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The Daily Reckoning | Tuesday, June 19, 2012 How the financial sector continues to profit from federal giveaways... The real US housing recovery: Closer than you may think... Plus, Bill Bonner with more on the great correction, trudging along despite all the bad press... ------------------------------------------------------- External Advertisement URGENT GOLD EVENT: This could occur in less than 24 hours We’ve just received information from a very credible source in the gold industry. It concerns an event that could be the single most profitable opportunity of the year in the gold industry... Potentially worth $100,000 or more to you. Click here to access the details. The Great Correction Continues Correcting Bill Bonner Reckoning today from Baltimore, Maryland... Overpaid b**tards! You gotta love this Great Correction. It’s gotten so much bad press. And so many people trying to stop it. But it just keeps going...doing its work. From Barry Ritholtz... — There have been an average of 1.6 million nationwide foreclosure starts per year for the past five years. — Foreclosure starts nationwide increased on an annual basis after 27 consecutive months of year-over-year declines. — Bank repossessions are still down 18% year over year. Voluntary foreclosure freezes and increasing pre-foreclosure sales are the primary factors. ...2.8 million Americans are 12 months or more behind on their mortgages. This truly amazing data point represents a very sad fact of the housing market. Once a homeowner falls that far behind in their mortgage, the odds are that they will never catch up. (Mortgage mods are likely to fail at an exceedingly high rate as well). Nearly all of these 2.8 million homes are likely to be some sort of distressed sale — short sale, auction, walkaway or foreclosure. The bottom line is it means we are looking at a minimum of another 3 million homes going into foreclosure (or some variant) over the next few years. Beyond the coming wave of foreclosures, credit availability is another factor holding housing activity down: Since 2007, 19% of all borrowers (~9 million borrowers) have gone >90 days delinquent on their mortgages, or have had their mortgage liquidated. In other words, one in five people who held or qualified for a mortgage not too long ago would not today. The 90 days delinquency on their credit reports prevents them from qualifying for a new mortgage. This is a very significant data point to the idea of a housing turnaround. Why? Based on this delinquency alone, nearly all of these borrowers — about 9 million current homeowners — would be unable to qualify for [a] bank loan today. That is 9 million potential home buyers who are effectively barred from the market due to their credit scores. Removing that many people as potential home buyers amounts to a huge reduction in demand. Isn’t that terrible? No, it’s just a correction correcting the overbuilding and overbuying in the housing market. And here’s more correcting.... (Reuters) — New claims for US state jobless benefits rose for the fifth time in six weeks and consumer prices fell in May... Terrible again, right? Wrong...the correction is doing what it’s supposed to do.Bloomberg: Americans are digging themselves out of mortgage debt. Home equity in the first quarter rose to $6.7 trillion, the highest level since 2008, as homeowners taking advantage of record-low borrowing costs to refinance their loans brought cash to the table to pay down principal. The 7.3 percent gain was the biggest jump in more than 60 years, according to an analysis by Bloomberg of Federal Reserve data. Residential mortgage debt peaked in 2007 at $10.6 trillion, doubling in six years, according to Fed data. Since then, it has fallen 7 percent as the value [of] all residential property has dropped 23 percent. But the correction is not correcting the sector that needs correction most. The financial sector. Why? The feds protect it. While the private sector digs out from under the burden of a debt bubble, the financial sector profits from federal giveaways. Wall Street CEO pay rose 20% in 2011. And here’s our new friend, Barry Dyke, reporting and commenting: ...while Main Street net worth has been pummeled, Wall Street asset managers’ compensation is soaring. In his new book, the author documents the explosion of the investment asset management business — which he calls the “asset management industrial complex” where managers are guaranteed Olympian paydays and consumers are left holding the bag with poor investment performance. The current financial report card for Main Street Americans is grim. In June 2012, the Federal Reserve reported that the median net worth of families plunged by 39% in just three years from $126,400 in 2007 to $77,000 in 2010. According to the Fed, the financial crisis, which began in 2007, wiped out nearly two decades of wealth — with middle class families bearing the brunt of the decline. This puts Americans roughly in the financial position they were in 1992. In three years, Americans saw two decades of economic efforts vaporize. Much of Americans’ wealth resides in retirement plans managed by the asset management industrial complex (mutual funds, private equity, hedge funds, banks, etc.) — which the author estimates to be a minimum $18 trillion. However, management fees eat up investor returns — creating headwinds virtually impossible to overcome. The author, citing Morningstar data, estimates that mutual fund shareholders — where most 401(k) funds reside — pay a minimum of 0.90 percent for every $10 thousand invested (and much higher when trading costs and other costs are factored in). Private equity and hedge fund managers—extract a much higher fee schedule, commanding 2 to 3% manager fee, plus 20 to 30% incentive compensation fee known as “carried interest.” [Private equity is where Presidential Candidate Mitt Romney made his fortune]. The author comments, “On a whole, investment performance from highly paid investment managers has been horrible over extended periods of time. According to Morningstar, over 61 percent of stock mutual funds have lagged the S&P 500 index over the past five years. In 2011, only 20 percent of funds beat the Standard & Poor’s 500-stock index, the worst showing for active fund manages in over a decade. Returns for private equity and hedge funds [both get much of their money from state pension funds] have been inconsistent, opaque, self-serving and hard to measure.” However, asset managers saw their compensation soar. According to reports filed with the SEC in 2012, in reporting to go public, the private equity firm The Carlyle Group [which gets a great of investment money from state pension giant CalPERS] reported that three billionaire founders David Rubinstein, William Conway and Daniel D’Aniello reported a combined payday of $402 million in 2011. Most of this compensation was in cash dividends, where financiers enjoy a