The False Bottomed Boat

The False Bottomed Boat

During a fire sale, most prices are well below their natural market levels. The credit meltdown crisis of 2008-9 is a fire sale on a biblical scale, but the principle still holds. Fire sale prices are below the bottom. I’m not qualified to make “buy recommendations” but it doesn’t take a genius to notice that GE stocks are so low and the company is so well positioned for an eventual robust recovery that its current stock price is well below the bottom. The price is a panic-driven number and most shareholders know it. They ain’t selling.

But there is one sector where the bottom has not yet been reached: There is no bottom yet in sight for real estate prices in overheated markets like those California, the Las Vegas area of Nevada and, truth be told, most of the upper reaches of the urban-suburban realm…everywhere that the bidding wars in home prices have driven out the teachers and cops from all the desirable neighborhoods.

As I said in an earlier post: It’s the incomes stupid!

The entire sub-prime, toxic-finance mess grew out of the misguided attempt to marry overpriced homes with people whose incomes could never support any reasonable payback arrangement, based on the pie-in-the-sky notion that, in a rising market, they could refinance forever and ever.

All of the efforts to shore up real estate prices are futile and ultimately harmful. We may well have a housing surplus. That means that prices must fall to unmanipulated market levels so that the properties can be resold to willing and able buyers. In parts of California, that means another 20% on average, more than 35% in many cases and more than 45% in many others. Why? “It’s the incomes, stupid!”

Now here is the dirty little secret that everybody knows, but won’t fully acknowledge. We would already be on the way to recovery if the damage had been confined to the banks and borrowers who went over the cliff (or should have been allowed to). This notion is called the compartmentalization of risk — apparently a novel idea for the current masters of finance and their political handlers. [Or is it? I suspect we’re talking about the masters of politics and their corrupt financial handlers.] In any case, the compartment has leaked all over the place.

Not all financial institutions were seriously compromised, but enough major players were badly damaged that two administrations in succession have panicked. The exiting Bush and entering Obama administrations were so freaked by the condition of several well-placed major financial players that they were willing to hide the extent of leakage. Their finance teams were and are apparently willing to bail out the incoming flood, endlessly it seems, so that we-the-people won’t lose confidence in our boat’s seaworthiness.

Here’s the other dirty little secret. The boat will not actually sink. Many financial institutions are quite sound. The Canadian banks, thanks to their traditionally conservative lending practices, are doing fine at the moment. And I know of local banks that are equally untainted by toxic lending.

A friend, a lawyer with an MBA who has made a number of astute real estate purchases over the years and is still doing quite well, thank you, recently wrote me in response to my last post, “Finding the Bottom.”

“The bottom in the real-estate market will be – When the rents, from a property, will cover the interest on the money invested in the property, plus the yearly Property Taxes, Plus the cost of maintaining the property. With interest rates dropping in the 4 to 5 % range and other costs dropping there is still room to go down. The other factor is the general lack of confidence in the government’s intrusion into the credit market, as when Obama also says, ‘I inherited this problem, things will get worse before they get better.’ No wonder investors take a wait-and-see attitude. With the President’s cover-my ass comment he has prophesized things to come. This can be a self-fulfilling prophesy, bringing on the ‘D’ word.”


Even normally restrained sources have succumbed to the panic atmosphere. For example, this report:

US Stocks Losses Mount; DJIA Off 214; Nasdaq Off 36

By Peter A. McKay

The Dow Jones Industrial Average was recently off about 214 points at 6848. The benchmark slid under 7000 on an intraday basis for the first time since Oct. 28, 1997. The Dow last closed below 7000 on May 1, 1997.

… Industrial giants like Alcoa and Caterpillar also fell, as did shares of General Electric which dropped nearly 8% to slide below $8 a share.

… Friday, the Dow industrials fell nearly 120 points, leaving the benchmark down 11.7% for February – its worst performance for the month since 1933, when it fell 15.6%.

