Thursday, December 04, 2008


Consumers and businesses are getting the break of a life time. Central governments around the world are pumping money into the world economy like never before. Earlier today, England and Sweden cut their interest rates, yesterday, it was Australia and China. The cut by England, of one full percent, took rates to levels not seen since 1951! There is talk that the FOMC will set a 4.5% target on 30 year home mortgages and start buying those next!

The 1% cut by England was a huge price decrease. When my wife finds a big discount advertised in the newspaper, she will often ask me a question like, "what is 25% off on top of 50% off"? The uneducated are sometimes fooled into thinking the discount is 75%. Of course, the second 25% discount is only a 12.5% discount on the original price and the monster discounts are on a few "come on" items. This is not what just happened in England. The price of money in England was cut and cut and cut from 5.75% down to 5% and then the bank got serious. On October 8 the bank cut from 5% to 4.5%, on November 6 the bank cut from 4.5% to 3%! and on December 4 the bank cut from 3% to 2%!. The total cut from 5.75% to 2% is a huge money sale. The total discount is 65% and it is on "every item in the store". In other words, the cost of any good or service in the entire country has been reduced by the lower cost of money.


Folks, it does not get any better than this! In the summer of 2007, I misread the situation and believed that we were only having a mid cycle correction. I cried wolf and lost my money and my credibility. Had Hank Paulson and Ben Bernanke used all the tools they had available in 2007 they could have flooded the banking system with money back then and avoided the worst of the real estate crisis. I made the mistake of believing that reelecting a republican to the White House was more important to the "old money crowd" than making a killing in stocks, bonds and real estate.

As a result, Hank proposed a new method of relief to banks. He chose a method that was a very public, drawn out and divisive. A program that had to be passed by congress. Over the past few weeks, central bankers have flooded banks with money by using "standard methodology". Sure, the FOMC has purchased an unusual array of paper but the methods being used were in place before the vote by congress. Only half of the money voted by congress has been used and it went to the selected few. The current public display over the potential auto bailout is accomplishing the same purpose as the banking bailouts. The investing public is confused, angry and not willing to participate. The public could not buy enough real estate or stocks from 2004 to 2007 when prices were high, but they have been scared into selling or holding off on purchases for the past 6 months while prices have been extremely low.

There is a huge sale on equity prices, equity in real estate is especially cheap and equity in stock prices has not been this cheap since at least 1982. In addition there is a huge sale on money. The present value of assets is discounted by the rates on long bonds and long bonds have not offered such low yields since the 1940's.

Today, you have the opportunity of a life time.

A friend wrote a week or two ago to ask if he should lock into a 30 year mortgage. I pointed out that mortgage rates do not normally hit bottom until 2 years after the end of real estate recessions. I noted that spreads between the 30 year mortgage rate and the 30 year bond are still extremely high but that spreads are gradually narrowing. Since I wrote him, the 30 year bond rate has fallen and fallen again and spreads are still too wide. My youngest daughter has a variable rate first mortgage that is down to 4%. Chances are good that I will recommend that she "lock-in" sometime in the months ahead, but not yet. In the mean time, she will enjoy the lower mortgage payment. She will also enjoy significant appreciation in the value of her house.

The payment on a $240,000 loan at 6% is $1,438. The payment on a $240,000 loan at 4% is $1,145. The difference of $293 per month is a 20% cut in the cost of the house. When pent up demand from the public surfaces, the value of a $300,000 house will jump by $60,000 quickly. Her home is within walking distance to a major medical center. The demand for homes in her area will grow for years to come.

Beach condos and houses, that had very little rental value this past summer when gasoline went for over $4 will see a massive increase in rental value by the summer of 2009 and again in 2010. The sale on money and gas is a powerful combination. Beach homes will bounce in value by surprising amounts.

Everything in the store is on sale! Some are much better bargains than others. The price of copper has fallen from around $4.25 per pound to $1.55 per pound. However, there is still little demand for new homes and little demand for new cars and little demand for other capital goods that contain copper. The price of copper was below 50 cents when this cycle got started and it will return to about that price before this cycle is over. The price of copper and the price of a 30 year home mortgage will not reach bottom until about 2 years after the recession is over.

Yesterday, Al expressed concern that the public will gradually return to their excessive use of energy. He is right but it will take a very long time. When CAFE standards were introduced way back when, the pressure to build more fuel efficient cars grew each year that the standards tightened. This time the standards jump in 2010 and then go up each year for many more years. The next bottom in gasoline prices will be after 2020. The advent of nuclear power assembly lines (I know of two so far) will also decrease the demand for petroleum for the next 20 years or more. Furthermore, this time, the only way to meet the CAFE standards is to veer away from reliance on the internal combustion engine. The key proven technology to date is the hybrid vehicle. While there is much talk about the all electric vehicle, battery performance and costs have a long way to go before all electrics are competitive. On the other hand, the latest hybrids have come close to being economically worth buying and relative costs continue to fall. Early adopters almost always pay too much but when new technology reaches economies of scale, the reason to buy switches from being the proud owner of the latest and greatest to practical, economic reasons. Al is right that the hybrid technology will give Americans the ability to stay in big comfortable cars but I still see a continuation of the 40 year suburb to city cycle. In about 30 years, there will be a surprising number of people who have opted to live in town or close to town. Many of them will commute without cranking a car engine.

Many an American is making the smart decision not to buy a new car right now. Why buy a new car when highly profitable assets are on sale for deep discounts. The person who puts $20,000 into a new car will own a 5 year old significantly outdated car in 5 years that is worth less than half of what he paid for it. On the other hand, the person who takes over the payments on a beach property, to help the seller keep a good credit rating, might put in $20,000 more than the rent over the next 5 years but then have ownership of a property that is producing positive cash flow; his equity might be over $200,000. In relative terms, the fellow with the 5 year old car has paid more than $200,000 for it.

Assets are on sale and money is on sale, at levels not seen in 50 or more years. Buy now!