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Eric Sprott Interview - Pushing silver, 90% of net worth in precious metals


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Guest broxburnboy

Just to add to Sprott's longtime held beliefs in the precious metal/inflation scenario, a newer well reasoned article on one possible resolution to the burgeoning money supply problem:

 

http://www.ritholtz.com/blog/2010/11/brodsky-on-gold/

 

I have no idea who this guy is but his reasoning is sound and his conclusion compelling.

 

Disclaimer: long gold/silver stocks, shares in Sprott inc. and Sprott Precious metals funds, I'm definitely talking my book here.

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One topic the article neglected to mention was the spiraling wage inflation of the 1970s.  This I believe is what led to consumer price inflation -- the consumers had more nominal income and thus nominal consumer prices rose.

 

Is the author expecting wages to take off soon?  Or is he expecting consumer prices to rise even though nobody can afford price increases without increased wages?

 

I can see the argument for gold rising over time vs the dollar.  You have more goods and services in the world today than back in 1980 at the last real gold peak.  Were you to exchange the increased goods and services for gold, it would put upward pressure on the real price of gold given that supply of gold is static.  When mass psychology gets involved, you can have a sudden move in gold if this becomes a popular way of thinking.   The same would happen for the dollar if it's quantity remained static, except that the supply of dollars has increased.  This suggests that it is entirely possible to have static consumer prices (in dollars) despite both a higher supply of dollars as well as a higher gold price (expressed either in dollars or in a currency "basket" of goods and services).  Consumer inflation (in dollar terms) I think would have been much higher over the past 30 years if there weren't so many advances in productive output.  I think partially this is by design -- I suspect they used the advances in productivity to justify much of the dollar supply increases.  Regardless, the same amount of gold should logically buy more goods and services if there have been real advances in productivity -- that ought to be a no brainer, if it costs less to produce because of some new gizmo scientific advance, shouldn't you be able to afford more of it?  How can you call it a rise in the standard of living if you aren't able to afford more goods and services?

 

I guess what I'm saying is you can have a devalued dollar even if you have stable prices.  Technological advancements like machines should in theory make manufactured and farmed goods cheaper -- if you get no downward consumer price movement then you effectively have devaluation because you entirely lost the would-be cost of production savings.  Your dollar made no advance in buying power despite improved technology -- therefore devaluation.  Gold can therefore advance versus the dollar... but this doesn't necessarily indicate that prices will go up at the grocery store.  

 

If gold (at it's current exchange rate with the dollar) doesn't buy you an appropriately larger amount of goods and services (as suggested by increases in productivity) then it could be reasoned to be logically undervalued as a currency.  Why should we believe that it should only buy you a finely tailored suit if somebody invents a machine that can duplicate the quality of that suit at 1/4 of the cost?  Shouldn't it then buy you four suits?  And if the dollar (due to increased supply) can still only buy you one of those suits, then shouldn't gold be a four bagger vs the dollar?  In a roundabout way I suppose I'm reasoning that the dollar is already devalued more than people think, and gold could possibly be rising due to undervaluation.  It can take a crisis and fear mongering to get people to look at gold again, and that becomes the catalyst to get the needed price correction -- however this may happen independently of any dollar crisis... because the purchasing power of dollar may already have been stealthily devalued during a period of historically high productivity gains that have masked the loss in would-be consumer purchasing power.

 

Based on the supply demand argument based on the rising productivity, I would expect gold over time to buy you more and more... until we hit some productivity limit (if there is one).  The question for me though is can I do better investing in other things?  Prem said recently "we don't invest in gold" -- I think he feels he can just do better.  He also stated that he is worried about a commodity bubble forming right now -- although he didn't say which commodities.

 

 

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Sprott's argument on silver sounds very much like the argument for natural gas.  NG is 6:1 BTU content to oil, was trading at 12:1, and many including Southeastern's Hawkins and Cately argued that it would trade back to 6:1.  It didn't.  Now it trades somewhere between 15 to 20:1.

It's just a mean reversion to a historical relative ratio.

