The 800 lb Gorilla in the Room

Whether Obama or Romney gets elected tonight, the next administration within the next four years will have two major crises that they will have to confront head on. One has been discussed frequently on the campaign trail – Iran getting a nuclear weapon, the other has been virtually ignored.  It's the 800 lb gorilla in the room.  We would prefer not to acknowledge that it even exists, which is, the inevitable financial collapse of Europe.

What most people don’t realize, or are unwilling to admit, there is no solution to the sovereign debt crisis in Europe. European leaders could assemble the brightest economist minds from all around the world together in one room, give them complete authority to act on the crisis as they see fit and it still would not change the ultimate outcome: Europe is going down. It’s inevitable. They are too far down the path to their own destruction to turn it around.

It’s only a matter of when, not if. True, they’ve done an excellent job “kicking the can down the road” these past three years and can continue to do so for some time to come but at some point the market is going to perceive their feeble attempts at a solution as putting a band aid on a gaping wound. When that occurs, market confidence will collapse taking down the European bond market and many of the European banks.

By now I suspect that many of you consider me a “nut job,” a “doom and gloom” type who thinks the world is coming to an end which I categorically deny. Humor me for a moment and for the sake of argument let’s assume my prediction is true. What then? How will this affect commercial real estate in the Pacific Northwest? To answer that question the following questions need to be answered:

• How will this affect trade with our largest trading partner, the European Union? We will see a substantial decline in our exports to Europe.
• How will this affect the U.S. economy? This will likely throw our economy into another recession.
• How will this affect our stock market? The stock market is affected by emotion. When things are good it soars far beyond any justification. When things are bad it plummets far lower than it should. In this case the stock market will initially plummet similar to what happened in 2008, maybe worse. At best it will be a roller coaster of a ride, soaring to new heights on good news and plummeting back down with any hiccup in economic news. This will not be a good time to be heavily invested in the stock market.
• How will this affect our bond market? It’s likely that Europeans will see our bond market as a safe haven and heavily invest in U.S. treasuries. If true, treasury yields, which are at historic lows, will likely go lower.
• How will this affect our financial institutions? This is where it gets ominous. The vast majority of our lending institutions should be unaffected. Only our five largest banks – Bank of America, JP Morgan Chase, Goldman Sachs, Citigroup and Morgan Stanley are heavily invested in credit default swaps on European sovereign debt. A credit default swap is a fancy term for bond insurance. Our five largest banks have insured a boat load of European sovereign bonds. When these European countries default on their bonds, these U.S. banks will be left holding the bag. Though these banks have confidently stated they have it under control, call me a cynic but I don’t believe them.  Between you and me, I hope they do. I truly hope they do because the alternative is these banks are going down.
• What response will the president (Obama or Romney) make to minimize the fallout on the American economy? This is where it gets interesting. The president has a very difficult decision to make: Does he let these five largest U.S. financial institutions go bankrupt? Or does he bail them out? Is the country in the mood to bail Wall Street out once again? Are these banks too big to fail? If he doesn’t bail them out will it not bring down the rest of the world’s financial system? Good luck Mr. President!
• So back to the original question: How will this affect commercial real estate in the Pacific Northwest? I think this can best be answered by looking back to the 2008 financial debacle. Four years ago some commercial real estate investors survived while others did not. The common denominator for survival was:
• Property type mattered. Apartments fared well. Office, raw land and single family subdivisions did poorly. Everything else was in between.
• Those properties that were modestly leveraged survived. Those that weren’t were taken over by the lender. 
• Those who have subsequently locked in long-term, low interest rate financing were the big winners.

When the Europe bond market collapses commercial real estate will be the investment that has the best chance to weather the economic storm. The stock market, on the other hand, will be a roller coaster basket case, the bond market will have incredibly low yields, and cash in the bank will yield no return. As long as investors invest in the right property type, leverage their properties modestly and lock in low interest rate, long-term fixed rate financing they will come out of this future economic crisis intact. And if inflation is the natural result of this disaster what better hedge against inflation than commercial real estate?

So am I a “nut job?” You decide.

