Avoid getting caught in this trap …

A long, long time ago in a world without video games, we played a boardgame called Mousetrap. Since a picture’s worth a thousand words …

image

To see it in action, click here.

As you can see, Mousetrap is a pretty elaborate set up where an initial action sets off a chain reaction of subsequent actions …

… until finally the unsuspecting mouse is caught in a descending trap.

Credit markets are a lot like Mousetrap …

… and the further back you can see through the chain of events, the more likely you are to see what’s coming … and avoid getting trapped out of position.

The Great Financial Crisis of 2008 taught us how dangerous it is to keep our noses myopically to the real estate investing grindstone … falsely aloof and insulated from the turmoil of credit and currency markets.

When the trap fell, we were caught … illiquid and upside down … with not enough time to react.

So we’ve learned to pay careful attention to the machinations of the markets. And right now, there are a lot of moving parts.

Depending on how long you’ve been watching, some of the action may seem disconnected and even irrelevant to your daily real estate investing.

Be careful.

Gold, oil, trade, tariffs, currency, and bonds are far more intertwined than most folks realize … and they all conspire together to impact credit markets and interest rates.

And last time we looked, credit markets and interest rates are very important to serious real estate investors.

By now, you’re probably aware the Fed dropped interest rates for the first time in 11 years.

Granted, it wasn’t much … only 25 basis points (.25%).

But the stock market didn’t like it. And neither did President Trump, who was unabashed in his displeasure with the Jerome Powell led Fed.

So that’s one piece of the puzzle.

You’ve also probably heard that the U.S. and China have been engaged in an economic pissing contest for quite some time.

Here again, President Trump is displeased with China’s trade policy with the U.S. and he’s been using tariffs to goad them to the negotiating table.

But the last round of talks didn’t end well, so Trump slapped more tariffs on the Chinese exports to the United States.

Once again, the stock market didn’t like it much.

Let’s take a time out here to remind ourselves that when money flees the stock market, it usually ends up in bonds. As demand for bonds goes UP, interest rates go DOWN.

Then, as interest rates do down, investors go back to stocks in pursuit of yield, and everything reverses. It’s an ebb and flow of funds which creates a degree of equilibrium.

Or at least that’s how it usually works …

Sometimes, when investors don’t like either stocks or bonds, they buy other things for safety … including gold and real estate.

This is a far more interesting development and something we discussed at length in a recent commentary.

But that was before China allegedly punched back at Uncle Sam’s latest tariffs by allowing their currency to fall below the politically significant 7:1 ratio to the dollar.

Now before your eyes glaze over, it’s not as complicated as it seems. And as we’re about to point out, it has more of an impact on your real estate investing than you may realize.

When China allows its yuan to weaken relative to the dollar, it takes more yuan to buy a dollar. More significantly, it means dollars will buy more Chinese goods.

In other words, it makes Chinese goods cheaper for Americans … effectively negating the punitive impact of U.S. tariffs. It’s like blocking the punch.

The Trump Administration wasn’t happy about China’s “block” and, for first time since the Clinton Administration, decided to brand the Chinese as “currency manipulators”.

Without getting into the weeds, it means the conflict is escalating … and the two heavyweight economies are turning a gentleman’s disagreement into a street fight.

With the two economies highly intertwined with each other … and very influential around the globe … this altercation has the potential to impact virtually everyone world-wide … including Main Street real estate investors.

Of course, we’ve been talking about this since 2013 when the clues in the news made it clear the dollar is under attack by China (and Russia).

We’re not telling you this to brag. We’re simply saying these are events which many people have seen coming … and have been preparing for.

And it’s not over by a long shot.

So if want a broader context for what you see reported in the daily news, you might want to check out our Real Asset Investing report and our Future of Money and Wealth video series.

And if you’re not sure why all this matters to a lowly Main Street real estate investor, consider this headline …

China could unleash this weapon on the financial markets to wallop the USYahoo Finance, August 6, 2019

“They [China] could start selling Treasuries which is what they use to benchmark the yuan to the dollar and that would be the doomsday scenario.

(By the way, Russia’s already done it, but they’re small fry compared to China.)

“While China has reduced its holdings of Treasuries in recent years,
any amount of pronounced dumping could send U.S. interest rates skyrocketing.

Remember, this is Mouse Trap …

Think about what “skyrocketing” interest rates would mean to an economy bloated with record levels of consumer, corporate, municipal, and federal debt.

As we discussed exactly one year ago, America’s debt could be an Achilles heel China could attack by dropping the interest rate bomb.

