How big is $600 Trillion? Scary big.

The derivatives market is complex and largely fairy-tale finance. The vast supra-majority of people (presidents, presidential candidates, and Congress included) do not understand the derivatives market, and most barely even know the market exists. If you are unfamiliar with derivatives, please refer to my first post yesterday, which attempts to explain derivatives in layman's terms (and I am a layperson, I have not even traded in puts and calls on stocks).

The derivatives market has a face value of $600 Trillion. While the entire $600 Trillion is not at risk (see "What the heck is a derivative"), I have an enormous problem with the notional value of the derivatives market. The world's GDP is $65 Trillion - outstanding derivatives have a face value ~10 x the entire World's annual income. Warren Buffet is the world's wealthiest person, with a net worth of $62 Billion - about 1/10,000th. In fact, the net worth of the 25 wealthiest people, worldwide, combined, is just over $750 Billion - about 1/1,000th of the face value of the derivatives market. The net worth figures do not necessarily reflect the 30%+ decline in the stock market. The world's 100 richest people have a combined net worth of about $1.7 Trillion.

The 25 wealthiest people's net worth represents the value of everything they own - derivatives, real estate, stocks, bonds, businesses, precious metals, everything. Generally, the wealthiest 1% of people own about 1/3rd of all financial assets. The world's 100 richest people have a combined net worth of about $1.7 Trillion. The derivatives market has a notional value of about $600 Trillion.

There are approximately 1,000 Billionaires in the world - the "poorest" person out of the 100 richest was George Soros, with an estimated net worth of $9 Billion. If we assume that the other 900 Billionaires have an average net worth of $5 Billion, their combined net worth is about $4.5 Trillion. The derivatives market has a notional value of about $600 Trillion.

The world's population is about 7 Billion people. The derivatives market has a notional value of about $600 Trillion. That is about $100,000 for every man, woman, and child in every city, village, prison, slum, and palace in the world.

There are about 10 Million millionaires. From Market Watch: "The high-net-worth population swelled 6% last year to more than 10.1 million people who own assets totaling an eye-popping $40.7 trillion, according to the CapGemini/Merrill Lynch World Wealth Report." The derivatives market has a notional value of about $600 Trillion.

From Slate: "By contrast, the value of the world's financial assets—including all stock, bonds, and bank deposits—was pegged at $167 trillion last year by McKinsey. "

Most financial assets are held long-term. $167 Trillion in net worth of financial assets does not equal anywhere near $167 Trillion in transactions. And derivatives are a very narrow slice of markets. The relatively enormous size of the derivatives market in comparison to the world's assets is enervating.

Okay, but it's not $600 Trillion at risk. First off, we can assume that about half of the derivatives contracts are, say, betting that the market will go up, while the other half are betting that the market will go down. The market can only go up or down, so assume that roughly half of the derivatives bets cancel each other out. Furthermore, derivatives contracts tend to be time sensitive, so many will expire without paying out a dime. The purchase price is the dollar amount that actually trades hands when a contract is created - the purchase prices are a relatively sane $17 Trillion or so. But going back to my insurance policy analogy - if you pay $800 to buy a one-year homeowner's insurance policy worth $100k, only $800 changes hands until something happens to the house. Then, the insurance company could pay out up to $100k. So the money in play in derivatives is somewhere between the $17 Trillion purchase price and the $600 Trillion notional value.

Worse, the other side of the derivative trade may not have any money at all to back up his promises.

Remember, a stock option contract is a type of derivative. If I bought a put contract for $2 that guarantees me the right to sell Intel stock at $20 a share, I would be exercising that contract now that Intel is down around $14. The person who sold me the contract - the counter party - would be out $4 (the $20 face value minus the $2 contract minus the $14 share price today). The loss, in that case, would be twice the contract purchase price and 1/5th of the notional value. If I had been trading in financial stocks, the loss could be nearly the entire notional value; even Exxon is down 29%.

One of the early links in this post is to an article that says that only about $3 Trillion dollars is actually at risk, because most derivatives contracts will cancel each other out. I take issue with that claim - prove it. Because most traders are rational. If I bet you $5 that the sky is blue, would you find someone else to bet $5, with the same odds, that the sky is not blue? Probably not. Even if you found someone willing to bet that the sky is not blue, because they want to hedge a bet they made with me that the sky is blue, you wouldn't give them the same terms - you would charge a lot more to make a bet you are likely to lose, and you would charge very little to make a bet you're certain you'll win. But then a storm comes along, the sky turns purple, and you're out your lunch money because you never thought you'd lose that bet.

As financial markets go crazy, a lot more contracts are paying out than usual. Because there are essentially no reserve requirements for derivatives issuers, this is somewhat akin to Hurricanes Katrina, Andrew, and Iniki all hitting at the same time as major Midwestern flooding, tornadoes throughout the Southeast, and earthquakes up and down the West coast. The "insurance" companies can't pay out on massive and unexpected losses - they are designed to pay out on reasonably expected losses. You can reasonably expect 1 Cat 5 hurricane in a year; 2 would be bad but not shocking, three would probably bankrupt some insurance companies. I'll take any bet if I'm certain I won't pay out - and I bet a lot of Wall Street types, especially the ones betting with someone else's money, felt the same way. Only a very few people expected the Dow to drop from 14,000 to 8,400. Few people expected oil to rise to $140, and fewer still expected it to rise to $140 and then fall to $64. Unprecedented circumstances give rise to unprecedented profits and losses, and it's easy to be on the wrong side of a bet.

