Saturday, February 28, 2009

Capital Is On Strike

I've been reading Amity Schlaes book, The Forgotten Man - it is excellent. It is a book about the Great Depression. I did not start reading it because I think we are heading into a Depression, it has been on my list since it came out in 2007. I started reading it because I wanted to see what parallels there are between now and back then.

I won't write a full review of the book now, but I will say that I do not want it to end, Amity is a truly gifted researcher and writer.

Last night I came across a line that she used to described businesses at that point in time (after FDR's re-election), she said that "Capital is on strike". FDR was hell bent on punishing business and thus business responded the way you would expect, they sat on the sidelines. Why risk capital if the most of the profits go to your silent partner (the government), but you are stuck with all the losses and the risk if the entity fails? Without a friendly environment for business there will be very little - thus no real job growth.

As then, we are now - Capital has gone on strike. An environment that treats businesses and corporations as evil (not to mention capitalism) is now in vogue in Washington and this has played itself out in the dramatic fall of the stock market. When FDR started his second term the stock market began to plummet due to an environment that was not friendly to business, it became evident that anti-business, anti-capital and socialist ideals would not pull the United States out of depression. Roosevelt lost a lot of support and the last real New Deal legislation that got passed was the minimum wage.

Until and unless we see a balancing out of the current anti-business sentiment in Washington, we will not recover. We need Capital to go back to work, we need to entice it, encourage it and incentive it. That is not to say we shouldn't regulate it. Of course we didn't get into this situation because of a lack of regulation, but there was a lack of enforcement in many areas.

I am an eternal optimist and I've met enough American's to know who really keeps this country running. We will survive this Great Recession, but we must stop the practice of demonizing the only engine that provides long term growth in this country - small business.

A great man once said "Get on your knees and pray like it is up to God, then get up off your knees and work like it is up to you" - that is the spirit of this great country.

Scott Dauenhauer CFP, MSFP, AIF

P.S. That great man is Sam Cochran (thanks Gregg)

Thursday, February 26, 2009

Yields Stink - What To Do About It

If you hadn't already noticed, yields on relatively riskless assets are terrible. While the stock market has declined by 50% the decline in interest rates has been, in some case, almost 100%. Treasury money market funds that had been yielding near 5% just 15 months ago are now yielding near zero and are basically closed to new investors. The highest yielding money market I can find is the Vanguard Prime Money Market which is yielding 1.25%, down from about 5.25%, a decline of 76% in yield. Most short-term bond fund yields have also been cut in half or more and yield less than a Total Stock Market Index fund.

A falling stock market hurts, but most people don't depend on it for income and if they are positioned right do not need to touch those funds for many years, allowing them time to recover, not so for fixed income type investments. Fixed income serves two purposes in the portfolio, the first is to provide stability during turbulent times, the second is to provide yield to help the investor earn enough to live. While many fixed income funds failed last year to do either, most of the good one's provide stability, but their yields dropped dramatically.

To give you an example of the effects low interest rates can have on a retiree living off their assets, consider a couple who had $100,000 and was earning 5.5% in a two year bank Certificate of Deposit (back in 2007). They would be receiving $5,500 per year in income. The bank CD is now coming due and interest rates for a new two year CD are around 2.5% (if you're lucky), which yields only $2,500 per year. This represents a drop in income of 55%. Devastating.

So what do you do?

Most people start looking for higher yielding investments and with that higher yield comes higher risk. Many start attending "seminars" put on by brokers who advertise high rates but are really just selling snake oil, others buy "CD's" from offshore banks like Stanford Financial, believing that they are protected. The reach for yield becomes a dangerous game that rarely ends well even for those who purchase relatively safe bond funds. What most people don't realize is that when interest rates go up, bond prices go down - thus you incur losses. Now you've been hit with a double whammy, lower interest rates and less money. If you weren't spending this money, the higher rates would eventually offset the losses - a rising interest rate environment is actually good because your income starts rising.....its the short term pain that you must endure of principal loss that most people that understand.

Let me give you an example:

The money market fund that was paying you 5% is now paying you .5% (one-tenth of the previous rate) and you decide to stash your money into an Intermediate Term Investment Grade Bond fund that is now paying 6%. Seems like a good trade, you earn more money while all those poor schlubs are getting next to nothing. What most people don't understand is that this bond fund will react negatively to rising interest rates (eventually interest rates will rise). In fact, a 1% increase in interest rates will equal a 5% decline in principal. Furthermore this fund is very different than a money market or FDIC Certificate of Deposit, it has Credit Risk. Credit Risk is simply the risk that one or more of the bonds in the portfolio will default. But its Investment Grade, that won't happen right? Maybe, maybe not - but do you trust the rating agencies who gave these bonds Investment Grade status? I certainly don't. So you are getting your yield, but at what risk. If two years from now interest rates rise by 2% (let's say we have inflation and the fed decides to fight it by raising rates) your $100,000 falls to $90,000 and this assumes no defaults. If this is an acceptable risk to you, then go for it. I'm not inclined to bite just yet with so much incertainty. For those who want to take risk, this trade may pay off well - but remember, for individuals the goal of fixed income is to provide stability in the portfolio, you don't need your bonds sinking at the same time as your stocks.

