Wednesday, December 17, 2008

Crisis of Confidence/The Last Bubble

Good evening Folks!

Stocks were down around 1% today after rising sharply yesterday after the Fed shocker. Ahhh....I don't even know where to begin.

Lets start with SRS since many are confused with the price action here. Here is whats going on. There are a few reason why SRS has dropped. I have two articles posted below that I would like all of you to read. The key trigger was a new tax law that was announced last week that basically allows REITS to pay dividends in stock versus cash. The government is trying to create liquidity out there folks and this was a nice win for the REITS that are now bleeding red and are short on cash.

Keep in mind folks, the Fed will pull whatever trigger they can in order to create this liquidity including even changing tax codes. Yesterday's Fed statement pretty much told you that they plan on doing whatever it takes to create liquidity and stimulate borrowing. HA! Like thats gonna work!

Here is the tax code story on the REITS:

"A real estate investment trust can pay its dividends with stock, says a new ruling released last week.

Robert Willens - US
December 15, 2008

While cash hoarding may not be a conventional reaction to the holiday spirit of giving, it is likely a prudent move for some cash-strapped companies. That is especially true of real estate investment trusts, which may be better off paying out dividends in stock, rather than cash.
The National Association of Real Estate Investment Trusts (NAREIT) thought so too, and in response to the current liquidity crisis, was looking for ways to provide incentives to REIT shareholders to nudge them to take stock, rather than cash, out of the trusts. One incentive was to provide shareholders with a tax deduction. However, a tax code threshold — specifically having to do with a cash cap related to a dividend election option — would have to be reduced to sweeten the incentive.

As a result, NAREIT implored the Internal Revenue Service to lower the cash cap associated with the aggregate shareholder distribution to 5 percent. Last week, the IRS budged a little — albeit not as much as the trade association would have liked. In IRS Revenue Procedure 2008-68, the government delivered a cash preservation incentive to REITS that was in line with recent private letter rulings, and dropped the cap needed to qualify for the deduction from 20 percent to 10 percent."

Here is article #2 regarding SRS and the REITS

"15:07 Fitch reports liquidity of U.S. equity REITs weakening Fitch reports the liquidity of U.S. equity real estate investment trusts (REITs) is showing signs of drying up. With U.S. equity REITs situated at the nexus of a recessionary economy, weakening property fundamentals, near-frozen debt capital markets and weakened stock prices, the implications for liquidity are broad. While most REITs maintain liquidity surpluses, the number of REITs with liquidity shortfalls has increased. "We are more concerned about the refinancing and funding risks for companies with liquidity shortfalls, and such companies face potential ratings downgrades should funding markets not reopen." Moreover, with commercial real estate debt markets stressed and asset sale opportunities limited, REITs are now largely reliant on bank revolving lines of credit to fund near term maturities, which concerns Fitch as the banking system is significantly strained. While Fitch found that health care and self-storage REITs have improved their liquidity positions in recent months, each other sector has weaker liquidity on average. That being said, REITs' capital structures have not changed fundamentally during the current economic downturn, according to Fitch. Going forward into 2009, "management team focus on cash preservation and access to multiple sources of liquidity will remain an important aspect of Fitch's REIT ratings."

My Take:

Article one was a big reason why SRS has been flushed this week. Who knew a tax code change was coming on their divi payouts? The reality here is paying dividends in shares of stock versus dollars does nothing but dilute the share price of the stock. This is not a game that will end well.

My story hasn't changed regarding the oncoming disaster in commercial real estate. Article #2 pretty much tells you why there was a tax code change. These companies are barely keeping their heads above water and are on the verge of imploding. There survival is purely based on continuing access to credit, and we all know how bad the credit markets are right now.

Adding to SRS's problems is the perception that the Fed will provide the liquidity necessary to keep the credit game going in all real estate. This is why you also saw the financials hold up fairly well again today. Credit is back! The problem is nobody wants it!

There is a big problem here folks. THIS IS ALL AN ILLUSION. The Fed cannot continue to supply infinite credit to everyone. Its trying to create the illusion that they can because they are desperately attempting to restore confidence. Folks, confidence is DEAD. The Madoff $50 billion Ponzi scheme may have been the last nail in the coffin.

The mortgage aplication story says it all. Mortgage rates have been free falling as treasuries drop. So what did this do for mortgage applications? They rose a whopping 2.9% from already patheticly low levels.:

"Dec. 17 (Bloomberg) -- Mortgage applications in the U.S. increased 2.9 percent last week as more homeowners refinanced to take advantage of lower interest rates.

The Mortgage Bankers Association’s index of applications to buy a home or refinance a loan rose to 841.4 from a revised 817.7 a week earlier. The group’s refinancing index increased 6.5 percent, while the purchase gauge dropped 4.5 percent.

Declining mortgage rates, brought on by Federal Reserve actions to purchase mortgage-backed debt, are making it more attractive for existing loan holders to refinance. Even so, the faltering economy continues to discourage home purchases."

