There is growing intelligent dissent to the administration’s stimulus policy. Critics argue that recent growth is the result of market principles. Edward P. Lazear wrote Monday in the WSJ, that he forecasted a return to growth without stimulus spending. He goes on to argue, along with others, that housing programs have had questionable results. Lazear said that Uncle Sam is fibbing about job growth as well, reporting job retention as if it where job creation. John Irons of the Economic Policy Institute agrees. The administration has an incentive to report positive unemployment numbers- the most popular, but also misunderstood indicator.
Unemployment is only part of the overall picture. Other improving indicators reported this week tell us that the economy is turning around-but for whom? It depends on how you define growth. A technical definition says that growth is positive GDP. That means little to most people. Real growth, theoretically, is an improvement in living standards for the entire country. That’s why Main Street understands the unemployment rate. Accordingly, the media use it as the sole judge for growth. The problem is, as Lazear mentioned, job growth is the final component of recovery- behind financial stability and GDP growth. Unemployment lags years behind an actual recovery. If unemployment is a lagging indicator, Lazear cannot empirically link failed stimulus policy to persistent unemployment. He says that the administration is ignoring job losses while inflating job creation numbers. Isn’t he doing the same thing by ignoring market stabilization and GDP growth?
BEA Released GDP Data This Week
According to the BEA, GDP is up for a number of reasons. Look closely at the report. Exports rose 14 percent over last quarter and consumer spending rose 3.4 percent. Market Watch reported that positive numbers where in part due to stimulus spending, but as I argued in the past, these gains are only temporary. The purpose of the stimulus is to stabilize the economy so that private markets can function again. There is no wider conspiracy. The government will roll back stimulus as soon as it sees the return of private investment. There is evidence of this already: government spending actually slowed by 3.5 percent.
Not all the news was good. Personal income fell and prices rose. Hopefully this is a temporary trend based on slight price increases and high unemployment. However, as long as export growth remains positive, I see no need to fear 70s style stagflation.
Savings and Long-Term Growth
According to the old Solow Model, a country’s savings rate is positively related to long-term growth. Today, personal savings is around five percent, that’s up from around one percent just four years ago. This bodes well for long-term growth in the US. And now is a great time to invest. As private investment (including people’s savings) replaces public spending in the next few years, markets will rebound. Private investment will power an upswing in the business cycle, spark growth and reduce unemployment. The sooner the government rolls back stimulus, the better. In the mean time, citizens can take advantage of great opportunities in real estate and other deflated markets. This transfer of savings from a stock to a flow will jump-start the economy in way no stimulus could. It would take tens of trillions of dollars in government spending to match the power of private investors.
The new homebuyer tax credit expires at the end of next month. Officials are considering extending the credit into next year to avoid destabilizing the housing markets. The news today suggests that recent gains in residential real estate may be temporary. I think they should pull the plug on the subsidy and let the market function without intervention.
According to Goldman, what good has come from the credit is only temporary. They expect a five to ten percent decrease in prices when the credit expires. The administration also admits a possible decline in prices. The decision of whether to extend the credit depends on how much government intervention has aided recent stability.
Most people buying new homes would be buying now anyway. The tax credit amounts to a transfer payment, with no real value added to the market. At this point, the credit is either inflating prices or putting off an inevitable adjustment. Better to take the five percent hit now and let the market function as intended.
The Washington Post argues that the credit has artificially inflated prices and hurt commercial real-estate markets by transferring cash to homebuyers. It also argues, and I agree, that the credit exposes commercial real-estate to unfair competition. When the credit expires, both markets will be equally attractive. Low prices and low interest rates are enough to attract buyers in competitive markets. We don’t need the artificial stimulus.
The good news on Wall Street lately has little meaning for the rest of us. Yesterday, the Dow topped 10,000. The numbers signify a return to stability more than a return to growth. Though the market enjoys a modest up swing, hold off on the celebration. I see at least two explanations for the bullish performance: a market bubble and penny pinching companies.
A breakingnews.com story put yesterday’s Dow into historical context. If you take out the dotcom and housing bubbles and assume a nominal annual growth rate of four percent since 1995 (two percent real growth and two percent inflation), the Dow “valuation today would be just north of 7,800.” Today’s numbers, according to historical analysis, reflect higher than average growth rates.
