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United States News Title: a catastrophe that will make the Great Depression look like a walk in the park “Reality is the leading cause of stress amongst those in touch with it.” - Jane Wagner While I’m now in my 23rd year in the financial arena, I have never seen such a discrepancy between what I perceive the future holds versus how the majority of Americans are living their lives and are seemingly unprepared for it. I don’t consider myself a pessimist but a realist. I believe America as we knew it just a couple of decades ago, has ceased to exist—only it’s politically incorrect to even suggest that. Cultural relativism and secularism is becoming the norm while the very fabric that held this country together for the first 200 years is being ripped apart. At the same time, our country’s financial health is rapidly deteriorating and little if anything is being done to prevent a catastrophe that will make the Great Depression look like a walk in the park. Don’t for one minute assume this is merely a stance due to my work within the mining and metals industry. I am in no means a “gold bug.” I’ve been bearish and avoided gold during my career. However, it has been a most appropriate investment vehicle in recent times and nothing appears on the horizon to change that. My “dark” outlook comes more from work with Americans as a financial counselor who specializes in an alternative to traditional financial planning (which is a process destined to fail and why so many Americans’ financial futures are in jeopardy). My work specializes in a family’s “cash flow” and the recent “flow” has been to “rob Peter to pay Paul” but Peter is tapped out. Much of my work is within the county in which I reside-Monmouth County. Money Magazine has ranked it among the top 20 wealthiest in the nation. From what I’ve seen in the last year or so, that so-called wealth has been built on a house of cards whose foundation is debt, debt and more debt. Throw in living way beyond their means, and you have a recipe for economic hardship unlike anything this generation has seen or could imagine. The fact is that just about everyone I find who has used their house as an ATM, has many possessions but owns outright very few of them. These people, who see the cup as half full despite drowning in a sea of red, find my analogy of the future to be either foolhardy or scar-mongering. This makes me even more confident of my outlook. Debts, Deficits and You The social, economic and political upheaval facing America will be unprecedented in American history. We’ve become the world’s biggest debt junkie and foreigners are our Pushers. Terrorism and energy crises will pale in comparison to the biggest crisis America has ever faced – the aging of America. Moreover, come this November, new all-time lows in political mud slinging will be everyday occurrences as the Democrats and Republicans make the Hatfields and McCoys look like a love fest. “A man in debt is so far a slave.” - Ralph Waldo Emerson Whether you believe the Holy Bible is the word of God or just another book, it’s full of advice on money and possessions (theologians say it’s the second most spoken about topic in the entire Bible). Throughout the new and old testaments, debt is spoken about often, yet nowhere can you find even a sentence that encourages one to become a debtor. The inspiring voice for the Bible must have seen America at the beginning of the 21st century. By believing Madison Avenue’s marketing extraordinaire that more money and possessions equals more happiness, Americans have been like hamsters on a wheel in a futile attempt to keep up with the Joneses. The seductiveness of borrowing is at an all-time high: n Credit-card debt alone spiked from about $250 billion in 1992 to $804 billion in 2005. n To appreciate how much homes became “ATM machines” for Americans, one has to only recognize that Americans borrowed just $11 billion in home equity in 1995, but by 2005 borrowing had soared to $243 billion. n U.S. spending has reached 107 percent of GDP, requiring an $800 billion annual infusion of foreign money and even higher levels of debt to prevent a slowdown. We can’t stabilize both growth and debt levels at the same time. One of them has to give- I believe it will be growth. Not since the Great Depression 70 years ago have Americans saved so little. In fact, we now have a negative savings rate. In Debt We Trust will soon replace In God We Trust. Uncle Sam: Hey Buddy, Can You Spare A Dime? This past July, an extraordinary paper was published that said a ballooning U.S. budget deficit and a pensions and welfare time bomb could send the U.S. into insolvency. The author of that paper said by some measures, the U.S. is already bankrupt. What makes this paper so extraordinary is the fact it was published by one of the key members of the country’s central bank- the Federal Reserve Bank of St. Louis. The author was Professor Laurence Kotlikoff. http://research.stlouisfed.org/publications/review/06/07/JulAug2006Review.pdf In the paper, Professor Kotlikoff said, “To Paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bare, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors?” According to his central analysis, “the US government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.” The professor noted, “The proper way to consider a country’s solvency is to examine the lifetime fiscal burdens facing current and future generations. If these burdens exceed the resources of those generations, get close to doing so, or simply get so high as to preclude their full collection, the country’s policy will be unsustainable and can constitute or lead to national bankruptcy.” So is the United States broke? No, but it’s already well down the road to insolvency. Thankfully, the federal government keeps two sets of books. The one you hear about promotes a better bottom line – a $318 billion deficit in 2005. The set the government doesn’t talk about is the audited financial statement produced by the government’s accountants following standard accounting rules. It showed a $760 billion deficit for 2005. And, if Social Security and Medicare were included, as the board that sets accounting rules is considering, the federal deficit would have been $3.5 trillion (giving new meaning to cooking the books). Does the U.S. Congress play by its own rules? When it comes to accounting, they have written their own rules (which would be illegal for a corporation to use because they ignore important costs such as growing expenses of retirement benefits for civil servants and military personnel). According to a USA TODAY analysis, the audited financial statement, prepared by the Treasury Department, revealed a federal government in far worse financial shape than official budget reports indicated. The “official deficit was just $729 billion but the analysis found the government ran a deficit of $2.9 trillion since 1997. Congress and the President get away with this because they don’t count the growing burden of future pensions and medical care for federal retirees and military personnel. To appreciate how massive these obligations alone are, if they were accounted for back in the late 1990s, the then budget surpluses would have actually been deficits. If standard accounting rules had been applied, the government would have reported nearly $40 trillion in losses since 1997 due to the deterioration of Social Security and Medicare. You see in the “real” world, generally accepted accounting principles require reporting financial burdens when they are incurred, not when they come due. Let me give you an example. XYZ Corporation decides to give a new drug benefit to its retirees. The company would be required to count the future cost of the program, in today’s dollars, as a business expense. If the benefit costs $ 1 billion in today’s dollars and retirees were expected to pay $200 million of the cost, XYZ would be required to report a reduction in net income of $800 million. Social Security, Pensions, Retirement and You I’ve written often about the coming aging crisis so I won’t spend any real time on it in this issue. However, in a related matter, I can never speak enough about the impact the baby boomer generation reaching retirement age is going to have on us … to the downside. Again, I draw your attention back to my other business where I work with families in an alternative to traditional financial planning. It’s truly amazing to meet these folks in their 5,000 square foot homes (after I passed two leased Lexus and/or Mercedes in the garage), discover they have incomes anywhere from $100,000 to $500,000 and have little or no retirement funds. But it should come as no shock as this Social Security study shows the extent to how little Americans have saved. The cottage industry built around financial institutions is very evident on television networks like CNBC-TV. You won’t have to wait long before you see a commercial showing some older person/couple living the good life thanks to ABC Company helping them. One of my favorite slides in a presentation I make called "Investing For Excellence" in my financial counseling business features the cover of FORTUNE MAGAZINE, and a couple floating in a tropical ocean. The headline reads, "Retire Rich." To start, who wants to retire “poor”? In just one picture frame, the magazine clearly suggests an older couple enjoying their “retirement.” Much of the financial services industry markets in the same fashion (if not more aggressively). Why then, are study after study showing most Americans have not saved enough to retire “comfortably?” The Employee Benefit Research Institute’s (based in Washington D.C.) annual retirement confidence survey this year found that about 68 percent of workers are confident about having adequate funds for a comfortable retirement, yet half of all workers said they’ve saved less than $25,000 toward retirement. Even among workers 55 and older. Almost half have saved less than $25,000. What I find most disturbing about America’s poor savings performance is it comes at a time when the nation’s employers are eliminating “defined benefit plans” – better known as pensions and are eliminating