Vigilant Investor

You may recall over the past few years our posting about CondoFlip.com, a Florida website where, I can only surmise, users were supposed to get rich flipping Miami area condos. If ever there was a sign of a bubble, it was this day-trading equivalent that reminded us of the dot com buzz.

As we predicted, the floor has dropped out of what was never sustainable to begin with. The first predictor was Condflip’s own site this past May, when they introduced panic pricing buttons. Nine months later, here we are: It is just another example of how hot credit-bubble (inflated) money brings out the worst speculative behavior by transferring purchasing power from producers and stewards to hasty spenders and inexperienced speculators:

From “Florida’s overbuilt condo market starts to fizzle”:

“This market was too good to be true,” said Lewis Goodkin, a Miami economist and real estate analyst. “But it was a market fueled by speculators, so it wasn’t a true market.”

City officials say 15 condo projects, representing nearly 1,900 units, have been officially pulled from the waning market. But analysts say the numbers are much higher when you consider the rest of Florida’s overbuilt condo market.

Statewide sales of existing condos dropped 31 percent in October from the same month last year, according to the Florida Association of Realtors. Median prices fell 2 percent. In Fort Lauderdale, sales dropped 21 percent in October.

Miami was considered one of the most speculative markets in the years-long U.S. residential real-estate boom. Analysts said up to 80 percent of sales at some condo projects were to speculators who intended to quickly resell, or “flip,” the units.

The question with all speculation is always, how much was done with borrowed money? In the case of home real estate these days, in 2005 26% of all mortgages were for investment properties and another 14% for vacation properties. These second, non essential homes — many financed with the expectation of increasing prices — may have only begun to flood the market nationwide, lead of course by the frothiest of markets.

“We have been living in a fool’s paradise. We face a financial crisis that is not understood by the public…, but there is no disposition on either side of the aisle in Congress to face up to the problems.”
      Fed Chairman William McChesney Martin, 1968

The more things change, the more they are the same.

We are always worried when any side of a trade gets too popular. That holds for the weakening dollar trade. It seems as if more and more articles are hitting the mainstream about the changing of the guard. Is this a contrarian argument for a strengthening dollar?  Feel free to read these two articles on the Financial Times today:

• Euro notes cash in to overtake dollar
• A coming of age for the European currency

Perhaps in the short run the dollar might get some legs. You be the judge. But long term, the dollar is in deep trouble. Credit bubbles and insurmountable entitlement costs will force other nations to become more defensive. $4.6 trillion short in 2006, the U.S. government will only run higher and higher GAAP NPV deficits in the coming years since not politically viable alternative exists to the real cuts required to keep the train on the rails. If you are in denial, you need only adjust your DOW & S&P 500 returns since 2000 in terms of CPI, the Euro, Oil and Gold. New record highs? Care to buy a bridge?

You gotta love Robert Reich — perhaps the most collectivist of all Labor Secretaries we’ve had in the U.S. so far. Every now and then you can get dose of him if you listen to the generally collectivist-sympathetic NPR, where Reich gets his own commentary on the evening daily “Marketplace.”

In today’s edition [listen / transcript], Mr. Reich complains about several events in 2006. It’s not that he’s entirely wrong. Like so many with his beliefs, Reich has more than a few valid problems on his list of gripes. But, as is almost always the case with soclialistas, the blame is incorrectly assigned — half deliberately to malign what they hate (the free market), the other half out of ignorance. Robert is too intelligent to be among the later.

Still, we certainly can’t hold it against Roberto for criticizing most of what he does, especially when he is labeling the 2006 Congress as the porkfest that it was:

“A Congress that dispensed so much lard you’d think they had a pig-slaughtering operation in the cloak rooms…At last count, over $50 billion in earmarks - really favors for lobbyists who bundled campaign contributions on their behalf. Billions more in corporate welfare for Big Oil, Big Pharma, Big Telecom. And don’t forget the congressmen who put both hands into the trough and got back corporate gifts, junkets and outright bribes. The hall of shame grew bigger this year.”

Sor far, so good. Even Haliburton received its requisite mention for wasting billions. Reich then goes on to let Wall Street have it. He rips on investment bankers’ record bonuses, as well those of traders and hedge-fund managers. Notes Reich:

“How did they make all that money? Some, by timing trades. Or by taking companies private, loading them up with debt, cutting their payrolls, and then taking them public again. Or by monopolizing initial public offerings and getting in on the juiciest ones before the rest of the public.”

