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Unfortunately There are Three Types of Debt

2012-01-02T17:24:00.000-08:00

Except for PhD economists and government officials most rational people are beginning to understand our nation’s most urgent economic problem.

By any measurement the United States has borrowed far more than can ever be paid back.

As a percentage of GDP we hold twice as much total debt and off balance sheet liabilities than we have ever held before.

But unfortunately this is not our nation’s biggest dilemma. Our biggest problem is that we are ignoring our nation’s horrendous addiction to debt.

This is because the PhD economists that help our elected officials create policy are not trained in accounting or simple finance. All debt is the same to them whether it is borrowed to add more lanes to a congested stretch of highway or to add more layers to our monumentally bloated government.

Training PhD economists to treat all debt the same is like training a Doctor to think of the stimulants Ritalin and Crystal Meth as equal remedies for a child with Attention Deficit Disorder.

Thanks to our nation’s incompetent economists the economy is presently overstimulated on the Crystal Meth of debt, also known as Dysfunctional Debt.

Dysfunctional Debt is the exact opposite of Productive Debt.

Productive Debt is a financial tool that can create economic growth.

Dysfunctional Debt is almost always a political tool. It is used by government officials to reward their political favorites. It is exactly like Crystal Meth. It reduces the junkie’s drive to produce and it is highly addictive.

To understand the corrosive nature of Dysfunctional Debt one must understand the nature and function of debt.

Productive Debt: Is a business, government or personal financial tool that allows resources to be used in the most efficient way today without affecting the future.

There are very few examples of Productive Debt:

• In business, money can be borrowed to create new product markets and new technology that don’t compete with our current markets.

• In government, bonds can be sold to create new infrastructure that is required for optimal future growth. Like adding lanes to a congested highway.

• In households, money can be borrowed to purchase undervalued real estate.

Productive Debt is a financial tool that creates a permanent improvement in our economy’s growth curve. It does not pull resources from the future.

The fastest GDP growth that our nation has ever experienced was from 1933 to 1953. This remarkable growth was financed by Productive Debt that built a new manufacturing base, constructed needed infrastructure and financed the purchase of undervalued homes.

Non Productive Debt: Is a business, government or personal financial tool that moves money from one entity to another:

• In business, money can be loaned to one businessperson to compete against another businessperson.

• In government, bonds can be sold to repair existing infrastructure.

• In households, money can be borrowed to purchase fairly priced real estate.

Non Productive Debt keeps our nation moving forward at a constant rate. It is a financial tool that works as a buffer to maintain stable economic growth. It is the most common type of debt in a healthy economy.

Dysfunctional Debt: Is a political tool that creates a destructive liability with the help of a false promise and phony accounting. I use the term Destructive to mean the opposite of Productive. This is because the nature of the liability is hidden as the money props up bad business and rewards bad investing. In extreme examples it permanently corrupts free market mechanisms. This is what we are seeing today.

Before this generation there are very few examples in this country of Dysfunctional Debt. Unfortunately today there are too many examples to list. There is layer upon layer of gifts to favored individuals and groups by our government that is hidden by false promises, phony accounting and market manipulation.

Real Estate is a good example of a sector of our economy that is addicted to Dysfunctional Debt. In 1985 homeowners on average had 70 percent equity in their homes. Since then the government has made it a priority to give resources to the real estate sector to help it grow.

Resources were robbed from the future to support unwise decisions in the present.

This has caused home equity to go down almost every year since the government made real estate a favored sector of the economy.

According to the Federal Reserve homeowners on average own just 38% of their homes today. Half of the amount in 1985.

This is sad but it is not the problem. The problem is that the government is adding trillions of taxpayer debt to support the bankrupt banks. Trillions in the future will be borrowed to support the losses that Fannie Mae and Freddie Mac are incurring now.

Adding the trillions in hidden government debt to the $10 trillion in mortgage debt means that taxpayers owe more money than their homes are worth. This makes our housing market insolvent. Like addicts we have taken the crown jewel of our nation's wealth and with the government's help we have sold it off for immediate gratification.

The dysfunctional real estate market is easy to see but there are many other sectors of our economy that have used government debt to rob productive resources from the future.

The economy of the next ten years will be the antithesis of the miracle economy of 1933 through 1953. Destructive Debt has replaced the Productive Debt that fueled the record growth of our grandparent's generation.

The next decade will see the slowest GDP growth in our nation’s history.

Thanks to PhD economists, government officials and the Crystal Meth of Dysfunctional Debt.

How to Determine the Value of a Primary Residence

2011-12-02T21:40:00.000-08:00

I sold my home in 2007 and I am still renting today. According to the three mathematical valuations methods that I use it no longer made sense to own a primary residence in 07’. The irony was that everyone else in the country was climbing over themselves to buy a home in the most overpriced housing market in our nation’s history.

I used my three mathematical valuation methods to determine that it was a fantastic time to buy a primary residence in 1996. Back then I stretched to buy a home that was 5 times my household income. Maybe the purchase was a bit imprudent but what the heck, it was a great time to buy. And, even though houses were cheap, The Herd of clueless investors didn’t whan to buy a home in 96’.

We are animals and our Herd Mentality usurps our common sense much of the time.
It is happening today:

• Why does everyone want to purchase gold now at $1,800 an ounce? The time to buy was in 2001 at $275 an ounce. Today investors are climbing over themselves to purchase an overvalued asset that gives no investment return and is difficult and expensive to sell.

• Why would anyone in their right mind buy a 30 year treasury bond now? Yields are at historic lows which means prices are at historic highs as people are rushing to purchase this “perceived” risk free investment.

• Why would anyone have a significant portion of their retirement in the stock market now? We are heading into a global recession and the worst economy in the past 70 years. Most publicly traded companies are not growing; they are cutting costs to increase their profits. But investors don’t care about the quality of the growth or what will happen in the near future, they are only concerned with following The Herd into the current overvalued market.

• Why would anyone pay bubble prices in the housing market? Some young families are still purchasing overpriced homes that will be underwater in 5 years.

People are Herd investors.

This is why it is imperative that you use some sort of time tested valuation method to put a price on the most expensive asset you will ever own.

Perhaps the best method to determine if it makes sense to purchase a home is to:

• Compare the monthly cost of owning vs. the monthly cost of renting.

Without considering inflation, you should be able to own a home for a little less per month than renting a similar home. You will pay less to own because of the lost return on your 20% down payment and the ridiculously large transaction costs when it’s time to move.

The Rent vs. Own comparison method has been used for generations to determine whether it’s better to buy or rent a home. It always works.

The only other variable that effects the equation is inflation.

So now that we are in deflation, which is the opposite of inflation, it makes sense to pay less to purchase a home compared to renting a similar home.

In 7 to 10 years once inflation rears its ugly head, it will then make sense to pay a bit of a premium to own a home.

It makes no sense to pay a premium for a home in a stagnant economy. This is why I am not rushing out to purchase a home in Walnut Creek and Pleasant Hill. It is still a little cheaper to rent.

Then there are the “higher end” areas of Lafayette and Alamo where it is much, much cheaper to rent. Many “high end” areas are still stubbornly stuck in a bubble as young families purchase homes that will almost certainly be underwater in their mortgages in 5 years.

The second valuation method that can help determine the fair value of a primary residence is:

• Comparing Household income to Home Price.

Throughout history families did not speculate on their “primary residence. They wanted to be able to “afford” their home.

It may seem strange now but historically people have felt that it was prudent to pay between 2 to 4 times their household incomes for a primary residence. During good economic periods they would pay up to 4 times their household income and during questionable economic periods they would be more conservative and pay 2 times.

Our grandparents chose to buy homes at 2 times their household income.

Contrast the prudence of our grandparent with our generation.
Five years ago, as a nation, we were desperate to pay 8 times our household income for a place to live even though we could rent for half the price of owning.

In California buyers were climbing over each other to pay 10 times their household income for 4 walls and a roof.

It did not make any mathematical sense then and it still doesn’t today.

Many buyers in Walnut Creek, Pleasant Hill and Lafayette are still paying 6 times their household income for a house.

Considering that we are in deflation and that we are entering the worst economic period in our nation’s history, would it not make more sense for home buyers to be paying 2 times their household income for a home?

This brings us to our last valid method to value real estate. It is driven by looking at historical trends:

• Comparing Current Sale Prices vs. Historical Trends

This method is used by professors Karl Case and Robert Shiller. They created the Case-Shiller index. With the Case-Shiller index Robert Shiller was able to intelligently argue that we were in a massive real estate bubble from 2003 through 2007.

The fact that no one listened to him creates a good argument that it is extremely foolish not to use mathematically driven valuation methods to determine when to buy real estate.

In 2007 I made my own graphs of the national and local real estate markets. I compared aggregate income to house prices. The charts pictured a huge bubble. I tried to show this bubble to a number of people and no one could see it. In nature herd animals focus their attention side to side watching the actions of The Herd instead of straight ahead.

So it made sense that no one in The Herd could look at something directly in front of their face.

I am absolutely certain that the Rent vs. Own; Household Income vs. Home Price and Historical Trend Methods are the only 3 viable ways to determine the utility value of a primary residence.

Unfortunately our government, the financial sector and most economists do not seem to want anything to do with mathematically driven valuation methods.

Their goal is to keep our nation of clueless investors in a herd. For the past 8 years they have been content to stand at the edge of the financial cliff and wave The Herd into purchasing overvalued homes.

Even the Chairman of the Federal Reserve Ben Bernanke, who is a math genius, would never conceive of using a mathematical method to value the housing market. In 2006, just months before the housing market crashed Dr. Bernanke continued to profess there was no problem with real estate values in this country. He gave his blessing for young families to purchase the most overpricing housing in our nation's history.

Dr. Bernanke was gleefully waving a whole nation of real estate investors toward financial abyss as I was desperately fixing my home to unload it.

Today Chairman Bernanke and The Federal Reserve have been instrumental in destroying our free market interest rates in an attempt to trick more buyers back into the herd of homeowners. Even though in many cases these young families would be much more financially secure to rent for a while.

I don’t feel that tricking young people into buying an overpriced primary residence makes for a healthy housing market.

I feel that fairly priced assets and transparent and free markets are the foundation of a healthy economy and a free society.

Unfortunately Dr. Bernanke, our financial sector, most of our government and The Herd of clueless investors feel that overpriced assets driven by unsustainable debt and corrupted markets hidden by economic disinformation will lead to economic prosperity.

I will wait to buy a home until it makes financial sense for me to do so.

The Battle of The Upper End Housing Market

2011-11-05T08:05:00.001-07:00

There are three separate battles that must be fought in the war against the Housing Bubble.

The first battle was the bloodiest and has already been fought. The banksters have carpet bombed the lower end of the housing market with foreclosures. The speed and thoroughness of the operation could be compared to the Blitzkrieg by Nazi Germany in World War II. Robo signers replace the Messerschmitts that reighed terror from the sky.

There is no loss of life of course, but lives have been destroyed all the same.

Mercifully the destruction is complete and the battle of home prices is over. The banksters are moving out, and on to greener pastures of exploitation.

Lower end areas like Antioch, Pittsburg and many parts of Oakland are selling below 2000 prices. It is time for the citizens of these markets to come out of their bunkers and rebuild.

The destruction has laid a foundation for growth. For the first time in 8 years young families are buying homes at affordable prices and investors are getting a fair return on their investment. The lower end housing market has wrested itself free of the tyranny of greed caused by the banksters and the bubble.

There is still some fighting in the middle tier of the market. This would be the Walnut Creek and Pleasant Hill areas. In these areas there is reasonable value for the discerning buyer but there is still a small cohort of overpriced resistance fighting back.

The banksters are using a different and more cunning strategy than in the battle of the lower end. They are strategically unloading just enough foreclosures in an attempt to keep prices in the bubble. This market manipulation allows for a slower more painful decline in home prices. It’s more like the punji stick booby traps in Vietnam.

But home buyers are on the offensive. They are purchasing homes at median 2002 value, so this battle is close to an end. Unfortunately for the buyers there are still a few homes that are listed at 2007 prices. These landmines can booby trap an undiscerning young family that is not skilled in reading the new terrain.

It is exactly like an explosion. The 2007 purchase price radiates mispriced value out amongst the surrounding area. A devastating event for the young families involved. Indirectly there is collateral damage to the market. But as time goes by this will happen less and less. The new buyers coming into the fray will learn from the mistakes of their fallen comrades.

Looking at the numbers it appears that Walnut Creek and Pleasant Hill buyers are learning to avoid the landmines. The pending sales numbers are starting to trend at 2001 values. Once these pending sales are closed, it will mean affordable pricing for comparable homes in the future.

As long as there are no new Covert Operations, like the Homebuyer Tax Credit by our government, the neutral zone between buyer and sellers will be drawn at 2001 prices. The white flag will be raised just south of the bubble and the battle will be over. Young families will be able to safely enter into the Walnut Creek and Pleasant Hill markets in 2011.

The final battle rages in the high end markets of Alamo and Lafayette with no hope of ending anytime soon. Overall the market is selling at 2005 prices, solidly in the bubble. Young buyers are totally outmatched in this fight.

There are many homes that are still being sold at 2007 prices. Each sale creates a comparable that enables other sellers to price their home at peak bubble price. These booby traps will continue to snare young families into a home that in all likelihood will be underwater in 5 years as prices slowly trend downward to 2002 values.

To make matters worse for the young buyers is that the banksters have allied with the sellers in this battle. The same banks that carpet bombed the homeowners in the lower end housing market, and used punji sticks to demoralize the middle tier buyers are now stockpiling foreclosures in the high end market. This stockpile of foreclosures could very well become a weapon of mass destruction in the future when they are unloaded onto the unsuspecting young people purchasing homes today.

Another powder keg that could explode is the pent up force of rising interest rates. There are many more interest only loans in the upper end market compared to the middle and lower tiers of the housing market. This trip wire has the potential to blow the whole high end market back to the Stone Age.

But what should be most distressing to young home buyers is that the Black Ops team at the Federal Reserve has helicopters in the air. Even though there is no chance of winning the war, The Fed is fiercely fighting free market interest rates in an effort to stretch out this battle for as long as possible. This Kamikaze mission by The Fed is meant to Shanghai young high end home buyers into joining their futile battle against our nation's free markets.

The high end market is like the fight between brothers on opposing sides during the Civil War. Except in this fight the rich older brother that started the war is borrowing money from China to continue the war and sending the bill to the poor younger brother that had nothing to do with starting the war in the first place.

War is definitely Hell.

For the next 3-5 years this battle will continue between the young and the old in Alamo and Lafayette. I don’t see how the young people that want to move into these markets have a chance. The high end home sellers have the money and the means to hold out for bubble prices. They have also formed an alliance with the banksters and The Fed.

The young buyers that enter this battlefield are set to become the cannon fodder that allows many rich sellers to escape from the bubble with all of their false profits as it imprisons an unsuspecting young family into an overpriced home in a very, very unsound economy.

If you are a young family looking to purchase a home, I would urge you to stay clear of this war zone.

Zero Gravity Flight

2011-07-10T18:06:00.000-07:00

Over the past 4 years our government at all levels has borrowed $6 trillion in future productive resources that taxpayers must pay back. Little of this largesse has made it's way back to private sector Middle Class Producers. Much of this money is pooling in the bank accounts of; The Rich, Big Banks, Multinational Corporations, Overseas Investors and Wall Street.

The Federal Reserve is redistributing our savings in the same fashion. Ben Bernanke has the Federal Funds rate locked permanently at 3,000% below the 10 Year Treasury bond Yield. This is in effect confiscating the investment returns of savers. The money is pooling or "stagnating" in the reserve accounts of the Big Banks.

Although the amounts are getting larger and more aggressive, these policy choices that I mentioned above have been consistent for the last 15 years. We continue to rob resources from the future to reward government favorites now.

Taking resources from private sector production and savings and then distributing them randomly to the government’s public sector favorites is not a formula to create sustained growth in an economy. At the very best it will create economic stagnation, which is easy to see in our economy today. For the past 15 years real household incomes have stagnated. We continue to lose private sector jobs, while the total size of the public sector has been growing faster than Mississippi sumac in summertime.

Looking at the situation logically, the policy choices that our government has made over the last 15 years should lead to economic stagnation.

For the past 15 years we have had economic stagnation.

How could any rational person not see the cause and effect.

The problem is that investors don't seem to understand the cause and effect of this situation. It is very important that the market understand the probable outcomes and consequences of our government’s policy choices:

“We have borrowed extreme amounts from the future and locked ourselves into a slow growth economy now. The limited resources available during our slow growth period will probably continue to be directed by the choices of government officials as much as our free markets.”

The previous statement would give full disclosure to our current economic situation. Our future will be a slow growth environment with resources being allocated by the capriciousness of government officials instead of the free market.

But when the facts are distorted, the misinformation becomes a big problem for our investment markets and our economy.

Presently government policy makers continue to tell our financially incompetent populace that more private sector jobs are coming and economic recovery is on the horizon.

Obviously this is an impossible outcome given our government’s current policy choices and our limited economic options.

Therefore this erroneous information from a trusted source creates a large disconnect between reality and expectations. Misinformation is creating huge investment bubbles in our economy. We are now at the apex of our third bubble in 12 years.

Investment prices are floating dangerously higher than the valuations that support them.

Our present bubble is like an airplane achieving its maximum altitude as it flattens out and begins a quick decent. Presently we are at the point in the parabolic arch where gravity no longer exists. This is called Zero Gravity Flight and in an airplane or an investment market this period can only be temporary.

Zero Gravity Flight can be very enjoyable if you understand what is happening. But it can be very dangerous if the captain of the airplane tells his passengers that this weightless condition will continue for the rest of the flight.

So if everyone on the airplane becomes detached from their seats at the apex of the parabolic loop with unrealistic expectations, it becomes a mania. These unrealistic expectations of the future can come crashing down once gravity exerts its force.

Overvaluation in our assets will bring the same result as our economy slows.

Presently just about all asset classes are overvalued. Commodities and bonds are historically overvalued. Investors are only interested in watching their investment returns sail to the moon. They are blind to the consequences.

Investors are desperate to stretch the risk curve, at absolutely the worst time in the economic cycle to stretch the risk curve.

So as Investors are joyously bouncing off the sides of the airplane cabin and as our captain has permanently turned off the “fasten your seatbelt” sign.

There has never been a better time for the prudent investor to sit down and buckle your seat belt tight.

Hummingbird Economics

2011-07-05T19:28:00.000-07:00

Biff has been fixated with hummingbirds since he was five years old. He has written many books and articles on the care and feeding of nature’s most important bird.

Unfortunately none have ever been published.

Amazingly, hummingbirds don’t seem to be a priority for most people. So Biff never received the recognition that his brother Ben receives.

Biff used an inheritance to purchase a 1000 acre valley in upstate Vermont. The parcel has always been known as Honeysuckle Valley. He bought the property to be closer to his birds and to distance himself from Princeton and the success of his brother.

Biff like his brother Ben has always been focused on improving his environment, so he started placing honeypots out in the open to lure more hummingbirds to his property.

Over the years Biff began noticing a change in the hummingbirds. They seemed to be growing in size so it was obvious that his honey was helping the birds. The only puzzlement was that the extra bulk seemed to make the hummers less nimble in escaping the advances of their predators, the hawks.

Biff thought about this constantly. He remembered his brother talking about disequilibrium in an economy. Could this be the same?

He called his brother Ben and asked for help. Ben explained his theory about stimulating slow moving economies with more money. So together they surmised that it made sense to stimulate the slow moving hummingbirds with more honey.

Biff started his own version of Economic Stimulus for his hummingbirds. This seemingly small event turned into a watershed moment in economic history.

As Biff provided more and more stimulus for the hummingbirds an amazing equilibrium came about that no one could have predicted.

Like the hummingbirds, the bears have learned to use Biff’s stimulus. The bears now stay by the honeypots constantly waiting for honey. The slow moving hummingbirds have also learned to stay by the honeypots to utilize the benevolent bears as protection from the hawks. Continuous economic stimulus has created a new higher standard of living in Honeysuckle Valley for the hummingbirds and the bears.

Many years ago economic philosophers such as Plato and Jefferson suggested that a government that chooses “winners” and “losers” in a society would always end in corruption.

Then Keynes and Friedman postulated that small amounts of “temporary” stimulus during economic downturns could bring positive overall benefits to an economy provided the government manipulation was reversed after the recession ended.

Biff with the help of his brother Ben provided the research that has allowed government economists to take the final step away from our inefficient free markets and toward the inevitable “managed economy”. The findings in Honeysuckle Valley have proved that constant stimulus by a benevolent third party can increase the standard of living of all participants equally.

(It must be noted that the brothers decided that the hawks did not merit being a variable in their study because the pesky creatures left the valley and moved to New Hampshire midway through their research.)

Economists from all over the world now come to Honeysuckle Valley to study the first documented case which proves that continuous and unlimited economic stimulation can create a higher standard of living for everyone. This new theory is presently being utilized in Japan, Portugal, Ireland, Italy, Greece, Spain and of course here in the United States by Biff’s brother Ben.

Biff is rich and famous and is getting the recognition that he deserves.

There is only one thing that bothers Biff now.

He hates the first question that comes from all new visitors to Honeysuckle Valley:

“What in the heck is that Smell?”

The Recession Wolves

2011-06-25T06:34:00.000-07:00

Our economy is at the peak of the third economic bubble in 12 years as we are desperately mortgaging our country's productive resources to reward reckless speculation and to fight the free market.

This new bubble is driven by borrowing and then wastefully spending $6 trillion over the past 4 years to prop up false prices. Compounding this tsunami of waste, the Federal Reserve has destroyed free market interest rates by pushing the Federal Funds Rate more than 3,000% below the 10 year Treasury bond yield.

Our country and the world are ablaze in the intoxicating glow of easy money. Just like in 1999. Just like in 2005.

The government and The Fed have again poured gasoline on our campfire to keep The Wolves of Recession at bay.

Can this continue?

We can temporarily sustain the debt portion of the bubble if we decide to continue our financial child abuse and borrow another $10 trillion dollars that we have no intention of paying back. Surprisingly financial child abuse is not a crime in our society and being drunk, especially on debt, seems an adequate excuse.

But there is no way that nature will allow us to abuse our free markets much longer. Even if Chairman Bernanke wanted to keep the Fed Funds rate 3,000% below the 10 year Treasury bond yield for an extended period, it is not possible. As phony rates turn real, they will become a drag on the economy.

The government’s bond fire that keeps the predators outside will eventually dim. This will allow the Three Wolves into our camp.

The first to enter will be the Wolf of Free Markets. It will mercilessly attach the artificial interest rates and kill them dead.

Then and only then will the second and fiercest preditor be allowed to enter. Its bloodthirsty eyes will spy the surroundings as it looks for the focus of its rage. It will spot the children cowering, lying in the smoke and soot from the government’s smoldering bond fire. With lightning speed it will jump to their side. The Debt Wolf will stand bristling and snarling in between us and the children.

The third Wolf will then be allowed entry. Every ounce of its being will be focused on us. We have attempted to live far above our means by robbing resources from future generations in a vain attempt to manipulate asset values. The Wolf of Fair Prices will allow none of this. As the Debt Wolf and the Free Market Wolf protect the children, the Wolf of Fair Prices will tear our manipulated and bloated asset valuations to shreds.

The Three Wolves will lie next to the children and for the first time in their lives they will get economic warmth, protection and love. Nothing shows more love than blessing children with a sound government, free markets, fair prices and low debt. Our forefathers wished it for us many years ago, before we had our first taste of the drug of easy money.

They will fall to sleep, finally free from our greed and abuse of power. As the children wake to the safety of the economic sunrise the Wolves will be gone. The previous night will be a vague memory that is forgotten with time.

As sure as corrupt and abusive government policy nurtures unsustainable debt, false markets and unfair prices, The Recession Wolves will be there to protect the future generations.

Daddy and Maddie Ride the Bubble Coaster

2011-06-02T17:05:00.000-07:00

“This is going to be fun Maddie. First we will ride Cinderella’s Fairy Boat. Then maybe we can work our way up to Fannie Mae’s Teacups.”

“Daddy, those are baby rides. I want to go on the Bubble Coaster.”

“Madison, the Bubble Coaster is only for grownups.”

“No, Daddy you’re wrong. The Bubble Coaster is best for kids or people that think like kids.”

“Well, Maddie we will give it a try. What do we have to lose?”

“Daddy, I want to spend the whole day on the Bubble Coaster.”

“The car is moving now, and we are climbing to the top of the first Bubble. Hang on tight and get ready for the big fall.”

“No, Daddy, the man behind me, Mr. Greenspan just said that the coaster only goes in the air and levels off. He said it was just like Cinderella’s Fairy Boat, only higher. He guaranteed that there would be no big drops.”

“But Maddie, Mr. Greenspan is wrong. Look ahead. Can’t you see that the tracks go way up and then go way down? That’s why it’s called a roller coaster.”

“No Silly Daddy, Mr. Greenspan said it, so we must believe it.”

“Hang on tight Maddie, the coaster is ready to descend.

Whooooooooooooooooooooooooooooooooooooooooooosh

“Wasn’t that fun … hey, what’s wrong Maddie?”

“Daddy, I didn’t expect that to happen! I was so scared. I want out now.”

“Sorry, Maddie, there is no way to stop the ride now.”

“Wait, Daddy, Mr. Greenspan just told me that if we give him enough money he will be able flatten out the dips and make it a smoother ride. It will only cost $1,000.”

“Maddie, don’t you remember that Mr. Greenspan was wrong before, and what on earth is the $1,000 for?”

“It’s nothing for you to worry about Daddy. Mr. Greenspan has a friend that owns a big bank. He said I was highly qualified for a $1,000 loan. Isn’t that great? Now we are safe and we don’t have to worry about the dips anymore.”

“Maddie, quit talking to strangers and hang on! This is real estate; it is the biggest drop on the coaster.

Whoooooooooooooooooooooooooooooooooooooooooooooooooooosh

“Daddy, I didn’t expect that at all. We need to get out of this now.”

“Poor Maddie, the ride will be over after one more dip. Then I will have a talk with the carnival security about Mr. Greenspan.”

“No Daddy it’s not a problem anymore. I talked to the driver of the coaster, Mr. Bernanke and he said he can transport us over to Cinderella’s Fairy Boat to avoid any more drops. All he has to do is call the helicopter.”

“What! Maddie, look around, we are five hundred feet in the air. Cinderella’s Fairy Boat is on the other side of the carnival. Mr. Bernanke cannot magically transport us there. It’s not possible.”

“Mr. Bernanke says he can do it and we have to believe him Daddy. He says the helicopter will only cost $10,000.”

“ I am not sure if Mr. Bernanke is a thief or if this is part of the ride but I am not going to give him $10,000. Now get ready for the next fall, it is the Last Bubble and it’s the sharpest drop on the coaster.”

“Daddy, it’s no problem. Mr. Bernanke’s Chinese friend said he would loan us the $10,000. They say that the helicopter is on the way.”

“Madison, I am not going to borrow $10,000 from Mr. Bernanke’s Chinese friend. It doesn’t make sense. None of this makes any sense. It’s like a freak show.”

“Mr. Bernanke said he would help, Daddy. So we have to let him help.”

“Maddie, shouldn’t Mr. Bernanke be focused on driving the coaster safely instead of filling little children’s heads with thoughts of magic helicopters and large amounts of money?”

“No Daddy, you’re wrong.”

“Maddie, this is absolutely insane!”

“Daddy, you don’t understand. You have to give Mr. Bernanke the money! Please Daddy say it, for me, PLEASE!”

“OK Maddie. I want to borrow the money now.”

“Daddy, look really hard. See the helicopter coming to rescue us.”

“Maddie, I think I see it. We are going to be rescued!”

Whoooooooooooooooooooooooooooooooooooooooooooooooooosh!

“Maddie, I was not expecting that at all. I have never been so scared in all of my life. Get me out of this!”

“Do you understand how to play the game now Daddy?”

“Wow Maddie! I never would have figured that out in a million years.”

“Daddy, that’s because you were acting like a grownup. This is a make believe game for kids or people that think like kids.”

“Do you want to ride again Maddie? I think I might like this game.”

“Daddy, I told you, I want to spend the whole day on the Bubble Coaster.”

You Just Need to Look Out the Window

2011-05-07T19:24:00.000-07:00

We as a nation have spent the last 35 years borrowing more money than we can possibly pay back. After three and a half decades of decadence we appear to be coming to the absolute limit on our ability to borrow as a nation.