"3. Unregulated, over-the-counter derivatives. There are scary numbers floated
out there (in the hundreds of trillions of dollars or more) of “notional value” outstanding. The problem with these numbers is that they don’t represent
actual amount-at-risk, and in fact nobody seems to know what that figure actually is. The lack of a regulated exchange and central clearing means that there is no margin supervision of any sort; ergo, you have no way to know if your contract is in fact good (that is, the other guy has the money.) AIG, as an example, had $500 billion dollars of exposure outstanding in these contracts, and while this sounds somewhat reasonable when one considers they have a $1 trillion dollar balance sheet in fact
it is not because most of AIG’s balance sheet assets are committed to cover liabilities
(e.g. insurance policies, annuities and the like.) The lack of margin and regulatory supervision is directly responsible for this. These derivatives have become nothing more than a fancy game of “pick pocket”, where Broker “A” sells protection to Client “A” for $X, and then tries to find someone to buy that same protection from for “$X – something.” While speculation in the marketplace is fine, speculation without being able to prove capital adequacy to back up your bets is not." ... from http://www.denninger.net/letters/paulson-bernanke-senate.pdf

Bottom line: Who can afford a $17 Trillion loss? How about $4 Trillion? $50 Trillion? In a global economy where the value of everything produced and sold in the entire world is just $65 Trillion a year, I don't think anyone can afford to back $600 Trillion bets, even if the losses are mere tens of Trillions.

Notes: Trade in derivatives data comes from the Bureau of International Settlements. $600 Trillion is rounded. World GDP is likely understated somewhat, because there is no official tracking of grey market, black market, contraband, and under-the-table income. All figures in U.S. dollars are subject to exchange rate fluctuations.

How Big is the Derivatives Crisis?

My last post discussed the general concept of Derivatives. Now, let me give you some wild conjecture about the scope of the derivatives crisis.

The Bureau of International Settlements (BIS) estimates the derivatives market at about $600 Trillion. But that's the notional value - the face value. That's like saying that the face value of insurance policies is $600 Trillion - the actual amount paid out by insurance companies is a fraction of the total of all the face values of all the policies in the world combined.

So what's the real risk level?

Well, derivatives can be mere side bets - and, like the Super Bowl, the bets for and against any particular outcome should roughly even out. The BIS tries to estimate

But how much money is really going to be lost? Here's some guesses.

The derivatives market "insures" the value of assets, typically financial assets like stocks, bonds, and real estate. Financial assets are under pressure right now. The majority of real estate loans issued in the last few years borrowed against property in Florida, California, and Nevada. The once-hottest markets are now the icy-est, with property-value declines of 40% in the Sacramento market, and, conservatively, 20% in the majority of really-hot (and widely invested-in) markets. The stock market is down from a Dow of 14,000 to less than 9,000 (about a 35% decline). Oil is down from a high around $140 to today's value around $70 - a 50% decline.

So the assets that underlie the derivatives contracts have declined by about 30% (a very, very rough average of the declines in major asset categories). A homeowners' insurance contract doesn't pay out unless the house is damaged - an awful lot of our financial houses are on fire right now. This is an economic Hurricane Katrina, 1906 Earthquake, and Midwestern flood all in one.

If an insured car is totalled, the insurance company will try to sell the car for scrap and parts, while paying the car's owner to replace the car. The insurance company is out the difference between the market value of the car and the scrap value of the car. Well, with an options contract, you don't actually lose the full notional value of the contract, you merely lose (or win) the difference between today's market value and the notional value. If I buy a put contract on Corning stock at $20, the counter party doesn't lose $20 - they lose the difference between today's stock price (~$11) and the $20 contract price. So instead of losing $20, they lose $9.

So BIS says the total derivatives market is about $600 Trillion in notional value. That's like saying the Corning derivatives market is $20 - it doesn't mean anyone is losing $20 (or $600 Trillion). What they'll lose is the difference between today's value and the contract value.

Let's try a wild guess. If the major assets (real estate, stocks, oil) are down, that's the economic equivalent of a house fire. The "insurance companies" (derivatives counter parties) will have to pay out. The house isn't a total loss. Suppose that 10% of the derivatives market has to pay out - 10% of a $600 Trillion market is $60 Trillion. Now, stocks, bonds, real estate, and oil aren't total losses - they're just down.

So suppose the payout on the insurance policies (derivatives market) is the difference between face value and current value - that's about a 20% decline, on average, conservatively. That's $60 Trillion of derivatives (10% of the total derivatives market) paying out a 20% loss. That's $12 Trillion. That is, roughly, the equivalent of a full year's income for the United States as a whole. That is about 1/6th of the entire world's annual income.

Let's put this in perspective. Would you be okay with a salary reduction of 1/6th of your income? Would you be okay with your taxes increasing by 1/6th of your income? Would you lose weight if you ate 1/6th less than you eat today? 1/6th of the entire world's GDP is a lot.

I really think that assuming only 10% of the derivatives market will have to pay out, and that their losses will only be 20% of the total notional value at risk, is incredibly conservative. But, at least, having a reasonable floor gives us a basis for guesstimating the ceiling.

What the Heck is a Derivative?

A derivative is a contract that derives its value from something else. The notional value of a derivative is its face value. It might be simpler to think of it like your homeowners' insurance policy; the policy can pay out up to the stated replacement cost of your house - that is the face value (or notional value) of the insurance policy. If it costs $100,000 to rebuild your house, then the market in homeowners' insurance on your house is $100,000 in notional value. The insurance company doesn't pay $100k, they're simply at risk for up to $100k. The premium you pay to the insurance company each year is the part that gets added to GDP, the part the insurance company can save, spend, or invest, the part that matters in any year that you don't have losses.

But, Hurricane Katrinas can happen. So the insurance company has to set aside enough money to pay out the claims it can reasonably expect. Insurance companies are heavily regulated by State and Federal government agencies, and they are required to use reasonable assumptions to decide how many claims to reasonably expect, and they are required to keep enough money on hand to cover those claims.

Derivatives, on the other hand, are not heavily regulated. In many ways, a derivative is like an insurance policy. If I am worried that my Corning stock might decline in value right when I want to cash it in for a down payment on a house, I can buy a put option contract (one of many types of derivatives) that gives me a right to sell the stock at an agreed-upon price within a specific time period. Effectively, I am insuring against a decline in the value of an important asset (much like you insure against a fire destroying the value of your home).

