Personal Finance – Page 39

Eleven Articles on Residential Real Estate

Posted on 22 June 2007 by David Merkel

Those who have read me at RealMoney know that I have been bearish on residential real estate for the last 2-3 years, and on commercial real estate for the last year.? I have found it fascinating to see both markets move to situations where current income is exceeded by what can be earned in Treasury securities, much less mortgage funding costs.? Take it as a rule, when one must depend on rental growth and property appreciation to make a profit, it’s time to sell.? Anyway, here are the articles:

I guess I have to start with Bear Stearns’ hedge funds.? An ugly situation where Bear might have to tap $3.2 billion of liquidity to stem the crisis.? Bear can afford the money, but it might bite into their credit rating, and their ability to earn money off of their spare capital.? As I commented on RealMoney yesterday, it is not likely, but possible that this turns into a wider crisis.
Though this article is about Collateralized Debt Obligations [CDOs] generally, much of the excess yield that allowed the CDOs to be sold came from subprime CDOs.? Now who holds the risk?? From what I can tell, a bunch of hedge funds, hedge fund-of-funds, and pension plans.? The lure of easy yield beings out the worst in institutional investors stretching to make a certain total return target.? The low-paid managers of public funds are particularly drawn to these investments because of the political pressure to keep taxes low.
As an aside, the principal-protected versions are a sham; it is the same as investing a small amount in the volatile stuff, and a large amount in Treasuries.? That one can’t lose money on the package is meaningless; look at the two investments separately, and ask if they both make sense.? Lesson: don’t but investments that you don’t fully understand.
Little of the current troubles in residential real estate could have gone on without optimistic appraisals.? That’s putting it kindly; before the end of this crisis the appraisers are going to face some degree of additional regulation.? Will it be the right solution?? Probably not, but read the article, and watch a profession in need of tough ethical requirements, or perhaps, means of eliminating shady operators.
I’m not sure how one can rent out credit scores.? It would be fraud if done without the consent of the one whose score is borrowed.? With consent, it would be a stupid form of co-signing a loan.? I never recommend co-signing.? You have more protections loaning the person the money yourself, even if you have to take out a loan to do it.
I’ve followed this statistic for a while.? With a few conservative assumptions, it means that the average indebted homeowner has only 30% equity in his home.? Not a safe place to be.
Buying foreclosures?? Wait a year, okay?? Look, foreclosure, and other forms of distressed investing only work when the ratio of vultures to carrion is low.? It’s not low now.? Let the dumb vultures overspend now; come back when you hear of former vultures having to raise liquidity.
Barry Ritholtz and I have long been on the same page on residential real estate investing.? This article has some of the best charts I have seen in some time.
Here’s an alternative view of residential real estate pricing.? Rather than listen to the shills at the NAR, this might be a fairer take on the market.? Note that it has been lower and higher than NAR forecasts; I like that, because reality is almost aways more volatile than we would admit.
My view of the residential real estate markets is bifurcated.? The Midwest and the South suffered the worst initial foreclosures because housing prices did not rise much there, and refinancing was not an option.
? Tight finances + bad event = default.
But the pain will shift to the formerly hotter coastal markets, where subprime financing was more prevalent, as the ARM resets hit, and now prices are falling, and interest rates rising.
Excess supply is the rule; we have a little less than one year’s supply of housing vacant and ready to sell at present.? That is a record by almost double the long term average.? This will take years to clear up, particularly with the builders still constructing homes.? Perhaps we can solve the problem by selling all the excess homes to wealthy foreigners.? Kill two birds with one stone; fund the current account deficit, and reduce the the housing supply overhang in one fell swoop.
Interest rates are the silent killer here.? It would be wise for many people to refinance to prime fixed-rate loans, but with interest rates rising, the bar is getting raised for even creditworthy borrowers.

We are stopping at a butcher’s dozen here.? Not a great time to own residential real estate on leverage.? When I went to work for the hedge funds that employ me, I paid off my mortgage because my earnings would be less certain than what ai earned as a bond manager for an insurance company.? Would that more people were conservative with their finances in the same way.? As it is, I expect the residential real estate price slump to persist into 2009.