China to Start Liquidating US Treasuries

Over the past several blog posts, I've focused almost exclusively on the sovereign debt crisis in Europe, and for good reason.  The next jolt to the world economy will likely come from Europe.  How well or should I say how poorly the European Union handles Greece defaulting on its bond obligations will determine the severity of the impact on the world economy.  There are lots of interesting articles on the sovereign debt crisis in Europe that I could write about.  But I'm going to let that situation percolate awhile and instead focus on an obscure article I read recently in the British newspaper, The Telegraph. 

In this article by Ambrose Evans-Pritchard, the head of China's central bank stated that Beijing plans to reduce its portfolio of US bonds as soon as it is safely possible.  At the World Economic Form, Li Daokui, stated that China will in the future be investing more in physical assets.  "We would like to buy stakes in Boeing, Intel, and Apple... Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries," he said. 

It is estimated that China owns $2.2 trillion of US debt, and is second only to The Federal Reserve in the amount of US debt owned.  While China accumulated US bonds over the last three decades, The Fed accumulated its bonds in the last couple of years as a result of the Quantitative Easing program, which ended in June of this year. 

China is clearly worried that about the US debt issue, which now exceeds $14 trillion.  Mr. Li described the debt deals this summer on Capitol Hill as "just trying to buy time," saying it will not be enough to stop the growing debt crisis that is mounting.

It's always interesting to see how the rest of the world looks at us in the United States.  So hearing the comments of a Chinese official in a British newspaper about how the U.S. is handling it's debt crisis is like being the proverbial fly on the wall listening into a conversation about your class behavior between your grade school teacher and your mom.  It's interesting to hear what they're thinking but at the same time you know there's going to be consequences.      

So why is this proposed change in China policy important to those of us in the commercial real estate industry in the Pacific Northwest?  Why should we care whether the Chinese are buying more of our debt or conversely liquidating their holdings of US bonds?  BECAUSE U.S. TREASURY RATES ARE DETERMINED BY SUPPLY AND DEMAND!!! 

We now know that both The Federal Reserve and China are planning to stop buying our debt.  So what happens when the top two buyers of our debt are no longer buying?  To make matters worse China intends to liquidate some or all of their holdings of US debt which will only add to the supply of bonds available on the market to be purchased.  Is it conceivable that the rest of the world can purchase their normal market share of US debt plus China's and The Fed's too?  I don't think so.  Logic tells me it's not possible but smarter people than me who are in the know may disagree. 

Assuming I'm correct, then the rest of the world cannot buy the volume of debt we are currently hemorraghing.  What then?  That means over time treasury yields (interest rates) will have to increase in order to entice enough buyers to buy our debt.  If treasury rates go up, then interest rates of all kinds will follow, including interest rates on commercial real estate.  One offsetting factor are the spreads over treasury rates that lending institutions are charging these days are close to an all time high.  If lenders wanted to absorb some of the rise in treasury rates they could do so by lowering the spreads they are charging.  That is a possibility.  Another possibility is that Congress and the president could pass meaningul legislation to reduce our budget deficits.  I'll let you determine the chances of that happening...

Source: China to 'liquidate' US Treasuries, not dollars; The Telegraph Blogs, by Ambrose Evans-Pritchard, September 15, 2011.

How Bill Gross Got It All Wrong

Earlier this year Bill Gross, the head of bond giant PIMCO, announced in grand fashion that he was getting out of U.S. Treasuries. His reasoning was quite rational: The end of the Fed's quantitative easing program, which ended in June, would be bad for bonds. Prices would fall causing yields (or interest rates) to rise. This would happen because the Fed was the number one buyer of U.S. debt. Without the Fed buying bonds one of two things would have to happen to prevent yields from rising:

1. Some other country would have to step in to buy the Fed's volume of U.S. Treasuries which was highly unlikely, or
2. The U.S. government would have to significantly moderate their borrowing to shrink the volume of U.S. Treasuries being sold on the market. At the present time for every $1 spent by the federal government about 40 cents of that amount is borrowed.

So what do you think are the chances of either #1 or #2 happening? Not likely is it? Looking at it from this perspective, it seemed quite unlikely that another country could purchase the enormous quantity of bonds that the Fed had been buying over the last two years. And it also seemed unlikely that the federal government would reduce its need to borrower.

