Why Economic Recovery Will Be Slow

I have been thinking of a good analysis for our economy. Imagine if you were told 2 years ago that you had cancer and needed emergency surgery to live. After the surgery the doctors told you they successfully removed the cancer, but there were several infections that will remain and you need to prepare for a long, slow recovery. I feel the same about the US economy. We are past the bad stuff, but recovery will take time.

One of the "band aids" that was put on the economic "wound" initially was the Obama Stimulus Program. The program was designed to help the economy by creating jobs, prolonging benefits to the unemployed and elderly, provide tax cuts and other stimulus thus kick-starting the economy into growth. But, like drinking a caffeine soda, once the buzz is over you feel drained. The plan had good short-term intentions, but no long-term infrastructure was created by the plan to sustain economic recovery. The plan was intended to maintain household cash flow in a dropping economy, allow consumers debt relief via loan modifications thus increasing savings rates. Now a year later most of the jobs created by the stimulus have been completed, benefits are near end, tax cuts have helped somewhat, but with less income being earned tax cuts will only survive the economy not revive the economy.

The main infection we are facing is the depleting revenue needed to fund the infrastructure of government. Municipalities, being one of the largest employers in the US, are reliant on taxpayer revenue. Property tax, sales tax, payroll tax, personal income tax, retirement tax are all in decline and infrastructure costs (roads, bridges, health care, wages) are on the rise . We have reached a tipping point where alarming cut backs in schools budgets, police force, fire departments, water districts, department of transportation are deteriorating the fabric that holds everything together. Municipalities are searching for alternative revenue sources and will begin to include emergency sales tax increases on November ballots across the country. This move by municipalities will drive the economy into further decline by taxing the heart of the economy, the consumer. What else can government do? Without much needed revenue cities budget deficits face the same bitter economic reality as businesses and individuals. Just such an event is happening with the city of Half Moon Bay, Ca. The city is "strongly recommending" that residents vote to approve a sales tax increase or the city will consider un-incorporating and handing the city of Half Moon Bay back to San Mateo County because they are insolvent. Events like this show the depth of the problem we all face.

What we have a year later is an abundance of pessimism. Yes we are saving more money per household, but spending less as well. Consumer confidence, though currently on the rise, is the life blood of the economic revival. With interest rates low and budget deficits high the government is running out of tools to fix the problem. Small business are the back bone of this great nation. Governments can stimulate small business growth through hiring incentives, revenue tax cuts, payroll tax cuts, temporarily lowering the minimum wage and creating easy qualifier business loan programs. These measures will increase hiring and begin to turn the wheel of economic recovery. With these measures in place our patient will then get of bed and regain the health and strength it once had.

As Median Home Prices Decline Who Are The Winners?

News came out today that median home prices in Santa Cruz have dropped again. The Santa Cruz Sentinel reported that median home prices declined from a jaw dropping $775,000 in 2007 to a median value of $510,000 in July 2010 (down 34%). Initially the report seems to be good news for home buyers and would increase home affordability in a very depressed economy. Unfortunately, just like a snake in the grass when you step on it, the news has the potential to rear back and bite. When home prices plummet and home buyers are still reluctant to buy what does that tell the market?

There are some commodities that consumers will pay any price for (gas, water, air) and personal economics have little effect on demand. Real estate markets have witnessed depressions before, but none have had the meteoric rise and fall as the one we are currently experiencing. The shear magnitude of foreclosures that will be entering the market in the months to come coupled with rising unemployment has driven home buyers into a state of skepticism. Why should anyone buy a home now with future home prices softening?

Median home price drops portray a deeper meaning into consumer confidence. Market price reflects what buyers are willing to pay for a commodity. A large part of consumer confidence is future employment. If the economy reflects soft employment saving cash takes top priority and the need to buy big ticket items go on the back burner. If the consumer believes buying a home is like buying other depreciating assets like a car, a refrigerator or washer dryer then buying a home will take on a lower priority. In tight economies consumers will seek alternatives (buying used instead of new) for less cash. Renting a home will be seen as a cheaper alternative until the economy picks up or prices begin to rise.

