An Alternative to the Trillion Dollar Deficit

Am I the only one who thinks that a trillion dollar deficit, proposed by the President-elect, is financially insane?

True, as we head into the deepest recession since the Great Depression of the 1930's, we may succeed in becoming the Great Depression II. However, before we touch a lit match to a fuse on a trillion dollar budget deficit (not to mention funding for the wars in Iraq and Afghanistan occuring outside the annual budget, which will surely detonate our country in the future), let us try to address the original problem.

We all agree residential real estate began this current economic slide and that residential real estate's recovery is necessary to end this slump. So, let us rethink the solution.

Since a trillion dollars is on the table, why not try the following; The US government enacts a new program to refinance the following mortgages: 1) all sub-prime mortgages that have reset and will reset. 2) Any mortgage that is underwater by more than five percent; 3) mortgages of homes repossessed in the 4th quarter of 2008 and currently unoccupied, if the previous owners are interested in returning.

Once the government has identified these mortgages, borrowers may apply for a new, 30-year, fixed-rate mortgage, issued at one percent over the current 30 year T-bond.

Do not stop reading. Here is how we save residential real estate and America.

All refinanced mortgages are backed by the full faith and credit of the US government. All refinanced mortgages are assumable.

Yes, I said ASSUMABLE.

Catalog the benefits. Currently, a raging debate about mortgage cram-downs by banks is taking place. Both sides have valid points. By refinancing existing mortgages and paying off lenders immediately, investors holding MBSs are "made whole", per the terms of the mortgage, and contract law is preserved.

Is a home more valuable or less valuable with an assumable loan? The current inventory of vacant and unsold homes would quickly reduce while prices stabilized. Ask a real estate agent if a home with a 30-year, fixed rate mortgage, at 4.25%, completely assumable, is marketable.

Banks' capital requirements and their need to raise cash for 2009 is lessened. Banks will also have fewer assets on their books. Retirees living on fixed income investments are starving for yield. T-bills and CDs today only reduce investors' disposable income and subtract purchasing power from the economy.

On a $200,000 mortgage, refinancing a 6%, or 8%, 10% mortgage, down to 4.25% mortgage is like getting a stimulus check, for several hundred dollars, every 30 days. Would a small business owner rather receive a lower tax rate and fewer customers or 10 or 20 homeowners in his neighborhood with additional money in their pockets?

Vacant homes lower property values. Vandalism occurs to individual properties, squatters break in and stay illegally, and crime can increase in the neighborhood.

The government could begin taking applications 30 days after Congress approves such a bill and begin issuing checks within 90 days, for immediate repayment of mortgages to lenders and injecting more disposable income, through lower mortgage payments, throughout the economy. The psychological benefits to the country alone, with such a program, are incalculable.

Mortgages are public records. This program is completely transparent. As the money is spent, its final destination is available for all to see.

Lastly, if the government is going to destroy the dollar by issuing two trillion dollars in obligations this year, why not try this approach first.

It is just as insane as a trillion dollar deficit for years to come.

Monday Morning

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Last week, the markets continued its volatile decline.  The DJIA and the S&P 500 indices tested their October 10 lows, Thursday, but rebounded, to close up 552.59 and 58.99, respectively, for the day.  For the week, however,  they were both down following an about face by Treasury Secretary Hank Paulsen on buying toxic mortgages from troubled banks; deteriorating economic and housing data; and the impending showdown between congress and the auto industry.  At stake, another taxpayer bailout for the challenged carmakers versus bankruptcy for General Motors and the loss, of perhaps, millions of auto and auto-related jobs.

For income investors, fear is currently keeping treasury yields low prices high.  The public is piling into municipal bonds as the last safe haven for cash, too.  In 2009, headwinds will appear that will disturb all fixed income markets.  The US, next year, will issue two trillion dollars in new treasury obligations.  Markets will not be able to absorb this much debt without raising yields.  The Chinese domestic stimulus package of 500 billion dollars will inhibit one of our largest buyers of treasuries.  The collapse in oil prices will take petrodollars away from Middle Eastern oil producing countries that deposit those dollars into US banks and purchased treasuries.  At some point, our issuance of debt will also weaken the dollar.

