The Daily Reckoning Paris, France Monday, 21 June 2004
Longest day of the year in the Northern Hemisphere...
Nothing much happened last week. Fine with us.
Nothing much is likely to happen this week either. But - and here we are beginning to sound as tedious as a health warning on a pack of cigarettes - there will come a week when something does happen. On that week, and those weeks that follow, you will wish you had done something to protect yourself.
What we are doing is simple. We are out of stocks...except for a few old stray dogs and cats we can't turn out. We see no reason to be in stocks; they are near the upper end of their price range. Inflation will take them down. Deflation will take them down. An oil shock, higher interest rates, a war...anything could take them down. The only thing that will not knock them down is nothing. And the trouble with nothing is that you can't count on it. Something always happens.
Happily, nothing is what people expect. So, they under- price the odds of something. Serious inflation, for example. Protection is cheap. Gold is still below $400. And TIPS, the government's inflation-indexed bonds, were selling for only about 2% above regular 10-year notes - the last time we looked.
And look at bond spreads. You pay almost as much for a risky 'junk' bond as you do for a Treasury. Relatively, the Treasury is a bargain. Again relatively, the junk bond is a hidden land mine. Step on the thing at the wrong time and it will blow you up.
House prices rose nearly 40% in San Diego County last year. Rentals, by comparison, are cheap.
The Greenspan Fed continues to encourage the fantasy that high consumer debt levels don't matter; houses are going up in price, they say, so the debt declines as a percentage of assets. But just imagine what would happen if all houses suddenly rose over $1 million, more than 4 times today's average price. Householders could double - or even triple - their debt and still be okay, right?
Just one problem. How would they pay it? An average man with a house could only realize his 'wealth' by selling his house. But then...where would he live? And whom would he sell to? At 6%, the interest alone on a $1 million house would be greater than the entire man's salary.
Already, houses are becoming a burden. The median house in California has risen to $453,000. You need a minimum income over $100,000 to afford it. But only 20% of Californians have household incomes greater than $100,000. The safest bet is probably to sell the $453,000 house...and rent one just like it for $2,500 per month, or less.
The problem, generally, is that capital assets - including stocks and houses - are expensive. The risk of owning them outweighs the potential upside reward. Something will happen and they will fall in value. And because so few people expect something to happen, the cost of insuring against something is low. Stocks went nowhere last week. They went nowhere this year. They've gone nowhere in the last 6 years. You give up no capital gains by not owning them. Nor do you forgo much in the way of dividends. At less than 2% - let someone else take the risk.
Houses, on the other hand, are going up. But unlike stocks, they can't go up much more - people of limited means have to be able to afford them. And, like stocks, either inflation or deflation, will knock them down. Inflation leads to higher interest rates, which brings housing to its knees immediately. Deflation puts people out of work - so they can no longer afford to buy houses.
As in Japan, houses have risen for 4 years following the break in stock prices. As in Japan, it is now time for houses to give way too. Why take the chance? Rent; let someone else take the capital risk.
And here's Eric with the latest news from Manhattan:
*** Zero Down for the American Dream - Ron Paul ***
Hi Joe, I thought I'd post this here today as I don't consider this to be an 'incorrectly political' subject.
Ron Pauls's Texas Straight Talk June 21, 2004
Zero Down for the American Dream
The House Financial Services committee on which I serve often passes legislation that wastes taxpayer dollars, harms the economy, and egregiously violates the Constitution. The “Zero Downpayment Act” recently passed by the committee is a striking example of a bill that does all three.
This legislation is considered completely noncontroversial by both political parties, and will breeze through the full congress later this summer with the blessing of the administration. Nobody in Washington thinks twice about another welfare scheme that further entrenches the something-for-nothing mentality so prevalent today in America.
The Zero Downpayment Act, as its names suggests, creates a federal program that allows some homebuyers to obtain federally-insured mortgages without making a down payment. “Federally-insured” really means taxpayer-insured, as taxpayers like you foot the bill for defaults. So while Congress congratulates itself on yet another program that supposedly helps the poor, it is taxpayers who pay for the inevitable defaults.
Every mortgage banker knows that even a modest downpayment greatly increases the likelihood that a buyer will pay his mortgage as promised. A buyer who has consistently saved money for a down payment is by definition a better credit risk, and it’s harder to walk away from an obligation if it means losing a sizable amount of hard-earned money. A downpayment measures a buyer’s willingness and ability to make sacrifices in order to reach a goal and improve his standard of living. Banks used to recognize hard work and thrift as indicators of creditworthiness, and in a free market would demand a significant down payment for virtually all homebuyers.
But as with all federal intervention in the economy, housing welfare distorts the mortgage industry and makes ordinary Americans poorer. Banks, of course, love federal mortgage programs- after all, the risk of default is transferred to American taxpayers. The lending mortgage banks get paid whether homebuyers default or not, and what business wouldn’t love having the federal government guarantee the profitability of its ventures? Between the Federal Housing Administration, which is the largest insurer of mortgages in the world, and the government-created Fannie Mae and Freddie Mac corporations, the mortgage market is hopelessly distorted. Millions of mortgages in this country are federally insured, and the tax bill for defaults could be astronomical if the housing bubble bursts.
Despite the congressional rhetoric about helping the poor, federal housing policies often harm poor people by pushing them into houses they may not be ready to buy. Given the realities of insurance, property taxes, maintenance, and repairs, many low-income buyers lose their homes and destroy their credit ratings. Easy credit and low interest rates, courtesy of the Federal Reserve, have dramatically increased housing demand and artificially increased prices. Zero down payment schemes do the same thing by pushing renters into the housing market. This increased demand actually serves to price many poor Americans out of the housing market indefinitely.
The American dream cannot be lived courtesy of taxpayer handouts. The experience of working hard, saving for a downpayment, and buying a home is the essence of the true American dream. Eventually the beneficiaries of government programs stop thinking of themselves as independent citizens, and start viewing themselves as wards of the state. It is impossible to maintain a free society when more and more people look to the state to provide what Americans used to provide for themselves.
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