Millions of consumers have fallen out of favor with the credit scoring gods. Some lost their jobs or were just overwhelmed by mounting debt. Others got caught up in the real estate bubble or had major medical bills. Whatever the reason, the rising number of foreclosures, short sales, late credit card payments and the ultimate credit sin — bankruptcies — have left black marks on credit reports most everywhere.

So what can these people do to repair their credit?

The simple answer is to focus on the information that is used to generate the all-powerful FICO score — the measure used most frequently by traditional lenders to determine creditworthiness. Its scale runs from 300 points to 850 points; the higher the score, the better your credit standing. “FICO is still the 500-pound gorilla,” said John Ulzheimer, president of consumer education at SmartCredit.com. “In 2011, the best way to get credit from the mainstream lenders is to have a good FICO score.”

Consumers can hope that the banks will eventually consider alternatives to the traditional FICO score, which was developed by Fair Isaac Corporation and has been in wide use for about two decades. After all, as banks regain their appetite for lending, they will be looking for ways to differentiate between borrowers with the same scores, some of whom are temporarily struggling and others who chronically have trouble with money.

For now, though, the FICO score reigns. The best antidote to a poor score is time. Still, there are a half dozen ways to speed the process, or, at the least, avoid even more credit trouble.

What to Do

ASSESS YOUR SITUATION Before you even start to think about rehabilitating your credit, make sure that you can pay your bills on time and not do any more harm. If keeping up with your credit card bills is still an issue, then call the issuer, explain your situation and try to negotiate payments you can afford. Ask the issuer how that will be reported to the major three credit bureaus: Not paid as agreed, which can hurt your score? Or will the new terms say that you are now paying as agreed?

“You have to get in writing that this is what they agreed to do,” said Mechel Glass, director of education at CredAbility, a nonprofit consumer credit counseling agency. Ditto for other providers, like utility companies.

Then, assess all the damage by getting a free copy of your credit report from each of the three major credit reporting bureaus through annualcreditreport.com. Each of the major credit bureaus — Equifax, Experian and TransUnion — generate their own FICO scores based on the data they collect. Two versions of your FICO score are also available for $19.95 each, through myFico.com.

How far your credit score has fallen will depend on where it started, as well as the frequency and severity of your credit mistakes. If you had almost perfect credit, but because of the loss of a job your credit card bills ended up at a collection agency, you can expect to lose anywhere from 80 to 150 points from your FICO score. A short sale or foreclosure? Both, Mr. Ulzheimer said, “would turn a FICO 790 into a FICO 590 overnight.”

CLEAN UP YOUR SCORE Start with the low-hanging fruit. Let’s say you were late paying a bill from a company that no longer exists, or a bank that has since merged with a larger institution. If the credit reporting bureaus cannot verify the accuracy of that black mark, they are required to remove it. “Not only does it have to be correct, but it has to be verifiable,” Mr. Ulzheimer said.

Next, focus on paying off the loans — namely, credit cards — that will help give your score the most lift. Paying off a mortgage, a student loan or other installment debts, like car loans, feels good but that won’t necessarily do much for your credit score.

You also want to get your so-called debt utilization rate into good shape. FICO considers how the total amount of debt on each of your credit cards compares with your total available credit. The credit score “elite” — that is, people with FICO scores above 760 — typically don’t have debts that exceed 7 percent of their available credit. But if you are at 50 percent and can get the rate down to 30 percent, that will help.

LEAVE A NOTE Because prospective employers may pull a copy of your credit report, consider adding the equivalent of a doctor’s note to each of your reports explaining your hardship, like a job loss. All three major credit bureaus allow you to add a brief statement through their Web sites. FICO doesn’t consider these statements when formulating scores, however, so don’t expect it to sway lenders.

GET SECURED CARDS It will obviously be hard to get a traditional credit card when you have a poor credit history. Secured cards, if used strategically, can help nurse your credit back to health more quickly. These cards require you to put a set amount of money in a bank account, say $250 or $500, which is used as collateral. And the amount of available credit should be equivalent to the amount on deposit.

“What is the most predictive and powerful in your score are the things you’ve done most recently,” Mr. Ulzheimer said. “That cuts both ways. If you add a secured card and you pay it religiously and the balance is low, it will help your score a lot more quickly than if you do nothing.”

But read the fine print before signing up. Consumer advocates said some unscrupulous card issuers have charged the security deposit to the card. And be sure the issuer reports your payment information to the big three credit bureaus, since not all do.

