The Truth About Bailouts:
As a staunch supporter of free markets, the thought of a bailout makes me nervous. Many smart people made smart bets and didn’t over leverage themselves. So why should we be liable for others, who went nuts and borrowed themselves into the ground. This, of course, is a tragedy for some and an incredible opportunity for others. While your retail purchases, perhaps your primary residence, may have taken a 10 – 15% dip in value, chances are your foreclosure purchases are still excellent sources of wealth, with ample equity. Those of us who purchased homes 50 – 70 cents on the dollar are still in a great position. The flooded rental market has likely also helped you with better quality and higher paying tenants. In short, most savvy investors are still in great shape. So what will the bailout do for (to) us?
In the short term, a bailout represents more liquidity for financial markets. For those of you who’ve recently been told that you no longer qualify for credit, this is a direct reflection of tightening credit markets. Banks are being extremely cautious. They are increasing their debt service coverage ratios, they are increasing their vacancy factors in their analysis of you, all the while, they are lowering LTV’s. All this leads to less available credit for investors, which is a mess and it does affect our business. It affects my investors and it’s obviously not optimal for any real estate finance. In the face of this, I have requested and received an increase in my line of credit of $600,000, which now totals $1.6M. This will allow me to fund additional deals for investors who may qualify for end financing, however without a lease in place, they fall short of a commercial approval. This comes at a personal cost to me and my business, but was a necessary move. In addition, the new Fannie/Freddie guidelines have limited investors to 4 properties from 10. This is a huge decrease. Those of you who have 4 homes or more, will no longer be cashing out in the secondary market. I fall into this category as well. With close scrutiny of the markets and constant communication with banks, we foresaw this. We were able to increase my line of credit and move to an 80% "as completed" commercial loan product in order to limit the need for cash out refinances. This product is UNLIMITED in terms of the number of projects you can buy, as long as you qualify based on credit, cash flow and income.
Both of these solutions became available with incredible timing. You may be thinking that I love this bailout, as it will likely loosen the purse strings with the banks and credit will be more readily available. In one sense I do, as my investors will get reasonable credit again. There is however a down side to this. The $700 Billion comes from us, the taxpayer. While I’m for (and in need of) increased liquidity, I’m fundamentally and incredibly opposed to taxation. Taxation can cripple the economy further and bring us from a limp to a crawl. We need tax relief, not increased taxation. A tax on large corporations will undoubtedly hit you, me and everyone else in the country. There is no tax that does not take money out of private hands and into the government. Government can call it what they want but taxing anyone, even the oil companies, will hurt us. The thought that these companies take the hit without passing it on to us is sophomoric. In addition, the terms of the bailout are vague, to say the least. We need much more control over what these funds are used for and how they are used.
Newt Gingrich was on Fox and basically trashed the structure of the bailout. I tend to agree with what Newt says, as he’s both pragmatic and bright. Neal Covuto was on the same program and mentioned 2 times where bailouts have been profitable for tax payers in previous crisis situations. I see where this could be a long term win for the taxpayer if the government were to structure and manage this bailout properly. There, my friends, is the problem. Ever been to the DMV? How about the post office? Government couldn’t successfully work a toaster, let alone a $700 Billion dollar bailout. Let’s face it, this is a tough one.
Do we let the economy fall apart, or do we quickly solve the crisis with a huge bailout? I believe that the laissez faire approach is the best, however we live in a big government world, so chances are, libertarian ideals are never going to come to fruition, although I respect and agree with their passion for a free market. Something is needed for sure. I could argue that bad businesses deserve to die (ala the George W. national address), but if their death starts to carry over into your world, you may be torn as I am. I am not thrilled with the concept of a bailout, but I need it for some of my clients. The sad thing however, is that when government is in charge you can be sure that there will be a down side. The free market approach, in this situation, could ultimately lead to a bank run and mass panic. There’s just something that stinks about the urgency of this bill and how they plan to solve this in a weekend. The element that stinks to me is that the Fed (owner, printer and controller of the money supply) will have increased power over us. That’s just plain scary, especially if you believe the Fed was a huge contributing factor in this by jacking up rates 16 sessions in a row. Can you say overkill?