There are many other types of derivatives contracts, and they cover a wide variety of possible losses. One type of loss they cover is "credit default" - if I lend money to my brother-in-law, I know the odds aren't very good that he'll pay me back. A credit-default "swap" lets me pay somebody else to take on the risk (the other guy pays me if my BIL flakes) - we "swap" a little money in exchange for trading who bears the risk.

You'll note that my Brother-in-Law isn't very likely to pay me back, and I knew that when I lent him money. That's one of the problems with credit-default swaps. Banks made crazy mortgages, and they didn't have any good reason to believe that, say, the Target cashier buying a half-million-dollar house would actually pay the mortgage back. Since the derivatives market is essentially unregulated, you can actually buy the equivalent of a credit-default swap on your deadbeat Brother-in-Law. In real insurance, you can't do that - you can only insure against a risk that neither side could reasonably predict. Letting someone buy insurance after, say, the house burns down, would mean that the only people buying insurance are people whose houses are on fire.

Given the loosey-goosey rules around derivatives contracts, people can use options contracts responsibly and irresponsibly. The only limit is whether you can find someone to trade risk with you. And, mostly, you can - it's like having a group of dumb, fun-loving friends who will actually sell you fire insurance even after finding out you store kerosene next to your woodstove, and you're fixin' to build a fire.

And derivatives traders have something else in common with dumb frat boys. They'll bet on pretty much anything. If you've ever looked at a friend across a bar table and said "I'll bet you $10 she shoots him down," you're qualified to be a derivatives trader. Because derivatives contracts don't require that either side be directly involved in the transaction that the contract derives its value from. I don't have to own Corning stock to buy a put option on Corning, and you don't have to own Corning stock to sell me a put contract. So derivatives contracts can work as side bets - just like that bar bet about whether some guy you don't even know gets a date with some woman you don't even know.

So, that's a very rough description of these derivatives things people are talking about. My next post will provide some wild conjecture about how big the risk is in derivatives trading.

One of The Joys of Living in Northern California

I found a juvenile black widow spider in the house. It is now dead. The adult black widow is black with a red hourglass marking on her belly. The juvenile is brown and black. Although the picture here isn't as clear as I'd like, it does show the beginnings of the hourglass shape on the juvenile's belly.

A debtor government cannot afford deflation

Our government owes trillions of dollars (or, in smaller numbers, Thousands of billions of dollars). What's more, our government has committed to fund tens of Trillions of dollars in government and military pensions, Social Security, Medicare, and similar programs. Although there is no promissory note on these additional liabilities, they are owed just as sure as the cash your children are expecting for their next birthday. And our debt grows every year now.

Well, heck, we all know there's a lot of government debt, but what do we really care?

We care a lot - because the debt ties the government's hands. We pay a huge amount of money in interest on $10 Trillion dollars (figure $400 Billion in interest at 4%). In order to maintain that kind of debt, long-term, we need somebody to keep lending to us. Right now, there are a lot of foreign individuals and governments that are happy to fund our debt addiction. But we have to be careful to keep them happy, to keep them lending. Could part of our bailout/rescue plan be a "Keep the Chinese confident in American bonds so they keep lending us money" plan? I don't know, but there is certainly a risk that, when we hit $20 Trillion in debt to pay some of those pension obligations, lenders cut us off. That's a mighty scary scenario.

In the meantime, the debt ties the government's hands in dealing with the current crisis. If the government lets the market tank, we risk a deflationary spiral. If we have a deflationary spiral, corporate, personal and investment incomes could decline. If incomes decline, the government's tax revenues on that income will decline, too. If government revenues decline, the government's debt will not decline. Less income to pay the same debt = major pain. Either the government has to cut back (a lot) or the government has to try to keep the debt afloat until incomes rise again.

Now, we're back to the Chinese (and other foreign nations) again. Think about this - the government, in a deflationary situation, is like a CEO with a mortgage. He gets laid off, manages to find an embarassing job doing business development for a much smaller company for a much smaller salary (but he's got a job, thank goodness) - and his mortgage is suddenly huge in comparison to his income. Our CEO is suddenly a bad credit risk - he whips out his AmEx Gold card to buy a tank of gas, and it's denied. He charges the gas to his visa card, and finds out they've jacked his interest rate to 29%. Government borrowing is a bit more complex, but it's still the same basic idea - high debt-to-income rations equal higher interest rates, and some lenders just won't lend to you anymore.

The government currently spends a bit shy of $3 Trillion, with almost a $1 Trillion shortfall every year (and that shortfall gets borrowed, and added to our total debt). The government is taking in, roughly, $2 Trillion a year in an economy where the total GDP (total of everyone's income) is about $13 Trillion. Suppose GDP fell by 10%. Government revenues would probably fall about 10%, too. If a lot of people are laid off, the government could take a bigger hit (individual income taxes are a higher percent than corporate or investment income taxes) - AND more people would ask for government services (food stamps, welfare, etc.) because they can't find jobs. The government gets hit with a double whammy - lower income, higher expenses. The government's "credit rating" drops instantly.

The government is stuck between a rock and a hard place.

If they cut expenses to balance the budget, the economy will slow even more. If the economy slows more, incomes drop more, and income tax revenues drop more. The relative value of the debt becomes larger in comparison to tax revenues. Interest rates rise to reflect our declining credit-worthiness, raising expenses, requiring further cuts, further slowing the economy. Social security and pension payouts become more attractive compared to private sector employment income, and people retire earlier.

If they keep borrowing and spending, inflation will rise and their credit rating will fall and the value of the dollar will fall even more than it already has. If the value of the dollar falls, the price of oil rises, and the American public gets squeezed even harder between falling wealth and rising prices. And the government, paying to fuel everything from government vehicles to military tankers, gets squeezed, too. But, the silver lining is that the debt begins to look smaller in comparison to the inflation-swollen tax revenues. The downside, however, is that the falling dollar decimates the value of foreign investment in American debt. If a foreign investor is losing money on the exchange rate, lending us money becomes a bad investment.