Curtis Arnold, the founder of CardRatings.com, recommended two cards, both of which report payments to the big three: the Orchard Bank Secured MasterCard, which has an attractive interest rate of 7.9 percent, waives the annual fee in the first year and charges a moderate $35 annually thereafter. He also likes the Citi Secured MasterCard, largely because it offers an interest rate on the security deposit equivalent to an 18-month certificate of deposit, which he says is an industry first.

TALK TO A CREDIT UNION These institutions may be more willing to work with members who have checkered histories. Their offerings vary, but they may be more likely to consider alternative credit scores, offer free credit counseling or have products tailored for people with poor credit histories. “Certainly, many credit unions have credit builder or rebuilder loans, often structured as a loan with a built-in savings component so that a person gradually builds up funds that can act as partial collateral,” said Clifford Rosenthal, the president of the National Federation of Community Development Credit Unions, a trade association representing credit unions in low- and moderate-income areas.

ALTERNATIVE VERIFICATION There are other credit reporting agencies and services that — for a monthly fee, and sometimes a hefty one — will collect your payment history from sources that aren’t included in your traditional credit report or FICO score. At this point, however, most mainstream lenders base their decisions on the big three bureaus’ reports and FICO scores. So you’re better off saving your money. “All of those companies say they will report your accounts to a credit bureau, and they may be doing that,” Mr. Ulzheimer said. “But if it is not the big three, then who cares?”

This could change, of course, as banks become more willing to lend and potentially open to using other means to identify promising borrowers. Lenders may begin to consider rental payment histories, for instance. Or they may be willing to look at alternative credit scores that incorporate payment information that doesn’t show up on traditional credit reports.

Or perhaps one lender will permit so-called shoe box credit: Did you know that if you walk into a lender with a box stuffed with receipts proving that you paid your cable bill, for instance, that they are required to consider it? They aren’t obliged to give you a loan, but the regulation says they must consider the information.

What to Avoid

CREDIT REPAIR OFFERS You may have seen the advertisements for credit repair companies on the Web. “We really tell our clients to stay away,” said Ms. Glass, of CredAbility. One re-emerging scam, she says, involves companies that claim they can clean up your credit. Some companies manage to do this for a limited time by disputing all of your accounts, sending letters to the bureaus claiming the accounts aren’t valid. But after the credit bureaus validate the accounts and debts, they reappear on your report and your score will plummet again.

Legitimate credit repair companies exist, and they can assist in disputes. But there’s nothing they can do that you can’t do yourself at little cost. Besides, these companies often besiege the bureaus with letters, and the bureaus are allowed to ignore what they believe are frivolous disputes. Be wary of companies that do not disclose in writing that you can do these tasks free on your own, that guarantee results or that try to charge you before they perform any services.

CERTAIN CARDS Despite the tighter credit environment, Chi Chi Wu, a staff lawyer at the National Consumer Law Center, said the center was still receiving complaints about credit cards aimed at people with poor credit histories.

“These cards are pitched as a way to build credit, but with these kind of steep fees and high interest rates, there is a good chance they will hurt,” she said.

Quote of the week… “I’ve been blamed for just about everything that’s wrong with this country.”–Elvis Presley

We who work in the real estate and mortgage industries know exactly how Elvis felt. The same people who unfairly blamed us totally for the recession now look to us alone for signs the economic recovery has taken hold. They might want to remember the health of the housing market is directly dependent on the health of the jobs market, which is not under our control. In any case, everyone felt better last week when January Housing Starts were UP a surprising 14.6%. Even though starts are down 2.6% from a year ago, this still shows builders are more hopeful going forward. The boost came from multi-family units, though single-family starts were off a mere 1% for the month.

A lot of home buying activity is due to the affordability now out there. The National Association of Home Builders (NAHB) and a major bank reported their index shows home affordability in Q4 of 2010 at its highest level in 20 years. Their measure found that 73.9% of the new and existing homes sold in Q4 were affordable to families making the national median income of $64,400.

Business tip of the week… A big part of success is not giving up. Studies show that one trait shared by all very successful people is perseverance. They are persistent, determined, tenacious, pursuing a goal far beyond the point where the average person gets discouraged.

The Labor Department reported that 36,000 jobs were created in January, a much lower number than anticipated. However, there were upward revisions to both November and December, which added another 40,000 jobs than previously reported.

