"One of the true tests of leadership is the ability to recognize a problem before it becomes an emergency." - Arnold H Glasgow
We all knew that the Fiscal Cliff was approaching(we have known this for four years) and we all knew that the leadership of the United States would wait until the last minute to try to come to a resolution. It is clear that no resolution will be found between now and the end of the year and if one is found it will be another band aid placed on a fractured skull. There is no way to complete a proper working solution to this monumental problem in three days.
Furthermore while this is being debated the news reels report that they are coming together, falling apart, working bilaterally, working unilaterally, not working at all and any other fodder to make their readers more confused than ever. The noise from the press is creating a sense of urgency when in actual fact the Obama agenda is very clear - let the Fiscal Cliff happen as it was a Bush era tax cut that should be reversed. Drag the economy into recession and point a finger at the other side for creating the mess. Once again more finger pointing and no leadership.
As this all bubbles to the surface the debt ceiling is ounce again looming its head. The Treasury Secretary, Timothy Geithner, has said that the United States will reach the debt ceiling of $16.4 trillion by the end of the year. This level of debt is now over 100 percent of GDP and is accelerating at a rate of around 6 percent a year, more than triple the growth of GDP!
Now he will still be able to pay bills through February by moving money around in a take from Peter to pay Paul scenario but this too needs to be addressed. As the Obama administration will spend more than a trillion a year for the next four years the ceiling will need to be raised but this once again circles round to the Fiscal Cliff and how much in additional taxes will be received once the Bush tax cuts expire. A mess to be sure and one that has been left far too late once again showing that our current leadership (and I am talking about both sides of the isle) has one thing on its mind - saving their jobs!
How much longer can this leadership vacuum last before the people have had enough? Surprisingly the vote for more of the same was overwhelming but in in times of economic weakness it is not that difficult to buy votes by creating unfunded social programs. The problem now is that paying for these programs is becoming harder and harder to do and all the while the debt rises faster and faster. This debt will need to be repaid or at the very least a plan worked out on how to balance the budget, but the political bickering is creating a void between the politicians and reality and this is not an environment where a workable solution will be found. More often than not this is an environment where the economy runs into a brick wall at high speed.
Therefore in this type of political environment it is extremely important to protect your assets. The risks to investing in the stock market far outweigh any perceived upside as there is no way to hazard a vague guess as to the outcome. We are clearly at the mercy of our political leadership and it is very clear that no leader exists so investing in the market is like taking a ride on a sailboat without attending to the rudder.
I would like to take this opportunity to wish all my readers a wonderful New Year and a very prosperous 2013.
Friday, December 28, 2012
Friday, December 21, 2012
The Return of the HELOC
"If one considered life as a simple loan, one would perhaps be less exacting. We possess actually nothing; everything goes through us." - Eugene Delacroix
Back in the heyday of the housing bubble HELOCs (home equity lines of credit) were used as a type of a cash machine by the consumer. For six years over $110 billion dollars a year was withdrawn from the equity of houses. Consumers viewed it as money that was theirs and spent it freely creating a massive surge for consumer goods and services. Banks wanting to make money (as always) piled into the fray and issued HELOCs up to 125 percent of the value of the homeowner's residence. The thought was that the price of housing would never go down so this money was safe.
Well when the bubble in housing burst these HELOCs resulted in homeowners losing their houses as suddenly they owed far more than the house was worth. In addition without the support of a consumer willing to spend money the economy itself contracted and the homeowner was suddenly out of a job. The spiral started as quickly as it had begun and the rest as they say is history.
Six years later banks are still dealing with the mess. To date they have written off more than $4 billion in debt and there is still a long way to go. As an example assume that the total debt on the house is $500,000 and the value of the house is $400,000, on paper the bank has lost $100,000 but it is always worse than that. First you have to reduce the value to the bank by the agent commissions and closing costs and then there may be other liens such as HOA and taxes. All in all the bank would be lucky in this example to net $350,000 a 50% increase in the loss!
Given this backdrop I was surprised to read that 2012 is expected to see a 30 percent rise in HELOCs. The estimate is that just under $80 billion in debt will be offered to homeowners through HELOCs this year. Furthermore it is expected that 2013 will see over $110 billion issued in HELOC debt, more than the average issued during the housing bubble. This will definitely have an impact on consumer liquidity and should result in decent consumer spending growth however I wonder if this rise in HELOC debt is a good thing.
