Sidebars:
How much does the bailout bill really cost?
Good question. I mean, the bailout bill is a bit like some of the mortgages that got us in a fix in the first place. While I continue to weed through an avalanche of information on this mess, one item hit my inbox and I thought you ought to see it straight away. According to the folks at "Taxpayers for Common Sense", there are a laundry list of hidden costs associated with this bill. If you want to see how votes are bought, check out this little ditty.
On My Bookshelf
I read...a lot. Along with the inevitable fodder are some really good books on the economy and investing. These end up in my permanent library. I admit that not all of these books are an easy read but each one will provide valuable insights. Each book listed has a link to the appropriateAmazon page.
A little begging never hurts
The Market Informer has gotten off the ground in a series of fits and starts. Besides being near and dear to me, building content and paid advertising is part of my five year plan. I can provide the content but I need readers. Apart from the obvious reasons (with readers I can draw advertising), I really want reader emails. I need them to ask questions, to challenge me. So, I'd like your help. If you could enlist two people that would add their email address to my mail list, I'll let them know when a new post is added (just like I do with you!). Here's the best selling point of all...it's entirely free! Oh, and while I'm on the subject, let me say thank you for your continued support.
Attention Grabbers
So, this morning I'm listening to some radio DJ. Here was his take on the current state of market affairs, "You have to go back to your parents or grandparents generation for economic times that were this bad!" Here's what went through my mind before I flipped the station: Really? When did the 25% unemployment reports come out? I haven't seen one yet. And, in terms of stock market pricing, the last time the S&P was this cheap was...2002 (see my market comment at the end of this post)! I'm guessing that his demographic must be the under 2 crowd.
History Repeats...Again!
On September 26th I posted an article entitled "The Price of Oil". The gist of the article regarded oil pricing conspiracies and how much of the stuff is really in the ground. Shortly after that post, I was scanning the September 29th issue of Forbes Magazine and came across the following quote:
"Most Americans don't comprehend that soaring oil prices are not the result of U.S. oil company conspiracies, that the shortage of the stuff is real. Those gasoline station queues of six years ago are around the corner. So are $1-a-gallon prices. And until most Americans stop stupidly blaming nonexistent oil company "conspiracies" and instead start demanding that we do the many quickly do-able things that can really help solve the crisis, it'll continue to get worse." -- Malcolm Forbes (1979).
Evidently not much has changed in the past 29 years. Except that now we're looking at $3.00 a gallon gas. I can take some solice in knowing that the republic has always found the ability to deal with challenges much tougher then this and that the law of supply and demand is starting to cause prices to change direction.
The surge and recent decline in oil prices reminds us that being familiar with history and keeping a level head can put you in a good position when encountering turbulent waters. It may help to keep that in mind as you watch the current gyrations of the financial markets. Let's jump in...
Unless you are living under a rock you are well acquainted with the financial meltdown that is currently playing out. Such meltdowns are not new to investors. In fact, history is repleat with stories of financial alchemy. But here we are in the cat birds seat. Gaining some insight here will prove invaluable to our future investment success.
If you think about it, we are a pretty adaptable bunch. You could say that all we need to live is food, shelter, some clothes on our back, and a pair of shoes to pad our feet. But hey, even that short list costs money. Add to that our wants and you're into a brand new baliwick. We look around and see others with nicer clothes, bigger homes and better food -- and by golly, we want that too. We look a little more and see fancy cars, jewelry, computers, yada, yada, yada, ad infinitum. That damn list is endless and growing constantly! And, quite frankly, after a while it gets very confusing. We start to mix up our wants with our needs. Now, we don't just want a bigger car...we need that bigger car. It's not enough to want an engagement ring...we need the three caret engagement ring.
When the economy is good and growing strong it's easy to fall into this mindset. We sail down High Life Highway, stopping at stores, chargin' up stuff. Hell, why not? We're working hard, the money's flowin'. We're in the good life baby! Then the road starts to get a bit rough. In your mind you make a note of it but things still seem pretty good so you back off the gas a bit but keep on chuggin' along. All of a sudden, with no apparent warning, you start hitting potholes. They start out small but you don't get very far before those potholes are big enough to swallow that gangsta Escalade you're driving.
The product is money but money is not the problem!
In the original draft of this article I gave a fairly detailed comparison between two products: money and a refrigerator. It was pretty good (if I do say so myself) but it became rather lengthy when I considered the point I was trying to make. Simply put, money is a product like any other product and all products are sold for a profit! [In reality there is a minor difference: instead of selling money we either lend it or borrow it. In either case the profit is referred to as interest.]
The basics are simple enough. You deposit money in the bank. The bank in turn lends it out as a loan. The difference between the interest collected from the borrower and the interest paid to you is profit for the bank. From that profit the bank pays its operating expenses, taxes, capital improvements...all the costs associated with running a business. Yeah, I know what you're thinking: "Thanks Captain Obvious!" But I'm leading up to a point here...
Money, as a product, has another similarity to refrigerators: everybody likes, wants, and needs newer features. Refrigerators boast frost free, ice makers, water dispensers, stainless steel...whatever. Money vendors offer creative twists on basic ideas: the "traditional" thirty-year fixed mortgage with 15% down isn't enough. We needed (wanted) adjustable rate mortgages with 5% down.
Oh, and before I get too deep here, let me point something out to you...these fancy mortgages are sold just like a model on The Price Is Right shows off that shiny new refrigerator: "Yes, that adjustable rate mortgage will cost you a bit more in interest but the down-payment is lower and hey, Mr. Borrower, for the first few years all your payments are interest anyway. You can write that off on your taxes. Oh, and by the way Mr. Borrower, don't worry because the value of your home will increase along with your income and credit rating so you'll be able to refi in a couple of years and lower the interest rate. Heck, you could even pull some money out to buy more stuff."