When this is all said and done, I hope that the lesson future generations take away is "never, ever, ever let government debt get so high." But, for current generations, we are in an ugly, ugly place. Bottom line: I expect much higher taxes in the future, and probably for the rest of my lifetime. Priority 1 needs to be: Get things situated so we can pay down debt. Priority 2: Pay down debt. We will pay for this, one way or another. I would rather pay a little more tax today (to reduce the debt) than pay the interest over and over and over again.

(Many voters are confused about the fact the the Clinton administration left the Bush administration with a surplus. The Clinton administration left behind a mountain of debt, but with a budget that allowed surplus funds to begin whittling the debt down. Bush didn't run up the whole $10 Trillion in debt by himself. That's not to say that Bush is innocent, nor that Bush is to blame - we began borrowing from the Social Security trust fund during the Johnson administration, and every President since has continued us along this financially irresponsible path. Every Congress along the way - with ultimate power over the budget - has contributed to the mess. It is a bipartisan effort of the worst kind, and we voters should not tolerate any more partisan finger pointing.)

A tale of two doctor's visits

One of the major problems with health care costs in America is that the insured consumer is insulated from the real cost of care. Health care providers take great offense when consumers ask how much care costs - and doctors choose not to know, even when the doctor himself/herself set the prices. Doctors act as if their work is too holy to be muddled with financial realities - but, the truth is, finances are a major part of health care. Finances are the reason many doctors become doctors (if doctors were not motivated by money, why are soooo many doctors going into the higher-paying specialty fields today, rather than going into primary care medicine? Why aren't more doctors taking advantage of government-sponsored debt forgiveness programs for primary-care doctors serving under served populations?). Finances are the reason many people "can't afford" * health care. Let's face it - in a money-based economy, finances are both currency and culture, a way of measuring things and a way of communicating the value we apply to things.

In a free market, consumers are free to choose how to spend limited finances. The "invisible hand" of the market is what happens when many peoples' choices aggregate - if lots of people value, say, a house very highly, the price of the house will rise to reflect all those consumers' choices. But the invisible hand relies on people making rational choices, and rational choices rely on clear and accurate information. Health care price information is not clear and accurate, and it is not readily available. If a consumer does not know that doctor A charges twice as much as doctor B, the consumer cannot make a rational choice to compare the relative value of the two options and choose the best value. We need to increase the clarity and availability of medical price information.

I changed insurance plans this year. Last year, I paid a flat co-pay for any service, and the insurance company paid the rest. No paperwork, no fuss - I thought it was more efficient. However, with no paperwork, I had no idea how much services cost. This year, I changed to a plan where my co-pay is a percent of total cost. It is actually cheaper than the flat-rate plan, and I finally know how much health care costs.

We had two doctor's visits this year - one to an Urgent Care clinic, and one to our regular doctor. Both doctors pay to rent an office, both pay malpractice, both pay a receptionist, a billing clerk, and an assistant or nurse. Both negotiate fees with insurance companies, and both participate in multiple insurance networks. Both doctors deal with uninsured patients and unpaid bills (although the Urgent Care clinic has more uninsured patients and deals with more unpaid bills). The only real difference in overhead is that the Urgent Care clinic is open 24 hours a day, 7 days a week - requiring 4 times as many staff hours as the doctor's practice, and more electricity, too.

My better half sliced open a finger a few months ago. It was an evening incident, and our doctor's office was closed. A doctor at the urgent care clinic looked at the finger, performed a quick exam, and directed a medical tech to clean and dress the wound. The bill was $80.

I pulled a shoulder muscle a couple months ago. I went to my regular doctor, who spent less than five minutes listening to my symptoms, diagnosed a pulled muscle, ignored all the symptoms of a pinched nerve, and wrote a prescription. My regular doctor is completely computerized, so she was able to pull up my chart, read it, and enter the visit notes right there in the exam room - she actually spent just minutes interacting with me. The bill was $120.

Last year, we visited the primary doctor and the Urgent Care clinic for two different situations. Honestly, the Urgent Care clinic provides better care. I simply assumed that the Urgent Care clinic was more expensive than my primary doctor. Now that I know better - and now that I know how unreasonably expensive my primary doctor is - I can make an economically rational decision about my health care spending. Oh, sure, the insurance company is paying the bulk of the cost, but they are, in effect, paying the bills with my money - if total expenses exceed what the insurance company has set aside to pay expenses, my insurance costs will rise next year.

* Some people truly can't afford health care. Some people "can't afford" health care - they have sufficient cash after paying basic expenses, but they value other things more highly. As an example, my SIL who died of something that is easily detectable and easily treatable - she "couldn't afford" health insurance because she "had" to pay for private school for her child, she "had" to pay for cigarettes, she "had" to go shopping for knick-knacks (and buy some) every week, she "had" to have supplies for her hobbies, she "had" to go out with her friends, she "had" to take her kid out to eat....

When I was 18, I couldn't afford health care. While living and working in Hawaii (yes, Hawaii - the state that Hillary Clinton held up as the model for universal health care, the Hawaii that requires employers to provide health care to their employees), I became ill. I had "aged out" of foster care, with no family to fall back on. My college went bankrupt, and I took the first job I could find to keep a roof over my head. I was poor. I had no health insurance. Without health care, I couldn't work to make money to save to pay for health care. In order to pay my health care expenses, I moved out of my apartment and became homeless for a while, as I saved money for health care. My employer, though required to provide health care to employees, did not offer me health insurance. As an 18 year-old, I didn't know any better. I could not afford health care.

So when I put quotes around "can't afford" health care, it is meant to reflect the full range of people claiming that health care is unaffordable - from the people who must choose between food, shelter, and health care, to people who choose to drive a BMW because it is a necessity, while foregoing health insurance because it is "too expensive." And you would do well to keep that distinction in mind when the inevitable Universal health care debates arise again. If health care is a necessity, then it should be paid along with other necessities (food, clothing, shelter) and before luxuries like cell phones, car payments, cable TV, etc. Before we give a family government help to pay for health care, we should make sure that health insurance is truly unaffordable for them, and not merely "unaffordable" in the face of life's many temptations.