Certainly lenders will have far stricter criteria for issuing a HELOC than before and there is over $7.3 trillion in home equity in the United States so the amount lent in HELOC loans is small. In addition the rates attached to the loans are very attractive so the question remains where will the proceeds be invested?
During the housing bubble consumers spent money on everything from upgrading their house to buying boats and overseas trips. It was one big party funded by the banks. Looking around now there are opportunities to invest into real estate, private equity and a few select stocks however outside of this the investment world is very tentative. In most cases a homeowner's house is their largest asset so it needs to be treated with care.
There is the thought that you can get the HELOC and keep it for emergencies and I am sure that a decent amount of this money will be used for that purpose. Outside of this I am hopeful that the remaining proceeds are being put to good use and invested wisely as if anything was learnt during the housing bubble it was that spending it on a big Holiday Season will not end in Ho Ho Ho but rather with a No No No. From me to you have a very Happy Holiday!
Back in the heyday of the housing bubble HELOCs (home equity lines of credit) were used as a type of a cash machine by the consumer. For six years over $110 billion dollars a year was withdrawn from the equity of houses. Consumers viewed it as money that was theirs and spent it freely creating a massive surge for consumer goods and services. Banks wanting to make money (as always) piled into the fray and issued HELOCs up to 125 percent of the value of the homeowner's residence. The thought was that the price of housing would never go down so this money was safe.
Well when the bubble in housing burst these HELOCs resulted in homeowners losing their houses as suddenly they owed far more than the house was worth. In addition without the support of a consumer willing to spend money the economy itself contracted and the homeowner was suddenly out of a job. The spiral started as quickly as it had begun and the rest as they say is history.
Six years later banks are still dealing with the mess. To date they have written off more than $4 billion in debt and there is still a long way to go. As an example assume that the total debt on the house is $500,000 and the value of the house is $400,000, on paper the bank has lost $100,000 but it is always worse than that. First you have to reduce the value to the bank by the agent commissions and closing costs and then there may be other liens such as HOA and taxes. All in all the bank would be lucky in this example to net $350,000 a 50% increase in the loss!
Given this backdrop I was surprised to read that 2012 is expected to see a 30 percent rise in HELOCs. The estimate is that just under $80 billion in debt will be offered to homeowners through HELOCs this year. Furthermore it is expected that 2013 will see over $110 billion issued in HELOC debt, more than the average issued during the housing bubble. This will definitely have an impact on consumer liquidity and should result in decent consumer spending growth however I wonder if this rise in HELOC debt is a good thing.
Certainly lenders will have far stricter criteria for issuing a HELOC than before and there is over $7.3 trillion in home equity in the United States so the amount lent in HELOC loans is small. In addition the rates attached to the loans are very attractive so the question remains where will the proceeds be invested?
During the housing bubble consumers spent money on everything from upgrading their house to buying boats and overseas trips. It was one big party funded by the banks. Looking around now there are opportunities to invest into real estate, private equity and a few select stocks however outside of this the investment world is very tentative. In most cases a homeowner's house is their largest asset so it needs to be treated with care.
There is the thought that you can get the HELOC and keep it for emergencies and I am sure that a decent amount of this money will be used for that purpose. Outside of this I am hopeful that the remaining proceeds are being put to good use and invested wisely as if anything was learnt during the housing bubble it was that spending it on a big Holiday Season will not end in Ho Ho Ho but rather with a No No No. From me to you have a very Happy Holiday!
Friday, December 14, 2012
China's Debt Problem
"Well, we lost a lot of our independence already. We are dependent on China for credit. We are dependent on Middle Eastern countries for energy supplies. And many Americans are dependent on the government for their income, health care, education of their children, food stamps." - Jim DeMint
It is common knowledge that China has enormous capital reserves. A current estimate is that the government in China is sitting on a foreign exchange reserve of more than $3 trillion. This money has been deployed into United States treasuries, Euro bonds, gold and many other mainstream investments and it is thought that with this stockpile of cash and reserves that they will be able to manage any kind of economic slowdown without much trouble.
