Fundmastery Blog

Kurt Brouwer April 20th, 2009

This question really has two components. First, when will the volume of new and existing home sales pick up? Second, when will home prices bottom and start moving up?

This chart shows sales volume for new and existing home and, besides the fact that it is not a pretty picture, there is an intriguing gap that has developed quite recently:

Source: Calculated Risk

The red line (new home sales volume) has plunged far more than the blue line (existing home sales volume). There are various reasons for speculation as to why this has happened. The most plausible one for me is the fact that homes in various forms of foreclosure proceedings are selling quite briskly now. In fact, estimates are that distressed sales (foreclosures, REOs, short sales etc.) make up 30%-45% of the existing home sales volume.

Home builders have certainly put in place incentives for new buyers, but they not discounting home prices at the same levels as banks and other sellers of distressed homes have done. As a result, potential home buyers almost certainly believe that better deals abound in the existing home market than in the new home market.

For example, a consultant I know just bought a home in Vallejo, California, which is a contrarian move by any estimate (see California City On Verge Of Bankruptcy). His house payment will be quite a bit less than he is currently paying to rent a home.

So, we see from this chart that sales volume for homes is perking up. This chart based on data from the California Board of Realtors suggests that the real estate market in hard-hit California is perking up. Prices in many communities are way down, but unit sales have surged. A big chunk of these sales are short sales or foreclosures.

Source: Carpe Diem

We can see the same process as work around the country. Sales volumes is up in most parts of the country. In particular though, this process is most apparent in those states that have had the most foreclosures such as California. This map really makes the point. The fine print is a little hard to read, but the colors tell the story. California, Nevada, Arizona and Florida are Ground Zero for the housing mess:

Source: Carpe Diem

This map came from a recent report on foreclosures from the University of Virginia. Here is a link to the report ( full study here).

So, in answer to the question raised in this post — when will housing bottom? — there are at least two parts. Though these are two separate questions, they are also closely-related because prices for new and existing homes are unlikely to stop falling until demand rises and begins to eat into the inventory of new and existing homes. Also, as long as more and more homes in some form of default or foreclosure come on the market, prices will be under pressure. Eventually, those distressed homes will get sold off and then we may see some stability in pricing for existing homes.

Part One of the question has to do with sales volume. Tumbling prices have given potential buyers an incentive to come in and snap up homes they believe are cheap. Also, at work is the fact that construction of new homes — particularly single family homes — have almost come to a standstill. The unsold inventory is still heavy, but eventually supply and demand will come back into balance and new homes will begin moving too. I think we are close to the bottom for sales of new homes, but only because new construction is so low. Existing home sales volume is soaring, but that is primarily driven by distressed sales. Eventually, those will get sold off and then buyers will start eating into the inventory of unsold, existing homes.

Part Two is the issue of price. When will prices bottom? Unfortunately, that is almost certainly a ways in the future. Increasing demand is a necessary first step for a bottom in prices, but the unsold inventory for both existing and new homes is still high.

So, home prices probably have a bit further to fall before the bottom is reached.

• Business , Economy , Geopolitics , Money , Personal Finance , inflation
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Kurt Brouwer April 17th, 2009

I believe most living, breathing Americans know that GM is not a viable company in its present bloated configuration. I don’t like writing this and, having grown up in Michigan, I wish this were not the case. But, it is. GM is a mess.

There has been talk recently from President Obama and his administration of a ’surgical’ bankruptcy for GM. I’m happy they have finally used the B word in discussing the company, but the idea that something as messy as bankruptcy could be surgical is false. I presume they are doing this in order to ease the public into an understanding that bankruptcy is the only viable option.

A surgical bankruptcy is a term that probably refers to what is known as a preplanned or ‘pre-packaged’ bankruptcy. A ‘pre-pak’ is a bankruptcy case in which the problems and differences are largely ironed out before the case goes before the court.

This New York Times piece spells out why bankruptcy for a vast and complex entity such as GM will be anything but surgical [emphasis added]:

A Fast Bankruptcy for G.M.? Don’t Be So Quick (New York Times, April 17, 2009, Jonathan D. Glater)

Any hope of a high-speed bankruptcy by General Motors faces a serious obstacle: a judge — not the Obama administration, not G.M. management and not the company’s creditors — would reign in court.

A bankruptcy judge would be required by law to listen to unions, whose members fear for their jobs, benefits and pensions. And the judge would have to pay attention to creditors, including bondholders frustrated by how much they stand to lose if G.M. is broken up into “good” and “bad” companies as the administration is planning. Even a judge sympathetic to the administration — and the administration would look for a sympathetic court — might be reluctant to rubber-stamp that plan.

