Down to Earth with John Sterne

Railroad Tracks... Interesting

Here is a basic explanation or a "Dummies Guide" version of what went wrong with the banking system on a few, easy to understand levels.

This post isn't about some introspection about death or life, like some would expect from its title. Rather, it's about a literal possibility.

Tonight as I leave my wife and children and head off to Portland, OR we will all or at least most of us will be falling asleep tonight oblivious to the possible changes that could take place tomorrow.

Tomorrow we could wake up in a very different world. Over night the CME has changed the margin requirements on futures accounts to 100% or at least this is what I've been told and I hope I have faulty information because this could be one of the final straws in a long line of straws that, proverbally broke the camels back.

If my information is correct... Tomorrow is going to be a very back day on Wall Street and don't think that we are immune. Chicago, Hong Kong, Japan, and London will all be affected or perhaps I should say afflicted by the ramifications.

Moves like this scare me... but alas tomorrow is another day. So we shall see how this plays out,

But... If I were a Gambler I would bet on a very be down day and perhaps a down week for the markets ahead. Oh right, I am... My bets are already placed on this one.

Johnny

This is a story about a particular vision. A man's vision. A vision that leads one way or another to a moral quandry.

This is a story I'd like to share with you about a company. A big company. The Leader in it's industry.

Now, in this company, their is a man. He could be any man, a smart man, but most likely he's an executive. And most likely he's a somewhat overly optimistic man, but I'll get to that later. For now, just know that the idea or ideas that I impart to you in this story are both real and hypothetical. But, I digress, back to the man or woman... but given the psychology involved I'm going to assume he's a man.

One day the man had a vision. He thought, "You know, predatory pricing models can be illegal and certainly, even when they are not, look bad morally. My company doesn't want egg on it's face. It's up to me to come up with a new strategy to eliminate competitors from our markets, but aggressive pricing strategies are just to 80's. We need something new."

So the man thought and thought and came up with a plan. He passed it by the CEO and maybe the board perhaps only select members.

First he explained what he felty was happening in the economy, and most of the erudite men agreed with his take on the situation. Next he eplained where he thought the industry and the economy was heading and how that effected their business. Finally, he explained he plan and described how it would work and how his plan would be more subtle than a simple aggressive price strategy and organic growth.

He explained how with his plan, given the current market conditions, the company could force their competitors to near bankruptcy, drive their competitors to their knees just looking for a way out. Then, when their competitors are at their weakest, the company would pounce. They would buy the assets of their competitors take over their work, their customers, their goodwill, their best employees all for a bargain basement price near hard, current asset value. All the while they, the company, would look like white knights in the eyes of their failed competitors, the shareholders, even the employees of the competitors they take over.

You might say, " Well, that just sounds like normal business. M&A activity is usually in that form or something close to it," but my friends their is another shoe to drop. You see part of the plan is to build the company up, sycophantically off of the parts of their competitors. Also, they, the company, won't be satisfied with a few competitors... They want them all.

They operate these acquisitions unprofitably. They use existing empoyees and lower management so that they can be the scapegoats when the ongoing business of the new acquisition goes horribly wrong. They bring in sales persons who under-sell their services. Under-price their sales. They are given the pat answer, but these are the companys rates. When they are asked why the rates are lower than they need to be, by employees at the acquistion company. Obliviously, the unsuspecting scapegoats go on in peaceful, ignorant bliss. Little do they know that they are actually the fallguys when the inevitable happens.

This is because the company isn't finished yet. They continue to be a big player in the market and continue, also, to hold down prices at slow-death levels for their competitors. The low prices of their goods and services keep driving nail after nail, not only, into the coffins of their competitors but also into the coffins of their acquistion companies. Show all the world that, "the evironment, is killing us too." One by one, the acquisition companies die off only the very best and brightest employees are retained.

The final plan in this strategy is that all or at least the vast majority of their more important competitors are eventually wiped from the field, their assets and best employees absorbed at bargain rates. That is if all goes according to plan...

Of course, there are more details that I have excluded here that also relate to this plan, this vision, but, as I see it, there is one major flaw in this plan, a monumental flaw with this strategy.

The flaw is that this plan, is the plan laid out by a pathelogical Optimist. The problem with optimists is that they overlook facts, negative outcomes and they seldom recognize negative risks.

You see, the real flaw with this plan is... Is their going to be a market left to serve by the time you are done? A real possibility in this economic environment. The reason sucess can be had in the first place with this strategy is that the market is weak and unstable. Margins are low because of broad competition... My question is, "from whom?" Look at the real source of the pressures and one will see the flaw here. It should hit you like watching a freight-train hit a tiny puppy. And then, you will feel sick to your stomach, particularly if you are the person responsible for this flawed logic.

