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Foreclosure and the Housing Bubble

Posted On: 2006-10-25Length: 1:04:49

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Alright everybody, thanks for tuning on in tonight's episode of Vigilant Investor live this is Johannes Ernharth. And tonight we should have an interesting show ahead of us with Casey Serin, he's going to be our guest in a few minutes, he's in from California and he is the blogger who has been running a web site that, boy over the past few weeks has been getting more and more notoriety one way of the other, it's called iamfacingforeclosure.com. We talked about it a few weeks back, and we were talking about it in the context of being somewhat of and indicator as to what's going on out there relative to the overall economy and specific, one of our big gripes here at vigilantinvestor.com has been for a long while the credit bubble. So, a lot of that credit that's getting jacked up out there is flooding the market with liquidity, flooding the economy with liquidity, all sorts of different things, inflating up in value and of course the housing bubble is one of the distensions that we talk about that's affecting the economy. Of course our critique is that a lot of people are saying it's not a big deal and we don't have to worry too much about it, and for a better part of the last 12 months, we've had people finally coming around to acknowledge that the housing bubble is real, and now the news is getting to be a little more frequent where we're seeing that in reality the housing bubble is beginning to burst and maybe hit a little bit harder than people had anticipated. First it was all soft landing talk and so forth. We'll be talking to Casey in just a few minutes, we'll get in that a little more in depth and just sort of explore that subject from the standpoint of the housing bubble and some of the eccentricities that typically happen when you get a lot of credit fueled manias going on out there. And I think Casey's situation is unfortunate and represents what I think is going to happen to a lot of people out there, and that Casey has definitely become somewhat of a poster child for being in the C, the money section of USA Today a few days ago. But, nonetheless, we'll be talking with Casey and in the meantime, lets cover a couple of other subjects out of the recent news, today the Dow Jones Industrial market wise up again to 12, 134, closing, Nasdaq was up about 1, 175 about a half percent, S&P 500 up about 4.84, so just a little bit of , you know, three tenths of a percent rise there. And the markets are giving people a lot of confidence, Republicans definitely like it for their re-election objectives coming in November, just a few, boy, it's right around the corner here, in just a couple of weeks, and we're definitely getting a lot of people out there trotting out that the economy has been chugging along and doing just fine and that, boy with the Dow Jones Industrial hitting 12, 000 I've been seeing that in a lot of campaign commercials, what a great new milestone the Dow at 12,000, closing over 12, 000 has been. And of course we've been pointing out over the past few weeks that the Dow hitting 12,000 is a new record if you're considering in nominal terms and again the difference between nominal and real returns is that nominal is not adjusted for inflation or for what's going on out there relative to other prices. And, at least in our terms of what nominal is we're of course not just relying on CPI, the Consumer Price Index which is what most people are looking at. But if we really were to have the Dow Jones Industrial hitting a new record, we remind everybody that we are looking at a number that is probably closer to around 13,800, and if we were looking at even a more legitimate indicator of inflation verses the heavily manipulated CPI that comes out of the government every week, well we'd be talking about, well, who knows what, 14,000 and some change probably but if we're to rely on that again as we talked with John Williams a few weeks back from shadowstats.com, of course we recommend that everybody go to that site just to take a look at some of those graphs, occasionally we'll post some of his, John Williams' material up on our site. But in any event, as the conversation we had with John a few weeks ago indicated, you know boy, CPI, GDP, the GDP indicator for economic growth for the U.S. country as a whole, the U.S. economy as a whole, all that is overstated, it is pro growth oriented, and understated when we talk about things like inflation and that's just been something that's progressively happened over the last 30, 40 years as those statistics have been largely marginalized by politicization. And, I probably, not to beat a dead horse, but probably my favorite is the unemployment number which is running closer to 12 percent if we use the traditional method of simply looking at how many people who are able bodies adults that could work, that simple choose, that simply are not working and that's the old classic definition of unemployment if you think about it, somebody who just doesn't, you know, is not able to find a job, well that's no longer the definition of unemployment by the government standards. These days people who choose not to work, and are simply not looking for work, because they would rather do something else a la sit around and do nothing if that's their choice, well those people are considered to be discouraged workers and they are statistically removed from the unemployed. We also have sampling changes where high areas of, excuse me, areas, geographic areas that have demographics of highly, more unemployed than other areas, well they're statistically moving those figures out of the figure as well. So that's how we get and infla -, excuse me a unemployment number that is 4.6 percent, which I think was the most recent number, maybe even closer to 4 percent. When if we went back and simply measured it like we used to back during the depression when it was at 25 percent, back like during the 50's when it was a lot better than that, well we'd be at probably 12 percent, which is not too different from what's going on in the urban and other areas And I think a better indicator for the economy is, considering a lot of those people, that 12 percent are functionally deadwood to the economy and many of them are also absorbing welfare and so forth coming out of the tax revenues and the inflationary apparatus coming out of the Federal Government. But, wait that's a heck of a tangent from where we were, we were talking about the Dow Jones Industrial and real adjusted numbers, and real returns verses the records. All that said, the Dow, you know all this talk in the media about new records, it's really not a new record and again, and we don't mean to beat that horse to death either, but it's just something to keep your eye on the ball. Now, winding that all back in, I want to move on to opening the interview up with Casey here, Casey Serin of iamfacingforeclosure.com. Boy, if you've been a regular visitor to vigilantinvestor.com over the years, you've gotten to know that one of our big themes had been the real estate bubble. And the process of which this bubble really was initiated is through our credit system and if anybody understands how the banking system works in the United States, it is at the well, it has the ability to really crank up money supply and functionally the way the U.S. system works, we don't we would not have U.S. dollars in our hands, we would not have a currency to work with in the United States, and this goes back to the creation of the Federal Reserve back in 1911 and its ultimate running in the mid-teens there, but if it was not for debt being issued, none of us would have any dollars to work with. Every dollar that is in existence has been loaned into existence through the banking system. And via the Federal Reserve and Federal Reserve either drives that directly into the banking system or via the government, and of course that's a cozy relationship, between the Federal Reserve and the government, but because congress gets to spend, and anytime it can't find money or doesn't feel like taxing people to generate more money it simply goes to the Federal Reserve and Says, "hey, we'd like to issue a few billion dollars in new bonds and deficit spend some more," and the Federal Reserve says, "Sure we'll buy those," and the Federal Reserve just basically prints money out of thin air; now these days it's digitally, they simply add a few zeros on the computer screen and voila you have those billions of dollars getting transferred from the Federal Reserve and to the U.S. government and the U.S. government starts spending that money. Now, keep in mind, that money did not exist prior to that there was no anything behind that money other than simply the decision to create a few billion dollars out of thin air. That sounds pretty crazy but that is how it functions. So, tying back into the credit bubble and the housing bubble what we've seen over the last 5 years, 6 years, has been a, well an economic reaction, we consider the formal policy of what's been going on in the U.S. government and the reaction to the big stock bubble burst in the late 1990's which led into a recession in 2001, and the reaction, the policy reaction that we saw was that the Federal Reserve began plowing down its lending rates to banks to the record. To basically as low as 1 percent, which is functionally an emergency rate. And the idea behind that was that the federal reserve wanted to get, keep the economy above water by getting money out there into circulation, which the philosophy as it stands at least is that that creates economic growth and it helps an economy get moving again. And our problem with that is you know being of the Austrian economist persuasion, and by Austrian we don't mean from the nation of Austria but Austrian school, which is an economic philosophy that kind of migrated out of Austria into the United States, but is very much a free market approach to dealing with the economy and especially with banking and definitely hands off relative to monkying with money supply. Well, the critique with monkeying with money supply and credit is that when you do that, when you increase money supply, you really don't create anything you didn't do anything to print money out of thin air. And what it does is by injecting all that money, well first off that money gets its purchasing power at the expense of everybody else out there who is holding existing dollars number one, and number two it is functionally via that process of taking that purchasing power from existing holders, it transfers it into money into the hands of people who are willing to move and shake with that money. And that's all fine early on, you know if you have responsible actions going on, it can you know not cause really too much of a problem for the economy, but the more that cycle reverberates around and around the further you get away from the people who are actually holding that money and doing perhaps more responsible things with it, because the reason they had it in the first place largely is because they knew how to be good stewards of it, they knew how to build a business, they knew how to save and so forth. And, what ends up happening is that money gets moved over into the mover and shakers side of the balance sheet if you will, and it starts getting circulated around. Now, all the movers and shakers and the people who are recipients of that new money don't understand that this money has been created out of thin air and they actually believe that it represents real growth and real economic activity, when in reality it's just simply representing a transfer payment. And it certainly gets things moving, but the problem is people become, they get to be under the impression that that is something that is sustainable, that it's going to continue and we saw it happen back in the go go 20's when everybody was all crazy about how well the economy was doing and it was all the new era and everybody thought it was a completely different way to live life, you no longer had to live the way you did back in the 1800's. And boy, the 20's especially after WWI really represented a huge change in advancement for the economy and for the United States as a whole. And all the sudden poof! it was all gone. That's because everybody got faked into believing that a huge money supply increase, which is what happened, and in the teens in response to WWI was actually economic growth. So, let's wind all that yapping into this housing bubble here. Now, Casey, I came across Casey Serin's site a few weeks back and just you know basically I shook my head a little bit saying wow, this is exactly a representation of what we're talking about. Casey, are you there right now?