This past week people were crowing about how Bill Gross got it all wrong and how he lost a lot of money for his bond fund investors. He even admitted sheepishly that it had been a "mistake" to get out of U.S. treasuries. Since Mr. Gross’s announcement in March the 10 year treasury rate has plummeted from 3.46% to 2.02% (Sep 2nd). So how does someone of Mr. Gross's caliber get it wrong? What did he miss?

Back in March when Mr. Gross made his announcement there was no way for anyone to predict:

1. That the sovereign debt crisis in Europe would reach critical mass this year. European leaders had been successful over the years in “kicking the can down the road” and it seemed likely this year would be no different. Wrong!
2. What the impact of the sovereign debt crisis would have on the U.S. treasury market. Fear of a default of sovereign debt by Greece and then by Italy has caused a panic among Europeans. And when panic ensues, investors take their money out of risky investments promising a return on their money and instead invest in less risky investments, in this case U.S. treasuries, where they focus on getting a return of their money.

What has happened is the law of supply and demand has kicked in. Concerned European investors have dramatically increased the demand for U.S. treasuries while the supply has stayed the same. When that happens, yields decline. It’s really that simple.

But the big question is, “How does this affect those of us in the commercial real estate market?” We are currently seeing historically low interest rates.  A lower interest rate means a lower mortgage payment which means better cash flows after debt service. If you own commercial real estate now is the time to lock in long term fixed rate financing.

I know I sound like the boy who cried wolf one too many times but some day we are all going to wake up and the world will be different. Some unpredictable catastrophic event will have occurred (a run on U.S. banks perhaps) causing interest rates to skyrocket and when that happens those who had the foresight to lock in the low rates will be the big winners.

Source: Bill Gross and the Case for Buy Low and Hold, Morgan Housel, The Motley Fool, August 31, 2011.

What Happens if Debt Ceiling is Not Raised?

You may be thinking I'm going to weigh in on the debt ceiling debate.  This reminds me of the old saying, "Fools rush in where angels fear to tread."  I'm not going there.  Not a chance.  I've heard everything from the world is going to end to nothing is going to happen and everything in between.  And likely you have too.  

What I am going to discuss is a bizarre side effect of this fiasco: contrary to everything I've ever read on this subject interest rates on U.S. treasuries are plummeting.  What's going on here???   

Regardless of what happens on the debt ceiling debate the U.S. is likely to lose its triple A bond rating.  The rating agencies have been threatening a down grade of our nation's credit rating not unless $4 trillion is reduced from our spiraling out of control federal deficit.  None of the proposals currently being considered are close to this amount of deficit reduction.  So the likely effect will be a downgrading of our bond rating.  If this happens then logic dictates that interest rates on everything will go up, from credit cards, to auto and home loans to loans on commercial real estate.  But no one really knows for sure the consequences of a down grading of our bonds.  No one.    

So how is it that on Friday last week the 10 year treasury rate plummeted 17 basis points and is now at 2.78% as of this writing?  This is the biggest one-day drop since December 2010.  A drop in interest rates seems so counterintuitive to me.  This is just the opposite of what I would think would happen.  The "experts" believe that investors view the stock market as being more adversely impacted by the debt ceiling debate than the bond market.  As a result investors are selling stocks (notice the Dow Industrials declined 537 points last week, the worst week this year) and are buying bonds.  Go figure!  There is a "flight to quality" - the selling of riskier assets, in this case equities, and the buying of the most secure investment available today - treasuries.

Other so-called safe havens will also benefit from this uncertainty caused by the debt ceiling crisis.  But gold, top-rated corporate debt or the bonds of other countries with triple A ratings are miniscual markets in comparison to the almost $10 trillion U.S. treasury market.  Investors are also confident that the U.S. Treasury will continue to pay the principal and interest owed on existing bonds, even in the case of a prolonged deadlock.      

In addition it is in China's best interest, as the largest holder of U.S. debt, to come to our rescue if things got out of hand with a gridlocked Congress in order to prevent serious harm to their huge existing holdings of U.S. treasuries.  