That theory is now being questioned due to the fact that their banking system has shown many structural flaws and Europe, which makes up around 40 percent of all Chinese exports, is struggling. Both of these are causing a weakness in the balance of payments but aside from that there is the threat that an economic slowdown in China could destabilize its political structure.
As more and more of the Chinese population becomes mobile there is a desire and a demand for living standards to improve. The only way that this can be achieved is for China to continue to grow at a rate north of 6 percent. This is an extremely fast clip for a nation as large as China but it was achievable during the last decade due to the cheapness of its labor pool and a weak currency. Now with the global economic weakness and a rapid increase in labor rates China is being squeezed and this reserve pool looks like it may not be enough. In addition it is starting to appear that the Chinese currency the renminbi is no longer grossly undervalued and manufacturers around the globe are starting to take notice of this and are repatriating work to their local countries.
In order to shore up growth the government has undertaken numerous infrastructure projects many of which are the equivalent of digging holes and filling them up again. Airports lie vacant, subways have no traffic and bridges lead to nowhere. In order to finance this the government has relied heavily on foreign investment but that is beginning to dry up as many of these projects are turning out to be alligators. During the second quarter China's capital account shrunk by $110 billion as capital fled the country so China is now having to finance these projects itself using its capital reserves.
This is creating another problem as when foreign capital moves into a country it is forced to exchange it for local currency. This flows into the banking system and results in banks being awash with reserve so it starts to offer loans to locals. A reverse of this trend shrinks the capital base and results in a contraction of the loan pool. The issue is that a lot of the loans that were made are turning sour. Companies that took out the loans are closing down as demand for their goods and services is not keeping up with the ever spiralling debt payments.
The bulk of these loans were made back in 2008 and are now coming back to haunt the government as a big portion of these loans were made to state owned businesses many of whom are running deep in the red already. The state will then have to fund these obligations whether it likes it or not and this will have another major drag on its capital base. In the boom years overcapacity at steel plants and such was considered a necessary requirement to fill expected demand but with this demand gone these investments are turning into a black hole.
Currently the total corporate debt level is at roughly 125 percent of total GDP. This is up from 110 percent in 2008. Now the size is not a major problem if the economy can continue to grow at 8 percent and the growth in borrowing slows. However now that the global economy is stuttering and there is no sign that a recovery is imminent China's reserves are looking very weak and this will have major implications around the globe particularly if they have to start to claw back their massive foreign investment pool.
It is common knowledge that China has enormous capital reserves. A current estimate is that the government in China is sitting on a foreign exchange reserve of more than $3 trillion. This money has been deployed into United States treasuries, Euro bonds, gold and many other mainstream investments and it is thought that with this stockpile of cash and reserves that they will be able to manage any kind of economic slowdown without much trouble.
That theory is now being questioned due to the fact that their banking system has shown many structural flaws and Europe, which makes up around 40 percent of all Chinese exports, is struggling. Both of these are causing a weakness in the balance of payments but aside from that there is the threat that an economic slowdown in China could destabilize its political structure.
As more and more of the Chinese population becomes mobile there is a desire and a demand for living standards to improve. The only way that this can be achieved is for China to continue to grow at a rate north of 6 percent. This is an extremely fast clip for a nation as large as China but it was achievable during the last decade due to the cheapness of its labor pool and a weak currency. Now with the global economic weakness and a rapid increase in labor rates China is being squeezed and this reserve pool looks like it may not be enough. In addition it is starting to appear that the Chinese currency the renminbi is no longer grossly undervalued and manufacturers around the globe are starting to take notice of this and are repatriating work to their local countries.
In order to shore up growth the government has undertaken numerous infrastructure projects many of which are the equivalent of digging holes and filling them up again. Airports lie vacant, subways have no traffic and bridges lead to nowhere. In order to finance this the government has relied heavily on foreign investment but that is beginning to dry up as many of these projects are turning out to be alligators. During the second quarter China's capital account shrunk by $110 billion as capital fled the country so China is now having to finance these projects itself using its capital reserves.