retiree health care coverage or asking retirees to contribute more for it. A study by the Center for Retirement Research at Boston College found that many Americans are doing far too little to prepare financially for retirement and are unaware of how their lives might change as a result. Ms. Alicia Munnell, the center’s director and one of the author’s of the research said, “Retirement is going to get tougher for people over time, and people don’t know it. Look at these numbers: they tell you that there’s trouble ahead.” FED Chairman Greenspan spent much of his last few months in office speaking out about the entitlement nightmare he envisioned if steps weren’t taken ASAP. Knowing his need to double-talk was behind him, he made numerous dire comments about the coming aging crisis, social security and the financial health of Americans. I believe it was no coincidence that he was doing so while Social Security and Medicare trustees were reporting further deterioration in the financial condition of the government’s two biggest benefit programs. These trustees now say the Social Security trust fund will be depleted by 2040 and that the Medicare hospital insurance trust fund will be depleted by 2018. The trustees, who include the head of the Social Security Administration and three members of the cabinet, said long-term growth rates for both programs were not “sustainable under current financial arrangements.” Former Treasury Secretary John Snow, chairman of the trustees group, said without action “the coming demographic bulge will drive federal spending to unprecedented levels” (thanks to 78 million baby boomers approaching retirement). I unfortunately half laugh, half cry, when I hear politicians talk about “lowering” taxes. How anyone can speak of an era of “lower taxes” knowing what America faces on the entitlement issue alone, is either stupid, ignorant or a liar (okay, I know I just gave the job description for a congressman). The math is simple: There’s an estimated $80 trillion in unfunded future entitlement liabilities, which is six times larger than the U.S. economy and 16 times the federal debt held by the public. It’s been estimated that future workers are going to have to pay tax rates from 55% to 80% over their lifetimes to fund these promises. Say hello to European socialism. Those who say the problem is not severe are banking on a much stronger U.S. economy over the next couple of decades and therefore future payments will come from a bigger pie. Warning – Goldilocks Economy believers are urged to stop reading now! Okay, I assume if you’re still with me, you are like me and watch much of CNBC-TV with the sound off. My friend, you don’t have to be an economist to know that the “promised” benefits are scheduled to rise at the rate of real wages increases. This means in the end, the only real answer to the entitlement nightmare is raising taxes, extending the age before one can receive benefits, or lowering and/or eliminating the benefits. Impossible you say? What do you think Congress will choose: to renege (default) on a T-Bond and effectively file “bankruptcy” or not pay an entitlement benefit, which is not a contractual government obligation (look up Flemming v. Nestor, a 1960 Supreme Court ruling that said there is no legal right to Social Security)? I believe (and advise in my counseling) that one of the key reasons the government has been allowing so many new ways for people to save for retirement is the knowledge that Social Security will one day cease to exist (or be so maligned that future retirees will surely never see a dime). Look for more bad news on our pension system as the Pension Benefit Guaranty Corporation – PBGC, is the Savings and Loans crisis of the 21st century. Parents tell little children fairytales like Goldilocks and the three bears. The “Don’t Worry, Be Happy” crowd on Wall Street tells investors fairytales like “Goldilocks’ economies” and the ever elusive “soft landing” (I would sooner believe the Vancouver Canucks winning the Stanley Cup-LOL). I wish the next time one of the many “soft-landing” preachers appear on CNBC-TV, one of those “softie” anchor personnel would actually ask when in the last 30 years did we ever have a soft-landing? The answer is that since the mid-1970s, almost every time the Fed had pushed rates higher, it has created a recession, a bear market or both. The notable exception came in 1994 and 1995, when the Fed raised rates without causing either, but bonds blew up and the Mexico Peso tanked. I have a recommendation if you’re betting the soft landing theory actually works this time: make sure your life insurance is fully paid and remove all sharp objects from your reach. “But all bubbles have a way of bursting or being deflated in the end.” - Barry Gibb The Bee Gees’ Barry Gibb wasn’t talking about market bubbles, but his commentary was indeed most appropriate for the 21st century real estate market. And the Bee Gees song, “Jive Talkin'”, certainly could describe those who claimed there was no bubble. It’s been my contention that Americans have been living way beyond their means by