Casey: I sure am, thanks for having me.

Thanks a lot for joining us today. Now, Casey maybe you can help me out a little bit by explaining your situation. Now, you have, you were able to basically get, was it eight properties originally?

Casey: Yes, I bought eight houses in eight months, from October of 2005 to May of this year. I'm sorry, October of 2005 to May of this year, 2006.

Okay. Now, during that time, how much money down, were you required to put down for each of these?

Casey: I bought all of these properties with 100 percent financed loans and no money out of my pocket.

Okay. Now, again as I was saying before, and Casey bear with me while I just sort of tie up what I was saying before a little bit. This is an example, Casey's situation of where all this money is circulating around out there, and I can't stress how much that the Federal Reserve really was trying to get people to borrow over the past few years in order to pull the economy out of the recession of 2001. Now, a lot off that money got into the mortgage side of things through very, very low interest rates. Now, typically Casey, how low were those mortgage rates that you were running into to get the homes? Were you doing traditional 30 years were you doing adjustable rates? How were you doing those?

Casey: Well, see my goal was to buy, fix and flip houses, because I needed to create some capital so later on I can use that capital for doing more long term investment. So, I wasn't concerned about the rates so much, my goal was simply get in with as little money down as possible and no prepayment penalties. So my rates were a little higher because I was taking a hit by going stated income and things like that. So, anywhere from I'd say on the low side 6.5 to on a high side 8.5. Now that was for the first mortgages, the second mortgages, because typically they were 80-20 loans, 80 percent first and at 20 percent second, which composed 100 percent financing, that avoids mortgage insurance, saves you a little bit of money. The seconds are almost always run pretty high, we're talking 12 to 14 percent on the second.

Okay. Now, when you started, I guess, how did you learn about getting to become a real estate investor?

Casey: Well, you know I went to these seminars in gurus that you see on late night TV and I read books and my goal was simply to learn how to do this investing to make money in the real estate industry, the real estate business and that's how I got started.

Now, I was reading in the USA Today article that you were, now I should have mentioned earlier to our listeners that Casey you're 24 years old now?

Casey: Correct, yes 24.

Now, at the time when you were getting a lot of these loans you were making I think initially was it about 36, 000 a year is that right?

Casey: Well there's, some people are a little bit confused because the USA Today article was stuck on my very, very first purchase back when I was 19. And that was just a personal residence, I wasn't looking to do any investing at that point. I was just trying to buy my own place. [...] I was making 35, 30,000 as year at that particular job and that was 100 percent financing but then it was also a government program, I believe it was a FHA loan for first time buyers. And then when I started doing investing then I was making 50,000 dollars, last year in 2005.

