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When one considers the state of the modern American economy, the phrase "survival of the fittest" hardly springs to mind. Instead, we think of idioms like "too big to fail" and "zombie bank." We think of Band-Aid fixes, public make-work schemes/scams, of borrowing demand and earnings from the future and assorted other conjuring tricks used by economists and politicians, all designed to ensure the survival of the weakest...at the expense of the fittest. The nation's largest insurer, for instance, remains but a coddled mass of inefficiency, even after hundreds of billions in taxpayer-funded cash infusions; and its flagship automotive companies still suckle desperately on Washington DC's nanny-state teat. Ol' Fannie and Freddie were gifted - on Christmas eve, no less - enough taxpayer juice to guarantee they will waste at least that much...and probably many times more...before all is said and done. It seems that all a company needs to do to "earn" somebody else's bailout cash is to display an unrivaled aptitude for first loosing their own. The more bereft of any real world capabilities an institution is, the more likely it will find itself the recipient of your tax dollars. Thankfully, not all acts of corporate stupidity are noticed by Big Brother. Some reckless companies are actually, GULP, "allowed" to fail. Here at The Daily Reckoning, we like to pay homage to those institutions kind enough to remove themselves from the corporate gene pool. We are all better off without bankers who can't count and automakers that can't compete. It's time to stand by the tar pit to cheer their timely demise. With that in mind, we recently opened nominations for this year's Daily Reckoning Financial Darwin Awards. In short, the Financial Darwin Awards recognizes the efforts of companies that, through unwavering dedication to idiocy, rendered themselves either financially castrated or entirely extinct. Readers were quick to nominate the US Congress, the education system, the Federal Reserve (with separate nominations aplenty for its Helicopter-in-Chief), the "entire middle class of America" and even "the state of California." There were also a few nominations for individual companies, among them Circuit City and the creatively named Linens 'N Things. "Circuit City was a damn good electronics chain that was too stupid and slow to adapt to Wal-Mart's entry into electronics," observed one reader. Chimed another: "I would give the award to Circuit City's corporate managers for deciding that the best way to save money and ensure business survival was to get rid of their best salespeople. Aside from depriving the business of those people themselves, the decision also sent a message to the survivors: Stay mediocre or lose your job. (Well, they lost their jobs anyway, but it probably took a few months longer.)" A reader from Down Under was kind enough to send through a small list of ill-fated morons... "ABC Learning - ended up being bought out by welfare groups with Rudd federal government financial assistance... Storm Financial - the case of this company reads like a frenzy of stupidity and greed, combining into a black comedy... Timbercorp - the model of this business growing trees proved to be an abject failure... Opes Prime - another failed financial advisory..." And still more... "Don't forget Washington Mutual," writes another, "for forgetting the good banking activities that made them as large and well liked as they [once] were." Now, as much as we enjoy laughing at others' stupidity, we enjoy profiting from it even more. So, in today's guest essay, we decided to bring you some thoughts from a man who makes a career out of spotting the extinct companies of tomorrow. In fact, when Washington Mutual crashed to the ground back in September of 2008, readers of Dan Amoss' Strategic Short Report were laughing all the way to the (obviously different) bank. And, according to Dan, 2010 is shaping up to be a great year for more short selling opportunities...especially in the commercial real estate sector. Details below... |
| The Daily Reckoning PRESENTS: For many Americans, the subprime meltdown must have felt like a complete economic collapse. Tens of thousands lost their homes in the ensuing mess and a growing number face, even now, threats of foreclosure and badly underwater loans. But subprime real estate loans were only part of the problem. Dan Amoss, editor of the Strategic Short Report, explains... The End of Extend and Pretend By Dan Amoss Jacobus, Pennsylvania Attention REIT investors! The commercial real estate is a disaster-in- the-making - both for property investors and for the thousands of American banks that are carrying outsized exposure to commercial borrowers. Commercial real estate borrowers and their lenders face a