Posted on Tuesday, 30th August 2011 by Robert Domini

My Head is Spinning

Remember the old guns versus butter argument? The Nazi war machine used the metaphor to promote the buildup of the German Army. Joseph Goebbles and Hermann Goring popularized the argument stating that guns would make them powerful while butter would make them fat. Our government, in effect, debates the issue non-stop. Do we spend our money (as a percentage of GDP), on the military or on the production of goods? Or, to give it a sharper edge, do we spend our money, more on defense or on domestic programs, (otherwise known as social spending)? While attempting to build the Great Society, President Lyndon Johnson was frustrated that he was forced to spend on the Vietnam War and the Cold War instead of on social programs. Ultimately he fulfilled his social agenda by establishing long term programs that would be paid for by future generations. Today we have a class of big spenders who don’t really care what the dollars are being spent for, just so they get to spend. The taxpayer’s dollar is being used to buy a vote. The old butter versus guns argument is of no consequence.

There are those who argue there is a multiplier effect to social spending. The big spenders are making the argument today that for every dollar spent on social programs there is a multiplier effect of $1.85. But remember, that dollar has to come from one of two places. Sixty cents of it comes from someone else, an endangered species known as a taxpayer. The other forty cents comes from borrowed funds, likely the Chinese. The 60 cents that comes from another person is a “transfer payment”. It has a net effect of zero on the economy because it is taken out of the hands of one person and is put into the hands of another. This concept is also known as redistribution of the wealth. The borrowed forty cents is even more onerous. It has to be repaid, with interest.

Or, wait a minute, if we need more money, why not just print it? That’s a tool which has been available to the Fed now for many decades, traditionally used to regulate the economy. The idea was to use it to speed up the economy by “buying” securities, and vice versa. As a tool for fine tuning the economy, monetary policy has performed admirably. But, during the last two years, the Fed’s monetary policy has been elevated to an entirely new level. The Government has spent $3.2 trillion more than it has taken in. $2.3 trillion of the shortfall has been paid with printed money. You might ask where our Fed has gotten the money since they really don’t have any money of their own. The answer is that they have diluted the equity of the dollar.

“Government Spending Cuts Have Hurt the Economy”

It’s being said now. It was said after the economy took a nosedive in 1936 costing FDR his Congressional support. The reason given then and ever since was that the Republicans forced spending cuts which killed the Golden Goose, aka the economy. Not true. Spending during the New Deal period was never cut. Fast forward to 2011. The Congress and the Administration just signed an agreement to cut spending… some time down the road. No cuts have been enacted yet. In fact, the Federal Budget rises about 7% per year on its own. It’s called Baseline Spending. Per yesterday’s WSJ, Federal spending has risen from $1.7 trillion in 2007 to $3.5 trillion in 2009 when the emergency stimulus bill was passed to pull us out of this recession. It is the famous $787 billion. But spending has stayed at that same “emergency” level ever since. In fact, it’s been at $3.6 trillion the last two years. So, Congress has avoided passing a budget these last two years why? So they could just keep spending at the same “emergency” level. So, folks, we have a permanent $787 billion stimulus plan in our budget whether we like it or not.

How’s this Impacting the Financial Markets?

About two weeks ago Congress and the President made an agreement to raise the debt ceiling by $2.5 trillion, thereby taking that issue off the table until after the elections late in 2012. In effect, the President does have a blank check to spend that money as he sees fit between now and the next time it comes up. This is why the S+P lowered the U.S. credit rating. The spending cuts are down the road, just like everyone thought they would be. As a result of the downgrade, investors are becoming more risk averse. Investors are flocking to the ten-year T-bill, bringing that rate down. The 10-year T-bill rate is the rate most often used to help set mortgage interest rates. Yet, foreclosures are surging. One out every three residential sales is a foreclosure.