As we come to this precipice, our nation’s economic elite that sold us this debt are imploring us to continue to borrow at our current unsustainable rate. They say Keynesian Economics will allow us to pay off the extreme debt that we hold now with cheaper money that our friends in China and the Middle East will loan us in the future.

They say that as long as we continue to borrow, Keynesian Theory will just magically and painlessly make our debt problem disappear… poof.

Although this sounds wonderful and magical, it is mathematically impossible. An extremely debt heavy accounting balance sheet “always” slows economic growth.

So I have another name for what our economic elite are trying to call “Keynesian Economics”. It’s called “fraud”. This would be borrowing money knowing full well that you are incapable of paying it back.

The fact is that all economists derive their paychecks from Wall Street or our wasteful government. Who else would hire them?

So if they want to be employed, economists must always recommend more debt, more consumers spending, a larger financial sector and a larger more wasteful government.

It is all about growing the source of their paycheck.

Upton Sinclair stated it best during the roaring twenties when he said “It is difficult to get a man to understand something, when his salary depends on his not understanding it”.

Economists are salespeople. They are hired guns that will create a “flawed” model for anyone that gives them a paycheck.

I know their models are “flawed” because economists as a group are incapable of predicting major turns in our economy. Their track record is zero. They have missed predicting every major event for the past 12 years:

· In 2000 they missed predicting the biggest stock bubble in our nation’s history.
· In 2002 they rallied for “end of the world” monetary and fiscal stimulation to prevent the continuing collapse of the stock bubble that they could not see in 2000.
· In 2005 they could not see the biggest housing bubble in our nation’s history caused by the “end of the world” monetary and fiscal stimulation that they recommended in 2002.
· In 2006 they could not see the biggest credit bubble in our nation’s history caused by the deregulation that they recommended in the 1990’s.
· In 2007 no major economist saw the coming recession even though every economic indicator pointed to a recession.
· In 2008 they rallied again for another round of “end of the world” fiscal and monetary stimulus to continue the housing bubble that they could not see in 2006.
· Now in 2011 no major economist can see our current asset bubbles in commodities and bonds.
· In 2012 they will again suggest “end of the world” monetary and fiscal stimulus to prop up the commodity and bond bubble that they can’t see now.

Economists continue to ignore the destructive bubbles in the economy until they realize that a bubble has popped. Then they demand that our elected officials use “end of the world” monetary and fiscal stimulus to prop up overpriced assets in an attempt to continue the bubble.

Our bubble economy is making fortunes for the sellers of helium of which the economists get their cut. But there is a huge cost to everyone else. No jobs are created as fortunes are being borrowed from our children and given to Wall Street speculators and our monstrously wasteful government.

I suggest that our method for predicting the economy is hopelessly broken and cannot be fixed.

So what does one do when the speed indicator of your car is broken and can’t be fixed?
You look out the window to judge your speed.

And if you look out the window this is what you will see:

1) We are borrowing money from hostile foreign nations … This must stop.
2) We are destroying our free markets … This must stop.
3) We are sending our productive manufacturing jobs overseas… This must stop.
4) We are heavily subsidizing our “destructive” financial sector … This must stop.
5) We are rewarding people for uncontrolled speculation … This must stop.
6) We are punishing our savers … This must stop.
7) We are destroying our currency … This must stop.
8) And worst of all we are borrowing money in our children’s name to continue this madness … This absolutely must stop.

Nothing our economists are suggesting today appears in any economic textbook of the past. They have thrown away 4,000 years of economic thought from the geniuses of history as they prostitute their profession in order for their employers to steal money from our unborn children.

In a perfect world any economist that recommends more debt on top of the $100 trillion that we have already borrowed from our kids would immediately be labeled as a financial child abuser.
They would then be included on a “child predator” list and never be allowed to suggest that theft is the key to economic growth.

This one law would make all current economists unemployable. These villains would then learn firsthand what is like to look for work with no skills in the economy they have almost single handedly created.

But alas, our world is far from perfect.

And our economic theory is hopelessly broken and can’t be fixed.

Change will start when we stop looking at our broken economic theory and take a look at the reality that is happening around us.

We just need to look out the window.

I am in Love with The Great Depression

2010-12-07T16:13:00.000-08:00

Perfection, of a kind, was what he was after,
And the poetry he invented was easy to understand;
He knew human folly like the back of his hand,
And was greatly interested in armies and fleets;
When he laughed, respectable senators burst with laughter,
And when he cried the little children died in the streets.

Epitaph of a Tyrant by W. H. Auden
_____________________________________________

I would like to dedicate the following thoughts
to my father and his father on this special day. Thank you both for being part of this country's greatest generation.

I am in Love with The Great Depression

I started gaining my affection for The Great Depression as The Tech Bubble was ending. My stock account was going to astronomical amounts. I bought my dream house. My financial life was fantastic in every way but in the back of my mind I knew something was very wrong. I soothed myself at night with investment books like The Intelligent Investor by Benjamin Graham and books of the Great Depression such as The Great Crash by John Kenneth Galbraith. I didn't read these books for knowledge or insight because I was very clear on the inevitable path of our country. I read them for purification and to calm my worried soul. Thoughts of The Great Depression have become my economic "Waldon's Pond" during this period of government mandated excess and speculation in our nation's financial markets.

As the 1990's were winding down I would compare the 90's to the 1920's. They are very favorably compared. The roaring 20's saw the advent of the radio, the auto and the airplane. The roaring 90's brought about home computers and the Internet. Both period's had massive speculation stoked with easy money by The Federal Reserve.

The 20's of course ended in The Great Depression. I had hope that the 1990's would end in the same way and that our nation would come to it's senses and stop living so far beyond it's means. I realized that our government and The Financial Elite would make the same mistakes as The Great Depression and turn a deep recession into a depression. But I also knew that the people of this country were resourceful and could come out of the ten year depression in 2009 with the same independent, hard working attitude that created my grandparents' generation.

My grandparents' and their contemporaries are considered our nation's greatest generation. I had equally high hopes for my own generation. I wanted to feel the same pride that my grandfather felt as he passed the economic torch to my dad.

But something odd happened after The Tech Bubble. There was just a very, very mild recession. There was practically no real unemployment. A pipeline was created between the government and the moneylenders. A pipeline full of gold that from the outside smelled of filth. No one noticed. No one cared. I can't compare it to anything that has occurred in our country before. One would have to go back to the times of Rome under Nero to find a similar totally self serving act. Our Empire is ablaze and our leaders are responsible!

A recession is a natural event. An economic Winter that follows an overabundant Summer. A cleansing that removes speculation and greed from the system and passes along fairly priced assets and a sound government to the next generation.

Business cycles have been recorded since the beginning of the industrial revolution and probably occurred even in primitive societies. Economies move from overproduction, excess and speculation to underproduction, prudence and saving. This cycle can't be regulated because it is tied to the avarice of being human.

Recessions will occur even in a tightly controlled society, as we are seeing today. The only difference is that in a free society everyone is aware of what is happening and can react accordingly. In the tightly controlled society The Financial Elite are able to mask the business cycle. This allows the Financial Elite more power and with this power the ability to choose the winners and losers in our economy.

Our Financial Elite have pilloried The Great Depression and made it a priority to protect us from recessions at all costs. The costs that we are presently incurring are massive debt to future generations and the destruction of sound government. This is the antithesis of the business cycle. It is not sustainable in the long run.

The reason that I love The Great Depression is that in spite of massive government intervention the people of this nation were able to survive and then prosper. The Great Depression forged a generation of fiercely independent, highly productive, family and community oriented households. This was the most productive body of citizens any nation has ever known. This was the Middle Class. My grandparents' generation.

The antithesis of my grandfather's generation is my generation. We robbed trillions of dollars of our children's inheritance to prop up stock values after the Tech Bubble which sent our housing market into a bubble. We are presently borrowing tens of trillions of dollars from foreign nations to prop up inflated housing prices that occurred during the housing bubble. We have created the biggest government in our country's history with borrowed money.

So we have spent the savings of our grandparents' generation and borrowed more. We have used this money to inflate asset values and create bigger government. We are passing the debt, the inflated asset values and the government boondoggle to our children. My generation will go down in history as this nation's most selfish generation. It is a very helpless feeling being carried by this ravel of avarice.

I don't blame our people, I blame the tyrants, The Financial Elite. They are far to cunning for our pampered populous. My lament is that we are appeased by bread and circuses as our country is being looted and then burdened with stifling debt.

I am very sure that my grandfather's generation would never have allowed this to happen. A generation that formed massive strikes against unfair employment, rallied against unjust government and to a man gladly sacrificed their lives to keep this country free.

My hope looks to the future as my mind dwells in the past. I await the glory that my children and grandchildren will feel as they slay this dragon of debt. Like my grandparents did before me. I bide time in between two great generations. "They also serve who only stand and wait".

A recession is a natural event. An economic Winter that follows an overabundant Summer. A cleansing that removes speculation and greed from the system and passes along fairly priced assets and a sound government to the next generation.

I am in Love with The Great Depression

The Difference Between Real Mortgage Rates and Our Current Phony Rates Could Wipe Out Your 20% Down Payment

2010-11-28T11:39:00.000-08:00

Speculators in the housing market have been the beneficiary of a once in 100 year event.

Over the last 25 years interest rates have collapsed from 18% to 4.5%. This has allowed home buyers to borrow 200% more than they could in 1985.

This is how the numbers work:

In 1985 a $1,800 mortgage payment would purchase a $150,000 home at a mortgage rate of 18% and 20% down.

Today a $1,800 mortgage payment will purchase a $450,000 home at a mortgage rate of 4.5% and 20% down.

The collapse in rates has directly caused a tripling of home values over the last 25 years.

It’s simple math.

This math works in reverse also:

Today a $1,800 mortgage payment would purchase a $465,000 home at a rate of 4.15% and a 20% down.

Tomorrow a $1,800 mortgage payment would purchase a $381,300 at a rate of 6% and a 20% down.

This $83,700 loss is due to mortgage rates changing from 4.15% to 6%.

What is the possibility that rates will go from 4.15% to 6%?

I would like to suggest that "real" mortgage rates are 6% now.

Over the last 2 years the government has used Fannie Mae and Freddie Mac to take over the mortgage market. 95% of the loans are government guaranteed. Also the Federal Reserve has committed to at least 2 trillion dollars of asset purchases to manipulate interest rates.

I think it is safe to say that today we don’t have real interest rates. They are being manipulated by the government.

What would they be if the government was not spending trillions of taxpayer dollars to manipulate the market?

One could argue that without the trillions of dollars of government intervention mortgage rates could be at 6%. This is far below the average over the last 25 years.

A change from a manipulated 4.15% mortgage rate to a “real” 6% mortgage rate would mean the immediate loss of 18% in purchasing power or $83,700 on a $465,000 home.

Add the 2% purchase costs to this 18% interest rate loss and you have basically wiped out your 20% down payment.

If you are purchasing a home now in a phony interest rate environment and plan to sell in 5 years at a real interest rate you have already lost your down payment.

There is one last variable to consider. It takes over 6 years of mortgage payments on a 30 year mortgage to gain enough principle to prepay the closing costs when you sell your home.

So if you buy today and sell in 5 years not only could you lose your down payment but you will also need to bring a $5,400 check to pay the balance on the $26,600 in closing costs to sell your home in 5 years for $381,300.

That’s the math, not including our nation's current deflation problem and the fact that housing is a depreciating asset.

The Destruction of our Last Free Market

2010-11-23T22:05:00.000-08:00

I work as an accountant. I am not supposed to be innovative. Accountants are trained to follow the rules. Andrew Fastow of Enron or Mark Schwarz of Tyco tried to be innovative. They now reside in jail.

The opposite of accounting is economics. Economists must be innovative. Their job depends on inventing new theories. These new rules give their employers or their clients an advantage in the marketplace.

Over the past 15 years our nation’s top economists have been very innovative in coming up with new theories for our government and Wall Street to improve our nation’s markets. It is not surprising that most of these suggestions have enriched the pockets that employ these economists. It is also not surprising that these forays of crony capitalism have destroyed every free market that the government has attempted to control.

I only bring all this up because of the latest nonsensical plan that is being presented to save our country.

John Burns is one of our nation’s leading housing economists. He sees a new profit center for his clients. So he has come up with a new theory.

Mr. Burn’s scheme involves the government hiring private sector companies to create a huge real estate investment trust. This Wall Street trust will take all of the underwater homes from the banks, Fannie Mae and Freddy Mac and rent them out.

He says that renting out these homes will prevent our nation's house prices from falling any further.

This is economic theory at its finest. There will be huge profits for Wall Street and the banks. There will be monstrous subsidies to be paid by the taxpayer. There will be limitless unintended consequences in the future. But best of all there are fat commissions for the innovative economist that can explain how this nonsensical plan can benefit the country.

So let me recap.

Presently investors that are entering our real estate rental market are not receiving subsidies, implied bailouts or tax breaks. They are not benefiting from the easy money from the Federal Reserve. So rental real estate is the only market that is not subsidized by the taxpayer.

Investors that are entering the rental real estate market are the only investors in this country that are receiving a fair return on their money. Today investors are getting a positive cash flow on their investment. This is in line with the historical return on investment. They are receiving a fair return because the government is not distorting the market.

This is possibly the only market that the government is not distorting.

Investors that are entering the rental real estate market are not using large amounts of debt. Most are purchasing with at least 30% down and some are purchasing with all cash. So these investors will not be a risk to be bailed out by the government.

Looking at the facts one could argue that the rental real estate market is the only free investment market in our country today.

John Burn’s intends to destroy our last free market, for a profit. He is a very smart man has a good chance of achieving his goal.

It is funny how economists preach the religion of free markets as they devise ever more self-serving ways to corrupt the system.

Warning Label on Economic Advice

2010-11-02T20:01:00.000-07:00

I believe many people are confused by the role of economists in our society. They are very similar to the fortune teller at the circus. These charlatans sell their measurement of the future to the unsuspecting public. They are unconcerned with how their guess affects the outcome of their victim but laser focused on getting their paycheck from the owner of the circus.

Our government is the circus.

Our nation under the direction of our political economists has spent the last 25 years using debt to increase our nations total standard of living above the sustainable trendline. Soon our total debt to GDP will be triple what it was in 1985.

Most of this debt has been used to increase the size of the unproductive financial sector and the government. These areas are the major employers of economists. This public sector growth has occurred while our job producing private sector has stagnated. The private sector hires very few economists.

Our nation’s unsustainable growth trend of borrowing is a big worry for anyone with an ounce of common sense. But is of little concern for political economists. Their focus is on growing the source of their paycheck. Upton Sinclair said it correctly 80 years ago about our crony capitalistic system: “it is impossible to get a man to understand something when his job depends on him not understanding it”.

Our unsustainable borrowing is so unimportant to political economists that they have created very flawed models so that taxpayer debt can be overstated. These models have eliminated “total debt” as a variable. The models only include the “debt payment”. This flaw allows an unlimited amount of money to be borrowed if interest rates can be manipulated down to zero. To make matters worse the models don’t use any form of amortization, so in economic theory our nation’s debt never needs to be paid back. Borrowing $1 trillion or $20 trillion is the same to an economist because neither amount will ever be repaid.

As an accountant I feel that it is important for the taxpayer to understand the understated accounting and the conflict of interest inherent in the field of economics. There should be a disclosure notice similar to the warning on a pack of cigarettes attached to anything that is published by an economist.

Warning label to taxpayers:

Economists can only be relied upon to predict small insignificant changes in the economy. On average they have a moderate degree of success in predicting year over year economic growth of 3.5%. But as a group they have never, ever correctly predicted a major shift in our economy. Therefore the predictions of an economist of the future should never be relied upon in business. In a free market society the successful business owner is the only entity that has the ability to predict the future.

Economists are not accountants. They are not regulated by any authority and are never held accountable for anything that they say. If a private sector accountant overstates the numbers they will go to jail. If a political economist overstates the numbers they are hired by Wall Street, the goverment or by a universtiy to train other economists. So if you require accurate numbers always seek the advice of an accountant.

Taxpayers should understand that as more tax dollars flow into government, then the government will give large amounts of this money to Wall Street. Wall Street in turn uses this largess to train more economists which they send back to the government. Be aware that every time your taxes are increased, it indirectly allows the government to hire an economist that has a vested interest in increasing your taxes even more.

It is important that you understand as a taxpayer that any money the government borrows must be paid back by you. If you are a middle class family of four and the government borrows $1 trillion then that is an immediate debt to you of $26,667 plus interest.

It is important that you understand that the debasement of a nation’s currency has a cost. If you are of the middle class you are very likely to be negatively effected by the indirect effect of currency debasement. This is called “inflation”. Historically inflation has been used by tyrants to reward political favorites. Presently, our government has chosen to funnel most of the gains from inflation to the financial sector, speculators and the upper classes.

So, as a taxpayer, if the attached economic report deviates from common sense and suggests “unsustainable debt”, “a larger government”, “a larger financial sector”, “manipulating markets” or “debasing our money supply” then it is in your best interest to disregard the information.

Actually, We Aren’t All In This Together

2010-10-13T17:11:00.001-07:00

This is the story of an average middle class town. This town could be the snapshot representing the American Dream anytime in history.

Anytime up until 25 years ago. This is when the town and all of its citizens found out that they wanted more than the American Dream could offer.

The story starts in 1985. A newcomer walks into Bernie’s, the local bar. This pilgrim’s name is Sam.

Sam had just inherited what seemed to be a limitless amount of income from a family trust that had been set up in 1776 by his ancestors.

Sam enjoyed the people and the town. So he stayed. He came to Bernie’s every night and bought drinks for the patrons. He made many friends.

Sam liked the attention he received from this generosity and through the years bought more and more drinks for the house. Eventually it became a ritual for him to pay for everyone’s drinks from 7pm until the bar closed at two in the morning.

He continued to draw more and more from the family trust that was set up to last forever.

By all rights, with prudent management the trust could have lasted forever because it was a vast amount of wealth.

Sam loved the attention. And everyone loved Sam. They voted him the figurehead of the bar. This came with a title. Whenever he entered the bar he was always affectionately hailed as Uncle Sam.

One day, Ms. Bair, the conservator accountant of Sam’s trust, started to become worried. Sam was spending a lot of money. If the spending kept increasing, the principle that was lovingly placed in the trust 200 years ago by his ancestors would start to diminish.

Ms. Bair said that she was proud of Sam for helping his friends but it would be best if he didn’t increase the spending any further. This prudence would insure that the trust could provide income forever.

“Besides”, the accountant added, “if you went broke, it would hurt your friends a lot more than one free drink each evening."

This made sense but it was a worry for Sam. So it became a topic of conversation among his friends at the bar.

One of his friends at the bar was a young man named Klugman.

Everyone loved Klugman, almost as much as Sam. He was handsome and articulate and a wonderful story teller.

Sam would buy the drinks and Klugman would speak of the prosperity that lay in the future.

Klugman was a dreamer. This attribute was perfectly suited for his trade as an economist. His job was to consult with business owners and show why they needed to borrow money to grow bigger.

That’s what economists do.

And for a time, the local businesses did grow bigger and bigger, thanks to Sam and Klugman and the bar.

As Sam spent money at the bar, the patrons spent less buying drinks. In this way everyone had more money to spend on other things, except for Sam of course. But he didn’t care.

This additional money flowed though the local economy. Everyone’s businesses grew. Everyone was happy. Everything was perfect.

But the problem with unrelenting perfection is that it eventually becomes average.

Over time the economy stabilized. Businesses stopped growing at a rapid pace but continued to borrow at the behest of Klugman.

At night in the bar Klugman spun even bigger tales of the prosperity in the future.

Because that’s what economists do.

And being an economist Klugman felt that this slowdown in business was becoming serious. His clients that borrowed money to grow their businesses were having trouble paying their loans. He felt the local economy had to be stimulated back to the growth trend that was established when Sam came to town.

He had a talk with Sam and explained that it was imperative that Sam buy more drinks in the bar. “Maybe you could start buying drinks at six o’clock instead of seven.” Klugman urged. "This would save everyone money that they could spend in the local economy."

Klugman promised that this would only be temporary. Local businesses only needed a temporary jumpstart to begin growing again.

The next day Sam explained Klugman’s theory to Ms. Bair. After she stopped laughing the accountant tried to suggest that buying more drinks for bad businessmen that incurred too much debt didn't seem like a viable solution.

"The businesspeople of this town need to live within their means today and not worry so much about tomorrow." Ms. Bair suggested.

This was the nature of an accountant. Today was more important than tomorrow.

Ms. Bair didn’t want to talk about tomorrow as Klugman worried about nothing else.

Sam needed another opinion.

He went to see his friend Mr. Hoenig who was the town banker. Mr. Hoenig seldom came to the bar and always paid for his own drinks. This made Hoenig the only man in the bar that didn’t take advantage of Sam’s kindness.

Sam posed his concerns to his friend. The banker tried to reply in a way his young guest could understand.

“Every businessperson has a place and a time in the economy” he stated. “Bankers live in the past. We are the caretakers of our town’s savings. This is the excess production that becomes a store of wealth. We use a businessperson’s history to determine if they are a suitable guardian of the town’s stored wealth. So we must always live in the past. I can only guess about the future, the same as you”.

Then he interjected “Accountants view the world through their balance sheet which is nothing more that a snapshot of the present. They are not as interested in tomorrow.”

“And, as you have surmised, our friend Klugman lives on the expectation of income. Economists sell business people risk in the future”

“But who can help me?” asked Sam.

“Well it appears you want a forecast” Mr. Hoenig said, “only Economists and Astrologers will give you a prediction of the future. Although some are better than others, I have found that in the aggregate both are correct about 50% of the time. So one could argue that a coin flip has similar predictive value at much less expense”

“But let me suggest that you talk with my friend Mr. Volcker. You will find him at the park everyday feeding the birds.”

“Can I ask one more question Mr. Hoenig? How come you never allow me to buy you a drink?”

Mr. Hoenig knew the answer would be hard for Sam to understand but he made this attempt:

"Sam, although I am happy to drink with you I cannot accept the cool aid that you and Bernie provide. Each free drink from you would distort my view of the market. If the small window for which I view the future becomes cloudy. Then I am lost. As I have said before, I live in the past."

Mr. Hoenig could see that Sam was even more confused so he made another attempt,

“Sam you are not a businessperson or an investor in this town. You are a disinterested third party in our economy. Very much like a government who’s spending is random. You do not add production or efficiency to the market. Production and efficiency is only added by the competition of the market participants. For an economy to work properly neighbors must be competitors. This is the only way in which scarce resources can be allocated correctly. This is only way that productivity can be created and then captured. And hopefully some of this captured productivity or 'savings' is given to me for safekeeping.”

He still didn't quite understand why Mr. Hoenig would not accept his generosity. But they were friends and that was all that concerned Sam.

The fact of the matter was that Mr. Hoenig was Sam's only true friend.

They said goodbye as Sam made his way to the park. Mr. Volcker was there as he was every day, feeding the birds.

Mr. Volcker, like Sam had just appeared in town one day. Mr. Volcker would never talk about his past or anyone’s past for that matter. He would only speak in riddles about the future.

Some speculated that he was a general who was a hero in battle. Others said he was a rich investor that gave up his wealth to live the simple life. There were other stories even more fabulous and truth be told, all these stories had some basis in fact.

Sam said hello and posed his concern to Mr. Volcker.

Mr. Volcker reiterated what Sam had already learned. Bankers must live in the past, accountants must live in the present and economists attempt to sell the future.

“But” Sam said, “Who is the best person to give me advice on the future”.

“Again, I must agree with Mr. Hoenig” said Mr. Volcker, “There is no one that can give you good advice about the future”.

“But do you know what lies in the future?” ask Sam.

“Of course I do son. But I will not tell you. There are others that could tell you too but they will be mute like me”.

“In the long run, a good businessperson is the only one that can accurately predict the future. And they will never tell you what they know for it would distort their market.”

He continued, “I am much like you, a traveler that came to take respite in this town. But I would like to note that I exist in this economy and you don't. Even though my fortune pales in comparison to yours. The fact is, I have earned it myself therefore it holds much, much more value.”

“If you ask me for advice, my suggestion is that you leave this town. You have no wants or needs that allow you to benefit this town or these people.”

“But how can I leave all of my friends?” cried Sam.

“These people are not your friends” retorted Volcker, “You do not exist to them, other than a free drink. You do not have a business, you do not invest for profit and you do not consume. You are only used by people that are incapable of surviving in the market. Therefore you distort the market. No matter how much wealth you bring to our town it will have no effect in the long run. When you are gone your wealth will be just a memory”

Volcker grew tired of the talk and focused on his wards, the swans.

Sam said goodbye and headed back to Bernie’s

Klugman was already at the bar holding court. Slapping backs and spinning tales.

Sam explained to his friend about his day and expressed his worry.

“Well Sam, I know that life is not worth living without friends. And we are your friends. And I also know that life involves risk. Speaking of which why is your capital placed in such ridiculously safe investments?” Klugman harangued.

As an accountant, Ms. Bair had always demanded that Sam’s money be 100% safe in the present. Ms. Bair told Sam that the local economy was very dependent on his spending so his money must not be tied to his neighbors. It must be placed in very safe bonds with a touch of equity in foreign lands.

In this way Sam’s money would always be there for him no matter what happened to the local economy. She had tried to explain that Sam was not a businessman or an investor and therefore not in a position to take risks.

“This is the crux of the argument” stated Klugman. Why can’t you take the same risk as your neighbors? Aren’t we are all in this together?"

But the fact was that Sam was not a businessman and he was not an investor or even a consumer. He was a disinterested third party that didn’t care what he earned or what he spent.

As an economist Klugman’s job was to sell his picture of the future to businessmen. So it was easy to convince a disinterested third party to do just about anything. Especially since this person considered him a friend.

The next day Sam told Ms. Bair what he wanted. She was to follow Klugman’s advice and invest his trust in the local community.

He loved this area and its people so it made sense to invest his money in the town.

And with this investment the local businesses and the economy boomed.

Sam began to make so much profit that Klugman suggested that Sam start buying drinks at 6 o’clock, then 4 o’clock then 2 o’clock. How could Sam argue, Klugman had been right before.

The wealth of the town grew at a phenomenal pace. Sam’s income increased so quickly that the bar was always open and drinks were always free.

The local economy boomed like never before. Businesses grew and took on new debt and then grew some more.

It was undeniable that Klugman was correct and Ms. Bair, Mr Hoenig and Mr. Volcker were wrong.

Klugman became a hero in the town.

(If you think like an economist, this is where the story ends. The short term is all that matters. As Lord Keynes said, “in the long run we are all dead”.)

(the story will continue for everyone else)

...

Actually, We Aren’t All in This Together – the rest of the story

2010-10-13T17:10:00.000-07:00

(the story continues for everyone but economists)

There came a time when the local business growth started to slow. And because Sam’s trust was invested in local business equity and not in safe bonds his income stopped.

Sam started dipping into the principle of the trust that was lovingly set aside 200 years ago, the money that should have lasted forever.

Common sense told Sam that there was only one thing to do. He must reduce his spending in the bar down to the amount that the accountant had recommended. This was the only sensible long term solution. Local business owners would have to stop their excessive borrowing and get though this economic downturn by themselves.

Also, it seemed to Sam that some of the local business owners were horrible at what they did and shouldn’t be in business at all. They spent all their time at the bar as they borrowed more and more money from Sam.

If the bad business owners shut down, wouldn’t the other owners prosper?

And if they wanted drinks, Sam was happy to provide them in the evening. It just didn’t seem right that they should borrow money from Sam with no hope of paying it back as they spend all of their time in the bar.

When Klugman heard that Sam was considering slowing his spending at the bar, he became enraged.

Sam must keep up his spending. Everyone depended on him. It didn’t matter if some business owners were absolutely terrible at their trade; it was heartless of Sam to put them out of business.

“Remember, we are all in this together.”

So it went. Sam spent his principle as the economy stagnated. There were too many businesspeople servicing too few customers.

And everyone spent too much time at the bar.

As always happens with imprudent spending, the money disappeared as if it had never existed.

Sam lost the trust that was handed down lovingly for 15 generations.

He still comes to Bernie's everyday, but never drinks. He just takes his same old seat at the bar and stares off into the distance. He is mostly ignored by all except when stories of the boom are discussed.

He does not exist in the town’s economy today. And if you believed Mr. Volcker he never really existed in the first place. Except as a distortion in the market.