mountain of debt maturities over the next few years. And re-financing this debt will be next to impossible, thanks to soaring vacancy rates and plummeting property values. "Zombie buildings" are popping up all over the place, according to Crain's New York Business. "Virtually all the assets bought between '05 and '07 cannot be refinanced today without a significant capital infusion," says Shawn Mobley, executive vice-president at real estate firm Grubb & Ellis Co. "These buildings need to be recapitalized to get back in the business of being active real estate." Unfortunately, these "zombie buildings" can't compete for new tenants because they lack the money to cover brokers' commissions and interior office reconstruction. The number of zombie buildings in the Chicago area is likely to grow in 2010, according to a forecast by Grubb & Ellis. For landlords, the trend means even top-quality office properties are likely to divide themselves into "haves" and "have- nots," with the latter seeing their vacancy rates worsen because of the lack of financing. We'll see many more zombie buildings emerge in 2010. Many REIT investors seem to have grown complacent about the risks in the commercial real estate market. These investors seem to believe that banks will simply roll over underwater loans once they reach maturity, in the hopes that a future rebound in property values will catapult these loans back into solvency. This phenomenon is known as "extend and pretend." The "extend and pretend" strategy did not work for Japan's banking system, and it won't work for the US either. It won't work because it will lead to a two-tiered commercial property market. In one tier, we'll see property owners with affordable mortgages cut rents to fill their vacancies. In the other tier, we'll see property owners and lenders hoping for a return to bubble values, and maintaining a high- mortgage, high-rent strategy. Property owners in the high-rent tier may be making payments on their underwater mortgage for now. But once the low-rent tier starts winning all of the scarce leasing activity, vacancies in the high-rent, high- mortgage tier will accelerate and property-level cash flow will fall dramatically. In other words, just because a mortgage happens to be performing now does not mean it will be viable in the long run. As commercial landlords with negative mark-to-market equity watch their tenants flee, they will stop making mortgage payments and surrender their properties to the lenders. Thus, sooner or later, commercial real estate will find its way down to the prices that would attract new investors and speculators. This process is known as "price discovery." By rolling over the maturing bubble-vintage loans made to underwater, but cash-flowing properties, the banking system (if allowed to do so by its regulators) would establish an artificially high price floor. Such industry-wide collusion would slow - but not prevent - the slide toward real-world pricing - the kind that would attract new investment. But even if the process of price discovery in real estate is delayed by "extend and pretend" at banks, some measure of price discovery will come from the liquidation of properties that collateralize commercial mortgage-backed securities (CMBS). In these securities, when the underlying properties default on mortgages, the holders of the senior CMBS tranches usually push for liquidation. This means that junior tranche holders get wiped out, but losses to the senior tranches are minimized. The senior tranche holders have neither the patience nor the risk tolerance to hope for a rebound in property values. They just want their principal back as soon as possible. One way or another, commercial real estate prices will fall toward their real-world prices...which are clearly below the "pretend" prices that most banks are using today. Therefore, my outlook for REITs remains very bearish. Many REIT investors seem to believe that "extend and pretend" is a viable strategy for the over-levered commercial real estate sector. I do not. REITs, despite facing the toughest fundamental outlook in the history of the asset class, are trading at valuations typical of market peaks. Citigroup's REIT team, in a recent research note, estimates that the REITs it follows are trading for 18 times estimated 2010 cash flow and a 7.2% implied cap rate. This is expensive in ANY market environment. Investors speculating in REITs at today's high valuations give themselves no margin of safety. Citigroup's estimated 2010 cash flow for its REIT coverage universe assumes a strong rebound in demand for commercial space, which I do not expect. Demand will remain below supply for years, forcing REIT landlords to cut the asking price for rents on vacant space. The REIT sector has already "priced in" the typical sharp post-WWII