So what is my advice? This is tough, there is no good immediate answer. What I'm advising my taxable clients to do is to stay short and not take on much if any credit risk. It means sacrificing yield in the short term, but I believe it will end up saving them money in the longer term. Bank CD's are reasonable alternatives if you can get a good rate, savings accounts that offer higher yields and FDIC protection are reasonable right now and I also think that Treasury Inflation Protected Securities offer a reasonable return over a five year period (though with some fluctuation risk).

I'm going to list some Vanguard Funds and their current yields as well as the latest rates from Bankrate to give you an idea of the current market environment for yield.

Treasury Money Market .27%
Prime Money Market 1.19%
California Tax Exempt Money Market .53%
Short Term Bond Index 2.40%
Short Term Federal 2.15%
Short Term Investment Grade 4.98%
Short Term Treasury 1.22%
GNMA (Ginnie Mae) 4.69%
High Yield (Junk Bonds) 10.66%
Intermediate Bond Index 4.56%
Intermediate Investment Grade 6.06%
Intermediate Treasury 2.50%
Total Bond Market 4.48%
Inflation Protected 2.43%

Bankrate overnight CD Rates

6 Month 1.66%
1 year 2.15%
5 year 2.68%

If I can help you better understand interest rates and different fixed income investment options please let me know.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, February 24, 2009

Opinion: A Plan to Resolve the Banking Crisis

Here is a link to an Opinion piece on

Interesting idea, I'd like to hear more - it doesn't seem like it solves the problem, bad assets. Seems like it would require a lot of faith and trust in government, something in short supply right now.

Scott Dauenhauer CFP, MSFP, AIF

Signs of life Commentary: The economy's worst may be past

Interesting information, I agree with Irwin that if a recovery does happen it will be due to Monetary policy.....of course this easy monetary policy may end up hurting us worse down the road, we'll have to wait and see.

Scott Dauenhauer CFP, MSFP, AIF

Humor Break: Investment Banking Explained

Young Chuck moved to Texas and bought a donkey from a farmer for $100.

The farmer agreed to deliver the donkey the next day.

The next day the farmer drove up and said, "Sorry Chuck, but I have some bad news. The donkey died.'"

Chuck replied, "Well then, just give me my money back."

The farmer said," 'Can't do that. I went and spent it already."

Chuck said, "OK, then, just bring me the dead donkey."

The farmer asked, "What ya gonna do with a dead donkey?"

Chuck said, "I'm going to raffle him off."

The farmer said, "You can't raffle off a dead donkey!"

Chuck said, "Sure I can. Watch me. I just won't tell anybody he's dead."

A month later, the farmer met up with Chuck and asked, "What happened with that dead donkey?"

Chuck said, "I raffled him off. I sold 500 tickets at two dollars apiece and made a profit of $898.00."

The farmer said, "Didn't anyone complain?"

Chuck said, "Just the guy who won. So I gave him his two dollars back."

Chuck now works for Morgan Stanley.

Monday, February 23, 2009

Why Bank Nationalization Is So Scary

Rick Newman explains in an easy to understand manner why the market has been so freaked out lately, Nationalization is a bad idea.

Scott Dauenhauer CFP, MSFP, AIF

Sunday, February 22, 2009

Foreclosure Solution: More Foreclosures / Also - What About Bank Nationalization?

This might sound strange coming from someone living in the middle of the biggest foreclosure crisis in our nation's history, however I have come to believe that one of the answers to our current foreclosure crisis is.....more foreclosures.

In previous posts I've laid out frameworks for helping to solve this current crisis. One of the key components is to purge the system of people who cannot now and cannot even if a loan was modified with a principal reduction afford a home. There are many people who bought homes they couldn't afford and would never be able to sustain. Some of these people live in homes that have dropped significantly in value, some live in homes that have only dropped a little in value (amazingly I consider "a little" to be 10 - 20%"). Ironically, the one's who have experienced the largest price drops are the ones who have the best chance of coming out ahead, but only because the economics work. Let me give a few examples of who should lose their home and who should keep their home:

A person takes out a $600,000 loan for a home worth about the same, the home price drops to $500,000. This individual makes $60,000 per year. This person, even with a loan modification that included a 4% interest rate and a principal reduction of $100,000 would have a fully amortized loan payment of $2387. Add in taxes and insurance and you are close to $3,000 per month. That is a front end ratio (PITI divided by Gross Income) of 60%. It doesn't matter if they have other debt, under no circumstance can they afford this home. If they stop making payments the only economically smart decision is to foreclose. Propping this individual up will begin a process (yet another one) of grossly distorting market values.