“Once you’re in, nobody knows where it’s going because anyone can come into court and say no, no, no,” said Sandra E. Mayerson, head of the insolvency practice in the New York law office of Squire, Sanders & Dempsey. “I’ve had preplanned bankruptcies that we thought would be out in 90 days but we were in for a year.”

…On Friday, the G.M. chief executive Fritz Henderson emphasized the company’s desire for a quick bankruptcy case if the company ends up seeking Chapter 11 protection. He said G.M. was examining both pre-packaged elements to a bankruptcy, meaning it would reach agreements with creditors before filing, and the sale of assets under Section 363 of bankruptcy law that would allow G.M. to set up a new entity.

…Bankruptcy cases often drag on far longer than anticipated, slowed by unexpected obstacles to reorganization. The auto-parts company Delphi, once a unit of G.M. and now a supplier, has languished in bankruptcy proceedings for four years, twice as long as originally planned, for example.

…Typically, companies sell off assets to third parties as part of a reorganization in Chapter 11. Plans for G.M. would go further, selling virtually all the viable parts of the company very quickly to a new one created solely to buy it.

…Allowing the automaker to sell off the good assets would essentially sidestep the rest of the bankruptcy process, lawyers said, especially the nettlesome requirement that creditors approve a plan of reorganization. Once blessed, that tactic would be alluring to other troubled companies.

“If you could do this, it’s too cheap a trick — everyone would do it,” said Lynn M. LoPucki, a law professor at the University of California, Los Angeles. “There would be no other kind of bankruptcy remaining.”

…If union contracts on pensions, employment and benefits remain tied to the old G.M., employees and retirees could be devastated financially.

One little anecdote to illustrate the problem GM faces. I recently heard an interview with an auto company retiree who has been retired — drawing a pension — for longer than he worked in the industry. If you just extrapolate from that single case, you can see that the economics of GM’s situation are not easily resolved.

That employee was promised a pension for life and a promise is a promise. But, given the woeful financial state of GM, that promise may not be achievable anymore. The NYT piece continues:

If the contracts move to the new, good company, the surviving business would look considerably weaker. That creates a political problem that would make a rapid, clean bankruptcy unlikely.

“It’s going to be about the union and the pensions,” said Ms. Mayerson, the bankruptcy lawyer. “And I don’t see any way that this is a quickie bankruptcy. After all, it took them 30 years to get into this mess.”

There are very real dilemmas and differences in this case such as the promises made to retirees.

In addition, GM is a complex company with operations around the globe. It has many thousands of contractual relationships and intertwined business dealings across the country and the globe. This complexity should not dissuade the company from entering bankruptcy proceedings, but that very complexity will preclude a quick or surgical bankruptcy.

See

General Motors May Be Worthless

More Retirees Than Workers In Domestic Car Companies

Should We Let GM Fail?.

• Business , Economy , Geopolitics , Investing , Money
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Kurt Brouwer April 17th, 2009

Source: Carpe Diem

This chart from the Carpe Diem blog shows the real or after-inflation price of oil. As you can see, oil prices spiked 30 years and then fell. Prices stayed low for many years, but then they spiked again in mid-2008 at about $146 per barrel.

Going forward, the question remains: will we see a reprise of the early 1980s in which prices plummeted and stayed low for years. Or, will we see a return to high inflation and high and rising prices for commodities such as oil.

Right now, disinflation or deflation is the order of the day. However, given the monetary and fiscal responses to this financial crisis, we are likely to see a return of inflation within a couple of years. Assuming that is correct, oil prices would likely get a nice boost at that time.

However, the demand/supply dynamics of oil are pretty complex. Certainly, demand should grow once the global economy recovers. And, most major oil fields are showing declining production. With growing demand and constrained supply, the price should go up. On the other hand, new fields are being discovered and new technologies allow for increased production from existing fields.

The other big wild card is alternative energy for major uses of oil. For example, a viable electric (plug-in) car would change the long-term outlook for oil quite a bit because much of our electrical energy is produced in plants powered by natural gas, coal, nuclear and hydropower. Oil-fired plants are still significant, but plenty of viable alternatives for producing electricity exist.

If a million or two million cars used electricity instead of gas, then demand for oil would drop a bit. And, if those electric cars seemed to be a viable replacement for a sizeable part of the auto fleet, well then that would change the future supply/demand dynamics considerably.

See The Deflation / Inflation Balancing Act.