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Guest broxburnboy

One topic the article neglected to mention was the spiraling wage inflation of the 1970s.  This I believe is what led to consumer price inflation -- the consumers had more nominal income and thus nominal consumer prices rose.

 

Is the author expecting wages to take off soon?  Or is he expecting consumer prices to rise even though nobody can afford price increases without increased wages?

 

I can see the argument for gold rising over time vs the dollar.  You have more goods and services in the world today than back in 1980 at the last real gold peak.  Were you to exchange the increased goods and services for gold, it would put upward pressure on the real price of gold given that supply of gold is static.  When mass psychology gets involved, you can have a sudden move in gold if this becomes a popular way of thinking.   The same would happen for the dollar if it's quantity remained static, except that the supply of dollars has increased.  This suggests that it is entirely possible to have static consumer prices (in dollars) despite both a higher supply of dollars as well as a higher gold price (expressed either in dollars or in a currency "basket" of goods and services).  Consumer inflation (in dollar terms) I think would have been much higher over the past 30 years if there weren't so many advances in productive output.  I think partially this is by design -- I suspect they used the advances in productivity to justify much of the dollar supply increases.  Regardless, the same amount of gold should logically buy more goods and services if there have been real advances in productivity -- that ought to be a no brainer, if it costs less to produce because of some new gizmo scientific advance, shouldn't you be able to afford more of it?  How can you call it a rise in the standard of living if you aren't able to afford more goods and services?

 

I guess what I'm saying is you can have a devalued dollar even if you have stable prices.  Technological advancements like machines should in theory make manufactured and farmed goods cheaper -- if you get no downward consumer price movement then you effectively have devaluation because you entirely lost the would-be cost of production savings.  Your dollar made no advance in buying power despite improved technology -- therefore devaluation.  Gold can therefore advance versus the dollar... but this doesn't necessarily indicate that prices will go up at the grocery store.  

 

If gold (at it's current exchange rate with the dollar) doesn't buy you an appropriately larger amount of goods and services (as suggested by increases in productivity) then it could be reasoned to be logically undervalued as a currency.  Why should we believe that it should only buy you a finely tailored suit if somebody invents a machine that can duplicate the quality of that suit at 1/4 of the cost?  Shouldn't it then buy you four suits?  And if the dollar (due to increased supply) can still only buy you one of those suits, then shouldn't gold be a four bagger vs the dollar?  In a roundabout way I suppose I'm reasoning that the dollar is already devalued more than people think, and gold could possibly be rising due to undervaluation.  It can take a crisis and fear mongering to get people to look at gold again, and that becomes the catalyst to get the needed price correction -- however this may happen independently of any dollar crisis... because the purchasing power of dollar may already have been stealthily devalued during a period of historically high productivity gains that have masked the loss in would-be consumer purchasing power.

 

Based on the supply demand argument based on the rising productivity, I would expect gold over time to buy you more and more... until we hit some productivity limit (if there is one).  The question for me though is can I do better investing in other things?  Prem said recently "we don't invest in gold" -- I think he feels he can just do better.  He also stated that he is worried about a commodity bubble forming right now -- although he didn't say which commodities.

 

 

 

 

If you really believe that monetizing bad debt.. and it is bad... and using the money to finance the ongoing burgeoning deficit is going to create price stability and economic "recovery"... and cutting taxes will result in more tax revenue... then you have truly found the source of all wealth... the Fed's printing press. Why not cut taxes to zero... or better yet ...pay taxpayers with some newly minted money to incur more personal debt. After all taxes are obsolete if debt can be monetized without dillution of purchasing power.

I better sell my scrap gold to the shamwow guy before the rest of  the goldbugs catch on to the bubble in PMs.

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If you really believe that monetizing bad debt.. and it is bad... and using the money to finance the ongoing burgeoning deficit is going to create price stability and economic "recovery"... and cutting taxes will result in more tax revenue... then you have truly found the source of all wealth... the Fed's printing press. Why not cut taxes to zero... or better yet ...pay taxpayers with some newly minted money to incur more personal debt. After all taxes are obsolete if debt can be monetized without dillution of purchasing power.