Let's take the same person who bought a house for $500,000 and the value has dropped to $200,000. Utilizing my framework (see previous post) the loan is written down to $250,000 with a 4% interest rate. The Payment is $1,194 and about $1,600 with PITI for a front end ratio of 32%. 32% is a reasonable front-end ratio and this person should be able to make these payments assuming employment; they should be given a modification and kept in the house.....because it makes economic sense. To foreclose on this person would yield a much bigger loss for the institution than if they modified the loan.

In both instances we had the exact same person, but we had different outcomes. Is it unfair to the first person who lost their home? You bet, but if we start using "fairness" as the key to solving this crisis we will make the crisis bigger and distort the market place leading to bigger bailouts in the not to distance future.

To solve the foreclosure crisis we must allow and encourage failure. Without failure we cannot succeed in purging the system of loans that have no possibility of being made good on.

I know that this type of position will lead to attacks on me for wanting to throw out good people from their homes. I don't want to see good people kicked out of their homes, I've seen it up close and it isn't pretty. The pain and suffering truly makes your heart hurt, however propping up people and keeping them in a situation that will never improve will serve as a much worse condition that ripping the band-aid off now and forcing a solution.

The Obama administration has completely dropped the ball with their mortgage plan. Ironically they are following the same failed housing policy that the Bush administration set forth last year. Does Obama really have it in him to bring forth "Change We Can Believe In" when it comes to the credit/foreclosure/mortgage crisis? Only time will tell, but I think he does.

Bank Nationalization

There is much talk these days about the government taking over the banks, or Nationalization. Many of my clients have been asking me thoughts on the subject, so here goes.

The government has already effectively nationalized our banking system.

My question really is - what would be the difference? If we convert the governments current preferred stock ownership into actual ownership in the nation's major banks we find that the government is already the biggest shareholder of every major bank. The government is already dictating to banks executive compensation and that they must make loans, so what is the real difference?

I think nationalization is a stupid idea, but its already been done. Shareholders have almost been entirely wiped out. Bank of America was a solid bank until it did the government a favor and bought Countrywide and Merrill Lynch to prevent a "systemic failure" in the system and now it is effectively an insolvent, failed bank. Shareholders have been basically wiped out because they did the "right" and "patriotic" thing. B of A would have been better off avoiding these toxic companies.

What should have happened is these entities should have been allowed to fail. Failure would have forced a mechanism whereby assets would be sold at a market price, not an inflated price (which is what is preventing current write downs of many of these assets).

We can play the "should have" game all day, instead we'll play the what should we do now game. My answer to this situation is "I don't know".

Should we nationalize or not? I don't know. The banks need capital, but they need it because they need to do massive write downs of bad loans, they can't even think about writing new loans write now, beside the FHA (the new subprime) and Fannie/Freddie are taking care of that.

Nationalizing the banking system poses a huge threat to our economic freedom and for that reason I am against it. Having said that the banks are already effectively worthless and cannot possibly raise the capital needed to make them solvent, they are effectively wards of the state already.

I've stated many times that I believe the government will need to pump a couple trillion into the system and will need to do so by printing money. This will facilitate greater government control over every aspect of our lives and this scares me. But what is the alternative? Again, I don't know.

The only possible solution would include a government guarantee that they will, at a specific point in time give up outright ownership of the nationalized banks. Evidently this is called "The swedish model"......which sounds like something out of a Victoria Secrets photo shoot (so of course I would normally whole heartedly endorse!), however I'm not so sure.

I still think there is a way to keep the banks from being nationalized and it is for the banks to move their assets off their balance sheets into a separate entity. I called for this back in December. This would not be a "bad bank" and current banks would not "sell" their assets to this entity, they would exchange their assets for equity and liability guarantees. The government would also help capitalize this entity and provide certain guarantees. This plan helps make the banks solvent, allows them to attract private capital and eventually gets them lending again to well qualified borrowers. It could also be the start to a plan where these entities begin the repayment process on the government preferred stocks, liquidating the government ownership.

None of this should be done without a better regulatory scheme put in place. At this point I don't support nationalizing the banks anymore than we have already done. We have existing institutions that function, they just need to be restructured - lets not reinvent the wheel.

Bottom-line: Banks have already been partly nationalized, further nationalization via complete takeovers is a bad idea, getting bad assets off the books is the only way out of this crisis and a process to work out the mortgage crisis must be undertaken that purges the system and makes economically viable decisions.