55% Off Amazon Grocery Clearance

This was worth sharing, and bookmarking for later:

Save an additional 55% instantly when you purchase select September Clearance products offered by Amazon.com. Enter code CLRNCFTY at checkout. Here's how (restrictions apply). Offer valid through September 30, 2008.

I found pages upon pages of coffees and teas included in the clearance items, as well as more standard grocery fare like soup mixes and nuts. They still qualify for free shipping if the order totals more than $25.

And while we're sharing money savers, here's a free shipping promo code for Lands End (their quality is very good and their overstocks are quite fairly priced):
Code: AUTUMN, Pin: 9432

Sorry about the hiatus

I lost my four-legged best friend on Tuesday, after many months of illness. It was both a hassle to deal with the new medical protocols and an unmitigated blessing to be able to make my buddy feel better and get some more living in, for the final months of her life.

A quick update on the house we made an offer on - according to the property tax assessor, the home is still delinquent on taxes, which means it hasn't sold/closed (an escrow company would pay off delinquent taxes at close of escrow). It's not back on the market, it's not sold, and nobody's paying the taxes. Hmm.

The housing bill: First Time Home Buyers' Credit recapture

All about the housing bill: "Here's how the tax credit will work. You buy a
$200,000 house. The next year, when you file your income tax return, you have a
$7,500 credit. Not a deduction -- a credit. Essentially, you get to reduce your
income taxes by $7,500. That ought to make for some big refund checks.

But. Yeah, you know there's a 'but.' But you have to pay the money back
over 15 years. Say you buy the house this October. You get the $7,500 tax credit
for the 2008 tax year. That's the one with the filing deadline of April 15,
2009. Then you have to start repaying one-fifteenth of that amount, or $500,
every year for 15 years, starting with the 2010 tax year."

That's right - the first-time home buyer tax credit isn't a reduction in taxes, it's basically an interest-free loan. For the next 15 years (or until the home is sold/made into a rental), the taxpayer will pay a tax of 6 2/3% of the amount of the credit ($500/year on a $7500 tax credit). But, hey, an interest-free loan is an interest-free loan. If you haven't owned a home in the last 3 years, and your modified adjusted gross income is $70k or less (single), or $140k (married), it's a nice little bonus for buying a house. Provided you meet all the restrictions.

And, if first-time home buyers can't be expected to read a mortgage contract, it might amuse you to imagine them reading the text of the mortgage bailout law to discover that the "free" money has to be paid back:

`(f) Recapture of Credit-
`(1) IN GENERAL- Except as otherwise provided in this subsection, if a credit under subsection (a) is allowed to a taxpayer, the tax imposed by this chapter shall be increased by 6 2/3 percent of the amount of such credit for each taxable year in the recapture period.
`(2) ACCELERATION OF RECAPTURE- If a taxpayer disposes of the principal residence with respect to which a credit was allowed under subsection (a) (or such residence ceases to be the principal residence of the taxpayer (and, if married, the taxpayer's spouse)) before the end of the recapture period--
`(A) the tax imposed by this chapter for the taxable year of such disposition or cessation, shall be increased by the excess of the amount of the credit allowed over the amounts of tax imposed by paragraph (1) for preceding taxable years, and
`(B) paragraph (1) shall not apply with respect to such credit for such taxable year or any subsequent taxable year.
`(3) LIMITATION BASED ON GAIN- In the case of the sale of the principal residence to a person who is not related to the taxpayer, the increase in tax determined under paragraph (2) shall not exceed the amount of gain (if any) on such sale. Solely for purposes of the preceding sentence, the adjusted basis of such residence shall be reduced by the amount of the credit allowed under subsection (a) to the extent not previously recaptured under paragraph (1).
`(4) EXCEPTIONS-
`(A) DEATH OF TAXPAYER- Paragraphs (1) and (2) shall not apply to any taxable year ending after the date of the taxpayer's death.
`(B) INVOLUNTARY CONVERSION- Paragraph (2) shall not apply in the case of a residence which is compulsorily or involuntarily converted (within the meaning of section 1033(a)) if the taxpayer acquires a new principal residence during the 2-year period beginning on the date of the disposition or cessation referred to in paragraph (2). Paragraph (2) shall apply to such new principal residence during the recapture period in the same manner as if such new principal residence were the converted residence.
`(C) TRANSFERS BETWEEN SPOUSES OR INCIDENT TO DIVORCE- In the case of a transfer of a residence to which section 1041(a) applies--
`(i) paragraph (2) shall not apply to such transfer, and
`(ii) in the case of taxable years ending after such transfer, paragraphs (1) and (2) shall apply to the transferee in the same manner as if such transferee were the transferor (and shall not apply to the transferor).
`(5) JOINT RETURNS- In the case of a credit allowed under subsection (a) with respect to a joint return, half of such credit shall be treated as having been allowed to each individual filing such return for purposes of this subsection.
`(6) RECAPTURE PERIOD- For purposes of this subsection, the term `recapture period' means the 15 taxable years beginning with the second taxable year following the taxable year in which the purchase of the principal residence for which a credit is allowed under subsection (a) was made.

7 bank failures so far this year

In 2007, the FDIC closed 3 failed banks. None in 2006 and 2005. 4 in 2004, 3 in 2003, 12 in 2002, 4 in 2001. So far this century, 2008 is on track to be the second worst year for bank failures.

FDIC: Failed Bank List
2007 Bank closures:
Bank Name, City, State, Closing Date
First Heritage Bank, NA, Newport Beach, CA July 25, 2008
First National Bank of Nevada, Reno, NV July 25, 2008
IndyMac Bank, Pasadena, CA July 11, 2008
First Integrity Bank, NA, Staples, MN May 30, 2008
ANB Financial, NA, Bentonville, AR May 9, 2008
Hume Bank, Hume, MO March 7, 2008
Douglass National Bank, Kansas City, MO January 25, 2008

http://www.fdic.gov/bank/individual/failed/ Includes links to Is My Account Fully Insured? and When a Bank Fails - Facts for Depositors, Creditors, and Borrowers.

