentioned that they are millionaires. I don’t know who they are trying to impress, but when my dad earned 5K a year and our home cost 25K, a million dollars was something. In today’s world, the “air” part of millionaire is the only real part. Not too long ago a million dollars in the bank would earn 100K in interest a year and there were taxes to pay; but at 2 percent interest, your return from the bank is a paltry 20K. Many a person saving for retirement needs to consider the fact that a million dollar nest egg isn’t much if you end up in a rest home at 70k per year ( that goes double in spades if you are married). It will only last about 8 to 12 years. The concept of being a millionaire hasn’t lost its luster in the mind’s eye; everyone overlooks the reality that the bar has been moved up to billionaire, and that of course has nothing at all to do with inflation (cough cough).

If these George W Bush tax cuts expire, the rich escape,  the middle class gets hit and the poor get a free ride. And the funny thing is, it happens without Congress doing a damn thing; everyone’s taxes return to pre-Bush rates (Is "pre-Bush," "Democrat" spelled backwards?). The concept of making a tax cut permanent, runs against the grain of Congressional job security; it would be the last tax cut we would ever hear about. This way the tax cut expires and Congress can vote again to cut taxes.  It's a little like a furniture store holding their annual "Going out of Business sale," only in this case, Obama wants the rich people to pay full price. I guess millionaires don't shop at Walmart, do they?

Educational Loans, Student Slavery to a Bank

It school time, and a lot of our sons and daughters have headed on to college. This is where parents and the young who wish to improve their station in life seek out college loans to finance their great quest. Whether it is a trade school or college, the government will co-sign on these loans. What most people don’t realize is that a college and a trade school are businesses. Without customers who can pay for the services to be rendered, they cannot survive. Student loans are the life blood of higher education and more so for the fly-by-night trade schools.

There is one little snag to the whole warm and fuzzy idea of higher education. Nowhere does it say that you will be offered or even find a job after graduation. The other thing not mentioned is that your field of study might be flooded with graduates or technicians already looking for a job, X-ray technician and dental assistant come to mind. You might not like the idea of moving to Montana, Wyoming or Tennessee, they are not the greatest places if you’re single looking for a wife. Plus usually the single mom with kids, looking for a new career gets cornholed into a trade school that spits out plenty of hope but no real jobs.

So here is what happens, the student applies for these student loans and gets everyone of them. Your kid can run up 20K a year on student loans. So it is not uncommon for a college graduate to have 80K (or more) in student loans and the payments start 6 months after you graduate. Sounds just great doesn’t it, but what happens if you can’t find a job? Once you sign that promissary note, you can never file bankruptcy and wipe that student loan off of your slate. It follows you for life.

Here is a little story of what happened to me many, many years ago at Syracuse University. I graduated in June of 1971. My student loan came due six months after I graduated. The bank sent me a letter with a promissory note to sign for all of the money I had borrowed. The amount was for $4,000 which by today’s standards would be about $40K (inflation—go figure!). As a young padawan, I read the note and several things stood out. (This is from memory, so the wording is not legalese and it has been a long time—39 years) My debt to them was to be paid first even if I filed for bankruptcy. I thought that a little unfair if I owed money to other people, I thought everyone should get a slice of what was left. Then there was a passage that said if the US government no longer existed, I would owe the money to the new government. I thought that a bit strange also. Anyway, there were three lines of verbiage that I did not like, and took a ruler and a pen to and crossed them out. I signed it and mailed it to the bank. They called me and asked me to come down to the bank and I did. When I got there, they informed me that I couldn’t cross out items on their legal agreement, they wouldn’t allow it. The bank manager was saying “You can’t do this!” I explained to him that I already received the money, spent it, and if he didn’t like the agreement, I wasn’t going to sign another just to please him. They defaulted my loan even though I had never missed a payment.

To make a long story short, I paid the interest on the loan every month for 10 years. About that time I was making more money and they called again to see if I would increase my payment. I had been talking to this collection agent for several years and I asked him what the payoff was? He said something strange, “Offer 50 cents on the dollar and see if they take it. So I offered them $1,500 to pay off the $4,000 note and they countered with $1,800. I wrote them a check.

I don’t know if things are still the same, but when Congress offers money to students and these loans are excluded from the bankruptcy laws, they have enslaved our college students to the banks. My advice to students who receive a promissory note to sign, tell the bank to go fish. You already have the money. All they can do is ruin your nonexistent credit rating.

I'm not suggesting that college students walk away from their obligations. But the right to file bankruptcy would make these lenders think twice about the amount of money they would lend to a teenager who has never held a job.

Bankruptcy is a way we can preserve our right to prove to Congress that we don’t have to pay for their bumbling stupidity. College should be the door that opens to new opportunity, not one that leaves students prey to their trusting naive innocence.

Where's the Money?

A while back Congress came out with the 814 billion dollar stimulus program. In essence they borrowed money to pay others who lost money in the grand scheme of investment finance. Today Obama announced a 50 billion dollar work program. Isn’t it missing a zero? It seems rather paltry. And then on top of it he blames the Republicans for our current economic plight because they are opposing his plans for the country. From my vantage point, it looks like the Republicans only have an issue of how do we pay for all of this. It’s a little like taking 10 of your friends to a massage parlor and telling the Madam that the last guy is paying. If the lady of the house is a Republican, the last guy with the money, is going to move to the head of the line—naturally of course he can’t find his wallet.

The Democrats are beginning to look like dead beats in a restaurant with no money,trying to stall for time by ordering another entrée. The New York Times today suggest that the government should let the housing market collapse.

“Housing needs to go back to reasonable levels,” said Anthony B. Sanders, a professor of real estate finance at George Mason University. “If we keep trying to stimulate the market, that’s the definition of insanity.”

The further the market descends, however, the more miserable one group — important both politically and economically — will be: the tens of millions of homeowners who have already seen their home values drop an average of 30 percent.

The poorer these owners feel, the less likely they will indulge in the sort of consumer spending the economy needs to recover. If they see an identical house down the street going for half what they owe, the temptation to default might be irresistible. That could make the market’s current malaise seem minor.

Caught in the middle is an administration that gambled on a recovery that is not happening.

And then we have all of this stuff exploding around us, absurd government salaries, retirement benefits and States going broke. Unemployment is doing just great; too bad it’s not a stock. Most graphical comparisons to historical statistics are off the charts. One news article the other day, called this, “The worst recession since the Great Depression.” When you think about it, most things in life, start out small and get bigger. So we started out with a “small” recession and now it’s getting bigger.

The Democrats think that the solution lies in bigger government and increased spending. The Republicans are not quite so sure. The elections are coming up in November and they could prove quite interesting. California could be the state to watch Jerry Brown Dem vs. Meg Whitman Rep; one’s too old and the other’s too rich. The present Republican Governorator has been giving the Democratic legislature a wedgie, still no budget for the fiscal year that started in July.

The State of California will be writing IOU’s in a couple of weeks. I wonder how that works if your paycheck is direct deposited? The electronic transfer of an IOU to your bank account?? It looks like Halloween pranks are a little early this year.

Interest Rates Suck Big Time

The going joke is “If you ask 3 economists their opinion on the economy, you get 5 different answers.” The question arises today, if economists have inside knowledge to the economy, why didn’t they spot this mess coming years ago?

And then we have the question will it be inflation or deflation. Out come the experts with all sorts of graphs and charts pointing to deflation. Meanwhile I went over to Wendy’s for my 99¢ bacon cheeseburger today and the price is now $1.29. That’s a 30 percent increase. And if that wasn't bad enough, my Gin went up a dollar to $14 for 1.75 liters (I'm not sure that at that price it is considered Gin, rocket fuel might be a better description).