“It’s like an unending nightmare,” said Kent Engelke, managing director at Capitol Securities Management in Glen Allen, VA.{BA2F0D30-92A8-426C-BD1F-26D0C0B84E4C}

Nightmare? No one was widely quoted using that word in the Carter recession…which was actually worse.
Many pundits are studying the Japanese experience, as we all should. In the New York Times piece quoted below, Japan’s experience, an 18 year slump, presents an appalling prospect….
Japan’s Slump Tests Faith in the Resilience of Stocks


Published: March 5, 2009

TOKYO — When Japan’s stock market took a nose dive in 1990, analysts told Shizuko Kitamura to take the long view, just invest consistently and stoically and wait for share prices to recover…[BUT] she is still waiting… 20 years after Japan’s stock market peaked, share prices are still less than 25 percent of their top values…..

The longest [US] bear market in a major economy occurred after the Wall Street crash of 1929. Stocks did not reach their pre-Depression levels until 1954. …Japan’s stock market has many problems that are particular to Japan. To name two: Japan took a decade to rid its banks of bad loans, hurting confidence in the market; and Japanese companies performed poorly on return on equity, a measure of how effectively shareholders’ money is used to develop a company or increase its profits…..


During the 08 campaign, when Senator McCain said that the fundamentals of the US economy were sound, he took flack because the financial sector’s fundamentals were like the late Aunt Tilly’s cancer-ridden body when metastases was discovered. That America’s situation differs from a terminal cancer patient is clear enough: Our underlying financial support infrastructure, however compromised, is well diversified.

There are plenty of healthy banks and lending institutions to fund a robust recovery as long as the private enterprises that will do the heavy lifting can see a clear path to profitability.

We are different than Japan in three important ways:

Americans still have the most robust, entrepreneurial capitalist culture in the world.
We still have abundant real natural and human resources, food production capability, engineering and scientific talent, even huge energy and mineral resources.
Americans are still the most optimistic culture on the planet.  These are the real fundamentals.  They will generate a true economic recovery the minute the financial conditions stabilize...provided government is part of the solution and not just another obstacle.


MY PREDICTION: Within 90 days of today, the individual, well managed enterprises that make/sell/.move the “real stuff” on which day-to-day commerce depends will link up with the “better mousetrap’ ideas and the surviving sound financial sources. This is where the real recovery will begin.

And this is where a whole set of government impediments, tolerable in a boom, are fully capable, during a fragile recovery, of aborting the new stirrings of economic life in utero.

What impediments, you ask? Think of tariffs, business licenses, building permits, mindless approval loops, excise taxes, sales taxes, capital gains and income taxes, land use barriers, fees, more fees, hearings, slow-moving bureaucrats, all standing in line, blocking the path to economic growth…. You get the idea. This is why successful businesses in the Third World have line-item budgets for bribes.

Collectively I call this the “Political Commerce Load Factor” (or PCL).

The existing PCL has been augmented by an environmental set. NOTE: the even more oppressive “evil carbon” set that is now in the queue could take down a prosperous economy. The PCL factors (extant and contemplated) are dangerous enough by themselves. But when combined with price/cost instabilities induced by haphazard political market manipulation (the unintended consequences of non-productive subsidies, leading to artificial supply scarcities and-spot inflation), the effect is the same as putting a heavy foot on the national carotid. Unchecked, political good intentions will consign us to Japan’s fate.

All of the practical and effective economic models of robust recovery, however they might differ in particulars, have these four common elements in common:

(1) Full transparency among lending institutions and borrowers.

(2) Failures and successes are punished and rewarded by the market without political interference.

(3) Credit liquidity.

(4) A long term political commitment to a business-friendly regulatory and taxation environment.

Our path to economic recovery really is that simple: I can make it even simpler: You stabilize finance, clear the path to entrepreneurial private development and get out of the way. I wish it could be made more complicated for the benefit of the policy wonks. But that’s the trouble with radical common sense.


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