Taking Risks and Reaping Rewards

Another Sign of China's Collapse

Often times I hope I am wrong.

The FT reported that forest land that is to be preserved has been used as collateral in bank loans to build infrastructure by local governments. So if the loans go bad, they will have to sell the land to pay off the debt.

Since they are unlikely to be willing to part with large tracks of forest and other natural wonders, a bank bailout would be the natural option.

But why would the loans go bad?

Because no one is using the buildings that were built by their funds.

The FT reported that Chenggong is a new town near Kunming, one of the main cities in the south-west of China.

Construction started in 2003 and the results are now apparent in 13 immaculate local government buildings, each clad in marble tiles.

A high school boasts an impressive indoor swimming pool and several of the region's main universities have built large campuses.

Pristine high-rise apartment blocks stand in rows, their new windows glinting in the subtropical sun.

The one drawback: at the moment, Chenggong is almost completely empty. Its wide streets are all but bereft of traffic, a bank branch has no customers and leaves collect in the foyers of the municipal offices.

What's worse is that haven't stopped building or borrowing to do so. While China's GDP has grown substantially, the debt to GDP ratio has barely budged. The explanation of this is that the growth was from spending by state-owned financial institutions, not directly from the government. Loans last year more than doubled to nearly a third of GDP. 

Can you say unsustainable?

To put that in perspective it would be as if Bank of America Wells Fargo, etc. were state owned and they loaned out 33% of GDP, which would be almost $5,000,000,000,000.00 (trillion) if it were happening here. 

Investment that was once 25% of the Chinese economy is now more like 50%.That means that for every dollar (yuan) spent in China, 50 cents of it is by the government. Again in perspective, that would be $7,000,000,000,000.00 (trillion) in government spending if it were happening here.

China is trying to increase domestic consumption, reduce foreign demand, and reduce government spending, but it's a long and difficult process. One that we hope will go smoothly, but as I often say, hope is not an investment strategy.

Here's why it matters to you

When the highly likely burst of the China property bubble occurs, the repercussions won't stay inside their borders. It would easily drag the rest of the world into a double dip recession.

And we are pretty much out of economic bullets to shoot at another recession, so the next one will likely be worse than the last one.

Worse yet, China could be forced to quickly appreciate their currency which they have pegged to the dollar and is keeping our imported purchases of their goods at low prices, or they might dump the US government debt which they own plenty of. Either would send the dollar plummeting and the prices of imported goods skyrocketing.

And if that happened with no economic bullets left in our gun, well...let's just not go there before we have to.  

In conclusion, with no one living in an entire new city, it's hard to think that everything will be fine and this will all work itself out, but I sure hope I am wrong.

Chugging Ahead or Are We?

The Federal Reserve Open Market Committee (FOMC) left interest rates unchanged and released a statement that updated their position on the economy just a bit. A comparison of this statement vs. the previous one in January can be found HERE.

Notable changes were changing the words "Deterioration in the labor market was abating" to "The labor market is stabilizing." While that's little consolation if you are out of a job, it's clearly a minor improvement.

Also, the addition of "business spending has risen significantly" is a positive sign as is the removal of the special liquidity they put in place during the crisis.

Could this be a return to normalcy? Are we going to just go chugging ahead?

Maybe.

But before we go to our cabin and take a nap feeling all is well, it should be noted that what they didn't change may be more telling.

They continue with language that "bank lending continues to contract" which means that banks are doing something other than lending with their money.

The one dissenting vote, from Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, continued his stance that things have "improved enough that the expectation of low rates for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability."

What can you learn from this?

The economy is still in need of help because otherwise they would be moving interest rates up to more normal levels.

The rear view mirror shows some positive signs that we are headed on the right path, but the windshield is still foggy and there are still some icebergs out there.

So full steam ahead is very risky.

The reduction in the special liquidity is the first step in normalizing monetary policy and before they move interest rates, the Fed will have to see how the market reacts to the reduction this action.

The potential for another bubble is already forming. (or worse, one has already formed!) This is the concern of Fed President Hoenig.

Me too.

The banks are able to borrow money at basically zero percent. Anything they do with it is a positive return. They could lend this money to consumers or businesses, but consumers aren't interested in excessive borrowing and small businesses are risky. So banks take that interest free money and invest it in stocks and other assets that they can sell quickly should an iceberg appear. Also, they are still using leverage, perhaps high leverage, which exacerbates the problem and increases their desire to pull back quickly at any sign of real trouble.