Right now, I am buying homes that provide tremendous equity and cash flow. Most investors can still get money and they are doing the same, however the denials are stacking up and the bank’s credit criteria is not getting looser. The problem in my opinion, is that the pendulum has swung and it’s swung too far. This is not the immediate fault of the banks. Remember the FDIC insurance tag that you see at your banks? This insurance comes at a cost. The banks are being scrutinized by regulators. Regulators come in and review the loans of the banks. They review concentrations, appraisals, valuations, insurance and many more components. In order to insure your deposits, these banks need make sure the loans that are on the books are not “risky”. "Risky" loans can lead to default, which leads to less "insurability" of your money. Bad loans, can lead to liquidity issues for banks and ultimately insolvency. Banks become insolvent and your money is gone. These bank runs from the depression era were attributing causes to the formation of the Federal Reserve Bank. The catch of course, is that the Federal Reserve Bank has quite a large amount of control, yet it is not quite a governmental institution. The Fed lends money to the banks, government and ultimately us. Every dollar you have is a borrowed dollar. This is a core reason that I am vigilant with leveraging “appreciating” assets. Remember, houses don’t go up in value, dollars go down. Accumulating cash will NOT solve your problem, however assets that tend to keep up with inflation (houses) can curb the ever deflating dollar and create the stabilization of your financial wealth. If you have stock, you’re down big. If you have cash, you’re down big. If you have homes, you may be down from retail values, but if you buy foreclosures, you’re likely still up big. Your cash flow is likely up big too.
Last weekend I was with some investors who were discussing what amount of cash would allow you to live in this world without actually working. I’m not saying here that you’re yachting or at the country club, but you’re comfortable and eating. Your number can vary quite a bit, but the number I hear often is $3M.
$3,000,000 @ 3.5% in a bank is $105,000. No worries right? Remember, you’re only insured to $100,000.
$3,000,000 @ 5% in bonds is $150,000. Very limited worries right? What about market swings and corporate insolvency? Mortgage back securities were triple a rated, now the only buyer is the government (us).
Invest $3,000,000 in small single family homes, priced at $80,000 each, that rent for $1,200/mo. This would allow you to purchase 37.5 homes. Assume you pay $300/mo in real estate tax and insurance. This will yield you $405,000. Insurance Companies will insure $3M in real estate.
My point was, if you have half a brain and just a little drive, you can create the same returns with half the money. I’ll take bricks & mortar over cash, bonds, crooked ceo’s or the government anytime. I’m not exactly a conspiracy theorist, but it seems odd that the Fed is garnering even more power, with a swift move, in a time of crisis. If the Fed was created to control the money supply, curb inflation and stop crisis, then why are we, in 2008, faced with a such a national and global crisis? It could be that the Fed is overrated. It could be that the Fed overshot by raising rates 16 times in a row. Nobody was more outspoken about rates being artificially high than I was, I had quite a bit of my portfolio floating with Prime. Remember the inverted yield curve? How we got here is important, the liquidity is needed, and we must ensure that politicians are taken to task. I keep hearing that this bailout will cost $7,000 per taxpayer. In the same broadcast, I hear someone else say that it’s possible that the government and taxpayers make money on this deal. After all, 92% of people are current on their mortgage, so why are these mortgage backed securities worthless? The answer, is that something is worth what you can get for it. This reminds me of my dad telling me that the Becket stating my Ryne Sandberg rookie card was worth $49 may not mean I can actually get that price. I was devastated! I bought the card for $7 at a flea market, and to a 9 year old kid, I was loaded and impressed with myself. Baseball cards, homes and mortgage backed securities are all the same, you get what someone is willing to pay. Timing the purchase and sale is often more important than how or even what you buy. The intrinsic value of these securities is supposedly much higher than we’re paying, which I like. I’ve heard several of my friends who are investment bankers say that someone is going to make a lot of money out of this mess. I agree. It’s time to BUY. Ever heard of buy low, sell high? This is what they are talking about. The fact that the government is managing the process, well that’s a gamble.