inventory-led economic recovery. But I expect a very tepid, narrow recovery with a "double dip" recession by late 2010. The current "recovery" is not typical. It is merely a stimulus-induced bounce in the midst of what will likely wind up as a decade-long deleveraging, downscaling economy. So all that's necessary for a 40% decline in the REIT index is for net operating income to fall 20% to 30% (through a combination of falling rents, rising tenant defaults, and higher interest rates on new CRE mortgages), and cap rates to increase by 200 to 300 basis points - just slightly above the long-term average. A slow economy could easily produce such an outcome...if not much worse. The UltraShort Real Estate ProShares (NYSE:SRS) is an aggressive way to bet against the REIT sector. This stock has performed very poorly during the last several months, as REIT shares have soared to the heavens. But I think it makes sense to be holding SRS now, because REIT valuations are high, and fundamentals will remain terrible, no matter how successfully real estate lenders manage to "extend and pretend." Sell REITs. Until next time, Dan Amoss for The Daily Reckoning Joel's Note: To commemorate the Daily Reckoning Financial Darwin Awards, we're working on securing a very special deal for readers interested in trialing Dan's Strategic Short Report. We should have the details ironed out in a few days...so stay tuned... --------------------------------------------------------------- And now over to Bill Bonner, who has today's reckoning from Baltimore, Maryland... Hey ho...what goes? The stock market registered a gain of 53 points on the Dow yesterday. Gold saw a modest gain too. And the White House came right out and with a straight face said it had saved 2 million jobs. How do you like that? More than 7 million jobs have disappeared in the correction so far. But the total would have been more than 9 million, had it not been for the feds. Let's see, $700 billion worth of stimulus spending...hey, that's $350,000 per job. But every dollar of deficit is actually 'stimulus spending.' At that rate, each job cost about $800,000. And what about all the Fed's pump priming? What about all the loan guarantees and toxic asset purchases...and bailouts of the auto industry, AIG, the banks, mortgage holders, Fannie and Freddie...etc. etc? That's all stimulating too, isn't it? The total is said to be around $13 trillion, putting the cost at $65 million for each job saved. Of course, it's all hooey...all nonsense...all balderdash. It makes sense to 'save' a job if and only if the job didn't need saving. In other words, the jobs that are worth doing are worth saving...but they don't need saving. Why? Because a job that is worth doing is a job people will pay for. And if they won't...or can't...it's NOT worth doing. Otherwise, the feds could have 100% employment...just as they did in the Soviet Union. Give everybody a job. What the heck, give everybody two jobs! But it only really does any good if the jobs are productive. And how can you know if they're productive or not? You have to wait for Mr. Market to tell you. If a job is productive, people will pay for it. If not, well...the job is cut and/or the business goes bust. Mr. Market never gets a say on government jobs, however. That's why the feds can say any fool thing they want. Washington, DC is full of government bureaucrats who earn 30% to 50% more than people in the private sector. In the private sector Mr. Market puts his thumb up or his thumb down. The job is saved. Or the job is cut. But here in the federal city his thumbs are in his pockets. For example, every day, we drive by the NIH - National Institute of Health. Thousands of cars go in and out every day. The NIH was set up in 1930. It had 140 employees, which seems like more than enough. Today, it has 18,442. The same sort of employee inflation happens at every government level on practically every government project. You set up an agency or a commission. Then, you can't get rid of it. As the saying goes, 'nothing is more eternal than a temporary government agency.' But are Americans any healthier thanks to the NIH's 18,000 + employees? No one knows. And that's just the NIH...where employees might conceivably be doing something worthwhile. Just for fun we went to the A-Z Index of US Government Departments and Agencies and copied some of the list. This is just the beginning of the As:
But what are we ranting about? The Daily Reckoning is about money, right? It's not about politics... But...whoa...now politics and economics are mighty cozy with one another. A growing part of GDP comes directly from the federal government. Already, there is now more government spending than there is private investment. And many mainstream economists are calling on the government to spend more money to fight the downturn...and 'save jobs.' They don't bother to think about whether the jobs are worth saving or not. And they don't seem to care that government spending is not the same as private spending. As the feds take over, the economy changes shape. It becomes less and less a free-market, productive, wealth enhancing economy. Instead, it becomes more and more of a centrally-planned, unproductive, wealth destroying one. It becomes Sovietized, in other words...like Venezuela...more below... --- Outstanding Investments Gold Investing Report --- From Hulbert's #1 Ranked Advisory Letter Over a Five-Year Period... Even if Gold hits $2,000 by the end of 2010 here's a hidden way you can get in for less than one cent per ounce Over the next two years, you'll witness the greatest surge in gold prices in market history - at least 119% above where gold sits today, as I write this. But even better, I've just discovered a way for you to sneak into the soaring gold market for next to nothing, with what I call "penny-per- ounce" gold. That is, doing this is a "backdoor" way to own as much of a position in gold as you like... for the equivalent of paying a single cent per ounce. Get All The Details Right Here. --------------------------------------------------------------- And back to our thoughts... The poor Venezuelans. But that's the problem with democracy. Everyone gets what the majority of voters deserve. They voted for Chavez. Now, they have to pay for it. The lawfully elected (insofar as these things are ever lawful) government of Venezuela cut the value of its currency in half. That was only a week or so ago. Then, there was "chaos" in the streets, according to press reports. "Inflation fear grips nation," says The Washington Post story. In response, Venezuelans are on a buying spree. "What can the citizen do, but conclude that his money is best spent on a toaster [that] he really doesn't need," said the mayor of Caracas. Señor Chavez has only done what Señor Bernanke and Señor Geithner have done, too. They have all so confused the situation that ordinary people have no way of knowing what to think...and no way of protecting themselves, other than by doing something stupid. But wait...there's more... Now, the press is reporting that Caracas faces "rolling blackouts." Well, isn't that just like dunderheaded government? Energy rich Venezuela is running out of juice. Good work, central planners! How long will it be before New York runs out of power, too? Or Los Angeles? We don't know...but give the feds a chance. They'll make a mess of things; count on it. "How come Mexicans are doing all the work?" asked Edward innocently. Edward was raised in France. He was only 2 years old when we left to live in Europe. He is now discovering his homeland. So are we. "All the people who clean up at the school are Mexicans. So are the guards. And look at the guys working on the roads. They all look like Mexicans...or Latin Americans." Yesterday, we were late picking him up. We went into the school building and asked one of the cleaning ladies if she had seen him waiting somewhere. "No hablo ingles," she replied. She was then delighted when your editor was able to respond in flawless Spanish - albeit heavily accented. Not for nothing has he been taking Spanish lessons for the last 3 years! The woman who cleans our office in Baltimore is from Nicaragua. The woman who serves coffee at The Diner in Bethesda is from El Salvador. Guys operating backhoes, trucks, shovels - all of them look like they are from Latin America. "I don't know Edward," we replied. "They were all black when we left." Regards, Bill Bonner, for The Daily Reckoning --------------------------------------------------------------- Joel's Endnote: Finally today, a quick mention to save the date for the 2010 Agora Financial Investment Symposium. The buzz is already creeping in around the office as tentative lists of speakers are passed around. We expect to hear from a 2010 US congressional candidate...a well regarded Moscow fund manager...and a leading petroleum analyst, speaking on "one of the largest oil discoveries in the last 40 years." If you've been to one of our previous events in picturesque Vancouver, you'll know how valuable (and fun) this event is. One attendee this editor spoke with last year called it his "must see" financial event of the year. So here's a very early "Save the Date" heads up to get in early. The conference gets bigger and better each year...but the venue remains the same size. We've had people standing in the aisles in the past so, if you want in, don't tarry. Here's some preliminary info for your calendar. Until next time... Cheers, Joel Bowman Managing Editor for The Daily Reckoning --------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com |
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