But that’s not the only bit of good news in the report. The unemployment rate fell to 9%, down from 9.4% last month, rather than increasing as had been expected. In addition, the U6 unemployment report, which includes job seekers who haven’t actively looked for a job recently and those who have accepted part-time employment for economic reasons, fell to 16.1%, from the previous month of 16.7% and reflects the lowest level since April 2009.

So what does all of this mean when it comes to home loan rates?

It’s important to remember two things:

• First, the Fed’s goals for their current Quantitative Easing policy (QE2) where $600 billion is being injected into the economy are to: (1) boost stock prices, (2) create inflation, and (3) lower the unemployment rate.
• Second, while these goals are designed to stimulate our economy and keep our recovery moving forward, they are also unfriendly to bonds and home loan rates.

In recent weeks, we’ve seen evidence of all three goals: stocks have been improving, the unemployment rate has declined, and we’ve seen an increase in global unrest of late, not just in Egypt, but in other parts of the world as well and much of this centers around runaway inflation in commodities and food. 

The 4.5% fixed-rate mortgage is here, although more than 14 months late. That magic number, or a close approximation, was reached recently, when Freddie Mac reported a 30-year rate of 4.54%. The possibility first arose in early 2009, when the government began mass-purchasing mortgages from Fannie Mae and Freddie Mac to prop up housing. Just about everyone predicted the rates would hit what builders and real estate agents call a “sweet spot” in a few months, and the housing recovery would begin, especially if consumer confidence had recovered to prerecession levels as well.

“What gets people buying again?” asked mortgage broker Peter Buchsbaum of Arlington Capital Mortgage in Horsham, Pa. “The answer is confidence—confidence in the value not falling and confidence they’ll still have a job.”

Even if behind schedule, the 4.5% rate has arrived, but in an environment that buyers perceive as anything but inviting.

Consumer confidence fell again in July, and why? Jobs and sagging real estate values.

“People will start buying houses again when they feel securely employed, house prices are rising, and they can make low down payments,” Bankrate.com columnist Holden Lewis said. “I don’t see any of those conditions coming anytime soon, at least in most parts of the country,” Lewis said. “Job security is the most important factor.”

Suburban homebuilder Marshal Granor said that “when we went under 6 percent, I was amazed and excited, but 4.5 percent artificially increases affordability. If rates start to climb, it will severely dampen already-spotty sales.”

Moody’s Economy.com chief economist Mark Zandi concurs. “The key to more homebuying is more jobs,” he said. “Once job growth kicks in earnestly, household growth will ramp up, and so will demand.”

Zandi added that despite these “extraordinarily low rates,” many prospective buyers have little savings for a down payment and tattered credit scores.” The securely employed appear to be nibbling at the bait, however.

“There’s a new group of buyers just entering the market because of the low rates,” said Art Herling, regional vice president of Long & Foster Real Estate, although the weather is keeping them “from totally getting into the buying mood.”

Buchsbaum also reports “a greater influx of buyers than past summers.”

Philadelphia Realtor Fred Glick compared the economy to a driver with his “feet on both the accelerator and the brake at the same time.”

“Until the jobs are produced, the banks start lending, and the underwriting guidelines start to make sense, we’ll be caught in this conundrum,” Glick said.

What about home prices?

Although the Case-Shiller Home Price Index rose again in May, economists believe that prices nationally will drop 6-8% more through the end of the year.

May’s increase, economists say, is attributable to the federal tax credit that expired April 30, and to seasonal buying patterns that typically boost prices.

The indexes are three-month moving averages, “so May’s readings reflect transactions in 20 markets that closed in March, April and May,” IHS Global Insight economist Patrick Newport said. With the credit gone, “we expect them to rise for two months, then start to decline,” with recovery in 2011.

That means a lot of buyers will remain on the sidelines until prices level off completely. The lowest fixed interest rates in 50 years won’t be enough to draw them in.

“Many people are bottom-fishing,” Herling said.

On the other hand, “People are starting to view houses as places to live and build equity over time, not financial assets where they can make a killing,” said economist Joel L. Naroff of Holland, Pa. If that is the case, demand for housing would rise much more moderately. “Add to that the lack of equity and the difficulty in qualifying for a mortgage, and the outlook for sales is not great,” Naroff said.

Interest rates are rock-bottom because the economy is rock-bottom. As more investors shift their money out of a volatile stock market and to the safety of Treasurys, rates will drop further, at least in theory.

Assuming “the debt crisis abates and the economy doesn’t double-dip, both of which seem more than likely,” Zandi expects rates to close in on 5% by year’s end and over 6% next year.

