Commercial Real-Estate Crisis Squabble

For the past few weeks, financial news has been mixed on commercial real estate.  On the one side, fear mongers like Randall Zisler expect crisis in the next few years.  The meat of their argument is that high default rates and high unemployment will keep the market depressed.  On the other side, high profile investors like Sam Zell  say that the crisis is a myth. 

I’m leaning toward Zell here, and agree with Sheryl Nance-Nash.  She referenced a report that found commercial real estate markets are likely to bottom in 2010.  Notice the verb there- bottom, not crash.  The report calls 2010 through 2012 a “cyclical low” period in the market.  In other words, there will be great opportunities for prudent investors in the next few years.  As the rest of the economy picks back up, capital will flow into commercial real estate and bring prices back up to normal, or at least 70 percent of recent highs.  The report is worth taking a look at.

The federal propensity for bail out clouds the issue.  The FDIC announced last week that it would allow banks to report underperforming loans as performing.  Many properties are worth less than the debt owed on them, and this legislation gives banks leeway for renegotiation.  There is little evidence on how much refinancing is actually taking place.  Instead of selling properties off, banks are keeping them on the books.  As long as seller is kept from buyer, the market is on freeze.  In the short-term this policy prevents a crisis by avoiding a panicked sell-off.  However, the regulation prevents the market from functioning, perhaps even prolonging recovery in the long-term.

Fed Policy

Don Bauder at the San Diego Reader links, correctly, the troubled commercial real estate market in California with its budget problem.  He then argues that recent stock gains are not based on ‘reality’ but a low federal funds rate: 

“The Journal’s lead sub-headline Tuesday morning was “Cheap Money Sends Shares to 2009 High” — a stark warning that liquidity is buoying various markets, not reality. The Federal Reserve promises to keep interest rates around zero for the indefinite future. This emboldens investors to gamble…. — watch out.”

Under Greenspan, this was a fair argument.   However, today we are at the ‘zero-lower bound’ of interest rate policy. Any increase in the funds rate is seen as devastating for recovery. It’s important to recognize that the source of growth today may not be interst rate policy- since monetary policy has become ineffective.  Also, liquidity is welcomed by the Fed during recessionary periods.

Thomas J. Powell

 

 

 

Real Estate Wrap-Up and the RIA

Residential Real Estate  

There are dozens of reasons why the residential real estate market bubbled and exploded, causing the ensuing credit crisis and economic strife. The popularity of loans requiring no documentation, the easy access to sub-prime loans and the Federal Reserve’s decision to keep interest rates low all intertwined to fuel the housing crisis. The housing bubble was also inflated by Wall Street’s ability to package and sell mortgages in large pools. Now, after struggling to repair the housing market for more than a year, we are seeing improvements that are unveiling extraordinary investment opportunities in residential real estate.

It appears we have hit the bottom of the housing market trough. Housing prices found some stabilization, although the prices are still close to the lowest they have been all decade. But, the collapse took years to build and expecting a complete turnaround in 2009 is unrealistic. The real promise in housing is in the future. Getting your money into the market now is optimal because of low prices and reasonable mortgage rates. Plus, there will continue to be tax relief with the recent Obama-endorsed home-buyers’ tax credit extension—which is planned to be available for repeat buyers who have lived in their prior residence for at least five years.

The United States should see a gradual increase in home sales throughout 2010, but the residential market will most likely not witness a return to “normalcy” until 2011. According to Steve Bergsman, author of “After the Fall, Opportunities and Strategies for Real Estate Investing in the Coming Decade,” “When a bubble market bursts, left behind is a lot of carnage and it takes about three years for the markets just to get a handle on the mess.”[1]

The three-year anniversary of the housing collapse is fast approaching and a number of high-profile reports have been published this month that suggest the residential housing market is already improving. The Case-Shiller index, which tracks variations in the values of houses in 20 U.S. metropolitan areas, showed an increase of 2.9 percent in the second quarter of 2009. In the first quarter it was down 7.9 percent. Two reports released by the Commerce Department last week suggest that while the overall economy continues on a wobbly path toward recovery, the housing industry is experiencing a number of positive signs. For example, “The supply of new homes was at 7.5 months in September, down from 9.5 months in May.”

