Taking Risks and Reaping Rewards

Another Iceberg in the Foggy Distance

The Capitan of the Titanic was asleep in his cabin when they hit the iceberg.

In today's dangerous waters, it's tough to get any sleep at all because of icebergs like this: High Yield Debt Refunding Requirements

A recent Moody's report says, "U.S. speculative-grade issuers face more than $800 billion in refunding requirements over the next five years, including $555 billion in bank credit facilities and $250 billion of bonds. About 995 of our 1,300 speculative-grade issuers have debt maturing over this period. The enormous amount of debt due over the next five years stems from a robust period of refinancing and leveraged buy-out activity prior to summer 2007."

The tidal wave of junk bond refinancing that will need to take place is concerning as the market may not be in a position to absorb such debt or have the risk appetite for it.

This comes as the Fed, as will other global banks, will very likely be increasing interest rates or may already have, so even if the debt can be rolled over, the price isn't certain at all.

But assuming someone will to lend them money at some price, this can impact the other debt markets and a crowding out could occur. This means other needy folks can't borrow the money they want or need. All of which slows the economy going forward.

More Yuck!

What this means to you

Right this minute, nothing. The debt has been rolled over and we are in another eye of the hurricane waiting for the next wall to see how hard it will hit us.

This is really just another lesson in looking out the foggy windshield and looking for things that might need to be avoided in the future.

Like icebergs of junk bonds.

The Impact of Kicking the Fiscal Can Down the Road

The EU's top economy official, Olli Rehn, said today that he wanted the Greek government to supply answers by Friday on how it used currency swaps and how that affected debt and deficit figures.

European Union finance ministers also gave Greece a deadline of March 16 to show that it can make big spending cuts to bring its deficit down from the EU's highest, 12.7 percent, to 8.7 percent this year.

In comparison, the US deficit is growing - at an unsustainable rate.

Further the EU finance ministers said that this was essential to "remove the risk of jeopardizing the proper functioning of economic and monetary union."

So what's apparent here is that Greece has been kicking it's fiscal can down the road and now the can has grown so big that it can't be kicked any further. Deadlines are imminent.

Sound familiar?

What we can learn from this

California, along with many other states and local jurisdictions, often kick their fiscal problems into future years. This may work in the short term, but over the long term, the can grows so large that kicking it again will break your foot. 

Federally, we are not only kicking the can down the road to our children, the lead weights of Social Security and Medicare are guaranteed to prevent us kicking the can at some point.

And currently we are filing our can with more lead, in terms of deficit borrowing, that makes it harder to kick right now. 

The bottom line is that Greece is just an example of what we can expect in our own future if we don't get our fiscal can in order. 

You can only kick the can so far until it kicks back.

Could China Collapse?

China announced that they are trying to slow the pace of lending.

That move, along with several others recently, is sending fear about a China collapse throughout the markets. 

It's pretty clear that China has been lending too much money as this chart shows:

The growth needs to be slowed, not only for the typical reason of inflation, but because China is producing a lot of goods, especially real estate, that it can't use efficiently. In fact, many buildings are just sitting empty.

Many pundits have pontificated that Shanghai and Hong Kong have their own real estate bubble going on. 

The FT reported that former Morgan Stanley chief Asia economist Andy Xie said, "China's asset markets are a Ponzi scheme."

A ponzi scheme is scam where the scam artist uses money paid from new investors to pay off previous investors and they never really make any real profit. This works until there are no more new investors and then system collapses. 

Could this really be what's happening in China?

In addition to material from reasonably reliable sources, I was fortunate enough to have dinner with a good friend recently that just came back from three months in China.

In sharing his experience he made it clear not only was China going to have significant real estate problems, but also the people in China that are involved know it.

He felt their attitude is that they need to get as much as they can right now because they don't know how long the good times will last.

Further, he said the pace was at a furious dot-com like speed. Clearly not something that can continue.

While this is anecdotal evidence, there is no better way to understand what is going on than to talk to the people involved. 

Plus this is just another confirmation of the information that is already in circulation. 

Why this matters to you

China led the global markets out of the recent downturn by increasing spending faster than any other nation and creating demand that pushed all markets higher. 