“I wouldn’t bet my mortgage payment on rates remaining this low for a long time,” Lewis said. “If I were refinancing, I would lock now instead of floating in hopes of rates falling further. I think there’s a greater possibility of rates rising than falling.”

Some analysts feel the homebuyer tax credits artificially boosted the housing market by pushing forward home sales that would have happened later. Others feel most buyers would have bought anyway. In any case, there’s now concern about a coming drop in sales. Well, June sales figures should still benefit from activity spurred on by the tax credits. And tax credit sales should even help monthly reports through September, now that buyers in contract on April 30 have been given until September 30 to close.

Nonetheless, we ought to keep an eye on monthly Pending Home Sales, which track signed contracts that turn into sales a few months out. Even though we may have a sales dip after the tax credit, the fact remains that near historic low mortgage interest rates are getting people back into the market. These rates, combined with today’s prices, have made homes more affordable than they’ve been in years, letting many buyers move up to better neighborhoods with more choices.

But buyers shouldn’t wait. The National Association of Realtors chief economist sees the median home price rising nationally 2% to 3% this year. The NAR’s CEO feels sales will pick up in the fall and that the down-cycle has run its course. The chief economist at Moody’s Economy.com also believes the housing crash is nearly over. And we all know mortgage rates won’t stay at their current levels indefinitely. In other words, this could be one of the best times to buy a home in decades.

MortgageOrb.com, Sunday 02 May 2010 – 22:00:02

Fannie Maehas announced new standards for the purchase and securitization of adjustable-rate mortgage (ARM) products. The company says it is changing its eligibility criteria to protect consumers from potentially dramatic payment increases and to help ensure that borrowers who hold these types of mortgages can sustain them beyond the initial interest-rate period.

“Our goal is to make sure consumers can sustain their mortgages and remain in their homes over the long term, while helping our lender partners offer a range of mortgage products for qualified borrowers,”says Marianne Sullivan, senior vice president of single-family credit policy and risk management at Fannie Mae. “These policy changes reflect our intention to continue providing liquidity to different market segments by ensuring that support for ARM products remains in appropriate circumstances.”

For ARMs with initial periods of five years or less, Fannie Mae will require that borrowers be qualified at the greater of the note rate plus 2% or the fully indexed rate (i.e., index plus margin).

Fannie Mae will continue to make available an interest-only loan product, but will change its qualification criteria. The maximum loan-to-value ratio cannot exceed 70%, the borrower’s credit score must be 720 or higher and the borrower must have a minimum of 24 months of liquid asset reserves remaining after loan closing.

Balloon mortgages, which typically offer lower initial interest rates but leave a significant balance due at maturity, will no longer be eligible, except with special approval from Fannie Mae.

All loans not meeting the new guidelines must be purchased as whole loans on or before Aug. 31, or delivered into mortgage-backed security pools with issue dates on or before Aug. 1, the agency says.

SOURCE: Fannie Mae

© 2007 Zackin Publications, All Rights Reserved

Banks and investment banks played with the US economy and profited mightily at the expense of America on the whole.  Regardless if you were conservative and never played in the housing boom, you were used by the banking industry and are now worse off for it. 

On Saturday the Reno Gazette-Journal ran a front page story “Rescue may miss many who need it”. First, let me say in essence that the paper is correct.  Bank of America is recognizing that 45,000 very sick homeowners are going to lose their homes.  The real issue is that those 45,000 are the nearly dead and it is the 16 million homes underwater that need to be focused on and until all banks step up to the plate, housing is flying south for a very long and bitter winter. 

I want to acknowledge just how difficult acting on the problem really is.  The banks have woven a web of curious networks between insurers, investors, servicers and others with protections, profits and liabilities that can be hard to understand.  Despite the problems we are facing, some are profiting from the chaos, not least the very assorted banks and investment banks that brought on the disaster to the American people.

On one hand the commonly held belief, still held by many, is to let the cleansing process work itself out.  Many homeowners that never bought during the boom, or have free and clear homes, are heard to shout this sentiment out and cast all that are in trouble as dilatants that have received their just rewards for not being smart like them.   Without a question in 2006-2007 tens of thousands of people lost their homes that should never have ever received a loan.  But now we are talking about 2010.   We are talking about people that bought homes in 2007, after the “bubble burst”, fully qualified for a home, put 20% cash down and today are underwater!  We are also talking about homeowners that purchased homes in 2001, well before the much talked about “bubble” and put 20% cash down and today have homes that are underwater.  Our market has rolled back well beyond the stupidity of 2003-2006, back to 1998-1999 values.