highly favorable 15% capital gains taxation rate on income. The author details one of the greatest compensation crimes in 2008 when Citigroup and Merrill Lynch blew up and had to be bailed out by taxpayers for their failed cataclysmic bets in subprime mortgages. Citigroup lost $27.7 billion yet paid its top bankers $5.33 billion in bonuses. [In the same year Citigroup froze its cash balance pension plan for rank-and-file employees]. Merrill Lynch lost $27.6 billion and paid its top bankers $3.6 billion in bonuses. In 2011, Robert P. Kelly, CEO of Bank of NYMellon, a giant asset manager, got $33.8 million in severance and benefits as an exit package in 2011 just prior to the bank being sued by the US Justice Department for allegedly overcharging pension clients as much as $2 billion over a ten year period. Prior to this, Kelly was CFO of Wachovia, a failed bank which is now part of Wells Fargo. Not only were the banks bailed out during the crisis, most of the mutual industry was bailed out by the Federal Reserve. Regards, Bill Bonner for The Daily Reckoning The “Lost” Gold Bible Congress Never Wanted Anyone To See “Locked away” for almost 3 decades. Kept virtually secret...until now. You’ll soon discover why all the secrecy surrounds this book...and why it would be to your great benefit to read this book now. You’ll also see why I’m doing everything in my power to get this book into your hands for FREE by following one simple step Click here to read more. The Daily Reckoning Presents On the Trail of the Housing Recovery Chris Mayer One crisp fall Sunday afternoon under bright blue skies, my wife and I visited five homes up for sale. We remembered them by their street names: Big Acre, Blue Silo, Pontiac, Prairie Rose and Lamont. The lineup has a poetic ring to it, but the real music is the potential rates of return from owning them and renting them out. This was the second weekend we went hunting. It’s been a fascinating experience so far, and what I’ve found tells me the housing recovery is not too far off, despite all the dire talk to the contrary. The investment implications are many and varied. Being bullish on housing is a contrarian view. In a recent national survey, 37% of homeowners say they think buying a house is a “risky investment.” And 86% think prices will either stay flat or fall. This is a big difference from four or five years ago. But people always tend to gauge the future based on their recent experience, like trying to predict the weather tomorrow based on what it was yesterday. In 1958, for instance, the Federal Reserve did a survey in which they found 58% of respondents thought owning real estate was a bad idea. Of course, folks said that based on recent experience. In 1920, if you bought a home in the US, odds are it was worth about half what you paid for it two decades later. In many instances, it wasn’t until 1960 that housing prices got above pre-Depression levels. In this context, the feelings of people in 1958 were reasonable... but their predictions were wrong. So too people in the year 2011 will rue their bearishness on housing. The beauty of markets is how they self-correct, when allowed to do so. The housing bubble popped in 2008. Prices collapsed. The bust shredded the balance sheets of many an American family and did violence to their credit ratings. Today, foreclosures and short sales chew through the inventory of homes, re-pricing them and putting the assets on better financial footings. The prices of homes are now at realistic levels, supported by the rental market and more in tune with what people can afford. In fact, rental rates have been rising. In 12 of the 27 largest metropolitan markets in the US, it is cheaper to buy than to rent. In some markets, the gap is pretty wide. In Atlanta, monthly rental rates average $840. By contrast, mortgage payments, including taxes and insurance, average $539. So there is a good opportunity there for investors. Real estate is intensely local, of course. Housing markets are multifaceted prisms. It is hard to generalize. But clearly, there is value out there. One individual I know runs a partnership that has purchased 87 homes in Georgia and North Carolina during the last year. When he leases out these homes, his firm averages a 16.5% gross yield. That’s annual rent divided by purchase price, plus closing costs and estimated repair costs. And that is without leverage, net of all expenses, and includes estimates for vacancy and maintenance. This is what the big-picture guys miss. Economists can talk all they want about how a housing recovery is years away. Maybe so, but the opportunity to invest and make good money is now. In a world of 2% Treasury rates, 16.5% gross ain’t bad. I’m not seeing those kinds of yields in my home market, but more- modest cash yields are still attractive. I fully intend to put a mortgage on my properties, locking in rates that are the lowest in six decades. Don’t forget rental rates can rise over time, while the mortgage is fixed. When housing prices rise, you can really make a killing. Why does this opportunity exist? To me, it’s clear, especially now, after bidding unsuccessfully on one property and hunting for others. It’s simply because, in the post-bubble rubble, there aren’t that many people with the kind of clean credit and cash that can afford to be investors in residential real estate. Nor is there much appetite for it. But there are plenty of people with good-enough credit and cash to rent. Even so, we’re finding competition from other investors for the properties we’ve looked at. We’re not the only ones who have sat down and done the math. Now, I am not saying a housing boom is about to happen. There is more wood to chop before we get there. But I am saying that American housing as an asset looks cheap. And I think the free competitive forces at work are improving the market. It’s not getting worse. The bottom is in. Where rental markets are supportive of current pricing, I don’t see much downside. This has all kinds of investment implications beyond just buying a house and renting it. There is a lot of money that will go toward renovations as this process unfolds. Spending on home improvements is at a multi-decade low, well below the long-term historical trendline. This suggests a recovery in the future. The housing recovery is likely to be a long-term story. But here’s an early prediction: In the ashes of the bust, a phoenix shall rise. That phoenix is the humble American home. Regards, Chris Mayer 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 Dozens of Congressmen have used “inside information” to make a fortune on stocks... ..without so much as getting a slap on the wrist by the SEC. But did you know that there’s another way Congressmen pile up personal wealth while they’re in office? Senator Kerry did this recently and took home at least $92,723. What’s really surprising is that you and I can use this “trick” as well. Learn about the full story here.