No end in sight for real estate slide

The most recent figures showed a 1.1% price decline for real estate prices in March (Zillow), and that 21% of all mortgages in LA are under water - the borrower owes more than the house is worth.  Until prices bottom, we are not going to see an end to defaults and foreclosures.  Inventories will remain high, especially in places like Utah, Vegas, Arizona, Florida, and anywhere else where builders overbuilt.  Every market is unique, so price declines from current levels on a local basis will depend on the characteristics of that local market.  In Santa Barbara, we didn't overbuild because there is no supply of new land that hasn't already been built.  This somewhat shields us from the oversupply issue.  We have a bigger problem however, in that prices spiked so much that we have more room to fall, both on a percentage basis as well as a dollar basis.

Still more pain to follow!

Stocks rally on jobs

Stocks are rallying strongly on today's employment data, which showed the U.S. economy added 244,000 new jobs in April.  The Dow is up about 160 points at the moment, or about 1.27% for the session.  The unemployment rate actually increased to 9% from 8.8% last month.

This optimism may be a bit premature however, since we just saw last week's jobless claims number jump up dramatically to 474,000 people applying for first-time jobless benefits.

Volt No Va

A long time ago Chevrolet tried to sell the Nova in Mexico.  They just couldn't understand why it sold really well in the U.S. and other markets, but would not sell in Mexico at all.  Some genius finally realized that no va in Spanish means "no go."

Chevrolet is about to release their new all-electric Chevy Volt.  Reviewers are raving about how the car can go 1,000+ miles on one tank of gasoline.  Fantastic!  The only problem is that the car costs an estimated $44,000 -about twice what  Prius costs.  Keep in mind that the Volt is a true electric car - it has an electric motor, with a gas engine there only to recharge the batteries (not to propel the car), while the Prius is a hybrid - it has a gasoline engine that propels the car with an additional electric motor that kicks-in under certain driving conditions, and which increases gas mileage.

Let's look at some math:

Let's say we can save, on average $50 a week with the Volt.
That's $200 a month, or $2,400 a year.
To make the math easy, let's say you could get a Prius at $20,000
This means that the Volt is $24,000 more than the Prius
This also means that, at $50 a week savings on gas, it would take 10 years to break-even
This assumes that maintenance was equal (not likely when comparing a Toyota product with a Chevy (sorry Chevy owners)

Ten years is a very long time for any car to last, especially one that gets driven enough to generate $50 a week in gasoline savings.

The bottom line is that, although I appreciate GM's willingness to spend the money on development, the Volt is simply not a viable product.  My hope is that it will lead to more development, so that eventually regular cars and trucks that the average person wants and can use will contain some good electric technology that will increase gas mileage significantly.

Until someone develops a cheap, effective battery system that can store large amounts of energy in a small, light-weight package, we will not see any real progress on electric vehicle technology.

Out of control consumer debt could sink the recovery

The latest statistics show that the total amount of consumer debt outstanding in 2010 in the United States is nearly $2.4 trillion.  Based on the 2010 Census statistics, that works out to be nearly $7,800 in debt for every man, woman and child that lives here in the U.S.  This, of course, does not include mortgages and other types of debt.  About one-third of this consumer debt, or about $800 billion, is revolving debt-mostly credit card debt.  The other two-thirds is comprised of car loans, student loans, and other non-revolving types of debt.

With such extreme levels of consumer debt, and the additional debt burden on the country from mortgage, commercial, and government debt, the U.S. economy will certainly struggle for many, many years to overcome the negative impact this debt will have on our economic future.  Lenders will need to rethink how the evaluate the creditworthiness of borrowers, especially in light of the huge number od defaults we are experiencing on every type of debt.

Banks traditionally look at many factors when considering making loans, but one of the key statistics they use to determine whether or not to lend to an individual is the FICO score.  An individual's FICO score is derived through a complex and proprietary formula, but the just of it depends on prompt, on-time payment of outstanding debts and the ratio of that outstanding debt to available credit.  Late payments and defaults on debts reduces the FICO score dramatically, which can mean no loan.  FICO scores typically below about 680, especially in today's tight lending environment will typically spell doom for a would-be home or car buyer.  