Is there a way out of this crisis that doesn't lead to a Greater Depression? Yes, it is up to out current leadership to make tough decisions and to lead.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, February 19, 2009

Documentary Review: House of Cards

I just finished watching the CNBC documentary House of Cards (hat tip to Gregg for pointing it out to me). For those who don't want to wait to find out if they should watch it till the end of this should watch it.

I cannot say that this documentary presented the complete picture or even an accurate one, but it does present many of the basic precepts that helped cause our current crisis. It clearly places the blame on Wall Street (what I now refer to as Hubris Street) and very little on government or the people, but from my extensive readings I'm not so sure they are wrong. There is plenty of blame to go around, but Hubris Street deserves the overwhelming majority.

I think I bring an interesting prospective to this current crisis as I and most of my clients lived through it. I moved to Orange County in 1995 and housing prices were fairly low, in fact I was working for Bank of America doing first and second home loans. What I found was that a lot of people were underwater or had very little equity.

I bought a townhome in the OC in 2000 and watched the price double in just a few years. I saw the whole of Orange County come out of its housing slump and boom. What I saw scared me. In 2004 I sold my condo as I thought housing was becoming overpriced. I was quoted in a bloomberg article saying "I think there's a bubble. It's similar to the Nasdaq (stock market) several years ago. I tell any clients who come to me who want to buy a house that there's more downside than upside now to the home market."

I had people coming into my office at least once a week wanting to flip homes and going to community college workshops (Marshall Redick anyone) to learn how to buy and sell property. To my amazement these people were getting loans for several homes at one time. I would tell people that I love real estate and that I think its a great way to build a net worth, however it has to make sense. Nothing that people brought to me made any sense.

Prices continued to go up as I rented a home in Orange County. I decided to move out Orange County as I knew I couldn't afford a $1.5 million home (notice I didn't say I couldn't get a loan for that amount). I ended up moving to Murrieta where I could buy the exact same home for a third of the price and I could afford the payments. I figured that I was willing to take a short term loss of even up to 20% in order to have some safety and stability in my life, I still thought prices would fall.

It wasn't until about 2005 that I started to see and hear more and more about people getting loans that should not be getting loans. I was seeing people buy homes who didn't have jobs and they were financing 100% of the purchase price (technically more as they would bid a higher price in order to get a rebate to pay for closing). But prices continued to go up. My house was at one point appraised at almost 20% higher than I had paid just a year or so earlier. The appraisal felt bogus, I knew there was nobody out there who would buy my house at that price - they'd be crazy. Heck, I figured I had overpaid.

If only I had followed my instincts a little further and attempted to understand better what was going on maybe, just maybe I could have seen what was coming.

Little did I know Hubris Street had been funding huge amounts of purchases and refinances with no money down and low teaser rates for people who couldn't afford a home that was even half the price of the one they were buying. I naively thought that the banking industry was regulated enough to prevent such stupidity. Of course, I was wrong.

The documentary basically ends at this point - after the fall, it doesn't tell us much more about what they think will happen next.

Watching this documentary I can't help but kick myself for not being more of a sleuth. Here I was one of the very few advisors to go on the record with Bloomberg and equate the housing market to the tech bubble and yet the possible consequences of such a meltdown escaped me. I faced ridicule amongst some of my colleagues. In one meeting an older financial planner openly mocked me for my position on real estate values and basically called me a fool for selling my townhome....sometimes I'd rather be that fool than be the person who was right. Of course being right and predicting the outcome of being right are two different things, I never in my wildest imagination expected what has happened in the past six months.

I've now read hundreds of articles and about a half dozen books on the current crisis and have filled in a lot of the back story as to how things got to where they were. I'm now convinced that what we are experiencing is unprecedented and the future is still unknowable.

What I do know is that this mess has to be cleaned up and that it can't be cleaned up by allowing the same set of policies that led us into this mess lead us out. It is going to be tough and heartbreaking, but good people are going to have to be foreclosed on. The market needs to purge itself and prices need to find an equilibrium, this means that homeowners who can't afford their home even under a massive principle reduction program must be foreclosed on. I've outlined a basic framework in previous posts as to how this can be done. Its actually a terrible framework as it relies on government money and is full of moral hazard.....but its most basic element is to begin the purge, find a bottom and then move on. It will take years to work out, quite possibly a decade.

The good news is that if the right plan is implemented I believe that the stock market won't wait until housing recovers to go up, it will rally based on the fact that it sees direction, clarity and a way out. Until the market sees such direction, I believe it won't be able to have a sustained rally. This doesn't mean you should sell.

America's brand has been tarnished, but it hasn't been destroyed. The American people are unlike any other this earth has ever seen and the march of progress will continue, even if slower than we originally thought.