That may not be a perfect description, but it generally tells the correct story, that many big insiders closest to the deals get the richest while the rif-raf are supposed to invest blindly into index funds.

Reich then begins to show his true, scarlet colors:

“Most of the cost of this feeding frenzy among politicians, defense contractors and Wall Streeter’s has been borne by average workers, normal taxpayers and small investors.

But the real price of all this has been to our democratic-capitalist system itself. When people at the top abuse their power, the average person loses trust in that system. And then how can we possibly change it?”

Of course, this is where you’ve been fed the old bait and switch. Certainly those in power get the perks, and we sympathize not just with the little guy, but anyone, rich or poor, who is getting the short end of the stick in this game. (Yes, many entrepreneurial, non-connected rich are victims of the power brokers — they are among the top 5% of earners who pay for over 80% of all government, inflation, etc.)  But Mr. Reich is, by all standards, a major proponent of collectivist government — one where power is accumulated at the top. Reich really ought to be railing on the true problem: there is far too much centralized power, and as such, it is up for grabs to the highest bidders and strongest voting blocks. No matter how many freedom killing election reform laws you pass, it will remain. Youy see, the Reich’s of the world believe that if only the smartest of them — the ones that really know what’s wrong and how to fix it - were in charge (like him) then the world would certainly be a better place.

Note that he does not have a problem with a democratic capitalism, per say. Yet our problem today is partially the conventional emphasis and infatuation on the democracy above all other rights that has brought us to a situation where we have such a centralized power problem to begin with. If the Robert Reich’s of the world hadn’t put so much power in the hands of the government and instead left the republic as the consensualist democracy it mostly was at its inception, we’d all be better off. Instead we have central banks robbing the poorest blind with steady money supply inflation. The same inflation — created through massive credit expansion available primarily to Wall Street — that enables all Robert’s criminals noted above to earn their record bonuses and waste hundreds of billions on pork. It is the same Federal Reserve that funds the massive deficits of the U.S. government, either directly through open market operations, or indirectly by simply flooding the environment with so many dollars that the rest of the world does not know what to do with them other than to invest in U.S. Treasuries.

And how can we possibly change it, asks Mr. Reich? We know his answer: blame capitalism, and the put his “smarter than thou” cronies in charge to fix it, too bad if a few eggs get broken in the omelet begot of intelligentsia omnipotence.

No reader should be distracted to believing the U.S.A. is operating as a free market capitalist nation. No. It much more closely resembles, by definition, a blend of mercantilism and fascism, where major corporations and special interests are quasi government fixtures, running legislation in their favor while parasitically living off the masses. I personally prefer the term parasitic capitalism for what Reich pawns off as capitalism, pure and clean.

The real solution to this problem, I’m afraid, was long ago dead in the water: stop the out-of-control government growth. The end-game is now a forced-hand solution: serious trouble lies ahead for the U.S. balance sheet, the U.S. dollar, and the U.S. consumer — not to mention the tens of millions of beneficiaries of Mr. Reich’s own supported Government benefit largess. All of it is a free lunch house of cards built upon a soft foundation of massive credit expansion (e.g. expanding money supply). When this credit bubble breaks, look out below.

[If you are new to the site, and don't know of the credit bubble, please peruse the site for the details.]

We’ve seen only a handful of articles tucked in the pages here and there of various publications noting how the CBOE Volatility Index (VIX) continues to trade at levels demonstrating virtually zero worry about volatility hitting the markets. The WSJ is now in the game, pointing out that the VIX has again fallen below 10 — only the eight time since 1990. It should be noted that three of those “below tens” have happened in the last few weeks, including just prior to the dollar plummet on Thanksgiving Friday. VIX is trading in its 99th percentile in terms of indifference to risk.

The vigilant are taking note, especially given how many other indicators are lining up showing similar indifference on Wall Street. Overconfidence often breeds recklessness and stupidity, lest you forget the dot-com fiasco.

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“When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it.”

–Frederic Bastiat, The Law

Hear, hear! After all, what is an election today but an opportunity for various special-interest groups to fight over how they will doll out the wealth and freedoms of others, all for their own benefit.

