Saving Without A Budget

Wake Up! The Fed Is Not Going to Cut Rates

On September 18, the Federal Reserve is going to take the unpopular stance and will announce that they have decided to leave the federal funds rate at 5.25%, where it has been for over a year.

It’s going to shock Wall Street - who apparently believes it’s a foregone conclusion that the Fed will drop rates by at least 25 basis points - and could very well cause the Dow, Nasdaq and S&P 500 to drop by five percent or more on the 18th alone.

From Day One, Ben Bernanke, the guy left to fix all of Alan Greenspan’s misguided policies, has said that his number one concern is curbing inflation - not soothing the market.

Despite the credit crunch, the United States’ economy is still moving along quite nicely. We’re still on pace for another year of at least 3% growth, even in the midst of an economy that appears to be slowing. Notice, I said “slowing,” not “coming to a grinding halt.” Regardless, the economy does not yet need the jolt that a cut (or continued cutting) in interest rates would provide.

With a barrel of oil sitting at $80 (a record high), the cost of heating our homes this winter will probably be markedly higher than last year - which was the story the previous winter, as well as the winter before that. Throw in a healthy spike in the cost of food, gasoline, and (thanks to a falling dollar) imported goods, we’re very likely to face strong inflationary pressure for months to come.

In addition to the U.S.’s economy, the world economy in general is still booming, especially in developing nations like China and India, which is probably why most of the world’s central banks are either holding interest rates steady or continuing to bump them up. In the midst of a falling dollar, Bernanke can’t start taking rates down if his counterparts aren’t going to join in the fun.

I also think that Bernanke would like to separate himself from his predecessor and let the pigs get slaughtered. Let’s face it, recession is part of the business cycle, trying to lessen, negate or do away with it could very well just create a much larger problem (i.e. a depression) down the road when all of the problems that had been swept under the rug and never dealt with all decide to pop up at once.

I know that the drop in the housing market is weighing on many of us (hell, it’s giving me an ulcer) and is probably altering our spending habits, but a cut in the federal funds rate isn’t going to solve the problem. Housing prices are just too high and have vastly outgrown wage increases over the past decade or so. The market is due for a correction. It sucks for people who bought recently (I’m in that boat), but that’s the way it goes.

Even if the Fed were to cut rates, it doesn’t necessarily mean that the housing market will bounce back or that it will even slow the market’s fall. Financial institutions need to start lending money again in order to reach the market’s bottom, but they’re not going to do that until they’re certain all of the risky debt that they’ve taken on (much to their own doing) has either been contained or shaken out of the market all together.

Unfortunately, since we’re just now entering the first big wave of mortgage rate resets, it’s going to take a lot of time for that to happen. Cutting the federal funds rate isn’t going to expedite that process.

Long story short, the Fed is going to do what it should do, and it will keep the all-important federal funds rate where it has been for the last 14 months.

Posted in Investing, News | 1 Comment »

The Second Great Depression or a Blip on the Radar?

Depending on who you ask, the “crisis” surrounding the United States housing market is likely to go one of two ways: 1) the decline in the price of homes, and the subsequent drying up of the housing ATM is going to lead the country into the second Great Depression; or 2) yes, home prices will continue to sag for the time being, but the economy is strong enough to withstand this due to strength in other sectors.

With so many opinions flying around, each with pretty significant data backing them up (heck, you even get both points of view on this very site) it’s pretty tough to know who to believe.

I was reading an interesting article on MarketOracle.com today which talked about the parallels between pre-Depression America and where we have been over the last couple of years.

It seems both bubbles - the equity bubble in the 1920s and the housing bubble of the 2000s - were borne out of people using money they didn’t have (either buying massive amounts of stocks on margin or using creative financing to get into a home that they couldn’t realistically afford) to try and build wealth, all in the face of stagnant salaries.

In both instances, the prices of what was being bought ended up being far too inflated for the underlying fundamentals. Once this caught up both items ended up seeing a precipitous drop in price (not necessarily value). We all know how it ended in the 1920s, and, unfortunately, how it ultimately ends today is still very much in the air.