As for talk about a Depression or a Great Depression......I can't discount these feelings, what I can say is that the poorest among us (in America) live better than many of the rich people during the Great Depression. Did you know that penicillin was not widely available during the Great Depression? We have a standard of living that could fall dramatically and still never compare to what the average person went through during the Depression. The Great Depression wasn't America's first Depression, it was something like its was just much worse than the others. At this point in time during the Great Depression unemployement was in the 20% range, we are at 7.6%.

The bottomline after all this rambling is that House of Cards was a pretty interesting story to watch and I think you'll find it entertaining, angering and educational.

I also want to say one thing about Alan Greenspan - for the next several decades, perhaps centuries we will debate whether he caused this mess with his prolonged period of low interest rates - however just because you have low interest rates it doesn't mean that you have carte blanche to eliminate all lending standards....that was done by the Investment Banks, not Greenspan.

Scott Dauenhauer CFP, MSFP, AFI

Wednesday, February 18, 2009

Will The New Mortgage Plan Work? Not A Chance...Strike Three

Several months ago I said it would probably take four times before the government actually came out with a program that would help mitigate the current foreclosure and credit crisis. Today marked the third attempt and it will fail. Ordinarily this would be Strike Three and you're out, however since Obama just became President we'll give him another shot at hitting a home run.

The plan announced today is based on a fairy tale - the same fairy tale that the Bush administration and congress hoped would have a "happily ever after" ending. That ending would be a world where foreclosures stop and home prices climb back up allowing the banks not to have to write down trillions in bad mortgage loans. This is what everybody in Washington is hoping for, but it just won't happen - it isn't possible.

This latest plan fails on five fronts:

1. It aims to help those who can least afford to stay in the home
2. It helps people who have reasonable interest rates already and have only lost a little on their home
3. It doesn't help out anyone for whom helping would make financial sense
4. There is not enough money being used
5. There is no provision for real write down of principal

This plan aims to keep people in their homes who simply can't afford to keep such an expensive loan. It does this by subsidizing interest rates, not by principal reductions. This distorts the marketplace and will eventually lead to a prolonging of the crisis and perhaps even more foreclosures.

I presented a framework for a mortgage plan in a previous post. A simple test could be designed to see if the homeowner could afford the house if the principal was reduced to about 120% of the current value (this is for hard hit regions) for example, if not the home could be rented to the homeowner and eventually sold or the the foreclosure process would start. As hard and as bad as it might sound we need to purge the market of those who will never be able to afford the house they are currently living in - subsidizing them doesn't help anyone and only prolongs the inevitable.

The second part of the plan is really the weirdest provision, it's going to be cool for those people who have an LTV higher than 70% as they'll be able to refinance and lower their rate, but these aren't the people in trouble of foreclosure, so it doesn't actually save anybody from going into foreclosure, it simply makes money for a mortgage broker (hey, they gotta eat too) and gives the owner some more dough in their pocket......kind of like a tax cut - but at other taxpayers expense.

This plan will basically bypass most of California, Arizona, Nevada and Florida......where the problem is. It doesn't help, if someone can demonstrate how it will, I'm all ears. Those who are most likely to foreclose and leave the banks with billions and trillions in losses aren't addressed at all.

The actual cost of a real mortgage plan is not $275 billion. This plan is similar to Bush's Hope For Homeowners program which helped only 25 people when it was supposed to help 400,000. The real goal with that plan was to provide bailout money to Fannie and Freddie - we could dub this Hope For Homeowners II - it does more to help Fannie and Freddie than anyone else. Two mortgage plans have been proposed - $75 billion will be spent in some manner (this isn't actually clear to me) on helping homeowners - $400 billion for Fannie and Freddie.....see where I'm going with this. Both plans are, were and will be smokescreens for getting money into these two failed entities.

Without a plan that focuses on principal reductions and lower interest rates, along with the sharing of equity and actually foreclosing on those who should be foreclosed on......there will be no recovery. This plan doesn't focus on principal reductions and will thus fail, potentially costing the taxpayers another $500 million as the housing market continues to crumble.

Wall Street obviously wasn't impressed with the plan, there was no rally.

Here is the problem - this housing crisis will cost possibly $2 Trillion or more to fix. The "T" word is scaring the heck out of the politicians and so they are putting their finger in the dike, the problem is that there are holes everywhere and not nearly enough fingers. The longer we wait the higher the price tag.

I've said it will take four stabs to get it right, the good news is that this it the third one.....perhaps we are closer to the point where the politicians finally capitulate and do what is actually needed.

Until then, no recovery. You'll know that they got it right when they announce a plan and the market jumps a thousand points. The bad news is that the only way to pay for the cost of this fix is to print money, leading potentially to higher commodity prices, inflation and the devaluation of the dollar.