Cost cutting companies provide another explanation for recent highs. Facing devastating market devaluations, companies cut inventories and eliminate jobs. Profits will then rise relative to previous periods of poor performance. As companies post gains- stocks rise. What we are seeing could be more of a new status quo: low growth and smaller companies. Smaller companies mean fewer jobs, sustained, institutional unemployment and lower living standards for all.
A Lesson in Personal Responsibility- Okay, Get out the Champagne
Congratulations to 76-year-old Elinor Ostrom, the first women to win a Nobel Prize in economics. Ostrom found that individuals can manage common resources more efficiently than government or private institutions do.
“What we have ignored is what citizens can do and the importance of real involvement of the people involved — as opposed to just having somebody in Washington … make a rule,” Ostrom told reporters.
Her work focused on public land and resource use. Her insights tell us not to rely on government or the private markets to solve our problems. Those conclusions may be a little abstract, but I agree with the first part. Efficient economies balance personal incentive with public outcomes. Governments cannot regulate every aspect of the economy. Individuals need the freedom to adapt to changing conditions without waiting for a bailout.
What can citizens do? Focus on personal initiave. We, the participants of a private marketplace, can solve our problems by building private industry. Governments cannot efficiently fund the recovery. Look at what AIG did with its money. Cash that didn’t go to sustaining a flawed securities industry went to paying out huge bonuses. Little of the bailout, or stimulus for that matter, has actually reached worthy projects. The path to real growth begins when private banks, investors and entreprenuers create capital flow.
There’s much more to this story. I just wanted to take a moment to cheers Ostrom and her lesson of personal reasonability.
It is now evident that this recession has uncovered a number of substantial flaws in our country’s financial industry. The now-exposed wounds became so complex that it took a meltdown of this size to identify them and it will take a long, sluggish recovery for them to heal. The majority of the flaws in our financial system hit individual investors the hardest. Faced with frauds, unclear loan agreements, mislabeled ratings and much more; individual investors have felt the pain and are now changing their behaviors in order to wisely navigate through this new investment jungle.
In this new, heavily-battered playing field, I have seen one group of investors disguised as two vastly different types of investors. They appear to have swapped each other spots on the risk spectrum, but the groups are really one in the same. The first type is the group that fears more losses so much that they are persuaded to stay out of the game. The second is the group of investors that has been chasing risky investments in an attempt to quickly recoup the wealth they lost in the crash. Once this type of investor wins back their losses, they pull out and leave the game; joining the first type of investor on the sidelines. These groups share a trait that makes them more similar than different: They both fear the current market.
Emotion and speculation fueled many investors before the bust and will certainly again fuel the masses during the next boom. The tendency to chase easy money is in our hardwiring and it is a difficult force to resist. Now, as is the case immediately following any recession, investors are cautious. But, this caution should do more than lead to rampant mattress stuffing. Investors should now be more willing to seek the knowledge that will allow them to make more informed decisions. The bust knocked the wind out of the majority of individual investors. Many were forced into being cautious but all can use this new caution to their benefit.
Rather than abandon investing, now is the time to be fine tuning your investment strategy by getting back to the fundamentals. Rebalance your portfolio in a way that makes sense. Hold stocks in companies with good business models. Learn to make informed decisions. Demand transparency. Get in the habit of practicing prudent due diligence or search for an expert who you trust will. Instead of letting the fear of uncertainty keep you on the sidelines, analyze your risks, lower your uncertainty and reestablish your place on the field.
Unleashing Small Business Horsepower
Small businesses have historically been the force that pulls our country out of tough economic times. Their ability to work more efficiently allows them to find innovative ways that spur job creation. But, without being able to find available capital, small businesses are restrained. A full recovery will not take hold until small businesses have access to adequate capital. The mega businesses have been propped up by the government, but small businesses heavily rely on the private-capital investments that are currently lacking.
