What are the interest rates going to be in 5 years? What are real estate prices going to be in 5 years? What is unemployment going to be 5 years from now? The answer to these questions is "Who knows?". These are exactly the questions that institutional Note Buyers and investors are asking.

In this chaotic economic environment, it is time we revisit why notes are discounted. "The time value of money", you say. Not quite. Notes are discounted because of the risks a Note Buyer incurs when purchasing a note. These are really the same risks all investors take. In the January 2009 Issue of THE NOTE PROFESSOR NEWSLETTER. we discussed the different risks associated with purchasing notes.

Without going into an explanation of all the risks involved in purchasing a note, let's examine the three questions above as applied to the risks a Note Buyer takes on:

Interest Rate Risk: What is the possibility we will have inflation, like we experienced in the 70s and 80s? This question is rhetorical, but none the less the possibility that an institution invests in a long term note at a yield of say 10% and interest rates rise to 14% is realistic, is it not?

Collateral Devaluation and Deterioration: What is the possibility that real estate prices will continue to drop should we go deeper into an economic downturn? Is this not also a realistic concern?

Repayment Risk: What is the possibility that unemployment will continue to rise, which results in Note Buyers having to foreclose because their payors have no income. Add to this the prospect the property has declined in value.

If you follow my Economic Observation article, you realize that all of the above are not only possible, but probable. If you are a bank or pension fund which purchases owner financed notes, how do you overcome these risks.

The answer is Partials. I was talking to a major institutional fund last week. She told me they are also concerned about the economy and the risks they would be taking. As a result, they are going to start making partial offers their main Note Buying vehicle. Buying partials is becoming the norm for institutional Note Buyers. Why? Because by purchasing a partial of the note, Note Buyers are reducing their risk and exposure in order to make purchasing a note more attractive. Selling your note on a partial can be very advantageous to you also.

For example, say you sold your house for $110,000 with $10,000 and carried a note of $100,000 for 30 years with payments of $733.76. If a Note Buyer wanted to purchase this note at a 60% ITV (Investment to Value), the Note Buyer would offer you $66,000. This is a hefty discount. Why are they offering such a low price; to take into account the possibility the property will be devalued in the coming years due to more economic downturn. This is very real concern; wouldn't you agree?

Now let's take this same note, where the Note Buyer offers to pay $35,000 for the right to receive the next 72 payments. (This BTW is a discount of only $6,824). At the end of 72 months, the note reverts back to you, with a balance of $93,825. Is this not the best of both worlds for the Note Buyer and you, the note seller? You will receive a lump sum cash, and not take a big hickie on the discount. This is not to mention that at the end of 72 months, you have the option to sell another 72 months, and still have a balance of $83,862 at the end of the second 72 month period. At the same time the Note Buyer has reduced his/her exposure to $35,000. Should the note go into default and real estate prices take more of a nose dive, the Note Buyer will be protected.

Are there problems with partials, YES. However, the problems are not insurmountable. I will cover these problems and/or solutions in another issue. The purpose of this issue is to alert all who have notes they might want to sell to be prepared to be offered "low ball" offers or partials. The reason behind both offers is to reduce the Note Buyer's risk of default and collateral deterioration in today's market.

If you have not read Spencer Johnson's "Who Moved My Cheese" , I strongly suggest you do so. I still have note sellers contacting me about selling their notes, only to become angry when offers are presented to them. The common response is "I was selling notes to Note One a few years ago and getting 95% of face value." I wish this were still the case. But the fact of the matter is Someone Moved the Cheese; this is not a few years ago, and Note One is no longer in business. We must deal with the present; and not stay stuck in the past.

There are steps to make your note more valuable, even if selling a partial. In October 2003 I wrote a series of articles on "How to Structure a Note to Sell at Closing". Although selling your note at closing is all but gone by the wayside, there are still prudent procedures to take no matter if you are creating a note to sell or to keep.

Summary: If you are contemplating selling your note, be prepared to entertain the concept of a partial, if you want to sell your note, especially if you are getting less than 10% down. Reality has changed, and Note Buyers are not the Green Meanies for taking into account the risks of property devaluation, economic downturn, or a rise in interest rates. They are merely realizing the "Cheese Has Been Moved" and are moving to where the cheese is now, not dwelling on where it was.

We can all learn from Haw's message to Hem from "Who Moved My Cheese".

1.Change Happens
--they keep moving the cheese
2.Anticipate Change
--get ready for the cheese to move
3.Monitor Change
--smell the cheese often so you know when it is getting old
4.Adapt To Change Quickly
--the quicker you let go of old cheese, the sooner you can enjoy new cheese
5.Change
--move with the cheese
6.Enjoy Change!
--savor the adventure and enjoy the taste of new cheese!
7.Be Ready To Change Quickly And Enjoy It Again
--they keep moving the cheese

If you have a note to sell, or know of someone who wants to sell a note, CONTACT ME Remember, I pay referral fees.

Be sure to contact THE PROFESSOR with questions or comments. This is where I get my topics.