With hundreds of billions of dollars and the power to regulate / hinder your competition being up for grabs each election, it is no wonder so much effort and money is spent each election cycle. (No wonder the chairman of the Federal Election Commission yesterday predicted that 2008 will produce the first $1 billion presidential race.) As H.L. Mencken once quipped, elections are fast becoming nothing short of an advance auction sale of stolen goods.

This terrible addiction of the masses is hardly new, and it’s hardly confined to the often cited issue of welfare. Much resentment is misdirected at the Free Market, which wrongly indicts an innocent bystander for the crimes of real felons. The U.S. system of markets is hardly free and barely ever was. What was is less so by the day. When one must hire a fleet of lawyers, tax professionals and consultants just to put a shingle up for business to comply with legislation that is absurdly punitive with its complexity, the market is not free. When existing businesses are constantly shackled by ever-increasing regulations that make staying in business impossible unless one sells-out or merges, while larger firms with the requisite critical mass are able to survive and absorb the smaller competition, you do not have a free market.

But as Bastiat knew so well in his quote above, we are deluged with syrupy explanations for why the absurd isn’t; for why state confiscation of your rights and property is good; for why humans are are greedy on their own, but not when working as a collective and using blunt government force to reach their goals; for why the infallible intelligence of mob-rule justly trumps any individual’s basic rights to their own freedom, liberty and property.

As Congress allies up with the usual suspects to blame other nations, such as China, for our economic problems - labeled as unfair competition that is stealing U.S. jobs, don’t forget it is all a distraction from the real problem: The U.S. is slowly committing economic suicide.

For the last couple of months we’ve continued to tell folks that we are just seeing the tip of the housing bubble break. One of the areas to monitor is the subprime mortgage market (made to borrowers with unfavorable credit) given how lenient lending standards have been over the last couple of years. And so, today we see an article published at the New York Times titled “Study Predicts Foreclosure for 1 in 5 Subprime Loans“. According to their study, one in five subprime mortgages made in the last two years will go belly up. Says the article, “At that rate, about 1.1 million homeowners who took out subprime loans in the last two years will lose their houses in the next few years, the report said. The foreclosures will cost those homeowners an estimated $74.6 billion, primarily in equity.”

One lesson we hope all readers gather from this — keeping in mind that credit expansion and money supply growth at the expense of existing dollar holders was used to finance these soon to fail mortgages — are the dislocations created by actions that the free market would not ordinarily tolerate absent government intervention. In this case, subprime loans were given extra leeway thanks to the quasi governmental mortgage institutions — Fannie Mae, Ginnie Mae / Mac, etc.

Continues the article, “The report offers a somber assessment of loans that had helped millions of Americans with blemished credit attain homeownership. About 2.2 million borrowers who took subprime loans from 1998 to 2006 are likely to lose their homes.”

We’d add, given that inflationary credit expansion is simply a hidden tax, and as such, the entire economy is a loser thanks to this intervention the voting U.S. citizen has enabled.

Once again consensus experts had the pants surprised off of them today: PPI (the producer price index), a wholesale indicator of rising prices published by the Labor Department, was up 2.00% — the biggest jump in 30 years! Wall Street was expecting a mere 1/2 percent increase.

Of course, PPI fell 1.6% in October, and the two numbers smooth the other. You can read the other details here.

Where and how prices will rise tomorrow, the next day or next week, is anyone’s guess, especially given how dramatically official government stats on prices have been deliberately understated over the last 20 years. But one trend is certain: the dollar is losing purchasing power at a greater pace than is has in a while, and the trend is merely a continuation of one that started when the Federal Reserve banking cartel was created in 1914. Since then, the dollar went from being a steady store of wealth to losing over 96% of its purchasing power in less than a century. Given our post this past Saturday on the real Federal Deficit running at $4.6 Trillion, the U.S. Government is on a crash course with extreme shortfalls that can be made up either by immediately doubling all taxes or cutting benefits by 2/3. Given neither is possible (show me any politician with the guts to stand up vs. the AARP!!), the only other alternative is to print fresh dollars to paper over the shortfall.

The world may wake up next week, next month or not fo five years or more. But when it does, look out below!

This little chart was published at Bloomberg today:

In other words, all 12 of the 12 largest firms on Wall Street are predicting a higher S&P 500 next year. Not since 2001 have we had such agreement!