While residential inventory appears to be slimming, foreclosure rates continue to mount in multiple areas across the country. With a significant number of Option ARMs set to reset over the next several months, many cities will continue to experience record-setting foreclosure levels.  

However, foreclosures are increasing in different cities than those affected in the last quarters of 2008.  Rates appear to be easing in the cities that were hit hardest by the housing collapse and rising in major metro areas in other states. This suggests that the cities previously overrun with foreclosures have found ways to combat the problem and are gradually making progress.

A continuing stream of foreclosures may keep the residential inventory plump, and prices could remain stable over the next couple quarters. But, as inventory shrinks, so too will the abundance of quality investment opportunities. With the residential real estate market now hovering around the bottom, now is the right time to invest.

Commercial Real Estate: No Reason to Panic

While it appears that we have already witnessed the worst of the residential real-estate collapse, we are preparing for the brunt of the crash in commercial real estate. The commercial real-estate industry has taken the place of residential real estate as the breeding ground for widespread fear. Daily reports suggest the commercial real estate storm will be more severe than the one that struck residential housing. Instead of causing another shipwreck, our economy’s commercial woes may prove to be more of an anchor that puts an imposing drag on our recovery.

The combination of job losses, store closings, rising vacancies and drastic cost-cutting measures puts commercial real estate in a serious bind. However, knowing their mortgages will soon come due or reset, owners and managers of office buildings, shopping centers, hotels and apartment complexes have had ample time to prepare for upcoming obstacles.

 Owners of commercial real estate are not backed into a corner. Banks prefer options that keep mortgage payments flowing. Therefore, banks are willing to work with borrowers to find solutions, even though bundled commercial mortgages will add to the difficulty of negotiations. Securing loan payments is not entirely the responsibility of banks or those who hold investments in pools of bundled loans. The owners of commercial buildings originally took on the responsibility and many of them are actively working to find solutions to keep their properties operating. Many property owners will continue to make their payments either because they have adapted their strategies to fit the difficult times, or because they have explored creative ways to bring in extra income. Of course, some number of defaults will be inevitable. Some of those property owners who are unable to acquire loan restructuring or extensions will view a loan default as their best option.

As with the residential real estate debacle, the government is sure to intervene in an attempt to keep our economy from falling into another dark hole. For example, the already-in-place Term Asset-Backed Securities Loan Facility (TALF) supports the issuance of asset-backed securities in order to help small businesses meet their credit needs. The TALF is one of a handful of sluggish government efforts that was created to help provide a crutch for the commercial real-estate industry.

Commercial real estate will continue to tug on recovery efforts, but it is not likely to cause the amount of damage we witnessed during the residential collapse. The time to invest is not when everyone shows interest in an asset. A staple to wise investing has always been buying low and selling high. The commercial real estate market has produced sound investments in the past and will once again flourish. Getting into the market in times of success is more costly, the opportunities are scarcer and the rewards are not as fruitful. The best time to invest is when the masses are fearful, and the masses are easily spooked by commercial real estate right now.

The Benefits of Hiring Professionals

As is the case when taking on any money-making venture, the waters are difficult to navigate alone. We all want to make investments that are conducive to both our current financial situation and our future goals. Investing with a Registered Investment Advisor (RIA) helps eliminate the series of headaches that come with making sound investment decisions.

Hiring a RIA has a number of benefits. For instance, a RIA can take on the following responsibilities:

• Provide objective investment and financial advice
• Set achievable financial and personal goals
• Take into account all of the factors that influence your current financial situation (your assets, liabilities, income, insurance, taxes, etc.) and provide a comprehensive analysis of where improvements can be made. Also, this helps to guide your investment plans and retirement goals
• Provide consistent investment consultation based on your fluctuating savings, investment selections and asset allocation

Before hiring a RIA, you should also be able to answer the following questions:

• What services do you need? Can your potential RIA deliver these services or are there any limitations on what they can deliver?
• What experience does the RIA have in dealing with investors in your situation?
• Has the RIA ever been disciplined by a government regulator for unethical behavior?
• What services are you paying for and how much do those services cost?
• How does the RIA plan on getting paid and are you comfortable with this payment method?
• RIAs are required to register with either the SEC or their state securities agency, depending on their size. It is imperative to ask for proof of their registration

There are a number of professionals who can provide guidance for your investment strategies. Hiring a RIA can help to take the frustration out of the investment process and help you avoid many of the common roadblocks. The true value of a RIA is their ability to thoroughly understand your overall financial goals and provide professional investment advice that is consistent with those goals.