A nifty little tool: The bank rater

TheStreet.com has a ratings lookup tool where users can look up thestreet.com's opinion of various entities. You can check their opinion of a stock, or get their idea of the financial stability of your life insurance provider. You can also look up your bank. I discovered this tool a year ago, when the bank failures began (just a trickle at first) - the bank that failed at that time was rated an E- before they failed.

To use the ratings screener, you go to the Banks tab on the Ratings Screener, type in your bank, and hit "Go." Pretty straightforward, except that some banks don't come up by exact name - if your bank doesn't come up, type in the first part of the bank's name and then sift manually through the results. Banks are rated from A to E-, just like academic grades. Personally, I'm wary about keeping my accounts below FDIC limits, but I'd be moving my checking account if I found my bank on the C- or worse list.

If you feel like whiling away a pleasant weekday afternoon, try this:

• Don't enter anything, and hit search (find out how many banks are in the database). I got 12,326.
• Set the rating option to "E" - the worst available rating. I got 332. Not bad - 332 "very weak" banks out of 12,326. Less than 3%.
• Set the rating option to "D" ("weak") and grab the drop-down box next to the rating drop-down - set that one to "or lower". That gets you all the D's and E's in one shot. I get 2,479 banks rated by the street.com as "weak" or worse. Yikes - That's 20% of all the banks they track.

You can play with the ratings screener, sorting by state or bank type, or see which states have the most banks named "Cowboy".

Call me paranoid, but, since I discovered the rater, I've made a point to check my bank's rating every couple of months. They're a B-rated bank, and, so far, they've maintained a solid B average.

And, please - PLEASE, pretty please with sugar on top, please keep your money FDIC insured. Consumers can keep more than $100k covered in a single bank, provided the accounts are titled in multiple names (for example, Mr. and Mrs. John Q. Public could be insured for $100k each, allowing a joint account to reach $200k before exceeding coverage limits). Payable on Death accounts can be covered for $100k per beneficiary - Mr. and Mrs. John Q. could get $400k FDIC coverage by setting up a POD account as "Payable on Death" to their 4 children.

Can the GAO get a mortgage bailout?

Why some conservatives are backing Obama: "Susan Eisenhower, granddaughter of Republican President Dwight Eisenhower: 'Deep in America's heart, I believe, is the nagging fear that our best years as a nation are over. We are disliked overseas and feel insecure at home. We watch as our federal budget hemorrhages red ink and our civil liberties are eroded. Crises in energy, health care and education threaten our way of life and our ability to compete internationally. ..."

I have not made up my mind about my Presidential vote, and linking to this article is not an endorsement of Obama - nor an indictment of him. But saving, investing, buying a house, pursuing an education, even having children - all these undertakings require a certain optimism, a trust that the future will bear them out, and a lot of Americans - especially investors, savers - you know, the kind of folk who sat out the housing bubble and are now prepared to swoop in and buy up houses - aren't feeling so optimistic. Politically, I believe that our government - under any candidate - needs to shore up those American "promises" - life, liberty, the pursuit of happiness, and freedom from the over-arching fear of Federal Government bankruptcy (or government spending hitting 50% of GDP, which the GAO projects will be necessary by 2070 - I don't know about you, but I do expect to be around in 2070, a mere 62 years from now; I hope to be a spry, active nonagenarian).

During the primaries, I read a candidate's treatise on his intended policies, and I found some of the ideas quite promising, but the overall takeaway was "That adds up to a lot of new expenses. Gosh, doesn't he know how bad the government debt is?" Whether you're leaning towards Obama, McCain, Nader, or "None of The Above," here's a stark reminder:

The government only has two ways out of their economic mess - man up and start solving the problem.... (I'll wait while the laughter subsides)... or go ahead and let inflation run wild (no need to default when you own the currency printing presses). Will consumers allow inflation to run? There's an interesting test. But if inflation goes wild, home ownership is a decent bet - as long as inflation inflates your salary faster than your expenses. Rising taxes are virtually a given, under any president, because our government obligation has reached the point where it's an exploding option-ARM itself. Pay less now, pay lots more later; pay more now, pay less more later (yes, I said less more - it's gonna be more later no matter how we dice it). The housing market has given us a brilliant illustration of what happens when folks pay less than the interest on enormous long-term debts - lots of folks are overdue on their property taxes, lots of folks couldn't afford basic maintenance, and, now, lots of folks lost their homes. If America couldn't afford to have Bear Stearns implode, we certainly can't afford to have the Federal Government implode.

Data on the Government financial status:
Complete FY 2007 Financial Report (PDF, 186 pages)
The Nation by the Numbers (PDF, 10 pages)
Notes to the Financial Statements (PDF, 62 pages)

Vulture real estate investors swoop in - Jul. 2, 2008

Vulture real estate investors swoop in - Jul. 2, 2008: "Jack McCabe says he still sees 'a large disconnect between what buyers are willing to pay and what lenders are willing to sell for.'
That's even more true in California, according to David Michelson, a partner in California-based developer Three Arch Investors - despite the fact that home prices there are already down 35% in the last 12 months. The company is putting together a $250 million vulture investing fund in anticipation of even further declines, and will buy foreclosed homes in California, Nevada and Arizona.

'The transactions are not happening yet,' he said. 'There are plenty of people looking, but the lenders are carrying the cash value [of these distressed homes] at two or three times the actual value,' said Michelson.

Until banks reduce these prices - and take the write downs that will come with them - buyers like Michelson won't budge.

He figures that the banks will have to start liquidating these properties by the end of the year to get them off their books. And then, he says, the floodgates will open."

This is in contrast to the cases earlier in the article, where investers are scooping up property in other areas where banks and sellers are getting real. But in California, it's different. Could it be that - in a state where half a million dollars wouldn't buy much more than a condo or an inland starter home - the banks are too heavily burdened by California defaults to dare admit just how badly they've been burned?