I better sell my scrap gold to the shamwow guy before the rest of  the goldbugs catch on to the bubble in PMs.

 

The key phrase you use is "if you really believe".  And none of what you then go on to say I "really believe" -- as you know, I don't "really believe" that bad debt has been monetized... I think the Fed has in effect granted a loan.  

 

You go on to call it a printing press, which it is not.  Hoisington has pointed out that the quantitative easing is not inflationary -- do you think he is wrong?  I presume you do, but I'm not quite so quick to dismiss him.

 

Here is what I believe QE2 is about -- an attempt to stop the increased government borrowing from starving the private sector of dollars.  That starvation of dollars would counteract the money that the government is trying to spend as stimulus -- but that stimulus isn't creating much inflation because the current macro environment is heavily deflationary.  It's like two very powerful winds blowing head to head but getting nowhere.  I believe they intend to lend this money from the Fed (and buying a bond is in fact lending) until the de-leveraging (the massive deflationary headwind) has substantially progressed.  They have said they intend to unwind it, and if you think about it all they really need to do is sit on their hands -- let the bonds mature, thus the dollars are brought back to the Fed.  This does not come wholly for free (if you support the current price level it's inflationary relative to an alternate path of letting prices fall), but it's far less than 1:1 money printing as many of these dollar bears suggest.

 

That doesn't mean that I believe QE2 will necessarily fix anything -- there is no guarantee that the private sector would invest their dollars in the US economy any differently whether or not they are starved of those particular dollars.

 

The problem is not with QE2 -- the problem is with the government borrowing.  QE2 can be reversed far easier than the government borrowing.  Do I worry about QE2?  No, I worry about the deficits.  Do I think QE2 will bring prosperity?  No, I think it will merely keep some dollars from being siphoned by the government out of the private sector... for a period of time until they mature (or perhaps sold a year or two before maturity).

 

I've stated before that if you really want a printing press analogy, then this QE2 printing press has disappearing ink.

 

 

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"The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening."

 

 

I pulled that quote from Hoisington (from page 2):

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

 

 

Record Expansion of the Fed©s Balance Sheet and M2

In the past year, the Fed’s balance sheet, as measured by the monetary base, has nearly doubled from $826 billion last March to $1.64 trillion, and potentially larger increases are indicated for the future. The increases already posted are far above the range of historical experience. Many observers believe that this is the equivalent to printing money, and that it is only a matter of time until significant inflation erupts. They recall Milton Friedman’s famous quote that “inflation is always and everywhere a monetary phenomenon.”

 

These gigantic increases in the monetary base (or the Fed’s balance sheet) and M2, however, have not led to the creation of fresh credit or economic growth. The reason is that M2 is not determined by the monetary base alone, and GDP is not solely determined by M2. M2 is also determined by factors the Fed does not control. These include the public’s preference for checking accounts versus their preference for holding currency or time and saving deposits and the bank’s needs for excess reserves. These factors, beyond the Fed’s control, determine what is known as the money multiplier. M2 is equal to the base times the money multiplier. Over the past year total reserves, now 50% of the monetary base, increased by about $736 billion, but excess reserves went up by nearly as much, or about $722 billion, causing the money multiplier to fall (Chart 3). Thus, only $14 billion, or a paltry 1.9% of the massive increase of total reserves, was available to make loans and investments. Not surprisingly, from December to March, bank loans fell 5.4% annualized. Moreover, in the three months ended March, bank credit plus commercial paper posted a record decline.

 

If this all sounds complicated you are right, it is. The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening.

 

 

This quote from page 3 is also a good one:

 

The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.

 

 

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Ran into an old friend this week, who that day was trying to liquidate silver bars, (which the first bank wouldn't) and he said he had held them for decades, since the Hunt bubble i think, and was selling at a loss. That is one nasty ROI on silver.

 

Coincidentally, he told me he had received shares in a canadian blue chip around the same time as part of selling his business, and had he just held thru the decades and the splits, it would have been the biggest part of his wealth. Tough to do in hindsight, but a bit of cautionary tale, I think, although i wouldn't bet against Sprott.