On the other hand, you have articles like this one on Bloomberg.com which make the argument that the housing crisis may have already passed. The actual point of the article wasn’t to say that a housing turn around is imminent (although the author does say it could be closer than what many pundits are saying), but it was to show that the economy will survive and still move forward even as housing continues to sag.

The author also offered the reassurance that while nothing goes up forever, nothing goes down forever either. The population in America continues to grow and this growing population is going to need a place to live. Because construction has dramatically slowed down, at some point the supply/demand balance will even out, and the market will begin its usual five to eight percent annual increase.

So, who do you believe?

For what it’s worth, I think we’re going to come down somewhere in the middle. I don’t believe the bursting housing bubble will lead the country into another depression, but I don’t think we’re going to come out of this quickly or smelling like roses. It’s almost a foregone conclusion that we will enter some sort of recession and unfortunately many people are going to have some pretty tough economic and financial times ahead.

If you can weather the storm, even if it takes a couple of years, in the long term you should be just fine.

Posted in Around The House | 3 Comments »

The Flipside of my Argument Against a Housing Rally

Okay, so I sat down and thought more about what I wrote yesterday. After some careful consideration, I still think the housing market is in for some trouble, but I think that the light at the end of the tunnel might actually be closer than what I initially thought.

First off, I think it’s important to state what type of investor I am; I think that might give a little bit of insight as to how I think about investments and markets. Obviously, there are a million different ways to invest and none of the ways seem to be particularly right or wrong - unless you invest like Warren Buffet or Peter Lynch because then you’d almost always be right.

Anyway, I like to look at myself as the anti-trend investor. As a market’s climb becomes more pronounced and the number of people talking about how great things are increases, the more bearish I become. Conversely, as a market’s fall become more pronounced and the number of people talking about how terrible things have become increases, the more bullish I become.

So, let’s look at the latest data regarding the housing market. Yesterday, the National Associate of Realtors released data showing the number of houses sold in the past month is way down over where we were last year, so much so that they’ve revised their forecast for the number of homes sold during 2007 downward - again.

Today, there were two interesting tidbits put out there: 1) the data showing housing starts is down for the sixth straight month and is at its lowest level in a decade and 2) Countrywide Financial (the country’s largest mortgage lender) has had to draw upon its $11.5 billion line of credit to cover operations. Of course, this sent the stock market into another day of sell mode, although it did rebound nicely to close the day.

Anyway, what I think all of this means is that the Fed’s hand is going to be forced in the near future. With the prospect of the country’s largest home mortgage lender having to possibly file for bankruptcy (a claim the CEO of Countrywide has vehemently denied), all three major indices in a major correction mode (not sure if they’ve reached the 10% threshold yet, but they’re close) and the fact that the American credit mess has now become a major hiccup in the world economy, I think that Bernanke and the Fed will start lowering interest rates this September - maybe even by a full half percent.

Obviously, this will add some liquidity to the credit market and should spark a slight rally in both the stock and housing markets. Whether these rallies will be able to be sustained is yet to be seen, but I believe that this will cause most housing markets to find their footing. We probably won’t see much of a spike in prices, but at least the lower rates will entice people who had been waiting on the sidelines to get into the market and buy.

The only thing that worries me is that if the rates drop, the housing market will be come saturated with people trying to get out of their homes right away, just in case this plateau or moderate turn around is only temporary. If this were to happen, while more homes would be sold, prices would probably continue to slip as housing inventory increased.

So, I guess this is the counter argument to what I had to say yesterday. While I still lean towards the pessimistic side, I’m hopeful that there will soon be some stabilizing forces in the markets.

Posted in Around The House, Investing | No Comments »

Home Sales Fall to Five Year Low - When Will it End?

As a recent home buyer, it pains me to no end to write the article. At the same time, it pains me ever more to hear people say, “don’t worry, the home prices will bounce back soon,” when speaking about the currently woeful housing market.