In the town, many of the local businesses that were created to feed the boom either closed down or moved away.

The local economy is back to average. The town is exactly as before.

Back to what our ancestors would call the American Dream.

When they get together at Bernie’s, the people who lived through the boom never seem happy. They long for the golden days of unbridled prosperity and of course they miss the free drinks.

This lament stops when Klugman comes into the bar. He spins tall tales of a future of growth and riches.

Because that’s what economists do.

Everyone brightens up and talks of tomorrow,

and the next boom that will be even bigger than the last.

The End

(If you are anyone but an accountant this is where the story ends.)

Thanks for reading

...

Actually, We Aren’t All in This Together – the rest of the story (for accountants only)

2010-10-13T17:08:00.000-07:00

(accountants recap)

It is hard for one to gauge the size of the bubble that Sam created if one only listens to the reactions from the story’s participants.

Sam’s fortune was immense. Before its demise it was valued at 10 trillion dollars.

When Sam came wandering in, there were 10 bars in town. As Sam started to buy drinks at Bernie’s the other bars were immediately forced to close. Very quickly Bernie’s bar, like any other business that is subsidized by a disinterested entity, learned to raise it prices. Toward the end well drinks and beer were going for upwards of $10,000 a glass. But since there was no cost to the patrons, most drank the finest Champagne at $100,000 a glass even if they liked beer better.

Of course it is needless to say that billions of dollars of alcohol made its way out the back door to be resold in other towns, states and countries. This black market employed tens of thousand of people. Billions, perhaps trillions of dollars of income went untaxed.

Bernie’s bar ended up enveloping 4 square miles of the downtown area and could serve 300,000 people in an evening. So at the peak of the bubble, tens of billions of dollars could run through the bar in a night.

Obviously US Dollars could not be used to handle the transactions so everything was handled through credit with Sam’s expenses being sent directly to Ms. Bair’s staff of 1,000 accountants and wire transfers going back to the creditor’s offshore bank accounts.

With the growth of an economy than ran on debt, high interest was a necessity. 100% a week was not uncommon.

The town could be compared to gold rush Dawson City on steroids. Gas was $1000 a gallon, a meal in a restaurant was $10,000 and a room at one of the 1000 hotels in the area went for $50,000 a night.

Many that lived outside the 100 square mile area of easy commute while tipsy chose to move closer to the bar.

At the peak of the bubble this real estate had no value. There were not enough zeros on any number that could purchase a square foot of land.

As that is how it was sold.

Ms. Bair and Mr. Hoenig continually tried to get Sam to understand the enormity of what was happening.

Mr. Hoenig never did accept a free drink. But one must not feel empathy as his bank was making profits of $100 billion a year.

Mr. Hoenig could clearly see the problem and sold his loans to speculators before the bust for 500 cents on the dollar. Today of course all these loans are worth nothing.

Presently his bank is the only healthy one in the area.

Klugman never sensed that anything was wrong until the very end. His economic forecasting business still thrives.

Mr. Volcker is the only person in the story that never changed his lifestyle before, during or after the crash.

He continues to feed the birds in the park and enjoys going to work every day.

Once in a Lifetime Madness

2010-10-08T11:33:00.000-07:00

On August 11th I commented on the historically low yield of 1.46% on the 5 year treasury bond. At that point it was 21% below the historic low of the past 70 years set back in 1954. Here is the post:

Now There's Something You Don't See Every Day

Well today the yield on the 5 year treasury sailed below the 1.1% mark which is 42% below the lowest yield in the past 70 years. This insanity by The Federal Reserve is being applauded by the stock market as the Dow spiked over the 11,000 mark today.

Investors have very, very short memories I suppose.

We are destined to have episodes of once in a lifetime madness every few months or so.

I feel it is appropriate to completely remove myself from the 50% long position that I accumulated during the market swoon to 1022 in the S & P in July.

It is very likely that the market will go up in the next few months driven by the speculative madness that is being induced by The Federal Reserve.

But for me the rewards at the end of this market run don't seem to warrant the risks.

The markets are being driven by rumors that our government will continue to sell our kids down the river with a never ending stream of currency debasement, market manipulation and intergenerational theft through massive unsustainable government debt.

We are trying to grow our economy by starting a currency war with the rest of the world.

By borrowing trillions of dollars that mathematically our government can never pay back.

By using this borrowed money to make the government bigger and thus starve the private sector.

By creating the most unsound investment markets in the history of our country.

By bailing out wild speculation at the expense of prudent savers.

And by funneling ever more money to the wealthy and away from the working classes.

All of this at the direction of our government subsidized political economists that don't understand what is happening, but are happy to suggest that ever more borrowing and speculation are absolutely the solution to our country's historically high level of debt.

We Need to Fire Our Economists and Replace Them with Astrologers

2010-09-27T21:09:00.001-07:00

Once in a while in a news article I see the phrase “the science of economics”. It always makes me laugh.

Currently political economics is no more of a science than astrology.

It has no predictive value when extreme debt is involved.

Economists presently have no way to measure the unsustainable debt in our economy for four reasons:

1. Neoclassical(Wall Street) economists are not trained to look at total debt. They are only able to quantify the debt payment. Therefore if interest rates are placed at zero, then in theory our country can have unlimited debt.

2. To make matters worse, the public sector does not use real accounting standards. Neoclassical economists use Enron accounting to measure the public debt. Economists say that our federal government has about $13 trillion in total debt where in reality the liabilities of Uncle Sam are 4 times this amount.

3. To make this situation even worse, instead of comparing liabilities to income like an accountant, economists compare government liabilities to the total GDP in our economy. This avoids comparing the liability to the income that will eventually pay off the debt.

4. The craziest part of this situation is that Wall Street economists don't understand that the government's Enron liability must be paid off by the private sector in the future. It is indirectly a liability of the taxpayer.

The federal government has $60 trillion in liabilities and real income(without deficits) of $4 trillion. This is liabilities to income of 15 to 1.

Add this to the monstrous liability of our private sector and there is very little hope of taxpayers paying off this debt in real dollars.

This unsustainable debt is a problem. But the bigger problem is that our government subsidized economists don’t see it as a problem.

We are flying toward a mountain in zero visibility without an altimeter. We just asked our navigator how he is planning to circumvent the mountain.

Our navagator responds, “what mountain?"

Our navigator economists have no clue how to measure our nation's mountain of debt. They are blindly flying our economy straight into Mt. Fuji.

Economists are dead set on avoiding the pain of private sector deleveraging. This is exactly the policy mistake that Japan made 20 years ago.

Japan is experiencing 'death by a thousand cuts' instead of the debt amputation that would heal the economy immediately.

We are using the same flight plan. Our nation has incurred 3 years of moderate economic pain and only reduced debt in the private sector by 5%.

The government has increased its Enron balance sheet by 15%. This is trillions of dollars that the private sector will be required to pay in the future.

So after 3 years the mountain has grown larger and our airplane has not changed course.

Instead of looking at our private sector's mountain of liabilities our economists are dead set on keeping us from repeating the Great Depression.

Let me describe what happened during the Great Depression. We had 4 years of pain from 1930 to 1933. Most of the pain was caused by bad economic policy by our government. But even with the extremely bad government policy our private sector was allowed to deleverage.

This directly caused the greatest boom in our nation’s history.

From 1934 until 1953 our GDP grew a total of 580%. This was a compounded growth rate of over 10% a year for 20 years.

Our country has never grown that fast for that long.

Our incompetent economists are desperately trying to keep us from reliving the Great Depression. The goal is to become like Japan.

Their goal is 20 years of economic stagnation.

So instead of recreating the greatest period of growth in our country’s history our economists are intending to lever up our government 30 to one, without deleveraging our private sector.

This will slow the economy to a crawl so it will be impossible to pay off our government’s debt without destroying our currency.

Our private sector desperately needs to deleverage. Economists are manipulating markets to force people to borrow more money and spend it on speculation.

I suggest that we fire all Wall Street economists and hire astrologists to make policy decisions in the future.

Let us not forget,

Astrology worked out pretty well for Ronald Reagan.

Fine Tuning my Snap Trades

2010-09-21T06:58:00.000-07:00

A year and a half ago I suggested that it was a great time to buy into the stock market as equities were making new lows. But I did suggest that I wanted to be out of the market by the end of 2010 as the stimulus started to run out and as corporate earnings peaked.

I have suggested that for at least the next 5 years there will be no long term gains in the stock market but there could be monumental short term volatility. In my post Snap Trading I suggested how I will manage my retirement account and my Virtual House Equity.

http://taxhome.blogspot.com/2010/03/snap-trading.html

The market is getting close to the peak earnings so this current rally seems to be a good opportunity to sell my snap trading gains of the last few months and move to a market neutral position.

I have been selling my equity investments and I am buying into ETFs: FXP, PST, SRS, SH and VXX.

I am almost market neutral. If the market goes up I will happily trade into a small short position to weather the economic storms ahead.

Today the stock, housing and bond markets are more dysfunctional and volatile than anytime in history thanks to monumentally bad government policy.

Anyone 100% long in any of these markets is a fool.

The Desperation in the Housing Market

2010-09-09T08:27:00.000-07:00

I talk to a lot of people about housing. Many that I speak with are frantic to buy a home. Also when I check the current housing stats, I see some buyers biding over the asking price on homes that have been on the market for months.

There is desperation in a number of people that are looking to purchase a home.

When I talk to people about real estate I will spend ten minutes explaining how our banking sector is insolvent and many of our nation’s households are insolvent.

How there is a historically high inventory of homes listed with an equal size shadow inventory held by the banks that are not even listed yet.

Also, there are tens of millions of families that will put their homes on the market once prices stabilize. We have double the amount of any previously recorded inventory levels, while home sales amounts are at historic lows.

I explain how buying a home in many areas doesn’t make sense because rents are historically low compared to house prices.

We are in the most unsound economy in our nation’s history as interest rates and markets are being desperately manipulated by the government to force many people into buying homes that will absolutely go down in value.

I will sometimes be honest and say that most of the people today that are buying houses are not financially qualified to own. The government has created another bubble that is allowing many people through government subsidized loans to stretch to buy a home. These are people that have no concept of budgeting or saving or anything other that living paycheck to paycheck. They are renters that are being pushed into buying overpriced real estate. So if we consider that their 3% down is wiped out with purchase costs, these glorified renters are starting out home ownership with less than zero equity.

If I have time I might say that as a nation our savings rate and taxes must go higher making it harder for families to afford a higher priced home. And that our nation’s debt is mathematically impossible to pay off.

There are the demographic issues of our aging population that must sell their homes to fund retirement. They will exit the market and won’t be back.

There are the mathematical issues that state that as interest rates rise home prices decrease proportionally.

So interest rates will be a severe headwind on home prices for many years in the future.

Owners will learn that the buying and closing costs for a home are at historic highs. They will come to realize that it could take 8 years of mortgage payments to repay enough principle to be able to pay the round trip purchase and selling costs in a stagnant market.

So many people in the future will be surprised when they are required to write a large check when they sell their home.

There are the funding issues that suggest that as home prices decline there will be no money for move up buyers to purchase higher end homes. For the next ten years people will have to save for home improvement costs instead of robbing from their home’s equity.

So the move up market is dead for ten years and the home ATM is gone forever.

Honestly there is nothing that could possibly drive the housing market significantly higher above its present overvaluation. But there are thousands of events that will force prices back to the fair value that was the normal trend before 1999.

The fact of the matter is that assets will ALWAYS come down to fair value after a bubble and many times they can trend below fair value for a while. To think that this time is different is utter delusion. To make a highly leveraged bet on a delusional assumption is madness.

The people will listen for about ten minutes with a glazed expression.

When I am done they become animated and tell me how excited they are at the prospect of buying a home. Sometimes it almost seems like desperation.

They say that they must buy now. Everyone says that it is the best time in history to buy a home.

I love to go on the Housing Tracker website. I can follow the listing prices of homes in most major metro areas. Listing prices everywhere are still falling lower. Every month like clockwork they go down.

Every week we get closer to fair value. Every week desperate people are less likely to buy an overpriced home.

Every week there is a new person that might look at the data instead of the salespeople. And honestly decide if owning a house makes sense compared to renting.

Honestly decide if they want to lock themselves into 30 years of debt payments with absolutely no chance of escape once interest rates start to rise.

And acknowledge the fact that home prices are still historically overvalued in many areas compared to rent and household income.

As a nation we need to question how long the government can continue to desperately rob money from our children to prop up overpriced housing.

There will be a point in the future where people start looking at what is best for their family, for our children and for the nation in the long run.

I am not anxious for a housing bottom. That will take many years. I am looking for the emotional bottom.

I am anxious for our nation to stop looking at the real estate market with desperation.

Like we did before 1999,

and the previous 200 years before that.

Keynesians need a Class in Common Sense

2010-09-04T16:47:00.001-07:00

I read Paul Krugman’s blog once in a while just to find out what the other half is thinking. Presently he is harping on the need to save our country from another Great Depression with more government stimulus.

So far we have been saved three times from big Great Depressions in the last 8 years.

The first time was when Greenspan and Bush saved us in 2002. The second time was when Bernanke saved us two years ago with 0% interest rates. And the third time was the bailout bonus for bankers.

There have also been little mini rescues such as the housing credit and cash for clunkers to name a few.

Also the government is planning to fund deficits of $1 trillion a year for the next ten years to continuously prevent various other great depressions that might come along.

It seems like preventing great depressions is the major government activity of late.

But Paul Krugman is adamant that this one is for real and we must borrow more money to prevent economic collapse. I assume that along with incurring this monstrous debt, he wants the government to waste the money just like they have done in all the previous rescue attempts.

Paul Krugman sees this as the end of the world but I see it as an opportunity.

I would like to suggest that we end this once and for all.

Let’s decide how much stimulus will stop great depressions for the next 10 years. Let's suppose it is $5 trillion. Then we divide $5 trillion 300 million ways and give $16,000 to everyone.

But for that $5 trillion I would need Dr. Krugman to sign a contract saying that he can’t ask for any more stimulus money for 10 years.

So Dr.Krugman will fund the biggest stimulus of all time.

It will be the most expensive economics class anyone has ever attended.

But he will get a lesson in real world economics. He will learn that:

Destroying a currency can't create long term prosperity.
Debt can't be eliminated with more debt.
Wasteful government spending doesn't create long term private sector job growth.

Some might say that spending $5 trillion to give Keynesian economists a class in common sense is ridiculous.

I say it is money well spent.

The Most Expensive War in History

2010-08-28T07:18:00.000-07:00

Our nation is wasting an incredible amount of productive resources to fight a battle that has become distasteful to many in our population. At one time this war was cheered as patriotic, but with the massive increase in expenditures and mind boggling waste, many are becoming resentful of our American government’s presence in an area where it does not belong. Even if we stopped the war now it will have a lingering effect for generations.

Of course I am talking about our government’s War on Affordable Housing.

Today many young families must purchase homes for 6 times their household income. This is compared to their parents that bought homes at 3 times their household income 15 years ago and their grandparents that purchased at 2 times their household income.

The government has spent trillions of dollars through subsidies, tax breaks and direct market manipulation of interest rates in an attempt to make housing prices unaffordable for young families that want to enter the real estate market.

Our War on Affordable Housing dwarfs the resources that are presently being spent on the War on Drugs or The War on Terror.

Many are starting to question whether this is the proper battlefield to expend the limited resources of our nation.

An assault that might be more justified would be a War on Unemployment, like Roosevelt funded during the Great Depression He employed millions of workers to build things. This program constructed Hoover dam and much of the infrastructure in our National Parks.

How about a War on Outsourcing? This engagement would fight all of the crazy tax breaks that allow companies to send jobs overseas and would replace them with subsidies to hire workers at home.

The only thing that we must consider is that if we stopped the War on Affordable Housing and used those resources to fight a War on Unemployment and a War on Outsourcing at the same time, it could cause massive problems in our economy. Our unemployed labor pool would shrink to zero as the sale of fairly priced homes would quadruple. This would cause the biggest economic boom in our nation's history. We would then be forced to start a War on Employment to counteract the unbridled prosperity.

The biggest problem with the War on Affordable Housing is that prices are always being pulled toward affordability. The market trends in line with historical fair value in the long run no matter how much money is expended to manipulate the free market in the short run.

On top of the trillions that we have already spent, our government will have to spend many hundreds of billions of dollars a year, forever, to continually battle the forces of the free market to keep homes unaffordable for new families entering the real estate market.

So the War on Affordable Housing appears to be an extremely expensive fight that we can never win.

Also, understandably, it is fast becoming an unpopular government policy for our younger citizens who can't afford to buy a home because of the high taxes they have to pay to continue fighting the War on Affordable Housing.

But the War on Unemployment or the War on Outsourcing would be supported by everybody. Either battle would only be temporary. And both are 100% winnable.

The best part is that our nation will be able to win a war for the first time in a very long while.

Economic Elitism is not the Solution

2010-08-21T15:35:00.000-07:00

Last Tuesday we had what was called “The Summit on Housing Finance”. This was a get together of a group of individuals that were instrumental in the policy choices that caused The Housing Bubble, The Credit Crisis and The Great Recession. This is our “Economic Elite”. The government invited them to get together to figure out how to repair the system that they and others like them have destroyed.

Unsurprisingly the main suggestions from the event were that we need more unsustainable debt to taxpayers, more government control piled on top of our already dysfunctional markets and of course much more subsidies for the financial sector.

I looked back at all of the quotes from the economic philosophers of the past 2,500 years. And I couldn’t find any references that espoused unsustainable debt to manipulate asset prices, rewarding speculators at the expense of prudent savers or tightly controlling markets to reward government favorites.

No, actually there are a few economists that favored controlling free markets. Karl Marx is the most notable.

And I must admit there was a period where people felt that it was wise to give all of the resources of a country to a few very rich elite with the hope that this nobility would trickle some of the spoils back down to the rest of the populace. This “trickle down” economic period was called feudalism or more appropriately, “The Dark Ages”.

The tightly controlled markets of Karl Marx run by an Economic Elite of feudal lords sounds rather archaic. But that is how our economy runs today.

The Economic Elite have usurped our economy. Many of our markets are broken. The participants of “The Summit on Housing Finance” suggest that we break them even more.

The Economic Elite are saying that taxpayers must borrow ever more money and give it to the Government and The Financial Sector to waste, just like Japan.

But why do we want to emulate Japan? Japan’s economy is terrible.
Why can’t we emulate Germany? Or Canada? Or Australia?

Or better yet, why can’t we emulate the US economy at the point before our Economic Elite diverged from the philosophy of our forefathers?

Our country was based on free markets and rewarding good ideas. It was called capitalism. The market rewarded good ideas with wealth and power. The same free market severely penalized bad ideas with loss of wealth and power.

This freedom of markets has been removed and is now controlled by the Economic Elite through the government. Most of the people that ran our economy into the ground should be penniless and powerless. Instead they are put in charge.

This is not absolute tyranny but it is autocracy through subterfuge.

Economic doctrine has replaced free markets. This doctrine has become so complex, convoluted and conflicted that our economy doesn’t work properly anymore. Most of the policy we are using to solve our problems can’t be justified with logic, reason or common sense.

I feel that our economic policy needs to be simplified so it is in line with a time before our free markets were totally usurped by this failed experiment at government directed economic control.

The goal should be toward sustaining an economy with:

· A very large middle class.
· Free Markets for everyone where the government protects against collusion, monopoly and entities that become too large to compete fairly with the rest of the players.
· A government that runs like a business with a balanced budget.

I am suggesting that we replace the last 20 years of crony capitalism orchestrated by our nation’s economic elite with 200 years of successful economic governance by free markets.

I am also suggesting that no nation has ever prospered by:

· Tightly controlling investment markets to reward political favorites.
· Creating temporary bubbles to force an economy to grow.
· Robbing from savers to reward speculators.
· Robbing from future generations to live at a higher than sustainable standard of living today.
· Starving the productive private sector to create a bloated and inefficient non productive public sector.

Each of these policies would have been abhorrent to our founding fathers. They understood the nature of tyranny and economic elitism.

In the last 20 years we have thrown away a system that was put in place by our forefathers. It had worked perfectly for the previous 200 years.

We are refusing to emulate the United States of our grandparents. Instead the goal of our nation’s economic elite is to become an impoverished and feudalistic crony capitalistic version of Japan.

Inevitable Impossibilities

2010-08-15T08:35:00.000-07:00

Many economists are suggesting that our government continue pushing our economy in the same direction that caused The Tech Bubble, The Housing Bubble, The Credit Bubble, The Subprime Crisis, The Banking Crisis and The Great Recession.

As each of these economic events occurred these same economists were surprised by them. Each bubble or crisis was an outlier that was one of the last possibilities that they had expected.

Economists have stated that these outliers are “Impossible” to predict. This is ironic because, in my opinion, each of these economic events seems like the “Inevitable” outcome of bad government policy.

So in essence they are “Inevitable Impossibilities”.

As the government continues to push our economy in the same direction that caused all of our previous crises we are very likely to incur more “Inevitable Impossibilities”.

· The “Inevitable Impossibility” of increasing interest rates: Our nation’s interest rates have spent the last 30 years on a continuous trend almost straight down. A significant percentage of our nation’s economic growth is predicated on the continued contraction of interest rates forcing ever more gains from our extremely overvalued bond and real estate markets. Although it is an impossible event to economists, there is a distinct possibility that interest rates will increase in the future. Economists don't understand that as interest rates increase, bonds and real estate prices decline proportionally. So as our Federal Reserve is forcing rates artificially lower it is proportionally increasing the size of the inevitable crisis in the future.

· The “Inevitable Impossibility” of Living With-in Our Means: As a country we have been able to live beyond our means by borrowing resources from the future. We started by tripling our debt load to GDP over the last 30 years. When our individual credit ran dry we learned to use the government in our stead to borrow money from hostile foreign nations in the name of our grandchildren. Although economists feel that it is very unlikely, it is possible that during our lifetime we will be forced to stop robbing resources from our kids. As we continue to steal from our children it is just creating a bigger problem in the future.

· The “Inevitable Impossibility” of Free Investment Markets and Fair Wages: The government has usurped many of our formerly free markets. Interest rates are controlled by our political officials. The mortgage market is run by our government. Political policy sets most wages in the country with massive subsidies to the non productive sectors and huge tax burdens to the productive ones. Presently our elected officials have created a perfectly imbalanced economy where the financial sector earns twice and much as the government sector. And the government sector earns twice as much as the private sector. If the invisible hand of government stopped subsidizing the non productive sectors of the economy, then money would come flooding into the productive private sector. This would cause equally proportionate private sector employment growth with subsequent unbridled prosperity and possibly inflation. We are forcing more and more money out of the private sector. This is creating a bigger inflation problem once the flow of money starts to enter the private sector again.

All the examples above seem to be the most likely culmination of bad government policy because:·

Interest rates can’t be artificially manipulated any lower than they are now.
Asset prices can’t be artificially held above historical fair value forever.
We can’t live beyond our means forever.
In a democracy the government can’t control markets to reward political favorites forever.

But all of these logically “Inevitable” outcomes are not even among the “Possibilities” of our economic community. Economists say interest rates must be lower, asset prices must be forced higher, we must continue to borrow and spend. And absolutely the government is our savior.

For some reason, the most likely outcome of each of these “Inevitable Impossibilities” seems to lie far beyond the scope of our current crop of economic theorists to predict.

"Now There's Something You Don't See Every Day"

2010-08-11T09:20:00.000-07:00

Something interesting happened yesterday. The 5 year Treasury yield sailed below its historical all time low. In July of 1954 the 5 year Treasury yield spent a month below 1.9%. This was a temporary one month vacation and the only time since the Federal Reserve has kept records that the government’s 5 year bond yield has been below the 1.9% mark. Until Yesterday.

As of yesterday the 5 year Treasury bond is carrying a yield of 1.46%. That is over 21% below the unprecedented all time low in July of 1954. The amazing part of the equation is that it is still trending lower. It is 21% below the record and still trending lower! It reminds me of the famous line delivered by Kathy Bates playing the unsinkable Molly Brown in the movie Titanic. From a lifeboat as she was watching the ship sink she deadpanned: “Now there's something you don't see every day”.

I believe that Molly Brown’s line is appropriate today. We are incurring many events that our nation has never seen before. But the problem is not the events that we are seeing but our reaction to them.

The artificially low rates should be a specter of warning to investors. We are entering a period filled with financial icebergs. The only way to survive is to slow down and be more careful than anytime in your life.

Unfortunately most people are not heeding the warnings in the economy. We have events happening that are unprecedented and many investors are ignoring them as high end real estate, most commodities and all long term bonds are in bubble.

As individuals and as a nation we are steaming full speed into a sea filled with icebergs on a ship that is horrendously overloaded with debt.

My only thought at the moment is that anyone that is stretching to buy a home in the "high end" real estate market is buying a ticket on the RMS Titanic Housing Bubble II.

Low interest rates are pushing people into buying homes that they can’t afford.

Historically people will buy a home that is 3 times their household income. The low interest rates of today are allowing people to buy homes that are more than 6 times their household income.

I would like to suggest that this is 100% above the historical norm! So if you are buying a home today that is 6 times your household income you are making a highly leveraged bet that house prices will never come back down to historical fair value.

And I would like to add that there is definitely a possibility that home prices can go below historical fair value. It is happening in many, many lower end housing markets! Some markets are bottoming at historic valuation lows.

Because of our unsound economy and the historically low interest rates it is very, very imprudent to pay above historical valuation metrics for a home. Lower risk tolerances of investors in the future will lower prices. Higher interest rates will crush prices. Another recession will sink the boat.

The tried and true valuation metrics that you should follow to determine a prudent price of a home is 3 times your household income. And you should not buy a home that has monthly costs that are significantly higher than the monthly costs to rent the same house. Historically, the rule of thumb is not to pay more than 180 times the price of monthly rent for a house.

These are metrics for a normal economy. Presently we are living through the most unsound economy in our nation's history! Is this really the time to stretch your budget and borrow a million dollars to purchase an historically overpriced home?

There is still a flood of investors paying far above historical valuations for high end real estate. They are ignoring the economic warnings up ahead. They are ignoring the valuation metrics of the past.

To all of the speculators that are contemplating running full throttle into the purchase of high end real estate - Godspeed.

Our Economic Shell Game

2010-08-08T20:36:00.000-07:00

We are a nation of speculators that are being hoodwinked again and again in a confidence game run by our government subsidized financial sector.

We lost our savings in the Tech Bubble. Then we borrowed trillions of dollars to play in the biggest real estate bubble of our nation’s history. It was a highly leveraged bet that real estate prices would never come back down to historical average value again. This "fair value" is the average of the historical trend line so it the most likely outcome in the long run.

Of course this was an impossible bet. A shell game is driven by the profiteering of the operator and not the profits of the speculator.

Remember, this is not gambling. This is a shell game. There is no chance of winning.

The government and the financial sector sold our citizens on this impossible bet. Our job producing manufacturing sector that was the envy of the world has been dismantled as our nation’s resources are directed to the huge government run financial confidence game. Instead of growing our economy with increases in savings and productivity we live within the boom and bust caused by each new round of speculation.

The past two bubbles have taken our savings so now we are playing with borrowed money. We must go begging to China for the ten trillion dollars that will fund our next round of bets.

We have just begun the next game as our politicians have supposedly put the pea under the shell. The con is no different than before. We are betting that asset prices will continue to remain above historical fair value forever.

So far the game is exciting. Through massive unsustainable market manipulation by the government, high end real estate is being pushed back into a bubble as the cost to buy in many major metro areas is double the price of rent. Most commodities and many of the more speculative stocks are solidly in a bubble. Long term bonds are in a super bubble.

If the action slows then taxpayers fund bailouts to government shills to keep money in the game. The nimble fingers of the Federal Reserve pickpocket interest from savers to help foot the bill.

At some point in the future the shell will be lifted showing asset prices have come back down to historical fair value. As they absolutely always do, 100% of the time.

The suckers will be rolled yet again. Wall Street economists will call this inevitable loss a "black swan", or a "fat tail" or maybe a once in a 100 year event.

The outside observer must laugh at the fact that the most likely outcome is percieved as impossible by the speculators. This is all part of the "sleight of hand" in performing the con.

After the bust it will be time to go home and explain to our children that we have spent the last 15 years gambling at shell games instead of working and saving. Our money has left the job creating private sector to be wasted in this huge government subsidized financial con game.

I am sure our children won’t understand. But really what rational person can understand someone trying to win money in a shell game!