I wish that there were more positive news items to report.

This morning in Barron’s, Jacqueline Doherty wrote a story on which defensive stocks to own in a severe recession.  Colgate Palmolive (CL), Clorox (CLX), Procter & Gamble (PG), and Kimberly-Clark (KMB), sell products people use in good times and bad.  I know stock investors are salivating current prices and yields, but I believe the stocks will go much lower over the next six months.  Still, we can improve on her strategy by using long-term options (LEAPS).  Look at the chart below:

Stocks versus LEAPS

Stocks	Friday Closing Price	500 Shares	LEAP Call Jan. 2010 Strike Price	Friday Closing Ask Price	5 Contacts	Difference
Colgate Palmolive	62.06	$31,030	WTPAM - 65	8.80	$4,400
Clorox	59.30	$29,650	WUTAL - 60	10.00	$5,000
Procter & Gamble	63.11	$31,555	WPGAM - 65	8.70	$4,350
Kimberly-Clark	57.37	$28,685	WKLAL- 60	7.10	$3,550
Total Cost		$120,920			$17,300	$103,620

 

By using LEAPS, you are risking $17,300 to control two thousand shares of high quality stocks until January 2010.  In addition, the difference of $103,620 is available to invest in deeply discounted closed-end equity income funds such as Nuveen’s non-leveraged JPZ, JSN, JLA, or JPG, yielding 13.84%, 15.56%, 16.07%, and 14.01%, respectively, as of Friday’s price.

The Dow futures are lower this morning, and its Monday.  Buckle up; this morning could be a bumpy ride in the markets.

Slipping Into Darkness

From October 29, 2008

The Federal Reserve Board today, at 2:15 pm, announced their obligatory 50 basis point cut of the Federal Funds Rate, from 1.5 per cent to 1 per cent. This is the latest action taken to assuage investors’ fears about the hydra-bear market that has engulfed all capitalism. A triple digit rally was quickly vaporized with an erroneous General Electric rumor concerning the company’s 2009 earnings.

What are not mistaken rumors are the disastrous economic data that continues to flow. On Tuesday came the U.S. consumer confidence index, by the Conference Board, reporting an all time low of 38, down from 68 the previous month. That same day, the S&P Case-Shiller home price index fell 1 per cent, in August from July, and 16.6 per cent, from the previous year. The Census Bureau estimates for the 3rd quarter of 2008, of some 130 million housing units, nationwide, 18.6 million stand empty; 13.8 million year-round, 4 million for rent, and 2.2 million for sale.

On Wednesday, Durable Goods Orders were reported a curved up .8 per cent versus an expected decline of 1.8 per cent. For Thursday, the October 25th week Initial Jobless Claims are announced. Expect a drop of 3,000. Why, I’m not sure.

A General Motors -Chrysler shotgun merger is one step closer to happening, according to reports. If completed, it may add an additional 25,000 auto blue and white collar auto workers to the unemployment line of fixed income investment bankers recently cashiered.

Employment is rising, however, in villages and hamlets across the land as Investment Advisors and Money Managers are deploying their minions to hotel banquet rooms and restaurant’s private cubby holes, armed with clever four-color handouts, PowerPoint Presentations, and empty explanations, as to why their propriety indicators and models could not see the greatest bear market since the Great Depression, sneak up behind them.

I have a feeling that the traditional holiday feathered vertebra – turkey; will not be served this Thanksgiving. Instead, investors will be dining, if they can still afford a meal, on black swan; only recently very, very popular fowl of spenders of others-peoples-money. Of course, it’s too late to sale stocks with portfolios down 30 to over 50 per cent. But, if these Money managers are wrong again, keep some Gray Goose handy.

Thursday Market Action

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After shaking off a worrisome inflation report before the opening bell and a dismal real estate report soon after the opening, the Dow rose steadily throughout the morning and settled into positive territory for the remainder of the day. The DJIA closed up 82.97 or .72 per cent at 11,615.93. The S & P 500 also closed higher 7.10 or .55 per cent to 1,292.93. NASDAQ likewise ended the day up 25.05 or 1.03 per cent to 2,453.67.