So for these reasons we are seeing treasury rates declining.  At least for now.  This is a great time to be locking in long term fixed rate financing.  If you are on the sidelines wondering when I should refinance, what are you waiting for?   

Sources: Debt Ceiling Deadlock Could Lower Interest Rates, CNNMoney.com, July 28, 2011; and Treasury Yields Fall By the Most This Year, Market Watch, July 29, 2011. 

What Impact Will Inflation Have on Commercial Real Estate?

After decades of little or no inflation there is mounting evidence that the Federal Reserve's Quantatitive Easing program is beginning to take its toll on the value of the dollar.  Shown below are some of these indicators:

• The Producer Price Index (PPI), which measures average changes in prices received by domestic producers for their output, is up 5.6% for the twelve months ending February 2011.
• Commodity prices are rising in relation to the dollar.  The price of gold hit an all time high earlier this week before settling down a bit.  Silver prices continue to soar hitting a 31 year high.  So far this year silver has gained 33% in value.
• A recent Deloitte Consulting poll indicated that 74% of those polled believe their spending will slow due to rising prices they are currently experiencing.

So what impact will inflation have on commercial real estate?  In the short-term the real question is what impact will the threat of inflation have on the Federal Reserve raising interest rates?  An increase in the federal funds rate would ease the concerns of those who fear inflation but it would likely have a detrimental impact on the fragile U.S. economy which is just beginning to show signs of recovery.  It's a delicate balance between these two policy positions.

In the long run, modest inflation would be a great benefit to commercial real estate, as long as it happens gradually so that the market can make the necessary adjustments along the way.  Real estate over the long run has been an excellent inflation hedge and it should be the same this time around too.  Over time, with modest inflation those commercial real estate investors who are currently upside down on their investment portfolio could gradually become whole again. 

My greatest fear is what happens in June when the Federal Reserve ends its own bond purchase program known as quantitative easing.  Who will fill the gap in buying U.S. Treasuries?  If no one steps in to the fill the void what will happen to interest rates?  Doesn't the law of supply and demand require that interest rates have to increase?  And more importantly how quickly will they rise and how dramatically?

Those are the questions that are currently being debated.  Surprisingly there is no clear consensus among the pundits.  We'll have to watch and see.  Stay tuned.  It's going to be fascinating to watch! 

Sources: PIMCO bets against U.S. government debt, Reuters, April 11, 2011; Don't Believe the Inflation Fear-Mongers, The Mark, April 12, 2011; Inflation Not a Threat? Most Consumers Aren't So Sure; CNBC.com, April 12, 2011; Gold Price Sinks After Hitting Ne High at $1,478, Gold Alert, April 11, 2011; Producer Price Indexes - February 2011, Bureau of Labor Statistics, March 16, 2011.

Bill Gross Thumbs Nose at Bond Market

Last week Bill Gross, who runs the world's largest bond fund at Pacific Investment Management Co., sold all government related U.S. debt from PIMCO's $237 billion Total Return Fund.  You may be thinking, "Why is this tidbit of news important to us?"  Good question.  When someone who is as knowledgeable about the bond market as Mr. Gross decides to get out of U.S. bonds there's a good chance that something signficant is about to happen.  Gross is betting that the discontinuation of the Federal Reserve's Quantitative Easing program (QE2) in June will have a negative overall impact on the bond market. 

Let's back up for a minute and explain some things.  QE2 is the Federal Reserve program of buying U.S. government debt instruments for the purpose of stimulating the economy.  In a period of only 28 months the Federal Reserve has become the largest owner of U.S. Treasury Bonds ($972 billion as of December) surpassing both China and Japan who took decades to accumulate their bond holdings.  Yesterday, Mr. Bernanke, Chairman of the Federal Reserve confirmed that the Fed will discontinue QE2 as planned by the end of June.

Bill Gross wonders when the Fed stops buying bonds who will take their place?  The Federal Reserve is currently buying $75 billion in U.S. bonds a month.  That's a huge amount.  So what will be the impact when the Fed stops buying?  It all goes back to the law of supply and demand.  If the supply of U.S. treasuries remains the same but the #1 buyer of bonds is no longer buying, in order to get others to absorb the excess supply the market will demand a higher rate of return.  It's as simple as that.  Gross believes that the current interest rate on 10 year treasuries is at least 100 basis points below the historical average.