 All My Best,

Thomas J. Powell

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[1] Bergsman, Steve. After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade. Wiley, 2009.

Stimulus, Growth and Recovery: The Debate Continues

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.

Thomas J. Powell

Rebuilding Your Wealth with Real Estate

              As our economy slowly recovers, many investors are concerned with recouping the money they lost during the crisis. Pulling your funds out of investments all together will do nothing to bulk up your savings, while sinking your money into risky funds can do further damage. So, with black-and-white options not offering solutions, where can investors put their money to work?

Many investors are turning to investments that they feel are safe, such as bank CDs or money market mutual funds. The problem with these “safe havens” lies in the low returns. “The average money market fund yields .05 percent, or $5 on a $10,000 deposit.” With rates of return this low, these investments may not be able to keep up with inflation, let alone fill the gaps left by the losses experienced over the last 24 months.

Another option is to do nothing. Yvon Chouinard, founder of the Patagonia sports outlets, says, “There’s no difference between a pessimist who says, ‘Oh it’s hopeless, so don’t bother doing anything’ and an optimist who says, ‘Don’t bother doing anything, it’s going to turn out fine anyway.’ Either way, nothing happens.” The idea of holding on to your portfolio “as is” and wishing for the stocks you currently hold to rebound may work in some instances. But, if time turns out to be your enemy, your retirement years will be funded only by the amount you currently have, minus the effects of inflation.

As investors actively search for ways to re-energize their portfolios, many are returning to real estate. The real estate market is hovering around the bottom, interest rates remain near record lows and a large inventory gives buyers an abundance of options. On the residential side, many foreclosures and bank-owned properties can now be purchased for a fraction of their value. The same opportunities are becoming available in commercial real estate as owners are unable to pay off or refinance their loans.

As I have mentioned before, real estate can help your portfolio win the battle over inflation. Real estate’s value will return at some point.

Shaking Our Stone Age Tendencies  

Letting our emotions dictate our investment decisions is a risky behavior. Out of instinct, we all get emotional when we earn or lose money. It is in our wiring to feel connected with the money we have accumulated. We tend to panic when our money is in jeopardy.

We make a connection between money and safety. Psychology suggests that we are programmed to protect our safety the same way our ancient ancestors were. Even though we encounter vastly different problems than our ancestors did, we still attempt to solve them in the same way. Moving with the herd used to be crucial to staying alive. Today however, moving with a herd of investors can weaken your portfolio. Pushing money into an investment simply because the majority of others are is usually the exact opposite of what you should be doing.

In the same vein as the herd behavior, is our tendency to make investment decisions based on past success. Just because a strategy worked in the past does not necessarily mean it will work in the present. Markets change dramatically from week to week. Strategies you used in the Dotcom boom of the late nineties may lead to an unpleasant outcome in today’s market. Sticking to market fundamentals is one thing, but taking on blind risk a second time because it worked out the first, is nothing more than a gamble. It is the same concept behind betting on red because the roulette ball fell in a red pocket the previous spin. No matter what your past performance, prudent due diligence is always necessary to gauge the current market trends, analyze risk and make sound investment decisions.

I have encountered a number of studies that suggest we remember the bitter feeling of losing money more acutely than the feelings we have when we earn the same amount in an investment. A few lousy investment decisions and an investor can be turned off indefinitely. It is important to learn from our mistakes and use the knowledge to our advantage. Our emotions can lead us to make decisions that, in hindsight, are horrible ideas. A bad decision is bad no matter what the outcome. Making money out of an emotional decision is lucky, but the decision itself was still the wrong one.

There is no way to completely escape our tendencies to invest based on emotion. But, by being aware of the negative impact our emotions have on our investment decisions, we can limit their influence. Wise approaches such as hiring investment professionals, practicing prudent due diligence and planning sound exit strategies can all help us become better investors. 

Bank Closures v. the FDIC 

Last week, federal regulators seized seven more banks- three in Florida and one each in Georgia, Minnesota, Illinois and Wisconsin. The bank failures brought the year’s total to 106, which is the most since the savings and loan debacle brought about 181 failures in 1992.  Plus, with 416 banks on the FDIC’s watch list, the number of bank failures is expected to rise before the end of the year. With bank closures quickly absorbing millions of dollars from the FDIC’s Deposit Insurance Fund, is it possible that our savings accounts are realistically still protected?