The real question is this, the government borrowed 10 trillion dollars from all of us and we feel comfortable loaning it to the government for only TWO PERCENT INTEREST. I’ve heard of The Dumb Friends League, but investors aren’t dumber than pets, are they? What gives?

Borrowed money is one thing, printed money is another. When Ben buys one of Geithner’s T-bills, that is printing money (the Treasury sells Bernake a T-bill and the Treasury gets a bank entry for cash in the government account). No real dollars are printed; from there, the government just prints a Social Security check or an unemployment check. Of course, the government can tax and the Treasury can redeem Tim's markers at any time. The real question comes up, how much in markers does the Federal Reserve hold? I’m guessing, anywhere from 2 trillion to 10 trillion dollars. Just the management of Freddie and Fannie implies about 3 trillion right there. What they bought from the banks could be a rather absurd amount, possibly mind boggling. No saver has lost a bank dollar, but our government had to pony up printed dollars for the losses on all the failed banks' ledger sheets.

Look at it a different way, say you have one million dollars in the bank. Gee, that means you get 20k a year in interest. Let’s not all queue up at once to take advantage of this wonderful offer. It sucks so bad, why even put your dollars in the bank? Why not just spend it?

The government has printed money, borrowed money and spent every bit of it. The only reason there is no apparent inflation with interest rates is because the government has taken risk out of the market, all bank loans are insured against loss. Without risk, there is no need for higher interest rates. Of course one issue pops up. Gold had one hang up, it paid no interest. Today looking at long term, GOLD is better than holding government paper.

Ask yourself one question, where will the money come from to pay for all of the health care and Social Security benefits in the future? The money isn’t there; it will have to be printed. We couldn’t pay for it as individuals. What makes it more affordable as a government plan? Do we charge everyone a fair share for all of these new benefits? That doesn’t seem very likely. The absurdity of zero percent interest rates and a national debt towering over 13 trillion dollars should set off an alarm bell somewhere. Credit cards are charging 14 percent. No discount for taxpayers???--kind of figures doesn't it.

The thing we need to interpret from this mess, is that the information we are getting from our government is incomplete. The pieces of this puzzle are all there and they do not fit together as expected. Zero interest rates are similar to a hooker offering free sex. How you ended up in a closet nude, with your hands tied behind your back, is another story.

The Impending California “Bankruptcy”

The State of California taxes its residents and provides services. The legislature which has a Democratic majority can’t quite come up with a two thirds vote needed to raise taxes (two Republicans need to vote with them). And of course since the Governor is a Republican, it’s all his fault. The State is running out of funds; expenses are greater than the incoming taxes.

One thing little noticed, in the last 20 years, because it has been so gradual, is the absurd rise in pay and retirement benefits for public employees. It used to be that you got your experience in the public sector and then moved into the private sector for a pay raise—government jobs used to be a joke.

Presently, we have a State that can’t produce a balanced budget without "creative accounting." The thing to remember is that California is supposed to pay education and bond interest first out of the tax revenues. Then there is this State retirement plan called CALPERS.

CALPERS assets dropped from 260 billion to 180 Billion in a span of one year. At the time, 260 billion was sufficient; dropping to 180 billion ought to set off an alarm somewhere. The implication here is that the State guarantees your retirement even if the investors at CALPERS screw up. These money managers bought boat loads California Nevada and Arizona real estate paper. All we need now is a stock market crash and CALPERS will be sucked down a drain. It is assumed the taxpayers of California will be responsible to make up the shortfall of the CALPERS fund. Profits belong to the retirees, losses belong to the taxpayers. That’s not quite right.

Two questions arise. CALPERS took some horrific losses; are these losses automatically insured by the California taxpayer? If the cities/counties declare bankruptcy, is the State liable for their incurred losses? The answer is no in both cases.

Here is where things could get quite peculiar. Bankruptcy laws don’t cover States. California as a State can’t file for bankruptcy (it doesn’t have to), but every city and county in the State can. Bankruptcy is a tool used by many to avoid paying their debts. Stating matter of factually that the State cannot file for bankruptcy kind of implies that the State is on the hook no matter what, and that is a very wrong assumption.

States can repudiate their debts, it happened in the 1840’s. The real issue is state sovereignty. The concept of bankruptcy revolves around the settlement of debts through the courts. The courts can’t force the State to do anything. The 11th amendment prohibits citizens from suing the State.

California created a retirement fund that guarantees benefits according to the wage earners salary and not on what the fund has available to pay out. These two facts point to the obvious, you can’t have it both ways. That and the 40 billion dollars that the State needs to keep going next year means that California is at the end of its rope. California will run out of money soon.

If the State is short of funds there is no bankruptcy dodge, it can decide who gets paid and when. California doesn’t even have to repudiate the debts; it just doesn’t pay them all. Investors will find out what the implications are, when loaning to a sovereign State. You can’t sue them. Plus if you’re a city in trouble, file BK and give your debts to the State, chuckle, chuckle.

With CALPERS, California will contribute its designated percentage for this year’s wages to the fund. But from there, CALPERS is toast. The State is not obligated to bail them out. So a lot of these 100k retirement plans now have some issues. The item that amuses me, does CALPERS have sovereign immunity just like the State?

Things are getting a little dicey; reality and retirement are on a collision course. It reminds me of the airline pilot who use to email me, he had a future 80K pension and bought a 300K house just before retiring. When his airlines came out of bankruptcy he had a 40K pension and lost the house.

The Great Depression of 2006—seems like a start, and it is 2010 and the show has hardly begun—everyone is dragging their feet, and I don’t blame them. I hate to contemplate what's next.

Karl Denninger has also written some material on this. Here is a link to it.

Inflation the Path to Future Deflation

There are two ways a government can tax. The obvious way is with taxes, and the other way is by printing money. We hear all of this hoopla of “Tax the rich.” I can’t quite figure that one out. First of all if you’re rich, you don’t need to work and there isn’t much the government can tax except for your toys, like mansions, fast cars and yachts. Now if you’re earning quite a bit of money, then the government could get a good share of it. Of course that’s assuming that you’re dumber than a sack of rocks.

Here is a quote from the WSJ by Arthur Laffer

Just look at Sen. John Kerry’s recent yacht brouhaha. He bought and housed his $7 million yacht in Rhode Island instead of Massachusetts, where he is the senior senator and champion of higher taxes on the rich, avoiding some $437,500 in state sales tax and an annual excise tax of about $70,000.

(WSJ Aug2, 2010 page A13)

The government can try to levy a high income tax on the rich, but it will fail miserably. A tax accountant knows all the loop holes that the rich can use to their advantage to avoid taxes.

Inflation is one invisible tax that gets into everyone’s wallet. The eerie thing, is the poor (those living from paycheck to paycheck) never really experience the full blast of inflation. Those saving for retirement get hit the hardest 20 years down the road.

Figure an average taxpayer paying 20% in income taxes. His savings is being taxed by inflation rate of about 6%. Neat! huh? And the über rich, with bundles of dollars in the bank, are being taxed while they sleep. In 12 years they will have lost half their purchasing power from inflation alone. Of course if you’re unemployed and broke, you’re not very concerned about taxes or inflation.

In a depression unexpected things happen. Increasing tax rates brings in less revenue. Plus unemployed people generate less tax revenue. At this point, the government has to print more dollars to cover the short fall. It is the same with private business, the fixed costs are still there, the profit isn’t. This is where the herd gets thinned out, only the strong survive. Private enterprise can’t print their way out of this mess like our government can.