The reversal of that would push most, if not all, markets lower and that's bad for everyone.

China is now a big part of the global economy. It will likely surpass Japan shortly to become number two behind the United States. (Assuming you don't add up all the countries in the EU).

They're so big and so integral that if they have a problem, then we have a problem.

And we don't need any more problems.

Just because the view of their past results, outstanding growth for over a decade, is clear in the rear view mirror, there is no guarantee that the road ahead won't have a few sharp turns in it. 

Keep both eyes pealed on the foggy windshield ahead.

Could China Collapse?

Yes.

3 Ways To Relieve Financial Pressure

Financial pressure runs rampant these days.

If you aren't feeling it, you know someone who is.

In a 'do better,' 'accumulate more,' 'keep up or catch up,' and 'whatever you do don't let them see you sweat' culture, pressure is accepted as a given. But when a major crisis happens, the pressure is magnified.

More people lose jobs, all assets tank, debt increases and pressure mounts to very unhealthy and unproductive levels. For those feeling excessive financial pressure, here are three ways that you can find some relief.

1. Communicate: Under stress, it's more comfortable to sweep the problem under the rug and only clean up the mess when it gets out of hand. This increases the pressure, especially in couples. To relieve that pressure, clean house, and get the problems out in the open.

When communication opens up, get beyond griping and venting about the past, and move toward forgiving past actions, both in others and in yourself.

Where you are now and how you move forward is what really matters. Relief for many can stem from just talking it through.

2. Plan: If your previous financial plan worked, you wouldn't be feeling pressure. So the obvious thing to do is revise and update your plan and begin working it.

Analyze what happened, where you are now, and update where realistically you want to be and can go in the future. While the path to this new future will still have some bumps, moving forward should relieve feelings of hopelessness and despair.

This may start with a cash flow statement, a new budget, a net worth calculation, or something less mathematical such as reviewing credit card statements or discussing job options. Just having new goals will allow some forward movement and that can relieve the quandary about what to do.

3. Work: Idle minds dwell on past events, often reliving them, which can lead to increasing pressure.

One way to relieve this pressure is to stay focused on what you are doing and work harder to be more productive. Increasing your output will not only take your mind off your troubles, but it will also move you toward improving your situation.

If you are working at capacity, then consider what you are working on and its impact on your situation. You might find that you could be more productive doing something else.

A sense of accomplishment works wonders for relieving pressure. While the common advice of laughter and exercise will work wonders for relieving pressure, more specific actions may be more useful in this current financial environment.

The macro economy is beyond your control, but the things you do control can make a big difference. By increasing your communication, revising your financial plan, and increasing your productivity, you may find relief from your current financial pressures.

Eye of the Housing Hurricane

After the first wall of the hurricane passes, there's a lull.

You're in the eye of the hurricane. 

It may feel like it's over, but it's not. It just feels better because the wind stopped blowing for a minute. But when the second wall comes through, it could be just as bad as the first.

In housing, we weathered the storm - BARELY. 

But that was just the first wall. The second wall is approaching and some us need to take cover. 

Here's a chart that shows the impending mortgages that are going to reset in the next year or so. 

 

 As you can see, the second wall is coming. The first was the subprime loans, shown here in green. The second is the Option Adjustable Rate (Option ARM) loans, shown here in beige.

An Option ARM loan is often called a pick a payment loan as the borrower can decide what type of payment they want to make. Typically they can choose between a fixed rate of 15 or 30 years or interest only or a negative amortization minimum payment. 

The first two options are basically regular loans, so while the option exists, no one chooses it. The second two are where the problems come in.

Interest only provides a lower payment as you aren't paying the prinicpal back. But eventually, you have to start paying back the principal and when that happens the loan payment resets potentially sharply upward. 

If that wasn't enough of a problem, the other option is a negative amortization payment where not only have borrowers avoiding paying on the principal, they haven't even been paying the full interest due on the loan. So the balance due has been increasing. 

For example, if you borrowed $400,000 on a house, paid less than the interest on the loan each month, you could owe $440,000 now years later, and that home might only be worth $250,000.

