Obama's Housing Plan - A Turning Point?

My last couple of posts have dealt with what I feel is needed for the economy to turn the corner and start the path to recovery. Although I didn't initially intend to start a series of posts on economic recovery, I think that with the recent flow of news coming out of Washington and Wall St. it's appropriate to continue this series with at least one more post.


One of the key points that I've continually advocated that needs to occur for an economic recovery is stabilization of housing prices. This basic phenomenon is what I feel will impact other key areas of the markets and allow the economy to recover. Earlier this week, Pres. Obama announced a $75 billion dollar plan to help troubled homeowners with their mortgages and avoiding foreclosures. Although stabilizing housing prices is not a stated goal of the plan (it's more to help troubled borrowers), I do feel that this plan is a good first step in that direction.


What Does the Plan Do?

Let's take a high level look at the highlights of the plan:

1. Refinancing Requirements - The plan will change the requirements to refinance a home to make it easier for homeowners to refinance to today's extremely low rates. Generally, a homeowner' s mortgage must be less than 80% of the home's overall current equity in order to qualify for refinancing. However, due to the severe drop in home prices, many homeowners now owe greater than 80% of the home's current value through their mortgage. With this plan, the 80% requirement is increased to approx 105% - as long as the homeowner is current on their mortgage payments and the loan is conforming (i.e. securitized by Fannie or Freddie). This means that even if your mortgage is worth more than your home and you've been able to make your payments, you are eligible to refinance your home.
2. At Risk Homeowner Initiative - The meat of the plan really is in the stability program for at-risk homeowners. This $75 billion dollar plan is aimed to help homeowners whose mortgage payments are an excessively large percentage of their income - either due to monthly payments that have increased due to adjustable rate mortgages, or loss of income due to a layoff, injury, etc. In this plan, the borrower would work with the lender to modify the mortgage in order to reduce monthly payments to at most 38% of the borrowers monthly income. The government will then step in and subsidize the mortgage in order to reduce the payments further to 31% of income. One thing to note is that this plan is strictly voluntary for the lender and they do not have to participate. However, if they do, then the government will pay the lender $1,000 per modified loan, plus another $1,000 per year for three years if the borrower stays current on the loan. Plus, if the borrower stays current on the loan, he/she will get $1,000 in tax incentives per year for 5 years.
3. Fannie/Freddie Strengthening - Finally, the plan also provides financial assistance of $200 Billion dollars to both Fannie Mae and Freddie Mac - the government agencies that help subsidize mortgages, thereby allowing for lower interest rates. This will help provide stability to the troubled organizations allowing them to continue supporting the US housing market.

My Thoughts on the Plan

I really feel that this plan is an excellent first step in the economic recovery process. As I've repeatedly stated, housing price stabilization is the key component in the economic recovery process. This plan is the first significant and detailed step towards creating this stability. With that said, however, I think there are some significant gaps in the plans themselves. There's always the obvious question as to whether the government should be stepping in and artificially supporting the markets as it is in this case, especially this late in the process. There's no doubt this is an expensive plan (although most of it will be paid through the existing TARP funds). But at this point, in order to stop the bleeding in the economy, the government needs to backstop the slide and provide a clear message in order to restore confidence. I think this plan is a good step in that direction.

Another glaring weakness in the plan is there is no provision for the government to get its money back if the market recovers. If in the next few years, housing prices recover and homeowners end up profiting from the plan more than expected, the government will not be able to reap any of those rewards.

Finally, another gap in the plan is that many homeowners that are current on their mortgages and are not distressed borrowers will not get any sort of aid in the plan. In a sense of fairness, I believe that incentives should have been placed for these types of owners to be able to refinance their mortgages at a lower cost. Otherwise, this plan reeks of welfare to those that were either irresponsible borrowers, are had misfortune in their lives (there's no distinction in this plan for those types).


All in all, if this plan is successful, I think we'll see a quicker stabilization of housing prices than we would have seen without it. The plan is supposed to get rolling by March 4th, so I hope to see significant participation by this summer. On a macro lever, this will hopefully result in housing prices beginning to stabilize by the end of summer or early fall with a resulting significant recovery in the markets by the end of the year.


Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.

Housing Prices Article

So to relate back to my last post on how housing prices are an indicator of the economic recovery, take a look at this article:

http://biz.yahoo.com/ap/090212/metro_home_prices.html?.v=10

Highlights:

• Home Prices continued their decline in the 4th quarter of 2008 (when compared to Q4 2007)
• Sales are up in the hardest hit areas
• Number of foreclosure notices fell when compared to Q3 2008

What does this mean to me?

Well, I think it reaffirms my original thought that we're still a long ways away from a economic recovery. As I said before, stabilization of housing prices is key in so many ways for the economy. Since we're not seeing this yet, I don't think we're going to see any economic recovery.


