There are several reasons this investment vehicle is the next casualty of the credit crunch.
Many buyers “borrowed money” on commercial real estate based on what “cash flow will be” based on unreasonable inflation and demand assumptions, not on what cash flow actually was. Exceptionally high prices were paid on current small yield assumptions. Liberal financing was provided by “cash rich” banks that bought into these bloated expectations. The result, too many office buildings were built that were overleveraged. As the recession sets in, lost jobs create higher vacancies. In many cases, the current cash flows do not service the Mortgage Debt.
As the bail-out money sloshes into the poor hopeless, hapless US Economy, the potential for the next Grand Bubble becomes probable. In a “free market” economic system those that screw up, are allowed to fail. Most children only learn the lessons of life when they are allowed to fail and pay the consequences. Yet here we are, $8.5 Trillion has been pumped (and printed) into the American Economy (God knows what additional money will be printed) and the borrowing rate for Banks (Fed Funds) is at or near zero. The Federal Reserve is out of bullets. Your and my Government has decided to fight the current mess caused by years of easy money, easy credit, and low interest rates with easy money, easy credit and low interest rates. The Government is now supporting risk taking, with our bailed-out banks having little to lose. The Stag-Deflation is on.
The US Economy is dedicated to consumption. Consumption was 70.52% of GDP, in the 3rd Quarter of 2008. If Consumption falls, GDP falls, and if it falls far enough, we get a recession, or even worse, a depression.
Note the parabolic growth in consumption starting in 1980. The US consumer went on a buying spree due to easy credit, low interest rates and the “Wealth Effect”. The Wealth Effect is that wonderful emotional feeling you get, when assets you own go up in value (like your home and stocks). This increase in paper wealth creates the illusion that you can spend more because your wealth is rising. The US consumer borrowed on his new found wealth, and spent it on consumable goods, not appreciating assets. The average individual does not realize that it’s only wealth creation if you sell it.
Besides blowing money and over levering, the consumer bought a home with no money down, and without anyone checking his credit or his ability to pay. And look what happened. The housing prices declined and the market collapsed. For an encore, he just lost 50% of his retirement plan and/or his personal investment account in the stock market. DO YOU SERIOUSLY BELIEVE THE US CONSUMER IS NOW GOING TO GO OUT AND BUY/LEASE NEW CARS, BIG SCREEN TV’s, AND A NEW HOME? DO YOU REALLY THINK HE’S GOING TO POUR MORE MONEY INTO THE STOCK MARKET? I’LL BET YA THE US CONSIMER IS WORRYING ABOUT HIS JOB. ANY MONEY HE GETS FROM A BAIL OUT WILL BE USED TO PAY DOWN DEBT. IF HE HAS ANYTHING LEFT (WHICH IS DOUBTFUL), HE WILL BUY A PRAYER RUG.
The socialization of America is under way. The Government owns the Auto Industry, the Mortgage conduits (Fannie May, and Freddie Mac), Bear Sterns, and controls numerous big City Banks. The Government is now encouraging us to: spend money by giving us Income Tax Credits; and borrow money because interest rates are at all time lows. ARE THEY NUTS? Isn’t this how we got our self into this mess!
Look at the poor commodity market below. It’s a blood bath. Commodities tell us that Deflation has started.
Now we hear that our Government is very upset with the banks that got the bail out funds. They aren’t lending the money. As of this date we (the people that actually paid for the Bail-Out) don’t know who got the money. The Government is now putting pressure on the Banks to make loans. This means that the poorest credit risks will receive bank funds (taxpayer money), and once again the taxpayer takes a big hit.
The Government also wants to bail-out the poor foreclosed home owner. By lowering his interest rates and adding years to the payout, the homeowner is now supposed to be able to afford the mortgage. Isn’t it highly probable, that the sub-prime borrower is the first to be unemployed? Whatever the Government does to save foreclosed homeowners, only defers the ultimate foreclosure and collapse of credit. Anyone want to own a Mortgage Company?
The other great idea our Government has is to resurrect a plan that did not work in the Great Depression and certainly won’t work this time. Namely, get money out to the “shovel ready” infrastructure projects. This concept will put some folks to work with pay, and may be a benefit to the US Economy in the long run. However, how many “shovel ready” projects do you think exist? Translation: throw the money around as quickly as possible at hastily “dreamed up” projects that have no chance of being efficient. I see projects like building bridges, tea gardens, etc. The Government will of course impose environmental constraints on all of their projects. Just imagine the lobbyists running amuck finding “shovel ready” projects for their Brother, Mother, Uncles and Aunts. The result: another boondoggle, with little improvement in our current situation, and we all go deeper in debt.
President elect Obama has a plan that creates 3.5 Million jobs at a cost of $775 Billion (trust me; Congress will spend a lot more on this monkey business). This translates to an expenditure of $221,400 per new job. What not just give everybody $2,500 Tax Free?
The zero maturity money (money market funds) is now on the rise again growing at more than 10% for the year (See chart below). The world is awash in money and no one is taking any risk. Investors, out of fear, have driven the 90 Day T-Bill to a yield of .11% on 12/31/08. This build up of liquidity coupled with an unbelievable increase in Bank Reserves (printing press money), and low interest rates, sets the stage for the next bubble.
Economists and Financial Analysts base there work normally on past history. The Economic and Financial Models are all very sophisticated and contain elaborate equations that purport to forecast the future. The models are always based on past history and assorted assumptions. From 1965 to 1972 I ran complex models to forecast future Economic and Investment levels. I always achieved the same forecast results: Some I got right, some I got wrong, and mostly I got really wrong. Economists call the difference between what actually occurs and mathematical Forecasts as “white Noise”. What the mathematical models fail to take into account is the “people factor”. Investor and Consumer Psychology play’s a major role in determining outcomes in Finance and the Economy.
The human element needed in all equations, is: what is the investors current experience with investments? What is the consumer’s outlook for the future? In my view the investor is tired of losing money, and the consumer wants to keep his job, get out of debt, and save some money. Soon or later they all change their mind and return to taking risk and spending, but for now I find it highly improbable.
In my view the Recession will last past 2009 and probably end some time in 2010. Falling prices, slow to negative growth, and declining asset prices is our immediate future. Hold on to your cash, get out of debt, and stay close to your family and friends. The only risk you should take is going to and coming home from work.
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