For commercial real estate the market has a split personality. Some investors feel that with real estate at least you’re getting a hard asset, not a piece of paper. Yet, the negative news is piling up for the first two quarters of this year. Growth is averaging just 0.5%. There is now a much greater risk premium in the investment markets. Capital is going to be even more difficult to raise. Consumer spending is sure to become weaker and the ripple effect will follow on down the line to commercial real estate. Shoppers staying home will reduce retail spending, thereby increasing vacancies. Demand for goods and services will decline, reducing factory utilization and the demand for office space. Despite the negativity, compared to the alternatives, CRE, commercial real estate, is still a hard asset. Solid properties with good leases are still a commodity in demand. Cap rates had been falling the last year to eighteen months, and we don’t expect them to turn around and go the other way.

The markets are complaining about political gridlock. What do you suppose they mean by that? The left staked out a position where they did not want to cut any spending, but rather to raise taxes. The right refused to raise taxes and insisted on cutting spending. The agreement made laid out plans to cut spending very gradually. The national debt will not be coming down any time soon, so I wonder what they mean by gridlock, and what they really wanted Washington to accomplish.

Investors are lamenting that Washington had a scuffle over raising the debt ceiling which caused, they say, a decline in consumer confidence. They feel that the economy was just picking up a head of steam when old Washington started going at it. The problem is the economy had a head of steam based on printed money and that didn’t even goose it up enough to lower unemployment. Now that we are no longer printing money, the economy is left to survive on its own, and the road is pretty rough.

Could it Be The End for Gold?

On Wednesday, August 24, the price of gold declined a stunning 5.6% following a 1.6% drop on Tuesday. The price of gold has been on a non-stop run now for several months and almost literally for years. Glenn Beck says in commercials that he started buying gold at $300 and started recommending it at $900. I can remember Dock Treece, Sylvania, Ohio, recommending gold four or five years ago. A few months ago he mentioned to me that he wasn’t feeling as bullish about gold any longer. That was about $400 ago. Just remember, no one can perfectly predict the future, though many of us try, don’t we?

Investors Betting on QE3

As insane as it would be, there is actually talk of more printing of money. If they do it, buy, buy, buy stocks, that is. Regardless the fundamentals, the stock market just seems to love printed money.

Florida Real Estate

Notice I haven’t been talking about that much the last couple of years? Of course I’m licking my wounds. There went my retirement nest egg; at least for now! Who would have ever imagined that the downturn would go this long and this deep? Not I. Well, we’ve got a real deal for you in Bonita Springs right on an inlet of the Gulf in a building for which I am on the Board of Directors. A penthouse is coming up for foreclosure sale soon, and it could be really soon, like next week. Let me know if you’re interested and I can let you know the details.

CoStar says the era of “Extend and Pretend” is Coming to an End

This is good news, they say, for investors because for so long, investors in prime properties have not been able to find many foreclosure opportunities. Well, now the banks are finally facing up to the reality of their credits. This is really big. They are expecting between $40 and $60 billion in distressed transactions in 2011. They are forecasting $850 billion in loan maturities this year. Remember a few years ago we learned that investors were paying premiums for commercial real estate based on cap rates calculated from interest-only loans. When banks stopped making interest-only loans, the cap rates immediately increased a couple of hundred basis points. They have since come down, but today CRE values are considerably down from the highs of a few years ago, specifically 2005-2007. With values down, investors are being forced to come up with more cash or face foreclosure.

And Now for the Good News

Jones Lang LaSalle is saying, “Overall net absorption is positive, leasing volume is steady, oversupply is gradually disappearing and prime rents are pushing up as the supply gap for prime assets deepens in many core markets.”

Believe it or not, second quarter 2011 commercial and multifamily mortgage loans were up over 100%. They say that lending was way down in 2009 and 2010, but this year the markets have been much better. Those performing strongest are health care, hotels, retail, multifamily and offices. The office recovery has been uneven, performing admirably in what are known as gateway cities. The rest of us, well, we’re not so good. The U.S. CBD office vacancy rate is down from 14.6% to 13.7%. Apartments have actually been on a tear now for some time.

From the Author

This update has been brought to you by yours truly,

Robert D. Domini, MBA, MAI

President, Continental Valuations, Inc.

Remember us for your real estate appraisal needs; purchase, refinance, tax appeals, business planning, estate and trust, eminent domain, etc.  We can handle your property appraisals most anywhere in the U.S.

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