Our children will go back to just working and saving…

“Oh kids I almost forgot, China will probably be giving you a call soon about some money that you owe them ... "

“Double or Nothing?”

A Heartfelt Appeal to the Unemployed

2010-08-01T19:46:00.000-07:00

I am writing this letter as an appeal to all of the unemployed and underemployed people of this nation to contact your elected officials and demand that they vote for an extension of the Bush Tax cuts. We must help our government to make the difficult choices that will promote economic growth in the future. One of the most crucial decisions of Congress is to choose which sectors get heavily taxed and which sectors get heavily subsidized.

If you are an unemployed private sector worker, then I am sure that it is troubling to realize that your job was deemed unimportant by our politicians but you must understand this is all part of the “invisible hand” of government that will lead us to a higher standard of living in the future.

Quite frankly, no one in my circle of friends is unemployed. But I do read the Wall Street Journal so I understand the “rough patch” that our country is going through.

My friends and neighbors are highly paid government administrators, health care workers, lobbyists, university professors and Wall Street professionals.

We work as employees for the healthcare sector, the government sector and the finance sector. Our government subsidized salaries are increasing faster than GDP growth so we are the growth industries. Our pay is growing much faster than the salaries of the unimportant jobs in the private sector.

We must continue the Bush tax cuts because of the high salaries for the important jobs in government and the financial sector. Many of these employees are paying a lot of money in taxes. The workers in these growth industries will be the driver of consumption in the future. It is imperative that they continue spending lavishly.

I know that even with this perfect logic there are some naysayers.

My accountant Earl says that directing money toward rich government and financial sector employees does not create jobs. To create jobs we need targeted tax credits or direct subsidies for new hires in the private sector. Higher individual taxes and lower corporate tax rates will also promote job growth. He says in this way money goes directly to create jobs without rewarding people that don’t deserve it.

Now I ask you, who is he to say who deserves the money? I told him that even if he doesn’t want money to go to the rich government and financial workers, what about the rich farmers and the rich small employers? They create most of the jobs in this country.

Earl just blathers about how almost no small business owners in this country have wages of more than $250,000 a year, which is the lower income limit on the Bush tax cuts. Earl thinks that by lowering individual tax rates and raising corporate tax rates it just gives incentive for a handful of rich business owners to raise their own salaries and lower the wages of their employees – just like government administrators do as they ratchet up their own salaries and layoff police, teachers and firefighters.

I feel that Earl is just bitter and I take exception to his jibe against government administrators like me.

Earl is self employed in the heavily taxed private sector. He only makes $100,000 a year. Neither he nor his employees are subsidized at all. The government must feel that he has a very, very unimportant job. I have tried to explain this economic fact to him but he won’t listen.

He could make twice as much working for the government itself in a midlevel administrative job or four times as much in the government run financial sector. This pay would be remuneration for doing the same amount of work that he does now! Why would anyone choose to work in the private sector? It just doesn’t make any sense.

But Earl is very stubborn.

He talks about how if we removed the government subsidies from the non productive sectors there would be plenty of money for the productive ones. He says the government’s misdirected subsidies “crowd out” private sector investment. And that most of the small businesses that he works with could hire extra employees if the government got rid of some of the constantly changing and crazy financial, economic and regulatory laws that make it impossible for small employers to compete with the big corporate and foreign employers.

I think Earl belongs in the low paying private sector. He just doesn’t understand economics.

I would like to reaffirm to you little people that if you consider the extension of this gift to the rich, that in the long run it could create more jobs. Honey Poo and I are too busy with golf and “the club” to consider any new business endeavors. But with the continued tax breaks and my government subsidized salary increases my wife is planning to hire her own eyebrow and nail specialist and an additional au pair for Shitake, our beloved Shih Tzu.

This will be two new jobs to help the economy.

Also Honey Poo and I have made a pledge that we will continue to live well so that our spending will trickle down to help the people in need.

Thank you for continuing the Bush Tax Cuts.

Yours Truly,

Rich Administrator
Small Town, USA

A Complete History of Economic Thought

2010-07-23T22:55:00.000-07:00

Economic thought can be broken down into three distinct periods. The first is lodged between the twenty two hundred years starting with the height of Greek civilization in 500 BC and ending in the early 1700s with the coming of the industrial revolution. This epoch is populated with the political philosophy of the likes of Socrates, Plato and Aristotle as they attempted to define liberty, justice, property rights and law. These ideals provided a theoretical foundation for economic thought in the coming years.

The second period of economic thought evolved because of the industrial revolution and ended in 2002. During this era Adam Smith, David Ricardo and Thomas Malthus combined the political philosophy of the Greeks with the new profit driven concepts of capitalism. This unwieldy combination of political ideals and financial concepts never evolved to become a science.

During this dark period philosophers believed that savings and increased productivity created a higher standard of living for future generations. It was conjectured that debt could increase a nation’s standard of living in the short term but must be avoided as a long term panacea.

Along with these other misconceptions there was the delusion that the debasement of a currency by a wise and equitable government could create a misallocation of resources that rewards political “favorites”. Simpletons like Thomas Jefferson, Edmund Burke, and Alexis de Tocqueville wrote tomes about this government manipulation and suggested that it was a form of tyranny.

Today these well intentioned treatises are viewed as nothing more than Voodoo economics. Most of these “dismal” economic philosophers have been relegated to the dust bin of history.

The simplistic thinking of our ancestors changed in 2002 as our government and our financial system merged into a single entity. This symbiosis has allowed the science of government directed financial management to replace the theoretical “invisible hand” of Adam Smith. It is fostered by the bounty of the endless money that is created by our Federal Reserve and then funneled directly into our financial system.

There were a few master theorists that foresaw our current managed economy.

While Jefferson, Burke and de Tocqueville were writing about ideals, Karl Marx was using ideas to plan a future economy. He explained why capitalism can’t work and why the government must intercede.

Joseph Stalin commandeered Marx’s concepts and showed us a glimmer of our future as he managed an empire that had seemed unmanageable in the past. Papa’s deliberate style of management used his military to direct his populace through the emotion of fear.

Our elected officials have taken this egalitarian ideal one step further. Instead of using just the emotion of fear to direct an economy, our politicians utilize the fear and the greed of speculators to gently push our economy to new heights.

Today we take this government “stimulus” for granted. Stalin’s economic direction is replicated by economic enticements by our government run financial sector.

Thanks to the Federal Reserve money is constantly pulled from our non productive savers to create new bubbles of economic growth. This growth is not enabled by theoretical capitalistic ideals but with scientifically micro managed "free markets" run by Wall Street economists.

The government stimulus creates permanent economic plateaus very similar to the one predicted by Irving Fisher of Harvard in 1929 with accompanying economic moderation as predicted by Professor Bernanke of Princeton in 2004.

Only these permanent exuberant periods or “bubbles” as they are sometimes called will be the solid foundation for future growth.

The philosophy and ideals of the past have been replaced by hard science.

This economic renaissance is like a roller coaster with all of the falls eliminated and replaced with permanent plateaus supporting prolonged periods of prosperity courtesy of the economic science of our government run financial system.

History Never Repeats Itself Exactly

2010-07-11T07:42:00.000-07:00

Anyone except for perhaps the nation’s highest paid Wall Street Economists should be able to understand our nation’s present predicament. We are in a situation very similar to 1930. Our nation is carrying a historically high total debt to GDP ratio, our investment markets are jittery and we are looking to the government to somehow fix the problem.

During the Great Depression the major economic threat that most people feared was inflation. So the government used politics instead of common sense to solve the problem. Since people feared inflation then it was deemed that the government should abstain from "substantially" increasing the money supply.

Thanks to our unwarranted fear of inflation and with help from the Federal Reserve our economy was locked into 10 years of grinding deflation.

Today our nation has an abject fear of deflation because of the memory of the Great Depression. No matter what the alternative we will go to any length to avoid the dreaded “D” word.

It was this ridiculous deflation fear that caused then Fed Chairman Alan Greenspan to flood the economy with money in 2003. The Greenspan faux pas added to the supply side largess from the Bush Tax cuts to create the biggest real estate bubble in the history of our nation.

Even after the incredible debt, waste and excess of the housing bubble our nation still lives in abject fear of deflation. We are demanding another bubble from the government.

Of course they are happy to oblige.

Chairman Bernanke has removed the bolts from the base of the money fire hydrant and liquidity is shooting high in the sky. I have no idea how he is going to reattach it in the future. Money is gushing into the government and the financial sector faster than the oil spew coming from the Gulf of Mexico.

The high end real estate markets and our commodities markets are still in a bubble. And our long term bond market is in a super bubble. The unrestrained spending of the government and financial sector make Imelda Marcos’ shoe purchases seem frugal.

Although we are in a situation similar to 1930, bad government policy has created the antithesis of the Great Depression. Instead of runaway deflation and economic starvation we are incurring massive bubbles, horrendous waste and historic misallocation of resources.

Speculators are bailed out 100 cents on the dollar paid for by our savers. The highest paid government employees retire as kings at 50 while teachers and police are laid off. The financial sector is receiving record pay raises and bonuses for destroying our economy. Education and health care expenses are on a space shuttle trajectory to the moon. If the public sector was an economy unto itself, it would be in Zimbabwe style hyperinflation.

The private sector is affixed in a position antipodean in relation to the public sector. The private sector must hire illegal aliens and ship jobs to foreign countries to pay higher and higher taxes. Private sector jobs are extinguished with the massive subsidies required by this bloated non productive bubble creating bureaucratic behemoth.

But amazingly, the taxpayer is not upset at this monumental misallocation of resources as long as they are protected from the monster of deflation.

So our fear of the deflation of the Great Depression is driving policy in the opposite direction. Our government will fight tooth and claw against deflation even if it means living from bubble to bubble, creating massive borrowing and waste with the day of debt reckoning being pushed onto our children’s scrawny overtaxed shoulders.

Our highly paid Wall Street economists are telling us that we are on the verge of another Great Depression and that we must use extreme measures to avoid deflation at all costs.

My only advice is to be careful what you wish for.

Stagflation here we come.

Our Orwellian Economy

2010-07-07T14:58:00.000-07:00

Our economy is in the final acts of an Orwellian drama. Just as in Orwell’s fiction, the individual and the truth are usurped by the power of the state.

· Our Ministry of Housing had a goal to make homes affordable for the lower class. Now that these homeowners are desperately underwater, rich investors are buying up the lower end real estate. Many members of the lower class that were helped by the Ministry of Housing are destined to rent forever.

· Our Ministry of Lending had a goal to make mortgages affordable for all. Now, the indebtedness of our total mortgage market is equal to the value of our mortgaged housing stock. So in the aggregate, anyone with a mortgage is just a high priced renter locked into a 30 year lease.

· Our Ministry of Jobs had a goal to increase employment. It has heavily subsidized the non productive public and financial sector jobs market. To pay for these subsidies the productive private sector was heavily taxed. And now, even more taxes must be levied on the shrinking private sector to pay the unemployment benefits of displaced workers as their jobs are shipped overseas or staffed by illegal aliens.

· Our Ministry of Free Markets had a goal to create fair and stable investment markets. It has manipulated almost all market conditions and gamed the system by bailing out some to the most egregious speculators. This policy has created two of the largest investment bubbles in our nation's history. Not to be outdone the current ministry is using even more extreme measures to create the biggest bond bubble in the history of the world.

· The Ministry of Sound Investing had a goal to manage interest rates for the benefit of investors. It is now punishing savers with zero percent interest rates and using the windfall to bail out speculators.

· Our Ministry of Sound Money had a goal of controlling prices. One dollar in 1950 is now worth 12 cents.

· Our Ministry of Sound Government had a goal to reward citizens for voting appropriately. For the past 15 years our politicians have used ultra long term debt to purchase votes in the next election. Mathematically it has become impossible to pay back these promises with future income, so by definition it has become a Ponzi scheme.

· Our Ministry of Sound Accounting has created bookkeeping techniques to hide the Ministry of Sound Government’s Ponzi scheme.

Presently our Ministry of Freedom is saying that we need to borrow large amounts of money from hostile foreign nations to increase our children’s standard of living and keep them safe in the future.

Debt and consumption are good. Saving is very, very bad. Our non productive government and financial sectors must be heavily subsidized to create economic growth. The productive private sector must be heavily taxed to create more jobs. Up is down. And left is right.

There are many allocation problems with our economy today that are creating a high level of unemployment. Non productive government favorites receive ever increasing pay, benefits, pensions and subsidies. This must be paid for by the ever decreasing pool of private sector jobs.

As an accountant I don’t understand the math behind our policy choices in the ministry over the last 15 years. Why do our comrades in government feel that more borrowing for more subsidies to the financial and the public sector will produce more private sector job growth? It has not worked for the last 15 years. After massive spending and subsidies we have less private sector jobs today than a generation ago.

The pay and job growth in the non productive sectors of our economy have exploded.

Alas, in the end we must listen to the Ministry of Fairness when they say, “all citizens are equal.”

And, as good citizens we must understand that, “the government and the financial sector are more equal than everyone else.”

The Herd of Irrational Investors is Here to Stay

2010-07-01T08:14:00.000-07:00

Toward the end of 2007 I started accumulating a significant short position in the market as every economist and investment advisor in the country was sure that there where blue skies forever in the economy.

In March of 2009 I was pitchforking money into the stock market as most investment advisers were warning that we were on the verge of a financial meltdown. Before the recovery I ended up 90% market positive.

On March 17th of this year I went market neutral as the S & P index hit 1166. At that time most investment advisers were confident that our nation was on the road to a V shaped recovery.

Today, now that the S & P is trending toward 1000 and many economists are talking about a Depression, I am slowly buying into the stock market.

Maybe I am being a little too aggressive as my sleep at night portfolio is back up to 50% stocks and shorts on the long term bond market. I just think we have a couple more quarters of increasing corporate earnings before the next recession.

I would like to be accumulating a short position by the first quarter of 2011.

So does this make me a speculator. Absolutely not. I would suggest that in each case I am looking at the value of the market.

In 2007 the market was extremely overvalued as we were going into a recession.
In March of 2008 the market was extremely undervalued as the government was poring stimulus money into the economy.
In March of 2009 the S & P was 11% overvalued after the longest market run in the last 50 years.
Today the S & P index is 5% undervalued as we have 2 more quarters of corporate growth from the stimulus. And perhaps more stimulus.

In each case I based my decisions on the valuation of the market and only the valuation of the market.

But my moves seem to be the exact opposite of what everyone else is doing.

As I have said before in my blog. For the past 10 years our investment markets have been ruled by our nation of debt fueled speculators. People are getting very good at making irrational decisions and then the government bails them out. Which creates more market irrationality.

This dynamic isn't going to stop anytime soon.

When I invest I look at valuation. That is why I am renting a home today, why I am slowly buying into the stock market now as everyone is selling and why I am trying to accumulate a large short position in long term bonds.

What are the benefits of value investing? Mainly just piece of mind and low risk. I don't make investment decisions. I let the market make them for me.

Therefore I don't worry about my investments. I have not lost an hour of sleep worrying about my investments for the last 10 years.

Can you say the same thing?

The Perfect Waste of Princeton Economics

2010-06-25T08:36:00.000-07:00

I look at the economy differently than most Wall Street Economists. These highly paid salespeople have been consistent with their advice for the past 20 years. There is no economic problem that can’t be solved with more indebtedness. My perspective is different. Although I have a degree in Economics, I am an Accountant.

Presently our nation’s perceived high unemployment rate is the new mantra to sell our country more debt. Economists, such as Dr. Paul Krugman of Princeton, tell us that we are facing another Great Depression unless we borrow tens of trillions of dollars from hostile foreign nations and give it to our wasteful government. I can only shake my head and say, “Please look at the numbers before you panic our nation with unfounded comparisons.”

These are the facts. Our economy is growing and creating plenty of income for everyone. This income growth is being funneled to our government and the financial sector and away from the job creating productive private sector. Our government is using it's disproportionate share of income to subsidize inefficient areas of our economy and to give huge pay and pensions to it's highest paid employees. The highest paid bureaucrats retire at 50 with $100,000 pensions as we give pink slips to teachers and police officers. The government is the second best job killing machine that has ever existed.

The financial sector puts the government job killing machine to shame. Our financial sector has been able to kill the economy with huge investment bubbles. If the government can be called a job creation machine gun then the financial sector must be compared to an economic neutron bomb.

None of these government or financial sector shenanigans create jobs for the productive private sector. They are destroyers of jobs as income is misallocated and then wasted. One could almost call it a perfect system of wastefulness. The antithesis of the business model.

We can call the support of such a system 'Princeton Economics'. More debt, bigger government and an explosive financial sector while the economists are "tilting at windmills".

Let's look at the numbers.

Looking at the Asset side of the equation, our current housing market, our stock market, our bond market and our commodities markets are over valued compared to historical standards. We have a record $4.2 trillion in money in banks that could flow into investment markets when investors decide that the economy is safe once again. So there appears to be plenty of money in the economy. A rational person with an eye toward the long term could even argue that there might be too much liquidity in the system. Excess liquidity in 2003 caused the Housing Bubble.

Currently we have overpriced investment markets and plenty of liquidity to back them up. Now, compare that to the Great Depression. Stocks, Real Estate, Bonds and Commodities were driven to deep undervaluation. Banks closed their doors so depositors could not access their money. There wasn’t just a lack of money, there was no money. So we have too much money in the system today compared to none at the outset of the Great Depression.

Now the income side of the equation appears even better. Over the last 6 years our nation’s disposable household income has increased 34% and our nation’s GDP has increased by about the same amount. This is extremely good income growth considering we are overcoming a massive government induced bubble from too much liquidity in 2003. By all rights our nation’s GDP should be going down as a hangover from the Housing Bubble.

During the Great Depression the GDP was cut in half. This slash in income was a truly unprecedented event. A massive hit to income plus the historic lack of liquidity meant we got the one-two punch that knocked our nation to its knees in 1929 and did not recover until WWII.

Just in case the Princeton Economists are confused by the numbers let me recap. Today we have plenty of capital and very good income growth. During the Great Depression our nation was down for the count with income cut in half and the money spigot turned off. We are living through the antithesis of the Great Depression.

So instead of ludicrous comparisons to the Great Depression wouldn’t it be more useful to determine why the unemployed 10% of our population are not benefiting from the 34% national income growth over the last 6 years? Would it not be more fitting for a Nobel Prizing winning economist to question why we give our income growth to the government to mow down private sector job growth and why we enable our financial sector to play with economic bombs?

During the darkest days of the Great Depression 25% of our nation desperately wanted a job and had absolutely no income. There was no government support system so in many cases the unemployed went from town to town, willing to work at any job just for a hot meal. Our national income was cut in half so there just wasn’t enough money for everyone. Many investors lost everything. People starved.

Today 10% of our workers are paid by the government to stay at home. The other 90% share our growing national income with an unequal split between the government’s favorites and our productive private sector. We have created a huge government-run financial casino where rich investors are urged to make ridiculous leveraged bets and then are bailed out when these crazy bets lose money. As the rich spend an amount equivalent to the GDP of all the starving nations of the world on the diet industry, our poorest neighborhoods tend to lean toward obesity.

The only common variable between our current period of excess and waste and the deprivation of the Great Depression is the Government. During both periods our nation lived through historically bad government policy.

Krugman says we are reliving 1937. The numbers suggest that we are reliving 2003. We are bailing out rich investors. Absolutely no private jobs were created with Greenspan’s 2003 bailouts. Absolutely no private jobs will be created with the debt we are incurring now. The rich investors will be bailed our again and the poor will get poorer and more dependent on the government.

This is the antithesis of the Great Depression.

I am shocked by the waste and lack of accountability in our current government. But what is more shocking to me is how a Nobel Prize winning economists can demand that the remedy to our nation’s 15-year orgy of debt due to a total lack of government accountability is to give the government more money.

I am an accountant and I have described the math of the situation. If Dr. Krugman is adamant that he wants us to borrow money in our children’s name from hostile foreign nations to be paid back at high interest rates, so be it. Just please do me this courtesy. Please don’t compare the speculation and income misallocation of today with the desperation and hardship that our grandparents faced during the Great Depression.

They were our nation’s greatest generation and alas, we are the most selfish.

There is no comparison.

The Government Bubble

2010-06-21T09:38:00.000-07:00

Our government has pushed our nation of foolish investors solidly into our third bubble in the series. I was able to clearly document the Tech Bubble and the Housing Bubble while they were happening. My charts showed once in a hundred year manias that our nation’s economists demanded was a normal occurrence. But this bubble seems more opaque. I predicted this opacity a year ago as I stated that none of the economic indicators would point to a recession in 2011. This is because of the monumental market manipulation by our government in our investment markets and our economy. Even the most sophisticated market investors could be blindsided by this downturn.

When I say sophisticated investors I mean stock investors. The Government has managed to wipe out all of the sophisticated investors from the housing market. The housing market will be dead for the next ten years.

I’m not saying that there aren’t some reasonable values in lower end markets. For the first time in ten years rental real estate investors can get positive cash flow on an investment home purchase. This is good. But most of the investors that are coming into the low end market have very unrealistic expectations of the future. They see their investment as a way to make a quick buck and not a back loaded stream of income for the next 30 years. Even though these investors are buying in at fair value most have a good chance to lose money as the economy slows and interest rates rise. Only long term low end real estate investors will make money.

Most of the Bay Area’s high end real estate markets are the antithesis of the lower end markets. The Federal Reserve can feel proud that they are pushing many affluent young families into economic debt servitude for the next 30 years with no chance escape. Many families are paying bubble prices for homes that will be underwater in 5 years. I can not imagine how anyone can justify paying 30% to 50% above rental value in a contracting economy at historically low interest rates. When interest rates begin to increase these families will be locked into a runaway train. High end home prices will absolutely be forced toward fair value and quite possibly below fair value by rising interest rates, economic contraction, skyrocketing taxes for the rich and a higher national savings rate. There are no short term gains or long term gains anywhere in high end real estate.

I would absolutely love to own a home in Lafayette but unfortunately I am a value investor. I sold my home in 2007 with the hope that the housing bubble would subside in high end markets by 2010. It appears that I could be renting for another three years.

I have tried to think of a combination of economic events that could either keep home prices above fair value in Lafayette for an extended period or how the government could manipulate our economy to make rents and income increase at a faster rate than GDP. I am looking for some event that could force Lafayette home prices to fair value without a decline in prices.

Mathematically there is no combination of events that could push up income and rents without raising interest rates.

But there are two possible events that might create a demand shift in the higher end real estate markets. First would be if we let rich Chinese nationals become citizens if they buy our high end homes. The only other shift would be if our government makes an immediate overnight cut in the value of the dollar by 50%.

Both of these options will be suggested by lobbyists during the recession of 2011.

There is a very good chance that the financially unsophisticated families that are buying into overpriced high end housing will show outrage at their loss in value and demand a solution from the government.

As our nation of incompetent debt fueled speculators continues to make terrible decisions and then expect a bailout, I think anything is possible.

Who knows, in a couple years I might have to learn Chinese so I can communicate with my next door neighbors.

It's not an unemployment problem!

2010-06-18T17:18:00.000-07:00

I look forward to perusing the Federal Reserve Z.1 economic data when it is published each quarter. I am an accountant so I tend to look at the numbers a little differently than our nation’s cadre of highly paid Wall Street economists. The current numbers show some interesting facts.

Since 2003 disposable personal has increased 34% as our GDP has increased by about the same amount. Housing has increased about 2% as stocks have gone up 25%. The star performer in the investment markets has been long term bonds. Because of falling interest rates bond values have gone through the roof.

So in the past 6 years we had very good growth in our disposable household income and we made a ton of money on bonds. It seems crazy to me that our economists are comparing the last few years in our economy to The Great Depression. How on Earth do they come up with this stuff?

The reason that we have 10% unemployment now is because of monumental waste and greed in the system.

In the first quarter of 2010 each person’s share of total disposable household income was $37,000 per person per year. In 2003 it was $30,000 per person per year. So what we are going through now is not an income problem. From an accounting standpoint what we have now is an allocation problem.

And I would bet that the biggest impediment to the proper distribution of resources is the dysfunctional markets created by the government and the financial sector.

Pay in the unproductive government sector and the financial sector has increased at a much higher pace than the productive sectors of our economy. This is a zero sum game where the record profits and pay of employees in the heavily subsidized financial firms are taken from the unemployed factory workers.

There are record pay raises for the government’s favorites at the direct expense of the unemployed.

It's simple to understand if you are an accountant or unemployed.

It's impossible to understand if you are a Wall Street economist. Your $200,000 bonus depends on you not understanding it.

You Gotta Know When to Hold 'Em and Know When to Fold 'Em

2010-06-05T09:30:00.000-07:00

We are now solidly into our third and final economic bubble. I call it The Government Bubble. It will be the last bubble because of its nature. Our previous bubbles were created by greed and fear. This current bubble is different. It is the culmination of a chain of events that is leading our country into a period of disillusioned apathy. This is the point when a gambler realizes that realistically the game is over. The last step is just to hurry up and lose the rest of his money.

I would like to compare this point in history to that of a compulsive gambler on a bender in Las Vegas.

There is a family man that comes to Las Vegas with his $10,000 nest egg and high hopes. With help from the casino there is a chain of events that will occur to eventually appropriate the gambler from his money.

The first $5,000 would be lost because of greed at the crap table. This first loss isn't earth shaking and it could be fun. There is still hope for a comeback.

Compare the family man at the crap table to the Tech Bubble.

The Housing Bubble could be compared to the loss of the next $5,000 at the roulette wheel. This is where fear comes into play. The family man starts to worry about the long term consequences of his actions.

The final sequence in this chain of events is debt, then disillusionment and finally apathy.

Our current Government Bubble could be compared to the $10,000 marker that this family man signs in exhaustion at 3am to keep gambling at the high stakes poker table. This is a marker to the casino that is backed by his kid’s college account.

Later as the sun comes up, the gambler has $5,000 left to lose before he gets to go home and tell his wife the news. That he has gambled away his son’s college savings.

At this point the irony is that even though physically the gambler has only lost 75% of his total bankroll, mentally the money is already gone. The bets will get bigger and involve more risk. The compulsive gambler will play till his money is gone and his credit is cancelled.

Now compare this family man gone wild to our country's current predicament. Our homeowners are insolvent. Our banks are insolvent. Our taxpayers are insolvent. Our state and local governments are insolvent.

Our nation has spent the last 15 years spending our nest egg. Half the money has been wasted by our government and half has been gambled away by our citizens. But how the money disappeared doesn't matter. The tipping point comes when the gambler loses his fear. Fear is the emotion that will force a gambler away from table. It will snap him back to the reality of his obligation to his wife and his children.

There is no longer any fear in our economy. Only disillusionment and apathy. We are impoverishing our children to play another hand. There is no future, there is no past. Only living in the moment with borrowed money. Geithner flying to China, hat in hand, head bowed, begging for yet another stake to be gambled away in the markets.

A once proud nation of savers, now on it's knees groveling for loose change from strangers. Our forefathers that fought and died for our freedom would be horrified by the sight.

But we don't see it. We just sign the next marker so we are allowed to play the next hand.

It is 5am at the casino and the sun is coming up. We don't want to leave and face the realization that our nest egg is gone.

We will mechanically spend the last $10 trillion in credit that any hostile foreign nation will loan to us. It is all a part of the process. In the end we won't even save 5 bucks for a $3.99 steak and egg breakfast that the casino uses to lure unsuspecting patrons.

We will only stop borrowing and betting and spending when our last source of credit runs dry.

Debt is a Drag

2010-05-26T05:49:00.000-07:00

Sometimes in my mind I like to compare engineering and economics. In my revelry I think about what engineering would be like if Isaac Newton had been indisposed looking at a feather and hadn’t noticed the apple fall from the tree. Gravity would be represented a little differently in our science text books. Buildings would tend to collapse under their own weight. Our engineering schools would need to produce more and more engineers because we would have to rebuild our bridges every 5 years instead of once every 100 years or so. The pay of engineers would be higher than almost any other profession because of the demand.

I guess Newton kind of blew it for the engineering field.

But the good news is that all of the people that would have become engineers are now becoming economists. This is because of the same scenario that I stated above. Just replace gravity with debt. Gravity to engineering is exactly the same concept as debt is to economics. But the boon to the field of economics is that the concept of debt has been eliminated from all of our economics textbooks. The only variable that is represented now is the debt payment.