The quasi appearance of deflation will show up in items that we can do without; fast food, cable TV, Internet, sports tickets, advertising. The reduction in price of a taco at Del Taco from 59 cents to 39 cents is the final step before bankruptcy---sell them a taco and hope to make a buck on the soft drink. What we are looking at are institutions, that relied on a wild spending economy, to survive. Business models are collapsing. Can a basketball team afford to pay a superstar 16 million if the fans and advertising drop 50 percent? Do we need a Starbucks coffee shop spaced every half mile?

And with public services, we found out here in San Marcos what happens when everyone got together and cut down on water use during the drought, we got charged more for consuming less!

The real thing that bothers me is that the country as a whole is oblivious to the fact that the national debt is drastically out of whack. It’s the concept; “We did it yesterday and it worked, let’s do it again today.” Collectively we have 17 trillion in savings, and the government has borrowed and spent 13 Trillion of it. This is one of those plans that work until it doesn’t.

The deflation that we seem to be experiencing is coming from over capacity. Too many homes, too many restaurants, etc; lack of consumption is about to fix that. The inflation out there is real. My paycheck is buying less and less every day. The neat thing about inflation, the government doesn’t have to collect it as they do with taxes. Inflation generates more taxable income. The government finds it easier to pay off hard earned borrowed dollars with inflated ones in the future.

Real deflation (massive debt destruction) is still possible with this out of control unfunded government deficit spending. All it would take, is for interest rates to hit 8% and Uncle Sam would be insolvent; the national debt bubble would pop. Vaporizing 13 trillion in debt would be equivalent to what happened during the Great Depression. So its full speed ahead, the national debt be damned. We’re not sure where we are going, but we’re making excellent time.

Inflation, It's There Somewhere

We went to Berkeley last week to see where my son will be going to college. The two pictures below are of a parking meter that was a block from the campus.

Notice the rates in the second picture. Two minutes for a nickel and a dime is good for 4 minutes (minimum transaction is 30 cents). The thing that surprised me was that it also accepts credit cards. Three of the cars parked in front of this "Revenue Raising Tax God" had handicapped tags swinging from the rear view mirror. If you're handicapped, you don't have to pay. Notice the bicycler chained his bike to the machine.

You have to wonder about this 12 minute minimum charge. The nearest public restroom is a 6 minute walk (if you know where it is).

30 years ago, a quarter would have bought an hour of time on the meter. Now it buys 12 minutes. So the quarter buys only 1/5th of what it used to. Put another way, our dollar has lost 80 percent of its value in 30 years.

The dollar's devaluation has been very gradual and spread out over time. California is about to raise the state sales tax to around 10%. If you study history, you'll notice that the sales tax was started during the Great Depression as was Social Security. These two taxes are approaching absurd levels and now we will face a health care tax.

Here we sit arguing over whether or not we are going into inflation or deflation and the real question is; have we had enough of incompetent government yet? The Mayor of Bell California was getting $787,000 until it was put in the press. The price tag for running a photo red light in California is $400, thats enough to start a divorce among young newlywed couples.

I would like to suggest that the reason we haven't seen any inflation is because of the obscene salaries of many people, they can't spend it that fast so they put it in the bank. As long as it is in the bank, there is no inflation effect, if the bank can't find anyone credit worthy to loan it to. Of course the little people like you and me don't have to worry about how to keep $250,000K FDIC insured in a bank (we don't have it to begin with).

Bernanke's goal is to stave off deflation. It's kind of like him going into a "house of ill repute" and slashing rates 50% and claiming it will bring in more business. He's right, but he's wrong. You'll get more business, but it is business you never wanted to see in a lifetime. Common sense rules when you have to work for a dollar the hard way. It is a shame that the government doesn't do it's COLAS off of hooker revenue. Minimum Social Security might approach 100K a year.

It's Never Been This Bad Before (Reprinted)

I've been on vacation the last 10 days. This is a reprint from January 16, 2008 that is worth a second look.

Here is a little bit of history. It gives you an insight into real estate during the Great Depression from people who lived through it. Quoted from: http://xroads.virginia.edu/~HYPER/ALLEN/ch11.html

By 1927, according to Homer B. Vanderblue, most of the elaborate real-estate offices on Flagler Street in Miami were either closed or practically empty; the Davis Islands project, "bankrupt and unfinished," had been taken over by a syndicate organized by Stone & Webster; and many Florida cities, including Miami, were having difficulty collecting their taxes. By 1928 Henry S. Villard, writing in The Nation, thus described the approach to Miami by road: "Dead subdivisions line the highway, their pompous names half-obliterated on crumbling stucco gates. Lonely white-way lights stand guard over miles of cement side- walks, where grass and palmetto take the place of homes that were to be .... Whole sections of outlying subdivisions are composed of unoccupied houses, past which one speeds on broad thoroughfares as if traversing a city in the grip of death." In 1928 there were thirty-one bank failures in Florida; in 1929 there were fifty-seven; in both of these years the liabilities of the failed banks reached greater totals than were recorded for any other state in the Union. The Mediterranean fruit-fly added to the gravity of the local economic situation in 1929 by ravaging the citrus crop. Bank clearings for Miami, which had climbed sensation- ally to over a billion dollars in 1925, marched sadly downhill again:

1925.............................$1,066,528,000
1926................................632,867,000
1927................................260,039,000
1928................................143,364,000
1929................................142,316,000

And those were the very years when elsewhere in the country prosperity was triumphant! By the middle of 1930, after the general business depression had set in, no less than twenty-six Florida cities had gone into default of principal or interest on their bonds, the heaviest defaults being those of West Palm Beach, Miami, Sanford, and Lake Worth; and even Miami, which had a minor issue of bonds maturing in August, 1930, confessed its inability to redeem them and asked the bondholders for an extension.

This next bit discusses the dire straights of many states in 1933: Pg 285 America’s Great Depression by Murray Rothbard. Quoted from Agricultural Discontent in the Middle West, 1900-1939,Wisconsin Press 1951 p.448

As in most depressions, the property rights of the creditors in debts and claims were subjected to frequent attack, in favor of debtors who wished to refuse payment of their obligations with impunity. We have noted the Federal drive to weaken the bankruptcy laws. States also joined in the attack on creditors. Many states adopted compulsory debt moratoria in early 1933, and sales at auction for debt judgments were halted by Wisconsin, Iowa, Minnesota, Nebraska, and South Dakota. Governor Clyde Herring of Iowa asked insurance and mortgage companies to stop foreclosing mortgages. Life insurance companies protested that they were being very lenient, yet in many areas the courts would not enforce foreclosures for insurance companies, enabling many borrowers arrogantly to refuse to pay. Minnesota forbade foreclosures on farms or homes for several years.

So we can say without a doubt that we have never seen anything like this, but it did happen here about 78 years ago. We could be on our way to an experience of a life time. Are you ready?

We Have Been Here Before (Reprinted)

Reprinted from 2/1/07.
Today we read that the savings rate in the US has dropped to a negative one percent. It is also mentioned that it hasn’t been this bad since the Great Depression years of 1932 and 1933. The following is an article from way back when, that appeared in the Saturday Evening Post, CCV (November 5, 1932), pp. 3-4 titled" What about the Banks." It was written by Frank A. Vanderlip, former president of the National City Bank of New York. Bear in mind that 1932 was three years into the Great Depression. So if we carry forward to today, this would have appeared in the future year 2012. So we are not really where he was at, when he wrote this.

The present economic disturbance has been so severe that it as make even some changes in our language. No longer is it an apt metaphor to say that anything is “as safe as a bank.” The word “securities” has almost become obsolete. An investment that drops in price to a tenth or, perhaps, even to a twentieth of its former range is not a security; it is a jeopardy. The page of stock-and-bond quotations might well be headed Quotations of Risks and Hazards. To call them securities in the light of their fluctuations is ironical.

In 1720, a financial debacle added to the English language a phrase which has persisted in common world-wide use for two centuries. A hopelessly exploded financial venture is to this day called a South Sea Bubble.