The funny thing is that the housing crisis isn't our real problem (though it is huge and needs to be fixed), we could fix it for a mere couple trillion dollars (I'm not saying that with a straight face). Social Security, Medicare and Medicaid on the other hand..........that is about $65 Trillion and that is the real crisis that everyone is ignoring.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, February 17, 2009

SEC charges Stanford in alleged $8 billion scheme

"The Securities and Exchange Commission said Tuesday it charged billionaire Robert Allen Stanford and three of his companies with defrauding investors in an alleged $8 billion scheme involving certificates of deposit."

People believed the impossible, that you could safely earn twice the normal interest rate of FDIC insured CD's. When something sounds too good to be true, it is - if you live by this rule you will never be swindled out of your money. Note that I didn't say you would never see your holding fluctuate in value.

This guy is a slimeball and why it took the SEC this long to figure out what was going on is beyond me.

Scott Dauenhauer CFP, MSFP, AIF

The Barron's Plan

Barron's plan for housing is similar to mine, but still needs a little work.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, February 12, 2009

Market Conditions

Another month, another plunging stock market. This marks the fifth month in a row that the market has experienced abnormal fluctuation. I don't know about you, but I'm getting a bit tired of it.

I have little doubt that this latest plunge is due to a continued lack of leadership and outright irresponsibility by our congressional leaders and our new President. Promising hope and change we have gotten the exact same type of irresponsibility that the last four congresses have brought us.

The AP reported yesterday that Americans should start seeing an extra $13 in their paychecks soon, that should really stimulate things.

For nearly a year I have stated that we need to deal with the underlying issues, we need to treat the disease not the symptoms. Instead we are going to continue to ignore the disease as if it can't be diagnosed or isn't real. In the President's first press conference he outlined his priorities:

Priority One

"A particularly urgent priority is a further extension of unemployment insurance benefits for workers who cannot find work in the increasingly weak economy."

Priority Two

"Second, we have to address the spreading impact of the financial crisis on the other sectors of our economy -- small businesses that are struggling to meet their payrolls and finance their holiday inventories, and state and municipal governments facing devastating budget cuts and tax increases."

Priority Three

"In addition, I have made it a high priority for my transition team to work on additional policy options to help the auto industry adjust, weather the financial crisis, and succeed in producing fuel-efficient cars here in the United States of America."

Priority Four

"we will review the implementation of this administration's financial program to ensure that the government's efforts are achieving their central goal of stabilizing financial markets while protecting taxpayers, helping homeowners and not unduly rewarding the management of financial firms that are receiving government assistance."

Fixing the actual problem, which is an over-leveraged America barely makes the fourth priority (and only $50 billion has been pledged). This has to be the first priority and it has to start with a comprehensive plan to determine how best to handle all the homeowners who either can't afford their mortgage or have a financial incentive to give the home back. There are certain people that should be foreclosed on, but many others that the right thing to do financially is to write down the mortgage permanently.

Since this press conference and the two days of press conferences and congressional testimony by Treasury Secretary Timothy Geithner the markets have plunged, despite the passage of the "stimulus" bill that would save us all. Kind of reminds me of last year when a President, a Congress and a Treasury Secretary said that the world would fall apart if we didn't pass an $800 billion dollar plunged after it was passed.

It is clear that the market sees no leadership on the economy and is making its concern known.

Regardless of how you feel about Obama or the congress (judging by poll numbers most people still like Obama and still despise congress) he has America's priorities backwards.

Extending unemployment benefits is well and good, but allowing the private sector to provide long lasting jobs should be priority one.

I was against President Bush's stimulus package last year and grudgingly supported the TARP legislation despite the sick, twisted and demented pork that was added to it to bribe senators and congressman to vote for it. I want to make it clear that I do not oppose the stimulus because Obama supports it, I do not support it because it is makes no economic sense.

What needs to happen is the following:

1. Stimulus package must be killed or re-tooled. This won't happen so we'll have to live with it.
2. The first priority of the President, Congress, the Fed and the Treasury Secretary needs to be the Credit Crisis.
3. Banks must be allowed to fail
4. A mass write-down of mortgages must be undertaken (more on this in a minute)
5. Bad assets must be dealt with in a methodical way
6. We must incentivise business by cutting their taxes
7. We must not adhere to or pass anymore "buy american" clauses and we need Judd Gregg and Hillary Clinton to embark on a world tour of our partners to ensure they understand how much we need them (and vice versa). A trade war will doom the economy as it did during the 30's.
8. Reduce the tax burden on the middle class.

Much of the above might be controversial, however the most controversial is number 4, the mass write down of mortgage and other loans. People are upset that their tax dollars might go to pay off someone's mortgage that never should have been given a mortgage in the first place - this is understandable, however it is also unavoidable. This can be done though on a mass scale and in a way in which taxpayers don't share the entire burden and in fact will benefit.