Investing in small businesses has many advantages. From a business stance, while larger corporations have strayed from their original initiatives, small businesses usually have focused business plans that detail their near-future commitments. Yet, small businesses still tend to be more flexible, which is a huge advantage considering the amount of ideas that small businesses produce. Without flexibility and the willingness to take educated risks, their ideas would have no Petri dish in which to grow. Another advantage is that small businesses usually carry less debt than large corporations; which use debt as a primary ingredient in their financial engineering. Less debt equals fewer obligations, and this can translate into quicker returns for investors.
No matter how simple or complex a small-business investment appears, it is important to always keep in mind a few basics. First, invest in small businesses that have solid business models that you believe in. Just because a company has filed with the state to sell its securities does not mean that the investment will be a success. Businesses succeed because of vision and follow-through. Remember that “publicly-traded” does not necessarily mean “better.” Second, do not let an employee of a company convince you that an investment is not risky, that is a lie. Companies will often have securities salespeople who work on a commission. This does not mean they are automatically corrupt, it just means do not let their promises replace your due diligence. Plus, investments ALWAYS carry some level of risk. Which brings me to my last point: Always carry through with proper risk analysis. There are registered investment advisors, lawyers and other financial professionals that can help take the headache out of the process. Do not pinch pennies early on in the investment process only to be burned later by a flaw that a professional could have identified and corrected.
These are terrific times for investing in small businesses. There are countless opportunities to invest your capital in quality projects that will produce high returns. With credit not rushing like it did before the bust, business owners are actively searching for ways to acquire capital. Our recovery will continue to look and feel like a false hope until small businesses have the means to expand, create jobs and put people back to work.
Hanging on by a Home-Buyer Tax Credit
The $8,000 first-time homebuyer tax credit, included in the economic stimulus plan passed in February, is set to expire next month. The credit is widely touted as having given the stagnant housing industry its first sales jolt after a lengthy lull following the housing market’s implosion. Now, with legislation in recess, officials will be forced to scramble if they wish to extend the tax credit.
With a fast-approaching deadline of November 30th, many in the real-estate and construction industries have their fingers crossed that an extension will be filed and keep buyers approaching the market. Last month, some groups, such as the National Association of Home Builders, even launched newspaper advertising campaigns pleading for the extension of the credit. Several members of Congress have either drafted bills or showed support for bills in favor of extending and expanding the home-buyer tax credit. U.S. Senator John Isakson (R-Ga.) introduced a bill that would extend the program through 2010 and increase the amount to $15,000. Also, Isakson’s version would be available to all homebuyers, regardless of current ownership status or income level (the current tax credit is limited to first timers who make under $75,000 annually).
Nearly everyone agrees that the residential housing industry has been using the first-time homebuyer tax credit as a crutch; and therefore has managed to stay on its feet. However, not everyone agrees the tax credit should be extended. While many experts worry how the housing industry will fair when the tax credit expires, they also agree that a true housing-market recovery will be delayed until natural economic forces replace government support. Outside of the tax credit, the government currently provides support to home buyers in multiple ways. While attempting to thaw the credit freeze, the Fed has kept the interest rate at or around zero. This encourages lending, which includes home mortgages. Also, the current tax code already shows great support for home ownership by providing incentives such as deducting the interest on your mortgage.
A number of senators have been criticized that they support an extension because it would favor their states heavily. While this may be true for those states that have been badly bruised by the housing implosion, an extension is likely to benefit real-estate markets across the country. The general consensus is that extending the tax credit would continue to encourage buyers to explore the market. But, passing an extension depends on Congress giving attention to the matter before the November 30th deadline—for there is no shortage of higher-profile issues waiting to be addressed in September and October.
While Wall Street is celebrating an end to the recession, folks on Main Street know better. Jobs are still disappearing. It is widely acknowledged that America’s small businesses are the engine of job creation. So, the recession won’t end until small business expands. For this to happen, access to credit for working capital is essential.