But hold on, there are some signs of hope. If the number of foreclosure notices fell last quarter, it would be reasonable to assume that the number of foreclosures may also decrease. If that indeed does happen, that would be a great first step in the right direction in stabilizing housing prices. Let's hope we see this soon!

PS: Check out CNBC's documentary tonight on the economic crisis. David Faber is an awesome reporter and I'm sure it'll be very interesting! Check it out at 8 pm EST tonight!



Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.

Where I Think The Economy is Headed

Probably one of the most common questions in everyone's minds right now is 'Where's the light at the end of this economic tunnel?' This is a questions that is as difficult to answer as it is relevant. There are so many variables that come into play when determining the health of any economy - things like manufacturing output, employment, savings rates, etc. etc. etc. all play their part. Investors, who's job is essentially to play soothsayer in order to determine where their investments are headed, generally look at a few key economic indicators to determine where the economy is going. I'll explain a few of these and tell you my thoughts of where we're going

What Indicators Matter

If you watch CNBC for a couple of hours (not like I do that at all...not at all) you'll probably hear about some sort of 'economic indicators'. Although it is important to understand what the indicators mean, it is just as important how they relate to the health of the economy. Some are leading indicators - those that generally predict the future health of the economy. Others are lagging - those that change direction after the overall economy does. When trying to predict the direction of the economy, it is important to make sure you're making the right assumptions when using indicators.

Leading Indicators - These indicators will generally start going positive (bullish) early on when the next recovery takes place.

1. Wholesale Inventory/Sales - This number describes the overall inventory wholesalers are keeping in their warehouses. Generally, sales start dropping first and inventories soon follow as wholesalers cut back assuming sales declines will continue. The most recent inventories number was the lowest in 17 years and sales were still declining steeply
   
2. Housing Prices - Especially in this recession, housing prices and their direction, will largely dictate many other aspects of the economy. Intangible indicators like consumer sentiment, and business confidence will likely stay low if the value of homes continue declining. So far, housing prices continue to decline, albeit not as fast as they were last year.
3. The Stock Market - You might not realize it, but when trying to figure out the health of the economy, the stock market is a great leading indicator. The reason for this is because the market pretty much gives a picture of where investors think the economy is headed. They try to take into account all these indicators and make a judgement, whether it's up or down. Right now, the markets are still near the lows for his recession. However, they've been near the lows for several months now without breaking lower, indicating that investors may think the economy is at a low itself, but isn't ready to recover yet.

Lagging Indicators - These indicators will turn positive once the economic recover is well underway.

1. Employment - Companies hire and fire as a reaction to where they feel their business is headed. Generally, they want to have a pretty clear picture of the economy before hiring or firing employees. Therefore, employment figures generally trail the economic recoveries as businesses will wait to see some signs of the recovery before hiring again. Personally, I think the rate of unemployment increases is reaching a peak because of the panic layoffs that occurred late last year and early this year. I see the unemployment rate (which stands approx. 7.5% now) staying around 8% for a while until a recovery begins.
2. ISM - The Institute of Supply Management generally measures the manufacturing activity of the country. Manufacturing demand determines activity, and consumer demand determined manufacturing demand. Therefore, the ISM numbers will not increase significantly until consumer demand does.
3. Baltic Dry Index - This is a little less known, but I think still important index. It measures the international shipping rates for various dry goods, ranging from coal, to corn, to cars. I think it's an important index because, although it's a lagging indicator, it's one of the closest to being a leading one due to its elasticity. To me, it's the first lagging indicator to turn positive during a recovery. Interestingly, the index has experienced a strong rebound in the last month or so of over 10%.

Where I Think We're Headed -


With those indicators said, my thoughts on where we are in the economic cycle generally says that we're on the trailing end of the downturn. Although many of the leading indicators are still decidedly negative, they have been so for quite a while, and I expect some of them, namely housing prices to stabilize in the coming months. Properly exectuted (key word: properly) government intervention (i.e. TARP) can help speed us to the end of the downturn. However, just because we are coming to the end of the downturn, I don't think we'll be heading for an upturn soon. I think we're going to stay at these lows for at least the first half of this year, perhaps even all of it before we really start seeing some of those leading indicators recover. With that said, I believe as an investor, there are some really good opportunities to take advantage of now, namely very high quality banks, before the leading indicators start trending upwards again. The light at the end of the tunnel is there, and we can see it, it's just going to take some time to get to.

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.

Reader Question - Where to Put Your Money Now

I wanted to discuss a topic some investingdecoded readers have been asking lately. The question to where to put your money now is something that's more ambiguous than ever - there's just so much uncertainty out there that it's hard to say where the market will be in 1 month, let alone 1 year. However, there are some basic principles that I feel that everyone should use when investing their money. Just because there's more uncertainty doesn't have to mean there's more complication. Following some basic rules can ensure that you're not making common mistakes that many investors make.