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Current ARCHIVES (end of 2009-2011)

Demand: The want or desire to possess a good or service with the necessary goods, services, or financial instruments necessary to make a legal transaction for those goods or services.

Tom Vilsack's, the Secretary of Agriculture, statement that the Food Stamp Program is an economic stimulus and creates jobs is another example of how false economic principles seem to be common place among our politicians and bureaucrats of both parties. However, Vilsack's statement contains so many flaws, it is worth examining.

Vilsack and all politicans would do well to read Frederic Bastiat's "What Is Seen and What Is Not Seen", especially the "Broken Window Fallacy". (The one on "TAXES" would not hurt them either)

I will only briefly mention that Vilsack's assertion that for every dollar spent on food stamps (Vilsack calls it "benefits") generates a $1.84 in the economy. Without going into long specifics, suffice it to say, BOVINE SCATOLOGY. If you believe this, then you believe that something is created out of nothing. Use common sense. I have a dollar and I buy something from you. How much do you have? Is it more than a dollar? Nope. Think of it this way; If I have an apple, and trade you for an orange, do you have an "apple and half". Get the point? It makes no difference who has the dollar or who has the apple, it is still only one dollar or one apple.

That aside, let's examine his assertion that food stamps are a "stimulus" from a common sense approach.

Can we agree that consumption cannot exceed production? If this is true, consuming without producing is unsustainable, is it not? With these axioms in mind, let's move forward. Here are more of Vilsack's assertions: "If people are able to buy a little more in the grocery store, someone has to stock it, package it, shelve it, process it, ship it. All of those are jobs. It's the most direct stimulus you can get in the economy during these tough times."

This is a common belief system coming from both political parties. Now let's apply Bastiat's advice to Vilsack's assertions. We readily see the food stamp recipient buying more groceries. And yes, someone does have to package it, shelve it, and process it, and ship it. This is what is seen.

What is not seen is the money taken out of the pockets of individuals who provided the funds for the food stamp recipient. The same money the food stamp recipient received to purchase food will not be available to the individuals that were taxed in order to support the food stamp program. These tax payers will not be able to use their money to purchase food or other goods and services. While the food stamp recipient's grocery store benefited, it was at the expense of the merchants of the tax payer. The tax payer's grocery store, stocker, shipper etc were penalized, were they not? Why; because the money extracted from the tax payer and transferred to the food stamp recipient was not available for the tax payer to spend at his/her local merchant. In other words, no wealth was created but rather wealth was only redistributed from the tax payer's merchants to the food stamp recipient's merchant. The transferring and shifting of money is what politicians call "stimulus". Like all wealth redistribution programs, politicians will point to those who benefit, but will completely ignore the fact that one group benefited at the expense of others. This is the essence of all the "stimulus" packages. The false economic logic is government spending "creates demand". See my March 2011 newsletter for a more complete explanation.

Demand is not created by taking wealth from one group of people, and transferring it to another group. As the definition above indicates, demand requires production of goods and services in order to trade them for other goods and services. For more on demand, my February 2011 newsletter has an excellent explanation.

In reality, we produce in order to consume do we not? Why else go to work to produce except to consume food, shelter, clothing and luxuries. Politicians and Keynesian economic theorists believe that "stimulating" consumption through wealth redistribution is the same as producing. However, consuming without producing is unsustainable as Hoover and FDR discovered during the Great Depression. They also believed government spending would create "demand" and therefore jobs. Neither realized that taking money out of one person's pocket and putting it into another person's pocket is not the same as creating wealth. Why? NO WEALTH WAS CREATED, ONLY TRANSFERRED. As a result, the Great Depression lasted for over a decade. Government spending programs did not work then, and it will not work now.

Why will "stimulus packages" not work, no matter which party is in power? Because consumption cannot exceed production. More importantly, production must precede consumption. Food stamps and all government stimulus packages are a form of consuming without producing. It is wealth redistribution; no more, no less. Redistributing wealth; then pointing to the ones who benefit, while ignoring the tax payers who are deprived of their earnings is paramount to bad economics. Is this not what Vilsack has done?

It might be pointed out that in today's economic situation, the affects of consuming without producing CAN be readily seen; it is seen in the unemployment rate and the downturn in the economy. Even with this evidence available, we hear from our Secretary of Agriculture that redistributing wealth is a stimulus. During Bush's administration we heard similar statements. Until politicians from both sides realize that consumption cannot exceed production, as well as wealth redistribution is neither moral nor sustainable, do not look for a recovery. It needs repeating: CONSUMPTION CANNOT EXCEED PRODUCTION.

When wealth redistribution is deemed to be moral, the only thing left to do in a democracy is to vote to determine who is to be plundered and who is to receive the plunder. Ancient Rome had a very similar dilemma we face today; government spending and wealth redistribution drove the once mighty republic unto collapse. Unless an important current event comes up between now and my next issue, we will discuss ancient Rome from an economic point of view.

If you have questions, CONTACT ME. I will address them in future issues.

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