Final Take:

Why was there no substantial increase in mortgage applications despite historically low rates? BECAUSE THE ECONOMY IS IN SHAMBLES AND NO ONE TRUSTS THE SYSTEM. There is absolutely zero confidence out there folks. Nada...None..Zilch.

Imagine if rates had dropped to these levels during the housing bubble. There would have been a bing fest in refi's as the flippers and speculators ran wild! No one wants to buy a house now because you don't know what its worth because they keep changing the rules. What if you buy at 4% and the Fed is unable to continue to keep rates this low and rates move to 8%? You are asking to get screwed until the rules stop changing. Adding to the problem here is unemployment is rising as the economy falters. Who wants to make a 30 year commitment when they don't know if they will have a job next week!

The Fed continues to ignore the fact that no one wants credit right now and the FED CANNOT FORCE THEM TO. The fact that they dropped the FF rate to zero and promised to buy up MBS and treasuries in an attempt to re inflate the housing bubble is frightening. I feel like I am watching a train wreck in slow motion!

How could they be so stupid? Cheap money is what got us into this mess. How does creating even cheaper money fix it?

When a heroine addict loses control you don't fix the problem by giving him an even higher dose of HEROINE! My god the idiocy here is beyond belief.

Bottom Line:

SRS and treasuries are now ticking time bombs in my opinion. The price action on anything financial related could be positive short term as the Fed floods the financial system with money. How long does this BUBBLEFEST continue? I wish I knew.

What I do know is it cannot be sustained and the response by the Fed does not fix the problem around the economy. The actions taken here does nothing but kick the can down the road, and put us even deeper in the hole from a debt perspective.

This game can't go on forever because the Fed is essentially using our tax money to buy treasuries in order to fund itself. Its also highly dependent on the world demand for treasuries. There will be a point where the world says NO MAS and demand for treasuries will drop dramatically.

The Fed has a little problem in terms of creating demand for our debt: TREASURIES ARE NOW PAYING ZERO PERCENT! Whose to say there isn't a "run on the treasuries" akin to a "run on the bank"? Furthermore: Perhaps everyone that's in money markets will decide to put their money in a safe at home or underneath a mattress.

Why wouldn't you if you are losing money every month. Treasury based MM's funds will be forced to pay you nothing plus hit you with their normal fees. This means you will lose money every month on your nest egg! How long will investors put up with this? I know I won't! I am very close to telling the banks to go pound sand and take my money out of my CD's and sleep on top of them at night. Luckily I have a roomy mattress!

I can assure you I am not alone. The "unintended consequences" to these Fedactions are numerous, and I don't even think the Fed totally understands how the markets and investors are going to react to this.

I don't feel safe putting my money anywhere anymore. Making matters worse, nothing makes any fiscal sense because I get zero returns on anything thats considered to be safe. What starting to anger me now is I let the banks hold onto my money which then allows them to use it as capital to lend off of and make money.

Why in the hell should I allow them to make money off of my capital if they are paying me zero percent in return?

The safe is looking more and more like the safest option. The banks can go screw themselves as far as I am concerned.


Real quick. I sold my Goldman calls this morning for a tidy profit. I plan on continuing to scale into SRS. I see this as a great buying opportunity. It took an extraordinary combination of tax changes and historic Fed moves in order to get us down to these levels.

This ponzi debt game cannot be sustained and the Fitch article tells you that the REITS are hanging on by a thread.

That being said you need to respect the Fed's balance sheet. They will throw everything they can at this real estate problem. Buying into any financial or real estate shares should be done in increments versus all at once.

There is a lot I didn't get to tonight. 1873 will have to wait until later this week.

Stay tuned!


ZMonet said...

Jeff, As always, thanks for the insight, especially about SRS. I bought in at $52.87 today and plan on holding. With all this volatility I'm not sure stop losses serve all that well. I rather cost average in and see where it goes because I fundamentally think real estate i still headed down.

If you buy a house, will you change the website name to The Housing Bomb Shelter? It seems to be your only rational, albeit a good one, for buying now. It seems to me if the worst case scenario happened (i.e., your landlord became insolvent AND the mortgage holder wouldn't enter into a new lease with you..ala Fannie...then you could always buy a home then...or continue to rent someplace else).

Believe me, the 4.875% interest rates are enticing and hearing idiots like Cramer chirping, "Buy a house now, Buy 2" (Wasn't this guy just preaching fiscal responsibility just two weeks ago?!) but I still have another 17 months left on my lease and I'm not breaking it (my landlord is not insolvent).

You said a couple weeks ago that you'd do some posts on what a family connection was telling you about commercial real estate, but I never got to see your thoughts. Looking forward to it when you get the chance...

Finally, I forgot who posted here a few days ago about the hardship that has befallen them at mid-30s, but it was certainly sobering as to what matters at the end of the day.

Jeff said...


Your welcome.