We should all be disturbed, then, that our government has used trillions of our taxpayer dollars to save Wall Street while ignoring the financial institutions on Main Street who actually lend to small businesses (the community financial institutions). The number of troubled institutions on the FDIC’s list is now 416, mostly community institutions. With their insurance fund nearly depleted, it is a certainty that the FDIC will soon be using its Treasury line of credit. As long as they are now using our taxpayer money, shouldn’t these community institutions get the same treatment that the large Wall Street firms received (i.e., access to funds to shore up their capital bases until the recession ends)? Most of the troubled institutions are in the states hardest hit by the real estate bubble, i.e., AZ, CA, FL, and NV. Their assets are troubled, not because they made speculative bets on funny new financial instruments (like Wall Street did), but because their economies have tanked.
According to the Federal Reserve Bank of St. Louis, since TARP and other funds were given to the behemoths, business loans have declined every single month (Oct. ’08 through July ‘09). So much for the requirement that these folks increase loans to businesses. It appears that the TARP funds were either pocketed as unconscionable bonuses or went into shoring up the capital bases of these institutions that now prowl the countryside looking for takeover targets and requiring taxpayer participation in losses (the normal FDIC practice) when takeover occurs.
I have seen several in depth studies that indicate that today’s financial structure does not have the capacity to refinance the debt already out there that will be coming due in the next five years. Fortune 500 companies don’t have to worry because the now saved Wall Street banks will fund them. But, unless America’s community institutions get equal access to TARP, America’s small businesses won’t get the liquidity or credit they need to expand. So much for job creation!
The political party that now controls both Congress and the Presidency say they represent the “little guy”. So far, they have only aided the rich and greedy on Wall Street.
Guest Blogger,
Robert Barone, Ph.D.
Robert Barone is a Principal and an Investment Advisor Representative of Ancora West Advisors LLC an SEC Registered Investment Advisor. He is also a Registered Representative and a Registered Principal of Ancora Securities, Inc. (Member FINRA/SIPC).
Today marks the one year anniversary of the collapse of Lehman Brothers, one of the worst financial disasters of our time, as it nearly brought down the international financial system. Yesterday I was reading an article about how the big banks are showing signs of life with their actions and things are starting to move, signalling a possible economic recovery. This makes me wonder about the adage of being “too big to fail.” What is the right decision in this situation?
It appears to me that after the latest cycle, quite possibly and hopefully the worst we will see in our lifetimes, people are hoping that this time things will be different. That once we actually do reach a point of recovery, we won’t make the same mistakes that were recently experienced. This cycle has been painful; it has been gut-wrenching; it has been a lesson I surely don’t want to repeat, as I get it and don’t need to learn it again.
I am very nervous about this thought process. As the saying goes, history repeats itself, and that did not become a quote we all use without good reason. For generations, for decades, for centuries, the animal in human nature causes us to make the same decisions and choose the same paths as before.
Some of our largest banks, which the government determined were too big to fail, received billions in taxpayer TARP funds. Our money kept these institutions afloat and I understand the reasoning behind keeping their doors open, especially using the Lehman example. I am dismayed, however, at the actions of these institutions. By receiving government funds, they are able to continually take on high degrees of risk, knowing there is a safety net underneath them. Prudent due diligence has gone by the wayside with the knowledge of someone is there to catch them. I liken this to the casino industry. If you could borrow $1 Million dollars and gamble it, knowing you would get it back if you lost it PLUS knowing you would get to keep any winnings you made, why wouldn’t you do it? This is exactly the system we have allowed to be established.
And, what about the outrageous salaries and bonus payments we still continue to hear about? I am all for the entrepreneur earning as much as he or she can based on value and return to society, but I am not about taking from you and me, putting a chokehold on getting capital back into circulation while cutting off small business, and then handsomely rewarding the big bank players in the process.
The veritas, the truth, as I see it, is that nothing has really changed, that we are repeating ourselves and that we will all pay the price of the failure to learn what could be a valuable and useful lesson. As we continue through this cycle, which I believe still has more pain to come, I hope for and have faith in the success of the small business, for the will of the entrepreneur, and for the recovery of our great land.
Too big to fail? Ok, I’ll give the government that. But what about keeping the backbone of American capitalism healthy? I’m not saying the answer is in government bailouts for small business, as anyone who knows me knows I believe in complete personal responsibility. I’m only asking for the same access to capital for small business so that it can keep its doors open, giving it time to make the changes and adjustments necessary for its own success. In short, allowing business to help itself.