In the Saturday RGJ article titled “Rescue may miss many who need it”, University of Nevada, Reno economist Tom Cargill said of the new Obama plan “it’s a terrible waste of taxpayers’ money. It uses taxpayers’ money to support bad decisions made by people to buy homes they can’t afford.” Personally, I highly disagree.

We are looking at homeowners that now realize that they are $200,0000-$500,000 upside down in their homes. These were all qualified buyers, who all put down 20% or more and are underwater.  Mr. Cargill, please tell these tens of thousands of Nevada homeowners tough luck and that they made bad decisions.  Please tell them to forget that they owe more money than most and to go out and become consumers again and run up their credit cards and spend money so the economy can grow and the banks can profit and they just need to suck it up and in 7-12 years, if they are lucky, their homes just might, maybe have some equity in them.

What needs to be done?  I suggest the radical notion of the following:  protect the principal, protect the investors, encourage homeowners to pay off their principal loan balances.  First, work with all homeowners that have homes underwater and who are current on their payments.  Move all loans to a .5% interest based on a 15 year amortized loan.  Years 1-5 are at .5%, years 6-8 are at 4%, years 9+ are at 6%.

Example:  A $300,000 loan @ 5.5%/30 years has a P.I. payment of $1,703 per month.  .5% has a payment of $1,730 per month.  The point here is that many homeowners are short selling as much as they realize that it will easily be 10 years before they have equity but can make the payment.  With a 15 year loan not only do we have free and clear homes in 15 years in a mere 5-7 years, the loans will have been paid down so much that with no appreciation whatsoever in the housing market the homeowner will have equity. 

For those homeowners that are not current they can be offered 20, 25, 30 year loans.  In the same example the loan payment would drop over $800 per month on a 30 year loan.  If that does not save the homeowner then per Mr. Cargill they truly overbought or their income has been cut so much that foreclosure is their only option. 

 Drastic?  Not really.  Homeowners take homes off the market, principal is preserved, fewer homes for sale, better chance for stabilization.  Better stabilization and growth, better tax income for the city, better confidence in an individual’s personal financial position, the more likely they are to spend money. The more money they spend the more taxable income to the state, the more confidence homeowners have about themselves, the more likely to buy services, the more services they buy, the more companies can expand and hire. The more people that have jobs the better the economy and so on.

What about the federal government and the bailout money?  Well obviously .5% for 5 years is a bit painful for the banks so that money goes to give the banks/investors a 2% additional return for years 1-5.  When a seller sells in years 1-5 they pay to the federal government a percentage of the profits, if any, as a form of repayment.

Investors get their principal, banks stop write- downs, banks stop paying tens of thousands of employees to handle bad debt, banks save hundreds of millions of dollars on foreclosure costs and write-offs, homes come off the market and prices stabilize.

“Q: I am looking to buy my first home, and it seems like short-sales are priced much lower than regular sales. Are these prices negotiable, or are they the bottom line that lenders will accept?

A:Many lenders negotiate prices for short-sales [The lien holder is NOT the owner and cannot negotiate the price of the home],  in which the seller is offering the home for less than is owed on the mortgage. But traditionally the only way you could find out was to submit a below-list offer and wait—often for many months—for a response. If the bank made a counter-offer, you knew you were in the ballpark; if they didn’t respond at all, you were too low [The author missed the point.  The bank is NOT the seller and does not "counter the buyers offer". The short sale process is first and foremost to confirm that the lien holders will approve of a short sale for the seller.  That in fact the seller is approved to do a short sale.  Then the lien holders negotiate with the seller on terms acceptable to the lien holders/investors on what they will accept.  The lien holders are looking only at the costs of the sale or the HUD-1 settlement sheet]. By then, you may have lost all interest in buying the property.  [Lien holders are looking at what is best for them.  Is a foreclosure more profitable?  Is the offer within acceptable range to approve of a short sale for the investors without the expense and risk of a foreclosure?  It is all about the net.  Lien holders do not respond to offers per se, they respond to the owner of the home and a low offer only creates a barrier whereby the foreclosure route is the best way for the lien holders to go, thus a decline of the short sale.]

