March 21st 2010 I have been looking at the various indicators and although they are still not good, there are undoubtedly deals to be done. The question is: what do you want out of your deal? If you are looking for house prices to rise, then I suggest you forget it. It isn't going to happen. If, however, you are looking for income, then the deals are there. One of the most touted markets at the moment is the US market. Prices there are said to be rising, but I dont see it. They are only falling at a slower rate. We are also into what is called the "strategic default" period. Professor Luigi Zingales at the University of Chicago estimates 35% of home mortgage defaults in December were by folks who could keep up their payments, but decided it just wasn’t worth their while on an underwater property. Nine months earlier, that figure was only 23%. There are others who are practising what could be called "strategic non-payment". They could pay their mortgage, but choose not to. They are putting the money into a savings account, and when they finally get evicted, maybe in a year or two's time after what is effectively a rent-free period, they will have a nice deposit ready for a cheaper house. The whole of the US housing market is beset with false readings. There are so many games being played, not only by the government, but by banks, and occupiers, it is hard to see what is really going on. Several things are clear, however. Prices are still coming down, and they are likely to keep coming down for some time yet. The government has nationalised the two main mortgage companies, Freddie Mac, and Fanny Mae, and they are both running horrendous debt situations. The whole mortgage situation is totally toxic. The banks are in the same boat. Many are refusing to acknowledge the situation because by doing so it will destroy their balance sheets. By writing off a bad loan they must enter that in the books. By ignoring it, it does not show on the balance sheet. The simple way round non-performing loans is to enter into an agreement with the borrower that he can pay off what he can, and the situation can be reviewed in a year's time. The non-payment then becomes an extended loan rather than a non-performing loan. It is basically a fraud, and a hopeless mess. It also delays any real recovery. It effectively kicks the ball further down the road. The problem must be resolved, but cant be resolved unless either one of two things happens: either house prices rise, or the bank accepts the inevitable and writes off the loan, and thereby decimates its balance sheet. This is happening all over the western world. I wrote about it last year after I'd visited my bank here in Portugal. I was having an argument with an insurance company, and although they agreed in principal that they owed me money, there was a fierce argument over how much. I was led to believe that a settlement was at hand, and we all (there were a dozen of us all in the same boat) went to a mediation in Newcastle. It was a disaster. They offered us £5,000. I was thinking more in terms of £40,000. Naturally we walked out. Unfortunately, I had been relying on a deal, and was temporarily short of dosh. When I'm in trouble I go straight to the bank and tell them exactly what is happening. I prefer my bank to trust me. The manager said not to worry. They had lots of clients who bought several properties during the good times, hoping to flip them for a profit (obviously not people who read my advice in my newsletters), and of course, with a dead market they were stuck with these properties on heavy mortgages, and they had no way of paying off the loans. The bank came up with a scheme to lend these guys more money so that the extra funding could be put into a deposit account and subsequently used to pay off the original loans. So we now have a situation where the bank is effectively paying off the mortgage instead of the customer. The bank is digging a deeper hole for itself. The bank assumed the economic problems would all be over in 18 months, and things would go back to normal. I was going to fall about laughing at that point but thought better of it. But here we are almost 18 months down the line and things are looking no better, and with no prospect of them getting better in the near term. So what is the bank's next move? Another loan to pay off the first two? Foreclose into a dead market, putting a whole lot of red ink on the balance sheet? The whole scenario is a total mess, and without a rise in real estate values this mess can only get worse. As Professor Luigi Zingales says, this habit of simply not paying the mortgage is becoming the norm. And as more people do it, the stigma once attached to it falls away. “The risk that the number of people doing this might explode is significant,” says the professor. What we now have is a situation where the methodology the banks have been using to keep themselves afloat and pretend that all is well is in itself going to cause the markets to stay depressed. If the banks lend more money to broke clients, or let non-performing loans stay in limbo, they are, of course, going bankrupt themselves. If they foreclose they are shunting more and more property onto an already falling market, and this will reinforce the downward pressure of prices, pulling more and more people underwater with their mortgages. At this point, the housing glut appears to be self-reinforcing. The Census Bureau reports at least 6.6 million households had at least three generations under one roof in 2009. That was a 30% increase over 2000! That's some increase. There is also the problem of the US economic indicators. Although these problems are not limited to the US, but apply to several European countries, including the UK. Several countries are already past the point of no return. Even if America taxed 100% of all household wealth, it would not be enough to put its balance sheet in the black. And Professors Rogoff and Reinhart show that when external debt passes 73% of GDP or 239% of exports, the result is default, hyperinflation, or both. IMF data show the US already too far gone on both scores, with external debt at 96% of GDP and 748% of exports. Putting it bluntly, the US is bankrupt. As we know, Greece is technically bankrupt as well. Ireland, Italy and Spain are also bankrupt, and Portugal is teetering on the edge. If we move down the line a little we find the UK, Japan, and France are also edging closer to complete financial breakdown. We are in uncharted territory. I dont know where this is going, but however you look at it, things are in a serious mess. However, people have to live somewhere, and they have to pay rents (at least I think they have to pay rents). Certainly it seems that a lot of folks in the States are living in houses where they are not paying the mortgage, and the banking system (as explained above) has to live with that. So, are we approaching a time when renters will also start refusing to pay? I dont believe things have come to that just yet, but where things are going in America I cannot say. What does appear to be the case is that you can buy reasonably nice houses for about £35,000. The mortgage and insurance costs about $600 a month. The rent receivable is about $900 a month. That gives you a nice little earner, and the mortgage ought to be paid off within 15 years. After that the rent is all yours after local taxes have been paid. I will be adding similar deals to the Unique website over the course of the next week. These deals are fully managed. If you want a deal that brings you in a small income now, and a comfortable income in fifteen years time, then this appears to be a good deal. Next month I'll have a look at some of the indicators I use to show us what is happening in the world and where I think we are going. Best wishes john Back to the Top

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