The FDIC operates like a basic insurance policy, except banks are the customers instead of individuals or groups of individuals. Banks pay insurance premiums to the FDIC in exchange for its commitment to protect their depositors’ money. In the late 1920s, when banks closed at an alarming rate, depositors had no protection from bank failures. Between 1929 and 1933, banks lost an estimated $1.3 billion of their customers’ money. Today, the FDIC protects several trillion dollars worth of deposits. But as of June, it only had $10.4 billion in its deposit insurance fund—down from about $45 billion earlier this year.

The FDIC’s reserves have quickly depleted as the cost of bank failures outpace the fees the corporation collects. Last month, as bank closures continued to mount, the FDIC’s board of directors considered four ways to bulk up the insurance fund. The options considered were: borrow from healthy banks, borrow from the treasury, levy a special fee on banks or collect regular premiums early.

Borrowing from healthy banks would reduce the amount of money available to the private sector. Borrowing from the Treasury could send the wrong message to the public and have adverse effects on the banking industry. Levying a special fee on banks could push those on the edge into failure. The last option, albeit not particularly attractive either, is to collect regular premiums early. Deciding to follow through with this option, the FDIC stated it “adopted a Notice of Proposed Rulemaking that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.” The press release indicated that the FDIC estimates prepayments will total approximately $45 billion.

Once approved, the proposed prepayments could give banks a bill for three years of premiums by the end of this year. While the requirement would put banks in a tough situation, the FDIC does not seem to think banks will find it too cumbersome. The FDIC believes that “the banking industry has substantial liquidity to prepay assessments.” As stated in the press release, “As of June 30, FDIC-insured institutions held more than $1.3 trillion in liquid balances, or 22 percent more than they did a year ago.”

The FDIC does have the capability to protect our deposits. However, initiatives that charge banks three years’ worth of premiums at once could help the FDIC weather an onslaught of bank closures without requiring the government to print more money…I hope.

All My Best,

Thomas J. Powell 

Death of Tax Credit Signals Return to Market Functionality

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.

Thomas J. Powell

Market Breaks 10,000- Don’t Get out the Champagne Yet

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.

 

Reno’s ELP Capital Seeks OK for Investment Vehicles

BY JOHN SEELMEYER

ELP Capital Inc. of Reno seeks regulatory

approval for two investment funds that will

target well-heeled sophisticated individual

investors.

Thomas Powell, the chief executive officer

of ELP Capital Inc., says the funds mark an

effort to jump-start the northern Nevada economy

by channeling local investment dollars

into local projects.

The company last week filed a notice with

the U.S. Securities and Exchange Commission

that it believes the two funds are exempt from

securities regulations because they will be sold

to a limited number of investors or to buyers

who meet the SEC’s standards for accredited

investors. (Those standards include net worth

and annual income for individual investors.)

The ELP Strategic Asset Fund LLC has

raised $450,000 so far, the company said in an

SEC filing. There’s no maximum size on the

fund, and minimum investments are set at

$250,000.

A second fund, ELP Opportunity Fund 1—

GBLL LLC, is planned to raised $2.3 million.

So far, $100,000 has been raised.Minimum

investment in the fund is $50,000.

ELP Capital, incorporated in 2004, has

managed debt and equity financing of real

estate. The company traces its beginnings to

IntoHomes LLC, a residential mortgage lender

launched by Powell in 1999.

Along with Powell, its board includes Jesse

Haw, president of Hawco Properties of Spanish

Springs, and Bob Barone, chairman of Ancora

West Trust Co. in Reno.

Powell, who’s also an author of books and

articles, has argued recently that private

investors can play a major role in getting the

construction and development markets moving

again if they’ll fund stalled quality projects.

“This recession … 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,” he wrote in an

essay this month.

ELP Capital expects to charge an annual

management fee of 1 percent of the funds’

assets, and it also may collect a performance

fee.

Along with the two investment funds, ELP

Capital last week filed SEC paperwork for

exempt offerings of securities in two real estate

funds.

One of the filings covers ELP Mortgage

Fund III — The Ridges LLC. The company

said $2.1 million of the $2.5 million fund has

been sold to accredited investors.