So theoretically an economy can have an unlimited amount of debt if interest rates are at zero. This is such a compelling concept. When Ben Bernanke said that our government could prevent recessions it sounded almost magical. I kind of got a feeling of feathers and zero gravity. Or actually it was like a Care Bear on a cloud feeling. The economists will always be there to rescue us with limitless debt.

But my euphoria only lasted for a little while. I have a degree in economics but unfortunately I am also an accountant. So I did the math and sold my home in 2007 with the intention of renting for an extended period. I also shorted the stock market in 2008 when every single economist in our country was predicting blue sky forever. I jumped into the stock market as prices collapsed in late 2008 and now I am market neutral. I will short the stock market in the fourth quarter of 2010 and then buy in at good value sometime in 2012. I probably won’t buy a house again until at least 2013.

As the economists are making the economy more and more challenging, we are training more and more economists. Sometimes I think that it would be a good idea to pay them not to do anything. Kind of like farmers, only instead of a $20,000 crop subsidy it would be a $1 million bonus payment for not creating any more expensive, complicated and risky investment products that underperform the stock market. In the long run this would save our country a whole lot of money.

But this is not my beef with economists. I don’t buy any of the expensive, complicated and risky investment products that underperform the stock market. So that doesn’t affect me directly.

My gripe is that economists don’t think like engineers. They think of themselves as fluffy Care Bears. When we have economic prosperity they float on their cloud ignoring any kind of regulation or fiscal or monetary constraint. This would be the “kids are having fun don’t bother them” theory. They call it “free market theory”. But if our economy hits a slight rough patch then they down a quart of Red Bull and bolt from the Heavens to save us from absolute destruction with micro managed market manipulation. This theory doesn’t have a name so I just call it “Care Bears to the Rescue”.

There is no science to being a Care Bear. Especially when most of the Care Bears work in our financial sector and wear $5,000 suits and drive Porsches paid with government subsidies. This dynamic was never discussed by Adam Smith.

The economists may think of themselves as Care Bears but they react more like rats at a feeder bar. They only understand the need to press the liability lever faster to make the economy grow. The faster they push the lever the more they are paid by the government and the financial sector.

I admit that a little bit of leverage can increase a nation’s standard of living. But as an accountant I can tell you that there is a point where more indebtedness does not create more long run growth. We reached that point in the housing market in 2004. At the time I tried to explain this fact to anyone that would listen. I had charts and historical data to back up my claims. But accountants are party poopers. Everyone wanted to listen to the economists who guaranteed that housing would continue to skyrocket above affordable levels forever.

Today we have yet another bubble that is just as irrational. Instead of the homeowner ATM creating unlimited prosperity our economists are telling us that the taxpayer ATM will propel our nation back to the glory days of yore. Like The Rime of the Ancient Mariner the story remains the same. The albatross is destined to be carried around the neck of the taxpayer, forever.

We have tripled our nation’s debt load compared to GDP in the last 30 years as our government and financial sectors have become as obese as our populace. The goal is to starve our “productive” small business and manufacturing sectors with higher taxes while our “destructive” government and financial sectors get Super-Sized subsidies.

The economists’ plan is to continue borrowing from the taxpayer ATM for the next 10 years even though our government has not paid back a single dollar of the national debt for the last 30 years.

“Hey wait”, you say, “didn’t we pay back a little during the Clinton administration back in 1998 or something like that?”

Please do me this favor. Raise your hand and point to the stars. This has been the path of our debt for the last 30 years on a chart. Now where along that path that goes straight up did we pay back any of our government’s debt?

Yes, we have debased our currency and made a small portion of payments go away over the last 30 years. Yes there might have been an accounting error that allowed a tiny bit of fiscal surplus for a very short period of time. But the truth is that our government and the Care Bear Economists have not paid down our “real” debt load in 2 generations.

So let me rephrase this very important point. We weren’t able to muster the self-control to pay down a dollar of debt during the last 30 years of the best economic period in our country’s history as interest rates were falling sharply. But now we are planning on doubling our debt and then waiting to pay back the $60 trillion liability in “stated” and “unstated” debt during possibly the worst economic period in our country’s history as interest rates shoot to the moon.

This is all I know. There is absolutely no math in accounting that makes this policy decision tenable. Making extreme debt disappear with more debt can’t be quantified with numbers. Logically it is irresponsible and in my mind it appears irrational. Also, never in human history has a country been able to borrow itself out of extreme debt without having problems. Rising interest rates make this strategy virtually impossible without a penalty. The consequences could be stagflation or hyperinflation or a mild economic collapse. History tells us that the larger the debt to GDP ratio of a country then the bigger the consequences.

We currently have record setting total debt compared to GDP in our public and private sectors. Anyone that tells you differently is an economist or is getting information from an economist. They are trained to ignore the accounting balance sheet. This ignorance has allowed our nation’s economists to help the government and the financial sector balance their books by hiding tens of trillions of dollars of future liabilities. It is illegal for accountants to misstate their balance sheets but in economics it is rewarded. Economists get paid high salaries to suggest ways to hide debt so our government and our financial sector can borrow ever more money:

· Before the financial crisis our nation’s largest banks that are subsidized by taxpayer dollars were leveraged 30 to 1. An impossible number in accounting but for economists it was definitely no problem.

· The fact that our nation has not paid back a dime of it’s debt in 30 years is also not a problem. Economists are sure that more red ink will make this government lard melt away quicker than the fat from a chicken fried steak in a George Foreman Grill.

· And as for the future government deficits created by reckless spending for at least the next 10 years. Whataya kidding? There is no problem here, please move along.

Money is usurped and the bill is sent directly to the taxpayer. Rationalization is not required. And in the case of The Federal Reserve, documentation is not even required. The largess that is passed by savers to the government and the financial sector by currency debasement and artificially manipulated interest rates is all under the table, so to speak. The public sector is an economist’s dream and an accountant’s nightmare.

Sometimes I ponder the fate of Andrew Fastow, the CFO of Enron. If he was an economist, instead of sporting an orange jumpsuit he could be wearing Armani and raking in a huge salary working for some heavily subsidized quasi government organization while giving highly paid speeches espousing free markets. Who knows, he might have at least one Nobel Prize under his belt by now.

At this point, I really need to know something from our next Nobel Prize winner. Mr. Bernanke, could I actually see the chapter in the economics text book that says borrowing more money eliminates carrying an extreme amount of debt? Is it like two negatives make a positive? Are you sure that you’re not quoting Adam Sandler instead of Adam Smith? It’s a joke … right?

But alas it’s not a joke. We are in uncharted waters living in an economic fantasy world as 300 years of economic thought has been cavalierly tossed overboard. The knowledge of the financial geniuses of the past has been replaced by an Orwellian world where producers will be brutalized with high taxes in the future so speculators who make idiotic bets can be made whole today. The government is manipulating every aspect of our economy to keep our markets free. Savers are demonized and forced into the purgatory of zero interest rates as indebtedness is held up as our savior.

The Care Bear Economists keep hitting the liability lever as money pellets rain down from the financial sector and the government.

Can things get any worse? You better believe that they can. Just keep listening to the economists.

The fact of the matter is that our nation’s future economic problems will be 100% debt related. Unfortunately our economists are functionally illiterate in this area. As our nation’s debt becomes more of a drag their analysis will become even more useless.

Honestly, hasn’t their analysis been useless for the last ten years? Nobel Laureate Paul Krugman wrote an article about this fact called “How did economists get it so wrong?” But ironically he didn’t mention our country’s extreme debt load or even the idea of debt. So in essence he has it wrong also.

Bigger government and a bloated financial system make absolute sense to the Care Bear Economists. This is who pays their salaries. And in the future they will float to the taxpayer’s rescue once again with suggestions of even meatier pork for the government and ever larger bailouts for our financial sector. This will create even more jobs for the economists. The rest of us that don’t pay their salaries won’t be so lucky. Our fate will be to drag our country’s ever growing burden step by onerous step up the next interest rate mountain.

Now let us take a moment to predict the growth path of our economy. What are the chances that a future 10 years of reckless spending by our government will eliminate our nation’s extreme indebtedness? Does it make sense to strip future resources from our productive sectors and use them to increase the size of our nonproductive government and financial sectors today? But more importantly, will the weight of the burden that we are creating to increase the size of our nonproductive sectors today become a drag on the economy as interest rates rise in the future?

In my mind, the controversy between accounting reality and our nation’s present economic fantasy comes down to one simple question.

Do you believe in gravity?

Value Investing in this Dysfunctional Market

2010-05-10T07:26:00.000-07:00

I just listened to an interview by Rick Sutmeyer at the Value Engine website. I normally tend to agree with his thinking on the stock market. He says that the DOW has more of a chance of reaching 8500 before it reaches 11500. I would tend to agree with this analysis with a caveat.

Rick is presently short in the stock market and I am not. I will not hold a significant short position until at least the fourth quarter of this year. The current stock market is a freight train running down the mountain on greased rails created by unrealistic expectations and unlimited government debt. These unrealistic elements have been fermented by the extreme market manipulation by the Federal Reserve and our government. I refuse to stand in front of this rolling bomb.

But I am playing the volatility in the stock market. I sold most of my position in VXX(volatility ETF) at a tidy 30% profit for the week in this investment. I just bought a significant short position in long term bonds(TBT). Anyone that is presently long in this market has guts. I am a value investor and the only value in the stock market today is playing on the incompetence of The Herd of momentum investors. Considering our country's economic future, being long on this overpriced market is pure speculation. And given that the market manipulation of our government has created a herd of incompetent speculators then I can see short investors getting trampled.

Until the fourth quarter of 2010 I will trade the volatility of the market. If the S & P index is at least 20% overvalued by September then I will start to dollar cost average into a significant short position and then wait for the mild recession of 2011-2012. I have hopes that this will be the beginning of the change in our nation's outlook from growth created by debt, speculation and government bailouts. To a future of saving, prudent investing with less government bailouts and market manipulation.

But as always, my timing depends on the investment decisions of The Herd.

Party-nomics

2010-04-29T21:16:00.000-07:00

There are three types of economic thought: classical economics, behavioral economics and Austrian economics. Classical "Wall Street" economics has morphed into a make believe world where debt doesn't exist. The only variable that is measured is the debt payment. I have a degree in economics but unfortunately I am also an accountant, so thinking about both schools of thought gives me a headache.For my own sanity I have given up most thoughts of classical economic theory.

Once in a while I let myself think about Austrian economics where total debt is actually a variable. But this thinking is mostly just folly. The accounting balance sheet in the Austrian model does not allow for limitless debt so it presently can't be used by our government or our financial sector. If a real balance sheet was put it in place now it would be like opening the covering of a glass bottomed airplane at 45,000 feet without warning your passengers. And of course this event would be worse in our country's current condition because most of our population thinks we are on the ground and not flying high at the peak of maximum attainable debt load.

Anyway in my folly, I have heard some of the more thoughtful Austrian and behavioral economists use the idea of "bubble-nomics" to describe economic events like our recent period of excess. This would be the fiscal and monetary manipulation of an economy by a government creating a false period of prosperity followed by a real period of slower economic growth.

But I don't think that the idea of "bubble-nomics" is a true representation of our present situation. A bubble is a balloon that inflates to the point of maximum expansion. This is a very rigid and boring concept to describe a period of very extreme human behavior. Plus no matter how big the bubble gets it doesn't really burst. It just creates a hangover as the economy goes back to normal growth minus the false growth from the bubble.

It's more like a party. Our government spikes the economic punch with either fiscal or monetary manipulation and our country starts buying a lot of drinks for the house. If our citizens become really intoxicated we start to use extreme debt to keep the party going. And if the party gets really, really out of hand we bring our kids to the saloon, sit them on a stool by the bar and tell the bartender to charge the drinks to "them".

Borrowing money from children to keep an economic party going has happened only once in human history to my knowledge. But boy this has been a great party. The bartender is just now getting the tab ready for our kids to sign. Hold that thought! I think our kids still have a little credit left with China and The Middle East.

Hey maybe we could invite Iceland, Spain, Portugal, Ireland, Italy and Greece to the party? They are all in extreme debt but I don’t think that their kids have a Chinese credit card yet.

Well, it's just a thought.

But anyway, eventually someone has to sign the bar tab and we will need to get back to our lives of working and saving. The economy will get back to normal - minus the distortion caused by the bubble or the party or whatever metaphor floats your boat.

At the end of the 1920's that's what happened. We partied until we couldn't party anymore. Then the government spiked the punch and we started the party again until 1933 when we just couldn't borrow anymore. The bar tab seems to be the tipping point that shuts down the extreme party.

In 1933 total debt to GDP shot to 350%. At no time in our country's history has it been even close to that number. Well not until now. We have raced past 350% and now we mostly don't even keep track of the number anymore. All tiers of government, federal, state and local are using unfunded liabilities instead of stated debt so no one knows the exact amount of what has been borrowed. Our financial sector has learned this trick also.

How much debt does our country hold? No one really knows and nobody really cares. In Wall Street economics debt doesn't exist so it never needs to be paid back. But as an accountant I have been trained to assume that debt does need to be paid back by someone, at sometime in the future. I am sure that Japan, China and The Middle East would agree with me on this point.

Anyway, since we have been allowed to bring our children to the bar and charge their Chinese credit card to party we might be able to create more debt than was humanly possible before. Of course no one knows the number but let's say that "real" debt to GDP is 450%. Once we hit the debt wall in the next few years like we did in 1933 then GDP could go down 20% thus spiking the debt to GDP ratio to 563%.

It's really a shame that our government and our financial sector are using hidden accounting tricks to state their debt ratios. If they were required to use real accounting standards then we could have an all time record. Over 500% of debt to GDP! No one has done that before – Yee Haw!

Hey has anyone thought of asking North Korea to give us a hard money loan?

Just kidding.

It's not wise to take money from countries that don't like us. Maybe we should just stick with borrowing large amounts of money from China and The Middle East.

Once we are through partying and "our friends" decide not to lend us any more money then our kids will set up high interest payments to all of “their” creditors.

The bar tab will shut down the party. Everyone will have to go home.

Then and only then will our country go back to a normal life. Back to just worrying about working and saving.

And of course paying off the massive debt from the past 15 years.

Calling the last 15 years a "bubble" does not do it justice.

The biggest party the world has ever known will be over.

Let the hangover begin.

The Corrosive Nature of Debt

2010-04-21T10:25:00.000-07:00

Let's assume that our government, federal, state and local has an income of $5 trillion. This is equal to a third of our federal Gross Domestic Product. While their income is $5 trillion they have outstanding liabilities of maybe $100 trillion in stated and unstated debt. So our government is leveraged 20-1 above their income level. This is a government created liability that is directly owed by the taxpayers of our nation.

This includes the stated debt of federal, state and local entities of perhaps $20 trillion and their unstated promises of maybe $80 trillion. If you don't agree with the numbers then what are they? This is my point. No one knows and no one seems to care.

But we know that our government holds an extreme amount of debt and is desperate to borrow much much more. So as our government borrows more money to increase the debt to taxpayers, what is the expectation?

Common sense tells us that there are 3 and only 3 outcomes that can happen when an entity borrows money:

You can borrow money with the expectation of paying off interest and principle in the future. This debt would be used to amplify investment gains with the expectation that principle and interest will be paid back in the future with investment gains. This is called "speculation". An investor is making a bet on the future. It is a win or lose proposition.

You can borrow money with the expectation of only paying interest in the future. This is immediate gratification. Mortgaging your future to live better in the present is "debt servitude". Historically, "debt servitude" has been used by the more financially incompetent members of a society.

You can borrow money with the expectation of never paying the principle or interest off in the future. The is called "fraud". It is robbing present resources from others to pay for your excesses in the present.

So there are only 3 expectations when someone borrows money: Speculation, Debt Servitude or Fraud. You can either plan on paying all of the money back, or just the interest or nothing.

The type of debt depends on one's motive. Every society has many examples of each type of debt.

The first type of debt is speculation. Most people borrow money to make a single bet. And they have high hopes that this bet will be a winner. Our government has made bets in the past. They borrowed money to pay for World War II, the interstate highway system and putting a man on the moon. These investments have been winners. The speculation by our government was a good bet.

The second type of debt is normally created from the first type of debt. A speculator will win some bets and then they become comfortable speculating with future resources. This is called , "gaming the system". This gambling will become a habit. Then instead of the risk being one roll of the dice, it becomes a continuous recurring daily event that actually becomes a risk payment instead of a bet. This is "debt servitude". It's more of a drug than a bet. One individual is choosing to rob resources from their immediate future to give all of their future gains to another. It doesn't really make economic sense for anyone to live this way. It is just the immediate gratification from the drug of debt.

Unless you are a criminal, the third and last level of debt morphs out of the second level. As you game the system more and more then the drug of debt becomes a compulsion. Your risk payments will increase to the point were you can't make your interest payment out of current income. You choose to start paying the interest payment with more debt. This level is unsustainable. Our government and most of our households with a mortgage are at this level. The drug of debt has created a nation of junkies and dealers with our government being the biggest junkie of them all.

A whole science has emerged to explain how insurmountable debt is a good thing for our nation. Economists tell us that debt is presently no problem because we can make it go away with "magic inflation". So they are saying that we can get ourselves into "debt servitude" as long as at a later date we are able to make it go away with "fraud". The Economists also explain to the government how hiding debt off their balance sheet is a good idea and allows them to borrow more to buy more of the debt drug. So no one has any idea of how large the debt is.

We are misstating our debt so no one knows how much we hold. We are presently in a situation where we need to borrow money just to pay the interest on the loan so our nation has started a Ponzi scheme. And the game plan of our politicians is to keep the deceit going until we can create the "magic inflation" that will bring our nation back to the old "debt servitude" from our present period of "fraud". So we will use fraud to extricate ourselves from fraud. We are thinking just like a junkie.

It is beyond all reason, logic and math but in our country's drug induced state it makes all the sense in the world.

But I can tell you for a fact that "junkie economics" will not work. It has never worked in the thousands of times political tyrants have tried it in the past and it won't work now. First our country will hit the debt wall where the market will force us to slow down our creation of debt. This will collapse asset prices. Then interest rates will rise and collapse asset prices even more. Then we will have the magic inflation that will inflate us out of debt but it will only inflate our asset prices up to the values they were before. We are thinking exactly like a junkie. Avoiding pain now for a higher level in the future.

"Junkie economics" doesn't work for political tyrants any more than it works on the street.

Our plight compares perfectly with that of a junkie. We are now giving away trillions of dollars to the debt dealers in our financial sector for just another hit of the debt crack pipe. The money has been stolen as happens with all hard core junkies. Our nation is stealing money from our kids.

We are creating untenable debt in our children's name to be paid back at very high interest rates to hostile foreign nations. I am not even sure that a homeless crack smoking wino on the street in Washington DC would do something like this to his children.

But each day our government officials must create more of this unsustainable third level of debt so our nation can get one more hit of speculation from it's drug of choice. It is unconscionable and illogical but it happens thousands of times a day on the streets of every major city. But like I said before, I believe very few junkies would make the choice to sell their children's future into debt servitude to their enemies. As a country we have found ourselves at a lower level of morality than the junkie on the street.

How do we get out of this mess? Well I would suggest that the first step would be to look in the mirror and see the mess we are in. How does a government borrow 20 times their yearly income? And then lie and say that some of it doesn't exist. How can we say that the obligation of Social Security, or Medicare or the Pension Guarantee Corporation or a thousand other state and local obligations doesn't exist? Why would a government do such a thing?

It's time to look in the mirror and to make some hard choices. We have lived the last 20 years on debt and it could take 40 years of onerous payments to get back to the same standard of living that we had in the 1980's. This would be the choice to end the debt servitude.

Now try to focus and think about what it was like to live 30 years ago. Only one member of the household had to work. Health care and housing were very affordable. Our financial sector was much smaller and our education system was top notch. We had a solid middle class. Our currency was sound and our nation was strong. Our country had one third of the debt load that we currently carry and we were able to record it honestly. Our government and our financial sector didn't have to use Enron style accounting to misstate their debt. We absolutely had a higher standard of living because we weren't in "debt servitude".

But we have borrowed and borrowed and then borrowed some more to speculate as the bets have become more and more absurd. Then 20 years ago we started to borrow larger amounts of money to service the debt. We have borrowed so much that we must lie to ourselves about our debt load. We can't even look ourselves in the mirror anymore. Today our government, our financial sector and our households with a mortgage must commit "fraud" just to service the debt. Mathematics tells us that this will get worse as interest rates go higher.

Anyone that says we are better off today than 30 years ago must be a junkie or a Wall Street economist. And here I must apologise to the junkie for the comparison.

Even if we choose to live forever in our present debt servitude then we will still have to slow down debt creation from present levels. This will lock all future generations into a lower standard of living than we have now. That standard of living will get lower and lower as interest rates rise. It's simple accounting math and basic logic but it is far beyond what the economists at the Federal Reserve can possibly understand in their drug induced state.

So we are still at a juncture where we can choose a sustainable path. Hard work could make our country strong again. But what are the odds that a drug crazed junkie could do anything but beg for their next fix.

Our country will find out that debt addiction is exactly like drug addiction. It brings forth insurmountable choices, each with very bad outcomes. Our choices will probably be made for us as hostile foreign nations put us farther and farther into debt servitude.

Presently we are selling our children into debt servitude to China and The Middle East for more of the debt drug. The funny part is that this debt servitude will be just the start as we continue to sell off all of the priceless gifts that were given to us by our forefathers. Sound currency, sound government and finally our basic freedom. All of these cherished heirlooms lost for one more hit on the crack pipe of debt.

Blind Faith and Insidious Debt

2010-04-15T07:00:00.000-07:00

Blind faith is a blessing in one's religious life but it can be a curse when money becomes a variable. There is nothing more wonderful than having a direct connection to your Creator. But there is nothing more devilish than someone putting a roadblock between a spiritual traveler and paradise and then charging a fee at the gateway to the promised land. If there is a purgatory then it should be filled with people using the idea of Hell to make large amounts of money as the gatekeeper to Heaven.

Presently our elected officials are the gatekeepers to our Financial Heaven. They are spitting fire and brimstone as they tell us that if we don't borrow money and give it to the government and Wall Street then we are risking financial Armageddon.

Metaphorically speaking, savings is the road to the financial promised land. In a rational world a benign government would reward savers. This would help individual households grow and make our country strong. At the very least a government should stay out of the financial system.

But in our present irrational world our elected officials are using extreme measures to keep our citizens in horrendous debt. Currently our households are desperately trying to pay off the debt that the government has spend trillions of dollars to subsidize. Over the last two years our households have been able to pay off a few hundred billion dollars of debt as our government is creating trillions of dollars of debt to hostile foreign nations that households will be required to pay off at high interest rates in the future.

So as a country we have experienced two years of financial pain. This pain was fruitless because we have increased the amount of total debt that households will be required to pay in the future.

This corrosive debt cycle is getting more and more irrational every day. So why does no one care? Because we have blind faith that our elected officials will get us out of this mess that they are almost solely responsible for getting us into in the first place. Our nation has become totally disconnected from financial reality.

We have many recent examples of this disconnect. The Tech Bubble, the Credit Crisis and the Housing Bubble were directly propagated by our government. The financial collapse of Iceland, the collapse of the Japanese financial bubble and the contraction of the PIIGS(Portugal, Ireland, Italy, Greece and Spain) are examples of how corrosive debt can destroy an economy. We are ignoring all of these recent episodes as our government is desperately trying to recreate them.

How are most people dealing with our current period of insanity? They are creating another financial bubble. Stocks have become overvalued. Housing in some markets is going back into a bubble. Long term bonds are in a bubble. This is happening as our economy is contracting as households are desperately trying to eliminate debt.

How am I dealing with our current situation. I sold my primary residence in 2007 and rented a house in Lafayette. I started shorting the peak of the stock market in 2007. When the government started to make more irrational decisions, I moved to a house with half the rent payment in Walnut Creek. I jumped into the stock market as everyone was selling in March of 2009 and presently I am market neutral as stock investors apparently see blue sky forever.

I carry no debt and I am saving 50% of my household income. If the stock market keeps going up I will consider shorting the market in the fourth quarter of 2010. I will not buy a house until the next recession, probably 2012. Or maybe I will never buy a house if our government is successful in keeping our households in their current insidious debt ridden state.

Whether it is credit card debt and mortgage debt or government debt and higher taxes is not of consequence. It is all debt that will have to be paid back in the future by our households. Families like yours and mine. Anybody that tells you something different is lying to you, plain and simple. I don't care if it's a Nobel Prize winning economist that's paid by Wall Street or your financial advisor that is sucking you dry as your accounts go lower and lower.

I might add that both of these people have missed predicting every single major economic shift of the past ten years. But they are excellent at cheerleading you to borrow more money and speculate during bubbles.

Most people say that I'm crazy. I have become very used to it. I have developed a tough skin trying to talk people out of buying stocks during the Tech Bubble, houses during the Housing Bubble and getting into debt during this Debt Crisis.

Some would say that I am now acting irrationally and I really can't disagree.

But I would like to suggest that in an insane world it might be prudent for the rational man to act irrationally.

I would also like to suggest that our government and the Wall Street economists don't deserve the blind faith that should be saved for your connection to the Creator.

There is only one Savior and it is definitely not our government or Wall Street.

Good luck with your investing, your saving and your worshiping.

Bubble 3.0

2010-04-11T07:55:00.000-07:00

I see more and more indications that we are into our third bubble in the past 12 years. I will call this new economic event: "Bubble 3.0" until someone thinks of a more appropriate name. It will be named once we figure out what sector of the economy overheats. In 1998 the first bubble was called the Tech Bubble. In 2004 the second bubble was called the Housing Bubble. Maybe this third bubble will be called the Bond Bubble. But of course we won't know until the recession of 2012 rears it's ugly head.

Our nation's current economic environment is somewhat unprecedented. There are only two comparisons to what we are going though now. But neither is an exact match.

The first comparison would be with Japan of the 1990's. I will call this the Economic Model.

In the 1980's Japan's private sector borrowed much more money than it could pay back as it inflated real estate and stock prices. Presently Japan's private sector is desperately saving money as their government is desperately borrowing money. Total debt for the country is increasing because the government is a lot more efficient at borrowing money than the private sector is at saving.

The Wall Street economists that didn't see a problem with Japan's private sector debt in the 1980's, presently don't see a problem with the massive debt that the Japanese government is creating now. These same economists are emphatically saying that we must use the same Japanese style solution in our economy. But of course we are Americans. We have to do it bigger and better.

The second comparison to what we are going through now is the Accounting Model. This was the method suggested by the bankers at the outset of the Great Depression. This method involved the private sector repairing their balance sheets through debt destruction instead of the government taking over the debt. Our country incurred a lot more pain but we came out of the 10 year World Depression in 1940 as the strongest country that has ever existed. That's why I have such an affinity towards the Great Depression.

I kind of like the idea of going through a little hardship and having a reward at the end.

Anyway, there is no need to worry about that. We are a nation of financial weaklings and have chosen the Economic Method to solve our debt problem. So we are in uncharted waters. The only example that we have is Japan and that scenario hasn't played out yet.

How the decision was made to use the Japanese Economic Model instead of the Accounting Model is interesting.

This actually happened one night when Ben Bernanke went to sleep thinking that our economy was in fantastic shape. He must have had a nightmare because the next morning he woke up as a maniac, running around yelling that the sky was falling and that the only way to prevent the end of the world was to funnel as much money as humanly possible to our financial sector so that they don't have deal with their bad decisions of the previous few years.

Investors currently think that Bernanke and the Federal Reserve will keep borrowing money from China and The Middle East in the taxpayer's name and flooding it into the financial sector for "an extended period", or basically forever.

So investors have extrapolated that for the next period of "forever" our government will put taxpayer's into indentured servitude to hostile foreign nations and give the money borrowed to the financial sector. Presently the financial sector is so bloated with cash that they don't know what to do with it all. This money along with the hope that we are different than Japan is driving our current bubble.

Our government has showered money on the financial sector hoping that our insolvent banks will lend money to our insolvent households. There are two big problems with this plan and both of them involve insolvency. Japan could be the perfect example of what not to do. They tried to use debt to get themselves out of insolvency for 15 years. They are still dealing with the original problem of insolvency, or to much total debt.

We have cemented the Japanese chain of economic events into our future. So far our government is borrowing $5 for every $1 that is paid off in the private sector so we can plan on a faster outcome than Japan. We might even get "there" before Japan does. Where ever "there" is.