robbing Peter to pay Paul. They have managed to prolong the party (but the hangover will now be even greater and longer) by tapping the last ATM available to them- the equity in their homes. And just like the stories I heard in the late 1990s from then “market players” on how great the market was, I, like others, was hearing how real estate was the “can’t miss” investment for the new millennium (and of course Wall Street was there to lead them to the “promised land”). And just like the scores of people who “banked” on the Internet-led stock market bubble for their road to riches, sheep-like, overnight real estate mavens are now well on their way to being sheared. Home sales are plunging, inventories are bulging and the last missing ingredient to the total bust, falling prices, is knocking at the door (that’s not Avon calling). Remembering that if they tossed a real estate agent off the top of the empire State Building, the only thing you would hear them say on the way down is, “so far so good”, the next few years may prove its “not always a good time to buy real estate.” Housing starts are already down 20% from their January 2006 peak. The National Association of Home Builders recently reported that traffic of prospective buyers had tumbled to its lowest level since 1991 (a recession year). The cup is always half-full at the home of the “Don’t Worry, Be Happy” crowd. And at the height of the real estate bubble, they were out in full force (CNBC-TV is one of the favorite “stumping” grounds). The “come on in, the water’s fine” boys made many claims that are now being ripped apart in a dramatic housing slide: The Hype – Real estate was a safer and better bet than stocks. The huge price gains were not only going to hold, but additional appreciation rates better than money markets would continue. Reality – Prices actually have begun to fall where housing is most vulnerable, in the West and Northeast. Not earth-shattering yet, but realize that prices fell 2.1 percent in the Northeast from July of 2005 while at the same time rose around 3 percent nationwide. The Hype – CNBC-TV’s eternal optimistic economist has misfired on many fronts but one I’ve heard him harp on many times is going to bite him where the sun don’t shine. He states that so long as the jobs market is strong (and that’s highly questionable at this time), housing prices can’t fall (the theory is people doing well will want to buy and buy homes). Reality – This General in the always-positive army, fails to take into account how overextended the average American is. Most I see are barely able to make it each month, let alone now step up to bigger homes, cars, etc. And, the large increase in inventories will bring a halt to the consistently rising prices, effectively pulling the food chain down with it. The Hype – House values can only continue to rise in a low interest rate environment, or at worse, keep prices constant. Reality – The bubble grew because real interest rates fell sharply starting in 2001. After reaching historic lows, interest rates are all but certain to at least not go significantly lower than they were in 2005. This won’t allow most to borrow more at what they see as the same (or even lower) monthly payment, which allowed them to step up the food chain. The Hype – Home builders are much smarter than they were in past housing slumps. They won’t build lots of unsold “spec” homes. Reality – Just look at the actual operating results of some of the best known builders lately. Robert Toll, CEO of luxury home builder Toll Brothers, said recently that in his 40 years as a home builder, he has never seen a slump unfold like the current one. Can you spell U-G-L-Y? In the August 28, 2006 edition of U.S. News & World Report, an article ran entitled, “Housing Slump Threatens Jobs.” It began by noting how many Floridians had been “…hoping to cash in on the real estate gold rush but are now facing the cold reality of working in one of the cyclical businesses…” Home sales fell by one-third in Florida last quarter. I, along with other “bubble-busters,” have repeatedly warned how the housing industry had been the biggest single engine for job growth in the U.S., accounting for one-third of all new jobs added to the economy since the boom began several years ago. Add to that the fact that Americans withdrew over $600 billion in equity from their homes in 2005 alone (according to a Fed study) and the inability to see price growth and/or significant interest rate declines any time soon, and you can be assured that this stimulus to the economy will be missed. It will likely only add to more blood spilling in housing going forward (and let’s not forget the Bush tax cuts, which added to the consumption mania.) Just as we heard countless tens of thousands complain how they were caught up in the stock market bubble of the late 1990s, so shall we hear the anger from many Americans who took the bait of exotic mortgages (that gave new meaning to “creative financing”) in order to get into a new home and/or speculate in housing. One of the most riskiest and complicated home loan product ever created