The second filing covered ELP Acquisition

Fund—Citi Centre LLC, which has raised

about $3.28 million of a $4.5 million offering.

Proceed with Caution

 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 30^th, 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 30^th deadline—for there is no shortage of higher-profile issues waiting to be addressed in September and October.  

 

All My Best,

Thomas J. Powell 

 

 

 

             

Pulling the Unemployed off the Ropes and Into the Fight

As markets continue to produce signs of stabilization over the next quarter, it is unlikely that unemployment figures will show much improvement. With figures the highest they have been in more than 25 years, unemployment appears to have neared its peak. Lowering the rate to levels our economy can adequately support will prove to be a daunting task. But, with a little encouragement the corporate sector certainly has the power to handle it.
Last week, Federal Reserve Chairman Ben Bernanke was quoted by multiple major news sources after he told the Brookings Institute, “The recession is likely over at this point.” According to Bernanke, the economy appears to be growing, but not at a pace that will be sufficient for lowering the unemployment rate. Historically, economic upturns after recessions have been stamped with consumer demand. This time around, however, many Americans may not have the ability to help lead a recovery because they have been completely wiped out financially.
In order to spur consumer-led demand, the corporate sector will again have to make jobs readily available. The unemployed are not the kind of consumers that are needed to invigorate our economy and induce growth. We do not need to turn to an economics textbook to tell us that our broken economic cycle can be patched with more available jobs—this much we know.
Corporations large and small have been forced to adapt to this constricted economy and the majority of them were required to do so through downsizing. Now, company leaders are reluctant to increase their workforce until they are confident there is a significant increase in demand for their products and services. But, one strong possibility that could provide the encouragement needed to get company leaders hiring again is a temporary change in corporate tax policy.
A temporary tax break aimed at equaling the payroll costs of adding new employees would strip the risk for companies that are awaiting a full-blown recovery before they hire. Plus, according to a recent article published in The Wall Street Journal:
“The impact of a two-year program on the federal deficit would be relatively modest. Using a conservative set of assumptions, an $18 billion annual program, which represents 10% of estimated corporate tax receipts in the next fiscal year could create nearly 600,000 good-paying jobs …”

Before they commit to hiring, companies are waiting for consumers to spend. But, before consumers commit to spending, they are waiting for companies to hire. The cycle is stagnant and will remain so until one side is persuaded to change their behavior. A government-sponsored tax break for companies that agree to hire could be the first action taken during this recession that encourages our country’s government, companies and individuals to work together.

Capital River is Frozen; We Can Thaw it

Because of the severe impact of the recession, the stream of capital that once flooded our economy has been reduced to a trickle. The majority of the flow evaporated when banks were forced by the Fed to tighten their lending standards as delinquent loans polluted their books. Consequently, failing to restore the flow is making it extremely difficult for the Fed to take progressive measures toward recovery and has the potential to drop us back into another recession.
According to Bloomberg.com:
“The Fed’s second-quarter survey of senior loan officers, released Aug. 17, showed U.S. banks tightened standards on all types of loans and said they expect to maintain strict criteria on lending until at least the second half of 2010.”

With dropping values in commercial real estate, rising unemployment numbers and a seemingly unending onslaught of delinquent mortgages; banks are not lacking reasons to practice strict lending measures. Earlier this year, through a series of stress tests, the Fed found that 19 of the country’s largest banks needed $75 billion in new capital to protect themselves from mounting losses.
With all of my recent writings and blog postings concerning the benefits of getting our private capital back in the game, I am by no means hiding my agenda for restoring capital flow. The economy will only be repaired once the flow of capital is rejuvenated. It is much easier to lead capital tributaries back into the main stream if they are first flowing. Over the next couple of quarters, banks will continue to deleverage and work toward a balanced lending system. But, without raising more private capital, banks will not be able to establish a lending system that enables credit-worthy individuals and businesses to acquire reasonable loans; which puts an enormous restraint on economic progress.
Our economy is already positioned to attempt to force a jobless recovery, which will certainly create complications in sustaining a recovery. Trying to force a credit-less recovery will only exacerbate our struggles. Dragging our banks through a painful recovery without sufficient capital will only position them to break and lead us right back through more of the same. By identifying ways to put our private capital back into the equation we are positioning our financial system to rise from this recession stronger and more efficient. By investing in private enterprise, we are sparking long-term, mutually-beneficial relationships between capital-producing businesses and banks (while also earning gracious returns on our initial investments). Now is the time to put our private capital back to work.