Okay. Now, with respect to these mortgages, how does a guy making 50,000 a year able to get I think, what was it a total of about 2.5 million of mortgages, is that about right?

Casey: Yeah about 2.1, a little over 2.1 million in mortgages that I'm currently on the hook for.

What was the highest you had at one time?

Casey: It was a little higher because I think at one point I was holding 7 houses, I currently have 5 because I sold one just recently but it was a wrap around mortgage, all inclusive trust deed, is the technical name. I'm still on the hook for that loan, but I've already sold the property.

Did you ever get a sense that the lenders were really concerned about your income relative to the other loans you had out there? Were you disclosing these other loans to the lenders?

Casey: Well, this is the part which I'm not very proud of. What I was doing in order to keep buying these houses, was I was running them as owner occupied property. And the lenders don't really do too much checking to verify whether it's true or not, they kind of take your word for it. I think the only thing they'll do is they'll run your credit, and if they don't see any other properties then they just go with it. So I was running them around the same time with different lenders, and so I was able to get away buying several owner occupied properties.

Okay. So...and I should also state to our listeners that, now Casey you, on your site you have mentioned that you basically did fudge a little bit during your application process and so forth. The purpose of your site again, maybe you can just tell everybody what, you know, it seems like you're trying to make amends a little bit here, try to help other people avoid some of the problems you ran into.

Casey: Oh yeah, I mean, my purpose was, first of all I started to just try to market my properties, sell them to other investors. But then I thought, you know I need to sell my story because people were asking me, how are you doing? How are you handling this whole mess? Because I was definitely not the only one newbie investor who got in over his head. Plus I thought my story could be helpful to, just homeowners who are stuck because the times are really tough nowadays and it's going to get worse. And my goal was to help people by talking them out of the things I've done.

Now, when you were doing these seminars back, I guess it was prior to your first purchase, November of 2005. What were people telling you about doing real estate? I think you had said before that you went a little more aggressively than what they were saying?

Casey: You mean the people that, friend and family or the people at the seminar -

The people who were offering these seminars -

Casey: Oh, the gurus. Well, yeah the gurus, I don't want to say too much bad stuff about those guys, obviously they're trying to market their product, and just not show you how to do it, and if you use that information you could make money. But I went too aggressive with it see, they told you to start safe, start local and just work with other investors initially doing what they call wholesaling or in other words bird-dogging, finding deals and partnering up with other investors, and you never actually buy the property, you're just selling the rights to the deal to somebody for a quick 5 to 10 thousand dollars signing fee. Well I tried to do that initially, but the investor didn't want to buy my deal, thought I wasn't buying it low enough for him. And, so I thought, you know what, it's still a good deal, I'll go ahead and buy it myself. So I friend who is a mortgage broker, and she put together the loan and everything looked good and I went for it.

You also have properties in more than just California, you know. Where in California are you from?

Casey: Sacramento, California.

Sacramento, you also did other states was it Arizona and New Mexico as well, is that correct?

Casey: Texas, New Mexico and Utah.

Utah, okay. How difficult was it for you to just arrive as an out of towner to be getting properties?

Casey: Well, it was a lot harder than I thought. See, I was, I had a little bit of an overly optimistic outlook when I was starting out, thinking I could just show up there, build my local team, including finding a general contractor to take over the repairs and all that. But it doesn't work like that. I mean I was going off of referrals, but I really didn't have a team in place, that was one of the mistakes I made and I ended up losing a lot of money by hiring the wrong kind of people, and not being there to supervise and make sure everything was going right.

Now, seeing what's going on in the market right now, things are slowing down a good bit. Knowing what you know now, if you could start over with a clean slate, would you still be entering the real estate market at this point?

Casey: You know I still would. And that's because I wasn't really looking to be a speculator where I was buying it full market value and waiting for the market to go up. I only bought one house like that on pure speculation in New Mexico, because there's just a hot market, and a lot of California investors are going there so I kind of fell into that whole craze. But the rest of the properties, I was trying to be what they call a value buyer. Where I am buying at below retail value and doing sweat equity type of stuff, fixing them up because all of them pretty much needed repairs. And so I'm buying them wholesale and I have built in equity, and then when I return and re-sell, I should be able to still price it aggressively, even if the market is coming down, still make some money on it.

Okay. So, you were not out there trying to be like a quick flipper, kind of an investor. We've seen web sites out there that we commented on there before. Probably the most famous of them is condo flip.com for example where, boy, I mean people were trading, still are I gather at this point on un-built condo units. And -

Casey: I was not doing pre-construction. Pre-construction is just too risky because you're planning on the market going up. If it doesn't go up, and there's not the demand anymore, now you're stuck and you have to close on this thing. I was strictly trying to become what other successful investors have become as a buy, fix then sell investor. Which you always buy at whole sale at a deep discount, so no matter what the market is doing you should be able to sell, it's just the matter of instead of being on the market for 30 days it will be on there for 5 months but you adjust for that. So you're buying an even deeper discount in the down market.

It makes sense from that standpoint, see our big concern here on this end is and this is what I was talking about in the intro here has been that, what's been going on in the economy is that a lot of people, I don't think are seeing that in the long run, in a rising interest rate environment especially after things have been going so low as what we've had, that the prices have been maybe bid up to a point where there going to have to come back down maybe to reality at some point. Did that ever cross your mind, especially being out in some of the areas. I mean, we're based here in Pittsburgh and our housing market is going, not entirely dull, but generally pretty flat. And it's been going up but nothing like California, nothing like New York, nothing like Florida. Did it ever cross your mind that perhaps the prices would eventually slow down and maybe even reverse where you could end up upside down even if you had done it properly?