The good news is, on April 5, this frustrating system will change at least for some buyers and sellers. That’s when the federal government will begin to provide financial incentives to lenders to do more short sales. The rules also help standardize the process, so your chances of negotiating a distressed property bargain will increase.  [No, in fact we really do not know what to expect but the author is still thinking that a short sale and a foreclosed home are one and the same.  It is my opinion that in fact the author is right in the fact that more "bargain" sales are on the way but not for what is being said.  In reading the new directive it appears that the banks may well use the short sale process to circumvent the expenses of a foreclosure.  Only time will tell on this.  Until a home is foreclosed on the banks do not own the home and the owner is the seller.  Sellers today are finding that to approve of a short sale they must agree to financial terms on some form of loan payment.  That does not happen when a home is foreclosed, though the banks have the legal right to pursue the owner for lost monies, but that is another subject.]

Under the old practices, when a financially-distressed seller brought a potential buyer who was offering less than the amount owed on the loan, the bank would order an appraisal or broker’s price opinion (BPO) and then decide whether the offer was acceptable [Correct, the banks are looking at fair market value, as a buyer looking for a "bargain" this is where they go wrong.  Fair market value is what the home is worth].  Under the new federal rules, banks will order a BPO before the property is listed for sale, and will share information on the minimum net proceeds they’re willing to accept with the sellers. If they then bring in a buyer whose offer is equal to or greater than this pre-approved amount, the lender must accept it within 10 days.  [This is correct, but actually seeing the lenders adhere to such a time line will be interesting to see.  The new process if done correctly (something I have been asking for for two years) would be huge.  By placing a home on the market that can close in a near normal fashion, we can slow down and even stop the falling prices, therefore the question on bargains we hope will also be coming to an end as well.]

Not all sellers are eligible for this program, called Home Affordable Foreclosure Alternatives (HAFA) (for the requirements see Help for America’s Homeowner’s Supplemental Directive 09-09). But since the process is likely to go so much smoother for those who buy and sell under HAFA, I suggest you wait a bit until the program goes into effect and concentrate on finding these “pre-approved” deals.  [Agreed.  In fact, based on what I know now many homes will fall outside of this program.]

Of course, when you do find a property you like, you may not be the only person bidding on it. [The days are long gone where only one buyer bids on a home.  Today any buyer writing a low offer is pretty certain to fail, unless they are trying to buy a home that NO ONE else wants and that is also another story for another time.] To improve your chances of winning, make sure your offer is “clean,” with as few contingencies as possible (though I would never fore go a home inspection). Include tax and credit records, and a mortgage pre-approval letter. If you can afford to pay cash, that will put you in an even stronger bargaining position [This is not different than any offer, at any time, these are in fact standard items that any offer should include].  Still, in your eagerness to win the property, don’t forget that distressed properties often come with added financial burdens. Although under HAFA, the seller is supposed to provide clear title, to protect yourself your, your contract must make it clear that you will not be responsible for any of the seller’s unpaid property taxes, liens or second trusts.  [Here we go again, the author is confusing short sales and foreclosed homes, what she says is true on foreclosed homes but on short sales the home is still owned by the owner and in most states the law says that the owner is still responsible for full disclosures] . Also, cash-strapped homeowners often stop paying taxes and homeowners’ association fees during the time between when the house is listed and the deal is closed. To make sure that you’re not on the hook for these expenses, Leonard P. Baron, professor of finance at San Diego State University, recommends that you ask that the bank escrow at least six months worth of taxes and HOA fees, to cover any potential shortfall.  [We call this clear title and in areas that useescrow and title companies all recorded liens must be paid or the escrow cannot close.  Again the difference here is short sales versus foreclosures.]

 June Fletcher at fletcher.june@gmail.com”

  It went on to explain how to get a good deal and how the new government guidelines will address how short sales need to be handled from April on.  The general ignorance of the article was amazing and the lack of knowledge underscores the gap in understanding.  Later today we are going to post 60 graphs giving a update on what is happening in the Reno & Sparks Markets with the three dominate types of sales, short, foreclosed, traditional.

“As we work our way through the Great Recession, the discussion often sways between whether to expect inflation or deflation.  Deflationists mention the huge credit bubble that we are digesting, and often like to point out Japan’s experience over the last 20 years.  Inflationists point out all of the government spending and quantitative easing (essentially money printing) that may lead us to hyperinflation, mentioning episodes like the 1970’s Great Inflation, or even worse, Germany’s Weimar Republic. Who is right, and is the answer actionable for an investor?  In order to keep the brief discussion more interesting, I’ve decided to add a few quotes from John Maynard Keynes, the economist our leaders claim to emulate.