If Mr. Gross is correct the logical result will be a significant rise in interest rates and it should happen before the end of this year.  If true this could have a dramatic impact on the commercial real estate market.  Rising rates would require a re-adjustment in cap rates upward to offset the decline in investment returns due to higher interest rates.   

Years ago there was a TV ad by investment banking firm E.F. Hutton.  The ad shows an E.F. Hutton fiancial advisor about to give confidential investment advice to his client in a crowded, noisy room.  Before the advisor speaks the crowd stops talking and leans their ear to hear what he has to say.  The ad ends with the slogan, "When E.F. Hutton speaks people listen."  Mr. Gross has just spoken and his actions speak loud and clear.  Are we wise enough to follow his lead is the only question?  
_________________________________________________

On a totally different note, treasury rates have plunged in the last few days.  The 10 Year Treasury rate at this moment is 3.20%, down 55 basis points since January.  On the surface this flies in the face of what is being predicted by Mr. Gross.  In reality this substantial dip in rates is being caused by the crisis in Japan.  Japan's stock market, has plunged 16% in the last couple of days and investors are taking their money out of their stock market and putting it into the safest investment they know: U.S. Treasurys.  How ironic.   

Sources: Gross Sees Trouble Ahead for Treasurys, The Oregonian, March 15, 2011; Pimco's Bet Against Treasurys Not Working (So Far), Wall Street Journal, March 15, 2011; Federal Reserve Enters Final Lap of Easing Policy, National Journal by Clifford Marks, March 15, 2011. 

What’s Going On With Interest Rates?

by Doug Marshall, CCIM
Market Assessment

Over the past 60 days, the yields on 10-year Treasury notes have increased from 2.41% on October 8th to 3.53% as of December 15th, an increase of 1.12%.

What's going on?

Let's begin with a US Bonds 101 class. The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government bond market and is used to convey the market's take on longer-term macroeconomic expectations.

All of the marketable Treasury securities are very liquid and are heavily traded on the secondary market. The treasury yield expresses the relationship between the face value of the security and the amount of return the investor receives.

If there are more investors selling bonds then those who are buying bonds, the value of the bond declines (the law of supply and demand). A reduced price on the bond results in an increase in the yield or return on the bond.

Another name for “treasury yield” is “interest rate” which those of us in commercial real estate follow very closely. When US Treasury rates jump up significantly, like they have since early October, it means that investors are dumping their bonds in huge quantities. I can’t recall the last time I’ve seen interest rates jump so dramatically over such a short period of time.

So the $64,000 question is, “Why are bond holders selling off their bonds?” I have surfed the web for an answer to this question and unfortunately there is no agreement among the experts.

Depending on who you like to read there are a variety of answers. But being fearless and little bit stupid I am going to give you my opinion (take it for what it’s worth).

But before I give you my assessment of the situation let me muddy the waters a bit with some conflicting information.

Data released by the Treasury Department yesterday indicated that the Federal Reserve, China and Japan have recently been on a U.S. bond buying binge. The Fed is now owns $972 billion in Treasury holdings which surpasses China’s $906 billion (now the 2nd largest hold of U.S. treasuries).

And with more Quantitative Easing 2 purchases on the horizon it is highly probable that this lead will be greatly extended.

At the very same time, the debt crisis in Europe with what has happened in Greece and Ireland is continuing. Adding to the problem, on Tuesday Moody’s downgraded Spain’s sovereign debt causing further turmoil in the bond market. There is a very real debt crisis going on in Europe which is resulting in European investors transferring their wealth into (you guessed it) U.S. treasuries.

So in recent weeks bond purchases have been exceptionally strong by the major holders of U.S. debt and by the Europeans concerned with their own debt crisis but not nearly enough to offset all the little guys out there who own bonds and who are running scared.