Back then, this was considered an extreme view … highly unlikely because dumping that many Treasuries at once could cost China billions.

But China’s been stocking up on gold … perhaps as a hedge against collapsing the dollar?

And when you consider the cost of “war” … even a trillion dollar loss is less than what the U.S. has spent in the Middle East.

So it’s not too far-fetched to think China might consider the loss just the cost of winning the trade war.

Let’s bring it back down to Main Street …

We’re not saying interest rates will skyrocket. But they could. There’s a lot more room to rise than decline.

And if China is playing a different game than Uncle Sam thinks, they may make a move few expect.

Is your portfolio fortified to withstand a sudden spike in interest rates?

“The time to repair the roof is while the sun is shining.” – John F. Kennedy

Think about it. Pay attention. Inspect the roof … and make repairs.

Until next time … good investing!


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9/9/12: Rhetoric and Reality – A Look at the History of Economic Policy

As the U.S. presidential elections rapidly approach, there’s a lot of talk about economics and economic policy.  You probably noticed.

At their convention, the Democrats invoked the spirit (and oration) of ex-President Bill Clinton.  The GOP conjures up wistful visions of Reagonomics.  Dire predictions of fiscal cliffs, debt-ceilings, defaults, hyper-inflation, depression, civil unrest and other calamities pepper the debate.

It seems that EVERYONE has an opinion about what the future holds.  But what does history say?

To find out, we sit down with another big brain (one you’ve probably never heard of) in sunny Las Vegas, Nevada.

Tossing their own rhetoric into the radio ring for this episode of The Real Estate Guys™ Radio Show:

  • Your who-would-you-rather-have (rhetorically speaking) host, Robert Helms
  • Your his-mom-wanted-him-to-be-a-reality-TV-star (not really) co-host, Russell Gray
  • Special guest, Associate Professor of History and Economics at San Jose State University, Dr. Jeffrey Hummel

In our likely never to be written book, “It’s Not Obama’s Fault”, we’d put forth the idea that Mr. Obama, like every President before him, are victims or beneficiaries of “the economic cycle”, or what Jeffrey Hummel calls “the business cycle”.

Now we’re not picking sides here (life is too short for that). And if you’re into blaming Presidents for economic conditions, then Bush and Obama are both well deserving.  And if Romney wins, we’re sure he’ll have his turn in the barrel too.

But rather than try to find consensus on theories and concepts, Jeff persuades us that it’s useful to take a look at the history of the business cycle.  Everyone might disagree about what might happen if this or if that.  But since history has already happened, there’s less to argue about – and more to learn.

So why should real estate investors care?  Yes, you guessed it, it’s a somewhat rhetorical question. 😉

Obviously (we hope), the ups and downs (cycles) of the economy affect jobs, incomes, interest rates, asset values and the confidence of consumers, builders, lenders, employers, buyers and tenants.   And ALL of those things affect real estate and therefore provide important context to our investing decisions.

For example, some pundits have expressed grave concerns about the possibility of debt-burdened states defaulting.  But did you know that way back in 1840 there were four states that repudiated their debt and four more that defaulted?  Like today, they turned to Uncle Sam for help, but then-President Martin van Buren blocked the bailouts.  OMG!  What’s going to happen?

Oh, wait.  It already happened.  So we don’t have to guess.  We can look at history and find out.  But if you don’t know, then you’ll have to listen to this episode and hear what Professor Hummel tells us.

What we like about looking at history is that it helps us calm down.  When we are so focused on the now, we sometimes forget that markets have been cycling for a lot longer than we’ve been around.  We’re guessing they’ll still be cycling long after we’ve gone.

So even though there are many very real things to be concerned about, sometimes talking a giant step back and a few deep breaths can give us enough perspective to press forward when everyone else is running scared.

When we look at today’s real estate market, we keep coming back to the same thing.  Properties are selling below replacement costs, interest rates are at historic lows, there’s a growing renter population and still not enough new product coming on the market to meet the population growth.  Put all that in a blender and it looks pretty good for investors.

Add to this the notion that even though this down cycle has lasted longer than most, history teaches us that sooner or later the cycle will take the economy back up – and when it does, those investors who are actively acquiring bargains today, while properties are on sale, are going to come out the big winners…no matter who wins in November.

So listen in to our extremely interesting interview with Professor Jeffrey Hummel – and consider what your personal history will look like 20 years from now, depending on what you choose to do (or not do) today.