Centex, Pulte dump land in Rancho - Sacramento Business Journal:

Centex, Pulte dump land in Rancho - Sacramento Business Journal:: "At the height of the local housing boom, $8 million would have fetched less than 20 acres of land approved for new homes as prices had escalated to $600,000 an acre in some areas. Builders and developers are still waiting for a new benchmark on what land is worth in today's economy. The buyers in this deal, Alvarado and Somers, paid $32,000 an acre."

The weird thing about this story is that - Centex, at least - had already begun building, had models up, even had some homes completed and, apparently, sold. And then - poof - Centex's web site doesn't show anything in Rancho Cordova anymore. So what happens to the fine folks who bought new homes in the midst of the graded fields of mud that Centex no longer plans to build upon?

And, yowza - Centex and Pulte, as partners together, paid $50 Million, plus they spent another $30 Million in improvements - and then sold the land for $8 Million. I'll be very curious to see who survives - the Centexes or the Lennars? Centex recognized the downturn and the falling prices ahead, and they cut prices before anyone else - so they sold out before anyone else. Lennar is still dreaming of 2005 prices. Is it smarter to cut the losses and run, or to squeeze the last no-money-down, gotta-have-granite, easy financing nickel out of what history will surely remember as a crazy, self-indulgent market.

(C) 2008 All rights reserved

June: The month from heck, and what happened to our offer?

I am booked solid 16 hours a day, and get the other 8 hours a day to sleep, eat, bathe, grocery shop, cook, clean, and take care of my elderly and ailing dog. So I'll just give a quick update on our offer. Nothing. Nada. Zip, zilch, no reply, no counter, no rejection, and no, the house has not appeared on the "sold" lists in the paper. It's been about 2 months.

We made an offer on a house

We found a house that met our requirements, and the asking price made sense. It's a short sale - with two Cadillacs in the garage. Indy Mac bank owns the first and second mortgages. The house generated multiple offers, but, being a short sale, any offer had to be accepted by the seller AND the bank.

We made an all-cash offer. Our only contingencies were basic things like: we could do an inspection (only on the house) and we could back out or renegotiate if necessary repairs exceed $40k. We offered a large deposit, increasing the deposit to 30% upon acceptance of our offer. We offered a fast close - less than a month. I thought our offer was as good as a cashier's check. And we offered a tiny bit above asking price.

Well, that was three weeks ago. Last we heard, the bank was still thinking about it. Our offer has technically expired, although we would still proceed with the sale if we hear from the bank, say, tomorrow. I have to admit, I am surprised that the bank would drag their feet when they have a solid offer on the table for a property in Sacramento county, one of the nation's worst housing markets right now. The house, like many Sacramento-area homes purchased in the last several years, is suffering from deferred maintenance. If we buy it, I expect to replace the air conditioner this year - and I hope that it doesn't fail before we get it replaced.

We recently looked at another house, a REO. The house has water damage and mold because the water heater failed, dumping 40 gallons right in the center of the house. It has been vacant so long that rats and birds, at a minimum, are nesting in the attic. I am open to a lot of things, but rats and snakes cross my line. Another house - another REO - is barely salvageable because it sat vacant for so long that scavengers and children have picked it clean. The banks are playing a dangerous game when they repossess a house - hoping that the house will be livable and sellable by the time the bank gets an agent assigned to sell the house. From most of what I have seen on the market, banks are getting hosed on repossessing houses. But, I guess there's something I'm missing, because, at least for Indy Mac, it's worth losing a cash offer at a fair price while they play "don't call us, we'll call you if/when we get around to it."

John Lennon rolls over in his grave

Is It Time to Invade Burma? - TIME: "But we still haven't figured out when to give war a chance."

The Burmese people's only crime is being born in Burma, and, for that, many will die of starvation and preventable diseases while the world waits with food, shelter, and medicine earmarked for the Burmese. But what gives another nation the right to invade another nation? Isn't that a slippery slope that could be used against us - the Swedish could invade America for humanitarian reasons - we have the death penalty and we don't provide universal health care and daycare. The Chinese could invade - we are torturing our people with excessive opportunity and choices. Chavez could invade to deliver heating fuel to our poor. The French could invade on the humanitarian grounds that we cruelly induce our American women to shave their legs and armpits, instead of allowing them to revel in their natural, God-given beauty.

Fact is, lots of countries disagree with each others' values and methods. If we want our independence as a nation, don't we have to honor other nations' independence, too? Even when it really sucks?

An old joke about being Saved

I lived in Louisiana for a few years in the 90s. I worked with a local woman whose sister had just gotten indoor plumbing - all the neighbors came to see it. There are people out in the rural bogs who make their living off insurance checks - their trailers ain't worth nuthin', but every year, when their trailers flood out again, the insurance companies declare the trailer a total loss and pay out 10 or 20 thousand dollars. It ain't much, but it's a livin'. There's an old Louisiana joke about floods and God. This article reminded me of it today: Happy Mother's Day: Woman pregnant with 18th child about a couple who are gonna keep having babies as long as God keeps sending them. The recent news about a family that prayed until their daughter died of diabetes brought it to mind, as well.

So the joke goes, there's a flood out in one of the small bayou towns. The flood waters reach Gautreau's house, rising so fast that Gautreau can't get out. Gautreau, being a good God-fearin' Christian, proceeds to pray like he's never prayed before. The flood waters reach the first floor, then the second. Gautreau manages to climb up on the roof. The flood waters reach the soffits under the roof. Gautreau's friend, Boudreaux comes rowing up in a pirogue, and calls out "Gautreau, Gautreau, lucky I reached you in time! Dis flood's da worst I ever seen. Come, I hep you into da pirogue." Gautreau pauses a moment in his prayers to answer Boudreaux, "Boudreaux, you go on an' git outta here. The lord gon' save me." Boudreaux argues, "No, Gautreau, come on, it's too dangerous, git in da pirogue!" But Gautreau stands firm, "Boudreaux, I'm a good God-fearin' Christian, and I'm tellin' you, the Good Lord is gon' save me. You, however, are the devil's hand-maiden, and you'd best git, cause God ain't gon' save the likes of you." Boudreaux shrugs and sets out on his pirogue.