I have thoughts on how I believe this can be done without the banks, allowing history to repeat itself in the manner I believe will lead to our recovery. I will write more in the coming days, but in short I believe in private capital + private enterprise = economic recovery.
I look forward to sharing more of my thoughts and receiving your feedback.
Earlier this week, after wrestling with the spate of painful economic news provided by major media, I recognized that I had no immediate control over any of the massive economic concerns. The stock market zigged when I hoped it would zag. Unemployment numbers, often reported differently, moved at different paces in the undesirable direction. Our federal deficit grew, which increased our individual debt responsibility. The problems were not confined by the pages of the newspapers. When I peered through my office window I saw quality real-estate projects continuing to sit lifeless because they lacked funding. After a few moments of reflection, I recognized that I, and certainly the majority of us, am being forcibly weighed down by all of the negative. Instead of dwelling on the uncontrollable, we should be manifesting the positive by taking hold of the reins on those things in which we can have significant influence.
I decided to start anew with more refreshing thoughts. So, I turned to a medium in which I had some control over the information that was presented to me: Google. Two main pages topped the list when I searched for the words “Economy: We Are the Answer.” The first was an informal Yahoo Answer Board on which the following question was raised: “Is there hope for the American economy or should we just drastically change the way we live?” The user went on to define “drastically change” by giving up our private houses and cars. The second most-popular page that appeared was BarackObama.com, which suggests no one within Google’s reach really believes we the people have the capacity to be the answer to our economic problems. According to my Google search, the answer either rests in the hands of President Obama or we will all be forced to live in communal frat houses without automobiles.
When our economy is running smoothly, we all welcome the opportunities to be part of a do-it-yourself world. We bag our own groceries, scan our own documents, rent our own movies and print our own boarding passes. On a weekly basis, we all most likely take it upon ourselves to deposit, track, clean, swipe, dry, spray, refill, bus, organize, pour, dispense and scan in the presence of other do-it-yourselfers in the vast public. As long as the tasks are minimal and the goal is clearly in view, we are encouraged to do everything ourselves. The responsibilities we used to let others handle, we now do ourselves (I cooked my own meal at Melting Pot earlier in the month). About half of the times I visit a gas station, there is no reason for an attendant to be present—unless I am in Oregon or New Jersey, where state officials prohibit me from pumping my own gas. But, when an issue has options that are more complex than selecting diesel or regular, our individual accountability takes a vacation. Why do we turn our focus to other superpowers to take control and eliminate ourselves from the equation? The Problem is Passivity
This economic downturn is nothing more than a collection of intertwined problems. Although financially painful and physically overwhelming, there is no reason for any of us to hide underneath our desks and wait for the shaking to end. Think about the steps we all take when trying to overcome a timely problem—for an example, a clogged drain. We take a short period of time to analyze the situation. We look at all the factors involved and ask ourselves crucial questions: Is the water draining at all? Is the clog causing the pipes to leak? How severe is the leak? Is it causing immediate damage? Next, inevitably, it is human instinct to search for the quickest fix. We switch on the garbage disposal and rub our lucky rabbit’s foot. When we are forced to take real action we must recognize the weapons we have to combat the problem (a plunger, a drain snake, Drain-O). After we extinguish our resources, we then consult the knowledge of an expert.
Now consider the enormity of our current economic struggles. The formula for dealing with the problem is much more complex, but it should still follow the basic fundamentals. Why then have droves of investors been complacent to listen to long-winded “experts” before analyzing their situation and deducing what it is that they can do for themselves? The formula is flip-flopped when we let ourselves believe that any given problem is too big or too complex. Remember the old adage, “We can only eat an elephant one bite at a time”? Many of the intricacies of this recession are out of our control, but the sooner we take control over the issues we can influence, the sooner the complex problems begin to untangle.
If the severity of the problem is directly proportionate to the amount of time we take to analyze it, then we only need a brief moment to stare into a clogged drain. In that same vein, our economic crisis is much more complex and has required a longer period for analysis. I argue we have passed this stage of the process and action is required now. This summer brought about a number of signs that suggest we are now slogging around somewhere near the bottom. With home-improvement projects, summer vacations and outdoor entertainment, consumers typically spend more in the summer months. We are now entering what is destined to be a difficult autumn. Unemployment will continue to strain on families, foreclosures will mount and consumers will tighten the belts they let momentarily loosen over the summer.