But adjustable rate mortgages were mere childs play. We needed (or is that wanted?) more! Enter the Option ARM. I gotta tell ya, I want to meet the folks that came up with this one. Check this out. Let's say you are making $75,000 a year and you want to buy a home. Now, let's assume that, by "traditional" lending standards, you qualified for a $200,000 home. In many markets that would buy a pretty nice home -- not so in markets like California. No things are pretty pricey there. We need some financial alchemy.
The lender comes to you and presents this alternative, "Look, we want to help you get that $500,000 home you need for your growing family. Here's what we can do. We will give you a 3/27 mortgage with the super attractive interest rate of 2% for the first 3 years. Even better, you can name your monthly payment. That's right! If your payment is less then the calculated amount, we'll just tack the difference onto the principle! Now, there's no need to worry. You see how these markets are. Prices just keep going up and up. Heck, with the market the way it is you'll be able to sell that home in two years with enough profit to buy something even nicer and the down-payment will be large enough so that you can get a fixed rate mortgage with a reasonable payment!"
You sit back and think. Emotionally you want that house so bad you can taste it but you have some misgivings. A teaser rate for three years? That sounds risky. Tacking on money to the principle? Even worse! But then, either the realtor or the mortgage lender says something like this, "I know you're thinking about waiting. You'd like to think that you will find a bargain eventually, right? Look, I've shown you a lot of houses and you've been in the market for a while. Have you seen prices come down yet?" Well, that logic certainly justifies your decision and the rest is, as they say, history.
But wait...there's more! I want more products...I need more choices. Okay, how about this...an Alt-A mortgage?: "Normally, Mr. Borrower, perspective home buyers need to have a credit rating of 725 or better. The higher your score of course, the better the interest rate you'll get because you would be considered a better risk. But, I have these mortgages for folks just like you with a lower credit score. Even though your score is 640, we can qualify you. I can even give you a great rate for the first 3 years before it resets. Don't worry, as long as you make your payments on time your score will improve and we can refi that mortgage into a fixed rate. "Wow" you say, "where do I sign?"
Not enough Mr. Lender...I want something even better. Enter the sub-prime mortgage. "All right," the lender says, " how about a no-doc loan?" "Wow", you say, "what's that?" "Oh, a no-doc is great. You "tell" me what your income is and what assets you have. I'll write that up and send it to the underwriter. Assuming your credit is reasonable, you'll be good to go." Yippee!!!
Keep this in mind: these alt-a and sub-prime mortgages have existed for quite some time, just not to the extent that they do now. Previously, fees, interest rates and banking regulations were hefty enough to thwart reckless behavior; not as simple this time around. Why? Because traditional bankers weren't making the bulk of these loans. Instead, investment bankers were making the large majority of the loans. And investment bankers don't have to abide by the same rules as traditional bankers.
To make matters worse, many of these mortgages were given out in the hottest of real-estate markets - California, Florida and, to a lesser extent, New York. Markets like Indiana, where the real estate has appreciated at your average 6-7% per year, aren't experiencing the same extreme conditions. And that, by the way, is why many folks in the mid-west view the $700 billion bailout as a gift to Wall Street. People on Main Street in Indiana can't relate to the problems of the Main Street folks in California where appreciation rates were running in the double digits for the past four to five years and more. So, here you are with thousands of these mortgages being made to people who really weren't qualified for them. [In fact, today I heard that $1.2 trillion in adjustable rate mortgages are coming up for interest rate reset.]
For the first few years, everything just kept moving along...the cycle kept repeating: more sales increased the value of other homes that went up for sale. The cash out from home equity was flooding the streets. People were buying stuff -- all sorts of stuff. And those hot markets with housing prices that rose at meteroic rates are now seeing values plunge in the same fashion. So what have we ended up with? A mortgage market built on a foundation of sand.
I know that as you read this you are probably shaking your head in disbelief but there is an important point to remember here. This was like a national game of musical chairs. Everybody was making money here: real-estate brokers, mortgage brokers, traditional and non-traditional bankers. Then there was the "trickle-down" effect - the retail stores, car companies, and on and on and on. Who was going to say stop, this is getting out of hand? Everything was fine until the music stopped.
In part two and three we'll examine how these mortgages were sold into the global marketplace causing the bubble to expand at exponential rates. We'll also see how little cracks started to appear leading up to the inevitable point where the music stopped and the bubble burst (am I mixing metaphores here)?
Market Comment
If you read my posts or if we've spoken about the markets then you know that I've been negative on the indexes and funds in general for some time. Those of you who followed my advice and/or read my chapter on managing your 401K investments would have moved into a cash type account - i.e. The Stable Value Fund - once the fund(s) you were invested in moved below the 50 week Moving Average. The weekly chart above tells the story.
I took a look at the monthly chart for the S&P 500 as well - see below. One chart metric that I watch is the 50% retracement rule; referring to the tendency of prices to slide back 50% from the recent peak to the previous significant low, find support there and begin to rebound. For example, in April 1994, the average bottomed near 435. It subsequently peaked in February 2000 at 1527. So we would look for a 50% retracement near 981. You can see the bottoming action between June 2002 and April 2003 with prices closing in the range of 885 and 936.
In terms of the most recent rally I am using the April 2003 low of 849 and the October 2007 high of 1576. The index fell below the 50% of 1212 in September. The next significant bottom appears near 800. We will need to wait and see if this floor holds for a period of time. The longer that bottom stays in tact, the greater the likelihood of a rebound from there. Continue to watch the weekly charts and follow the moving average rules.
Until then you can count your monthly interest as profit and realize that you are further ahead then many. Remember this: in bear markets the winners are the folks that lose the least!
Send your questions and comments to Bill Mazzacca
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