The reason we can't move forward with our economy is because America as a whole is overleveraged - there is no capacity to borrow even if the money was available (which it isn't because institutions finally realized its stupid to lend to people who can't pay it back.....even if the government tells them it is ok).

Housing in many area's is down over 50%, in some area's 70%. In those area's even the people who are current and can afford their mortgage have a huge financial incentive to walk away and they will. Others simply couldn't afford the home they bought, still others lost their job and have no income. The solution is not to allow people who can't afford the mortgage to stay in the home, those people must be foreclosed on (flippers as well). Here is the solution:

1. Determine the value of the property
2. Determine if the current homeowners could afford the property at the current value or at 20% above the current value.
3. If so, re-write the mortgage to a 30 year amortized loan at a reasonable rate and let them stay in the home, if not, foreclose.
4. As part of the principal reduction in the loan the homeowner must give up appreciation rights. The appreciation rights they give up can't be too little or too much as their would be no incentive - but lets say they must give up 25% of future appreciation in exchange for the write down.

The announcement of a plan like this will automatically spur home prices upward, in some area's by a little, in other areas by 10% or more. Let's go through an example:

Homeowner bought a house for $500,000, it is now worth $185,000 (yes, its that bad in many places). If the there is no plan this homeowner will walk in all probability (whether they can afford the payments or not). If the homeowner walks the bank will own the property and it will sit there for a long time, the bank will be responsible for upkeep and property taxes. Eventually the house might sell for $185,000, but in all likelihood it will sell for lower and after legal costs the bank will net about $140,000, a loss of 72%.

Under my plan the house would probably be worth at least $200,000 after the announcement as people who had planned to go into foreclosure (or were in it) decide not to go through that process. The price may go up even more as it was artificially depressed by all the other foreclosures that caused the downward spiral in the first place.

Let's be conservative and put the value at $200,000. The bank offers the homeowner to write the mortgage down by 50% to $250,000, or 25% higher than the house appraised for. The homeowner is expected to share in some of the losses. Yes, the bank now has a loan that is at 125% loan to value, but that is better than 270% loan to value (that will foreclose). In addition, the interest rate drops to 5% and is fixed for 30 years and amortized. The homeowner agrees to give up 25% of all appreciation over and above $250,000 (the bank gets the first $50,000). Granted, the 25% number can be adjusted. 30 years from now the home is paid off and worth $500,000, the homeowner could borrow to pay off the appreciation rights or sell the home and net $387,500. The payment would drop to about $1,350, from close to $3,000. This could be supported with a job that pays in the $50,000 range. To incentive the banks to do this the government would add in a guarantee of a certain amount if the loan goes back into default.

The numbers can be adjusted to whatever makes sense, the above is just an example. This would take time to work out, but it would represent exactly what President Obama has asked of us all, "Shared Sacrifice". The bank takes a loss, the homeowner shares in the loss (and gives up future appreciation), the government shares in the loss (of which they had some responsibility for) and the country as a whole can begin the difficult steps of moving forward.

So how do we pay for this.......good question. There is only one way to pay for it - print more money. That is how we are financing the stimulus package. My mortgage write-down program would negate the need for the stimulus as it would be a stimulus in and of itself. The family above would have $1,700 more per month to spend - of course the above is a bit of an exaggeration, but there would be more money to spend, save and invest. In addition, without all that extra mortgage interest being deducted there would be more tax dollars coming in.

I hate the printing of money, but our other option is to become Japan and ignore our fundamental issues.

Of course none of my plan addresses the real structural issues of our country - Social Security and Medicare (and excessive state and congressional spending by both Republicans and Democrats). These issues I'm going to leave to President Obama, I think that he might be able to do what he couldn't do with the stimulus, reach a real consensus that all American's can support.

There is an enormous amount of pressure right now on the American family, it will be relieved one way or another, we have to find the best way to do it. In my above example the bank takes a 73% loss if that family goes into foreclosure, but if they agree to the plan the loss is only 50% immediately and becomes less each year as real estate recovers. The bank would receive $486,000 over that 30 year period in principal and interest, plus the $100,000 or so in shared appreciation for a total of about $585,000.......a gain of $85,000. Sure its only a return of .52% annually over 30 years, but that is better than a treasury bill is paying right now! Would you rather take a 72% loss now or have a half percent annual return over the next 30 years? This is why it makes sense to solve the foreclosure problem, even if it "rewards bad behavior". Stand by your principles of rewarding bad behavior and lose 72% of your money or do something about the problem and eke out a return? You decide.

The Market lacks leadership and until it sees some it will not recover. This week was a complete disaster for the Obama Administration and especially for the new Treasury Secretary Timothy Geithner. I believe that these guys are smart people and even though they haven't gotten it right.........perhaps in a week or two they will. We can hope, right?

