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The Daily Reckoning | Tuesday, August 3, 2010 The DR Coast to Coast Correction Tour hits the Las Vegas Strip, Frontline observations from Sin City and part two of the muni crackup, Plus, Bill Bonner on the difference - or lack thereof - between good and bad falling prices... ------------------------------------------------------- Watch the Presentation: Secret $200 Retirement Blueprint Last year $200 could have turned into $10.1 million following 5 simple steps revealed in this secretive retirement blueprint. It's happened before, but could it happen again and could it happen to you? Click here to watch the presentation now. (Turn your speakers on) Booming Vegas or Real Estate Bust? Why Sin City appears to be prospering despite a sluggish US economy Eric Fry Reporting from Laguna Beach, California... Over the weekend, your California editor jumped the border into Nevada. He took a spur-of-the-moment road trip to Las Vegas with his co-editor, Joel Bowman. During their two-day romp in Sin City, neither editor engaged in any activities that needed to "stay in Vegas." No drunken debauchery to report...or not report. No big-ticket gambling losses...or small-ticket moral lapses. Just the same old wholesome living with which they routinely bore themselves. While most of the tourists were busy losing their money and sleeping off hangovers, your editors were busy gathering macro-economic data points. After all, Las Vegas may be famous for its ostentatious casinos, but it is infamous for its outrageous housing bust. No city in the country throws a better housing bust than Vegas. Although the residential real estate market in Las Vegas has been stabilizing for the last two years, home prices remain more than 50% below the peak levels of 2006. "In 2000," the Las Vegas Sun reports, "the median price of existing homes was $134,500. That shot up to a high of $285,000 in 2006, but in 2010 prices have been running slightly more than $120,000." Not surprisingly, mortgage defaults and foreclosures have been soaring over the last three years. "Since January 2007, Nevada has ranked No. 1 in the nation in foreclosure filings [as a percentage of total mortgages]," the Sun continues. "[Among cities], Las Vegas was ranked No. 1 in 2009 and will be near the top again in 2010." And to judge from a recent report by the New York Fed, Las Vegas will not be surrendering its "No. 1" position any time soon. "Although the official home-ownership rate for Las Vegas is a respectable 58.6% as of August 2009," DailyFinance observes, citing the Fed study, "the 'effective' rate is more like a dismal 15%... How is the 'effective' home-ownership rate different from the official one? The authors of the New York Fed study removed those homeowners who have negative equity - those who are 'underwater' and owe more on their mortgage than their home is worth." In other words, 58.6% of all Las Vegas residents may own a mortgage, but only 15% of them own a home. The commercial real estate market in Las Vegas is almost as distressed as the residential market. Office vacancy rates have plummeted from about 8% in 2000 to 24% recently. Therefore, even if the Vegas real estate market is recovering, a lot more recovering will be required to restore stability...and rising prices. Given your California editor's familiarity with these macro-economic data points - and his unfamiliarity with Vegas itself - he expected to roll into a tawdry wasteland last Friday when he rolled off of I-15 onto Las Vegas Blvd. He expected to find clusters of low-budget tourists roaming the sidewalks of half-empty hotels. He expected to find deserted casinos in this gaudy patch of desert...and cut-rate pricing on everything. But he found the exact opposite. The place was packed - every square inch of it - and priced for boom-time conditions. On Day One of his visit - a Saturday - most of the best-known hotels on the Strip were either sold out or offering rooms at Midtown Manhattan prices. On Day Two, hotel room rates dropped sharply, but the crowds remained at capacity. All along the Strip, the casinos and restaurants were bustling, while the sidewalks and poolside lounge chairs were packed to capacity. Finding a lounge chair anywhere close to Mandalay Bay's wave pool required Green-Beret-style recon missions...or a lot of money. High- rolling hotel guests could chose to roll out $250 to $1,000 to rent a cabana...for one day! The cabanas were full. Where is all this money coming from? How on earth could the sluggish US economy play host to such seeming prosperity? Your editor has no decisive answer to these questions, but he does have indecisive guesses: First up, he observed a very large percentage of "ESL" tourists. The crowded sidewalks featured almost every language on the planet. Apparently, Vegas appeals to foreigners. Secondly, your editor suspects that Vegas has become a leading "staycation" beneficiary. Vacation destinations like Paris, Venice and Cairo are as expensive as they are distant. So why not go to Vegas, which enables tourists to visit the Eiffel Tower, the canals of Venice and the pyramids of Cairo...just by strolling from one end of the Strip to the other. Better still, these sites offer valet parking and free booze. Whatever the exact causes, the Las Vegas economy appears to be recovering. Sin is still selling. One busy weekend does not necessarily make a trend. But the official numbers seem to support your editor's first-hand impression. Tourist visits are on track to jump 3% this year to about 37.5 million, which would be the largest number of visits since 39.1 million tourists visited Sin City in 2007. Vegas may not have returned to