Just add that to the other pile of evidence that suggests a tremendous amount of confidence and bullishness on Wall Street at the moment. Those include:

• VIX trading at record lows the past month
• Investor Intelligence indicating unprecedented bullish trader sentiment
• Market Vane the same

Plus there are other indicators on call option and S&P 500 positions, average cash levels in equity funds, etc..  No contrarian indicator is perfect, but combined with all the structural problems we discuss day in and day out, plus very heavy insider traders, vigilant investor thinks you should exercise caution.

John Williams at Shadow Government Stats has already dug through the fine print in the 2006 Financial Statement of the U.S. Government and found the real 2006 deficit number to be 19 times the size of the “officially discussed” deficit of 2006.

The officially discussed deficit number for 2006 was actually down to $248 billion, from $315 in 2005. Yet, as Williams notes each year, unlike what any responsible accounting firm would require of a business, that number generally fails GAAP (Generally accepted accounting principles) requirements, and does not include the net present value of future unfunded obligations — Social (in)Security, Medicare, Medicade, etc. etc. etc. When those numbers (which are disclosed in the report) are added back into the number, the deficit grows to $4.6 trillion. That’s up from $3.5 Trillion last year. Again, you could tax all personal income in the U.S. 100% and not reach last year’s astronomical number.

We can’t stress the importance of comprehending the ramifications of this. The U.S. is severely addicted and dependent upon on cheap credit granted via foreign generosity. With total federal obligations climbing from $50 trillion to $54.6 trillion, it is only a matter of time before foreigners realize the debt of the U.S. is backed by the full faith and credit of a nation that has promised far too many free lunches to remain viable.

Moreover, as the Fed’s own study revealed earlier this year, the cuts and tax hikes required to solve the problem are politically impossible: doubling all taxes immediately, or cutting all benefits by 2/3. Just call the AARP if you think any of that will fly. That leaves the government with one viable option — inflation.

As everyone comes to grips, it is only a matter of time before the dollar must slide, and interest rates climb, and then, for the consumption and debt happy U.S., the party is over.

• Listen to our interview of John Williams earlier this year.

See our previous posts on the subject:

• Federal Reserve Says “The U.S. Heading For Bankruptcy”
• U.S. Government Debt by GAAP Revealed: Insurmountable

A few days ago we published some comments about Bill Gross’s most recent Investment Outlook publication. A worthy read, no less (both our post and his comments), but we threw in a couple of digs about Mr. Gross only sniffing around the edges of much deeper problems that he and other prominent skeptics of the economy (Stephen Roach comes to mind) seem to be missing. Hence, their conclusions are not entirely on the mark, although they are more with it than most.

Well, no sooner did we post that bit about Gross when we came across an update from someone who has his hands entirely on the pulse of the deeper problems: Sean Corrigan. Titled How the Global Boom Might End is short and to the point, and the perfect primer for those who need to get up to speed quickly. This is a must read for all.

Bottom line: endless inflation (and we mean the traditional definition: expanding the money supply) can be fun for a long time, but structurally it eventually must be paid for like all free lunches. The longer our credit bubble is allowed to compound, the worse the dislocations become that must be repaired.

Well, the U.S. Mint is making news today by warning folks that it is illegal to melt down pennies and nickels given the metal used to make them is now worth more than the actual listed purchasing power of the coins themselves. [Read their press release here.] Based on current metals prices, the value of the metal in a nickel is now 6.99 cents, while the penny’s metal is worth 1.12 cents, according to the U.S. Mint.

In order to prevent this from happening, the Mint implemented a rule making it illegal to melt both of the coins, as well as to prevent the unlicensed exportation of them in “mass quantities.” Defined, mass quantities aren’t so massive a number: travelers are allowed no more than $5 of the coins, and nobody is allowed to ship more than $100 of them, and then for only “legitimate” purposes.

While most folks will look at this news making no connection, it is the direct consequence of year after year of steady inflation of the currency – literally being printed out of thin air by the cartel affiliated with the privately owned Federal Reserve Bank of the U.S. Since the Fed experiment began in 1914, the U.S. dollar has lost well over 95% of its purchasing power, and that’s against the largely understated CPI. In other words, the damage is probably much worse.

By the way, don’t dare get caught trying to recoup some of your inflation-stolen purchasing power with your home-smelter: You could face $10,000 fines and imprisonment.