“It is better to be roughly right than precisely wrong” – John Maynard Keynes

Getting the inflation/deflation call seems very important. Inflation typically crushes fixed income, as higher rates can choke business, and pushes down the value of investor’s bonds.  Further, high interest rates make stock investments less appealing relative to bonds, and therefore stocks tend to fall in price until their dividend yields become more interesting to investors.  Hard assets can often make large gains during these periods, as falling currency values lose purchasing power, pushing up the nominal value of real assets.

On the other hand, deflation can cause investors to flock to bonds, which makes their values rise, and yields fall.  Business suffers as prices drop.  Wages also drop, as business slows.  People often save more and spend less, further deepening the deflationary spiral.  As business suffers, stocks typically drop.  A poor business climate usually leads to less use of commodities (hard assets), and their prices often fall.

It is easy to conclude that making a bold bet on inflation will be disastrous if deflation continues, and vice versa.

“Markets can remain irrational far longer than you or I can remain solvent.” – John Maynard Keynes

Even if an investor ultimately makes the right call on inflation/deflation, when does her/his thesis play out?  Remember, one of the best investors  of our generation called the debt bubble well before it happened.  George Soros (among others) mentioned the dangers of our enormous leverage in the mid 80’s, through the 90’s, and into the 2000’s.  He was spot on in his analysis, but acting on his forecast would have made one miss the greatest bull market in American history.  Imagine being short stocks as they rose 16+ percent a year from 1982-2000?

“Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally” - John Maynard Keynes

In order to avoid being out of sync, or even worse, loosing their investors, many “professional” money managers choose to follow the crowd.  They “manage” risk by hugging investment indexes, and feel it is ok to lose 49% of an investors portfolio, as long as the markets went down 50%.  Clearly, this may work for the stockbroker/financial advisor profession, but it doesn’t work for people who want to grow their assets and retire in comfort and safety.  We believe this mentality is destructive to most people’s savings.  The need to follow the herd is deep seeded in the human psyche.  To overcome this bias, one must first understand it.  Then, one must study history to see what people did well, and where they failed.  Most importantly, a rational investor must be willing to do things differently than the herd.  It is difficult to watch the neighbors make millions on tech stocks, or reap huge profits flipping houses and condos.  However, fundamentals eventually apply.  A rational investor will be called stupid, old fashioned, and jealous while bubbles expand.  She/he will be resented when the bubble pops.  In order to survive and thrive in an investment career, it would be wise to avoid “worldy wisdom”.

“A study of the history of opinion is a necessary preliminary to the emancipation of the mind.” - John Maynard Keynes

In the inflation/deflation debate, most people with an opinion attach their ideas to a specific guru or school of economics.  One theory is memorized, and doggedly followed, even when experiences dictate that things aren’t working as forecasted.  There is very little thinking and learning involved, only determined rooting for whichever “team” one has chosen to follow.  History is ignored, and few people open their minds to the idea that they might be wrong.  Instead of learning all sides of an issue, most observers start with a premise and assume that everyone else is wrong.  In our opinion, these debates are interesting, but only semi-relevant.   Often times, each school of economic thought offers a few nuggets of wisdom attached to much hubris.

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” John Maynard Keynes

While we understand the different schools of economic thought, and pay attention to their lessons, we choose to be open minded as to what may happen in the future.  History leaves a thick paper trail, and what actually happened to markets and asset valuations over time is more valuable to us than defending individual theories.  We want our clients to survive and thrive over their investing careers regardless of the direction that inflation goes.

Those of you that visit our office frequently know that while we religiously track current events, we also spend an enormous amount of time studying the history of the markets.  Often times, the parallels are chilling.

What we find is that most often, the bulk of the mainstream economists are wrong.  Most of our leaders appeared to be caught off guard by the collapse of the debt bubble, despite nearly twenty years of warnings by high profile investors, competent journalists, and the lessons of history.  Politicians typically follow Keynesian policies (stimulus spending to create jobs until the economy gets back on its feet), as this is often the school of economic thought most readily pushed on students at American Universities.  Further, Keynes’ prescription for recessions requires massive amounts of deficit spending and appeal to the populist mentality of “doing something to help”.  Our leaders forget that Keynes recommended government surpluses in good times, and government spending in tough times.  It seems that we either suffer from selective memory, or that we have chosen our theory because it allows our leaders to avoid fiscal responsibility, while feigning to follow a well known economist.  Historically, stimulus hasn’t worked well in solving recessions or credit bubbles.  Tough love (bankruptcies, assets price collapses, high unemployment) has worked faster, but has understandably wrought political unrest.  Our politicians don’t have the will to say “no” to their voting base, therefore stimulus will most likely continue until it creates massive inflation, high interest rates, and potential social unrest.  (Hey, no one said running a democracy is easy!)