• Business , Economy , Geopolitics , Money , inflation
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Kurt Brouwer April 13th, 2009

Bill Gross and his Pimco Total Return Bond Fund as loading up on government agency bonds such as Fannie Mae and Freddie Mac bonds. These agency securities carry an explicit guarantee from the U.S. Treasury. This Bloomberg piece gives a bit more detail:

Gross Raises U.S. Debt Holdings to Highest Level Since 2007 (Bloomberg, April 13, 2009, Dakin Campbell)

Bill Gross, manager of Pacific Investment Management Co.’s $144 billion Total Return Fund, increased his holdings of U.S. government debt to 28 percent in March, the highest percentage in almost two years.

Pimco’s founder and co-chief investment officer boosted government debt holdings from 15 percent in February to the most since April 2007, according to the Newport Beach, California- based company’s Web site. The world’s biggest bond fund’s holdings of mortgage-backed securities dropped to 66 percent of total assets from 86 percent in February.

…While the government debt category includes Treasuries, Gross has said that Pimco is not interested in buying the securities. In February, Gross said that while the Fed should buy Treasuries he would not follow its lead.

…The Total Return Fund rose 4.8 percent in 2008, beating 93 percent of its peers, data compiled by Bloomberg show. The fund has returned 1.5 percent this year through March, according to Pimco data.

In January, Gross held a negative position in government debt securities such as Treasuries, debt issued by government-backed agencies such as Fannie Mae, Freddie Mac and the Federal Home Loan Bank system or interest-rate derivatives.

The argument for agency (Fannie Mae, Freddie Mac etc.) mortgage-backed securities is that they have far higher yields than Treasury bonds with comparable maturities, yet both are backed by the U.S. government. Presumably, the Pimco brain trust believes the bond market will figure out that a U.S. government guarantee works equally well on agency bonds as it would on Treasuries.

See also Pimco Predicts Inflation Ahead and

• Geopolitics , Investing , Mutual Funds
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Kurt Brouwer April 11th, 2009

It’s a bit excessive don’t you think? That is, the U.S. tax code with its 3.7 million words, many thousands of pages and near-daily changes. IRS National Taxpayer Advocate Nina Olson writes in the Wall Street Journal piece about the national nightmare that is our tax code.

We Still Need a Simpler Tax Code (Wall Street Journal, April 10, 2009, Nina E. Olson)

As the national taxpayer advocate, I am required to report to Congress each year on the most serious problems facing U.S. taxpayers. With April 15 fast approaching, it will come as no surprise to many frustrated taxpayers that the complexity of the tax code tops my list.

Every year taxpayers and elected officials complain about the tax law’s complexity. But despite the exasperation, no significant simplification has occurred since the landmark Tax Reform Act of 1986. To the contrary, each new tax proposal is layered onto the existing code, rendering it more complex with every new act.

Consider the following:

- According to my office’s analysis of IRS data, U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with the filing requirements of the Internal Revenue Code.

- If tax compliance were an industry, it would be one of the largest in the United States. To consume 7.6 billion hours, such a “tax compliance industry” would require the equivalent of 3.8 million full-time workers.

- Compliance costs are huge both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics data on the hourly cost of an employee, my office estimates that the costs of complying with individual and corporate income tax requirements in 2006 amounted to $193 billion — or a staggering 14% of aggregate income tax receipts.

- More than 80% of individual taxpayers find the process of filing tax returns so overwhelming that they pay for help. About 60% of taxpayers pay preparers to do the job, and another 22% purchase tax software to help them perform the calculations themselves.

- Since the beginning of 2001, there have been more than 3,250 changes to the tax code — an average of more than one a day — including more than 500 changes last year alone.

- The tax code has grown so long that it’s challenging even to figure out its length. A search of the code conducted in the course of preparing my last report turned up 3.7 million words. A 2005 study by the Tax Foundation, a tax research organization, found that the number of words in the code has more than tripled since 1975.

But most importantly, the complexity of the tax code leads to perverse results. On the one hand, taxpayers who honestly seek to comply with the law often make inadvertent errors, causing them either to overpay, or to become subject to IRS enforcement actions for mistaken underpayments. On the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities…

Let’s see: on this last point, I could not help but note this continuing stream of political appointees who have not paid their taxes. I don’t view this as a deliberate matter, although some of these — such as Tom Daschle’s failure to pay $140,000 in back taxes until he was nominated for a Cabinet post — were very big deficiencies. Treasury Secretary Geithner’s failure to pay taxes until his appointment also comes to mind.

I tend to think that our tax system is so complex that well-intentioned people can easily make significant mistakes. However, I do have to note the fact that these folks are getting pretty favorable treatment once these things come to light.

Imagine what the IRS would do to you if you failed to pay $140,000 in taxes as Senator Daschle did? Also, isn’t it incumbent upon a sitting governor or senator or the Treasury Secretary who oversees the IRS to be especially careful with preparing tax returns?

• Business , Economy , Geopolitics , Money , income taxes
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