On Inflation

Posted on 19 May 2007 by David Merkel

Inflation is a vague concept, because the term stretches to do duty in multiple areas: wage inflation, consumer price inflation, asset inflation, and monetary inflation, to name a few.? I agree with what Milton Friedman said that inflation is always and everywhere a monetary phenomenon, but where I differ is that monetary inflation may express itself in terms of inflation in the prices of goods and services, or in asset inflation.? Where inflation chooses to manifest itself depends on the balance of savers vs. spenders in a country.? Monetary inflation plus saving equals asset price inflation.? Monetary inflation plus spending equals goods and services price inflation.

As for the last week, I have a few articles to bring to your attention on inflation:

Baby Boomers need to think about purchasing power risk in their old age.? This doesn’t mean overdosing on stocks, but it does mean considering investment classes that are correlated with inflation, like TIPS, floating rate bonds, selected commodities, and stocks of companies that produce them.
I’m on record that I don’t like the way that the US government calculates goods price inflation.? From the way that they deal with owners equivalent rent, to the substitution effect, to hedonics (correct in principle, but they don’t do it right), to plain mismeasurement of the proper basket of goods, and the concept of core inflation, they mess things up.
Barry Ritholtz and I agree on many things.? Inflation is one of them.? These two articles express much of what I think about what is wrong with the measurement of inflation.? Far better to use a median (Cleveland Fed) or trimmed mean (Dallas Fed) to eliminate volatility than to exclude food and energy.? Food and energy are crucial to our lives, and they have been running at higher rates of inflation.

Inflation is growing in many areas of the world, including those that finance our current account deficit.? Buying our bonds rather than letting their currencies rise, encourages inflation in their countries, while suppressing it in the US.? There will come a day when they float their currencies, and then inflation will return to the US with a vengeance.? When that happens, call Chuck Schumer to thank him for his vigilance on the Chinese exchange rate, not.

The Great Garbage Post

Posted on 25 April 200727 April 2007 by David Merkel

Perhaps for blogging, I should not do this. My editors at RealMoney told me that they liked my “Notes and Comments” posts in the Columnist Conversation, but they wished that I could give it a greater title. Titles are meant to give a common theme. Often with my “Miscellaneous Notes” posts, there is no common theme. Unlike other writers at RealMoney, I cover a lot more ground. I like to think of myself as a generalist in investing. I know at least a little about most topics.

Now, I have to be careful not to overestimate what I know, but the advantage that I have in being a generalist is that I can sometimes see interlinkages among the markets that generalists miss. Anyway, onto my unrelated comments…

1) So many arguments over at RealMoney over what market capitalization is better, small or large? Personally, I like midcaps, but market capitalization is largely a fallout of my processes. If one group of capitalizations looks cheap, I’ll will predominantly be buying them, subject to my rule #4, “Purchase companies appropriately sized to serve their market niches.” Analyze the competitive position. Sometimes scale matters, and sometimes it doesn’t.

2) My oscillator says to me that the market is now overbought. We can rise further from here, but the market needs to digest its gains. We should not see a rapid rise from here over the next two weeks, and we might see a pullback.

3) My, but the dollar has been weak. Good thing I have enough international bonds to support my balanced mandates. I am long the Yen, Swissie, and Loony.

4) Sold a little Tsakos today, just to rebalance after the nice run. Cleared out of Fresh Del Monte. Cash flow looks weak. Suggestions for a replacement candidate are solicited.
5) Roger Nusbaum is an underrated columnist at RealMoney in my opinion. Today, he had a great article dealing with understanding strategy. He asked the following two questions:

If you had to pick one overriding philosophy for your investment management, what would it be?
If you had to pick four of your strategies or tactics to accomplish this philosophy, what would they be?

Good questions that will focus anyone’s investment efforts.

6) In the “Good News is Bad News” department, there is an article from the WSJ describing how the SEC may eliminate the FASB by allowing US companies to ditch GAAP, and optionally use international accounting standards [IFRS]. If it happens, this is just the first move. Eventually all companies will follow an international standard, that is, if Congress in its infinite wisdom can restrain itself from meddling in the management of accounting. The private sector does well enough, thank you. Please limit your scope to tax accounting (or not).

