Wednesday, November 12, 2008

Ouch! Double Ouch! 54% down 54%

Back in 2002, before the real estate boom, a table in the Economist Magazine reported that the developed world had assets as follows:

Residential Real Estate $48 Trillion
Commercial Real Estate $14 Trillion
Equities $20 Trillion
Government Bonds $20 Trillion
Corporate Bonds $13 Trillion
Total $115 Trillion

We know that 2002 was the year of a major market bottom, just before a tremendous boom in real estate asset values. The Big Picture Blog reports that just financial assets had grown to $140 Trillion by 2005 and using the same ratio of financial to real we can guess that total assets were $260 Trillion in 2005, probably much more. It would take time to find current numbers but the above numbers show a number of things, including the relative size of the housing market. When the US Treasury proposed a $700 Billion Bail Out, the number sounded huge. It is; however, when compared to the size of the assets involved it is not big. It is less than 1% of the sum of US households assets and just slightly more than 1% of US households net worth. The bail out is a misuse of our treasury because it was done in a way to allow the powerful to pick winners and losers but not big relative to the problem. It is small relative to the size of the flood of dollars pouring in from the private sector. Much is made of the fact that a lot of homes are being sold through foreclosure but no one seems to consider who is buying all these foreclosed homes.

The Dow Jones Global REIT Index is currently trading 54% below its 52 week peak and 68% below its all time peak. The numbers above show that real estate was 54% of the developed worlds assets in 2002. Ouch! Double Ouch! Fifty four percent of the worlds assets fell 54% in 52 weeks.

The average individual owns more real estate than anything else. In 2002, the average guy held 54% of his assets in real estate. A family with assets of $115,000 averaged holding $48,000 in residential real estate and $20,000 in equities.

Of course, there is no average guy. The worlds assets have never been and never will be equally distributed. While much was made during the election of the fact that the US consumes 25% of the worlds oil consumption, the reality is much "worse" than what was implied. In terms of assets, the top 2% of the people of the world own half of everything! The bottom 50% own less than 1%! This is the 80/20 rule on steroids. The median family has assets of about $2,000. If the middle is $2,000, how would you like to be on the end?

Over the past 30 years the poor have benefited from the opening of trade by Richard Nixon and by policies encouraged by Ronald Reagan and Margaret Thatcher. Nixon was a democrat in republican clothes but he did get an important ball rolling. Sine the Reagan/Thatcher reforms, the rich have paid an increasing share of taxes and as can be seen at, the poor have made huge gains. The distribution curve of income and wealth is still lopsided but free and open markets have been a huge blessing for the poor. Free trade is the best way to help the poor. In one of the great ironies of ethical living, we help the poor when we help ourselves to their low cost products.

By blocking free trade agreements, democrats help rich union members, rich lobbyist and rich politicians. The workers at GM could not "earn" an average compensation of $73 per hour without the crushing of the poor done through trade restrictions. The average US car includes about $1,500 in health care expenses compared to the average Toyota car which includes $110 of health care expenses. By blocking the free market, the congress permits union workers to make 260% of the average American compensation while allowing poor people to go hungry. Because union workers are so dramatically overpaid, US car companies have spent more heavily than necessary on industrial robots. We have substituted too much capital for too much labor instead of accomplishing the same work while feeding the working poor. I object to democratic strategies to help the "middle class" because their policies are specifically designed to help the rich; it is hypocritical to throw poor man out of work by spending money to "help the middle class".

Just a few months ago, the public had been brain washed into believing oil supplies were running out. A couple of years ago, the public was brainwashed into believing man is over heating the earth (the earths temperature has fallen from a sun induced peak 10 years ago). During this election cycle, the public was brainwashed into believing that 95% of the people will receive tax cuts with the attached implication that they will not pay a portion of the planned tax increases on the most profitable of employees and businesses. Who said that the most insidious tax increase of all is the inflation tax?

The average real estate investment cycle is 18.3 years long. At the bottom of the real estate cycle, the world is always in pain. The world is currently in a lot of pain. In the last year, the results have been the same as if a world wide fire burned down half the houses. Over three years, the fire burned three out of four! The Dow Jones World REIT index was down around 75% at the bottom. It is still down 68%.

The good news is that the fire department is and has been on the scene, putting out the fires. These fires are being put out by a flood of money. My only complaint about the governments portion of the flood of money is that winners and losers are being selected by those in power. On the other hand, the biggest flood of government money has been more fairly distributed by the FOMC which has increased its balance sheet by about 1 Trillion Dollars over the past few months! The UK and EU fire departments were late to arrive but the fire chiefs are catching up quickly. There should be several more interest rate cuts in the days and weeks ahead. Australia has only sent a couple of fire trucks so far but more should be coming soon.

The remaining areas of tight money are fading fast. The US Treasury bond rate has bounced back above 2007 levels in terms of the Australian Dollar but in terms of the average world currency the rate has fallen from 3.52% in June of 2007 to 2.87 as of November 7, 2008. The reduction in money costs is far more powerful than all the other floods of money. The rents available from real estate are being discounted at lower and lower rates, the values ready to start a 15 year climb.

The Baa to T-Bill spread has jumped well above the levels reached in August of 1982. August of 1982 was the jumping off point after the worst manufacturing recessions the world has seen. The Baa to T-Bill spread is currently above 9%. Such as spread is a measure of extreme fear in the market place (buy on fear). After 9/11, on October 10, 2002, and during the great depression years of 1934 and 1936 this measure hit 6.5%. Only in 1982 and in 2008 has this indicator gone higher. It spiked to 8% in August of 1982 and it spiked to 9% last week.

When the poor old stock broker asked the wealthy pig farmer his secret to success, he answer, "Buy low and sell high". A broad index of the worlds real estate fell 54% in the past 52 weeks, the maximum draw down was about 75% and the index is currently 68% off its peak. The index has made a bottom and bounced.

At today's prices, the world's accounted for real estate is priced about 70 Trillion Dollars below its peak value. Seventy Trillion Dollars sounds like a lot of money but it is not. It is only $10,700 per person. But how many of the 6.5 Billion people will buy while prices are low? Probably less than one half of one percent. The few who buy will net 99.95% of the gains on the way back up. One half of one percent of the people will share in 70 Trillion Dollars of gains. Will you get your share?

I suspect the wealthy pig farmer is buying. Ouch! Double ouch!