88 percent of Option ARMs originated between 2004 and 2007 are going to adjust higher between now and 2012. Those option ARM borrowers could see their housing bills go up as much as 63 percent, according to Fitch ratings.

 

With house values still struggling, when this next wall of payment resets hits, who's going to stay in their house with that kind of payment increase and little hope for an increase in value?

Some reports are citing almost 500,000 option ARM loans in California that will reset between now and 2012. With the state already struggling, people won't be able to make the higher payments, putting a huge block of inventory on the market, which will simply kill prices in the "Golden" State.

What's even worse is that the Federal Reserve is going to start raising interest rates to offset potential inflation. Many option ARM loans will go up with them so the payments just get bigger.

Why this matters to you

You may be thinking that this doesn't impact you because you aren't in one of these crazy loans. You may even think that some people deserve to lose their home because they acted recklessly and this should be a lesson to them. 

Well, a lesson it is, but it does impact you too. Why?

Because another wave of housing foreclosures will impact the overall economy and will certainly impact residential real estate prices.

Going from "owning" a house to renting an apartment may not be the disaster of a lifetime, but no one does it, and then goes out and throws a party. And those watching it happen on TV and talking about it around the water cooler, don't throw parties either.

Consumer spending is almost 70% of the economy and if consumers are seeing people being thrown out of their homes, their own home price falling still, and the economy slowing again, it's likely they will tighten their purse strings. Which means the economy slows just that much faster.

We rarely get such a glimpse out the foggy windshield to the future. But in this case, it sure seems like the fog parted and it's pretty easy to see the road ahead. 

The next wall of the hurricane is approaching. It's on the radar and we can see it.  Batten down the hatches, and hold on. This could be a rough ride.

This is not a drill.

Greek Tragedy Coming to a Theatre Near You

Global markets are focused on the situation in Greece and the need for Germany to step up and bail out the troubled nation.

Protesters will likely take to the streets if something doesn't get resolved this week as they need to borrow money by next week or go into default.

It's likely that either Germany by itself or with a nudge from the EU and ECB will take steps to avoid widespread panic. But that's not guaranteed and has never been done.

Anytime you are in uncharted waters, you can hit icebergs you didn't see coming.

The solution to Greek situation is financially simple, but politically almost impossible.

Simply increase taxes and decrease benefits to put their fiscal house in order.

To put it in personal financial terms, work more and spend less. (Not many politicians running on that platform are there?)

They have proposed raising the retirement age from 61 to 63, and predictably, the baklava hit the fan.

While the extension to 63 doesn't seem like a Greek Tragedy to us, it sure does to them.

Why this matters to you

California has the lowest debt rating of any State and both Moody's and Fitch rate it below Greece!

Note: California's economy is five to six times larger than Greece.

And California isn't the only state that is in this trouble.

Because Greece is a member of the European Union, they don't have their own currency. So they can't pay their bills by printing money like our Federal Government can or any other truly sovereign nation.

Greece is like California in this respect. They have to pay their bills by borrowing money or collecting taxes. When the lenders stop lending, the only option is to collect more taxes or go bankrupt.

But this won't happen to us. The federal government will save us.

Won't it?

Here's the rub.

For Germany, or the ECB for that matter, to agree to bail out Greece, they are going to have conditions and they are concerned that whatever is done for Greece will need to be done for Portugal, Spain, Ireland, Iceland and maybe more.

So the conditions will be harsh; increasing taxes, cutting programs, other measures to put their fiscal house in order.

Exactly what the protesters are against and what will increase the unrest.

For the US federal government to bail out California, a similar problem exists. They could help us, but then they would have to help many, if not all, the other states.

And the conditions of their help could be more harsh that Californian's would like because they need to stop every other state from asking for the same thing.

Governments are no different than individuals. If you can't pay your bills, your lifestyle has to change until you can.

Most Americans aren't paying attention to Greece or any of the problems "over there" but they should be.

It's a rehearsal of our own version of a Greek Tragedy that could be coming to theater near you.

 

 

Bill Gates is still learning. R U?

Bill Gates writes a blog.

Who knew? 

It's called the Gates Notes and he covers what he's thinking, learning and doing.