7) Also from the WSJ, an article on how employers are grabbing back control of 401(k) plans. Good idea, since most people don’t know how to save or invest. But why not go all the way, and set up a defined benefit plan or a trustee-directed defined contribution plan? The latter idea is cheap to do; we have one at my current employer. Expenses are close to nil, because I mange the money in-house. Even with an external manager, it would be cheap.Would there be people who complain, saying they want more freedom? Of course, but they are the exception, not the rule, and of those who complain, maybe one in five can do better than an index fund over the long haul. I am for paternalism here; most ordinary people can’t save and invest wisely. Someone must do it for them.

8) Finally, the “hooey alert.” The concept of using custom indexes to analyze outperformance smacks of the inanity of “returns-based style analysis.” I wrote extensively on this topic in the mid-90s. Anytime one uses constrained optimization to calculate a benchmark using a bunch of equity indexes, the result is often spurious, because the indexes are highly correlated. Most differentiation between them is typically the overinterpretation of a random difference between the indexes. Typically, these calculations predict well in the past, but predict the future badly.

That’s all for now.

Full Disclosure: long TNP FXY FXF FXC

An Interesting Post from NPR Marketplace

Posted on 18 April 200721 April 2007 by David Merkel

We haven’t had foreclosure on a wide scale since securitization became common. Some municipalities are trying to figure out who truly owns a house in foreclosure if the loan was securitized. I would think that the trustees were the legal owners on behalf of the junior certificate holders, with the servicer acting in behalf of the trustee.

The radio show NPR Marketplace had an interesting piece on this phenomenon. When a city is dealing with a mass of abandoned buildings, they want to know who owns them, so that they can be protected, and blight avoided.
In this era of securitization, finding the owner after foreclosure is not simple. Listen to the piece, and consider the effects on our markets and society.

Let Them Eat Yield!

Posted on 5 April 200720 June 2017 by David Merkel

An article in Friday’s Wall Street Journal described the creation of new closed-end funds dedicated to the production of yield. I am simultaneously horrified at the concept, and yet wondering whether I couldn’t create one with multiple strategies to smooth out the difficulties of single strategy yield creation. I could buy:

unusual bonds with high yields.
certain fixed income closed end funds at a discount.
dividend paying stocks, and occasionally (ugh) preferred stocks.
non- or low dividend paying stocks that fit my eight rules, and sell out-of-the-money calls against them.
lever the fund by borrowing at LIBOR.
Use my mean reverting REIT, utility, LP strategy. Backtests have it generating a 20% return annually, and I haven’t tweaked it.

The thing is, though, yield is a conceit. People like to think that they are merely scraping the income off of the portfolio, when in many cases, they are truly consuming capital, but the accounting doesn’t make it look that way. Think of a high yield fund with a single-B average credit quality. During good times, the full yield, and maybe a tiny amount of capital gains comes into income. During bad times, the yield shrinks, and capital losses get passed through. Over a full cycle, the NAV of a high yield fund shrinks.

Logical people would not invest in income vehicles like that, but invest they do. Two parting bits of advice. One, there is no reason to ever invest in a closed-end fund IPO. Closed-end funds should trade at a discount equal to the annual fee times five (or so). Two, be conservative in yield investing. It is little known that lower yielding REITs tend to outperform higher yielding REITs. The only time to stretch for yield is when everyone is scared. Even then be careful; make sure the yield that you are getting is secure.

The Major Article List is Live!

Posted on 7 March 20077 March 2007 by David Merkel

Though it is something that will grow, the major article list section of this blog is now up-to-date. It is a complete index of my long-term writings at RealMoney (primarily).

The one thing that would make it better would be to index my long term Columnist Conversation posts. It is my favorite part of RealMoney, and that is why I have concentrated there, even though I don?t get paid for cc posts. (sad that) What would be interesting would be to scour my cc posts for long term value, though I have over 1500 cc posts. I?m not doing that anytime soon. 80% of my cc posts are ephemeral, and I?m not sure it is worth the effort to get the other 20%.