Credit card companies offer revolving, unsecured loans to consumers.  Because these loans are unsecured, credit card companies can justify charging much higher rates of interest, as compared to loans with collateral, like a mortgage or car loan.  However, these days credit card companies are selling debts in default to third-party collection agencies that are increasingly using the court system to basically turn unsecured credit card debts into secured debts.  Once the collection agency sues the consumer and wins a judgment, they can garnish wages, attach assets, put liens on property, such as cars and houses, etc.  

Many of these unscrupulous collection agencies will basically lie and state (to the courts) that they have served the consumer with papers on a lawsuit, when if fact they have never done so.  The court date comes and goes without the consumer ever knowing about it, and the collection agency then secures a default judgment against the consumer for the full amount of whatever they have claimed the consumer owed, plus interest and court costs in some cases.  Once the default judgment has been obtained, it is open season on the consumer and there is little that the consumer can do, other than pay the collection agency in full.  

There are many so-called debt consolidation and debt clean-up companies, that claim they can help consumers deal with credit card companies and collection agencies, once debts have gone into default.  Most of these are either complete scams, or at best are ineffective.

What is the consumer with debt problems to do?  Most credit card companies, if the debt has not already been sold to a collection agency, will negotiate with a consumer, to either reduce monthly payments, or to settle a debt in full for less (sometimes 50% less or more) than what is owed.  When credit card companies sell debts to collection agencies, they typically only get 5% to 20% maximum on the debt owed, so they will gladly take the 50% from the consumer.  This does not mean, however, that the consumer's credit report will be undamaged.  A settlement will show-up on credit reports, and will negatively affect the FICO score, etc.  Most collection agencies, once the debt has been sold by the credit card company, will negotiate a settlement as well, usually for some reasonable percentage of the total debt.  

Consumers entering into negotiations either with the credit card company, and especially with the collection agencies, should be sure to get all terms in writing, and should ensure that the agreement states clearly that the debt will be shown to be settled in full, and that any remaining amount will never be sold to another collection agency, and no additional attempts will be made to collect any remaining balance, etc.

The process of dealing with debts in default, or a full blown bankruptcy, can be complicated, and there are specialist attorneys out there that can help.  Consumers can do a lot of the necessary work themselves, however, if they take their time, research the issue, and work the problem through to conclusion.  Doing nothing is the worst thing one can do in this situation, so if you find yourself in default, take action, be proactive, and do your homework.  There is life after credit card debt, it just takes a long time and a lot of work to discover that life!

Fed Stands Firm - U.S. Economy is more like the Titanic than a speedboat

Bernanke, in his first ever press conference for the Fed, basically stated that the Fed still feels that maintaining rates at their current levels (basically zero), is still the best course of action.  The Fed statement, which is all we typically have to go on since they haven't changed rates in so long, maintained the same language about keeping rates low for an extended period of time.

The Fed did raise their inflation forecast (CPI) from 1.3% to 1.7% to 2.1% to 2.8%, and cut its GDP forecast to 3.1% to 3.3% from 3.4% to 3.9% (I think we will come in around 2% to 2.5%), for 2011.  They do see improvement in the unemployment rate from previous forecasts, to a range of 8.4% to 8.7% (it was 8.8% to 9% previously).  

For 2012, core inflation (ex food and energy) is now seen running at 1.3% to 1.8%, from the previous estimate of 1% to 1.5%, and U.S. (GDP) growth is now seen at 3.5% and 4.2% in 2012, and 3.5% to 4.3% in 2013.