While it might be interesting to some to find out what he is doing to help with Malaria in Africa, education in America, or system development to deal with the next pandemic - I assure you he is doing stellar work in all those areas and more - what it more useful for most of us is insight into how he thinks and acts.

If you had all the money in the world, which he actually does, then what would you do with your time?

Let's see... Work on your golf game? Travel to far away lands? Have lunch on your private yacht while playing cribbage at $1 million a point? Go to glamorous events cloaked in charities to reduce the guilt from your gluttony? 

Maybe. 

What most people wouldn't do is study economics.

After all, once you have all the money you could ever need, haven't you actually conquered economics?

In a recent post in his blog, thegatesnotes.com, Bill Gates says that he has been learning from the Great Lectures from the Teaching Company. He started with the sciences; biology, geology, medicine. The moved to history and then economics. 

Why this matters to you

Learning isn't something you do in school and forget.

Some of us have forgotten that.

We live in a complicated world bulging with information. At no time in history has it been so easy to learn something new. But with all the opportunity available to us comes another problem. 

How do we choose what we spend our limited time on learning?

Do we learn software to do our taxes? Do we learn how to manage our investments? Do we learn new skills so we can progress in our job? Do we learn about our health, our wealth, or our military stealth? 

(Sorry, I couldn't find anything else that rhymed with wealth and health and the rhythm seemed to need three terms.)

The point is that time is limited, energy is limited, but the amount you are capable of learning is unlimited. 

Overwhelming choice often leads to no choice at all and a confused mind typically says no. 

So we blow it off, don't bother learning anything, and just keep doing what we are doing, hoping that things will work out. 

To overcome this, start slow with a topic you like, that is fairly simple, and are interested in. Then start learning more about it. No midterms. No cramming. Just learning. Scan the web, watch some pod casts, read a book.

There's something I bet most haven't done lately. READ a BOOK. 

Just narrow it down to one thing and start somewhere. 

Once in the habit of continually learning, it's highly likely your life will change - for the better. 

Try it and see.

If the richest guy in the world spends his time doing it, then shouldn't you give it  a try?

Greenspan's Right

On Meet the Press yesterday, former Federal Reserve Chairman Alan Greenspan said a U.S. economic recovery is "going to be a slow, trudging thing," and that he "would get very concerned" if stock prices continue to fall.

He went on to say that a drop in stock prices is "...more than a warning sign. It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity."

He's right.

And we should be worried about this.

The masses that feels like they are hanging on by a thread, but at least their 401K has recovered somewhat, could easily become very discouraged at significant return to lower stock prices.

The result of that would be to spend less, which in turn would slow the economy, which in turn would lower stock values further, which would push people to spend even less.

If the downward spiral isn't broken fairly quickly, which is easier said than done, then the description of the economy recovery being "a slow trudging thing" would start to sound good. 

Downward spirals can last a long time. Look at what happened to Japan over the last two decades.

In the last 20 years the Nikkei 225, the broad measure of the Japanese stock market, has fallen from a high of 40,000 to around 10,000 today. The last 20 years in Japan show clearly that a major modern industrial nation can go long periods in a downward spiral. 

Will we slide this much or this long? 

We already lost a decade as the Dow is basically at the same place it was 10 years ago and the NASDAQ is down over 50% from 2000 highs. So one could view this as 10 years down, 10 years to go. 

Looking out the foggy windshield doesn't often provide clarity, but it's where we should be looking nonetheless.

Greenspan's right. If the markets continue to slide, the economic road ahead may be not only twisty and bumpy, but downhill.

Superbowl Prediction Folly

Parade, the insert in many Sunday papers has a section called the "Intelligence Report"

Intelligent? Well, let's see about that.

The article, The Truth Behind Super Bowl Myths caught my attention today as they knew it would.

But the pull quote saying, "Does the big game predict the stock market? Strangely, yes," made me stop to actually read it. 

Of course, it's just baloney. But it's misleading baloney so I thought I would clear it up. 