The South Sea Company in its time was the rival of the Bank of England. It was the ambition of the Tories that it should supplant the Bank of England. When the bubble burst, the extreme decline in the price of the stock was from 1,000 to 135. The company withstood the shock, however and continued in business for eighty years.

Here is an example from out own times: United States Steel and General Motors stocks, the two leading industrials of the country, declined from the high quotations of 1929 to 8 per cent of that price. The decline in the stock of the South Sea Company was only to 13 ½ per cent of its highest quotation. Take another: The stock of what has long been one of the premier banks of the country declined from 585 to 23 ½. That is to say, it fell to 4 percent of its highest quotation. The decline in the market price of this great American banking institution was therefore more than three times as severe as was the fall in the stock of the South Sea Company.

That illustration is by no means a unique one. There were innumerable American bank stocks which made a more distressing record. Between October 1, 1929, and August 31 1932, 4,835 American banks failed. They had deposits aggregating $3,263,049,000. . . . .

The decline in the price of bank stocks was only a minor phase of our debacle. The quoted value of all stocks listed on the New York Stock Exchange was, on September 1, 1929 $89,668,276,854. By July 1, 1932, the quoted value of all stocks had fallen to $15,633,479,577.

Stockholders had lost $74,000,000,000. This figure is so large, that not many minds can grasp it. It is $616 for every one of us in America. It is, roughly, three times what we spent in fighting the World War (WWI). . . . . . .

Not only did our investments shrivel in the last three years but we even frequently lost our pocketbooks. Cash in hand, left for safekeeping in a bank, often went the way of our investments, and worse. Almost $3,000,000,000 of our daily-used cash funds were sequestered in the doubtful assets of the 4,835 insolvent banks. Widespread communities were left with only the mattress as a safe depository, and with little to put into it. People became so frightened in regard to the safety of the banks that they locked up in safe-deposit vaults, or secreted elsewhere, more than $1,500,000,000.

In the Great Depression there was a very good reason for feeling negative about life. The interest only mortgage loan had ruined many banks. If you had any money invested, it was probably gone by then. Age 65 ready to retire, it must have been very depressing to some.

This bit of history was full of pain, the players from that era are just memories. The show will play again and we will be the actors upon the stage. The trouble is, we are not willing participants.

Invisible Inflation

Some prices seem to be declining, and others are increasing. So if one looks for inflation or deflation, it doesn’t take much searching to find an example to fit either argument. There are two different things happening here. One group of items that have been produced for retail sale, are also being resold by end consumers to raise cash. When you have consumers reselling into the market against retailers, prices will drop. The second group of items is pretty much just for consumption without a resale option. These prices are rising dramatically; food, beer, cigarettes, gasoline, drugs, and health care.

With prices rising the consumer has a choice, pay the higher price or switch to an off brand or generic. Blue Goose Vodka at $35 a liter doesn’t have quite the bang of a generic 1.75 liter bottle of the store brand at $10. Of course, then there is the nagging sleight of hand trick where the product size gets reduced and the price stays the same. The family size bag of potato chips now fits in a lunch box.

It’s not hard to notice the decreased consumption of optional goodies; cable, cell phones, internet, the second car, eating out at restaurants. This decreased consumption has a peculiar effect on public utilities. If everyone decreases their water consumption, water bills increase (this happened in our area). Why? Every company has fixed costs that don’t decrease when consumption decreases. With government services, the costs will increase or stay the same, even though they lay off police, firemen and teachers. You get less, so you’re really paying more for it.

What we are going to see from here in the coming year, is a concentration of thought, on how to enjoy our lifestyle by spending less. By shopping more carefully we get better prices from everyone. Some of us know how to do it, the rest of us will learn by going hungry now and then. The real question to ask is, are we able to buy more with our paycheck (deflation) or less (inflation)?

If you buy the premise that Bernanke and the Federal Reserve are saving us from deflation, then you’ve bought into the assumption that printing all these dollars is good for the economy. If you buy the premise that raising the national debt level passes these costs on to our kids, you have bought into the assumption that it’s free for now, and you’ll struggle with the morals of this despicable act of passing our debts onto future generations. If you reject both, you realize that we have a debt problem that will never make it to the grandkids. Our government has borrowed every penny in our banks and spent it.

One of my readers (Rob) commented that the candy bars he purchased had gotten smaller. My half gallons of ice cream are now 1.75 quarts and they take up more space in the freezer. The gallon bottles of ammonia for a dollar are now half gallons. If you have gotten on an airliner lately, there is a new seating section called “cattle class.” What is happening to us is almost invisible. It is a little like sawing a quarter inch off of Grandpa’s walking cane every week; sooner or later, he’s going to catch on. Old Ben Bernanke might convince Grandpa that he’s growing taller and sell him a new cane.

This Great Depression is Different

During the Great Depression of the 1930’s the banks, trust funds, and stock market lost 90 percent of their value. If you had a thousand dollars saved up or invested back then, you were left with one hundred dollars. If you lost your job there was no unemployment or Social Security. Deflation became a very serious issue; nobody had any money left to speak of. If you had been living paycheck to paycheck, all you could lose was your job (a rather anemic understatement).

March forward to today. No depositor has lost a dime in the banking system. All of the foreclosures will be bought by the government. Unemployment is collectible for two years. There has been no 90% loss of savings. The government has printed dollars to cover all bank failures.

Millions of people are collecting unemployment and not producing anything, but they are consuming product using their government check. At the same time, tax collection revenues have been decreasing at an alarming rate while government expenditures have been increasing geometrically.

Our government has no increased tax revenues coming in unless you count the new health care. They are printing money to pay the bills. At some point this leads to inflation. Deflation cannot happen, everyone has their dollars. The unemployed are consuming the products we savers chose forego, when we deposited our money in a retirement account. Our savings were a way to defer consumption into the future.

As long as retirement redemptions are minimal, inflation does not even enter the picture. The product produced matches the printed dollars spent. We will see inflation when the baby boomers decide to spend some of their deferred consumption.

The Economic rhetoric from Bernanke claiming his actions will save the country from a deflationary spiral, is pure nonsense. The Emperor is wearing no clothes, claiming otherwise changes nothing. Inflation is the name of the game, and hyper inflation is our destination. It cures all of Fannie Mae’s and Freddie Mac’s problems. They don’t have to mark down to market; they get to mark up to market.

At one point the government had a choice of deflation or inflation to solve this bubble. If we had done nothing, we would have had the 90 percent haircut and deflation just like the 1930's did. We chose to solve the problem differently with a printing press.

What’s it mean? The government can’t stop the inevitable; they can only slow it down. Our dollar will be the new dime of the 21st century. We still get the 90 percent haircut. The money borrowed was squandered on consumption. It is gone, it can't be undone. This is not something that can be reversed with a printing press. The government is only increasing the number of dollars chasing a decreasing inventory of product.

Where to from here? 15 trillion in debt and we have a President who keeps on saying “We are not out of the woods yet.” If you owe 15 trillion dollars, why get out of the woods? Stay there and hide!

Robbery Royale at Fannie Mae

Karl Denninger of the Market Ticker had a bit today on Fannie Mae giving everyone the green weenie. It’s worse that what he stated. Fannie Mae has a delaying tactic. They have a deed for lease program where you can rent back your property from them at the current market rental rate. Here is a Link. So, instead of a walk away home that gets stripped, you have a home that is being lived in by the previous owner. The lease is for one year and that could extend for many more if you read the tea leaves.

This program delays real estate from hitting the market in the form of a foreclosure. The inventory is eased into the market gradually instead of all at once. This is the hidden inventory that everyone talks about. The other thing is their great financing program for new buyers, here is a link.