Casey: Oh yeah, you have to be so much more careful in a down market. I still like to say that you could make money buying, fixing and selling even in a down market. I'm trying to learn right now from a local investor who made all his money in the last downturn here in California. He was buying houses when the markets crashed around him. Going down 25 percent in a span of I believe 2 years, maybe 3 years, and people though he was crazy. But again, he had expert knowledge, he had a team in place and he was in and out quickly. He focused on first time buyer homes. He was actually doing a good thing, because he was creating inventory for first time buyers, he was usually offering them the best house for the cheapest price in that neighborhood. Because he was buying them so cheap, he was able to sell them slightly below market and avoid the who catching of the falling knife scenario.

Sure. It goes without saying that even in a falling market, people are still moving, people are still looking for first homes, and that there should be buy and sell opportunities. I guess my big concern is with just the volume of houses that were moving over the past few years, this is just, boy the expectations that a lot of people had. And Casey and I think we're probably going to wrap up at this point, and I do appreciate you being on board but it's almost as if the, it sounds as Casey and you can correct me if I'm wrong but, by all means this has to be a career and not a, you know just get into it part time. As a lot of the ads I hear out there are you can make this just doing a few hours a week kind of an approach.

Casey: Completely agree with you. And that's kind of the words of advice I'd like to leave with people, is you can't do this kind of thing just sort of, you buy a house, wait for it to go up, you cannot be a speculator because that thing will catch up with you and you lose a bunch of money. You have to be an expert, you have to have some construction knowledge and you have to know what you're doing. Otherwise, you probably shouldn't be doing this business. Only very few people can do it successfully. Most people should be more conservative.

One last question from my standpoint is, would you, do you think that the market is, at least the lending market ought to have been lending out 2.1 million dollars to a guy in your situation?

Casey: Well honestly, I was surprised at how easy it is to get loans nowadays, and things are getting a little bit better, but I'll say one thing. Again, I'm not proud of doing some of the things I did on my loans where I was you know, representing myself as an owner occupant, but really I was trying to buy it as an investment. See those guidelines are there for a reason, and sure they got loose, but if you actually follow the guidelines, it could actually prevent you from getting too dangerous. Because if I was doing everything completely [...] with stating the exact income I was making, this and that, there's no way I would have been able to get all of these loans, and we wouldn't have been talking at this point.

Basically, they were -

Casey: You've got to follow the guidelines, they're there for a reason [...] they're loose -

Were they checking on your income through the process, or were they just taking, I've seen a lot of loans these days really aren't looking for a lot of proof.

Casey: That's what I found, there was very little checking happening, and of course I was doing stated income loans where they normally don't check the income, they just do, you know, they just kind of take your word for it. Of course you get hit with a higher rate on that kind of thing.

One last question for you Casey. Generally speaking, it's interesting, what are your thoughts about the publicity you've been receiving through your site and through your situation, USA today articles and so forth?

Casey: Well it's, honestly caught me by surprise, I wasn't even looking to be out there in the media, and a lot of people out there saying that I'm just running a scam blog to make some money off of the traffic. But really the essence of it is I started it to try to get out of my situation and tell a story hopefully that somebody can use to do the same thing if they're stuck also.

Well, Casey I certainly appreciate your time, and thanks for stopping by Vigilant Investor and I wish you the best of luck getting yourself out of the situation, I hope things work out for you and definitely that you can help a lot of other people who are in your situation and maybe become a guru of sorts in that respect, so good luck to you Casey. See you, and take care.

Casey: I appreciate it.

Well, it is an interesting situation with Casey there, and as we mentioned, and I think probably the most interesting thing out of that is the point that Casey made, that really this is not something that you can get rich quick at, you have to be in it for the business. And it sounds as if on one hand, Casey was going for that but on the other hand that you know, especially someone who is 24 you could easily get ahead of yourself. And when you thing about a 24 year old, you know chomping at the bit, trying to make you know, a decent living and a profit at turning you know, homes around and you know getting them below market and so forth, becoming a successful business person, getting a lot of money at it and people not asking a lot of question about your situation or at least not investigating too deeply. I'm reminded a little bit of a dot com era but maybe not you know, the analogy is not, or the comparison is maybe not perfect, but boy, do we all remember back in 1998, 1999 when we had 26 year olds getting 30 million dollar financing for the latest hot dot com idea simply because it was on the Internet, it was going to revolutionize everything and you know, maybe we were going to sell pets on the Internet, it was a pets.com kind of an approach, where, you know the whole concept of a pet store, well you put it online, you're going to instantly, you know make millions and millions of dollars and so forth and what have you. But, hey Stephan I see that you're logged on out there, are you listening on in at this point?

Stephan: Yes, can you hear me?

Yes, I can.

Stephan: Yeah, I think that's an interesting interview, but actually, you know I've sort of been getting the word through the grapevine from a couple of clients who are builders or are very close to builders stating that they are noticing, and this is along the lines, I suspect that they haven't seen the low point here in the real estate market despite the spin that you see in the media today. You know despite that [...] pick up the Wall Street Journal, or on MSN, you can see that the drop in, you know, the market is basically getting a record, at least a record over the last 40 years. And, you know that's really intriguing but when you talk, what the builders are noticing, that the developers are not buying any more new property. And the fear is that, you know the comments are, I know I'm going to have work through the spring, but after that, you know I have some concern. So, you know when you see statistics, statistics are looking in the rear view mirror, you know the retroactive and they are not necessarily precursors of, or predictors as to what is going to go on in the future. And it is always interesting to talk to car dealers, it's always interesting to talk to builders, people in the industry to see what they're saying. And so I think that you know this is something that certainly still bears watching and especially because the ripple effect that this could have on the economy could be 3 to 4 times more, if it continues on downward than a typical stock market crash. And you know if you just read on MSN today, you know sales have [...] 6 to 8 months in September and the median sales price dropped on an annual basis by the largest amount on record further documenting a [...] long housing market. Now, the spin there among this industry is, you know, the backlog in inventory has dropped a little bit also. But, this reminds me a lot of 2000, 2001 you know where bad news was spun into good news. And I tend to like to, statistics are great, they're in the past, I tend to like to talk to people in certain industries to really see what they're seeing, and that is more predictive than past statistics.