Without Our Capital, Banks Get the Axe

Our private capital plays an integral part in our local economies—which then all collectively have crucial roles in our country’s financial stability. Because banks have become over-reliant on easy credit, they are now struggling to keep their businesses running by raising capital the old fashioned way. Without our capital, our banks (and more importantly our communities) cannot function properly. Not able to fulfill their debt obligations, banks are closing their doors and falling under the control of the FDIC; which “estimates bank failures will cost the fund about $70 billion through 2013.”
Banks are necessary to ensure that money circulates in our communities. They distribute the money of their depositors to borrowers who have a worthwhile purpose for the money. The banks secure our savings and lend the money to companies or individuals. Banks provide a convenient location for borrowers to acquire funds. Without banks, companies would find it very difficult to borrow large sums of money.
While banks perform their role as intermediaries, they also essentially increase the supply of money. By accepting deposits from its customers and loaning the money to worthy borrowers, banks “create” money. Consider the following simple example. Imagine a customer deposits $20,000 into her bank account. Even though the bills are no longer in circulation, the amount of money in our country does not change as a result of the deposit. Allowing the money to simply sit in the bank’s safe would not earn the bank anything. Therefore, the bank lends $10,000 to an entrepreneur in return for an additional interest fee. The depositor still has a $20,000 credit in her account and the entrepreneur has $10,000, therefore the money supply has increased by $10,000. The entrepreneur purchases supplies with the money and creates a product that he sells for a profit. As long as banks have depositors, they are able play their crucial role of increasing the money supply by making funds available to those looking to find backing for their ventures.
The word “bank” itself is derived from the Italian word “banca,” which referred to the table on which coins were counted and exchanged in the middle ages. “Bancarotta,” from which the word “bankrupt” was derived, means “broken bank.” Originally, if a banker was unable to pay his debts, the authorities arrived to smash his table in half with an axe. Today, the FDIC seizes failed banks and seeks buyers for their branches, deposits and faulty loans—all, for some reason, without smashing anything with an axe.

All my best,

Thomas J. Powell

 

 

Ghost of Recessions Past

Maybe this is all a bad dream, and like Dickens’ Ebenezer Scrooge, a voice from the past is warning financial regulators.
Former Fed chairman Paul Volcker testified in front of the House Financial Services Committee today. Look at the excerpt from his prepared statement. He warns that the Fed’s reaction to the recent crisis may actually increase the likelihood of future collapse. By creating a safety net for the too-big-to fail banks, Volcker argues, we are exposing the financial system to more risk!
Paul Volcker is no stranger to economic crisis. As head of the fed from 1979-1987, Volcker helped steer the economy out of the infamous ‘stagflation’ of the late 1970s. Stagflation was an economic anomaly: high unemployment combined with inflation and negative growth rates. Many hail Reagan’s deregulatory policies as the solution. But this was only a piece of the puzzle. Volcker headed the Fed at a time when the structure of the world economy was undergoing an historic shift. The international monetary system had collapsed and, like today, monetary policy was ineffective at solving the nation’s problems. Volcker oversaw a dynamic shift in how we value currencies and conduct monetary policy.
Why is all this important? Because 82-year-old Volcker is saying the same thing I am. Instead of looking at real changes to the system itself, like Volcker did, regulators continue to recklessly throw money at the problem. Fortunately for us, we are not facing stagflation. The problem today is the steady deflation of our wealth. However, the lesson is the same: let’s look at ways to change the system instead of perpetuating the cycle with safety nets. Volcker suggested re-instating Glass-Steagall. This should reduce big bank’s incentives to gamble our wealth away.
I also agree with his stance that smaller institutions are getting squeezed out of the economy. If the government only backs a small handful of participants, how will smaller private firms compete? Without those firms we will never return to prosperity.
So let’s take a minute to heed Volcker’s advice. It’s more than Obama is doing. Volcker may be one of the president’s chief advisors, but he’s not listening. Unlike Dickens’ tale, this is not a dream. I think Volcker’s advice will haunt the halls in Washington for a long time.

Tom