If you read their boilerplate carefully, you don't need to pay for an appraisal, which costs dollars. My question, would the property appraise for what they are trying to sell it to you for? Probably not, it is called rip off the poor and uninformed, sell them that dream of home ownership. A dollar down moves you in. If you look this gift horse in the mouth, you would walk away.

Fannie will give you 3 1/2 percent of the home’s value for closing costs or whatever. You need to have 3% down, but you could get a check cut for 10% of the home’s value for repairs. Oh goodie free money.

Here is an article I wrote showing my frustration with what they were doing two years ago link . The couple that bought this home both worked at a movie theater making $8 per hour. They got $10,000 for repairs and spent it on a bike and a pick up. It ended up going back to the bank (Fannie Mae). It only cost them a dollar to move in.

The thing to take pause at here are the Realtors. Commissions are 6% so we know whose raking in the real money.

I use to sell VA repos, and that was on an auction basis. High bid won. Now we have a candy ass program; Fannie Mae will finance your dream, if you agree to pay their price. The people at Fannie Mae need some jail time.

The Low Bond Yield Conundrum (Reprinted)

This is an edited reprint from November 19, 2006 which demonstrates what large swings in interest rates can do of the bond market. Note the interest rates are off a bit; at the time of writing, there was less than 100 basis points between the 30 year Treasury bonds and the one year T-Bills. The 30 year interest rates have remained constant, the short term rates have gone to hell. Greenspan was the man in charge at the time.


The bond market is at a point right now that leaves an awful lot of long bond holders (buyers of the 30 year) very vulnerable.

With the coming vaporization of the second trust deed market, there should be a scarcity of funds. Add to that, marking to market of foreclosed homes adds even more to this up and coming "enterprise." Seventeen interest rate increases by the Fed and the long term rate comes out very little changed.

In Greenspans speech to Congress last year June 9, 2005 he is quoted:

Among the biggest surprises of the past year has been the pronounced decline in long-term interest rates on U.S. Treasury securities despite a 2-percentage-point increase in the federal funds rate. This is clearly without recent precedent. The yield on ten-year Treasury notes, currently at about 4 percent, is 80 basis points less than its level of a year ago. Moreover, even after the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period.

What it really boils down to is; there is a very large demand for long term bonds. More than the market can supply. Otherwise interest rates would rise to attract buyers (this may not seem obvious, but as the price of a bond drops, its interest rate increases and vise versa). The Baby Boomers could be going to less risk in their portfolios. An insurance company locking in rates on an annuity for thirty years, this would be a smart call.

Where it gets kinky, is the fact that everyone is loaning 30 year money at close to the rate paid for the one year Treasury. Look at a 30 year bond issued today at say 5%.

Value of Face amount-------interest rate--------interest paid
----$1,000,000-----------------5%-----------------$50,000

No problem with the investment, but if the interest rate went to 10%, the dynamics change. Using that same 1,000,000 bond we now have:

Value of face Amount-------interest rate--------interest paid
------$500,000------------------10%-----------------$50,000

What this shows, is that your market portfolio could, if marked to market have a haircut of 50 percent. Notice however, if you hold on to maturity, there is no "real" loss of principle. 30 years is a long time to wait if you are already 60 (I turned 60 yesterday).

The real pure play for the bond market is to buy when the market is at 10% and sell when it goes to 5%. That play, a reverse of the first example, would net a cool half million. This is where the money is made in the bond market. (Note if you were to buy at 10% and it swung even lower to 20%, your jaw could hit the floor rather hard.)

The only thing that makes today a buying opportunity, is the belief that the interest rate will drop to 2.5%, this would double your bond portfolio's value, and it just ain't going to happen.

Another thing that Greenspan mentioned, that people were willing to accept more risk with less reward. Everything except Delta Airlines Bonds are trading as if they are US Treasury's (admittedly an exaggeration, but the rates commanded are rather unrealistic if not pathetic).

We seem have a market running on the herd mentality of "If it works, go with the flow." At some point there will be a demand for funds that could raise the interest rate to quite a spectacular level, even if for a short period of time. It is at that point, that cash can buy into the bond market and make a killing.

A stock has to double to double your money. With a bond a 50% drop in the interest rate doubles your return. The thing to remember in a panic, it's like going into a pawn shop with a $10,000 wedding ring, you're not going to get list price or anywhere near it. You're are going to take what you can get according to how desperate you are for cash funds.

What you really have, is a mistake being made by retirement funds, that will take them 30 years to fully appreciate. Your clients only have 15 to 35 years to live. They just might need the money before the call date. The real culprit is unperceived inflation --your monthly retirement check might only buy a weeks worth of groceries. I guess this is how you get "saved" from a severe deflationary spiral--more government printing.

The Conundrum is, why invest in bonds? You're guaranteed a loss at present interest rates.

Read Between the Lines

Tuesday's San Diego Union Tribune ran a front page story; the county's median home prices were up 15.3 percent.

San Diego County home prices, which were falling at double-digit rates a year ago, are now rising rapidly as investors grab the last remaining bargains and upper-end buyers find deals to their liking.

It makes you wonder a bit about their chart below, until you look at the new homes for May 2009 and compare them with new homes for May 2010. [double click for a clearer image]

Looking at it realistically, the buyer lost $77,000 if they bought a new home last May (highlighted in yellow). And now there are a lot of 600K "used" homes that are now selling for 400K. The condo sales don't make much sense unless the new units in downtown San Diego (previously selling at 600K) have been reduced to move at 250K. Just try and find a banker that will finance a condo.

The other thing to realize is that used home totals are actual, new home sales are usually 2/3's of those listed; they are counted the minute the contract is signed and a lot fail to close. Another item to take into account, the tax incentive just expired so the totals for May stole from June.

You can't fault the newspaper for printing "Good News."

The Anatomy of a Bubble

In order to understand a bubble, one has to examine two conditions of our environment. One, there is a randomness with the way we interact with our economic community; everybody works, but we all have different types of jobs. Two, our resources are finite; they can be exhausted by consumption.

The first step of a bubble is the severe misallocation of resources. Production focuses on one particular item. The misallocation, means that we are about to allocate most of our resources towards that one goal. This starts out gradually and then progressively consumes more and more resources.

In the second step of a bubble, a large group of people are no longer interacting with the economy in a random fashion; they are all pursuing the same wealth creation formula. This too, starts out with a normal amount of people employed in the bubble sector of the economy. As the bubble gets more robust, more people with a desire for riches join in with lost abandon.

As we enter step three, there is the comfort that everyone participating in the bubble, feels sort of group camaraderie (the herd mentality). Notice as people acquire more riches from their venture, they come to accept the fact that they’re just MORE intelligent than ordinary people. At this point greed and stupidity mix well; double your investment and in turn, double your profit.

Then we come to the final stage (step four) loss of control; the resources are exhausted and the bubble collapses. The damage has been done and it is real.

Examine these two bubble examples from the past:

A river boat ferry, in India 20 years back, was packed with 600 people. Two teenagers in love were going to jump off the boat and commit suicide (their parents wouldn’t let them get married). Needless to say 600 people rushed to one side of the ferry to witness the event. The ferry capsized with a very large loss of life. What happened was sudden and very unexpected by all involved.

The second case was in Africa 50 years ago. Wealth was measured in cattle. The more cattle you owned, the more wives you could afford (this also produced a lot of kids that had to be fed). Cattle production shot through the roof over several years, everyone was getting rich. Even the people growing the hay to feed the cattle were making money. The price of cattle feed started to increase; there wasn't enough supply to meet demand. The cattle were starting to exhaust their food supply. Farmers found it difficult to feed all of their cattle, so more went to market for sale. Prices started to drop and the cattle market collapsed. The livestock died off in mass and the general population faced the aspect of starvation. There wasn’t any drought that brought this famine on, just the misallocation of resources.