I feel that the Fed is entirely too optimistic (about everything), and believe that they will be forced to start raising rates aggressively, very shortly.  The U.S. economy, I always say, is like the Titanic, not so much in that is is going to sink (although that is certainly a real possibility), but in that it is a huge ship with a small rudder - changes in rates, even dramatic changes, do not impact the economy for at least two quarters.  If the Fed waits too long to start raising rates, they may be too late to stem the tsunami of inflation.  Also, if they wait too long, they will be forced to raise rates at a much faster pace - so fast that it may stifle the economy.  A slower, more reasonable, moderate pace could be sustained without killing the economy, but they need to start right away (probably should have started about 6 months ago).  

Other countries, like Australia, China, and the ECB (European Central Bank), have already begun raising rates.  This has put even more pressure on the dollar.  A weak dollar can be good for our economy in the short-run because it makes our goods less expensive for foreign buyers.  But, in the long-run, a weak dollar will result in higher inflation, and will demand more drastic rate increases to defend our currency.

Commodity prices would begin to adjust back down, if we were to start raising rates.  We will have to raise rates anyway; it's just a question of when and not if.  Since we know this to be true, it would make more sense for the Fed to start raising rates sooner rather than later (right now), and to do so at a moderate pace that reduces inflation, including commodity price inflation, and still is slow enough to support continuing economic growth.  I fear they will wait too long (it may be too late already), and by the time they realize their error, they will be forced to drop the hammer on rates, which will feel like we are all getting hit over the head with a giant sledge.  

Is the U.S. a bad risk?

The recent change from S&P on their outlook for the U.S. as a AAA credit begs the question: Is the U.S. a bad credit risk?  Although this is an interesting question, and the answer is probably no, like a lot of things in life, the reality is that country risk is not absolute, it is relative - relative to other countries.

Despite the fact that our national debt and budget deficits are enormous, and skyrocketing, we have to compare ourselves to other countries, to evaluate the changing perceptions of U.S. credit risk.  In the developed world, basically every country, with the exception of Germany, made the same mistakes we made, that put us into this pickle.  Excesses in real estate and the credit markets in general, drove the worldwide economic collapse that resulted in the accumulation of not only huge national deficits, but also personal debt as well.

Even if we break the current debt ceiling, which is a virtual certainty, and even with the very real possibility (probability) that the U.S. credit rating will fall below AAA in the next year or two, the U.S. is still today, and will remain, the strongest economy on the planet, and therefore, to most, the safest place to put money.

While the fact that we will likely remain at the top of the heap economically is somewhat comforting, it does not mean that we will not feel some pain.  The reality is that financial markets trade on risk and reward perceptions.  If the risk of the U.S. is perceived to increase, as will be the case if and when our credit rating is lowered, the cost to service our debt or take on more debt, will increase.  In practical terms, the rates we will need to pay on new bonds issued will have to go up to compensate investors for that perceived increased risk.  If we couple this with a rising interest rate environment, which I believe we will be entering shortly, we could have a slingshot effect on the rising cost to maintain our debt and finance future budget deficits.

This scenario is very real, and has lead to the devaluation of many currencies around the globe.  We need to watch the value of the dollar closely, since rising inflation will be the trigger that forces the Fed to start the interest rate raising cycle.  The more the threat of inflation, the more aggressive the Fed will need to be with rates, and the greater the impact will be on the cost of servicing our debt (and the more negative will be the impact on economic growth as well).

Stocks getting spanked

The Dow is off almost 250 points and is falling fast after S&P changed their outlook on the U.S. debt situation to negative.  They maintained their AAA rating on the U.S., but made it clear that things are deteriorating.

The reaction in the stock market to this news underscores two key truths:

1.) Valuations are obviously very rich, otherwise negative news would not elicit such a negative response in prices;

2.) The serious debt issues facing countries across the globe is not going away, even though investors seem to ignore the obvious.

I remain cautious; looking for opportunities to re-enter at lower valuations/lower levels on the S&P.  Watch for the S&P 500 to challenge the 1,250 level shortly.  If it hold, I will likely put a little cash back to work.  If it cracks 1,250, I will look for lower levels before I risk my cash.