Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
9:00 AM EST, Monday, December 17, 2007: I
spent the weekend trying to get my arms around the sub-prime problems and what
they mean for you and me. My overwhelming conclusion is simple. We'll weather
this crisis as we have weathered others -- from the savings and loan crisis
of the 1990s to the Tech Wreck of the early 2000s. It's only a matter of time.
This one will take two years. In that time:
1. Cash remains king. It is hard to borrow and it will remain hard to
borrow. Everyone -- from banks to hedge funds, from investors to home owners
-- are hoarding their cash, fearful of the unknown. Sadly, there's no reward
for holding cash, other than as a security blanket. Short-term interest rates
Your cash should be in the safest place around. There is fear that some
of the banks' short-term money market funds may actually be "invested"
in "iffy" securities. The safest place for money is $100,000 in many
separate bank accounts. If you have a joint account with your spouse you can
go to $200,000. I have some money in bank CDs. This morning I'm questioning
what the CDs are invested in. If I don't get a satisfactory answer, I'll yank
my money asap.
Distressed assets make sense under only two conditions: First, the property
has real cash returns (also called rents). The rents are below market. And the
rents pay all your carrying costs (including mortgages and taxes) and then some.
Second, you find your dream house in which you want to live. A beautiful house
on a lake with nice acreage makes 1000% more sense than a recently-built house
in a half-finished development alongside a golf course that doesn't have sufficient
members to pay for its upkeep.
This is the time to invest personal effort and monies in your own business.
Anything you can do to improve your customers' experience -- speed of service,
quality of product, etc. -- will repay itself a thousand-fold when we emerge
from this. Get on a plane. Go visit them. Cuddle them. Love them. Do whatever
This is not the time to be in the stockmarket. With institutions and individuals
hoarding cash, there is now no prevailing enthusiasm for equities, except for
ultra-short-term day trading. We are in a bear market for at least a year. That
doesn't mean there won't be "bargains." There will be. But be wary
about gambling too heavily. If you do dare to go into the market, remember my
inviolate 15% Stop Loss Rule.
Three things will
determine how fast we recover:
1. How fast
financials get injection of new funds. Examples: USB just received an "emergency
capital injection" from two sovereign wealth funds. MBIA got $1 billion
from Warbug Pincus.
2. How fast
the Fed drops its interest rates. The Fed's BIG concern is not with saving
the stockmarket, nor the financials but saving the economy from inflation. Sadly,
inflation is rearing its ugly and threatening head. Nothing spooks central banks
more than escalating inflation.
3. How fast
housing recovers. Demand for houses comes from two sources: people who want
to live in them; and people who want to re-sell them quickly. One group is called
home owners. The other group is called speculators. The second group no longer
exists. There is still a demand for houses. People are getting married. Immigrants
are still arriving. We built too many houses. We have too many in inventory.
Ultimately demand will catch up with supply. I don't know when. No one does.
Interestingly, in the last year there has been a sharp reduction in the
number of new households being formed. More people are putting off marriage
and living with their folks, for now at least.
The worst thing
about today's financial mess is that we don't know its extent. The good thing
is you have to be optimistic. We've come through all the previous dumb asset
bubbles (from tulips to tech stocks) stronger. And we will this time too. But,
for the meantime, it is not business as usual.
This is what I'm
worried about --- in better words than I could express:
Moneys Gone by New York Times' columnist Paul Krugman
the Federal Reserve announced plans to lend $40 billion to banks. By my count,
its the fourth high-profile attempt to rescue the financial system since
things started falling apart about five months ago. Maybe this one will do
the trick, but I wouldnt count on it.
In past financial
crises the stock market crash of 1987, the aftermath of Russias
default in 1998 the Fed has been able to wave its magic wand and make
market turmoil disappear. But this time the magic isnt working.
Why not? Because
the problem with the markets isnt just a lack of liquidity theres
also a fundamental problem of solvency.
Let me explain
the difference with a hypothetical example.
theres a nasty rumor about the First Bank of Pottersville: people say
that the bank made a huge loan to the presidents brother-in-law, who
squandered the money on a failed business venture.