Well I also think too that you have to look beneath the surface of you know, what else is going on out there. You know one of the big points with the housing bubble that think needs to be very much understood is the fact that it was fueled by expansion of the money supply, by easy credit and simply by money being created out of thin air, and you know, those low rates drove everything to happen for a long while. And, you know even in Casey's situation, he's talking about, you know boy if this is done properly there's still opportunities to be had out there. And yeah, clearly, you know, the population is growing, you have an environment where, you know the housing downturn, you know all things being equal, you know people are going to be moving around still and if the population grows you're going to have new people entering the market and so forth. So there's the argument for that which is, you know, that's fine but you can't look at that in a vacuum, because of the broader elements of what's going on. First and foremost I think you have to consider just how distended this bubble has been, how many people have got acting in a way that's similar to what Casey did. And looking at it, you know, maybe even doing it 100 percent legitimately and you don't have to be a flipper to be getting sucked in by any stretch but a lot of people are related at this point to the housing industry. I think the figures are anywhere from, and I've seen the stats from this one being all, all over the place, anywhere from about 20 to 45 percent of new jobs, all new jobs created since 2001 were related to the housing bubble. And boy I'll tell you what, I know a lot of people who were doing something else 6 years ago who got into the real estate agent career or mortgage brokerage career, I know some people who started at mortgage brokerages over the past couple of years, and have really had a heyday of making hay while the sun shines with these low interest rates and everybody, you know moving around in homes and taking advantage of the low rates getting into bigger homes for the same monthly payment or a lower payment that they had before, and it really, really was nice but at the same time people yanking out home equities with these super low rates and new found home equity that wasn't there a few years ago, people seeing the house price go up by you know, 20 percent, 30 percent, well hey there's more home equity there, do some remodeling on the home and all the sudden you have the whole industry just booming along there where people are expanding their businesses in construction or people who are servicing the construction trades, your Home Depots your suppliers, all these people get really, really active and are working as if this is something that's you know, maybe they understand that it's out of whack, but do they realize how out of whack it is relative to everything else. And I think that some of what you're talking about it the reverberation or the backlash I guess when you have a housing bubble slow down, it's dramatically worse than what you find when you have a, say a break down of the stock bubble. And it ends up being a lot more prolonged and ends up bleeding into a lot more areas of the economy.

Stephan: Yeah, I think that there are some other things to keep things in perspective. You know I see a lot of parallels here along with the stock market in the 90's and a few parallels here with what's going on in automotive. And you know the run up in the 90's that we saw and we talk about it a lot, it really was created by massive amounts of liquidity of creation of money or increase in the money supply. And it's really important to understand how that works, but [...] point you made earlier, that there is no money without debt, and the debt initially comes from the government, it ends up in a bank then you know, with our fractional reserve system our banks can lend 90 percent of deposits out and then the new borrower puts that in his account, and his bank [...] 90 percent of that out etc.. So, basically it is really the creation of money. And without any debt there is no money in this country. And what's really important, when you look, you know parallels between automotive and real estate, what we saw in 00 to 02 was all of the sudden a massive pullback beginning from a massive run up that was really what an 18 year run up that really [...] had lift off in the 1990's. And at that point in time when you saw the downshift begin you had 15 wage cuts by the Federal Reserve and you also saw, and this is what you'll see in the mortgage industry, you see industries get creative, they try to continue the sales process. And you know zero percent financing on cars or rebates, now you talk to automotive dealers, you have American auto makers now throwing in you know, two or three years service free, that sort of thing. That to me tells you that for lack of a better term the manufacturers are almost getting desperate okay? And they're doing what ever they can, they're running out of ideas in trying to move cars, [...] things they wouldn't do if things were going well. When you look at the mortgage industry the articles you see today in the Wall Street Journal, you know all over the place is that you see articles about these people that they're adjustable mortgages are, they're adjusting upwards, you know and it's no longer just interest only. And, there's real concern, the industry has been really aggressive, trying basically to move money, and lend it out and gone to [...] it just don't, they really aren't worthy of those loans [...] Again, that is a sign that an industry whose job is to quote "lend money" or move money is getting desperate to keep things going, and what that tells you is that tends to be in our opinion the end of the cycle. And we had talked about one other point, the United States, we act like we're unique but we're still human beings. And when you look at the parallels and you've talked about it on the show before Johannes, but you list parallels between United States and Japan, you know, history is the study of human nature, economics is the science of human behavior. And people's spending patterns etc.. So much is tied into demographics. When you look at the United States and Japan there's a fury parallel that is on a 15-year lag. And that simply is as Bill Bonner writes in Financial Reckoning Day has a lot to do just when the Japanese baby boom started and when the baby boom started in the United States. So the Japanese baby boom started in the late 20's and went thorough the early to later 1930's. Human beings' peak spending age is about 50 and the Japanese were rocking and rolling and then turned 50 let's say in the 80's in mass. And then all of the sudden you saw a massive recession, you saw the Nikkei dies down from about 40,000 to 6,000, you saw the Japanese central bank lower rates dramatically actually to about zero, which created nothing but a real estate bubble with a lot of easy money chasing you know a limited supply of real estate. Then, if this all sounds very familiar, it similarly happened in our country 15 years later, but in 1994 the Japanese real estate market completely rolled over. And that's the wild card here, we have mirrored Japan exactly or to a great deal, some would say we're different and the Japanese they saved more wealth, they saved 20 percent of income historically, Americans have saved 10 percent of income historically. But in a nutshell, you know the savings rate in the United States has dropped from the historic 10 percent to a minus 1. And the big question is, when the Fed lowers interest rates, which we feel they'll attempt to do to re-stimulate next year, and for sure the mortgage industry is already getting more creative with 40 and 50 year mortgages and hopefully the rates will drop down so these people can re-fi out of their adjustable mortgages so that they can lock in rates and not foreclose on their home. The key question is, next year will Americans who are already so far in debt, will they buy one more time? And that's the big question mark. Yeah, and the balance sheet issue of course is a big one. And, you know, Casey was mentioning that he talked to a [...] who managed to go through the last cycle - by the way, if you are listening out there, and I should have mentioned this earlier, we do take in calls if you want to give a call in. The number is (724) 444-7444, again that number is (724) 444-7444 and when you dial in they're going to ask you for a talkcast id. and that's because we're using talkshoe.com to do this show, and the talkcast id. is 982, and then you're going to need a pin number, so if you haven't registered with Talk Shoe before, and I recommend highly that you do it, there's a lot of great content out there created by Talk Shoe, folks like ourselves, who are independent and just you know all around the world and the country and so forth. But, the pin number you can use to call in, we have a couple of them available you can use 222-333-4444 and the second on that you can do is 333-444-5555, that's 333-444-5555. So in any event, just to get back on my other point, you know, Casey was saying, you know in a declining environment, really there are opportunities and so forth. But I think that it misses one of the broader worries that I have relative to you know, where we are today, is that all cycles are not the same and all environments are not the same. But the balance sheet today as a whole on a lot of different levels is not the same balance sheet that we had in the 1970's, the last time it went through a pretty stiff housing downturn and you know I talked to a lot of people who say, you know boy, why should we worry about it this time, we heard the prognosticators of doom and gloom about housing before and if we acted on them, on their talks before we would have ended up, you know being completely wrong and then the stuff ever materialize and it didn't, you know things didn't fall apart. And, you know I think that it's not necessarily that we're saying that things are going to fall apart, but I think that you have to look at, you know from where is, you know the next round of liquidity going to come from to keep the economy as a whole, chugging along. We had this great liquidity boost from you know getting injected into the housing portion of the economy which of course trickled through a lot of different ways. You had the, you know, 650 billion dollars of you know, contributions coming out of home equity in 2004 and about the same in 2005. A lot of that is starting to dry up now. And I think what you're going to see that this time through coming out of the cycle, we made it out of the blow up of the dot coms and you know the stock market correction back in 2000, 2002, but it may not be so pretty coming out of this cycle because from where are we going to get the next round of liquidity and the other big thing to remember is that you know again, when I say the next round of liquidity is that people's balance sheets are worse off than they were 5 years ago in the recession they're a whole heck of a lot more in debt then they were back in the 70's as you mentioned negative savings rate these days. And we look at the government as a whole, boy the government used to be, you know the U.S. as a whole is a net blender back in the 70's and they weren't really even running deficits yet, we were running deficits but our debt was basically you know, excuse me, we were not running deficits really until the 70's and the [...] picking up in the 80's and of course in the 90's. But that's all a fairly new, new environment. And, you know it's just not the same as before. And I think that people are going to be surprised when they come around and see you know some of the shake out from, you know this as a, an expectation that this is going to continue.