The only events in the future that we can predict with accuracy is that within 3 years Ben Bernanke will get a Nobel Prize for using extreme measures to save the economy. And then 3 years after receiving these accolades he will start being demonized in the same way that Alan Greenspan is being demonized now for keeping the Fed Funds rate to low for to long.

So in essense all we know that our nation has a very, very short attention span as we are attempting to borrow our way out of to much borrowing.

So what is an investor to do?

I have thought about this moment a lot since Bernanke's nightmare. How do you invest when the Federal Reserve and the government are pouring massive amounts of money into the economy and creating an investment market full of drunken speculators? Is it wise to take risk and ride the bubble close to it's peak and then sell off? I told myself at the time that a ride on the bubble sounded like a good plan.

But now that it is happening I am a little nervous. I have rode the stock market up to overvaluation but presently I am totally out of the market. I have learned something about myself. I just don't have the guts to be a speculator.

I have made the decision to watch from the sidelines.

Sometimes I have delusions of grandeur and fantasize about placing a large short position at the peak of Bubble 3.0 just like I did with the stock market in 2008. But of course this is just folly. There are an elite few that have the intestinal fortitude to make money shorting a monumentally dysfunctional investment market like today. This market will create a lot of collateral damage. Shorts are already getting brutalized and it could get much, much worse. This could be the first market in history that has capitulation at a price peak instead of a price bottom.

For now my money will stay under the mattress, so to speak. I will buy as I always do, at good value. Probably in the declining market of 2012.

Today is not even a market for George Soros. He plays the odds. This will be a onetime bet for future Joe Kennedy's and John Paulson's that could potentially create investment dynasties. Or lose everything trying.

Presently any gain in this market from here to the peak is not worth the risk. From this point forward we will see a gun battle between the shorts and the longs. It will be like a winner take all, wild west shoot out on the muddy streets of Dawson during the gold rush of 1898. A pull of the trigger will determine who's standin' and who's lyin'.

All I can say is Yee Haw!

The Cookie Jar

2010-04-03T08:38:00.000-07:00

I think of our founding fathers like grandparents. They thought long and hard about the children of the future and created a framework of sound government and sound currency. Rules and laws to pass on to future generations. This is our country's legacy. I think of it like a cookie jar. A simple savings repository placed high on the early log cabin kitchen shelf that holds the family nest egg, important deeds and documents destined to be passed from generation to generation.

A cookie jar is a little different than a piggy bank. A piggy bank is savings passed directly to a child. A cookie jar represents a longer time line such as wealth and ideals passed from a grandparent to a grandchild. It's more of a legacy than a simple savings account.

A piggy bank can be seen as something with just an immediate dollar value. Money that will be spent when a child reaches adulthood. A cookie jar becomes more valuable with each generation until it ends up holding the morals, principles, ethics and values of a family, or in this case a country. It will also hold all of the country's accumulated wealth.

Anyway since the time of our founding fathers each generation has added something to this national cookie jar. Some generations have added wealth and some have added a framework of ideals and principles that would make our country stronger.

Andrew Jackson added a sound currency.
Abraham Lincoln added the concept of a united nation.
Teddy Roosevelt added laws to protect us from big corporations. He also set aside land for our national parks.
Franklin Delano Roosevelt added more laws to protect us from the financial elite and the big banking interests.
Lyndon Johnson added laws to protect the under represented.

By the 1970's our country's cookie jar was full of a nest egg with enough value to last for 200 years. We had a vast store of wealth and ideals. People owed their homes. People saved money. Many had pensions and fairly priced medical plans. Most household's only needed one member of the family to go to work while the other member could stay at home and raise the children. We had a solid middle class. Our currency was more sound than any in history. Our government was strong and protected us from the tyrannical wealth and power that can be created in an unchecked capitalistic society.

This in my opinion is the biggest problem with capitalism and I think our founding fathers knew this. Unchecked wealth and power are the biggest threat to any capitalistic nation.

So in the 1970's we had an almost perfect middle class society. But that wasn't good enough.

Wall Street suggested to our government that we could have a higher standard of living if we borrow a little from the cookie jar. They said that it would get paid back with interest and everyone would be better off.

I would call this robbing from our children's legacy but at the time they called it "trickle down economics". The Wall Street economists were certain that giving money to the rich will let some trickle down to the poor.

But in essence it took away most of the checks and balances to protect our people from tyrannical wealth and power. We lost many of our principles that had been placed in the cookie jar over the past 200 years.

I would like to compare this pivotal moment in history with actor Mickey Rooney's parents robbing all of his wealth from being a child actor. The first dollar that is stolen from a child's piggy bank is the hardest. I can picture it in my mind. A parent with a coat hanger fishing for pennies and nickles that will be stolen from his child. The mechanics of the theft is easy. The difficult part is rationalizing the behavior. The first dollar is the hardest to procure because of this guilt and progressively it becomes easier and easier until it becomes a parent's right to take the money.

The 1970's was our watershed moment. "Trickle down" was the first dollar that was stolen. Our country was able to rationalize the behavior. But this money was not just taken by a father from a child's piggy bank. This was the theft of a legacy handed down from all of our previous generations.

The theft of our children's piggy bank would have been a outrage. But the ruination of our children's cookie jar with the loss of all of the financial principles and values and wealth created with great sacrifice by the past 30 generations is an abomination.

We built this nation as savers but now we are debt fueled consumers. Our grandparents were individualists and mistrusted a government that is to large. Today our government is seen as our savior as it borrows more and more money and grows bigger and bigger controlling more and more of everything. There is far more debt than could ever be paid off but the Wall Street economists insist that we can debase our currency and magically make the debt go away.

So sound currency is gone, sound government is gone, all of the wealth has been spent and we are now placing our children into debt servitude to China, The Middle East and Japan.

Progressively we have robbed the cookie jar of all of wealth that was lovingly left for posterity. The wealth is gone and we are now doing what Mickey Rooney's parents were not even capable of accomplishing. We are borrowing money in our children's name and leaving IOU's in the cookie jar.

This behavior is easily seen on a graph. In the 1970's our country's debt to GDP ratio exploded like a bomb. For the last 30 years it has been on a space shuttle trajectory toward the moon. We have rationalized the theft and see it as our right to borrow every last dollar possible to maintain the false prosperity created by the original theft of our children's legacy. We are throwing around trillions of dollars like it's pocket change. The amounts don't matter anymore. It has no value to us because we never had to work for it, and we will never have to pay any of it back. It has become debt owed by our children.

So now thirty years later the cookie jar money is gone and our federal, state and local governments have at least $15 trillion in IOU's to the cookie jar and perhaps $100 trillion in obligations that they haven't even bothered to put IOU's into the cookie jar.

To put it in perspective. We have not paid off any of our country's debt for the last 30 years. None. A Wall Street economist might argue that a few billion dollars was paid back during the Clinton administration but they are wrong as always. We may have paid off a tiny portion of the stated debt but the unfunded liabilities that the government is not putting IOU's in the cookie jar far outweighs a paltry few billion. We have created $115 trillion in liabilities by federal, state and local governments and never paid a dime on the principle as it keeps getting bigger and bigger and bigger.

Here is the bottom line. We have been through absolutely the most prosperous time in human history. And during this unprecedented economic boom we could not pay off a dollar of the national debt.

The next ten years will be one of the most stagnant economic periods since the Great Depression. We couldn't pay off a dime of our debt during the biggest boom in human history but now we are expecting our children to to pay off $115 trillion dollars in a stagnating contracting economy.

And don't forget payments on this debt will at least triple due to spiking interest rates when this debt bomb goes off.

I can understand how our generation was able to rationalize the theft of the first dollar and how it has continued to the point where we feel we must take everything. Bernie Madoff started off as a honest guy but he took a dollar, then two, then, well you know how it ended. It's human nature. If you are in a position of trust, once you rationalize taking a penny you are pretty much bound to take it all. It has happened thousands and thousands of times in human history with people a lot more honest than our elected officials.

But what I don't understand is how our society has created a whole science to explain how the theft is a good thing. Almost every economist today is 100% certain that our country must borrow ever more money to stimulate ourselves out of this insolvency we have created. There is no math that can justify it and no logic that can explain it but everyone is positive that we must use the Japanese model to solve our problems.

I guarantee once Japan hits the debt wall and its economy collapses our economists will still be sure that debt will drive a country out of insolvency. Our economists don't use real math or logic. They would never think of back testing or comparing data. Their formula's are basically just a form of rationalization to create a planned outcome. And that outcome is the theft of our country's cookie jar.

Remember these are the same economic knuckleheads that didn't see the Tech Bubble, didn't see the Housing Bubble, didn't see the Credit Crisis and don't see a recession coming in 2011-2012. Their science is to simple minded to understand an accounting balance sheet and they can't comprehend the biggest economic event of the 20th century. This would be the collapsing of the interest rate mega bubble.

I would also like to add that these "economists" are the same people that are just now demonizing Alan Greenspan for pegging the Fed Funds rate 325% below the ten year treasury for a year and a half. This is happening while they are cavalierly forcing the Fed Funds rate over 2500% below the 10 year treasury rate for an "extended period" or basically "forever". Eight times as low for maybe ten times as long.

So it could create 80 times more distortion in our economy than Greenspan's faux pas.

Unfortunately, classical economic theory doesn't have a balance sheet. So debt doesn't really exist in Wall Street economic theory. All of the Nobel Prizes that were given to this group can't change the fact that debt has to be paid back by someone, someday.

Presently our government is insolvent. Our banks are insolvent. Homeowners that have a mortgage are insolvent. Over half of our households are living paycheck to paycheck as they pay far to much for education, health care and financial products because of inefficient and manipulated markets. For the past 15 years asset prices have spent most of their time in a bubble as the government is debasing our currency, manipulating interest rates, while borrowing vast amounts of money from the cookie jar and funneling a significant portion of it to Wall Street. Most of the time our government doesn't even put IOU's in the jar anymore.

Much of these unfunded promises will turn into high interest rate debt for our children to pay in the future.

Instead of one parent working, two must work. Families are so strapped for cash that they are not able to save. So most will not be able to retire.

In a generation we have spent the wealth created by our ancestors. We then decided to borrow more money than we can possibly pay back. We are so broke that the only people that will lend us money now are hostile foreign nations. We don't save and need twice the amount of people working to support a household while our children live at daycare. While our children live at daycare we can't afford to properly educate them. The education system in our country has become second rate.

But the biggest problem is that we are losing the "middle class" as our rich elite are taking more and more of our nation's resources.

So what are we doing.

Our markets are climbing to overvaluation once again as everyone in our nation is looking to the government, Wall Street and the big banks to come to our rescue.

All of the Wall Street economists are adamant that "Trickle down" will be our savior if we can just jam a few more IOU's into our children's cookie jar.

For me, I will never be able to understand political economics. Like I have said before, "I am absolutely 100% politically incompetent."

Why do we hate efficient markets?

2010-03-26T06:29:00.000-07:00

I am an economist and an accountant and I love thinking about efficient markets. I also hate thinking about politics. I know very little about politics because I purposely avoid talking about politics and I try to avoid reading about the subject. My wife tells me who to vote for most of the time. Normally it is a woman or a minority candidate or a democrat or a green party candidate. I know she would never vote for a white male republican if there was a decent alternative. I don't really care and it makes my wife happy when I vote for the same candidate as she does.

Most people would probably consider me politically incompetent and I would tend to agree with them.

It appears that everyone else in our country is the opposite of me. Most of our citizens hate efficient markets and love politics. People are constantly talking about what elected officials are doing and saying. It is all over the media. The media would never have a story about efficient markets. No one wants to hear about stuff like that.

Everyone wants our politicians to lower taxes and raise government services.

I would actually like to pay higher taxes and receive less government services. I would pay much higher taxes to get the government out of the investment markets. Of course you would not understand. Everyone in our society is attached to the golden government teet either directly or indirectly.

How can everyone benefit at the same time? Because we are robbing resources from future generations. In the past two generations we have created $15 trillion of government debt and the possibility of $100 trillion in unfunded liabilities that will have to be dealt with by our children. This was caused by the federal, state and local governments wildly overspending and then kicking the can down the road. Your life is much easier because of it but there is a cost. The cost is inefficient investment markets and a lower standard of living in the future for our children.

It is strange that in three generations our citizens have gone from a populace of 3 dimensional financial thinkers working toward a "middle class" society, to the present rabble of linear thinking automatons that are only capable of following the advice of highly paid Wall Street salespeople and depending on the government for handouts. I am not talking about transfer payments to the unfortunate. I am talking about the government spending trillions of dollars of direct involvement in manipulating the financial markets. The only benefit of this mammoth spending program is to make our financial sector bigger and less efficient.

Wall Street and the big banks are taking a larger and larger portion of investment profits as they cause more and more problems in our economy. Our grandparents understood that the financial sector is not a productive segment of our society. It is a simple service to hold money and transfer it from one location to another. In theory the financial sector should be a very small part of the GDP of a country. They should produce nothing. If the financial sector of a country gets to large it becomes a drag on the economy. Presently our financial sector is robbing a large portion of productive capacity that could be used for something else, perhaps education or health care.

But of course we are financially incompetent and need to have our hands held as we are being sold very complex, expensive and risky products that will under perform the stock market. We are happy to pay these salespeople five times the salary of a doctor. They make buying a stock or a home much, much more expensive than it would cost in an efficient market. I have stated before that if you use a money manager to buy mutual funds then your profit could be close to half of the earnings a stock investor would receive over the next 10 years.

But salespeople slap us on the back and call us "partner" and "buddy". They explain to us that this is the best time to buy a home or an annuity in the last 30 years. They warn us: "you can't miss out on this deal, someone else will steal it!" They push us into borrowing lots of money. Maybe they deserve to siphon off 30% of our country's national income. Who am I to say. All I know is that it is not efficient.

Anyway our government puts the backslapping salespeople to shame. The financial salespeople are only croupier's in the investment casino. The government is the casino owner.

The government is borrowing ten's of trillions of dollars from hostile foreign nations and funneling most of it into the financial sector. These are the profits from the casino and the taxpayer is paying the bill. Taxpayers are placing a high priced bet that they have no chance of winning. Unless they are a financial salesperson. The financial salespeople have been deemed the only important gamblers in the casino. As the financial sector is sucking 20% more from the economy than in an efficient market the financial sector is being bailed out by the taxpayers. Inefficiency piled on top of inefficiency. And our financially incompetent populace doesn't have a clue because they are listening to the politicians and the salespeople.

The trillions being borrowed by the government is not a redistribution of wealth. I would not have a problem with that. This is a casino game with arbitrary winners and losers chosen by our government.

Presently the winners are: the "too big to fail" banks", Wall Street and speculators.

The losers are: the smaller banks, small businesses, prudent investors, savers and definitely our children.

Large banks are so flush with cash thanks to a tsunami of government bailouts that they have gone on a spending spree. Not only are executives getting large bonuses but all bank employees are getting record pay raises. In a normal world all of this government money that is pouring into the banks would be used to repair their insolvent balance sheets. But our government is allowing the banks to misstate their balance sheets, Enron style. They are the government's best friend and will be rewarded for an "extended period".

Wall Street is raking in massive profits. This makes sense because the Wall Street economists are advising the government on where to spend the money robbed from our children's piggy bank. It's not surprising that the big Wall Street firms that were "to big to fail" are growing much bigger every day. Taking more and more of the resources of our economy. Very inefficient but of course very consistent. Everyone expects the government and Wall Street to magically get us out of the massive debt that our government and Wall Street talked our households into borrowing in the first place.

The government has been able to create another bubble. As stocks and housing go back into overvaluation, incompetent investor's are pouring money back into the overpriced markets thanks to government manipulation and government subsidies. Presently assets are being purchased at above fair value. Speculators are able to sell now and make record profits. But the people that are buying these assets will be holding an overvalued asset. The returns going forward must be lower. The speculators have made a huge windfall as anyone who intends to buy and hold the asset long term will get below average historical gains. It is another inefficiency piled upon our bloated financial system and the fixed government casino.

The fact that our government is choosing arbitrary winners and losers in a casino environment seems unethical to me. Shouldn't it be based more on need than favoritism? But I am politically incompetent so I am a bad person to judge this situation. All I know is that it will create dysfunctional markets in the future. I also know that our nation has never experienced this abject favoritism before. One could argue that this casino environment happened during the Great Depression but I would suggest that government's involvement then was a redistribution of wealth more than a casino game. I am sure that all Wall Street economists would disagree with me. This of course is a big part of the problem today. The Wall Street economists running the country are nothing more than salespeople. They are linear thinkers that are unable to see anything but the casino profits that are driving their salaries.

Presently our economy is contracting so I feel buying overpriced assets now is speculation. It may be hard to tell because the government has created another bubble. As for me, I will wait until our economy stops contracting before considering the purchase of an overpriced asset. For now I choose to back away from the table and let the drunken Herd mortgage their future with hopes of being a winner in the government run casino.

What our country is doing now is very inefficient. Spending trillions of dollars to create bubbles for speculators and then spending trillions to bail out the speculators so they don't lose any money. All of this while a significant number of our citizens are living paycheck to paycheck and are grossly overpaying for housing, financial products, education and medical expenses because of inefficient and in many cases manipulated markets.

It might make sense politically but it sure doesn't make sense from an efficient markets standpoint.

How would I solve the problem. Higher taxes and balanced budgets. This has been the solution for the past 4,000 years of organized government. In the ones that survived that is.

The fact is that our financially illiterate populace is attempting to do something that has never been suggested by any of the financial geniuses of the past is very disturbing to me. Our country has borrowed itself to the point of insolvency and now we are attempting to borrow our way out of insolvency. It makes no sense in any way shape or form except in political economics. Unfortunately this is something that I just don't understand.

The government is running a casino style economy for it's financially incompetent citizens with borrowed money and manipulated markets where the taxpayer can't win and Wall Street can't loose.

Although I know almost nothing about politics, I think Franklin, Jefferson and Hamilton would would agree with me. What do you think?

I'm done, it's official - Market Neutral

2010-03-17T07:54:00.000-07:00

Since 2008 I have followed the stock market very closely. My goal has been to buy into a large portfolio of fairly valued large cap stocks with the intention of holding them forever. I am very happy with my choices:

DELL, KFT,MDT, MSFT, SCHW, SWY, SYY, BAC, DIS, CI, CSCO, FDX, GOOG, INTC, JNJ, LOW, MMM, MRK, MT, PFE, RSH, SLB, TGT, UNH, WLP, WMT, X, YHOO.

All of them are large cap market leaders with minimal amounts of debt.

From 2005 until 2008 I was mostly in short term fixed income investments, so the last recession was a wonderful opportunity to buy into good companies at a fair price.

My goal has always been to trend with the S & P index. So now as the market has gone over fair value I have been buying generic hedges on my solid portfolio of stocks. FAZ and SKF protect my large holding in Bank of America and SPXU protects everything else. These are my main hedges which are presently protecting 60% of my stock portfolio. As the market has been going above fair I have been purchasing hedges. I feel that the fair value of the S & P index is around 1000 to 1050.

The last part of my "sleep at night" portfolio are my volatility bets. These also serve as hedges and round out the 100% protection of my portfolio. I am using: UNG, FXP and VXX. I am also planning on moving in and out of treasury bonds with TLT and TBT as interest rates swing wildly over the next few years.

Now that we are solidly into our next economic bubble my goal is to spend less time following the markets. I want to back away from the table and let the drunken Herd of investors move this market to whatever extreme their easy money intoxicated state allows.

As always, I am out of the market far too soon but this is always preferable to the alternative.

I can't start moving to a market long position until we are solidly into our next recession. But I will trade the volatility in the markets over the next year or two. I will try to eek out some gains as The Herd runs wildly back and forth in what could be one of our country's most dysfunctional stock market periods.

The S & P will probably go to 1250 or above as the government pumps trillions into our economy. Mathematically it's not sustainable but psychologically investors see nothing but green shoots and blue sky forever in the future. This is what makes me nervous.

So I will miss out on the last bit of this rally and watch from the sidelines.

This is just part of my financial strategy. I sold my house in 2007 and moved to a comparable rental property to save 50% on house expense. Then in 2009 I made the decision to cut my housing costs another 50% and moved to a very nice townhouse. So we are paying 1/4 of what we would be paying to own a house in Lafayette and giving up very little.

So for the next few years I will be able to save 50% of our household income. I feel this will be more than enough to make up for any loss of bubble profits in the stock market over the next year.

I would also like to say that as I am paying 1/4 the price of owning a home in Lafayette, comparable house prices in Lafayette will be trending downward. As I have stated before I will not buy a home above 2001 prices. How can anyone justify paying bubble prices in Lafayette when many other areas are hitting 2001 prices and below. This is happening while rent prices are trending downward. It may not feel like it because of the bubble but we are in a contracting economy. Paying over fair market value for assets in a contracting economy is a fools game.

My plan is to play it safe during what will be one of the most challenging economic periods in the last 100 years. I have no idea what will happen in the next year of two. But I know that now is the time to play it safe.

In 5 years our country's savings rate will increase, taxes will increase and market volatility will increase. Asset prices will come to equilibrium fair value after falling below fair value in the next recession.

Our country's standard of living must decrease proportionately as we work our way though this bubble and then through the third and hopefully last recession for a while.

We have lived though a magical period where money fell from the trees with the collapsing of the interest rate mega bubble, unprecedented debt creation and massive fiscal and monetary programs from our government.

This magical period is absolutely impossible to recreate no matter how many trillions are borrowed from our children. Our country's standard of living must decrease.

There is only one temporary alternative and I pray that our elected officials aren't allowed go down that road to perdition. Hopefully our children will be old enough by that time to stop the sale of our country to hostile foreign nations.

Snap Trading

2010-03-10T08:31:00.000-08:00

Congratulations are in order. Our government has managed to create another economic bubble. The Fed Funds rate has been at zero for close to a year and a half. Our elected officials are pumping over one and a half trillion dollars in to the economy this year with the expectation of continued largess carrying over for many years. Also, we are engaged in at least two wars not counting the war on terror, the war on drugs and the war on fair home prices.

Debt, unsound fiscal policy and war have a very stimulating effect on the economy but they can't last forever. Especially with our government presently insolvent with over $10 trillion in stated debt and an albatross of $60 trillion in unstated Enron style off balance sheet promises.

Mathematically, this false economy must end eventually. But strangely many see a bright future ahead for our nation. Investors have priced many sectors of our housing stock, commodities and our stock market to overvaluation yet again. Hence we are in another bubble. Therefore, I am approaching market neutral in my "sleep at night" portfolio . I refuse to buy overpriced assets.

In my last post I explained how our country has progressed in 2 generations from a society that thinks of investments in 3 dimensions to the baby boomers that are only capable of one dimensional economic thought. We use the advice of salespeople to make our investment decisions as Wall Street is taking a larger and larger portion of our gains.

Speaking of these salespeople, I just read a post by Nobel Laurette Paul Krugman. Dr. Krugman does very well in generating speaking and book fees and presently has found a nitch as the proponent of bigger government. He is a salesperson of the financial elite because his one dimensional thinking is being used by many people to make investment and policy decisions.

His latest post on his blog suggests that we don't need to worry about our country's present account deficit because at current interest rates our nation's debt will only account for 7% of government expenses in a few years. He says that at the current short term borrowing rate of 1.4% this country has nothing to fear borrowing large amounts of money from foreign nations.

This is the way it works. He states his opinion. He gains attention. He makes lots of money giving speeches and writing books. In 5 years no one will note whether his current thinking was right or wrong. Our nation of linear thinkers does not even look side to side, much less at the past. We are destined to repeat history again and again. Bubble after bubble as policy makers rack up monstrous debt to be paid by our children to hostile foreign nations.

I wish Krugman's call could be a wager in Las Vegas as an over or under bet. I would bet the over position. In my mind it would be a totally riskless wager. I also know that Krugman would take the "over" position also. He may make sensational statements to gain notoriety but he is no fool. If he could wager he would bet on the interest on the national debt as a much bigger percentage of government spending than 7% in the next 5-7 years. His assessment that government's 1.4% rate of borrowing will remain in place in the future is infantile at best.

Our government is churning over it's debt in short term vehicles. This short term policy is a huge structural problem and can't possibly continue forever. Our politicians are financing ultra long term debt in short term treasuries that are being purchased by hostile foreign nations. This is definately a problem and Krugman should understand this.

So why does he make the sensational statement then. Because he is a salesman. Just like everyone else that is giving you information.

I would like to take this a step further. Suppose we have a nation of Krugmans. One dimensional thinkers that see events change in a line and not as a trend. They would never be able to predict a bubble because a bubble is a curve. This is why no one in our present society has been able to predict any major turn in the economy.

In my opinion the only predictions that are important are the turns and in the future we are destined to have a lot of turns.

Investors in this country have a fixed focus on a goal that is straight ahead. Kind of like a herd of wildebeests following their leader across the plain. Our country's investors are a herd of mindless animals running in a straight line following the advice from Dr. Krugman, Wall Street, The National Association of Realtors, The Media and just about anyone that can make make a profit off our financially incompetent populace. Everyone is happily moving in a straight line knowing that the taxpayer ATM is the magic that will lead us to prosperity. Just like the homeowner ATM led us to prosperity during the housing bubble.

So what is an investor to do?

I say invest in the snap.

Given the current market metrics there is one thing that is under priced now in relation to the future. That is volatility. There is no value in the market now and The Herd has unrealistic expectations of the future.

I am a value investor so as the S & P index moves higher above fair value I am buying hedges on my stock holdings. Generic hedges on my large cap, market leaders with low debt. Once I get to market neutral at S & P 1200 it's not like I'm going to sit out this market. I'm going to start buying into volatility.

There are many ETF's on the market now that track just about everything. Most are not suitable long term investments but many have tremendous volatility. Presently I am slowly moving into FXP and UNG. These are both at historical lows. FXP is a short on a portion of the Chinese stock market and UNG is long on natural gas futures. I am dollar cost averaging very small amounts of capital into each.

You might say this is gambling. I say if you are significantly long on this market you are gambling a lot more.

I choose an ETF that is at a historical low that is backed by an asset base that is currently trending close to a 52 week low.

Natural gas futures are trending toward multi years lows while UNG is at an all time low.

If UNG trended down for another 6 months maybe I would end up with 5% of my portfolio in the investment. If I get the snap back to fair value my investment could make 30%. A 1.5% portfolio profit. 4 of these profits a year and that will equal the performance of the S & P per year over the next ten years.

Remember this volatility play is only on the table while the market is significantly overpriced. If stocks go under fair value I sell my generic hedges protecting my stock investments and make a profit. If stocks go significantly below fair value I buy more stock. If we stay in a bubble I take a small portion of my portfolio and play the snap. My goal is to stay with The Herd and equal the 6% to 6 1/2% gains in the stock market over the next 7 to 10 years. But I choose to take those gains in a straight line and without risk.

I would like to note that to make my intended goal without risk, I choose to avoid long term bonds like the plague. There is presently just to much distortion in the market. But I will invest in the volatility of long term bonds as interest rates vacillate wildly over the next few years as the government distorts the market. Presently I am slowly buying a small position in TLT, an ETF that is long on long term treasury bonds. I sold off my treasury short last year at a very nice gain thanks to The Herd.

Back and forth, back and forth over the next few years. You will deal with it by taking Rolaids. I will make a little profit while I wait for The Herd to start climbing the next interest rate mega bubble in 5 to 7 years. That is when it will get challenging.

But for now my premise is that if stock prices are forced to overvaluation by investors that have unrealistic expectations of the future then this will cause volatility. My goal is to trend with the S & P index. But as an investor that hates risk I must smooth out the wild gyrations that will occur in the stock market over the next 5 to 7 years. My gain will be in a straight line as I use the two dimensional surface of the investment plain. The Herd's movement will be a frenetic two dimensional zig zag as their linear focus is diverted from the salespeople, to the government to the dysfunctional markets that are being created by bad government policy.

Buy and hold does not seem to be a prudent way to invest in this market.

I remember talking to day traders back in 1997. They were buying and selling stocks and stock options. It didn't make sense to me at the time. The volatile stocks that they were trading were the ones that were likely to go to zero. One stock investment goes to zero and that wipes out a lot of capital.

Now that we have ETF's and massive volatility on the horizon day trading makes sense. If I start to buy into VXX, a direct investment in VIX volatility futures at a 52 year low there is no chance of it going to zero and wiping me out. As it is being sold off, The Herd is running away from the 52 week low as they are tethered to an elastic band tied to historical fair value. As that band stretches it becomes harder and harder for The Herd to pull away. The farther from historical fair value and the further beyond the 52 week low then theoretically the harder the snap back.