I hate to be the bearer of bad news, but it’s just not going to happen any time soon. And by any time soon, I’m talking about the next three years.

While I’m sure plenty of you are going to shoot down what I’m about to say as an “apples and oranges” argument, I’d at least like you to hear me out first.

I liken this housing bubble to the most recent boom and bust we experienced in the stock market (specifically tech stocks) back in the early 2000s. I just see too many parallels between the two, which, unfortunately, makes me believe that we still have a ways to go before we see home prices stabilize.

The main reason why I see parallels between the two bubbles is because neither bubble was built on solid fundamentals. Investors jumped in not because they knew what they were doing or what they were buying into, rather because they were looking to make a quick buck in a market that made everything seem like it was sure to go up.

Because of these speculators’/investors’ actions, prices in both bubbles were artificially inflated and drive up to absurd and, most importantly, unsustainable levels. There’s no way that prices could ever remain that high, whether it was due to the fact that there wasn’t anything there to substantiate the high prices (i.e. no revenue), salaries weren’t keeping up, or banks were giving out money that people couldn’t afford to repay.

Anyway, I think it’s fairly obvious the the housing market is in the middle of its downturn. According to a recent press release by the National Associate of Realtors, home sales were down in 41 states and, for the most part, prices have yet to stabilize across the country. Not exactly great news.

In order to finish the parallel, I think housing prices will follow much the same path as many of the tech boom leaders: obviously, at some point the slide will end, prices will stabilize, but will then take years (possibly decades) to return to their peak values.

I’m sure you’re now screaming at your monitor that a piece of paper (a stock) is completely different from a house. You’re right it is. For those of us who bought our house as a long-term investment, and so that we could have a place to live and raise a family, none of this will really matter (assuming you can afford your payments).

However, the fact that both bubbles were fueled by uninformed speculative investors trying to make a quick buck is completely undeniable, and that’s really the point that I’m trying to make. These are the people that are responsible for the last two boom/bust investment cycles in our country and it’s unfortunate that many millions of “little guys” got caught in the wake.

I certainly hope that I’m wrong, but I really don’t think I am.

Posted in Around The House, Investing | No Comments »

Thanks Mr. Greenspan!

Let me preface everything I’m about to write by reminding you that despite having a degree in business/finance, I am nothing more than an arm-chair economist. I find economic theory to be completely fascinating, but at the same time, I’m not exactly well versed in it.

That being said, I don’t think it takes a PhD in economics to realize that both the United States and the world’s economies are in a very, very tight spot right now. Credit markets are seizing up, world indices are swinging wildly each and every day and there appears to be a lack of credible and feasible solutions to the problems.

In short, I think we are on the verge of a very significant international recession. While I don’t think we’re going to see anything like the Great Depression, I fear that many of us - throughout the world, not just in the U.S. - are on the verge of financial ruin.

While it’s tough to place the blame on just one country or group of countries, especially considering how interconnected the world has become, I think it’s safe to say that one person (yes, a single individual) should be held accountable for a large portion of the problems we’re facing right now.

That person’s name is Alan Greenspan.

You see, Mr. Greenspan was the champion of cheap money. Under his watch, we saw the Federal Reserve, the group entrusted with controlling our country’s money supply, drop federal funds rate 1% - an absurdly low amount.

While this helped to stimulate growth in what had become a stagnant economy (especially after the September 11 attacks) it brought a lot of cheap money into the economy. What I mean by cheap money is due to the historically low interest rates there wasn’t much cost associated with borrowing money.

This of course ended up being the major cause behind this country’s real estate boom and subsequent bust.

We have always been brought up to believe in the “American dream,” part of which includes owning your very own home. Since most of us don’t have between $200,000 and $500,000 spare cash lying around, the most common way for people to realize this dream is to borrow money from a lending institution. However, because these institutions aren’t charities, they expect to be paid extra (the interest that you pay) in order to compensate for the large amount of money they give to you so that you may buy your home.