On the other hand, as the leaves turn and nature gets stripped of its color, a buckled economy will continue to present opportunities for us to take action. It is time for all of us to stop viewing ourselves as helpless observers and again consider ourselves part of the equation. In some ways we already are important variables, but we rely on the inadvertent action we take to be sufficient. How many times have you heard an angry citizen blurt out something along the lines of “I do my part, I’m a taxpayer”? The somewhat-passive action of paying taxes funds many integral economic systems in which our country balances itself. Just as we hire plumbers to help unclog our drains and keep them running smoothly we elect (read “hire”) officials to help unclog our economy and keep it running smoothly. With our plumbers, we are responsible for paying the bill to enable them to do their job. The same is true for the officials; by paying our taxes, we essentially all pick up our share of the bill and expect them to do their share of the work. Without our capital, their positions would not exist; but this hardly means we have positioned ourselves as active parts of the recovery. Investing to Make a Difference
To be an important cog in the recovery machine, we must put our money to work. Our money does not do any good stuffed in a mattress or buried underneath the deck. Private capital built this country and there are few economic problems that private capital cannot solve, if allocated effectively. During the Great Depression, a time when the economy constricted and the majority of construction projects were put on hold, the entire construction of the Empire State Building was completed. Thanks to funding from its principle backer, an automobile tycoon aiming to one-up a major competitor, the Empire State Building was constructed with staggering momentum. During the Depression, building materials were cheaper and workers were eager to earn a wage, much like today. The construction put people and money back to work in dire times; not to mention the mystique the building has given our country for nearly eight decades.
A project as grand as the Empire State Building might only come around once a century, but that does not rule out the need for quality projects in our own communities. When private capital teams with quality-managed projects, the outcomes can be extraordinary. But, you need both. Whereas quality projects cannot get off the ground without capital, poorly-managed projects get ran back into the ground even with all the capital in the world.
This recession has torn through our communities and left a stockpile of quality real-estate projects to collect dust. Without proper funding, the projects remain undeveloped, unproductive and severely underemployed. Placing our private capital into quality projects will bolster the number of available jobs in our communities and get people behind a meaningful cause. There are loads of individuals that could be taking charge and becoming part of this recovery. We will show great resilience when we, on our own, come out of this strong, super-charged and feeling part of something.
We have to put the days of excuses behind us. We should be searching for any project that someone says “can’t be done” and aim to defy. When the newspapers have stopped reporting stories that highlight economic blemishes, our unemployment numbers are approaching all-time lows and our government takes a permanent vacation from bailouts; we will only vaguely remember our current doubts. We will, however, remember the period of time when we all did our part to restore communities. We will remember the turning point when we took action to pull ourselves from the painful times and regained our spot as part of the equation.
In a recent USA Today post, Rhonda Abrams compared entrepreneurship to whitewater rafting. My favorite tip is number six, “keep paddling…you’ve got to navigate your way through tough challenges.” In a recession like this one, you must navigate your own course. We cannot rely on the government to get us out of this mess
Policy makers are beginning to signal the same sentiment. The Treasury Department announced today that it would be scaling back government intervention in the financial markets. They’re sending an important message- mainly, the bail-out will not last forever- just long enough to stabilize lending so the markets can take over.
Though Treasury warns of continued lack-luster performance in the short-term, today’s news isn’t all bad. Oil production is to remain constant and trade data shows growth in both imports and exports as demand increases on international stimulus spending. Remember, the stimulus spending is a temporary fix. The real rebound will come from the private sector, the entrepreneur.
So I agree with Abrams, make your own plan, get the advice you need, and hold on in troubled times.
Every day, and every minute somewhere on the Web, another statistic that hints at an economic recovery is reported, copied, translated, manipulated and reevaluated. It seems for every positive up tick in economic numbers, there is also a negative. We have been experiencing shaky times for the past 20 months. Every sector is not going to at once join together on an all-knowing graph somewhere and move together as one gradually-rising black arrow.