Why are they running scared? There are two reasons that I think make the most sense

1. The Fed’s policy of QE2 is not working as planned. The printing of money by the U.S. Treasury and the purchase of these bonds by The Fed is perceived by the holders of bonds to be inflationary which makes their modest fixed yields less desirable if inflation is going to come roaring back
2. The other issue spooking bondholders that’s surfaced recently is the possible agreement by the Obama administration and Congress about extending the Bush era tax rates for another two years.
   

The compromise between the White House and Republicans included extending employment benefits for another 13 months which combined with extending the existing tax rates will increase the national debt by another trillion dollars. This means the U.S. Treasury will need to issue more bonds to cover the debt.

That being said, I believe that Ben Bernanke will do everything in his power to calm the bond market. What tricks he still has in his bag is anyone’s guess but he will do whatever he can to avoid runaway inflation.

Stay tuned. It’s beginning to get interesting.

Sources:
Fed Surpasses China in Treasury Binge, The Street by Eric Rosenbaum, December 15, 2010;
United States Treasury Securities, Wikipedia;
Bond Prices Fall Sharply after Federal Reserve Says It Will Continue to Boost Economy, The Associated Press, December 14, 2010.

Why Interest Rates Will Rise

Doug Marshall, CCIM
Market Assessment

Shown below is an article written by Ted Jones, PhD who is the Senior Vice President-Chief Economist for Stewart Title Guaranty Company.

Mr. Jones opines about why interest rates will rise in the near term. He predicted back in August that rates would rise 100 basis point increase (1%) before the end of this year!


I wrote last month how a typical Japanese investor that had purchased a two-year Treasury note lost more than 10 percent per year on their investment – see post from September 27th – and that the only way they would keep coming back and buying U.S. Treasury instruments would be an increase (eventually) in interest rates.

Since then at the 17 economic forecast presentations I have given, the issue of rising rates seems to be most contemptuous by the audience. Simply stated, they believe that with no demand for money rates should not rise.

My response is that there is massive demand for money—but not in the typical avenues of home purchases, autos and other durable goods—and that is in record federal deficit financing and corresponding record-trade deficits.

Just look at the article link from the Wall Street Journal on Friday. The August trade deficit approached $50 billion ($46.3 billion to be exact) of which $28 billion was with China (and the $28 billion was an all-time record). Wow.

Add that to a massive Federal deficit in this past fiscal year of $1.3 trillion in 2010 and an a projection of $1.1 trillion in 2011 (that’s the off-budget surplus which reduces the deficit by estimated excess Social Security cash flows—with the 2011 on-budget deficit of $1.154 trillion) and you are looking at almost a couple of trillion of equivalent borrowing. Massive.

Looking at it another way, just contrast the Federal deficit of 2009 through 2011 to total commercial real estate lending in place and total first-lien residential loans in place.

Fannie Mae estimates that as of 2010 first-lien residential lending outstanding is $9.6 trillion and other sources tally total commercial real estate lending at $3.5 trillion. Total Federal deficits in 2009, 2010 and 2011 are estimated to be $1.4 trillion, $1.3 trillion and $1.1 trillion, respectively, for a total of $3.8 trillion.

That means that in just a 36 month period, the Federal government borrowed more money than all of the total commercial real estate loans outstanding. When comparing residential lending, that equates to 40 percent of the amount of the total first-lien lending outstanding on U.S. homes. Now you see that there is significant demand for borrowing.

Now throw in the inflation data contained in the linked Wall Street Journal article, and you might start being a believer in rising rates. Wholesale prices in the past three months jumped 1 percent (and yes—that includes energy and food, but unless you do not eat nor use any energy then that remains the appropriate factor) which annualizes to a potential 4 percent annual wholesale inflation rate.

The Fed released on Friday their expectations on inflation, but do not be surprised if they respond by stating they are going to increase the money supply by printing more money—which in the long run will be inflationary.

And that is my two cents. Or with inflation 2.08 cents……

I hope for all of our sakes that he is wrong about rising interest rates. What impact would a 1% rise in interest rates, over a short 3 month period, do to commercial real estate sales?

My guess is that everything would come to a stop until cap rates adjusted upward. And if you haven’t refinanced your properties, what are you waiting for?