This is creating another problem as when foreign capital moves into a country it is forced to exchange it for local currency. This flows into the banking system and results in banks being awash with reserve so it starts to offer loans to locals. A reverse of this trend shrinks the capital base and results in a contraction of the loan pool. The issue is that a lot of the loans that were made are turning sour. Companies that took out the loans are closing down as demand for their goods and services is not keeping up with the ever spiralling debt payments.
The bulk of these loans were made back in 2008 and are now coming back to haunt the government as a big portion of these loans were made to state owned businesses many of whom are running deep in the red already. The state will then have to fund these obligations whether it likes it or not and this will have another major drag on its capital base. In the boom years overcapacity at steel plants and such was considered a necessary requirement to fill expected demand but with this demand gone these investments are turning into a black hole.
Currently the total corporate debt level is at roughly 125 percent of total GDP. This is up from 110 percent in 2008. Now the size is not a major problem if the economy can continue to grow at 8 percent and the growth in borrowing slows. However now that the global economy is stuttering and there is no sign that a recovery is imminent China's reserves are looking very weak and this will have major implications around the globe particularly if they have to start to claw back their massive foreign investment pool.
Friday, December 7, 2012
Jobs Up Sentiment Down
"Living at risk is jumping off a cliff and build the wings on the way down." - Ray Bradbury
Today we received some more positive news on the job front with the number of jobs growing faster than expected. Furthermore the unemployment rate fell to 7.7 percent but this number once again masked the fact that a lot of the improvement to the unemployment number was due to the fact that more and more people are just giving up searching for a job.
Of more interest is the fact that consumer confidence fell sharply in as consumers finally are coming to terms with the massive economic impact of the approaching Fiscal Cliff. Normally consumer confidence rises with good jobs reports but not this time. With the thought of taxes spiralling higher and the probability of the effects dragging economic growth lower the number plunged from 82.7 to 74.5. Combined with this number is the Future Expectation Index which dropped to its lowest reading since December 2011.
So with jobs still hard or impossible to find and with the impact of the Fiscal Cliff approaching consumers are skittish and this does not bode well for both the holiday shopping season and the economy in 2013. As I have mentioned repeatedly, consumers and investors need to wake up and realize that this slow growth scenario is going to be around for a long time and that coupled with this are low rates of return on investments.
Gone are the days of earning 5 or 6 percent real rates of return (a real rate of return is the rate of return in excess of inflation). In its place are rates that are lucky to even be positive. In this environment you need to make sure that your portfolio is protected against any downside shocks as recovery from these will take years if not decades. In place of risk you need to seek out a portfolio that protects your assets and to me this should include gold, properties and alternative investments such as private equity.
With all the risks that abound at present leveraging up in the stock market just does not make sense so protect your assets even if it means remaining in cash for an extended period.
Today we received some more positive news on the job front with the number of jobs growing faster than expected. Furthermore the unemployment rate fell to 7.7 percent but this number once again masked the fact that a lot of the improvement to the unemployment number was due to the fact that more and more people are just giving up searching for a job.
Of more interest is the fact that consumer confidence fell sharply in as consumers finally are coming to terms with the massive economic impact of the approaching Fiscal Cliff. Normally consumer confidence rises with good jobs reports but not this time. With the thought of taxes spiralling higher and the probability of the effects dragging economic growth lower the number plunged from 82.7 to 74.5. Combined with this number is the Future Expectation Index which dropped to its lowest reading since December 2011.
So with jobs still hard or impossible to find and with the impact of the Fiscal Cliff approaching consumers are skittish and this does not bode well for both the holiday shopping season and the economy in 2013. As I have mentioned repeatedly, consumers and investors need to wake up and realize that this slow growth scenario is going to be around for a long time and that coupled with this are low rates of return on investments.
Gone are the days of earning 5 or 6 percent real rates of return (a real rate of return is the rate of return in excess of inflation). In its place are rates that are lucky to even be positive. In this environment you need to make sure that your portfolio is protected against any downside shocks as recovery from these will take years if not decades. In place of risk you need to seek out a portfolio that protects your assets and to me this should include gold, properties and alternative investments such as private equity.
With all the risks that abound at present leveraging up in the stock market just does not make sense so protect your assets even if it means remaining in cash for an extended period.
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