 

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Guest broxburnboy

Ran into an old friend this week, who that day was trying to liquidate silver bars, (which the first bank wouldn't) and he said he had held them for decades, since the Hunt bubble i think, and was selling at a loss. That is one nasty ROI on silver.

 

Coincidentally, he told me he had received shares in a canadian blue chip around the same time as part of selling his business, and had he just held thru the decades and the splits, it would have been the biggest part of his wealth. Tough to do in hindsight, but a bit of cautionary tale, I think, although i wouldn't bet against Sprott.

 

 

Too bad your old friend didn't follow Buffett's strategy.. buying when the silver price was low and selling it into a rising market.

 

http://www.time.com/time/magazine/article/0,9171,138593,00.html

 

 

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1) I believe the article is wrong in saying that 90% of Eric Sprott's net worth is in precious metals. The bulk of his net worth is tied up in SII stock - $700m at current prices. Yes, you can say that SII is quite exposed to the precious metals play but it is not 90%. Besides, much of their exposure is via performance fees, which has option like characteristics (upside, no downside) - I think I discussed this before in another thread a few months ago when SII was just 50% of the current price.

 

2) Is QE2 = printing money? To the extent that it increases the monetary base, I would imagine that an economist would equate that to money creation (i.e. printing). This is not necessarily inconsistent with Hoisington's view that in the short term this may not result in inflation - because of a drop in the velocity of money. (Saying that money is printed only if the loan goes bad is virtually like saying that you don't have a mortgage when you first take it out because it is backed by the property and that you can only call it a mortgage when the property becomes worth less (or worthless)).

 

3) Is it possible that Hoisington is right in the short term and Sprott right in the longer term? Seems conceivable to me; especially if, as seems likely,  Bernanke continues to respond to deflation by throwing money out of helicopters and the politicians continue to fumble with the deficits.

 

4) Can we look at just the one example of the 1970s inflation to conclude that inflation cannot occur without wage inflation? I don't know enough about economics or the original causes of the 1970s wage spiral to give a coherent answer. However, I suspect that inflationary expectations can, in the absence of wage inflation, spark off goods inflation which in turn drives wage inflation. If inflationary expectations are bad enough, won't people just rush to convert their cash into "things" (salt, sugar, gold, whatever). Even if their wages have not risen yet, they may feel it is better to borrow first and pay back in tomorrow's cheaper dollars.

 

5) Buffett has said that the bailouts and stimuli were necessary but there would be a price to pay later on for the past excesses. The problem is that there is no sign that the policy makers have accepted this truism. Right now, the current policies seem to me to be remarkably similar to those that Greenspan favoured - i.e. keep the economy growing at all costs and deal with the consequences when they arise. There seems to be little consideration of "what if we are wrong" and "what unintended consequences could there be?" Until they accept the reality that we have to take some tough medicine, it seems unlikely we will get good long term solutions. Till then, it is prudent to be aware of the risks.

 

6) Gold & silver - people like Sprott and Rogers have got this argument right for a long time. This does not mean they will get the sell timing right although their track record is pretty good. They may continue to be right but anyone deciding to join the party today has to realise that their risk reward ratio is not the same as those who got into gold at $400. At these levels, it feels too much of a 50:50 bet; not sufficiently good odds, imo, unless you can find ways to manage your risk.

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4) Can we look at just the one example of the 1970s inflation to conclude that inflation cannot occur without wage inflation?

 

It is actually the opposite -- the author wrote that article bringing up 1970s without mention of wage pressures.  I'm not letting him off that easy.  If he's going to compare two periods, he needs to address important variables that differ remarkably.  He may have guessed correctly, but he is not showing his work.

 

Hoisington has a chart that Fairfax watchers popularized on this board -- the chart shows the spike/collapse in long term interest rates (inflation expectations) coinciding with the Rise/Collapse of Iron/Bamboo curtains.  I've argued in the past that Hoisington failed to mention the depegging of the dollar -- I wondered out loud on this board whether the historically low Treasury yields of the past ought to come back again or not... after all, the gold bugs argue quite loudly that a currency backed by gold will hold down inflation.  Why should bond yields today reach the levels of the past when back then the dollar was backed by gold?  Is there no such thing as a risk premium for fiat money?