Stats are meant to give us market indication. “Experts” on the economy make sense of the stats by attaching other positive attributes to them without any solid proof. In social psychology, it is similar to how the halo effect works: If I see Bob Somebody helping an old lady cross a busy intersection, then I automatically believe Bob to be a good person; without having any solid proof. Helping the elderly in dangerous situations is good, I saw Bob do that, so Bob must be good. Similarly, the media tells us recessions are scary and bad, positive things do not happen in recessions; therefore a positive up tick in one sector must mean we are out of the bad recession and into the good recovery. Experts link good news with other good news without any solid proof.
Earlier this month, Newsweek ran a cover that pictured a big red balloon which read “The Recession is Over!” The cover and its related story caused a small uproar that resulted in criticism from President Obama. Although the cover story was meant primarily to sell magazines, the author did make a solid point: “… when economists proclaim a recession over, they’re celebrating a technicality: they mean economic output has stopped contracting.”[1] When the economy stops contracting, it does not simultaneously return to the rising rates we experienced in the years prior to this recession.
The reporting of numbers, percentages, graphs and ratios should only be taken for face value. We use them as indicators, as ways to gauge where we are and the possibilities of where we could be heading. Be aware that we are approaching a period that is sure to be overflowing with economists eager to be the first to accurately predict the recovery by accident. Statistics will punctuate every news story you ingest. A small increase over a quarter is no reason to speculate and sink loads of savings into any financial market. The recovery will come. As we work towards it, I encourage you to stick with the basics. Own stocks that make sense. Consider incorporating alternative investments such as real estate into your portfolio not only because of their soundness, but also because they work as a wonderful hedge against inflation. Pay off debt. Adapt to the times. And, most importantly, focus on those things in your life that you care about the most.
Tangled in the Reins of Negative Equity
Recent housing numbers indicate that first-time home buyers are being attracted to the market via low home prices and the $8,000 federal tax credit. But, the tax credit is scheduled to be pulled before the end of the year and declining home prices are leaving more and more home owners with the burden of negative equity.
This month, The Wall Street Journal reported that 16 million Americans owed more on their mortgages than their house was worth, up from 10 million this time last year.[2] Furthermore, Deutsche Bank estimated that 48 percent of U.S. homeowners will be “underwater” by the end of the first quarter of 2011, as unemployment rises and house prices remain low. A prediction similar to this appears frightening, but what place does negative equity have among the gory stories of today’s economy? I see three major implications.
For starters, if somewhere between 20 and 50 percent of all homeowners have negative equity over the next 2 years, then default rates will continue to plague the housing industry. True, not every residential mortgage with negative equity will default. But, having negative equity is frustrating for owners and the more underwater they become, the better chance they have of defaulting.
Next, this recession has placed a new taboo on debt, causing those that have lots of it to feel guiltier than during times of rampant overextended credit. Those with heavy debt burdens, such as negative equity in their largest assets, are less likely to spend. Our gross domestic product relies heavily on consumers to purchase. A sustained decline in consumption will further constrain our GDP growth and further ail our economy.
Lastly, a large population of home owners with negative equity translates to a large number of houses waiting to be sold. Because no one wants to take a large loss on their home, the majority of owners looking to sell are holding on to their homes. Do not get me wrong, this is not a bad thing if the owner is looking to hold on to the home as a long-term investment or to serve as a primary residence. However, a portion of the huge supply of homes waiting to be sold will be flushed into the market every time there is a bump in prices. Each time, this will dilute the market, bring down prices and elongate the downturn. Consequently, this ever-appearing inventory will also put a damper on the demand for new construction.
From state to state, local markets will continue to be choked by a high percentage of home owners with negative equity. Not surprisingly, the states with the greatest percentages of home owners with negative equity are primarily the states whose real estate markets were demolished by the housing burst. Nevada leads all states with 40 percent, Arizona follows close behind with 37 percent, California falls in third place with 30 percent and Colorado and Michigan round out the top five with 31 percent and 29 percent, respectively.[3]
Speaking Real Estate Today
As it becomes more popular for investors to include real estate as an active player in their portfolios, the asset class is being talked about differently. Left behind are the days of talking about real estate as an integral part of the next speculative boom. Banks are no longer willing to take the responsibility of the loan off the shoulders of the borrower by offering zero-down mortgages. Lending is tighter, though not unreasonable, and borrowers are more educated about the risks involved with taking on a mortgage.