Here's what it said: 

"MYTH #6. The outcome of the Super Bowl predicts the stock market's performance for the coming year. Absurd as it may sound, this is the only Super Bowl myth with clear evidence to back it up. The "Super Bowl Indicator" says that if a team from the old American Football League wins, stock markets go down; if one from the old National Football League wins, the markets will go up. Things get tricky when expansion teams or teams that have relocated make it to the big game, but many still have links to former AFL or NFL teams or cities. Robert Stovall, an investment strategist from Sarasota, Fla., who tracks the indicator, says it has been accurate for 34 of the 43 Super Bowls played thus far, a rate "better than any gaggle of gurus I've ever heard of." Stovall doesn't recommend that investors act on its winning record, but, he says, " It does make me feel better when we have an all-clear from the Super Bowl Indicator."  

An "all-clear from the Super Bowl Indicator"? Is he kidding or is he delusional? I'll assume the former and let it go.

But a scientist, before accepting that premise, would wonder if the second event was caused by the first event. In other words, is there a causal (not casual) relationship between the two? And if so, why?

Simply because there is a limited set of data that shows some anecdotal correlation doesn't make it causal.

If you flip a coin 43 times and it comes up heads 34 times, that still doesn't mean that the stock market is going to go up or down the next time you flip. It's irrelevant. The two aren't related.

For there to be a causal relationship and the Super Bowl to actually be a predictor of the future stock market, then the first event, the Super Bowl, would have to cause the second event, the stock market, to change.

If there isn't a causal relationship, they are independent events. The first has no baring on the second. 

Saying the stock market is dependent upon the Super Bowl winner, simply put, is crazy talk.

Why this matters to you

When thinking about the decisions in your life, especially the important ones, it's crucial to not make assumptions based on a faulty premise. 

Now I know most of you are thinking this is silly as no one would invest based on a football game.

But it wasn't that long ago that many people believed that the real estate market will never go down, the interest rate on home loans won't adjust, or if it does, refinancing options will be available.

Faulty premises all, the result of which cost many people dearly.

Telling people that the big game predicts the stock market may catch people's attention in the newspaper, drawing readers to increase advertising dollars.

But it's emblematic of the problem with articles called the "Intelligence Report" printed in widespread publications that have baloney like this in them: Some people believe it.

 

A Look Into Our Fiscal Future

Looking out the windshield into the foggy future is always somewhat uncertain. So we look for a clear break in the fog to see where we are going.

Here's a BIG, pretty darn clear, clue about the road ahead. 

It's from the Congressional Budget Office report on the Long Term Budget Outlook that can be found HERE.

In a nutshell, if we don't get spending under control, and even if we do, our fiscal future shows us driving into a wall of debt, full speed actually. 

The main problem isn't the bills we are running up now, although they certainly don't help. It's Medicare and Medical that is going to kill us. 

(Note: I do love the irony that our health care program is going to kill us.)

The difference between the two projections is the baseline scenario assumes no changes in the laws on the books. The alternative assumes that certain changes will happen. 

So the alternative shows that upcoming changes just make things worse? That begs the question then why do them?

As we have seen recently in the PIIGS and other countries that are struggling with their debt, even large developed nations face stiff austerity programs that become necessary at that point they can't pay their bills.

And the longer we wait, the bigger the bills. 

We aren't immune to this as this chart suggests. Far from it.

The CBO Report says, "...an immediate and permanent reduction in spending or an immediate and permanent increase in revenues equal to 3.2 percent of GDP would be needed to create a sustainable fiscal path for the next three-quarters of a century under the baseline estimate, but the alternative estimate is 8.1%."

If we use GDP of $14 Trillion, then 3.2% is $448 Billion, and 8.1? is $1.13 Trillion that we need to increase taxes or cut spending.

The budget that was just proposed was $3.8 Trillion, so a spending cut would need to be about a quarter of the entire federal budget. 

And a tax hike, given 308 million people would be either, $1,454 per person increase per year, or $3,668 per person per year, depending on which estimate was used

And that's if they act today. Which we clearly aren't going to do.

Why this matters

Clearly we can't sustain the path we are on. Something will change.

The key in planing for the worst and hoping for the best is to have a plan in the first place.

For those counting on stable tax rates, Social Security, and Medicare in the decades to come. That's not what we see when looking out the foggy windshield into the future. 

So for those with a plan, plan accordingly, and those without a plan, get one.