Stephan: Well, I think that you're right and it's also important to [...] basically what you're saying in essence is that you know if you have a certain amount of equity build up, or at least a certain line of credit build up and while you are blowing through that it's a party, and it's a lot of fun, and there is no pain. But there comes a point in time when the amount of debt you take on, whether you're an individual, or a business or a national government, there comes a time when the amount of debt you take on has to be paid off or it will affect your future purchasing power. Now governments with central banks or not has the ability to print money okay, and that's why every currency that's been [...] from a metal, like gold or silver is actually ultimately every currency in the history of the world is recorded to it's own value or the value of the paper it's been printed on. Alright but, you know, if you don't have a printing press in your basement you can't go counterfeiting and do that sort of thing you ultimately have to curtail your spending power. And then again that this economy is made up of 300 million human beings. And when you see a net rate, savings rate of minus one from a positive 10, you know at what point in time does a home equity line, which is a line of credit, which really is your home, when does that dry up and when does that stop? You have to [...] for that so, and we've been through this. What should happen doesn't always happen right away, you know, you're seeing automotive makers adjust and do whatever they can with cars, you're seeing lenders adjust and do whatever they can to move cars, or, I'm sorry, with mortgages. Automotive lenders are going with 6 and 7-year payments on cars. Mortgage lenders are going to 40 and 50 year mortgages, okay? You know they'll do whatever they can to keep it going and governments will do with same, you know with massaging interest rates or borrowing more from foreign lenders or printing more money. But inevitably it does peter out. But it sometimes takes, it doesn't happen quite as soon as you think it will. But along those lines Johannes you know there's the illusion of making headway but you made some interesting comments about, you know the Dow is at 12,100 right now or there abouts, what is that in 2000 dollars adjusted for inflation?