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, February 10, 2009

Is That Hoover I Hear? No, It's "Stimulus"

Last year I railed against the stupid "stimulus" plan that congress and the Bush administration passed (Shove It), I said it was a sham that would not work, it didn't.

This current stimulus package is a boondoggle. It is stupid and wasteful. For years I have been outspoken about wasteful spending in congress, that is one of the major reasons I believe the Republicans were ousted in 2006. It appears no one has learned there lesson. This is a bad idea.

One of the things that turned a Great Recession into a Great Depression in the 30's was protectionism. Hoover and the congress passed legislation that started trade wars and killed our exports. This stimulus bill does the same thing, though thankfully not to the same extent - but it does risk starting a global trade war. We cannot afford protectionism.

The stimulus bill will not get us out of recession, fixing the banking industry and writing down loans (possibly a currency devaluation) will. Without first fixing the underlying problem we cannot recover. Fix housing and all the other bad lending, then you can build a base with which to build and move forward.

One last thing - congress keeps saying that the banks need to lend now that they've been given money.......that is stupid. Let's take a step back and think about this - should we require the banks to make loans to entities and people that shouldn't be given loans? If the answer is yes, then you are not allowed to be upset about the current crisis because that is how we got into it. We need banks to be healthy and consumers and businesses to be healthy and less leveraged so that lending can take place within reasonable guidelines. We shouldn't lend because congress says so, that is how we got into this mess in the first place.

Scott Dauenhauer CFP, MSFP, AIF

Monday, February 09, 2009

No Mortgage Workout, No Recovery

From the Hussman Report:

“What the Federal Reserve has done and what the Treasury has done, by and large, is to take an existing debt and say they will own it or lend against it. But they haven't said they are going to write down the debt and cut debt payments each month. There has been little in the way of debt relief yet. Very, very few actual mortgages have been restructured. Very little corporate debt has been restructured. The reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt.

“If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -- the mortgage piece, the corporate piece, the real-estate piece -- you are wrong, because they need financially sound entities to lend to, and that won't happen until there are restructurings."

What I've been saying for almost a year now, until the foreclosure problem is dealt with, the economy will not be able to move on. This is the third priority of the President......not a good sign.

Scott Dauenhauer CFP, MSFP, AIF

More Proof of the Jim Cramer Myth

For those of you who still think Jim Cramer is a stock market guru or even a good stock picker.....this article should dispell that myth. Why people like this guy is beyond me.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, February 05, 2009

Humor Break: Smart Ass Answers of the Year 2008

The Best Smart Ass Answers of 2008 !!


It was mealtime during an airline flight. 'Would you like dinner?' the
flight attendant asked John, seated in front. 'What are my choices?' John
asked. 'Yes or no,' she replied.


A flight attendant was stationed at the departure gate to check tickets.
As a man approached, she extended her hand for the ticket and he opened his
trench coat and flashed her. Without missing a beat, she said, 'Sir, I need
to see your ticket, not your stub.'


A lady was picking through! the frozen turkeys at the grocery store but
she couldn't find one big enough for her family. She asked a stock boy, ' Do
these turkeys get any bigger?' The stock boy replied, 'No ma'am, they're


The police officer got out of his car as the kid who was stopped for
speeding rolled down his window. 'I've been waiting for you all day,' the
officer said. The kid replied, Yeah, well I got here as fast as I could.'
When the cop finally stopped laughing, he sent the kid on his way without a


A truck driver was driving along on the freeway and noticed a sign that
read: Low Bridge Ahead. Before he knows it, the bridge is right in front of
him and his truck gets wedged under it. Cars are backed up for miles.
Finally a police car comes up. The cop gets out of his car and walks to the
truck driver, puts his hands on his hips and says, 'Got stuck, huh?' The
truck driver says, 'No, I was delivering this bridge and I ran out of gas.'


A college teacher reminds her class of tomorrow's final exam. 'Now class,
I won't tolerate any excuses for you not being here tomorrow. I might
consider a nuclear attack or a serious personal injury, illness, or a death
in your immediate family, but that's it, no other excuses whatsoever!' A
smart-ass student in the back of the room raised his hand and asked, 'What
would you say if tomorrow I said I was suffering from complete and utter
sexual exhaustion?' The entire class is reduced to laughter and snickering
When silence was restored, the teacher smiled knowingly at the student,
shook her head and sweetly said, 'Well, I guess you'd have to wri te the exam
with your other hand.'


A woman is standing nude looking in the bedroom mirror. She is not happy
with what she sees and says to her husband, 'I feel horrible; I look old,
fat and ugly. I really need you to pay me a compliment.' The husband
replies, 'Your eyesight's damn near perfect.