So who stands to gain the most when home ownership becomes less attractive? Not real estate agents, not homeowners, not mortgage brokers, appraisers, home inspectors and certainly not home buyers either. Real estate investors are winners on both ends of the this scenario. As home prices fall investor acquisition costs will fall. As fewer consumers buy and turn into renters the demand for rental units will increase. For owners of rental properties (especially multi-unit) value should remain strong, capitalization rates and vacancy rates should fall and rents will rise. Because a large portion of multi-residential values are based the above mentioned factors, values will rise accordingly. It will be a real estate investors that will laugh all the way to the bank gaining both appreciation and cash flow, a rare event in a down economy. Good to know there will be some winners to will keep the sector going.

Summertime Blues

Summer has historically been a slow time to buy real estate. The slowest months for sales is November through March, but August ranks #2. During August most home sellers are on vacation soaking up the final few weeks before kids are back in school. August is a time where minds meander under camp sites starry skies. These are the final weeks before 9 months of a heavy regiment of football practice shuttles, daylight savings time adjustments and daily homework assignment check ups. Preoccupation is a significant hindrance and the big brains in real estate know this fact. That is why inventories are very low right now. There is a strange calmness in the air. Things are beginning to change in the real estate market. Kind of like the still before a huge thunderstorm releases its fury.


Banks are sitting on hundreds of thousands of bank-owned properties that will be released as a steady stream onto the market after the Labor Day weekend. The release will be a significant opportunity for home buyers. It will provide what is called a perfect storm: Real estate values 30% to 50% off their 2007 highs combined with mortgage rates at historic lows. Why then are US home buyers not bursting down the doors like shoppers at a one day 50% off sale? Does real estate offer less shelter value than it did 4 years ago? Have families stopped growing? Simply put, consumers are scared about future employment and are very cautious when adding large debt items (like mortgages) to the household budget. Consumers shopping habits are a clear sign of their optimism or pessimism. Currently US home renters, though interested in the quality of life upgrade home ownership offers, are staying put until the job market improves.


For the bold, few that can qualify for home ownership, have steady employment and FICO scores above 630 there are amazing loan programs available with as little as 3% down and 30 year fixed mortgage rates well under 5%. If you are a veteran with an honorable discharge (DD214) VA loans offer 0% down and the VA funding fees can be financed into the first mortgage. Don't let bad credit stop you either, most veterans can qualify 3 years after a bankruptcy. Don't let lack of closing cost money stop you, there are still some government closing costs credits available in certain areas. Home sellers are offering appliance upgrade incentives, closing costs credits, inspections and repair costs credit as well. Bottom line, if you need shelter and are ready to see amazing value in real estate, start looking at the housing inventory after Labor Day. You will be very impressed with the quantity of properties available at tremendous value.

Let's Get Back to Work!

There have been several economic theories mentioned in the news lately about the correct plan to stimulate economic growth. The current plan is for the Federal Reserve to begin an aggressive attack on lowering interest rates. There are many tools in the Fed toll belt that could be used, but recently the Fed has been purchasing Treasury bonds with the proceeds of maturing mortgage bonds. The Fed did so to make sure that the money supply wouldn't start contracting at a time when cash-strapped states are cutting spending to close their budget gaps. Buying bonds in the open market lowers the inventory of existing bonds for sale thus decreasing bond rates.

Is lowering the cost of borrowing money the answer to economic stimulus? In theory, by lowering rates and increasing the ability for consumers to qualify for loans, the Fed would be adding money to the economy, boosting consumers cash flow and increasing consumer spending. The theory seems credible except for the fact that increasing consumer debt is the foundation of the stimulus.

Having originated mortgages for 15 years and witnessing the economic impact of borrowing money first hand, I can honestly say that lowering the cost of debt does not lower the long term effects of debt. It simply moves short-term concerns (cash flow) to long-term concerns (accumulation of debt). The pendulum swings, but unfortunately does not stop swinging. Over the long term it turns a fire cracker into a stick of dynamite. At sometime the debt needs to be paid back. Do we really want to add more debt to a nation with a savings rate of less than 3%?
In the big picture, after the immediate need has passed, did the stimulus really benefit the debtor?