Volume on the NYSE was 1,003,398,038; advancing shares were 663,931,108 and declining shares were 332,074,290 with 7,392,640 unchanged. NASDAQ volume was 1,842,236,076; 1,414,017,121 shares were up, 358,110,252 were down, and 70,108,703 were unchanged.

Bond yields fell and prices rose as the market digested the early morning four week average jobless claims number which increased by 19,500 to 440,500 and the and a much higher consumer price number of 5.6 per cent, year over year. The Two-Year Note closing yield was 2.43 percent; the Ten Year Note was 3.89 per cent; and the Thirty Year Bond was 4.51 percent.

Foreclosures were up 55 per cent from a year ago, July. More than 272,000 homes received at least one notice, compared to 175,000 last July. This was eight per cent higher than June, as reported by RealityTrac. Lenders reprocessed 77,000 homes in July.

Existing home sales fell 16 per cent to 4.91M, annualized, in the 2nd quarter while prices fell 7.6 percent to $206,500 from $223,500 last year. One in three home sales was a short sale or sold out of foreclosure, according to the National Association of Realtors.

Crude oil finished the day at $114.70 a barrel and Gold closed at $807.4 an ounce.

Weekly Review and Outlook: Deleveraging's Not Just for I-Banks

Like a wild jungle creature forced into a confrontation, but unsuccessful, this past week's stock market limped into the weekend, stunned, pensive, and little changed with Dow Jones Industrial Average [DJIA] closing at 11370.69, the Standard & Poor's 500 ending at 1256.76, and NASDAQ finishing its week at 2310.53. The Dow lost 125.88 for the week. Likewise, the S&P 500 dropped 2.92 and NASDAQ subtracted 27.75, respectively.

The CNBC midday rowdies strained themselves lifting a Hubble sized telescope looking for positive data points in the housing numbers. Existing home sales came out Thursday; they were down 2.4 percent in June, at a seasonally adjusted annual rate of 4.86 million units. New home sales for June, appearing Friday, was lower by .06 percent, on a seasonally adjusted annual rate of 530,000, from a revised upward May figure of 533,000.

I can imagine the rowdies on an express elevator to hell remarking that our destination has dry heat, that it's a gated community, and that it's a Christian neighborhood with few trespassers.

In the second quarter, 739,714 foreclosure filings were recorded. Also, 220,000 homes were lost to bank repossession, according to RealtyTrac. That is up 14 percent from the first quarter and up 121 percent from the same quarter in 2007.

A report published on Friday, by an International Monetary Fund economist, concluded U.S. housing prices were still overvalued, in the first quarter this year, perhaps, 14 percent, within a range of 8 percent to 20 percent. According to Reuters, IMF economist Vladimir Klyuev's report "What goes up must come down? House price dynamics in the United States", examined the inventory-to-sales ratio, foreclosure rates, market inertia, and other data points, formulating this opinion. That would mean at least an additional $1 trillion in lost asset value. The government debt market is still comatose.

The 2 year and 10 year US Treasury Notes, as well as the 30 year US Treasury Bond ended the week with higher yields, paying 2.71%, 4.10%, and 4.68%, versus 2.64%, 4.85%, and 4.65, respectively. August is a major refunding month with auctions scheduled for the Two, Five, Ten, and Thirty Year Treasury obligations, in addition to the weekly T-Bill The brightest spot in the market was the Nymex Light Sweet Crude Oil September contract; it closed Friday at $123.26 per barrel, extending its reprieve to cash strapped motorists from its recent high of $147.20.

Online retail analysts are reporting double digit growth in sales among several retailers because of consumers passively boycotting higher gasoline prices. Who would have thought that one day we would be happy seeing oil prices heading towards $100 a barrel?

Late Friday afternoon, the Office of the Comptroller of the Currency closed First National Bank and the FDIC was named receiver of another two banks, one California-based and the other Nevada based, First National Bank of Nevada with $3.4 billion in assets, and First Heritage with $254 million in assets. Both were owned by undercapitalized First National Bank Holding Co., of Scottsdale, Arizona. First National lost $140 million in the first quarter. They reported $4.6 billion in assets and $4.3 billion in liabilities. Nine point four percent of it $3.7 billion in loans were non-current, ending March 31. Mutual of Omaha Bank acquired the deposits of the two banks from the FDIC for a 4.41 percent premium. The new Mutual of Omaha Bank branches will open Monday morning.