Identifying a bubble is at best, very difficult in the early stages. The housing bubble over time has become obvious. Medicare is a bubble in progress. Resources are limited more so than is apparent; high costs in the past have kept medical demands in check.

The national debt is also a bubble but the concept of what constitutes resources (real money) is one of those magic acts, that go on forever. An increase in the interest rate to 9% could spell doom for the US Treasury and the national debt (of course that could never happen).

The ferry boat (our Ship of State) is full and pushing away from the dock; I wonder if Romeo and Juliet are on board?

Live Rent Free, Don't Give the Bank the Keys (Reprinted)

Here is a reprint from this blog back 3 years ago, September 6, 2007. The probability of it, has come to pass.

Everyone is talking about all of the foreclosures and how rental rates will rise because of the demand from all of the displaced owners. Maybe there is one item that has been overlooked.

When banks foreclose and get title, there is a year or two wait to complete the process. We are talking about the actual deed, not a note saying that the title was conveyed and it is free and clear. The paperwork takes a while.

In the mean time, the neighbor across the way trades out his broken dishwasher with the one in the foreclosure. In California, the air conditioner would probably grow legs in two weeks. In a year’s time, there might not be much left. I’ve seen places that the neighborhood kids would use and by the time they are finished with it, you really wouldn’t want it at any price.

This can even get worse. Consider a foreclosure in Colorado, the pipes freeze and break. In Florida, a closed up house might mold over like a loaf of bread. Some states have laws on the books that allow the foreclosed owner two years to redeem the house after the event. So, clear title could be a very long wait.

Considering the length of time needed to sell a house lately, a year is not an unreasonable estimate of time. The note holder has a chance to lose big time. His asset could be run through the local recycler without his knowledge, copper pipes and all. It behooves him to have the house occupied.

The foreclosed home owner can’t lose if he plays his cards right. Walk up to the lender handling the foreclosure, and offer to keep living in the house rent free until it is sold, on the condition that you take care of the lawn and the house in general. Sounds crazy, but who the hell is going to buy it in this market? At least nobody is going to steal the air conditioner before you have a chance to sell it. At the present time, things aren't quite that bad, so you might have to pay monthly rent payments.

An impossible pipe dream? People living in foreclosed homes and not being tossed out?? It’s happened before, just not in the last 75 years. States even passed laws so it could happen.

Post-note June 5, 2010:

The property tax arrears on these homes could become a nightmare. They are not being paid and the states depend on the dollars for their budgets. Just who owes the money is the real question. Some states allow you to pick up a home for back taxes, others don't. In California it looks like the bank pays the back taxes from the proceeds of the foreclosure sale. If the home is upside down, the FDIC, FANNIE, or FREDDIE become the indirect guarantor of the taxes. It's just another way of saying this is a free ride on the taxpayer.

Pay Rates, Here and There

An AP report on the front page of the San Diego Tribunes business section Saturday boggled my mind. A $26 a month pay raise for 300,000 workers in China making our cell phones, IPods and computers.

TAIPEI, Taiwan (AP) — The Taiwanese electronics company buffeted by a spate of suicides at its China factories said Friday it will raise the pay of workers by an average of 20 percent.

The pay raises at Foxconn Technology Group have been in the works for months to cope with a labor shortage following China's recovery from the global recession, said a company official speaking on condition of anonymity because he was not authorized to talk to the press.
. . . . The basic salary at the China plants of Foxconn Technology Group — which makes iPhones and other popular gadgets — is currently about 900 yuan ($130) per month.

. . . . The company, part of Taiwan's Hon Hai Precision Industry Co., is the world's largest contract maker of electronics. Its long list of big-name customers include Apple Inc., Sony Corp., Dell Inc., Nokia Corp. and Hewlett-Packard Co.

Cheap labor runs the industrial world. A manufacturer that can sell it cheaper and better will make money. You have to marvel on how these workers can survive on the present $130 a month. Just imagine if they took out for Health care and Social Security. It does explain how electronics in this country are so cheap. Of course if that’s all you are being paid, you can’t consume very much either.

Here is a link to a CNBC video with Steve Wynn. He is a big resort owner in Las Vegas who needs inexpensive labor to keep his hotels running.

CNBC Video

In essence, Obama’s new health care plan adds 2 dollars to the minimum wage (the employer’s share). Of course the employee gets to kick in a matching 2 dollars. If we figure the minimum wage right now at $8, add $2 for employee SSI and unemployment benefits then add $2 from the new health insurance costs, and calculate employee cost per month; $12 X 40 hours X 4 weeks, $1,920.

Let’s see if I have this right. The monthly wage of Chinese laborers is being raised to $156 dollars per month, and stateside the minimum wage will soon be $1,920 a month. If a manufacturer wants to produce a retail product for consumption, they’d be an idiot to produce it in this country. On the other hand, if the business deals in servicing customers, the employer is caught paying the going rate unless it can be accomplished by phone support based in some third world country.

Steve Wynn from the link above is taking advantage of this dichotomy in the world economy; gambling is a service business. His move to Asia allows him to offer 10 times more in service and still pay less on the bottom line.

A lot of medical procedures are going offshore also. India offers open heart surgery at one third the price in the US and that includes airfare.

The question arises, how do we recapture our industrial base that has moved offshore? I guess the real question is; “Why bother?” China is still advancing us credit, by buying our Treasury’s on the “Fog a Mirror” plan. It worked great for us for a while, in real estate. I guess this is where I keep quiet; we’ll let China figure this out the hard way.

The Pot is getting warmer

Here is a small AP news release from May 22, 2010, hidden on page 6 of the Sunday San Diego Tribune that speaks volumes:

Protesters decry proposed New Jersey cuts

TRENTON, N.J. (AP) — A crowd estimated at 30,000 to 35,000 people gathered Saturday near New Jersey's Statehouse to protest Gov. Chris Christie's proposed budget cuts.

State police, who gave the crowd estimate, said no problems were reported.

The crowd is believed to be one of the largest ever to protest in state history. It was mostly composed of public employee union members and several community and nonprofit groups that would lose some or all their funding if Christie's plans are adopted.

Christie has called for workers to accept wage freezes, and he's pushed for them to contribute toward their health benefits.

Christie has called for workers to accept wage freezes, and he has pushed for them to contribute toward their health benefits. The governor was not in the Statehouse on Saturday and was not at the rally.

The Republican governor has said that protesters have the right to speak their minds.

Here is a Link to a very dynamic and entertaining video by New Jersey's Governor Christie, that explains what is happening (it's 26 minutes long). His plan of action is quite impressive, it is drastic. Here is a governor that isn't all talk. We need more people like him, but as he suggests, it won't get you re-elected.

This is the sort of news that defined the Great Depression of the 1930's; hardship and protests. It was a sign of the times.

CalPERS-- A Bridge Too Far

A pension plan is a form of savings that allows one to retire with a predetermined monthly income. It’s a little like putting money in a savings bank until you retire. A pension fund is a little more sophisticated they employ all sorts of advisors to figure out what your monthly payment from them will be when you choose to retire. In order to come up with these projections, they have to know beforehand your monthly contribution, the average life expectancy and a projection of future interest rates. From there it is a pretty cut and dry calculation.

Let’s examine it in a more simplified form. Assume that we have a person ready to retire with one million dollars in cash in the bank. That’s his total retirement. If we compute the interest rate on that at 12%, it comes out to about $120,000 a year. At 8% we get $80,000, at 4% we get $40,000, at 2% we get $20,000 and at 1% figure a whopping $10,000.  Just examining the return rates here, it is easy to realize that a mistaken assumption of where interest rates will be, changes your spending habits and could force you to tap into the principle as well.

