Fear, greed and loathing in Las Vegas - The US economy; then and now.
I have always been very interested in economics. The interpretation of the behavior of millions of individuals all making decisions simultaneously is fascinating. Macroeconomics is incredibly complex, but if we can see some trends, above average returns are possible. First I will present my interpretation of how we have arrived at today's economy.
Las Vegas - circa 2004
I visit LV many time every year. I only live a few hours away, so the drive is quite pleasant. You would not believe my reasons for visiting sin city, but let us not digress. Sometime in 2004, I was having dinner at a PF Changs. I always go right to the bar since I hate waiting to eat, and I meet some real characters while dinning. On this particular evening, there were 3 young kids(anyone below 30 get my KID moniker) eating and drinking next me. They were all boasting of there latest real estate deals and profits. As a former slum lord, Having bought and sold over 30 properties, I was keenly interested in there discussions.
Not to my surprise, they were very willing to tell me about there recent killings in the LV real estate market. These young Turks were buying several new homes at the same time, then flipping within a few months for 50-75K profits per home. These guy were fun, and I enjoyed our conversations. I have found that ground level info on the economy is very valuable - our government should try this approach. On my drive into the desert, I dismissed there claims as just some lying, and one upping each other.
Las Vegas - circa 2005 - 2006
I'm back in Vegas baby! At PF Changs, at the same bar. The bar is packed - in fact LV is packed and vibrant. I can't believe the amount of desert being scrapped for more ugly boxes - this can not continue I scream! I am wrong - at the PF's bar I meet more 20 somethings and everyone is talking real estate. Everyone is a flipper and dealer - Can everyone be lying? I start to investigate. I am not surprised to find people buying more than one property at the same time - I have done this in the past with rental houses/condo's back in the 1980's. The banks still don't know real time that people are lying on there mortgage applications? HM I guess not. But I was buying property that ware cash flow positive - I had tenants paying my multiple mortgages. In LV there were no renters, these were new homes that could not be cash flow positive. These new buyers had no cash, and there jobs were fairly low paying - they could not even qualify for one of these ugly boxes - but they were buying 3 or 4 at a time?
The reason, ALT A loans and basically ZERO due diligence from lenders. You can say anything - I make 15K per month - RIGHT.....This was when I started buying puts on some of the HB's. I picked KBH as my target for a hedge against my long fund.
How could this happen? a Macro interpretation.
I started to analyze this crazy home financing system. My theory is fairly simple. To much liquidity chasing an ever shrinking yield. After the US depression in 2001-2002 the federal bank lower the funds rate to 1% and kept it there. Wealthy investors were stumped; With short and long term risk free yields a pathetic low level - cash was getting very hard to invest. Investors were still hurt from the stock market crash, so these investor would not put there cash in equity markets. Then the US gave a large tax break to these investors, giving them even more cash per year to handle - what to do with all this money?????
The combination of historic low yields, fear of equities, and a poorly targeted tax cut; created a HUGE increase in demand for stable return or yield on all this cash. Can you say SIV? Where you have demand - supply will not be far behind. The larger banks and investment house increased the creations of CMO, CDO's that satisfy the large increase in demand for yield. 5-6% yield will do just fine in this now low yield environment. To satisfy this large uptick in demand, lending standard had to fall - there is no other way to meet this new demand. No doc, negative amort., sub-prime, teaser rates loans all became common place - and much to the glee of my box flipping buddies back at the PF Chang bar in Vegas.....
Year of reckoning - 2008
Where is the US economy today? We are in a recession, and it may be a longer than average one. Housing is no loner the issue - it is the credit collapsing due to the lending ponzi scheme finally falling apart. In conclusion, IMHO the US government has helped create the current housing bubble, and the current credit meltdown.
As far as housing, my calculations show that home prices have already fallen back to base affordability levels. The measure to use is simple - the monthly $ amount per sq. footage of new home price. Rates are close to historic lows, and the sq footage of new homes are at historic highs. Do not look at simplistic home price charts - stupidity or fear mongering - take your pick.
Will home prices continue to fall? IMHO, yes. Lenders are still trying to raise capital, not lend, and US consumers do not wish to buy an asset that is still falling.
Future US economy 2008 - 2009; what's next?
I think we need to get helicopter Ben, and Hank Paulson to frequent a PF Changs bar once a month. It is still unbelievable to me that our GVMT did not see this recession coming.......I know many CAPS bloggers love to hate the HB stocks. Many have made the top 1-2% on CAPS by shorting this group. Your days are numbered IMHO. We will get a US housing bailout package before the end of the year.
Even without a bailout, making additional money on shorting the HB's will be increasingly difficult. It will be like trying to kick a dead whale down the beach - good luck! Am I going long the HB's? No, I have many other stocks and industries(like my NG Blog) for my cash. I will be publishing my top 20 DCF stocks this weeks. Many of these are already in my CAPS picks, and real fund.
The US housing bailout needs to work as follows. 300-500B of lower level tranches of CMO debt needs to be purchased and held by the US government. Also the GSE's/FHA need to loan cheap money 5.5% 30 yr, to refi the weak/poor loans with 2006-2007 vintages. and slow down the foreclosure process. The third leg of the bailout would be the GVMT helping states and cities raise bond funds to purchase distressed homes in hard hit communities and take them off the market - maybe affordable rentals, for lower level workers, etc....
This is an election year, and the politicians will be tripping over each other to show how much they care about us. If the US economy is a weak as I suspect - and as weak as all the bears on CAPS think, then this above housing/economic bailout will happen. And if the economy is really not as bad as we think - no bailout, but no more profits for shorts either way.
What about moral hazard? This is not an issue for me. As my blog suggests, I hold our government responsible for the current credit meltdown, so a bailout is not unreasonable. Don't even get me started about the questions about government oversight and regulating the fraudulent lending practices, and ratings agencies during the past 5 years.
Baseline economic projection is a recession for most of 2008, followed by slow but steady recovery in 2009. I think the recession started in Dec. 2007. The midpoint of a recession is typically the best time to buy equities IMHO. So April/May will be the best time to increase exposure to equities. The HB's tanked first, so they may bounce back up first and hard. So if you have cash on the sidelines I would average down slowly to a fully invested position by May. I still like my high yielding cash flow stocks, energy(natural gas) stocks, and international infrastructure plays like MTW, or TEX.
Good luck to my fellow investors during this challenging period - and if you get a chance - visit a PF Changs in Las Vegas for more real time economic data!