BFP Management Blog

Archive: October 2011

Deciphering the Noise

Lately, lots of conflicting economic information has come our way in a hurry. Our national government makes California’s disfunction look sane as they wrestle with the “debt ceiling” debates which if all sides had recently maxed taxes and cuts, it still wouldn’t have slowed the massive borrowing. Standard and Poors cut the AAA credit rating on US bonds. The stock market swings by hundreds of points in a day. Gold is hitting record levels on a daily basis. Unemployment is still extremely high by historical standards while the housing market continues to worsen. Apartments however in many markets are seeing a cap rate compression while NOI’s are growing.

Where should you invest your money? Savings, stocks, currencies, bonds, real estate?

It is clear that there is widespread panic which is causing these swings. There are also some serious undercurrents that must be considered. For one, the sovereign (most countries in Europe, the UK, Japan and the United States) debt issue continues as countries are drowning in red ink yet they still need to borrow more. At the same time investor confidence in loaning additional money wanes. If a country (i.e. Greece) defaults, it will force banks in other countries into bankruptcy and show that if judged by the collateral of their outstanding loans (forget “the stress tests”) with any measure of adequate cash reserves then nearly every major bank in Europe, UK and the US is insolvent. The fear of cascading collapses of sovereigns and banks is very real.

Another undercurrent is the Federal Reserve Bank of the United States deciding to keep interest rates at zero through mid-2013.

 Figure 1

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Clearly the strategy in Europe, the UK and especially the US is to essentially tax savers for the benefit of the banks. Those who have money market or savings accounts are being punished for their frugal ways by being paid almost 0% to help build bank balance sheets from use of this cheap money. At the same time we are being encouraged through policy to invest since any yield seems attractive by comparison.

This has been the economic strategy that Japan has employed for over 20 years after their massive asset bubble (tripling of land and stock prices in the 1980’s) burst and it has resulted in the “lost decades” which has meant little to no growth. The official interest rate has been 0.1% for many years and the government is actually running a larger deficit (as a percent of GDP) compared to the United States. While many would argue that this has been a slow moving train wreck which staved off a collapse of the Japanses banking system, this will end up being a very long kick of the can.

Figure 2


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In figure 2, we see that everytime GDP drops (year-over-year) by more than 2%, we have had a recession. We are at 1.5% year-over-year which is like an ominous dark cloud above our heads.

Figure 3

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In figure 3, the jobless rate in California has started moving up again. The White House recently forecasted high unemployment through 2012 nationally.

I’m predicting a continued soft economy with shocks and swings in the bond and equity markets. The government through FHA, Fannie, Freddie and Ginnie will tinker with allowing refinances of the federally guaranteed loans and ignore the current loan-to-value requirements so that homeowners can refinance (or basically lower their interest rates). While this would put billions of dollars back into the pockets of homeowners, it won’t put a significant dent in foreclosures. We may also see those same entities start renting homes instead of putting them on the market to sell. As there are over 2 million vacant foreclosed homes with as many at 10 million more in the pipeline, it will be interesting to see if the government becomes a massive REIT.

Ultimately, there will be a lot of distressed commercial and single family real estate coming available over the next few years. While in no real hurry, my vulture wings are beginning to flap!




Kyle Kazan


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