Examine the rule of 72. Divide the interest rate into 72 and you have a pretty good idea how many years it takes for your savings to double. It also works quite well for inflation. Divide the inflation rate into 72; only in this case we are not doubling, we are halving. Figure that the banks are paying 2% interest. That is about 36 years to double your money. Inflation is around 6% so figure 12 years down the road, you’ll still have a million dollars, but only half the buying power.

The difference between say CalPERS (California Public Employees' Retirement System)  and an individual savings account used for retirement is that the left over funds in a savings account goes to your heirs. Pension funds don’t need a big cushion. They know that everyone as a group will drop dead at age 78 by using actuary tables.

Every year in the past CalPERS was asked, "Is there enough money in the plan to carry everyone to the drop dead age?" At 7.75% interest with no loss of principle, the answer was "Yes." Well, CalPERS lost 56 billion and the interest rate is now about 1.5%. Rates can’t stay this low for 20 years, like Japan, now can they? So this is only temporary. Now that you’ve bought the bridge, can we interest you in a toll booth to go with it?

The picture below is an excerpt from a Stanford study requested by the Governator's office, published in April of 2010. Here's a Link to it. Notice that CalPERS is using a 7.75% interest rate for their calculations and Stanford at the time chose 4.14%.

Double click for a larger view

The present attainable interest rates are in a range of 2 to 4 percent. CalPERS whole financial structure was built on 8%. This low interest rate was not anticipated. If we were to take their present asset base and double it, that doubling would generate the interest income needed, to keep the fund solvent.

As usual, I could be shot for this over simplification. It seems certain that things are going to get worse before they get better. This Stanford projection of future pension costs appears quite reasonable. The three retirement funds cited in the report could have a half trillion dollar short fall. The size of the shortfall amount appears absurdly large, the possible reality of it, is rather unsettling.

Governor Schwarzenegger has stated that the California pension plan program is unsustainable. At the same time CalPERS wants 600 million more of State funds for just this year. Who do you listen to? One thing to consider, our next governor won't work for $1 a year.

The Kalifornia Solution

A lot of states are coming to a fork in the road; how to live within their budget. Here in California, teachers, firemen and police have already gotten their budgets trimmed. Now it is time for deeper budget cuts or entertain the idea of raising taxes.

Here is a breakdown of present expenditures:

The Republicans are dead set against tax increases and more or less figure if you pay no taxes in, you’re first in line to lose benefits. In essence, it's the free stuff that the poor qualify for.

The Democrats on the other hand, want to raise taxes on the rich and big business and leave entitlements alone. Needless to say, the Democrats are not after the Big business vote. By God, make those fat corporations pay their fair share, rah rah rah! (I might sound a bit biased here, but show me a business that pays taxes, it's passed on to the customer)

We have two political philosophies that differ immensely. California’s problem is a financial one created by an economy that has gone sour. If the economy was in good shape, this problem would not exist.

The question arises, will either political view, result in a solution? Sadly, probably not. From looking back at history, raising taxes in hard times (the Democrats plan) brings in less revenue and stifles the creation of new businesses. Of course if you are poor and your entitlements get cut (The Republicans plan), you will vote for the Democrats to get them back. Both perspectives appear doomed to failure.

Where else can the state governments cut? There are limits here; people expect and demand services for their tax dollars. The part of the budget that might end up being cut could be welfare and health care.

Governator Schwarzenegger is suggesting elimination of some welfare programs. However it seems more likely that California residents might see an across the board cut in welfare benefits of say 25% this year and another 25% the following year. This would put our state in line with the benefits other states pay. We could also see major cuts in health care. Health care for kids could flat out disappear.

And as if it couldn't get any worse, new laws will prevent four million Arizona "tourists" from their annual trek to the San Joaquin Valley in California to harvest vegetables this year (a definite crimp on "tourism"). This should have no adverse effect on this years bumper pot crop.

It kind of looks as if those that don't help row and bail water out of the boat, get to swim along side.

The Last Hurrah

Interest rates right now are a joke; Banks are paying ½ to 2%. My wife and I stopped buying T-bills that were paying a ¼ percent. Interest rates usually measured risk, the lesser the risk, the lower the rate.

Look at bonds as a long term investment. The investor might be willing to take more risk to increase his rate of return. If there is no risk (because of government guarantees), the interest paid will approach zero. With inflation running in a range of around 6 to 15 percent (pick a value) bonds look like a real dumb investment.

Consider that the bond market is 5 times larger than the stock market, where is money going to go? The stock market appears to be the only option left.

The real question is, what level do interest rates need to rise to keep money in the bond market? A 10 percent rate would ruin the housing market, and a 20 percent rate would spell financial disaster for the country. Now we have the European Union printing up one trillion Euros to save the Euro. This frees up the money from bad loans (unredeemable) made to Greece. Where are investors going to put this money, in other markets? What’s a trillion Euros trying to find a home? Answer: Inflation.

Notice, governments never question markets that reach to the sky. But have one that takes an ugly dip like the real estate market or the stock market and they hold an inquisition.

Where to from here? Dow 30,000, Gold $3,000? So as the Dow Jones average rips through 40,000 next week, look for Obama to declare the recession over. Even though I am joking around here, this is the last party in town and they just refilled the punch bowl.

Greek Bailout

From the AP wire May 2, 2010:

Of the 110 billion euros in total commitments endorsed Sunday, the euro zone will contribute 80 billion euros to the package, with 30 billion of that to be made available this year. The rest of the money would come from the Washington-based IMF

Greece gets 30 billion this year from everyone. But reexamine the statement. The total amount raised is 110 billion euros. The Eurozone will contribute 80 billion (sometime in the future) with 30 billion of that available to Greece this year. 110 minus 80 comes out to 30 billion not covered---“The rest of the money would come from the Washington-based IMF.” Here is a Link that goes into more detail

IMF funding, hmmm! Sounds like some big bucks there, ever wonder whose money is being spent? Who’s in charge of this “One stop shop for loans with no collateral?” The United States of America pretty much runs the organization they have 17% of the vote and nothing happens unless they say so. Who’s in charge for our side?--- Tim Geithner and Ben Bernanke. At the last Senate hearing for the Federal Reserve, Bernanke got asked a question about the IMF and more or less stated he didn’t have enough information on the subject. Talk about a piece of lit dynamite and no one in the panel called Ben on it! Here's a graphical representation of how the United States fits into the IMF. It is our baby, we run it.

There is absolutely no reason to bail out Greece. They had a walapalosa party; does the rest of the world have to pick up the tab? Do we keep the game going one more year, or let the chips fall where they may? There is Spain and Portugal with Ireland waiting in the wings.

Germany may find 29 billion (over a time span of 3 years) for Greece, what happens when Spain comes knocking? At what point do these loans become grants of aid that have to be written off by the issuer? This wouldn’t be an issue to bring up when running for reelection in say Germany.

There are two different goals here “Save the Euro,” and/or “Save the PIIGS.” Everyone is for the idealistic Euro. Europe is not ready to save the Greeks. The bar of soap is on the shower floor, and no one has any intention, to bend over and pick it up. Refinancing Greece’s debt, in a world economy that is plunging into the abyss, has very little chance of success. You are only adding more debt to the system. It could be time to cut and run. Sometimes doing nothing is the solution, the problem solves itself.

My advice, go to the concession stand and get a box of popcorn and a drink and find a seat, the show is about to begin. In this episode, Ben is going to save the Euro with American Dollars from the IMF. Aw gee, I guess I spoiled the ending—sorry.