Greece: Standing Alone?

Doug Marshall, CCIM
Market Assessment
Published May 4, 2010

On April 27, Greece had their bond status cut by Standard and Poor’s, downgraded to ‘junk’ status, which set off a chain reaction in stock markets throughout the world.

On the same day Portugal, too, had their bond rating reduced. A day later, Spain’s debt got classed lower, from AA+ to AA. Who’s next?

The critical question is whether the proposed bailout action being worked up now going to be sufficient to keep Greece out of default on its European Union obligations?

The approach to Greece seems to be attempting to redress two rather co-dependent issues: 1) how to keep the “contagion” from spreading, through a massive combined bailout effort and a drastic tightening of the Greek belt through austerity measures, and 2) how to infuse confidence in euro debt-holders around the world who have dropped European debt like they were holding hot coals.

Jean-Claude Trichet, European Central Bank president, said a Greek default was “out of the question”. But several market analysts with MarketWatch.com, of the Wall Street Journal, suggest that the EU go ahead and cut Greece loose.

It is being argued that expulsion from the EU is not a terrible or irresponsible idea, in that the contagion spreads no further and Greece learns a lesson over the next few years while it gets its collective house in order.

It’s clear that one whisper of default causes many debt-holders to run for the door. But people seem to question whether this situation should be seen as an emergency encompassing the entire EU, simply because EU confidence and influence create domino-like effects. Or should it be considered as Greece problem and spare the rest of the EU shares in its drama?

But while these analysts suggest that the Greek situation and its long-term effect on the euro and world stock markets may be exaggerated, there is no exaggerating the way in which institutional investors have responded to Greece’s financial woes.

The euro has dropped to a new one year low compared when compared to the dollar and is continuing to fall in value. Since mid-2008 the euro has lost a whopping 16 percent of its value when compared to the dollar.

More importantly, from our view point as Americans, investors around the world are buying U.S. Treasuries, which is the typical “flight to quality” that occurs during times of crisis. This increase in demand of U.S. Treasuries has caused interest rates to drop significantly during the past few weeks.

The 10 year treasury was recently above 4.0% and at the time of this writing is now at 3.59%. This bodes well in the short run for our economic recovery as the crisis in Greece will keep our interest rates lower than they would otherwise be.

One thing is certain: comparisons are easy, but the reality is harsh. Barring a removal from the EU by the governing body, a numbing idea, Greece and other nations will have no choice but to issue more and more debt holdings in order to survive.

And who is buying those these days?

Sources:
David Oakley, Alan Beattie, Kerin Hope; “IMF Looks At Offering Greece More Cash”, FT.com April 27 2010
Jon Markman, “Let Greece Default On Its Debts”, MarketWatch.com April 28 2010
Nicholas Kulish, “Europe Looks To Aid Package As Spain’s Debt Rating Is Cut”, The New York Times April 28 2010

The China Effect On The Dollar

by Doug Marshall, CCIM
Market Assessment
Published September 15, 2009


During America’s recent economic swan dive, we must admit that we have issued some dire warnings and predicted some difficult times.

But we’ve also come to the conclusion that we need to focus our attention these days on some key financial indicators instead of rambling all over the place about the bad news.

Right now, we believe, the key financial indicator to watch is the health of the dollar.

The almighty dollar has been for many investors the most important, reliable, and used currency in the world. The question is – what is the dollar’s long-term outlook?

To prognosticate accurately, one must think globally because the dollar really isn’t ours anymore. It belongs, in the purest sense, to whoever has the most of them. Um, that would be China (see chart below).

As we wend our way through the economic morass, America has counted on the ability for China and Japan, among others, to continue buying Treasuries at their typical rate.

Right now, though, that demand has slowed, especially for long-term Treasuries.

This is bad news for Washington. When investors got nervous about the crazed spending, borrowing, and printing of money from the Bush & Obama administrations, they backed off on the purchase of Treasuries, which is how Washington raises cash to fund their agenda.

Now, to make matters worse, China has actually begun selling, in net terms, their massive holdings of Treasuries.