Always keep your outlook in mind

Whether you're a recent college graduate who has just started a new job, or a experienced professional approaching retirement, your investing strategy should always correlate to your outlook. Every investor needs to understand his/her risk profile and tolerance before buying a single stock - if you're investing your nestegg and may need the money in a relatively short timeframe (e.g. retirement is a couple of years away), you should make sure that you don't invest in areas where there's a great deal of short term volatility. On the other hand, if you're investing some of your savings and will likely not need the money soon, you're probably better off investing in something with a higher risk profile but with greater potential rewards.

Do Your Homework

Once you've established your outlook, take some time to research what you're investing in. To a certain extent, investing is always a form of gambling. But doing proper research can greatly change the odds into your favor. In future posts, I will write more about how I do my research. But for now, I'd like to say make sure you understand what you're investing in. Several hours per stock before buying it is a minimum. This includes researching analyst reports, historical events, and annual reports. With this information, you should develop a risk/reward profile and make sure it fits with your outlook.

Have an Exit Strategy

A common mistake that even I sometimes make is not having a well-defined exit strategy. Before even buying a stock you should have a good idea of when you want to sell it. Even I make this mistake often. Sometimes I just fall in love with stocks and hold them longer than I should. It's important to have the discipline to come up with an exit strategy and hold to it. You may lose some upside...but you'll lose a lot less sleep.


Those are three basic principles that I think everyone should follow. They are a little vague right now, but I'll try to elaborate further in future posts.

The next natural question that comes up is where to invest. You may have established your investment outlook and the levels of risk you can tolerate, but where can you invest and what are the risk/reward profiles like in those investments? Here are a few general investments and associated profiles:


1. Stocks - The most commonly known investment is equities - better known as stocks. These are easy to get in and out of, have a good potential return, and, for people like me, are a lot of fun.

• Pros - Near liquid investment (easily sold in case you need the cash, often in 48 hours). Potentially high return. Usually available on well-centralized markets so they're easy to buy and sell
• Cons - Usually a fairly risky investment - can easily go to 0. Stock holders are usually the last to get any money if the company declares bankruptcy. A little more difficult to find good deals since the market is so liquid. It's much harder to find good stocks than to actually buy any stocks, often resulting in mistakes among investors

2. Money Market - The most common version of a money market account is your savings account. It's a place where you put your money and expect to be able to easily access it later.

• Pros - Safe investments that are still liquid. Usually offer a return (instead of just holding the money).
  
• Cons - Returns are generally very low compared to the potential returns in the stock market or other areas.
  

3. Bonds - A slightly less common investment vehicle for small time investors like me, bonds are essentially buying debt for either the government of corporations. Bonds can be a good compromise investment between stocks and money market accounts.

• Pros - Offer a better return than money market with less risk than stocks. Bond holders have earlier claims to money than equity holders when a company goes bankrupt. Usually offer a fixed rate return
• Cons - Somewhat difficult for individual investors to directly buy bonds.
  

4. Real Estate - Pretty self-explanatory. Buy land, house, condo, etc and sell it later or rent it out.

• Pros - Historically a very well yielding investment when held for the long term (yeah, might be hard to believe right now, but it's true). Strong asset since you're buying a physical piece of property (in case you want to use it as collateral for other purchases)
• Cons - Usually high initial cost (down payment, etc.). Usually need a long time before investment returns are positive. Not easy to sell if you need the cash.
  

5. Options - Similar to futures, options are a good way to leverage your money to make more. You can buy/sell options for pretty much anything, but it's most commonly done for company stock

• Pros - Easy way to multiply gains substantially
• Cons - Very risky since the Options themselves don't have any inherent value (they're just contracts that eventually become worthless). Usually very volatile. Can be very complex.

6. Mutual Funds/ETF's - Instead of buying a specific stock/bond etc., it's common for investors to buy baskets of various types of investments. Depending on the type of basket, investors usually buy a Mutual Fund or ETF.

• Pros - Easy way to diversify your investments and reduce downward pressure due to volatility. Easily available and, although not as liquid as stocks, still easily accessible.
• Cons - Management fees take a bite out of principle whether you make money or not (usually 1-2%). Diligence required (at least the same as stock research) before buying).

7. CD - Certified Deposits, usually available at your banks, is similar to a money market, but not as easily accessible. You basically guarantee the bank that you'll keep your money there for a certain amount of time, and, in turn, the bank guarantees you a higher rate of return. The longer you promise to keep it there, the more return they will give you.

• Pros - Safe investment that has better returns than regular money market accounts.
• Cons - Money is locked away and inaccessible (without penalties) for a period of time.
  

The above are a few different examples of how you can invest your money. Most asset managers will tell you that you need a combination of them to be properly invested. Depending on you outlook, you should have more or less of some or all of those categories in your portfolio. Let me know if you need help allocating yours and we can chat!

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.