I think cost averaging is a great strategy. The bulls use it to buy when stocks are moving higher. You can use the same strategy in reverse on the down side.

Cramer drives me insane. He is in the game so you need to ignore him. Anyone in stocks is going to try and spin this as a way to take the market higher.

These interest rates are great for people looking to refinance. The problem is if you hava e no equity and bought in a bubble area this isn't going to help you.

No bank wants to re finance a $600k mortgage on a house thats worth 400k.

However, if you have been in your house for awhile and have equity its a great opportunity.

If I eventually buy a house who knows what the name of this will be! I am not too worried about that because until deflation takes down home prices I will continue to rent.

I think my landlord is financially sound as well.

Good luck trading. $52 is a nice entry. This is a tough market. I continue to hedge long when I find a rare opportunity. This market is in a range.

Growler said...


If deflation is rearing it's head, would those who have money in MM funds not re-coup the loses via an increase in the value of the USD?

For you safety, I hope you do not put your money under the mattress. : )

Jeff said...


Also regarding my discussions with my friend in commercial:

His main point was that a lot of lending was done in commercial baseed on rental rates rising 5% a year.

As a result, many of the commercial borrowers lent way over their heads because rents are heading down not up. I didn't even get a chance to discuss the guaranteed BK's affecting occupancy rates with him.

This will further hurt revenues.

He thinks commercial is heading for deep troubles. This friend in commercial was in the commercial credit markets so he saw how the loans were done.

Jeff said...


That would work but have you seen the dollar lately?

Its crashing versus all currencies. I think dollar /yen is down to around 88 which is a 13 year low.

I think the US dollar may strengthen as everyone else falls apart, but this violent leg down is alarming. A strong dollar is imperitve to any sound economy.

BB doesn't seem concerned by the US dollar because he wants inflation. He is dying for it. Deflation is what keeps him up at night.

The fact that he is ignoring the US dollar and its value could blow up in his face if this USD correction gets outta hand.

Jeff said...

And G

My mattress is still empty for now. I may be in the safe buying biz soon though!

Avl Guy said...

Seaking of crisis of about Chrysler & Cerebus?

They sure know how to play poker via scary headlines!
Bush is game too, I bet he keeps stalling til Jan 5 when Congress returns, and dumps the auto bailout mess and its headlines back atop Pelosi/Frank.

Jeff said...


So True!

I keep hearing that an announcement is immenent on the auto bailout because GM will be out of money by the end of the year.

I have no idea how this plays out. You nailed it though...High stakes poker.

So is GMAC with their $38 billion in bonds. It will be interesting to see how that plays out.

flipdippy said...

Jeff...SRS could certainly be back up in triple digits in a few months, but it could also go close to zero before it rockets up. The government keeps changing the rules and seems intent on doing anything it can to prop up real estate until some sort of recovery can take over...and that's very bearish short term for SRS.

Avl Guy said...

The market can stay irrational longer than you can stay solvent. -- John Maynard Keynes

Jeff said...


So true.

We are bouncing back here nicely mid day here. Up almost $4.

I believe eventually we ge back to triple digits at some point in the near future.

Retail is a mess and once they start closing their doors SRS will take a moonshot. The government is running out of bullets, and I think of all the ETF shorts this is the best buy right now.

Lets see what happens!

Growler said...

SRS caveat. The IYR (index that SRS tracks) has broken out of it's down trend line. I've heard more than a few mention the reason may be because of little increase in construction, therefore, helping fight the enormous overhang of inventory. Thus a the "future looks brighter".

Both arguments make sense but as I've learned lately, common sense no longer applies.

I'm gonna trade the IYR for now as I'm hesitant to jump in on SRS, especially since it's a 3x ETF and has already taken a few trips to the moon.

Growler said...

EDIT: I'm shorting the IYR.

Sorry for the poor grammar, etc.

Growler said...

One last thing: As much as I want to remain an agnostic trader, I just can't see how we're gonna get a massive bear market rally w/out the participation of oil, a weakening dollar (but perhaps that correlation is over) and the incredible flight to safety.

Or am I missing something?!

Jeff said...


YOu nailed it as far as I am concerned.

Oil is dropping despite the fact that OPEC announced they are dramatically reducing production.

Dr. McHugh's news letter basically says that the bonds are pricing in the fact that we are headed for an economic depression.

He expects one more wave up early in the year followed by a monster crash.

He advises everyone to sell on the next wave up to raise cash for survival.

This guy has been spot on with his calls and I have never heard him sound so grim.

ZMonet said...

My prudent side tells me to take the 25% profit on SRS, especially since I've had it for less than 24 hours. I just don't want to miss the possibility that this makes a huge run. I've decided to set trade triggers roughly 10% below the high stock price as it rises. I'd be interested in getting other people's strategies on short turn-around trades.

Jeff said...


You can always sell half and let the rest ride.

This is a tough market. The bulls lost a lot of confidence today.

However, I don't see any conviction in either direction. I think GE spooked the market today.