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Dear ,
A Common Sense Look at the Fiscal Cliff
There has been a lot of talk going on about whether the Fiscal Cliff is a big deal or not. I'm not going to answer that question for you. What I am going to do is present some facts, ask some questions, and let you reach your own conclusions.
We want to cut through the BS and help you take a good old gut level common sense approach to this issue. Once you have reached your conclusion then you want to make sure that your investments are in line with your expectations. Make sense?
Let's go back to the start of the 2000s. We had a 3 year downturn in the stock market, 2000-2002. Three back to back to back losing years had not happened since the 70s. However even though the market had gone down, real estate was still going up year after year like crazy. So while people had lost money in the stock market they didn't feel especially poor because of the increased value of their homes. So what they couldn't afford to spend out of earnings and saving, they simply borrowed out of their homes in the form of home equity loans and spent the money that way. Sound familiar?
So as the decade progressed the mortgage lenders started coming up with ever more exotic mortgages. Option ARMs. Negative Amortization Loans. Sub Prime loans. No Doc loans. Interest Only loans. No Money Down loans, etc.
And How Did That Turn Out?
Not well did it? Looking back as we always do, we wonder how the banks could have been so stupid as to make those kinds of loans. We also wonder about how stupid those people were that took out those loans. "What morons!" we rage as a nation. But remember what the experts were saying at the time.
According to Wikipedia, here is what Alan Greenspan, former Fed Chairman, was saying at the time.
- American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.
- February 2004, in a speech praising the benefits of adjustable-rate mortgages.
- While local economies may experience significant price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversity.
- Without calling the overall national issue a bubble, it's pretty clear that it's an unsustainable underlying pattern.
- May 2005, Greenspan said in a speech that he did not believe there was a national housing bubble similar to the bubble in the stock market. But he said there was "froth" in housing and he called the pace of housing price increases unsustainable.
- A decline in the national housing price level would need to be substantial to trigger a significant rise in foreclosures, because the vast majority of homeowners have built up substantial equity in their homes despite large mortgage-market financed withdrawals of home equity in recent years.
- July 2005, in testimony to the House Financial Services Committee.
- [There are] signs of froth in some local markets where home prices seem to have risen to unsustainable levels.
- July 2005, in testimony to the House Financial Services Committee.
- I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk. But I believed then, as now, that the benefits of broadened home ownership are worth the risk.
- September 2007, Greenspan's memoir The Age of Turbulence: Adventures in the New World.
- I really didn't get it until very late in 2005 and 2006.
Here are some quotes from current Fed Chairman Ben Bernanke during that same time period.
7/1/05 - Interview with CNBC
"We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's gonna drive the economy too far from its full employment path, though."
10/20/05 - Testimony before the Joint Economic Committee
"House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals."
2/15/06 - Hearing before the Committee on Financial Services
"Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise."
2/15/07 - Semiannual Monetary Policy Report to the Congress
"Despite the ongoing adjustments in the housing sector, overall economic prospects for households remain good. Household finances appear generally solid, and delinquency rates on most types of consumer loans and residential mortgages remain low."
3/28/07 - Testimony before the Joint Economic Committee
"At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency."
5/17/07 - At the Federal Reserve Bank of Chicago's 43rd Annual Conference on Bank Structure and Competition
"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable."
8/31/07 - At the Federal Reserve Bank of Kansas City's Economic Symposium
"It is not the responsibility of the Federal Reserve-nor would it be appropriate-to protect lenders and investors from the consequences of their financial decisions."
6/10/08 - Boston Federal Reserve's 52nd annual economic conference
"The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."
(Bernanke said this when we had already been in a recession for 6 months. When he said this the Dow was stillover 12,280. The Dow went on to lose another 45%+ after he made this statement)
OK So What's My Point?
I have two common sense points to make here.
Common Sense Point #1
If we see the same type of pattern, the same type of nonsense developing again, what type of outcome should we expect this time? According to BrainyQuote.com it was Albert Einstein who said "the definition of insanity is doing the same thing over and over again and expecting different results".
Common Sense Point #2
This is related to number 1. If the experts are again telling us not to worry, it's no big deal, should we believe them?
But Are They Doing the Same Things?
They are and they aren't. Let me explain.
They aren't from the standpoint of homeowners taking the equity out of their homes to spend the money etc. That party is over. Over the last five years, on an individual level, people have had to learn to live within their means. However, governments have yet to learn that lesson.
While the consumer has had to severely pull back on their deficit spending, governments are just getting started. They are finding more and more creative ways to borrow money. Now is "creative" just another way of saying exotic like the loans that brought us down just 5 years ago? I'll let you decide. Take a look.
 | | (Click to read article) |
Here is just one of the examples in the article.
"Perhaps the best example of the CAB issue is suburban San Diego's Poway Unified School District, which borrowed a little more than $100 million. But "debt service will be almost $1 billion," Lockyer says. "So, over nine times amount of the borrowing. There are worse ones, but that's pretty bad.""
BTW, the Lockyer referred to in the paragraph above is California State Treasurer Bill Lockyer. Here is what he has to say about these types of loans.
""It's the school district equivalent of a payday loan or a balloon payment that you might obligate yourself for," Lockyer says."
The Final Common Sense Question
Here it is folks, the final question. The examples that I gave you above are far from unusual. If we have states and municipalities taking out crazy loans just like the consumers did before them, do you really expect this to turn out any better than it did the last time?
Then Plan Accordingly
Whatever your answer to that question is, you need to plan accordingly. If you aren't sure how to do that, feel free to give us a call or send us an email.
preames@reamesfinancial.com
BTW!
Last week we got one of the best responses we have ever receieved to one of our columns. If you haven't read it yet you can find it here.
Until next week , Protect Your Wealth!
Sincerely,
  
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