Even if the
rumor is false, it can break the bank. If everyone, believing that the bank
is about to go bust, demands their money out at the same time, the bank would
have to raise cash by selling off assets at fire-sale prices and it
may indeed go bust even though it didnt really make that bum loan.
loss of confidence can be a self-fulfilling prophecy, even depositors who
dont believe the rumor would join in the bank run, trying to get their
money out while they can.
But the Fed
can come to the rescue. If the rumor is false, the bank has enough assets
to cover its debts; all it lacks is liquidity the ability to raise
cash on short notice. And the Fed can solve that problem by giving the bank
a temporary loan, tiding it over until things calm down.
very different, however, if the rumor is true: the bank really did make a
big bad loan. Then the problem isnt how to restore confidence; its
how to deal with the fact that the bank is really, truly insolvent, that is,
My story about
a basically sound bank beset by a crisis of confidence, which can be rescued
with a temporary loan from the Fed, is more or less what happened to the financial
system as a whole in 1998. Russias default led to the collapse of the
giant hedge fund Long Term Capital Management, and for a few weeks there was
panic in the markets.
But when all
was said and done, not that much money had been lost; a temporary expansion
of credit by the Fed gave everyone time to regain their nerve, and the crisis
In August, the
Fed tried again to do what it did in 1998, and at first it seemed to work.
But then the crisis of confidence came back, worse than ever. And the reason
is that this time the financial system both banks and, probably even
more important, nonbank financial institutions made a lot of loans
that are likely to go very, very bad.
to get lost in the details of subprime mortgages, resets, collateralized debt
obligations, and so on. But there are two important facts that may give you
a sense of just how big the problem is.
First, we had
an enormous housing bubble in the middle of this decade. To restore a historically
normal ratio of housing prices to rents or incomes, average home prices would
have to fall about 30 percent from their current levels.
was a tremendous amount of borrowing into the bubble, as new home buyers purchased
houses with little or no money down, and as people who already owned houses
refinanced their mortgages as a way of converting rising home prices into
As home prices
come back down to earth, many of these borrowers will find themselves with
negative equity owing more than their houses are worth. Negative equity,
in turn, often leads to foreclosures and big losses for lenders.
And the numbers
are huge. The financial blog Calculated Risk, using data from First American
CoreLogic, estimates that if home prices fall 20 percent there will be 13.7
million homeowners with negative equity. If prices fall 30 percent, that number
would rise to more than 20 million.
into a lot of losses, and explains why liquidity has dried up. Whats
going on in the markets isnt an irrational panic. Its a wholly
rational panic, because theres a lot of bad debt out there, and you
dont know how much of that bad debt is held by the guy who wants to
borrow your money.
How will it
all end? Markets wont start functioning normally until investors are
reasonably sure that they know where the bodies I mean, the bad debts
are buried. And that probably wont happen until house prices
have finished falling and financial institutions have come clean about all
their losses. All of this will probably take years.
who expects the Fed or anyone else to come up with a plan that makes this
financial crisis just go away will be sorely disappointed.
old scam: Your phone rings. The caller identifies himself as an officer
of the court. You failed to report for jury duty and a warrant is out for your
arrest. To clear it up, the caller says he'll need some information for "verification
purposes" -- your birth date, your your social security number, your address
and maybe even a credit card number.
Bingo, your identity
has just been stolen.
Please send me a baby brother.
Santa writes back, "Please send me your mother."
immigrants are now the #1 presidential political issue
Jose and Carlos are panhandlers.
on different areas of town. Carlos panhandles just as long as Jose, but only
collects $2 to $3 dollars every day.
Jose brings home
a suitcase FULL of $10 bills, drives a Mercedes, lives in a mortgage free house
and has a lot of money to spend.
Carlos says to
Jose "I work just as long and hard as you do but how do you bring home
a suitcase full of $10 bills every day?"
at your sign, what does it say?"
Carlos sign reads
"I have no work, a wife and 6 kids to support."
Jose says "No
wonder you only get $2-$3 dollars."
Carlos says "So
what does your sign say?"
Jose shows Carlos
It reads, "I
only need another $10 to move back to Mexico."
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
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