is the option adjustable rate mortgage (ARM). The “devilish” attraction of low minimum payments became among the single biggest lures the mortgage industry used to bring in the very people who could least afford the “downside” and allowed the bubble to get even bigger. Countless media reports hit the wires almost daily on how these “last to the food chain line” folks are now seeing their payment schedules ratcheted up substantially. With home prices leveling off, borrowers can’t count on rising equity to bail them out. They’re also “surprised” to find out they can’t refinance again without steep penalties. What’s really going to piss these folks off is when they learn their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan’s interest rates might not have been set by a bank but rather a hedgefund; and that they will soon (if not already) face either making higher payments or leaving their home. Another fact that will come out in time and be part of the “blame game” is according to the National Associated of Mortgage Brokers, 80% of all mortgage originations are now being dome by unregulated mortgage brokers (the pennystock brokers of the 21st century?). Other “hindsight” stories sure to come will be: n Fixed-rated Interest Only Loans – Here, too, a relatively low monthly payment in the early years is the attraction. While the borrower gets to enjoy their “castle” (and you would be surprised to find how little furniture is in the castle), they don’t build up any equity other than potential price appreciation. They can also be hit with sharply higher monthly payments once the interest-only period ends and the borrower is then obliged to repay the balance of the mortgage over the rest of the loan’s term. They will also discover the savings wasn’t that great since their loan typically had a higher interest rate than a 30-year fixed rate mortgage. n Piggyback loans - In recent years, many cash-strapped buyers opted for piggyback loans — a package of mortgages that includes a first lien at 80% of the property's selling price and a second lien for some portion of the remaining 20%, depending on how much money they could put in the deal. In the old days, 20% down was virtually mandatory and kept people who couldn’t afford the risk of lower home prices and/or higher interest rates out of the housing market, and that was a good thing. We all know where pigs eventually end up? n Inflated Appraisals – Critics inside and outside the appraisal business have been warning that appraisals have been unrealistically high. You see, the loan officer and mortgage broker often choose the appraiser. If a home is appraised at less than the buyer offered, the deal is likely to fall through. Inflated prices meant little during a rising housing market but now some sellers are getting hit with a reality blast. This leads to having to lower the asking price. Some, who were about to lock in new loan terms, are finding they have less equity then they assumed, thanks in part to the original inflated appraisal. You can even see lenders and mortgage investors taking a hit if the collateral backing the loan is worth less than expected. Things are going to have to get a lot worse, for a long time, before any light can be seen at the end of the real estate tunnel (any light now being touted is a freight train heading right at you). Real estate special note – Real estate as an asset class is now larger than the US equity market and approaching the scale of outstanding corporate bonds. Recognizing institutional clients such as builders and mortgage investors need to manage their exposure to real estate, the Chicago Mercantile Exchange (CME) has begun trading futures and options on an index tied to changes in residential real estate prices. It’s called the S&P CME Housing Futures and Options. Should you hedge your house against it? Probably not. But if you’re heavily invested in real estate, you may want to explore this further. IRAN / IRAQ: The Last Letters Are Different, But Both Spell Major TROUBLE One could write hundreds of pages describing the conflicts in the Middle East and still not come close to fully describing it. I won’t fool you or myself into thinking I’m an expert on the matter (there are enough highly paid think tanks in Washington for this). But I don’t think one needs to be a rocket scientist to figure out how America stands with regard to these conflicts. A Harris/Financial Times poll recently taken showed that Europeans see the US as a greater threat to global stability than either Iran or China. Five thousand people in the UK, France, Germany, Italy and Spain took part in the poll. European nations, once considered America’s strongest allies, are no longer a big fan of Uncle Sam. In fact, when it once only took two hands to count all the countries in the world who disliked Americans, you can now basically count Uncle Sam’s real friends on those same two hands. American Middle East policy, touted by the Bush Administration as on the threshold of democracy less than two years ago, is unraveling as we speak...
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