We also find is that quality businesses purchased at low prices tend to thrive over all time and space.  The price of their stocks may swing with the ebb and flow of boom and bust cycles, but this really has little to do with the cash that these businesses earn and distribute to their shareholders.  Large, multinational corporations have the added advantage of doing business in different countries.  Some countries boom while others bust, creating some protection in the event of regional issues.  Regardless of the economic outlook, people still eat, drink, and wear clothes, and the companies that supply these products really don’t care if we are of the Keynesian or Austrian persuasion!

Further, when we buy a bond, we actually become a creditor.  Our thought process, when loaning money, is no different when buying a corporate bond than if we were loaning money to a distant cousin.  When do we get paid back?  Is there adequate cash flow to pay us timely interest and principle?  Is the interest rate we are charging enough in context of both the risk of the loan, as well as in regard to competing investments?  Only if these questions can be adequately answered will we invest.

By the way, these things also work for real estate investments, with an additional look at regional supply/demand characteristics as well as incomes and cap rates.

History shows that rational analysis of business and loans, as well as the proper pricing of these investments is more important to financial success than just looking at the economic backdrop prevailing at the time of investment.  To reiterate, the safety of an investment (whether it be a loan or an ownership position) is of paramount concern for an investor, but the price paid is nearly as important.  Money managers and individuals that got these two concepts right made money during the 30’s and 70’s, two difficult periods for investors.

“The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”  John Maynard Keynes

As pointed out above, it is not only difficult to pinpoint the direction of inflation/deflation, but also the timing.  Credit bubbles tend to cause significant damage to an economy (see Reinhart and Rogoff’s This Time is Different) that takes years to play out.  Contrast this with the United States high debt, inflationary policies, and a fed Chairman that has stated he will “drop money from helicopters” before he allows deflation to take hold.

Instead of making a bold wager on one or the other directions, we think it is prudent to remain open minded and hedge our bets.  Housing and other big-ticket items that require financing to purchase are likely to continue falling in price.  Until incomes begin to stabilize, and even rise, expect other discretionary purchases to remain weak.

Keep in mind (thanks Dave Rosenberg of Gluskin Scheff) that some Americans are walking from their homes and freeing up their cash, which leaves more room for consumption, while further hurting banks, investors, and the fed which hold the mortgages on these properties.  If enough people strategically default, without retribution, consumption can recover quicker, although the losses will most likely be born by investors and by taxpayers in the form of more bailouts, with  higher government debt and rising taxes.

As the government continues to add debt, and the Federal Reserve continues to monetize assets (print money), we put our currency at risk.  A floating currency means that the value of said currency is left up to the financial markets in theory at least. In practice, many countries manage the value of their currencies through market intervention.  If investors believe in the stability of the U.S. dollar, it’s value can remain high despite skyrocketing debt and quantitative easing.  If, on the other hand, investors panic, the results could be severe, and could happen almost instantly. The British Pound’s recent sharp drop should be a warning to developed countries.  We are a nation that imports more than we export.  If the value of our currency plummets, the cost of much of what we import will rise.

Tying it together, we think it is entirely possible to see, for example, houses continue to fall, while the cost of food and oil rise.

We could spend hours discussing other potential sources of inflation/deflation, but I think our readers get the big picture.  There are legitimate threats for both inflation and deflation.  Over time, our spiraling deficits will most likely lead to a weaker dollar.  Whether these trends play out over 2 years or 10 years, nobody knows. In the meantime, the collapse of a credit bubble tends to push prices down for years, slowly unfolding despite our impatient desire for “things to get better”.  In conclusion, we think it is entirely possible to see, for example, house prices continue to fall, while the cost of food and oil rise. There is no reason to believe that all prices must rise or fall at the same time.  If history is any guide, quality assets bought at cheap prices will provide protection from inflation and deflation.  By owning assets of this type, we believe an investor can both protect capital, and grow purchasing power.”  Courtesy of Ancorawest, Robert Barone

Bob says a lot in his writing but I feel that this is worth reading, and thought provoking as well.

David Morris

CRS, CRB,CLHMS, CDPE, SFR, ABR