The future of stock and stocklike investments will be one of high volatility as the market gyrates wildly over the next 10 years making below average historical gains. Probably on average about 6 to 6 1/2% increases a year. But those gains will not be linear like the advice of the salespeople. Those gains will come after a stock market roller coaster with The Herd running large distances for very little gains.

During periods in which the market is overvalued I plan on making small profits on the long distances that The Herd will be running as they race back and forth across the investment plain.

The Herd is trained to follow the salespeople. Destined to run wildly toward the oasis of golden prosperity that will be created by the massive debt from the Taxpayer ATM. But using ultra long term debt funded by hostile foreign nations to buy votes in the next election does not seem like a solution to me. Call me crazy, but it seems like a bit of an ethical problem in the short term and it is definitely a structural problem over the long term.

Dr. Krugman will cheer, "just another $10 trillion of debt to China will bring us closer."

But like a mirage in the distance, adding more debt to our already over leveraged nation will keep true prosperity just out of reach.

In 7 years when The Herd is exhausted from running they will find themselves at the bottom of a mountain. This will be the beginning of the next interest rate mega bubble.

Dr. Krugman's legacy will be the crushing debt that our children will be destined to carry to the top.

Value Investors, Santa Clause and the Easter Bunny

2010-03-03T06:53:00.000-08:00

There are 3 types of investors. The first type would be people that only see one dimension of their investments. They rely on a salesperson to make their decisions for them. The salesperson in turn wants to take the biggest portion of your investment principle without having repercussions coming back upon themselves later. One dimensional investing is the easiest but unfortunately the most costly way to invest.

I can always pick out a one dimensional investor. When I try to explain two dimensional value investing I get the "bovine stare". Their eyes become black vacuous holes as brain neurons immediately stop functioning. Go down to the stockyard and look in the eyes of livestock. The same far off stare. This is the herd behavior of our ancestors. This is the same behavior that is making Wall Street huge profits today.

The salespeople that are advising the one dimensional investor can be real estate agents, financial advisers, the media, Wall Street and our government. But they are also friends, family members and neighbors. If your friend bought a house in 2007 then our course they will try to sway you into thinking that house prices are a good value. You can call it a defense mechanism but in the end it is just a sales pitch to validate their bad decision.

The second dimension of investing would be thinking about the investment yourself instead of letting someone else do it for you. This approach works best using mathematics and historical trends to determine if investments are priced appropriately. Most importantly one would have to ignore the sales pitch and get information directly from a reliable source. An almost insurmountable task.

This two dimensional investing can have complications. There is a group of people that think they are value investors as they use data from tainted sources. So in the end, they are no better off than the one dimensional investor. This creates more useless data and more static for the true two dimensional investor. If there really is such an animal. I have never really seen one.

Suppose that there was a true two dimensional investor. Their performance would have to tie to real events. The larger the event the more credible the performance indicator. The fact is that no one saw the 2004 housing bubble. No one saw the 2007 credit crisis. No one saw the 2008 recession. These were huge events that where basically, "no brainers". Our best and brightest not only ignored all variables to predict these events but they belittled anyone that suggested these almost certain outcomes as even a possibility.

The last type of investor sees in all three dimensions, up, down and to each side. It is impossible to teach or learn. It is breed by circumstance. The only way to be a three dimensional investor is to live through a period of extreme economic hardship.

This is why I tell people that The Great Depression was a wonderful event. It created two generations of fiercely independant, hard working, family oriented individuals. This country had two generations of three dimensional investors. These people understood value, hard work and sound government.

The last 15 years has seen a three tiered collapse. The collapse of the Interest Rate Mega Bubble rewarded a generation of one dimensional investors that have lived far beyond their means. This has collapsed our savings rate and turned our nation from a creditor to a debtor. These one dimensional investors are dismantaling the constitution to maintain this profligate lifestyle. This is the collapse of sound government.

This collapse should have seen an outcry that was heard around the world. Our grandparents would have thrown out the lawyers, economists and politicians that have forced the most powerful nation on earth to mortgage our children's future to hostile foreign nations with the sole intention of creating economic bubbles and making government bigger. It would not have made sense to our grandparents but oddly we are unable to see what is right in front of our eyes.

We have tainted investment DNA. Kind of like the 3 eyed chickens that live next to Chernobyl. Only the Chernobyl chickens aren't sacrificing their chick's future to live decadently in the present.

Our country has changed from a nation of 3 dimensional hard working savers to mindless debt producing consumers. We have become one dimensional thinkers.

For myself I would rather read a memoir about the Great Depression than today's paper. There is so much more honesty in people working together in overcoming a period of extreme hardship than what we are going through today. The excess and avarice of today's pampered populace. Everyone listening as salespeople tell us to create stifling debt for our children so we can create another housing bubble and consume more Chinese junk.

I have wanted to write a post comparing our current plight to the movie Starwars. Paul Volcker would be Obe wan Kenobi. Elizabeth Warren could be Princess Leia. Of course our government would be Jabba the Hut. Darth Vader would be played by Wall Street with Giethner and Bernanke piloting the Death Star. But the story would be incomplete because there are no Luke Skywalker or Han Solo characters yet. You can't put Krugman, Roubini, Shiller or Taleb in these roles. They are profit driven and are just motivated by book and speaking fees. Some day we will have a young Volcker that will save our economy but that is far in the future.

Presently the only way for me to describe our present situation is as an Orwellian drama. Animal Farm but with just pigs. Our population has become pigs at a trough with the most favored pigs being at the opening of where the government pork comes out. The rest of us less favored pigs are in line to pick up the leftovers. Our piglets are in the pen next door as we hear wild squeals. Later the young pigs exit with the same blank stares as the adults. Their future has been chopped off and sold to the Chinese. Scraps come back to the feedlot and are ground up for the soylent pork that the government feeds us.

It seems to fit current events pretty closely.

So you think you are a two dimensional value investor.

Here are some questions:

Do you think the economy is growing?

If you said "yes" then you are being led by salespeople which makes you a one dimensional investor. Our economy is contracting. Presently we do have a positive GDP number but it is only positive as our government uses massive debt to borrow resources from the future to pay for votes in the next election.

Are you investing with an eye toward inflation in the future?

If you said "yes" then you are being led by salespeople which makes you a one dimensional investor. There is no way that our government can create "magic inflation" that will not raise interest rates. As interest rates rise it will collapse long term asset values. We are in a contractionary period and will stay there until we get halfway up the slope of the next interest rate mega bubble that our Federal Reserve is creating. Then and only then can we have real inflation. Yes our government can create a new bubble but hopefully you have learned by now that this in not inflation. Look back in history, there has never been "magic inflation" that brings prosperity to a country after a period of wild excess and stifling debt.

Do you like dividend paying stocks?

If you said "yes" then you are being led by salespeople. There is no long term tie between dividends and long term stock performance. Increased dividends are a sales tool by a company to sway investors to buy their stock. Actually dividends could be a drag on company's performance as they take productive resources from the company to be taxed twice and given out to shareholders. Historically mature slow growth companies have higher dividends. Young high growth companies don't issue dividends because they are able to invest their profits in future growth instead of dividend payments that entice short term thinking investors to buy their stock. If you own high dividend producing stocks you are sacrificing long term gains to replace your lack of long term investment planning. It is ironic that our financial salespeople are selling unwary investors on this scheme after our country has lost 30% of your retirement account.

Do you own any long term bonds?

If you said "yes" then you are being led by salespeople. The only way you should be holding any long term bonds is as a short term hedge. These of course would have to be sold long before interest rates start to rise. Presently long term bonds are a terrible long term investment.

Do you feel that real estate will make more than 1 1/2% real gains in the future?

You have to be honest here. This is part of the DNA change that has festered over the last 15 years. A house has become a speculative high priced rent payment. Contrast this to how our grandparents treated their homes. Back then real estate was something to be paid off as soon as possible. Our grandparents had memories of the Great Depression and how housing debt ruined families in a contracting economy. Our next generation will have these same memories. Presently, you know in your bones that real estate will pay for your retirement, even though it is mathematically impossible. Over the past 100 years real estate gains were 1 1/2% above inflation and stocks 6 1/2%. You will favor real estate as an investment over stocks because it is part of your DNA.

Do you have a vast understanding of the interest rate mega bubble?

This is the deal breaker. The interest rate mega bubble is the biggest single economic event in the last 50 years. 187% of the last 300% profit from real estate was driven by this event. Over half the profits from long term bonds since 1988 have come from this government created bubble. This event that you have never heard about and definitely don't understand changed your investment DNA. You will never be the same.

Our present generation only has memories of the "financial geniuses" that through no ingenuity of their own, rode the collapse of the interest rate mega bubble and the easy money of the Federal Reserve to a once in a hundred year profit. This is an event that is mathematically impossible to recreate and will never happen again. Except in the minds of present day speculators. Our generation is tainted, financially illiterate and totally dependent on salespeople to make our investment decisions.

You are not a value investor because like Santa Clause and The Easter Bunny they presently don't exist. You are a product of your environment. We will not have value investors until the next generation takes over the helm. They will be able to see very clearly what a value investor looks like. The exact opposite of our generation.

Herd Behavior vs Casino Gambling

2010-02-26T06:23:00.000-08:00

When I was a kid my parents had a pool with a 10 foot bottom. Sometimes I would play games in the water. One of my favorites was tying an anchor from my Dad's boat around my ankle and throwing it into the deep end of the pool. I would spend 2 minutes trying to untie the knot and then if I couldn't, I would grab the anchor, get in a crouch on the bottom of the pool and push myself up to grab the pool ladder. When my Mom found out about the anchor in the pool she kind of freaked out.

Contrast the pool anchor to the high wire acrobatics that some high end buyers are choosing to perform today. Let me recap.

There are thousands of examples in the areas that I follow of high end buyers that took on far to much risk and are presently underwater. There are many others that bought at fair prices before 2001 but have used their homes as ATM's and are presently underwater. As a behavioral economist I have noticed that this herd-like mentally has become very common in the last 15 years. With the collapsing of the interest rate mega bubble and the easy money policy by our Federal Reserve many people have become "financial geniuses". These "financial geniuses" through no ingenuity of their own have been able to make huge profits in speculation. Other people see this behavior and want to emulate it. This is herd behavior and is very human .

What is happening now seems very foreign to me. Now that the interest rate mega bubble, the housing bubble and the credit bubble are collapsing why are people still choosing to make huge gambles in the high end real estate market? There is no one to emulate. It's not herd behavior. It's just flat out speculation. Purchasing in any high end area of the Bay Area is taking on a huge risk with almost no chance of gain in the end. Unless the thrill of owning a house is worth the cost of overpaying a million dollars or more in rent for 30 years plus the immediate downside risk of over $300,000 when house prices correct to fair value in 5 years.

I go through the actual numbers in my last post called "Immediate Gratification?".

Let me explain one simple fact that is understood by absolutely no one today. Buying a home is renting. It is not like renting. It is in fact renting. You are renting money from the bank. The only difference in renting money from a bank compared to renting a home is that instead of a month to month lease you are tied to renting money for 30 years or until you sell your home.

Some might argue that you can refinance your loan. Let me explain another fact that no one understands. We are at the end of the interest rate mega bubble and are starting a new one. When you are in the upslope of an interest rate mega bubble you can't refinance because your equity is being wiped out as interest rates are increasing. Plus why would you want to refinance at a higher rate anyway. It doesn't make sense.

Some might argue that a house is "inflation protection". Let me explain again. We are in a contracting economy with no inflation on the horizon. It could be 7 years before we stop contracting. If you have any questions about this comment just google "Japanese lost decade". The Wall Street economists that are guiding our policy decisions are the same ones that were used by Japan to create twenty years of economic contraction. I also write about "inflation protection" in my "Immediate Gratification?" post.

Why would one bet on "inflation" when we are presently in "disinflation". Anyone that is buying an overpriced asset as "inflation protection" is betting that the people at our Federal Reserve that didn't notice the biggest housing bubble in history will be able to create Latin American style inflation without interest rates rising. If you are buying an overpriced house in a high end area now, it is a million to one bet, that if you win you are just given your money back. Good luck with that wager. I think that I will sit this one out and watch.

While I'm on a roll let me include one other fact that no one understands. Our housing market according to the latest Federal Reserve figures has a net worth of $6 trillion. We have outstanding mortgages on that $6 trillion dollar investment of $10 trillion. So as a country we have decided to create $10 in debt for every $6 in equity. We are debt slaves to our homes. Before it was a figurative expression that owners are renters through the banks. Looking at the present figures owners have literally become leaseholders that are overpaying the price of rent as they are locked into 30 year leases.

Back to the pool anchor. Would I vote to outlaw anchors in pools? Absolutely. There are just to many people that are willing to take risks far beyond what is prudent. The anchor that I spoke of above was an 8 pound plasticoated dingy anchor. At the time I could have given a pearl diver a run for their money. I could tread water while I held it. I could have repeated the game a million times without a problem. These were the variables then. But changing one variable would make it far to risky. People in general are very poor judges of risk. Plus there are always people that overextend a game and create more risk than is tolerable. An example would be anyone that is choosing to pay bubble prices to buy into a high end market.

In most high end markets people have gone beyond good natured herd behavior. There are less and less suckers to pass the overpriced asset to. There is absolutely no driver to warrant the behavior. No herd behavior, why would you emulate people that are losing money. No profit motive as I have shown in many times in my previous posts. It's just an individual madness to own a home no matter how overpriced it is. It is casino gambling and the "house" almost always wins in the long run.

It was a little painful to watch during the housing bubble as people were overpaying for homes. But it was so human, this herd behavior. The present high end real estate market is driving me nuts. That's one of the reasons that I started this blog, as kind of an outlet for my angst as I watch people make very bad decisions. It is not herd behavior anymore, it is flat out speculation in a negative economic environment. Casino gambling by a nation of "financial geniuses" who don't understand that the last 25 years of easy money was a once in a century aberration and not a birthright. It is mathematically impossible to recreate this madness in the same way that it is impossible for someone that is underwater in their home to borrow another $250,000 from the bank. We are tapped out and Uncle Sam the loan shark is soon to run out of easy money. The game is over. When you buy an asset it has to make financial sense. It has to be affordable and the worse the economic environment the more affordable the asset must be.

It was impossible to document all of the bad decisions of the past 8 years because there were so many. But of course it was a mania so it is better to document the event in the aggregate. But now is different. The group is not driving prices anymore in high end areas as herdmembers are leaving the market. The market is being driven more and more by individuals. Unfortunately some of these individuals are tying a boat anchor very tightly around their necks. It will have a bad effect on the whole high end market as we trend toward affordable prices.

I would like to document some individual sales that are creating some of the Lafayette Lotto(see my Lafayette Lotto post) winners. These casino gamblers that are risking everything for no chance of gain.

Looking at the sales from 1/1/2010 it is comforting to see that prices in Lafayette are trending downward toward fair value. But there are still uninformed individuals that are grossly overpaying for individual homes and slowing the fall in prices to affordability for everyone while they are taking on huge risk to themselves. I would like to use examples gleaned from Property Shark to track the markets trend back to the fair value prices of 2001.

My first example will be a sale in Burton Valley in January. It sold for $1.1 million. It is an average home built in 1962 on a quarter acre lot. The purchase price works to over $503 a square foot. Close to peak bubble price. This home sold for $397,000 in 2001. This will be property "A" from January 2010. In 5 years it could trend to $300 a square foot while each month the owner is overpaying rent by 100%.

I would like to interject that 99% of the people that read this blog will not understand what I am talking about. They are not able to comprehend the idea of fair value because it is a foreign concept. We have lived in a period like none other with money falling from the trees. That is what you are used to just as someone that lived through the Great Depression saved 25% of their income and kept it under the mattress. We are a product of our environment. So if what I just said did not make sense don't worry about it. I will have another chance in two years to explain once the data is in. You will be able to see the trend downward. Of course you can deny it then also. In psychology I guess that is called a self defense mechanism. But be aware that there will be some point in the future where everyone will realize that money does not fall from trees. Where saving and productivity gains are the way to increase our standard of living. Not easy money bubbles, government pork and horrendous amounts of debt. The sooner that you realize this the better off you will be. The sooner that our society realizes this the better for everyone, especially our children.

Speculation with debt is so ingrained in our society it is almost impossible for investors to step back and look at value. Believe me I know. I have spent the last 15 years getting blank stares from people when I explain the principle of fair value.

Would I purchase a home in a lower end area like Anitoch? Absolutely, prices there are affordable compared to rents, household income and historical trends. Would I buy a home in a higher end area? I would much rather tie an anchor to myself and throw it in the pool.

My next post will explain why there is no such thing as a value investor.

Delayed Gratification?

2010-02-20T19:49:00.000-08:00

One of the topics that I love to discuss with my kids is saving. The longer one can delay gratification the better. It builds character as one is creating a pool of assets which could directly lead to comfort and security in the future.

Contrast this concept to the fact that our present government is desperately trying to force our insolvent banks to lend as much as possible to our insolvent households. I'm sure this dynamic makes sense to most of the Wall Street economists that are advising our government but on paper the numbers don't work.

Anyway I would like to suggest some other numbers that don't work. Buying a home in a "high end" area of San Francisco instead of renting.

Let us suppose there are two people that want to live in Lafayette for 7 years. Let's call them "you" and "me". You buy a $1.2 million home and I rent an identical home. We both have a 30% down payment.

But we must agree on what the future will be. I say homes will trend downward 30% in 7 years. You say homes should increase slightly. So let's say that prices will stay the same. I don't agree with it but I accept the premise.

I am sure we can both agree on a historical 6.5% return on stocks and we will let you have a 6% loan.

Now let's look at the numbers. At the end of 7 years I will have made $500,256 cash gains and you will have made $85,764 in equity.

No, I didn't misplace a decimal point.

Your mortgage, real estate taxes, extra insurance and maintenance for your home is $6,188 after the $1,158 itemized deduction subsidy from our government.

I will pay $4,000 to rent the same house. I will put the $2,188 that I save each month in the stock market and after 7 years will have $264,457. I will also earn the same 6.5% on my down payment which will be another $235,798. This is a long term capital gain of $500,256 in 7 years.

You will tie up your down payment for 7 years as you make very large interest payments to the bank.

At this point you are saying, "what about your capital gains tax?". I will say, "what about the 6.5% cost of selling your home?" Both charges to exit the investment end up being a little over $75,000. Let's call it a wash.

Is it possible that my rent will go up some? Yes. But it is much more likely that your home will go down in value much, much more. By my calculations about 30%. With a 30% discount the price of your house would still be overpriced compared to 1998 values. Back in 1998 homes were affordable compared to rent and household income. Housing markets almost always trend toward affordability. The last ten years have been a very, very large anomaly.

The example above is what I mean when I talk about affordability. Homes in Lafayette are unaffordable. Look at the numbers!

I would have $860,256 minus capital gain taxes, to put as a down payment on my $1.2 million home if I wanted to buy it. This includes my original down payment with capital gain plus my profit from renting with my long term capital gains.

So if I purchased then my housing costs after the tax deduction would be $1,907. This is $4,280 less per month than you would be paying if you had stayed in you house.

But my original premise for posting was Delayed Gratification and the example above actually gives me a beautiful house with free pool and lawn care.

So what if I decided to delay my gratification for a few years and live in Walnut Creek to save money. Suppose that I decided to rent a smaller place for half the rent. Then I would be able to pay cash for a house next to yours in a little over 8 years.

I will not pay a mortgage payment for 22 years while you are paying $5,036. I will have $2.8 million in the bank and a home in 30 years. You will have just a home.

The numbers are outrageous but they are not the main focus when I choose to rent instead of own a home. I am not renting to save $2.8 million in the next 22 years.

I am renting because of the huge downside risk in high end housing. Real estate has always trended toward affordability. To think that this time is different is lunacy. There are no variables in the future that can possibly drive real estate prices in high end areas to more unaffordable levels short of the government giving upper middle class taxpayers money. Realistically the opposite will be true. Taxes for residents of Lafayette will skyrocket in the future. The top 50% of wage earners pay 96% of the taxes. Almost all of this debt that our government is creating now will be paid by people that live in high end areas. And just in my opinion, rightfully so.

There will be no positive inertia in the future that will push high end real estate to more unaffordable values. But there will be many, many factors in the future that will push prices toward affordability. Affordability is where prices trend most of the time and that's a good thing.

There are great examples of affordability in many lower end real estate markets. In Antioch, Sacramento, Las Vegas and Phoenix homes are below fair value. In these areas and many others it is cheaper to own than rent. By historical standards this is not unusual. Real estate prices trend toward affordability so sometimes they are below fair value and sometimes they are above. As a value investor, if I lived in Antioch I would definitely buy a home.

The Lafayette housing market will absolutely come back to affordable levels at or below 1998-2001 pricing. There is also a chance that they could go below fair value.

As a value investor the chance to lose $360,000 or more by choosing to spend an extra $2.8 million on housing does not make sense.

There is one last idea that the gullible will parrot from the salespeople that are trying to entice them into 30 years of debt servitude. A house is "inflation protection".

Let me explain the chain of events that are in process. Our economy is contracting. This is the opposite of inflation. If our Federal Reserve is lucky enough to debase our currency enough to create inflation then interest rates will spike first. This will cause stagflation exactly like the 1970's and eventually inflation like the 1980's.

So if we are eventually lucky enough to get inflation first we must deal with spiking interest rates. These higher interest rates will collapse housing prices. At that point one could argue that housing would be an insurance against inflation but not now.

Presently housing is not an inflation hedge in fact it's just the opposite. You won't be able to use real estate or long term bonds as an inflation hedge until interest rates are 2/3rds of the way to the peak in the interest rate cycle. That is a long way down the road. We are presently at the bottom of the interest rate cycle. Inflation is not even a variable that I am presently considering.

Inflation might not be a factor for 7 years. Hence my example above comparing renting to purchasing.

During the Great Depression our country incurred economic contraction just like today. But ironically when you read memoirs of investors during that time period their biggest concern was inflation. It's very similar to today. As our economy is contracting most people are worried about inflation. Inflation is the next red herring that Wall Street will use to take your money. We are not even close to stagflation much less inflation.

My recommendation is the same today as it was 10 years ago. Only buy a home when it's affordable. When we are halfway up the next interest rate cycle then we can talk about "inflation protection".

Why Does Our Country Hate Fair House Prices?

2010-02-18T13:16:00.000-08:00

I follow the Lafayette real estate market very closely. Today was unusual in that there was a house that sold for close to fair value, which is 2001 pricing - $188 a square foot. One of the first in the past 8 years, so it is kind of exciting to me. It was an REO sale in a pretty nice neighborhood. Mountain View Drive to be exact.

Since I am a value investor. It always gives me a good feeling when I see an asset priced at fair value. You can call it historical trend value, intrinsic value or fair value, it all means the same thing to me. It implies that the asset is affordable and the price is fair. That's a very good thing.

Now here is a question to determine if you are a value investor:

Do you feel that Lafayette will go back to 2001 prices?

Most of the recent sales in Lafayette are at 2006 prices. Therefore homes are still priced at bubble prices. Every once in a while I will even see one sell at 2007 prices. This kind of makes me cringe.

What is strange is that most of the market experts be it Realtors, economists, bankers or brokers would say that this recent Mountain View sale is an aberration. The Lafayette housing market definitely knows it's an anomaly because families are paying on average 2006 prices. So what's the deal.

I reflect back to 1990, 1996, 2007 and today:

1990 - Houses were unaffordable and everyone was climbing over themselves to buy a bigger and pricier house. Everyone was telling me I had to buy a bigger house for my growing family. I looked at prices and they didn't make sense to me so I refused to buy and we lived for the next 6 years in a house that was too small, much to the consternation of my wife and my Mother-in-Law. Houses at the time were priced above historical trend.
1996 - No one wanted to buy a home. Everyone said houses were overpriced. I bought a house that was a stretch for me. I remember people coming over to my home and not being able to understand how I could afford a house that was so impressive. Well the fact was that I had saved money while others were debt slaves to an overpriced home. Houses at this time were very affordable and way below historical value trend. But no one wanted to buy. Very strange but of course very consistent
2007 - This was the peak of the last housing bubble and our whole society had decided that they were going to retire at 50 from the equity in their homes. Since homes were far, far above historical value trend when I sold my home I made a vow to myself not to buy another home until at least 2010.
2010 - I am renting and saving a significant amount of money while my down payment is in a brokerage account earning interest. Lafayette housing will have to fall 30% to be in line with historical value trends. The economy will slow and this could shave even more value off that amount as rents and household income decline. For myself, I refuse to buy a home at over fair value.

This post is not meant to give all of the variables that will contribute to the high end real estate market correcting at least 30% in the next 5 years. I have written extensively on that. I would like to make an observation about human nature.

Why is it that most of the time our economic experts miss the big turns in the economy? Why is it that they can't determine the historical value trend of assets? Why on earth would we let the knuckleheads that consistently and continually denied our economic problems in the first place use extreme fiscal and monetary policies that have never been successful before?

So, I would like to say very clearly that this Mountain View property that just sold is the first of a trend back to fair value.

So you say this is impossible. Well, Antioch real estate is presently selling at 1998 prices and Sacramento is selling at 1996 prices.

Las Vegas is the same. Phoenix the same. Florida the same. So is this bad?

Lower end real estate markets always come back to fair value more quickly than higher end areas after a bubble. Presently real estate in lower end markets like Antioch have become affordable for the first time in 9 years.

Now each sale in Antioch wipes out a speculator. Each sale eliminates a subprime loan that was sold by a corrupt mortgage broker. Each sale helps a family get out of stifling debt which could make their rent payment less than half of their old mortgage payment. Each sale will strengthen the balance sheet of the bank that is financing the new home. Each sale could weaken the balance sheet of the bad bank that made the toxic loan in the first place and hopefully make them fire the person responsible. This could create a job for a more capable young person in the future.

But the most important event is that each sale allows a young family to feel the joy of buying a new home that is affordable. Is this bad?

So back to the sticky high end real estate market. There is no reason why Lafayette can't bottom at 2001 prices. It is actually the most likely scenario. Young families that buy now are making a very large leveraged bet buying an overpriced asset in an extremely unsound economy. Is it good that our government is slowing the trend back to affordable values by robbing trillions of dollars from our children?

These young upper middle class families that are buying now in Lafayette could very well be underwater in 5 years as the government is artificially manipulating almost every facet of the real estate market with borrowed money. Will this be a victory for our government?

So I come back to the human nature part of the equation. Why is it so important for asset prices in Lafayette to be wildly overpriced? Why has our government spent tens of trillions of dollars over the last 25 years in subsidies, incentives, gifts, graft and bailouts in an attempt to make prices of homes unaffordable?

Why do we want our government to choose the winners and losers? Why do we love home owners and hate renters? Why do we love speculators and hate savers? Why do we hate our children and expect them to take on the debt that we are creating to distort our asset markets to reward favored members of our society?

Why does our country hate fair house prices?

Going one step further. The net value of our nation's residential housing stock is honestly about $6 trillion on a good day. Our government has spent tens of trillions of dollars over the last 25 years in an attempt to artificially manipulate house prices higher. The choice by our government to pay $10 trillion to distort prices in a $6 trillion market does not make sense. Even paying $1 to distort any market prices does not make sense.

It makes no sense economically. Fair and affordable asset prices cultivate a sound and vibrant economy. Or to state it differently: improperly priced assets will reek havoc with even the strongest economy. So why do we hate fair house prices?

House prices in the upper end of Lafayette are mispriced. I can rent for half the price of buying. Case closed, now let's move along.

People say to me all of the time, "how could you possibly know what house prices will be in the future". "Do you have a crystal ball?".

All I can say is yes, I have a crystal ball. It's a chart of the historical value trends. Assets have always come back in line with affordability. It is an irrefutable fact that all of our economic experts consistently ignore. In the same way that we ignore the fact that our experts have been consistently wrong on every major turn in the housing market and the economy.

Blind faith is a blessing in one's religious life but it is definitely our country's curse when it comes to investing.

It Caught Me By Surprise

2010-02-13T19:45:00.000-08:00

I have spent a lot of time analysing the housing market over the past 5 years. Probably too much time, but I enjoy it. It was very surreal back in 2005. I had only charted half of the real estate bubble. I would try to show my family, friends and clients my graphs but since it was only half of a bubble nobody could see it. I would try to explain that houses were overvalued but nobody would listen. Everyone and I mean everyone felt house prices would never go down.