Readers I apologize for that similie and I am also sorry I can't go into greater detail.

The end result. This plan makes some very rosy assumptions about the final outcome. There is no guarantee that we will even be in a world where there is any demand for the goods and services of the company when the smoke clears. There is no guarantee that they can either buy or force out enough competitors to make a real difference and last, the creation of such a large gap in the market, assuming all of their other assumptions miraculously come true, create a massive opportunity for new, smaller, more agile and more efficient competitors to take the place of their former competitors as well as allowing them to "eat the companys lunch."

Yes, folks this man is smart and really sly but his mind is tainted by the disease of the optimist.

I do, however, admire the subtlety of his plan though.

Sorry about the incredibly long stretch since my last post. I will be trying to make more of an effort to post more often. Right now I have about a dozen ideas for blog posts so I will get some more up on here shortly.

The housing market finally in decline?

If you ask most real estate professionals they will probably tell you that the housing market in BC continues on a strong footing, that house prices continue to increase and that sales should continue to be strong into the future.

This is the same propaganda that has been going around the industry for years and in the irrational, exuberrant past they would have been right.

From my perspective, however anecdotal, I believe that we have finally reached the apex of our market, particularly in the Greater Vancouver / Fraser Valley regions. For the first time in over a decade there is actually opportunities to purchase properties, here, for less than they were in, at least, 5 years. Not many, but some, and this, I beieve, is due to foreclosures and negative economic pressures inflicted upon our citizens by a slow job market, high taxation, high oil prices, rediculous real estate prices, and the overly strong Canadian dollar.

Due to these pressures, I suggest, that the turning point is finally here. I have to be honest, I thought that the turning point would have been here 2 or 3 years ago but I finally see real signs of the US plague, finally, having more than just job market effects on our local economic landscape.

The last time we have seen an actual downturn in real estate prices here was 1999-2001.

While this downturn could have an impact on our market. I will go out on a couple of limbs here with some more predictions.

Firstly, I think the downturn here could go on for some time. This prediction goes against professionals in the industry and many investors' beliefs that the future, here, will continue in the manner that it has in the recent past. I make this prediction with the greatest reservation not because it goes against the general view but because it goes against my second prediction, on a local scale.

Which leads me to my second prediction for the real estate market and the US economy in general.

Recently, I have been seeing evidence that the economic downturn in the USA may be in it's final stages. There could be two possible paths I see the US economy taking from here both involve a recovery of sorts.

First, the US recovery comes starting soon, as soon as early next year. This upturn will be accompanied by a period of rapid inflation and therefore while the job markets will recover in the short term inflation and higher interest rates  that will inevitably following will hamper further growth. This would be a stagflation type of recovery similar to the 1970's. It will be long and difficult.

The second possibility is that there will be a small, short term, recovery in States. The banks will have worked through most of their inventory of REO's. The CDO's and CDS's whose average expiration will culminate 6 years after the peak of 2007 will have been worked through and will no longer have as much negative effect on the overall economy. This, along with banking austerity measures, will allow the housing markets to normalize and recover. Don't expect exuberrant returns in the short term but a recovery will occur and prices will rise. The only problem with this senario is the amount of liquidity that is currently in the US economy. Any recovery will inevitably increase the velocity of money through that economy and lead to again inflation. This is both a good thing and a bad thing. Higher interest rates should attract more foreign capital to US money markets and government debt instruments, thereby ensuring that a deeper deflationary recession is no longer a risk for the United States. The largest risk to the approaching recovery is that inflation comes on too quickly and the FEDs can't catch it with interest rates without killing the whole economy. Then foreign capital could flee the dollar and dollar deflation could occur which would make things even more expensive for consumers and reinforcing the inflation cycle. This is perhaps one of the greatest risks.

Regardless, a recovery in the US would tend to counter the effects of a local pull back in real estate prices and might render any pull back very short term here.

I realize that this post hasn't made the most sense and would probably make more sense if I provided my reasoning and study points that have brought me to these conclusions. However, I would have to write a small book in order to include a complete description of these points. So I believe, it is sufficient to make my predictions and to let them stand alone. Right or wrong... The future alone knows.

To summarize my predictions:

1) Locally a real estate downturn - A pull back in prices perhaps to 2004 or 2005 levels. This before other macro economic effects take hold.

2) US recovery - Now is the pinnacle of opportunity. 2 Years from now the recovery will be well under way. Real Estate inventories will have dried up and prices will rise. The potential counter balance to this rise will be an environment of high inflation which would be negative in it's effect but it would change the whole nature of the market.

For now, that is where I stand on the future.