When the Fed continued to lower interest rates, it became easier for people to afford to own a home because essentially their payments would be lower due to the decreased interest expense. However, because more people could afford houses, the demand for houses began to increase, and as we all know from basic economics, as demand increases, prices tend to increase as well.

Additionally, for those of us who already owned a home and had realized a gain in equity (due to the increased values) we were able to borrow against our homes (usually with a home equity credit line) at a cheap rate and with the possibility of that money being tax deductible. Essentially, our homes became ATM machines.

So far we’ve covered regular first time home buyers as well as people who already owned homes and borrowed money against their house’s escalating value. Two down, two to go.

Now, we’ve got home builders. Because they see that there is now a huge demand for houses because of absurdly cheap money, they jump in and just start building left and right. Condos, townhouses, regular sized homes, McMansions, you name it, they built it. And people were buying left and right.

Finally, we come back to Mr. Greenspan and his desire for alternative mortgages.

Not too long ago, pretty much the only way that you could buy a house would be to qualify for a fixed rate mortgage, typically a 30 year loan, and at closing put down 20% of the value of the house you were buying. Example - you’re buying a $100,000 house; at closing you would hand over $20,000 and you would assume a 30 year, fixed rate mortgage for $80,000.

Because it’s asking a lot for someone to be able to pony up tens of thousands of dollars when buying a home, many people previously had to sit on the sidelines, rent, and hope to be able to save up enough money over time. Unfortunately, this wasn’t good enough for Mr. Greenspan, who encouraged lenders to become more creative in their lending products.

This, in turn, led to items like the ARM mortgage, the interest only mortgage, and mortgages that offered teaser rates only to balloon after a short period of time or actually tack the “unpaid” interest onto the back of the balance of the loan.

Essentially, this allowed people who had no business buying a home to not only buy a home, but probably a much bigger home than they could ever realistically expect to afford.

Aside from people who actually wanted to live in the house that they purchased, these low rates and wacky mortgages brought out many people who were looking to make a quick buck in the market. I’m sure you’ve seen the commercials for real estate flipping programs, where someone buys a property using an alternative mortgage, waits for the property to appreciate and then quickly flips it for a profit.

It was these investors that artificially drove up the prices of homes throughout the country. They had no intent on living in the property, but because they were buying something that other people wanted, they were essentially driving up the prices of every house around theirs (including their own property).

Anyway, so Mr. Greenspan set all of this up by dropping interest rates to 1%. Then, he flipped the tables by raising interest rates 17 consecutive times to the current rate of 5.25%. Essentially, he got most people in the country to buy into the 1% teaser rate, knowing that it couldn’t stay that long forever, and then raised the price on everyone and everything.

Granted, he HAD to raise the rates, otherwise inflation would have crippled the country; but he pretty much set up a no win situation. Either he had to keep the rates low and let lots of cheap money slosh around in the economy or he had to raise the rates and watch as people who bought using these creative mortgages suffer to make their higher payments.

This uncertainty in the housing sector (as well as the credit sector in general) has caused both the U.S. and world stock markets to fall sharply during the last three weeks, and, unfortunately, there doesn’t appear to be a rosy resolution in sight.

I believe that Ben Bernanke is doing the right thing by keeping interest rates where they are and not caving in to pressure to lower interest rates to soothe the credit market. I don’t believe that it is his (or the Fed’s) job to bail out these mortgage companies by lowering rates to revive a dying housing market. And, even though it’s sad to say, it’s not his job to bail out people who bought homes that they couldn’t reasonably afford.

It looks like the only way this problem is going to be solved is by tough love from the Fed. Keep interest rates the same (or even raise them slightly), stabilize the dollar, and let the housing market correct itself.

By doing this, we may end up in a mild recession throughout the country as the housing ATM dries up and people spend less money, but, like always, we will recover and ultimately resume our upward trend.

No thanks to Mr. Greenspan though.

Posted in Investing, Miscellaneous | 3 Comments »