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The Mortgage Meltdown and Healthcare

What do these two topics have to do with each other?  Well, certainly after the mortgage meltdown the US economy is in need of health care.  Not reform.  Just getting healthy!  But that’s not the topic of this post.  Instead the question is: What lessons from the mortgage meltdown can be applied to the health care debate?  And, as a real estate investor, why should you care?

Without going into an extensive history lesson, here’s a quick recap of the mortgage meltdown:

  1. Government decides to “help” the free market for mortgages by establishing Fannie and Freddie to buy mortgages in the secondary market.
  2. Assured of a buyer for their mortgages, mortgage originators aggressively market them.  They sell it silly.  People buy houses. Values go up and more people buy. Equity happens and life is good.
  3. Private industry sees opportunity and wants to play, but find themselves competing against the “Government Sponsored Enterprises” (GSE’s) Fannie and Freddie.  Mortgage rates are dictated by risk and the implied government guarantee of Fannie and Freddie means mortgages that “conform) (i.e., conforming loans) are cheaper than private industry.  Of course, the consumer will buy the cheaper loan.
  4. Private industry expands into “non-conforming” (i.e. Jumbo, sub-prime, etc) in order to be in the mortgage business without having to compete directly with the GSE’s.  They make money.
  5. In 1999, the Clinton Administration says, “Fannie and Freddie, you need to make it even easier for people to get home loans”, which is code for “lower your standards”.  Fannie and Freddie comply.
  6. Home ownership surges under George W. Bush.  He’s an economic genius.  Home values soar.  Private industry says, “I want some more!” and recruits foreign investors to plow money into “super safe” mortgage backed securities.  The money is directed at sub-prime, alt-a, investors, jumbo, etc.  Now equity is REALLY happening!
  7. Reality sets in.  People who shouldn’t have gotten loans do what people who shouldn’t have gotten loans do: they default.  The sub-prime crisis sets off a chain reaction of well chronicled events that set off The Great Recession.  As a result, the private mortgage business is almost wiped out.  Fannie and Freddie survive on the backs of the taxpayers (the working private sector).

Obviously, there’s a lot more to the story, but what are the lessons?  Here are two of the most important ones:

1. In a capitalistic society, the objective of enterprise is to make a profit.    It’s what motivates the brightest people to work hard and sacrifice to create solutions to society’s problems – solutions that can be sold for a profit.  Profits are what allow people to pay taxes, give to charity, invest in product development and new enterprises that create jobs and enrich society. Profits are not evil, they are essential.

2. When the government, though well intentioned (giving it the benefit of the doubt) enters into competition with private industry, with the goal of making a product or service “more affordable”  (code for reducing or eliminating those evil profits), the result is a) private industry is crushed, taking its jobs with it; or b) private industry is forced to compromise sound business practice in order to survive (like loaning money to people who can’t afford to pay it back) and eventually those unsound business practices result in failure – and the loss of jobs.

And the correlation to healthcare?

The President of the United States has gone on record as stating that one of the “benefits” of a public option is to create a health care insurance program “without a profit motive” to compete with private industry.  When you follow that thought track to its logical conclusion, does anyone see a train wreck?

When you think about how big the health care industry is, you can imagine how many private sector jobs would be lost if it were to melt down too.  And since the private sector economy is the one that pays 100% of the taxes, the smaller it gets, the larger the tax burden will be on those who remain.

Loss of private sector jobs and higher taxes have a DIRECT impact on your real estate investments. When more private sector capital is sucked into government, there is less of it available for private purposes. And what is available becomes more expensive (higher interest rates).

So even though “homes and healthcare for all” are noble and compassionate causes that everyone can support, the methodology of undermining the private sector to accomplish them is counterproductive in the long term IF one is operating in a CAPITALISTIC society.

There is no debate about whether we all want people to have homes, healthcare and abundance.  We all want that.  The debate is whether or not we are committed to capitalism.  If we are (and you should be as a real estate investor), then the solution will be found in the private sector as entrepreneurs work every day in their “enlightened self-interest” to invent, build and sell homes, health insurance, health services and whatever other products or services enhance the human experience.

Diesel engines run great on diesel fuel. Regular gas engines run great on regular gas.  But when you put diesel fuel in a regular gas engine or vice versa, it might run for a little while, but it won’t run well.  Eventually, it will break down and not work at all.

Until someone re-writes the Constitution of the United States, the US is a capitalistic society.  Let’s be careful about injecting incompatible “fuel” no matter how noble the motive.