its peak prosperity, but neither has it descended into anything resembling a bust. Perhaps, therefore, the Vegas housing bust is drawing to a close...no matter what else is happening in the rest of the country. As we noted in yesterday's Reckoning, the weight of stubbornly high foreclosure rates - coupled with stubbornly high unemployment rates - continues to weigh on the national housing market. Addison Wiggin returns today to present additional insights on the struggling housing market...and a high-risk way to profit if the housing market fails to recover as quickly and completely as many investors expect. Read on... A Special Note From the Desk of Addison Wiggin... Dear Daily Reckoning Readers, For seven years, we've been conspiring to put together a research advisory service that covers the nexus between money and politics, between Wall Street and Washington. We wanted to cut through the clutter you see from corrupt and polluted research departments at the biggest investment banks on Wall Street to deliver you useful ideas on how to protect and grow your wealth. Now, after seven years, countless hours spent and miles traveled, conferences attended and books written, we're finally ready test the idea of Apogee's high vantage point research again...and we need your help. Details Here... The Daily Reckoning Presents Son of Subprime, Part II AddisonWiggin Here's a myth we'd like to smash. It's the one about how America stopped being a manufacturing economy and became a "service" economy. The truth is found in figures like these: In the late 1960s, the finance sector accounted for around 20% of corporate profits. Just before the onset of the financial crisis, it was 40%. Financial stocks made up 13% of the S&P 500 in 1999. Just before the onset of the financial crisis, it was 22%. Call it the "financialization" of the economy. The root of the problem is the nature of investing itself - at least, the public form of investing, as practiced by most investors and as tempted by Wall Street. The idea of it is that a man can get rich without actually working or coming up with an insight or an invention by careful study or dumb luck. All he has to do is put his money "in the market" by handing it over to Wall Street, and poof! - by some magic never fully described it comes back to him tenfold. Too often in the last couple of years, it's felt as if Wall Street's hocus-pocus has had the opposite result - collapsing wealth tenfold. We see it happening all over - in sovereign debt, municipal debt, even the gold market. In yesterday's edition of The Daily Reckoning, I explained why municipal bonds, in general are a bad bet. The numbers just don't add up. Municipal finances have become as ugly - and as unsustainable - as the federal government's. Municipal obligations are simply too large, relative to current and (likely) future revenues. It is a classic "train wreck." All this being said, betting against municipal bonds, or funds of muni bonds, is a bad idea for most investors. Most of the closed-end funds and ETFs that hold municipal bonds pay monthly or quarterly dividends. Which means that a short seller of those securities would have to cover them while they wait for their bet to pan out. And the muni breakdown could be months away, if not years. Also, when muni funds do suffer, the fallout may not be as dramatic as the housing bust. Even if you manage to pick the right municipal bond to short, it's tough to make money. Take an ETF of Californian muni bonds (CMF). You'd think it would have suffered terribly over the last few years. But it never fell more than 20% during the worst of the credit crisis. Furthermore, financially stressed municipalities pull all kinds of strings to avoid actually defaulting. It's an all-too-common practice for cities and states to rescue failing projects (with taxpayer money) to prevent the repercussions of a bond default. Those wishing to bet against muni bonds - the fates of local and state balance sheets - are better served shorting companies that hold a large portfolio of municipal bonds or those that are in the business of insuring munis. The latter category means the monolines like MBIA, AMBAC and Financial Guaranty. As for the former, organizations with large portfolios of municipal bonds, one in particular comes to mind. It has a notoriously opaque business and balance sheet. It's a bailed out, flailing company that also holds the world's second largest portfolio of American municipal bonds... AIG. "AIG holds approximately $48.6 billion of tax-exempt and taxable securities issued by a wide number of municipal authorities across the US and its territories," its latest 10-K boasts. "The average credit quality of these issuers is A+." It continues... Currently, several states, local governments and other issuers are facing pressures on their budget revenues from the effects of the recession and have had to cut spending and draw on reserve funds. Consequently, several municipal issuers in AIG's portfolios have been downgraded one or more notches by the rating agencies. The most notable of these issuers is the State of California, of which AIG holds approximately $1.1 billion of general obligation bonds and which at Dec. 31, 2009, was also the largest single issuer in AIG's municipal finance portfolio. Nevertheless, despite the budget pressures facing the sector, AIG does not expect any significant defaults in portfolio holdings of municipal issuers. In our opinion, these two paragraphs alone warrant intense suspicion. AIG holds tens of billions in munis, and with an average rating of A+, a lot of them aren't very good. The company's stake is so big that the fate of muni bonds and AIG is intertwined. In a company