That desire to pull back the sign of trouble wouldn't be there if asset prices were fairly valued. But the markets are priced at levels that anticipate a solid future expansion. If that's not what happens, all that money put into the markets will disappear, probably fairly quickly. The potential for a quick pull back combines with plenty of potential reasons to have a pull back to provide clear concern about the foggy future.

Icebergs...I hate icebergs.

Basically, It's Over...Or Is It?

Warren Buffett, the Oracle of Omaha and the second richest person in the world, released his annual shareholder letter recently.

This is required reading for any investment professional. They already know that.

You should read it too. But assuming you won't, I will try to summarize the salient points from which you can learn and apply to your own situation.

In case you aren't aware Mr. Buffett has a partner and consigliere in Charlie Munger.

And that's where we'll start.

Mr. Munger's sharp mind has been written about for quite sometime as he clearly sees through the fog and cuts to the chase. His recent article entitled, "Basically, It's Over" isn't to be taken lightly. 

Again, THIS IS MUST READING for anyone concerned about the world around us.

He calls it a parable about how one nation came to financial ruin. Clearly this as a warning shot across the bow of our current economic brouhaha.

Pessimistic? Yes.

Too pessimistic? Maybe.

Clearly on point with a valuable message? Duh! Of course.

Expect nothing less from Mr. Munger.

Here's here's a quick take on this:

• People with a vested interest don't care about much else. It's difficult to fix our problems because to do so would impact the profiteering of someone else. To protect those profits, they make political contributions to prevent the fix. Hence, same old, same old. Which won't work forever, because...
  
• Avoiding trouble doesn't make it go away.  Our health care situation is untenable long term as is our fascination of short term "casino" profits over long term wealth creation. But...
• This can go on for a long time. We won't collapse overnight, again. We almost did that just a short time ago. So we have a bit of time until it will happen again. However we are clearly still speeding toward a cliff. If we don't change our course...
• It will very likely will come to a sorrowful conclusion. The longer we continue on our current road, the more painful the conclusion will be. And if course isn't going to change, you need to...
• Make sure you aren't sorrowful when it concludes. If leaders won't listen to BenFranklin LeeKwonYou Volkker (read the article to understand this reference), they aren't going to listen to you or me. So your best move is to stay abreast of the situation and use our understanding of it to your advantage.

(Warning... this requires real work - actually reading and thinking. If you are out of practice at either, now is the time to start training.)

So is it basically over?

Clearly not for Mr. Munger or Mr. Buffett. 

I am doing what I can to make sure it's not over for me either.

Hopefully, it won't be over for you. But that depends on you.(Did you read the article yet? Again, work required. You might want to start there.)

Ouch! Your Lack of Confidence Really Hurts

This can't be spun to be anything that painful, bad news.

Today, the new economic data shows a decided drop in consumer confidence.

The Conference Board, a private research group, said its index of consumer confidence declined by 10 points or fell by almost 20%!

In February the index fell to 46.0, from a revised 56.5 in January. The February reading was far below expectations by economists.

The present situation index, a gage of consumers' assessment of current economic conditions, fell to 19.4 this month from 25.2 in January, originally reported as 25.0. The February index was the lowest in 27 years. 

(Note: Always pay attention to numbers that are the the highest or lowest in decades.)

Why this is important to you

The economy is comprised of (C) consumer spending, (I) business spending or investment, (G) government spending, and (NX) net exports - the difference in what is spent on domestic goods minus what is spent on foreign goods. 

The breakdown (in round numbers) is 70% C + 20% I + 20% G + (-10%) NX for 100% of the Gross Domestic Product or GDP.

If consumers aren't confident, they don't spend. If they don't spend, given that they (we) are 70% of the economy, the economy can't grow. If they economy doesn't grow, it does the opposite. It goes into recession. 

What's worse than one isolated number is that now it will hit the news wires and stories will circulate, like this one, that say the economy is in trouble. That will add to a downward pressure on confidence which can start feeding upon itself creating a downward spiral. 

That's why this wasn't good news at all for anyone.

Ouch! That's going to leave a mark. 

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.

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?