lookbeforeUleap

Three Reasons Commercial Real Estate Could Hold Back a Recovery

I would like to thank the author for the time and effort put into such a post, along with the authors of the measured responses. This issue is an important reminder to all of us that the problems created by the incredible valuations and leverage of the last half-decade have created billions in "dead assets" that are either extremely difficult to unwind or still incredibly overvalued, and the various government programs intended to deal with the problems will be unable to stop the natural market forces. Our society seems to have very little patience for the steps necessary to properly deal with such an economic crisis, and the government seems intent on "saving" the banks by bankrupting the Treasury, so I must agree that after the limitations and consequences of the bailout plans are fully exposed, there will be more pain to come in equities and bonds. I counsel patience for prudent investors - you're better off being late to the party than being the chump who pays for it.

Dr. Doom Responds on Wells Fargo

Douglas - I have read many posts on this site and never have I experianced reactions such as yours. It appears you think anyone who dares to say "The King has no clothes" is an irrepsonsible know-nothing who should be silenced and ridiculed. Schiff has been predicting the demise of our financial system for 3 years - it didn't happen simply because he predicted it and people got scared, it happend because it was inevitable. The situation is not getting worse because of Schiff and Roubini, it is getting worse because very intelligent and well meaning people are having an extremely hard time deciding what is the best method for resolving all of the credit crises, and that has led a lot of investors to critically analyze the problems our financial sector faces. Look at what happened in Japan after their drunken real estate orgy in the '80's, and what has happened since because they refused to deal with the bank problem in the manner necessary. You can refuse to acknowledge it all you want, but that doesn't make it go away.

I suggest you save your invective and vitriol for someone who truely deserves it - your personal attacks on others in this blog are ridiculous and childish. Go ahead and disagree all you want, but stuff the name calling in a sock. Your anger is misplaced - it shoud be directed towards those that led the sheeple into this mess in the first place.

Buying USO Is a No-Brainer

A simple warning for all who expect to make a killing going long on USO. I suggest you read the USO prospectus and familiarize yourselves with the methodology used by USO to make the Nymex contract investments, and the effects of contango. As the fund manager said, even if the price of the current month contract stabilizes at the price the previous month settled at, USO investors will lose 30% each month since the forward month contracts are all priced at over $40. The contango was more than $9 at the expiration of the January delivery contract on 12/19/08 - so if the February deliver contract simply maintains the $33 price that the January contract settled at, the purchaser of the February contract on 12/19/08 will have a loss of $9 even though the February delivery contract settled at the same price as the January delivery contract.

USO sells the current month's contract and purchases the next month's contract 2 weeks prior to the expiration of the current month contract no matter what the price of the contracts, and as long as the future contracts are priced higher than the current month contract, that amount of price appreciation will never benefit the NAV of USO. Why do you think their are so many shorts on USO - only a fool would buy USO under the present conditions. Wait until the forward month contract prices come down, or the current month contract price stops dropping so precipitously, so that the contango decreases and when USO rolls out of the current month contract it can buy the next month's contract at relativley the same price or a much smaller premium. Until then, USO will not benefit in price appreciation and will even continue to lose NAV if the current month contract price simply stabilizes.

Where Was the Inflation?

Dirk - I am somewhat surprised regarding some of your comments in this post. To suggest that there has been relatively little inflation during the past few years is too ignore everything that surrounds you. Energy, all commodities, food, housing, vehicles - all experianced significant inflation during the last few years but most are not included in the government's CPI or have been nulified by some subjective determinations that the price increases were supported by perceived value increases in the products. Are you actually suggesting that goods & services during the past few years have been created in an amount that would have absorbed all the additional credit (money supply) that the real estate bubble produced? Your comments indicate that you believe interest rates should not have been increased by the FED during this time period, and it was that increase that resulted in the death spiral we are in today.

With all due respect - are you out of your mind? First of all, almost all commercial debt is tied to Libor rates, not the prime rate (which is directly affected by the FED's discount rate). Secondly, many companies purchase interest rate swaps that put ceilings on the amount of interest rate exposure they have on their debt. That insulates them from subsequent market interest rate increases. Of course, new debt issuances are subject to the current interest rates, but a company will not incur the debt unless the return on the investment from the debt proceeds exceeds a certain level based on the risk of the investment. Once that debt is issued, it is irrelevant what happens to interest rates. Third, non-ARM mortgage debt rates have nothing to do with the FED discount rate. Many property purchasers received no-documentation loans or borrowed downpayment amounts using HELOC's. The no-doc loans were actually more lucrative to lenders because securitizers would pay more for those than conforming loans, so many mortgage brokers actually pushed buyer's into those loans. They may have paid a little more in interest, but it was so easy to get such a loan with a good credit score. How about the HELOCS - you could buy a home with no money down and simply pay interest only on the first mortgage and the HELOC!!Once housing prices stopped rising and started downward due to the fact of oversupply and exhausted demand, it was obvious what would happen on these kinds of loans. Fourth, the fact that ARM's were obtained by borrower's in the first place is indicative of the speculative nature of the purchase - the ARM's provide a low teaser rate that allowed buyer's to qualify, but many could only have continued to pay the mortgage if rates never changed. Some even chose negative amortization ARMS, with the unpaid interest added to the loan balance - I can't imagine that any investor would but such a loan. In fact, at the time of purchase of the property, the applicable interest rate upon conversion of the ARM was already greater than the teaser rate. Many buyer's just ignored this fact - they assumed they could refinance using all the equity they would "earn" during the teaser period or they would just sell the house at an appreciated value.

Your post seems to advocate a Ponzi scheme - if the loans start to come under stress, simply lower interest rates for borrowers. When that no longer works, just have the FED buy the debt and do a workout for the borrower. Finally, the FED can just issue the debt directly to the borrower under whatever terms the FED needs to prop up the price. In your world, the asset bubble continues unabated until when? I'm not sure what your economic background is, but your naivete is astounding.

Inflation is the growth of the money supply at a rate that exceeds the creation of goods & services. More money, relatively, chasing fewer goods and services, causes inflation. Price increases are the result of inflation. Increases in the value of a house or other real estate does not result in an increase in wealth and is not equivalent to the creation of goods and services. Increased productivity should have no affect on the price of existing homes, and should only increase the price of new homes in an amount equal to the value of the productivity increase. No serious economist would argue that the 10 - 25% annual increases in home prices per square foot were supported by increased productivity. Ultimately, the credit markets burst the bubble, but the mortgages had been securitized and then split up into tranches and sold through REMICS, with the non-investment grade tranches resecuritized and sold in another REMIC and so on and so on..... That is why we are facing the "death spiral" because there is no easy way to deal with the toxic debt due to the contracts the REMIC's have with the servicers and the fact that the tranches were sold all over the world.

If I misread the premise of your post please forgive me - if I haven't, then good luck with convincing the FED governors to bear your thoughts in mind when the next asset bubble appears.