Oh, probably it's just barely under 10,000. [...] using the Fed's own stats there, they're own CPI. I'm seeing we have some comments on the Talk Shoe interface, the IM interface. And this is one advantage of going to talkshoe.com you can download the interface and do some chatting. One of the comments that was made is you know if you are sort of countering our points, if you buy a house that you're going to live in you can, you know basically, you know, as long as you can afford the mortgage payments you'll be okay no matter what happens to the housing prices. And that goes without saying, I thing that, and our point is not that the average person out there is going to run into housing problems on their own, but keep in mind that you know earlier the interview we had with Casey Serin of iamfacingforeclosure.com, this is a guy, 24 years old who managed to get 2.1, 2.2 million dollars of mortgage loans very easily, granted he admits that he you know, fudged a little bit on the fringes of his application said that he was living here and there, but he was looking to be a business man, he had been to a few real estate seminars and you know he's heard from a lot of people who have done the same, you know, similar things that he's done and basically bought into a housing market in California and Utah and Texas and so forth at a peak. Now, this is a situation where someone is you know, how many people are out there like Casey who have overextended themselves and now are going to basically be sitting on properties for a while, accepting a lot less than they thought they were going to have. Now, these people are going to be facing issues, plus you also have the people in those environments who were the single home owners, who in order to get into a home in the L.A. area, the only way they could afford to get into a home was to get into adjustable rate mortgage and you hear I think it was something along the lines of boy, 75 percent, well this is, this is a different stat that I came across, 75 percent of purchases and loans this year in California have little or no documentation of income, that's up from 34 percent in 2000. So, how many people out there are actually fudging to get into their mortgage to begin with, that's number one and number two, how many people, you know, when you look at the lowest interest rates in 50 years on the 30 year mortgage and yet you have people jumping at adjustable rate mortgages like they're hotcakes, something is rotten in Denmark. Because you know, people have been interviewed as to why they're doing this, simply because that's they're only choice, that's their only option. They cannot afford a home in the L.A. area by going with the conventional 30 year so they're in an adjustable rate mortgage. Now, those mortgage rates are entirely dependant on the low interest rate environment we have today and I don't think we should basically be banking on you know and additional what, how many years, 10, 15 years of 50 year low mortgage rates for people to re-fi and come through this? If they can't even afford the 30 year at this point, what happens when their ARM start restating? And then should we expect these adjustable rates to continue until we get rolled over into new mortgages at the current prevailing rate? I just don't see that happening and what you're starting to hear stories about out there is a lot of people who are in that situation facing resets that are dramatically higher, their income, their disposable income is getting pinched dramatically, and suddenly, even though they still might be able to afford their home, the home is not the problem, but suddenly the disposable starts getting tightened up. And I think that's what we're seeing reflected through the rest of the economy now is people getting tighter and tighter and the reverberation on that tightness is going to be number one, disposable, discretionary spending is going to continue to decline, you're seeing it at, in some areas you're seeing the people are you know, again with the automotive that you've been talking about Stephan, boy, I mean tell me the auto industry didn't go out and advance sell, you know, a few years of cars, they basically [...] for a number of years.

Stephan: What you're doing is when you have your [...] to create money with this [...]ability to [...]a fractional reserve system, if we deposited 10 million dollars in an account at a bank tomorrow they can lend out 9 million. And the next person [puts it into an account] and the next day they can lend out basically 8 million. And the next day they put that in that account and that bank can lend out about 7.2 million, okay? That's really creating money via fractional reserve when your banks are not required to keep gold or silver in there on demand okay, and that is where the system has been set up to the advantage of the [...] So when you lower rates to move your wares, whether it's automotive or whether it's cars, okay? And you know, you want to maintain that rate of economy lets say, you are ultimately going to run out of people to borrow, okay? And like the automotive industry, we said this when they started doing it, what they're doing is they are borrowing activity from several years down the road and they're for this year, okay? And you know when people tighten up, people hey, America's turning fifty everybody, and when you're fifty your spending habits statistically decline, and it declines dramatically. And you get your house in order, you pay down your mortgage, you pay down your cars and that is, that is just a fact. And people will make comments that Japan is different, I don't think it's that much different. Their central bank tries to re-stimulate by lowering rates what has the Federal Reserve done? You know, what have the mortgage bankers done, what has GMAC done?

It's all through the banking system is what they're trying to do is get activity ginned up by making credit cheap.

Stephan: Right, right. And, but what you cannot force people to do, and it's what happened in Japan, you can make money free to borrow, but if you don't want to take on any more debt, because at least you have to pay the principle back, you're not going to take on any more debt. And the question is in America, when will that day come?

Well, I think the other thing, and another comment we've seen online is that the U.S. situation is, not to worry about it too much, because a lot of what we're seeing are huge increases in productivity. And I think that the productivity issue is you know somewhat of a distraction. Productivity, a), you know how do you measure productivity accurately so that you know exactly what you're dealing with. But, you know, it falls into the same line of reasoning that you know, boy we're converting in a way from a manufacturing economy into a service economy. The technology that we have is improving our productivity, boy aren't we efficient and moving right along. And that same, again, line of reasoning also starts talking about issues relative to the deficit, i.e. we don't have to worry about the trade deficit because what that basically means is that you know, of course the trade deficit in order to fund it we have to assume a lot of debt. And apologists for the trade deficit say basically well that's, you know, what's to worry about? All that says is that foreigners are willing to lend to the United States. That's you know, they see that as a good investment. It just simply says, you know, confidence, confidence, confidence. And, well you know the problems is we're exchanging a lot of that debt, we're assuming a lot of that debt, and we're not investing it into things that are investment oriented as much as we're converting it into consumption. What I mean by consumption, and again, U.S. economy, 70 percent of the U.S. economy is driven by consumer consumption, by personal consumption, that's just massive of a percentage, way out of whack with historical norms. What you end up getting with that is yeah sure, we're assuming a lot of debt, it's one thing if we're investing that like we did you know back in the 1800's when we were investing it into manufacturing, we were building steel mills with it, we were building you know infrastructure that basically made the United States the economic engine of the world there for you know 70 years, 100 years and so forth. But the legacy of which [...] still has managed to support a lot of really non self sustaining things over the last 50 [...] society. But the bottom line is we're exchanging that, we're assuming debt and what we're getting in place of it are big screen TVs computer technology, that kind of stuff, but these things age, they're not investment resources as much as you know, having a manufacturing plant. Now China on the other hand in the third world, these people have infrastructure. They have basically taken on that, all those dollars that we spent in the trade deficit, a lot of the wealth that was carried over there in brand new currency, manufactured out of thin air, that wealth was transferred from the United States, and is now sitting in China manufacturing infrastructure. And we've re-imported it as big screen TVs, home theatres as well as 600 dollar birthday parties for 6 year olds, where you have the horse rides and you know the clowns and the inflatables, jumpy devices in the back yard, we've all seen that.