I tracked the housing bubble until 2008 then I got bored. It was at that time when I started to see a lot of websites popping up with bearish housing predictions. It seemed like a good time to slow down on charting the real estate market and to let other people do the work. I follow the real estate market generally now by just crunching a little data. I don't do any charting. All of my charting now is focused on the stock market.

I have written recently in my blog about how the Antioch housing market is forming a price bottom. I used number crunching but no charting. I extrapolated that Antioch housing was priced at 1998 price per square foot. I also determined that prices were solidly in line with historical trend in rents and household income. My call was actually more of a hunch. Using my hunch on the Antioch real estate market I made the assumption that most low end housing markets had bottomed and were starting to trend upward.

Well I went on http://www.housingtracker.net/ today for the first time in 4 months and got a big surprise. Almost every real estate market that they track is still trending downward. Perfect downward slopes touching median bubble lows last week. This is very odd. It seems like most of the media reports say that the real estate market is trending upward. Well that's not what the charts tell me.

Looking at the Housing Tracker charts gives me pause. Here is why:

Most lower end markets have definitely not hit bottom yet. This is important because;

The medium end housing market will not hit bottom until at least 2 years after the low end hits bottom. This would be Walnut Creek.

The upper end housing market will not hit bottom until at least 3 years after the medium end hits bottom. This would be Alamo and Lafayette.

Of course I knew that Lafayette had a way to go to form a price bottom. But I kind of felt that Walnut Creek had only a year to go. The charts were a wake up call. It proves to me once again that charting the trends is the only way to follow a market. Presently I am having too much fun tracking the stock market to follow the real estate market. But I am going to make it a point to follow Housing Tracker more closely. I want to know when the low end markets hit bottom. Only then can I determine when the medium end and the high end will bottom.

I don't want to beat a dead horse here but there is absolutely no positive economic events that will happen in the next 5 years that can possibly stimulate housing. Housing will bottom at affordable prices in line with historical trend. But what must happen first is the sequence of events that I have described above. Every burst housing bubble has collapsed in tiers in the past. Low End, then Medium End then High End.

One could argue that our present housing bubble is the one in a thousand chance event that is different. One could argue that point but it would be much, much more appropriate to argue that point on Tiffany's Fantastic Fantasy Real Estate Blog than on my blog. Most of my analysis comes from number crunching and historical trends.

Unrealistic expectations are the root cause of the massive bubbles that our government, Wall Street and our nation of speculators have fermented. Our country is trying to use asset bubbles to drive economic prosperity. Historically production and saving are the only ways to increase a nation's standard of living.

Is it a problem for our government to use debt to create asset bubbles to attempt of create a higher standard of living for a favored portion of our society? Other than it being very entertaining for me to watch I don't have a strong opinion. I don't buy assets above their historical fair value so I do not participate in the bubbles.

But most of our population has been trained by Wall Street and the government to borrow money to purchase assets at prices over fair value. People were wildly throwing money at ridiculously valued tech stocks in 1999. Families were climbing over each other to place themselves into a lifetime of debt servitude to the banks during the housing bubble.

I chose not to participate:

I somewhat overlevedged myself to buy a house in 1996 because they were below historical value.
I sold most of my DOW and tech stocks in 1998 because they were far above historical value.
I was pitchforking money into the stock market in 2002 when stocks were a value.
I was net short in 2007 in the stock market and I also sold my primary residence.
I bought into the stock market at extreme value in March of 2009.
Now I am trending toward stock market neutral after the biggest stock market gain in 3 generations.

I have said many times that I have not lost an hours sleep on any of my investments. It is not rocket science. When an asset is at historical fair value I might tend to buy it. If it is overpriced I will not. If it is cheap....well I hope you can understand. I know my kids can but from what I observe it appears no one else can understand. When I say no one I mean no one.

Here is a test:

Have you lost an hour of sleep worrying about your investments?

If you said yes then you are not a value investor. If you let someone else manage your account then you are not a value investor in the same way that if your maid shops at the grocery for you then you are not a value shopper.

There has never been a time in history when buying a house below historical value would lose you money in 10 years. The same is true for the stock market. But, in 2005 everyone was purchasing homes far, far above historical value with the intention of flipping them. This kind of behaviour will lose you money almost all of the time. But that is when everyone frantically wanted to buy. The markets more than ever are run by Herd behaviour.

As an accountant with a degree in economics it is very entertaining to watch from a distance the wild vacillations in our economy as it is manipulated by the financial elite and the government.

But as a parent I take exception with our government and the financial elite impoverishing our children in debt servitude to foreign nations. There is absolutely no reason for this to happen. The fact that we are doing it to reward Wall Street and make government bigger makes it that much more distasteful to me.

Here is one more test:

Do you think the government should do anything else to help the economy other than giving benefits to the unemployed?

If you said yes then by definition you are attempting to borrow money from our children to artificially prop up our economy and hopefully create a new asset bubble.

There is only one expense above the normal that our country needs now. To help all of the unemployment that was caused by the housing bubble. One could also say that borrowing for a war is necessary. But every other bit of pork, bailout, graft, gift and largess that is borrowed by our government is only robbing our children to pay for our mistakes. It will probably lead to a new asset bubble in the future. Then what?

I have put Housing Tracker in my links on the right hand side of this page.

The Reset Button

2010-02-07T06:24:00.000-08:00

We are a care free generation that has enjoyed a 25 year party. The drug of "easy money" by our Federal Reserve has allowed speculators to borrow money at below market interest rates without the need of good credit. The Interest Rate Mega Bubble has made all speculators "financial geniuses" as Stocks, Bonds and Real Estate have all clocked wildly inflated gains due to the record breaking collapse in interest rates. And the avarice of human nature has allowed our generation to pay the bill for our lavish Bohemian lifestyle with our children's credit card. We are a generation of financial "hippies". This is an aberration in the long line of prudent hard working individuals that came before us.

We have navigated a nation formerly of immense wealth through the most profitable period in it's history and came out the other end insolvent and with an addiction to debt. Kind of like a child actor that starts a drug habit after starring on a bad TV sitcom.

The only difference is that child actors almost always lose their wealth but this is the first time our citizens have decided to frivolously impoverish our nation at the expense of our future generations and our national security.

Our government, our banks and over half of our households(including renters) are insolvent. We are so high on the "debt drug" that we are trying to solve our financial problems by borrowing even more money from foreign nations. It is ridiculous to think that we can extricate ourselves out of insolvency by taking on more debt. Plus it is extremely dangerous to sell ourselves into servitude to China, The Middle East and Japan. Even a child could understand this fact. Our leaders say that this gamble is our only viable solution. Instead of working to patch the hole in our financial deficit we are spending our time bailing water back into the boat.

If our Grandparents were magically put in our present situation I guarantee that they would spend 20 years working and saving and end up in good shape. Our Great Grandparents would not only pay off the debt but they would cast out the Wall Street lawyers, lobbyists and politicians that caused the problem in the first place. They would do this because they where financial adults.

But we are financial children dependent on the "debt drug dealers". Our younger generation will grow up quickly. They will become the financial adults. They have no choice.

Our generation is creating a mountain of debt to foreign nations that will be paid back at very high interest rates in the future by our children. Our kids will be able to monitor how Japan, Greece, Portugal and Spain collapse with their speculative debt burdens. These countries could end up pushing the "reset button".

What does the "reset button" look like? It depends. The most successful scenario would be a short very sharp recession like in 1920. It could also be a Latin American style currency collapse with spiking interest rates and high inflation. Either way it could possibly eliminate the problem, which is the debt created by corrupt government leaders unconstitutionally enriching themselves and their cronies at the expense of the taxpayer.

The current trend shows that by the time our generation is through with our "orgy of debt" that it will be mathematically impossible for our children to even pay off it's interest. Much less the principle that is funding our gluttonous debauchery of speculation. The only choice that will be left for our heirs will be to hit the "reset button".

Our overtaxed citizens give our bloated federal government about $3 trillion every year. None of this income has ever been used to pay down the $60 trillion in unfunded liabilities such as Social Security, Medicare, Government Pensions, The Pension Guarantee Corp, Fannie Mae and Freddie Mac. So by definition these programs and many other federal programs are Ponzi schemes

So let me put this in perspective. Our generation has created tens of trillions in future liabilities without even a line item in present spending to pay for it. The plan is to keep creating debt, never pay it off and then hand the debt and it's interest to our children.

Eventually we will be a great example for our kids. They will understand that the only way to increase a nation's standard of living is through productivity gains and saving. They will point to our generation as an example that excessive debt absolutely does not create wealth. It unjustly attempts to impoverish the future to pay for the excesses of the present.

So let's have a last hit on the debt crack-pipe and charge it to our children's Chinese credit card.

It's nothing that we need to worry about today.

The adults will handle it tomorrow.

2010-01-27T07:53:00.000-08:00

Lafayette Lotto

Since 2007 I have compared the Lafayette housing market with the state lottery. Both have big winners and both are run by the government.

Once in a while a high end home in Lafayette will sell at 2007 peak bubble price. This event can create up to a million dollar gift to the seller above the "present value" or utility value of the home. The short term dysfunction in pricing props up the comparables and allows other sellers to continue the lottery. Historically, after a bubble, "high end" home prices trend downward much more slowly than their "lower end" brethren. Interestingly, most of the "high end" areas of the Bay Area are not trending down to fair value, they are staying close to 2007 bubble prices.

I made up the term "lottery" because I needed a new word to describe this unprecedented economic behavior. Our nation's leaders are desperately borrowing trillions of dollars from our children as they frantically attempt to keep home prices in a bubble. The end goal is for real estate values to stay unaffordable for the future generations that will have to pay off this boondoggle(scheme that wastes time and money).

I am not a psychologist so I don't quite understand why we hate our children as we are attempting to mortgage their future with stifling debt and unaffordable homes. But I am an accountant with a degree in economics so I do understand that this market manipulation is unsustainable in the long run.

I don't disagree with a flood of money to help the unemployed. I take pause when our government unconstitutionally borrows trillions of dollars with the malicious intent to artificially distort capital markets so they can reward bankers and speculators. The amount of money being spend on bailing out banks dwarfs the money going to the unemployed 100 to 1.

The worst part of it is that this malicious money only creates short term distortion and will have no long term effect on the housing market. No amount of hope, money and debt that our politicians and their lobbyists throw at our housing market will keep real estate prices from going back to valuations that are in line with historic value trends.

Lower priced housing markets like Antioch are almost through the bubble. Some "low end" areas are selling below 1998 prices. In Antioch it is easy to see how prices come back to fair value. Presently Antioch prices are below fair value compared to rents and household income. Speculators are being kicked out of the market as young families and prudent investors are able to feel the joy of owning a home that is "affordable". This is the same feeling that my generation was able to enjoy for 25 years up until 2001 when the government and the banks colluded to make real estate unaffordable.

The wave of foreclosures in Antioch is allowing families to trade hundreds of thousands of dollars of debt for rents that are half of their former mortgage payments. The only cost is a 2-5 year ding in their credit. Each foreclosure eliminates personal debt and in the end makes our country stronger. Why is the government involved in this at all? Well, it appears that they feel that all bankers need large bonuses to keep the country strong.

There is a rebirth happening in Antioch and other "lower end" housing areas. This has nothing to do with the government. Houses are coming back into line with fair value. This is a wonderful event. Fairly priced assets are the foundation of a sound economy. The fact that our government is attempting to fix prices with Ponzi schemes and market manipulation makes me question the soundness of our government.

It will be a long slog for "high end" real estate. The government would say that Lafayette is benefiting from the stimulus. I myself do not see any benefit to manipulating the housing market to delude young families into bad investments. House prices must come in line with intrinsic value in the future. I believe it is unethical for our government to spend trillions of dollars of our children's money to slow the process.

Let's look at the significant variables that will drive future high end home values:

Prices on homes in Lafayette are selling at a 30% premium in relation to intrinsic value. Prices are also out of line with historic value trends. This makes sense because most of the time house prices find equilibrium at prices that buyers can afford. Eventually Lafayette prices must fall in line with rents and household income.
If interest rates rise from 5.5% to 8.5% then homes must be discounted by 25% to have the same mortgage payment. As interest rates rise real estate prices fall - always.
People are presently not saving. Historically we have saved 10% of our income. Future discretionary spending on housing will be reduced in the future due to higher savings rates that are in line with historical norms.
Taxes for the upper middle class will increase at least 10% in the future. The upper middle class will pay for just about all of the debt that is presently being created by our government. This will also have a large effect on discretionary spending on housing.
Rents in "high end" areas are trending downward so renting is becoming even a better value.

I can think of no scenario in which these 5 drivers will not push high end prices down at least 30%.

There are many other factors that will effect real estate in the future. Almost all of them will have a negative effect on "high end" real estate.

The recession of 2011 will have a significant effect on our nation's psyche. Hopefully this watershed event will send our nation on the road to saving instead of speculating. We must understand that the easy money of the last 25 years is over. Our government is spending trillions to keep the party going but this government largess must end soon. The longer it lasts the bigger the bill for the upper middle class taxpayer of Lafayette and for our country.

New buyers in "high end" Lafayette will slowly sink underwater over the next 5 years. During this time they will be responsible for the lion's share of the debt that is being created by our government. $1.3 trillion divided by 290 million is $4,500 a person. So this year an upper middle class family of four is responsible for about $45,000 of deficit for 2009. It works out to $4,500 for each family member and $4,500 each for another family of four that does not pay income tax. Also they will pay for half of an Antioch middle class family. Remember, the top 50% of taxpayers pay 96% of income tax with the highest proportion going to the upper middle class.

The $45,000 debt is just for 2009. The government is planning to run these deficits for at least 10 years. So multiply the $45,000 by 10 to get a realistic idea of an upper middle class family's portion of the government deficit.

The stimulus ends up being a circular function as it flushes through the upper middle class. The government debt is creating market dysfunction that is allowing high end home buyers to overpay for real estate. These new buyers will be underwater in their homes in 5 years and also be responsible for the $450,000 worth of debt that distorted the market to make the house seem like a good deal in the first place.

Let's look at the numbers comparing buying a mispriced home or renting the same exact $1.2 million home:

Realistic estimated loss in property value over 5 years = $300,000

Difference in cost of rent to house payments after tax = $120,000

Difference in cost to move = $48,000

So as a home buyer you are locked into a possible $420,000 loss until you decide to pay $48,000 to exit the investment.

As a renter I can move as many times as I want. I can buy a house next year or in ten years as my down payment grows with interest.

Also my landlord is responsible for cleaning my pool, maintaining my yard and cleaning my gutters.

It doesn't quite seem fair.

It's almost like there's a renter's bubble in Lafayette.

As a renter the only thing that I miss out on is the chance to hit the Lotto.

2010-01-16T14:34:00.000-08:00

Almost a Homeowner:

I monitor the Lafayette housing market very closely. A couple of weeks ago a Real Estate Owned(REO) property came on the market that was very intriguing. It was a great lot with an older home on it that was priced at 2001 value. I inspected the structure and determined that I could rehab the house for $70,000 thus making the total cost of the property around $650,000.

I am presently not anxious to own a home in the Bay Area because home values are due to fall another 30% in the high end areas like Lafayette. But this house was pretty special.

On the property's third day on the market I made a low offer that was accepted by the bank. I had a termite inspection and found some wet wood termites. Not a big problem. Dry wood termites are the killer. So far so good.

I received the preliminary title report and decided to perform my due diligence on the "chain of title". I went to the county and found that the bank had botched the foreclosure of the property. There were 2 investors named on the Grant Deed and one of them was not included in the Notice of Default or named in the Foreclosure.

I informed the title company that I needed this included in the title insurance. They mentioned this to the bank and of course the bank backed out of the deal. They are going to start the foreclosure process again and hopefully do it right this time.

The funny thing about this deal is that I mentioned the tarnished "chain of title" to a couple of real estate agents and they said that I shouldn't worry about it. Of course now they admit that I was right. Real estate agents are a little to easy going sometimes.

I would like to express that if you are buying real estate in today's dysfunctional market you must to be very careful:

1) House Value: House prices are still 25% overpriced in Lafayette. If anyone tells you differently they are basing their assessment on emotion and not on the numbers. House prices in Lafayette are on average hovering at 2004 values($440 sq. ft.). Every so often a home comes on the market at a good value. It is normally snapped up immediately. Most of the home inventory in Lafayette is still priced at bubble values. If you buy a house in Lafayette at 2007 prices($545 sq. ft.) you could lose at least 30% of your investment over the next 5 to 7 years depending on the area. Some areas need to trend to under $250 sq. ft. to fall in line with historic value trends. One can argue against this fact but you will be using emotion, nostalgia and hope to defend your convictions. All numbers, trends and economic indicators point in the other direction.

I myself would not consider buying a home priced over 2001 value. In Antioch homes are being sold below 1998 value($110 a sq. ft.). Lafayette was selling at $213 a sq. ft. in 1998. About twice as much as Antioch. Presently the price per square foot difference between Antioch and Lafayette is 4 to 1. This change in buyers attitudes is not the magic of Lafayette but the stubbornness of high end markets to reprice. The same trend happened during the 1990 housing bubble. The same trend has been happening in Japan for the last 20 years.

The price of any home over the long run will trend with household income and rental prices. Antioch is driven more by rental prices. Lafayette is a little more affected by household income. Antioch housing prices are a good value compared to rents in the area. Lafayette homes are a terrible value in relation to household income, rents or any other variable you might care to use to compare.

The last problem with the Lafayette housing market is that there is far to much debt. Also, unfortunately, most of the houses that were bought after 2002 were financed with adjustable rate mortgages that will recast before 2013. A contracting economy, increasing interest rates and exploding "option ARM" loans will have a very negative effect on all high end markets for the next 5 to 7 years.

One could argue that the Antioch real estate market is forming a price bottom. No one can intelligently argue that any high end area of the Bay Area is close to a bottom.

2) Get good advice: Be careful, there are a lot of salespeople that will push you to buy a house. I love the quote by Upton Sinclair: "It is difficult to get a man to understand something when his salary depends upon his not understanding it."

Even neighbors, friends and family can be salespeople. Anyone that presently owns a home has a vested interest in puffing up prices. Most of these people have unrealistic expectations created by the previous 25 years of easy money:

The government is the key to solving our economic problems
You don't need to save because you can retire with the equity in your home
Real estate prices always go up
Cash flow is not important when buying a rental property
Debt is important to economic prosperity
It is not important for our country to save because we will always be able to borrow from foreign nations
Buy a home while interest rates are low

The easy money period is officially over. Anyone that does not realize this fact is probably not going to give you the best advice.

3) The Economy: This area was my biggest concern when I made the offer on the house. Our economy is in a deflationary environment. Interest rates are set to increase. Unemployment will be high for an extended period of time. Almost none of the present economic malaise is priced into public opinion.

We have just ended the biggest private sector debt binge any country has ever experienced and now our strategy is to use taxpayer debt to grow the economy. What most people don't understand is that the "private sector" and "the taxpayer" are the same thing. Our citizens are being sold on a policy of borrowing money to pay off their own debt. This machination would be funny except that about a trillion dollars a year is being skimmed off the top by the government. The interest on the trillion dollars a year of graft will be paid by our children to foreign nations.

In 1985 foreign nations owned less than a $1 trillion in US investments. Today, 25 years later, foreign nations own over $15 trillion in US investments. Of course this is not the problem. The problem is the growth trend and our nation's willingness to "give away our country" instead of balancing our budget. If the present trend continues, in the future our largest government expense will be interest payments to foreign nations. Also, we will have a more difficult time paying this debt if a significant amount of our country's productive assets are owned by China, Japan and The Middle East.

Savings and increased productivity are the only ways to increase a nation's standard of living. The debt we are creating will actually reduce our standard of living as our children make onerous interest payments to foreign nations.

I am a little disappointed in not getting the house in Lafayette but there will be many more opportunities in the future as "high end" real estate prices trend downward.

2010-01-04T07:34:00.000-08:00

The Sleep at Night Portfolio

During my years of investing I have found that I am very risk adverse. I hate taking risks in my investments although I also find it distasteful to miss out on big gains in the stock market. My portfolio needs to trend with the S and P but at times trend away from The Herd. The Herd is the group of momentum speculators that distort valuations in dysfunctional markets. The Herd does not look at historical valuation trends. The Herd drove the market to unsustainable highs in October of 2007 and also to extreme value in March of 2009.

I was out of the market in October of 2007 and dove into the market in March of 2009. Presently the stock market is 20% overvalued by historical standards. I have adjusted my portfolio to take only 15% of the gains on upswings in the market. I will move in and out of the market for the next year or so trending away from the movements of The Herd. I would like to lean toward market neutral until The Herd realizes that the taxpayer ATM can't create future wealth. It took The Herd 5 years to realize that the homeowner ATM was not the road to riches.

My concern back in 2007 was capital preservation. My sleep at night portfolio managed well during the recession. It is up about 14% since October 2007. The S and P index is down 25% over the same period.

My portfolio will always under perform during periods of market overvaluation. Presently the S and P is about 20% overvalued. I have only taken 60% of the profits in the S and P since May. But when the market was undervalued in March and April I was able to take 120% of the profits of my benchmark. My investments ended the year only taking 95% of the S and P gains. Very boring but of course I didn't lose an hour of sleep worrying about my investments.

My 95% take rate for 2009 does not include the small 1.2% distribution that I pay myself for managing the account. This distribution is annuitized so that I don't have to pay the early distribution penalty to the IRS. The management payment that I pay myself is similar to what most people pay their financial advisors or mutual fund managers. Most people don't realize how much money is siphoned out of market gains from investment management. I keep this money separate just as a reminder.

If you have a financial planner that invests in mutual funds there would be a 1% charge for the planner on top of an average 1.25% charge for the mutual fund manager. In my situation I am my own money manager and the bulk of my investments are invested directly in stocks. Therefore I pay no fees or charges. This is a very large savings in the long run. Let me explain why.

Presently the stock market is overvalued by 20% so I feel that it is prudent to only expect to make gains on the 6% corporate profits over the next 20 years, not including inflation. Let us assume that your financial planner takes 1% of your investment and your mutual fund company takes 1.25%. If there are 6% stock gains over the next 20 years then your portfolio will end up with an overall 3.75% year over year return. That works out to a little over 131% return before inflation for twenty years. Without the money management fees you would make 221%. Quite a difference.

If you feel that the 6% return is low please Google "Japanese lost decade". You will see that thanks to the advice of top Wall Street economists Japan has been able to have almost zero equity growth for twenty years. So I don't think 6% growth is unrealistic.

Our Financial Elite have a very impressive track record in Japan and they are presently providing the same unsound advice to our government.

So in theory, assuming 6% stock market returns, you can almost double your investment return by managing your own account and investing directly in stocks. It's not for everyone but it is sure something to think about. There is also a side benefit to managing your own investments. Less of our nation's resources are funneled to the Financial Elite of Wall Street.

One other area that will be a disappointment in the future are bonds. As interest rates rise long term bonds decrease in value. We have spent the last twenty years on the windward side of the interest rate mega bubble. These gail force tailwinds have made massive gains for stocks, real estate and especially bonds. We are starting a new mega bubble which means severe headwinds for bonds and real estate. This is the end of easy money and no one is talking about it or seems to care. It is a little disconcerting.

This is my advice. Don't plan on using speculation as an investment vehicle. Learn to save. I sold my house in 2007. Presently I am saving 50% of my "take home" household income while renting a home. It sounds crazy but to me it just seems like the prudent thing to do in this dysfunctional economic environment. This is an extreme contrast to 15 years ago. From 1995 until 2005 I didn't save a dime. It was almost foolish to save. There were huge stock gains and even bigger housing gains. During that period saving was unnecessary.

This easy money period is over. We have ended the interest rate mega bubble and we are creating another. There will be no gains in housing or bonds for the next 10 years. Stocks will gain 6% a year. If you are worried about inflation please Google "Japanese lost decade" to quell your fears. It is very unlikely that The Federal Reserve can create significant inflation before interest rates rise above historical trend. Once we see real interest rates above 10% then we can talk about inflation. Presently we have no idea what the real interest rate is. The government is spending trillions to distort the market. This market manipulation could go on for a generation just like Japan of the last twenty years.

As a country we need to save, pay down our debt and stop speculating. During the 1990's and 2000's the easy money made anyone who borrowed money and speculated with it a financial genius. Stocks, bonds, real estate, collectables, commodities, it really didn't matter where the money was invested. It was a boomtime and everyone made money.

The investment winds have shifted. For the next 10 years we will have a lot less financial geniuses. The smart money will be saved.

2009-12-20T06:14:00.000-08:00

GDP growth vs Debt growth:

I listened to an economic debate last night on NPR between Jeremy Siegel and John Mauldin. Jeremy Siegel is a professor of economics at the Wharton school of business at UPenn and has in the past been a perma bull. John Mauldin writes one of the most widely read economic newsletters on the internet and is more of a perma bear. Here is the link if you want to listen: http://www.onpointradio.org/2009/12/an-economic-warning

Each economist gave his prediction of the strength in the economy over the next few years.

Jeremy Siegel predicted that the economy will rebound at a 6% to 7% pace over the next few years. His only premise is that the the current recovery will mirror recoveries of the past after similar deep recessions.

John Mauldin predicted that the economy will rebound at a 2% to 3% pace over the next year with a chance at a double dip recession in 2011. John's premise is that this situation is not like other recessions. In the next few years we as a country will deleverage and will have to start paying off our debt. We will even have to start saving. He also stated that there will be tax increases in 2011 as the Bush tax cuts phase out. His last observation is that it could take a decade or more for unemployment to trend below the 8% range. We are in a new "muddle through" economy.

Who do I think is correct?

It will be directly related to how much we borrow as a nation.

For Jeremy Siegel to be correct the government will have to borrow $2 trillion a year.

For John Mauldin to be correct we will only have to borrow $1 trillion a year.

Either scenario can be correct depending on how much debt our government creates. We could even create other scenarios by borrowing more money. $3 trillion, $4 trillion ... how much GDP growth do you want?

Both scenarios of Jeremy and John use debt, inflation, smoke and mirrors to solve our financial problems. Both of the scenarios will create bloated government and each will create huge distortions in the capital markets.

Why are both outcomes equally distasteful? Because our country's financial problems are already systemic and as a nation we just don't care. We have more debt financed at lower interest rates than anytime in our nation's history. The Federal Reserve has made a huge bet that it can create inflation to get our country out of this monstrous debt. The bet is premised on creating enough additional debt to force inflation so we will be able to pay off the monstrous debt that we already hold.

How monstrous is this debt?

The most recent Flow of Funds information from the Federal Reserve shows that the net holding value of homes with a mortgage is zero. Yes zero. $10 trillion of mortgages netted against a housing value of $10 trillion is zero for homes with a mortgage.

It is very odd to think that if you take out the subset of people that own their home outright then our housing stock is worthless. Of course as an accountant I might tend to value it at less than zero due to the $600 billion in sales commissions to exit this worthless $10 trillion investment.

Strike One.

Presently our banks are allowing hundreds of thousands of speculators to live in houses without paying mortgage payments. These squatters have been living in the homes for as long as two years before the bank will start to foreclose. The banks are doing this because if they foreclosed on everyone right now then their balance sheets would be insolvent. Presently The Federal Reserve is funneling trillions of dollars of taxpayer money(future debt) to the insolvent banks so the banks can allow the speculators to occupy the bank owned homes. This government debt also allows the banks to give out record bonuses this year.

Strike Two.

Presently the banks are not lending enough money to keep real estate prices in a bubble. Wall Street and housing speculators don't want to give back the false profits of the real estate bubble. Therefore the government is creating more debt through Fannie Mae and Freddie Mac to keep the bubble prices propped up. This will cost hundreds of billions in the next few years as Fannie and Freddie make bad loans to the next wave of speculators in this insolvent market.

Strike Three.

So the group of people that have mortgages on their homes are insolvent. The banks are insolvent and our government is insolvent. The only thing that is keeping this game going is debt.

Wall Street economists have already made the policy decisions for our nation. Negative GDP is not an option. Affordable homes are not an option. Lower prices are not an option. Losses for speculators are not an option. Sound government is not an option.

Whatever GDP number we get for the forth quarter will be smoke and mirrors. A large amount of debt by the government to create a small amount of growth for our economy. It really does not make sense. Unless or course you are a Wall Street economist.