The Eye of the Hurricane

The newspapers are all claiming that the housing market is coming back. Something isn’t quite right here. The banks aren’t about to loan any one money for a home unless they have a 20% down payment. Of course, if you want to buy a Fannie Mae foreclosure, all you need is 5% down and the government gets another bad loan off the books. This isn’t a bank loan; it’s a government loan that happens to be part of the national debt. The phrase "No skin in the game," seems to echo in the background.

Then you hear about the 20% of house sales that are completely cash sales. You have to wonder, where did they get the money? With 1 out of 17 homes in the US facing the possibility of foreclosure and then we have 1 out of 5 buyers paying all cash? I find it hard to believe. Common sense suggests, why buy one house? Investors only need 20% down, buy 5 and share the risk with the bank, the interest rate can’t be beat.

Three years ago, anyone that wanted a loan could have gotten one. And now you can’t get a loan without a substantial down payment. The marginal buyers (no doc’s) are gone and so is their demand for housing.

The housing market is not coming back, the surge of baby boomers has peaked, the Silver Foxes are looking for smaller retirement homes, not the McMansions that have been built. Real demand is declining. Our government wants to keep home prices from collapsing so people don’t take a walk; otherwise Freddie and Fanny get more home loans to eat. They have painted themselves into a real neat corner; 5% down moves you in and of course they’ll throw in $20,000 for repairs.

Right now the housing market is in the eye of a hurricane, enjoying the calm. The 5/30 interest only loans are starting to convert to conventional loans. Unemployment is getting worse. State tax collections are abysmal. On top of that, the baby boomers are getting ready to retire; they will be trying to sell their homes and move to Arizona (Mexico’s Northern most State). Why buy a home from a Silver Fox when you can buy one from Fannie Mae and get cash back? I just love these government programs, sure beats renting.

Risk Has Left the Building

The financial collapse of AIG wasn’t an accident. The conditions were just right for individuals of every walk of life to make a killing on the way the financial system reacted to the real estate boom. The basic mistake was the misallocation of resources. The world didn’t need all of this new housing, but it was very profitable to build and finance. The increased property values implied that the banks couldn’t lose on any loan. The tax base increased proportionally and government expanded (exploded). It was only "short bus" math to figure out that over 30 years, a person earning $35,000 per year was not going to have the resources to pay off, a 30 year, one million dollar mortgage.

All of a sudden it stopped, the bubble burst. AIG and several hedge funds collapsed. The side bets (derivatives/insurance/credit-default swaps) covering those exposed to loss came to the surface. These hedge funds were writing insurance on everything including the kitchen sink.

Risk had been removed from the business model. It’s hard to lose money if you place the right side bets (that’s without even including Fannie and Freddie in this mess). Too much “insurance coverage” had been written. The insurance premiums were collected and went into someone’s pocket. The estimated 40 to 80 trillion of derivatives written to insure against financial loss will never be paid.

For example, Greek bonds have a substantial risk, but buy insurance and your worries are gone. If you are the Greek government, buy the insurance (you can’t lose). If you work for the Greek government, why buy the bonds? Just buy the insurance and when Greece goes belly up, retire to the good life. Greece will make that glaringly apparent when they collapse (after receiving their bail out money).

The real fault with this "insurance" is that you don’t have to have a relationship to the asset being insured. There is nothing to stop you from insuring your neighbor’s home and then burning it down. Plus if the neighborhood has "a gut feeling about that house," there’s going to be several policies written on that home. Then when the expected happens, (it burns to the ground) everyone gets rich. It’s as if, AIG was the insurer for anyone placing a bet on that house. Geithner and Bernanke saved the day; everyone got paid on that one.

Three questions arise. Were the insurance rates too low for the coverage written? Should the contracts have been allowed to be written in the first place? Shouldn’t you have to prove your vested interest in the insured, in order to purchase the product?

The Panic of 1907 led to legislation that made this sort of "insurance" illegal; the bucket shops which sold it, were banned in 1909. And then 91 years later, Congress rolled that law back. We were smarter now and knew what we were doing. Just as a our person making $35,000 a year can't pay off that million dollar loan, the 50 trillion dollars in risk arbitrage can't be paid either. The risk in the market is real, the "insurance" isn't. And, as in all fairy tales, everyone lives happily ever after.

Mortgage Market Meltdown (reprinted)

This piece was written August 4, 2006. I thought it might bear a review.I get irritated when I watch the PBS feeds of the Congressional committees, who ask why no one saw this real estate mess coming? Congress has to assume the biggest share of the blame. If I could see it, they could too. Of course this was bringing in a lot of tax dollars, which they could spend on new toys; Spend-------ad infinitium.

Lets look at an organization named Fannie Mae. Picture it as a 4 x 4 x 4 foot black box with the words Fanny Mae printed in white on it. Envision Mr. or Ms. "Mortgage Market" dropping into the box all of their 80% finance loans and when the box gets to $1 million it spits out an investment certificate for 1 million paying 5%, face amount guaranteed, which is purchased by Mr. or Ms. "Unknown Entity," AKA "mark" or "sucker."

The little black box is a great transformer and redistributer of debt. Nobody wanted to touch that crap until they built the little black box. By God everyone is entitled to the American dream of home ownership rah! rah! rah!

So we have this box and the question arises, "What the hell do they do inside that box?" My guess--absolutely nothing.

There is really no problem with the design model aspect of the black box. It will perform within its parameters. After all, its rather absurd to have a real estate market drop 20% isn't it? (Believe that, and I have a bridge to sell you). What is not realized is that the market can drop 50 to 70 percent. In this scenario, the little black box fails to function as expected. It doesn't have the funds necessary to back the claims it made in the past. What funds does it have for back up of bad loans? My guess, is none. Say you need one or two trillion dollars to back up the investors who bought these certificates---total tax collections for the US of A is about 1 trillion a year. Sounds like someone is going to get short sheeted!

The question arises who's holding all of the crap and who is going to get burned?

My guess is mutual funds and IRA's and I could be wrong.

Off Track Betting

40 years ago I had a summer job working for Delco as an Engineer in training. It impressed me that there was this one guy that would get off early and go to the race track. Naturally everyone would give him a couple of dollars to bet on a horse or two. On one particular race day several of the requested bets won big. The guy didn’t come back to work for a while. It seems he had been pocketing the money and betting on his own tips. Two workers had asked for a Trifecta ticket of say 711. Those 3 horses won and the payout was astronomical; but no tickets for that combination were sold at the race track. So it got added to the payout for the next day.

This might seem unrelated to the stock market, but look at options. 90% of all options expire worthless. So a big brokerage, could take the orders and not place them, and cover them internally. And on expiration the brokerage gets the money. If there is a small winner, pay the guy off.

If you were to change your mutual fund holdings, and move from investment x to investment y, the question comes up; does the mutual fund go out and change what they are doing just because you move a few things around? Probably not.

Take gold and silver bullion storage facilities. It is not unreasonable to suspect that these companies only keep less than 10% of the demanded holdings in actual metal. It’s rather tempting to hold the rest as some sort of certificate, and invest the proceeds in selling puts and calls on the “bullion in storage?” Remember 90% of options expire worthless.----everyone is not going to ask for their gold at once. Hmmmm--- What happens if they do?

The amount of physical gold and silver in the world to date is a measured known amount. Just like everything else, as long as the system has no real stress applied to it, things function quite well. If everyone decided to take possession of their gold or silver, it just might not be there. It has been suggested that only one ounce of gold for every 100 under contract could be delivered, if demanded. The neat thing about gold and silver, is that the FDIC/Treasury can’t print either one.

The people we trust are not doing what we ask because they can buy an option to satisfy our requirements. The trouble is, these option tools may prove to be very inadequate in a panic. As Buffett suggests, we will see who was swimming nude, the irritating thing is, it could be us.