Stephan: Yeah and I think that's it's important to note that, you know there's nothing new that's really happening today, I mean the Federal Reserve, you know I see a comment, the Federal Reserve controls the short term interest rates. What the Federal Reserve is also given a license to do is create money out of thin air, and we could devote the whole program to this but, maybe when we get Mr. Griffin back to talk about his book we can get into it. The Federal Reserve and again, and I know we're pressed for time here but it's a [...] of private banks [created] special privileges by Congress. When Congress is short in effect [...] the Feds drove [...] check for how many billion Congress needs, they buy their bonds which are pieces of paper and the Fed has admitted that money is created out of thin air. That's the power of the Federal Reserve, that's the increase of the money supply, that's why the dollar has lost 97 percent of its purchasing power, and that's why the average income in 1904, which was, you know 600 dollars a year, got you 30 ounces of gold, and why the average income of 30 thousand dollars a year only gets you 60 ounces [...] The average income is really only at double, in basically over a hundred years in this country. And roughly that's really what's happened to the increase in housing prices. So you might feel rich, the Dow might be at 12,100 even though in "2000" dollars is 10 thousand and actually that's akin to me going to the gym, and they [...] 45 pound plate up, I paint the number 60 on it. Am I stronger? No. [...] makes me feel better, I ought to rethink things.

We're running short on time as you mentioned Stephan, so we probably ought to wrap up, I see one other comment just came up on the, via the Talk Shoe interface, and the comment is, the fed controls short term interest rates, the markets on the other hand control long term rates, and long rates are still historically average, don't you think the market knows more than you and me? Well, a couple of comments on that, boy, we are running short on time, I might not want to exceed the hour time frame. But, yeah [...] the Fed control short terms rates, however, short-term rates are not the only way that money supply is created of course. You can simply go out there, do open market operations and just create all the liquidity you want. Now as far as the market creating long term rates, well definitely, that's how it functions. Now, in the U.S. we've been the beneficiary of very, very low long term rates and mid term rates and you look at the 10 year you look at the 30 year bond, treasuries and so forth. All those have been depressed largely because there has been so much liquidity out there sloshing through the system, and largely because of the trade deficit venting so many dollars, so many of these newly minted dollars abroad via the trade deficit. Now, what that means is that foreigners who accept these dollars in exchange for good, they can't use them in their county, you can't run around and spend dollars in China too effectively. And a few things you can do with dollars, number one you can buy oil, okay? So, all oil transactions generally on most markets are transacted in the dollar, it's called the petro-dollar. So that ends up, we see what's happened there, the prices and oil basically they've gone up, they were in the 70's for a while a lot of people say we're premium, hurricane premium and so forth, and no we'll expect it back down in the 30's again. But, you know we're hanging pretty tough just beneath 60 as our low point and still hanging on, you know, haven't really broken a 12 month high in a while, or we haven't gone below our 12 month low in a while. I wouldn't expect given how many dollars when we consider how much new money is sloshing around out there that I would expect oil to be dropping. But back to the rate point, all that money, one of the other big things that foreigners have been doing has been acquiring U.S. treasuries as a safe place to park their money. Now, what you're beginning to see is foreigners saying, "you know what, maybe we don't want to have so many dollars in, or so many of our dollars converted into treasuries." We started seeing that shifting in spring where foreigners began backing off, but all they have to do is stop acquiring the debt at the rate they were before, and just start buying other things at a higher pace and tack back on their pace at which they were acquiring U.S. debt and suddenly rates in the U.S. start rising. And you had a quick reaction to the Yen Carry Trade, which is too complex to get into right now but, basically people are borrowing from the bank of Japan at super low rates, their banking system and investing it elsewhere. When that looked like it was going to wrap up people got very worried and started flying back to U.S. treasuries briefly, but this will come around where there's a point at which China now has a billion dollars of U.S. treasuries, at what point do they say, no more, we have enough of U.S. treasuries at 50 year lows. These are not average market rates right now, these are well below average market rates. Just to put that also in perspective, I saw an article today this is on the Der Spiegal which is Germany's number one newspaper Der Spiegal is you can go to spiegal d e and you can see, dot de, and read the English version there just by clicking on the correct link but, the American, American Dollar Illusion by Gabor Steingart, the dollar is still the world's reserve currency even though it hasn't deserved the status for a long time. The Devaluation of the dollar can't be stopped, it can only be deferred. The result could be world economic crisis. Now this is not in the U.S., this is not some fringe group in the United states, this is not the panic artists in, who have been talking about credit bubble breakdowns for the last you know, 30 years, this is Der Spiegal simply putting out and article saying here's what's going on, and there's a point at which the dollar is going to begin losing it's strength. It already has dropped down a good bit. When that starts happening, rates will start rising and what you're going to see is suddenly people exchanging their dollars for other things. Already, we've seen Japan, excuse me, China trying to do that, they try to buy oil companies they're converting into natural resource companies. And anything that can be printed out of thin air does not hold its value. Things like gold, things like boy, I mean you know, commodities generally speaking things that you cannot print out of thin air will not lose their value. And boy, if you go back in time and you look at comparative exchanges you can get about the same package of, you know pound of this for the same pound of that over years, with the exception of technology. Technology has clearly gotten to be cheaper and cheaper over time. But when it comes basically to you know hard things that simply can't be manufactured without effort, the exchange has been pretty much in sync. And I think that, you know I was even reading that you know the exchange rate for ounce for a Roman tunic is about the same exchange as you look for a you know in terms of gold ounces for a mid level suit for a business person these days. So, you know these things don't change, whereas you look again, what's happened to the dollar? It lost 97 percent of its purchasing power since the Fed came into existence. That's undeniable, I think the bet against that trend especially in the face of a deteriorating balance sheet is getting more and more risky and I think that you know, this could go on for a while longer but, boy we're getting out further in the wood, but hey folks we've gone way over our hour, time that we like to. We're about an hour and 5 minutes now so, we're going to wrap up at this point, thanks for listening, and tune in next week, in the next couple of weeks we're going to have again, rescheduling Edward Griffin who is going to come on, G. Edward Griffin, the author of The Creature From Jekyll Island. We're going to have Doug Wakefield on in a few weeks, and a few other very interesting guests just to talk about all sorts of different things. So tune on in and hopefully we'll hear from you soon, make sure to call on in and ask your questions. Take care and thanks for listening. This is Johannes Ernharth, and Stephan Ernharth for Vigilant Investor.

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