There are currently 8,494 institutions holding $13.4 trillion assets insured by the FDIC. The FDIC said the failures would cost its deposit insurance fund roughly $862 million. This brings the total number of bank failures in 2008 to seven. You can learn more about the status of a particular bank here

Game Changer : The really, really, big news this week came from Chrysler LLC. It announced Friday afternoon that its financing arm would discontinue offering leasing deals to its U.S. customers beginning August 1; the same date when their $30 billion credit facility is up for renewal. The rising cost of capital is making leasing terms less attractive to consumers. This is another aftershock resulting from stifling energy prices and an economy that's deleveraging.

Declining SUV and lease values forced Ford to take a $2.1 billion charge at its finance division last week. Although, third party banks and credit unions will step in to fill the void, expect some slippage in the approval rates for leasing transactions. The same market pressures compelling Ford (F) to exit this market will certainly continue to present as a business factor for any entity looking to make a profit leasing vehicles. The cost of capital is important, however, the residual value of the underlying asset is monumental. The percentage of Chrysler sales attributed to leasing is greater than 20 percent.

It will be very interesting to see if this extemporaneous admission becomes evolutionary inside America's automobile industry. Americans divine right to drive automobiles has been an unconditional assumption since the end of WWII. In 2008, it's a fair question to ask given this extraordinary economic environment of failing banks, growing home foreclosures, stagnant incomes, evaporating jobs, personal and business credit contraction, a runaway federal budget, an aging infrastructure, an expensive endless foreign war, a fractured financial system, rising worldwide demand for limited resources, and a demonstrable shifting of global wealth. Plus, the third generation of Americans, exposed growing up around an enlightenment concerning the ecology and global environmental issues, is being handed the task of running our economy. They will shape and modify our society's habits in the future.

The U.S. Senate actually gaveled a rare Saturday session passing landmark legislation to triage a metastasizing bankrupted residential real estate market. Highlights of the bill include; a new regulator for Fannie Mae (FNM) and Freddie Mac (FRE) and up to $300 billion to insure refinanced mortgages for the next 18 months; $4 billion to states to buy and rehabilitate foreclosed properties, a 10 percent tax credit up to $7,500 dollars for first time home buyers purchasing a home between April of this year and June of next year; increase the federal debt limit to $10.6 trillion, and more.

We now have a de facto nationalized residential real estate market. The reversal by the White House to withdraw a veto threat and sign a passed bill into law would create tears of joy on the face of Scottish economist John Law and Louis the XIV of France. Welcome to the new depression. France has succumbed to capitalism. In between fist bumping with the Democratic presumptive nominee Barack Obama and checking out his Italian-born former model turned pop star wife's, Carla Bruni-Sarkozy's new music album, "Comme si de rien n'etait"(As if nothing had happened), President Nicolas Sarkozy of France bullied his National Assembly into radically reforming their 1958 Constitution. Passage of the reform package includes limiting Presidential terms, strengthening the power of the legislature, weakening the position of Prime Minister, and repealing the 35 hour per week cap for workers.

It is an indication that the global downturn will affect everyone. The French are now more aware than ever of prioritizing work and leisure to enhance income and productivity. Calling national strikes on idealistic principles was an industrial age luxury. Cash flow is paramount in the beginning of the 21st century. Welcome to the club.

The year 2008 will record the resignation of Fidel Castro of Cuba, as its President, and the abandonment of immense leisure time by the average French worker; two aging symbols of 20th Century socialism. I wonder if Hank Paulson and Ben Bernanke are erecting the first 21st century's symbol of socialism. Tonight, I shall pour a very, very, nice XO Cognac and contemplate the upcoming Consumer Confidence figure on the 29th; the Employment and Crude Inventories figures on the 30th; the GDP-Advanced, Initial Claims, and Chicago PMI, on the 31st; and August 1st, Auto and Truck Sales, Average Workweek, Hourly Earnings, Nonfarm Payrolls, Unemployment Rate, Construction Spending, and the ISM Index. Maybe two drinks, au revoir!