And, according to Mike Larson of MoneyandMarkets.com, “One thing seems clear: that one of Washington’s most dependable sources of loans to finance our out-of-control deficits is drying up.”

Mr. Larson quotes the following figures in coming to this conclusion:
· In 2006, China and Hong Kong accounted for more than 50% of the increase in the amount of Treasury debt sold to the public.
· In 2008, their share had fallen to 22% of newly issued treasuries at the same time that the U.S. government increased its public debt by a record $1.2 trillion.
· In the first half of 2009, China and Hong Kong acquired only 9% of the more than $800 billion worth of Treasury bonds that were sold.
· In June of 2009, China actually reduced its note and bond holdings by $25 billion.

The sour appetite for Treasuries across the board is a concern to the Federal Reserve. Without a robust demand for U.S. Treasuries, treasury rates will have to increase to spark additional interest.

Higher treasury rates mean higher across the board rates for everything from auto loans, home loans, business loans, you name it.

So what would be the upshot of all this? At the least, higher interest rates would be inevitable as a result of China more and more leaving Treasuries where they sit on the table.

And in that process, the hope of vigorous economic recovery gets squashed.

Doggone ripple effect…!


Sources:
China Is Now A Net SELLER Of U.S. Treasury Notes And Bonds!, Mike Larson, moneyandmarkets.com (9/6/09)
U.S. Concerned on Debt Demand, Treasury’s Dollar SaysBloomberg News (9/11/09)

Fed, Focus! Beef Up That Dollar!

Doug Marshall
Market Assessment
Published June 19, 2008

The Federal Reserve, in continuing to focus on preventing recession and a greater economic downturn through interest rate-cutting, is now doing the American economy a disservice, according to Zaya Younan of Facts Matter.

Mr Younan, while applauding the aggressiveness with which the Fed has restrained the shadow of recession, points to the same rate-cutting done in the early months of 2008 as a primary reason for the current weak dollar and, not coincidentally, the rise in prices of commodities and inflation.

The U.S. dollar has taken a hard hit, dropping sharply to $1.5535 with the Euro (as of June 18, 2008), and will continue to fall unless the Fed takes off the rate brake and starts to increase them in an attempt to boost the battered greenback.

Until treasury rates come up and the dollar strengthens, Mr Younan sees inflation going further and creating the same recession that the Federal Reserve has sought so hard to avoid: consumer spending drops; commodities and gas prices jump; major corporations post deficit earnings; and economic growth goes negative.

While the Fed has announced that it will not be lowering rates further, it is imperative, says Mr Younan, that the Fed continue to play with and increase interest rates in an attempt to achieve equilibrium between diverting recession and dampening inflation.

Although we in commercial real estate wince at the prospect of higher interest rates it’s probably understood by all that such a move in this market will become more and more necessary. And the alternative (a devaluing of the dollar in relation to other currencies), at least according to Mr Younan, must be seen as even more unattractive.

Source:
Facts Matter by Zaya Younan, for GlobeSt.com, June 9, 2008

Bonds On The Ropes

Jennifer Sinclair
Summary of Market Information
May 9, 2008

In assessing how stocks, bonds, and treasuries are moving, the conclusion has been drawn that U.S. markets are headed down a tough road.

Bonds had, since June of last year, been trending upwards. Now, however, they seem to have peaked and, indeed, are moving frighteningly close to nasty falls and downward spirals.

Costs of mortgaging and other kinds of financing are in a position to get driven up, by spiking yields on Treasury notes. And, considering that the federal funds rate is yielding below inflation, real interest rates stand at negative values.

So, should inflation roar in, bond yields have the potential to soar, and even the conservative Federal Reserve is beginning to pay attention to that possibility. Kansas City Fed President Thomas Hoenig admitted that he is seeing “inflation psychology to an extent that he hasn’t seen since the 1970’s and early 1980’s.

So those looking to invest are advised to stay away from long-term bonds, a losing investment in an inflationary environment like this.

And for heaven’s sake lock the rates on any mortgage or borrowing instrument. Get financing for your project early and hang on to the interest rate, so that trying times don’t try your wallet.

Source:
Mike Larson, www.moneyandmarkets.com, May 9, 2008