presentation to the Treasury Department, AIG warned, "A forced sale of AIGCI's investment portfolio would significantly stress the US municipal bond market." In short, if munis fall, so does AIG... and vice versa. Gravity, it seems, is tugging at both. "AIG has no common shareholder equity remaining on its balance sheet," famous short seller Steve Eisman proclaimed at Grant's 2010 spring investment conference. "It would likely be insolvent if not for government support." Eisman, subject of Michael Lewis' book The Big Short, publicly announced his shorting campaign against AIG in early April. He's famous for nailing the subprime bust, netting his hedge fund clients ungodly amounts of money. Eisman is also often cited as mentor to Meredith Whitney, the analyst who so spectacularly called out bank stocks in 2008. Eisman has built an argument against AIG almost as complicated and difficult to comprehend as AIG itself. We'd boil it down to this: AIG, by Eisman's estimation, carries over $124 billion in debt, even taking into consideration the possible sale proceeds of its best units. The business itself, says Eisman, is worth $88 billion. The government owns 79.9% of AIG, which it hopes to sell as soon as possible. Shares of AIG have soared in the last year, from $6.60 in March 2009 to just under $40 today. Factor in a $48 billion portfolio of muni bonds we think are suspect (at best) and you've got a fine case for shorting AIG. Of course, betting against AIG is not a sure thing. The principal risk is the government. It has saved AIG from bankruptcy once. There's no guarantee it won't do it again. The Treasury could lend more money or forgive AIG's debt. The Fed could give greater access to lending facilities. We feel, however, that the public ire toward both AIG and taxpayer bailouts is so strong the government will offer AIG more support only under extreme circumstances. So with the caveat that this is only for the adventurous, you might consider short-selling AIG, say, above $40 a share. Fair warning: It's a "crowded short." Your broker may have trouble locating shares to borrow. But Dan Amoss of Strategic Short Report agrees with Steve Eisman's scenario: The government will convert its preferred shares to common stock - massively diluting existing shareholders and driving down the share price. Still, don't expect this to occur until after the midterm elections in November. Even if you don't short, AIG, beware munis! Addison Wiggin, for The Daily Reckoning Joel's Note: Covering "the nexus between money and politics, between Wall Street and Washington," Addison's Apogee Advisory cuts through the mainstream, talking head BS to get to the root of what's going on in today's economy. In this month's issue, which you can access right here, you'll also find specific recommendations on how to protect yourself from the shell game in gold, learn what to do about the euro and plenty more. Get in now. Free Presentation: Tiny Canadian Penny Stock Discovers a MASSIVE $172.5 Billion Oil Field! Harvard geologist Byron King just released this new online video presentation. Watch it to hear about a tiny Canadian penny stock potentially sitting on $172.5 billion barrels of oil... Because this company is so small, this huge discovery could mean a potential 3,577%gain for fast movers! Click here now to watch Byron's presentation instantly. Bill Bonner When Good Falling Prices Go Bad Bill Bonner Reckoning from Ouzilly, France... Keeping it short and sweet today... Well, at least short...well, maybe sweet... The Dow stood up on its hind legs yesterday - up 208 points. Gold rose $1. The dollar continues to fall. What to make of it? Well, it could be we're wrong about this market. There seems to be a lot of money eager to get into stocks. It's mostly fund managers and institutions. They can't risk missing out on a stock market rally - even a small one. If they fail to get in, what will they tell investors at the end of the quarter? And what kind of bonuses will they take home? Wall Street does not encourage people to take the long view. Instead, it focuses on quarterly results. Over the last ten years, even solid, blue chip companies have gone nowhere. Investors have waited...and waited... If there's an important rally now, they won't want to miss it! But what if it's a trap? Ah, there's the rub. After many years of trial and error, we now accept the fact that God may have other plans for the world than those He's disclosed to us. Still, when we look out at the US economy and the world in which it sits, we wonder how a rally at this point could be real and enduring. Are not consumers shedding debt? Are not 40 million on food stamps? Are not there more people out of work than at any time in history? And does not the US economy face the greatest competition ever...at a time when it is hobbled by its greatest burden of debt? Maybe, as we said, the stock market rally is just another trap. We'll find out...in the fullness of time. Meanwhile, we mentioned St. Louis Fed governor James Bullard yesterday. He seems to understand better than the others what is going on. The US economy, he says, risks being "enmeshed in a Japanese-style deflationary outcome within the next several years." We're not sure what being 'enmeshed in...a deflationary outcome' means exactly. Outcome sounds like something you get after being enmeshed. But we think we get the sense of it. "Japanese-style" and "deflationary" sound like what we've been expecting too. Mr. Bullard is viewed as an inflation hawk, which means he usually is worried about rising prices. But now is not the time to worry about inflation and Mr. Bullard knows it. The problem with inflation now, at least from the Fed's