Increasing consumer debt is not the answer to economic stimulus, creating jobs is. Jobs increase cash flow not at the expense of the consumer, but for the benefit of the consumer. Business expansion will do all the hard work for the economy. The Fed also has business stimulus tools in the tool belt that could jump start business loans. How about lowering payroll taxes, unburden business by decreasing health plan taxes, allow easier trade of goods to name a few. The Obama Administration is too focused on the benefits of the few and the expense of the many. Use the tools that stimulate business hiring. Let's get back to work!

Prepare for an Uppercut!

I hate getting hit in the face, so when I see a punch coming my way I try to duck. An uppercut to the jaw is coming to most Americans next year so here is your chance to dart and weave. Not that you need more bad news, but the Obama Administration will have sweeping tax increases waiting for most Americans in 2011 and 2012. This is especially bad news for small business owners struggling to stay afloat. If your best friend is not a tax consultant you may want to begin to find one, because your net income for the next two years will be on the ropes taking body blows and jabs.

Personal income tax rates in 2011 will begin to rise. The top income tax rate will rise from 35 to 39.6 percent (this is also the rate at which two-thirds of small business profits are taxed). The lowest rate will rise from 10 to 15 percent. All the rates in between will also rise. Itemized deductions and personal exemptions will again phase out, which has the same mathematical effect as higher marginal tax rates. The full list of marginal rate hikes is below:

The 10% bracket rises to an expanded 15%
The 25% bracket rises to 28%
The 28% bracket rises to 31%
The 33% bracket rises to 36%
The 35% bracket rises to 39.6%

Higher taxes on marriage and family. The “marriage penalty” (narrower tax brackets for married couples) will return from the first dollar of income. The child tax credit will be cut in half from $1000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level. The dependent care and adoption tax credits will be cut.

The return of the Death Tax! This year, there is no death tax. For those dying on or after January 1 2011, there is a 55 percent top death tax rate on estates over $1 million. A person leaving behind two homes and a retirement account could easily pass along a death tax bill to their loved ones. Higher tax rates on savers and investors. The capital gains tax will rise from 15 percent this year to 20 percent in 2011. The dividends tax will rise from 15 percent this year to 39.6 percent in 2011. These rates will rise another 3.8 percent in 2013.

This "Robin Hood Agenda" will rob Americans of much of their income tax deductions and distribute it to Obama funded health care programs, public infrastructure costs and a very expensive war overseas. If you feel that small business owners or families with children are feeling rich these days, you have another thing coming. This tax increase will drain the demographic, further decreasing consumer spending, thus extending the trend of bankruptcies and foreclosures. Worse than that it will extend US economic decline further into the future, decreasing jobs and business expansion. Hard to say what the impact will be to an already battered American, but imagine how Rocky Balboa looked after his prize fight with Apollo Creed after 15 rounds. "Yo, Adriane!!"

It's the Spending Stupid!

News reports are commenting on how the US consumer is spending less these days.
Why is consumer spending so important to the recovery of our economy? What about government spending, corporate spending, industrial or agricultural spending? Shouldn't these numbers far surpass the spending of Johnny Lunchbox?

Consumer spending taps into the very psych of the consumer. Think of it like a pulse on a patient in a doctors care. If the pulse is weak it says much about the patients overall health. Consumers spend with their emotions. Low confidence about future employment will equate to low spending at the retail counter. So if consumers are less confident are there any economic benefits to reduced consumer spending?

Consumer spending accounts for a whopping 60% of the US Job growth. Needless to say it is a key to the the economic recovery equation and 1.3% of the US growth rate is tied to consumer spending. Though second quarter 2010 GDP grew at a solid 3.2% annual pace that’s slower than the 5.6% pace of the previous quarter. This news arrives against the backdrop of a national unemployment rate that stubbornly remains at 9.5%. All this means that our economy is not changing anytime soon because the consumer has no confidence in the near term recovery.

The only benefit to not spending cash is saving cash. In the second quarter, the consumer savings rate was 6.2%, up from 5.5% in the prior two quarters. That's much better than the anemic savings rate of just 2.1% in 2007. If there is a silver lining to the slow economic recovery it is that the typical US consumer is reducing debt, saving more and being frugal with what they purchase. If we can maintain this pace the consumer will come out of this more stable and more financially sound. It is the spending that makes us or breaks us.