The housing burst exposed the problems involved with treating real estate as a short-term investment. Unsurprisingly, investors today approach real estate differently. Dave Kansas of The Wall Street Journal recently wrote that investors are more cautious and “focused on real estate as something they can use: a solid place to live or play…”[4] Going along with Kansas’ article, investors cannot enjoy a family barbeque in the front yard of their stock portfolio or be awe struck by the view off the back porch of their bonds.
Many investors are irritated with the roller-coaster ride of the stock market. These investors are on the hunt for alternative assets to occupy a larger percentage of their portfolio; making it long-term and balanced, with little need for sporadic buying and selling. On the other hand, some investors feel the impulse to be over active and are reluctant to leave the stock market.
Including an alternative asset such as real estate into your portfolio allows your entire investment livelihood to not solely rely on the stock market. Alternative investments are typically not correlated with stocks, which means when the stock market is taking a dive, alternative investments are likely to be stable or even rising. Including an alternative investment such a real estate into your portfolio can also significantly lessen the impact of inflation, which is currently a concern of many investors. With the steep drop in home prices and mortgage rates hovering near record lows, a number of signs are suggesting that now is the right time to invest in real estate.
The FDIC announced last week its insurance fund has dropped 20 percent to $10.4 billion. Previous to the past two years, the only bank failures many of us had experienced were those talked about by our parents or grandparents, or by watching George Bailey nearly lose his family’s savings and loan business in It’s a Wonderful Life. Of course, there was the S&L crisis in the 80s and 90s where more than 700 savings and loans associations failed, costing taxpayers the then unthinkable amount of nearly $125 billion. Comparing to today’s challenges, wouldn’t we all be thrilled with that small of a number, and how unsettling is it to know that ONLY $125 billion would make us all so happy!
The FDIC is shouldering a huge amount in our current state of affairs, precipitously balancing the stifling weight of the nearly 85 banks which have failed so far this year, and hundreds more which are in peril. With the $3.7 billion lost by US banks in the second quarter alone, the FDIC’s fund is at its lowest point since 1992 when the S&L crisis was at its peak. While Sheila Bair, FDIC Chairwoman, is saying no to borrowing from you and me at this point, what happens if this current crisis continues to drag along the bottom? Will it drag us down with it, as the government is us? Will the fear of no place is a safe place for your money cause more runs on the banks, such as George Bailey experienced?
With the FDIC forecasting spending up to $70 billion on replenishing insured accounts through 2013, we all face another potentially hefty bailout. Bair says don’t worry at this point, since she does not see the need to tap the US Treasury – not yet. The FDIC is searching for options – it will attempt to replenish the fund through additional bank fees and has also indicated it is considering allowing private investors to buy failed institutions, bending rules to reduce the cash required that private equity funds must maintain in an aquired bank.
In the end, we are all “protected” by the government, which is to say, we are protected by ourselves, as our accounts are insured up to $250,000. At some point however, the bailouts come with the bill collector. Hopefully we’ll have something left in our wallets instead of turning our pockets inside out to find that they are empty.
Earlier this week, after wrestling with the spate of painful economic news provided by major media, I recognized that I had no immediate control over any of the massive economic concerns. The stock market zigged when I hoped it would zag. Unemployment numbers, often reported differently, moved at different paces in the undesirable direction. Our federal deficit grew, which increased our individual debt responsibility. The problems were not confined by the pages of the newspapers. When I peered through my office window I saw quality real-estate projects continuing to sit lifeless because they lacked funding. After a few moments of reflection, I recognized that I, and certainly the majority of us, am being forcibly weighed down by all of the negative. Instead of dwelling on the uncontrollable, we should be manifesting the positive by taking hold of the reins on those things in which we can have significant influence.
The Powell Perspective 