point of view, is that there isn't any. So Mr. Bullard is going to worry about something else. And he's not the only one. Another Fed governor - Mr. Rosengren of the Boston branch office - said, "While I am not anticipating we will be in a deflationary period, it's a risk that I do take seriously, and we should continue to monitor what's happening with prices." What's happening with prices is hard to tell. The official tally puts consumer price inflation at less than one-third the level it was at when Ben Bernanke told us he had it under control. Targeting 2%...the CPI now measures 0.5%...which means either Mr. Bernanke missed the target by 300% or he can't really control inflation after all. We're told that there are two kinds of falling prices. There are the good kind and the bad kind. The good kind are the kind you find at Wal- Mart and Best Buy. They're the kind you find at the gas station when you see the price of gasoline is less than it was the day before. And they're the kind you read about in the paper when someone else's house is now much more affordable than it was a year ago. The bad kind of falling prices, on the other hand, are the kind that keep economists up at night worrying. They're the kind of falling prices that put Japan into a 20-year on-again, off-again slump. They're the kind of falling prices that lower the value of your own house below what you paid for it and that cut your retirement portfolio in half. But here at The Daily Reckoning, we see it differently. No prices are bad prices - unless they are crooked and dishonest. An honest price is just information. It tells producers what to produce, consumers what to consume, and investors where to put their money. In a healthy economy, prices often fall...because businesses get better at making things. At least, this was true in the 19th century. Industrialization improved output rapidly and incomes and consumption increased. Prices held steady...or fell. But this was before the Fed got control of the nation's money. The dollar was worth about the same thing in 1910 as it had been in 1810. But here we are in 2010, after nearly 100 years of Fed control. What's the dollar worth today? About 5% of a 1910 dollar. Maybe less. Maybe that is what stock market investors are really thinking: stocks may not go up...but at least they won't lose 95% of their value as Bullard, Bernanke et al desperately try to fight deflation... Stay tuned... And more thoughts... "When I retired, I didn't know what to expect. I didn't know what I was going to do with myself. And my wife didn't know what to do with me either. It was pretty rough at first." We were talking to a slightly older man. He retired two years ago. "There seem to be two possibilities. Either the wife is happy to have the man back after so many years of work, when they might not have seen much of each other...or, she is annoyed to have this fellow butting in to her life. Some guys try to re-organize the kitchen...or try to bring some more efficiency to the management of the household. They're trying to 'help,' of course, but it's a very bad idea. "In either case, though, the man needs to find another occupation pretty fast...or things are going to go bad. If the wife is glad to see him, he should enjoy the attention. She'll probably get tired of having him around the house after a while. If she is not happy to have him in the house at all, he'd better make himself scarce right away. Otherwise, the marriage might not work at all. People establish a pattern after many years of living together. If you change the pattern all of a sudden, it may not work. "I found a couple of non-profit organizations I like to help. I'm busier now than I was when I was working full time. "And there are the children too. Once they hear you're retired they think of things that you can do for them. We have the kids on the weekends sometimes. Or, they need help moving. Or this. Or that. Honestly, I thought I'd have a lot of time to do nothing. I don't have any free time at all." Regards, Bill Bonner 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 atjoel@dailyreckoning.com Inflate Your Debts Away The US government owes more than it can pay. When a debt cannot be paid by the borrower, someone else must pay. Typically, it’s the lender who pays when the borrower defaults. But the US government doesn’t have to default. It has another alternative, the aforementioned quantitative easing – monetary inflation, in other words. Instead of defaulting on its debts directly, the federal government can inflate them away. Three Out of Four Economists are Wrong Housing Market Sinks Beneath the Waves Hedonic Adjustments and the Mulligans of Monetary Policy The average family income is $53,000, and add a couple of kids to the insurance, and you are talking about health insurance consuming 38% of their gross, before-tax, income! And if you dare use any healthcare services, the first $2,000 of expenses are all yours, too, which will cost $2,394 before taxes, and then another 20% of claims all up to the out-of-pocket maximum. Wow! US Economic Outlook: Indebted to Death No Stopping the Money Creation Machine 25% in US Have Worst Credit Possible... Here’s the Silver Lining Given the dismal state of US employment it’s no surprise that Americans are walking away from underwater mortgages and defaulting on consumer debts. These actions, though, are leaving a greater share of citizens in what is essentially the worst credit rating category possible, under 600 according to FICO. As of April, 25% of Americans are under this lowest threshold, an increase from 15% before the financial crisis struck. Budget Deficit, Birthday Suit Surplus The Bygone Middle-Class Golden Era