The flood waters reach the bottom row of roof shingles, and Gautreau prays like he's never prayed before. A rescue helicopter sees Gautreau, and comes to save him. One of the rescuers throws down a ladder, and yells instructions to Gautreau about how to climb the ladder without falling. Gautreau shouts back "Naw, I'm a good God-fearin' Christian, and I don't need to be rescued. The Good Lord above is gon' save me." Gautreau goes back to his praying. The rescuer urges Gautreau to climb the ladder as the flood waters reach the middle of the roof. The rescuer tells Gautreau, "There's no time for that! Climb the ladder, the flood's gonna sweep you away!" But Gautreau stands firm, telling the rescuers to go away so he can get back to his prayin'. Sure enough, the flood waters reach the top of the roof. The rescue copter comes back for another pass, but Gautreau waves them away. The flood waters rise to Gautreau's waist, and the water flow tears Gautreau off his roof. Gautreau drowns.

At the pearly gates, Gautreau meets his maker. Gautreau says, "Well, Lord, I guess it was my time." God answers, "Naw, you just drowned." Gautreau wails, "but Lord, you sent the floods! I prayed and prayed, and awaited your salvation, Lord." God answers, "Gautreau, I sent a boat and a helicopter! What more do you want?!"

Los Lagos bargains

Granite Bay, California is ranked number 74 on Money Magazine's Best Places to Live. Los Lagos is a gated community in Granite Bay, home to executives and local basketball stars. Even within the gated community, one finds gated estates. The community features a beautiful pond/park next to the guard shack. Even in the Sacramento area, where most of our state's leaders keep at least a part-time home, Los Lagos is a special neighborhood befitting of movie stars and sports "royalty" (the local basketball team is the Sacramento Kings).

6080 BARCELONA CT, Granite Bay, CA 95746 is a bank repo priced at $944,900. At 4500 square feet on an acre, it is perhaps a modest home for Los Lagos. It doesn't even have a pool. But with HOA dues of just $175, it is a cheap entree to a neighborhood just across the street from Eddie Murphy's 10 acre estate (on the market for $6.9 million). Zillow reports 2007 property taxes at $12,577, making the old valuation somewhere around $1.257 Million dollars. But the last sale, presumably the bank repo, was only $866k, so don't cry for the bank yet.

5634 VIA AVION, Granite Bay, CA 95746 is more befitting the storied opulence of Los Lagos. At over 7,000 square feet on a 1.7 acre lot, this house is a bank-owned, as-is bargain at $1.539 Million. The new owner will only need to install a pool, add some landscaping to block the view of the power lines, and update the decor. Zillow reports 2007 property taxes at $24,326, making the old valuation somewhere around $2.43 Million dollars. But the last sale, presumably the bank repo, was only $1,710,00. It would appear that the prior owner (or the second mortgage and the prior owner) took a $700k loss, with the primary mortgage only losing a couple hundred grand (including repo costs).

I expected the real estate market to drop. Even I didn't expect to see open houses of bank repo homes in Los Lagos.

You don't have too many guns in Chicago. You have too many criminals.

32 people shot, 6 killed, in violent Chicago weekend - CNN.com: "CHICAGO, Illinois (AP) -- An epidemic of gunfire rattled the city during the weekend, with at least 32 people shot and six killed.

Police Superintendent Jody Weis blamed an excess of guns and gangs for the rash of violence. 'There are just too many weapons here,' Weis said at a news conference Sunday. 'Too many guns, too many gangs.'"

I once lived near a military base, where they had a LOT of guns. In all the time I lived there, they did not have 32 people shot in violence, nor 6 people killed violently. Over several years, shootings in that community that was chock full of guns did not add up to 32.

In suburban Pennsylvania, I learned to shoot a 12-gauge in my teens. Three of us teens loaded up the shotgun, a handgun, and a bag of rounds, and off we went to the outdoor shooting range. The friends who taught me to shoot taught me to be careful, too. It didn't take a parent lecturing us - we wanted to be safe, we didn't want to hurt each other or someone else, so we took it upon ourselves to include safety alongside "this is a trigger" and "here's how you load it." We had no adult supervision, and I don't even remember paying for the range time - it might have been a public park set up specifically for target practice. As far as I know, we were well within the limits of the law. You don't send kids out into the woods to hunt deer without giving them an opportunity to learn to shoot first. I never much thought about it - children didn't shoot up their schools back then, although we did hear about the odd adult shooting up an office or post office - but it was commonplace for a family to have guns in the house. Even children as young as 10 had hunting guns of their own. Between our own families and our friends, we all had access to guns.

We didn't have 32 shootings (not counting shooting at game while hunting) ANY weekend the entire time I lived in Pennsylvania. We didn't lock our doors, we didn't live in fear, and - remember, I'm in my 30's. I'm talking about the mid-80's to early-90's, not the Ozzie and Harriet 1950s. I read two newspapers in high school - the local paper and the Philadelphia paper - and I'll tell you, we didn't have many break-ins, muggings, burglaries, rapes, or robberies, either. All those guns - rifles and handguns and cross bows and knives and arrows - probably every other house had at least one gun - and we didn't have "an epidemic of gunfire" rattling the city, the county - heck, we didn't even have many shootings in Allentown/Reading, an area that still hadn't recovered from the steel bust. All those guns sat quiet, unused, unwanted for any purpose beyond hunting, target practice, skeet shooting, and perhaps home defense. Thousands upon thousands of guns, never once used in the commission of a crime.

So, to Police Superintendent Jody Weis, I would like to say this: You don't have too many guns in Chicago. You have too many criminals.

Copyright 2008 All rights reserved