 

In other words, let's say the Treasury were to auction off two issues side by side.  One of them would be exactly the same as Treasuries today, where principle and interest are paid in dollars.  The other issue is one where the principle and interest is paid in gold.  Which one do you figure will attract the most demand?  Shouldn't that be at least worthy of mention in Hoisington's chart?

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Here is what I believe QE2 is about -- an attempt to stop the increased government borrowing from starving the private sector of dollars.  That starvation of dollars would counteract the money that the government is trying to spend as stimulus -- but that stimulus isn't creating much inflation because the current macro environment is heavily deflationary.  It's like two very powerful winds blowing head to head but getting nowhere.  I believe they intend to lend this money from the Fed (and buying a bond is in fact lending) until the de-leveraging (the massive deflationary headwind) has substantially progressed.  They have said they intend to unwind it, and if you think about it all they really need to do is sit on their hands -- let the bonds mature, thus the dollars are brought back to the Fed.  This does not come wholly for free (if you support the current price level it's inflationary relative to an alternate path of letting prices fall), but it's far less than 1:1 money printing as many of these dollar bears suggest.

 

Ericopoly,

 

This is the best description of why they are doing what they are doing that I have seen.  Concise and likely quite accurate.  Nicely done.  As you say, whether it works is another discussion.  But, so far, I'm in the camp that thinks on whole, the gov't has handled this better than I would have predicted.

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Here is what I believe QE2 is about -- an attempt to stop the increased government borrowing from starving the private sector of dollars.  That starvation of dollars would counteract the money that the government is trying to spend as stimulus -- but that stimulus isn't creating much inflation because the current macro environment is heavily deflationary.  It's like two very powerful winds blowing head to head but getting nowhere.  I believe they intend to lend this money from the Fed (and buying a bond is in fact lending) until the de-leveraging (the massive deflationary headwind) has substantially progressed.  They have said they intend to unwind it, and if you think about it all they really need to do is sit on their hands -- let the bonds mature, thus the dollars are brought back to the Fed.  This does not come wholly for free (if you support the current price level it's inflationary relative to an alternate path of letting prices fall), but it's far less than 1:1 money printing as many of these dollar bears suggest.

 

Ericopoly,

 

This is the best description of why they are doing what they are doing that I have seen.  Concise and likely quite accurate.  Nicely done.  As you say, whether it works is another discussion.  But, so far, I'm in the camp that thinks on whole, the gov't has handled this better than I would have predicted.

 

Is there really any evidence that the govt deficits have been crowding out the creditworthy private sector's access to credit? It does not seem to be the case judging by the terms that recent corporate bonds have been able to attract (for very long maturities, too). Isn't the real reason why private sector credit is shrinking because the people who can borrow don't need to, and the ones who want to, can't (because they are not creditworthy)? The former don't need help from QE and the latter won't benefit from QE.

 

Hasn't Bernanke himself said that the idea is to create a wealth effect by boosting asset prices? The question is how is this different from what Greenspan effectively did earlier this decade? Isn't the definition of insanity, "Doing the same thing over and over again and expecting a different result each time?"

 

I agree with Ericopoly that government stimulus is necessary to offset the the sharply contracting private sector economy. But, QE is not strictly necessary to make this happen - unless you fear that the market will not lend the money to the US govt. In which case, we come back to the argument that Sprott is making that there will be a run on the US treasury. I don't think we are at that point yet, which is why I don't see how QE2 makes sense. What is the risk reward trade-off here? Is the negative psychological impact of QE2 a worthwhile risk for the marginal benefit of 50 bps of easing? I believe this is what people like Klarman are worried about. And, Hoisington is basically saying that further easing will not matter. It is not clear Bernanke has considered the risk that QE2 might spark off another asset bubble while not helping the real economy at all.

 

The idea that Bernanke will reverse QE on a dime is subject to question. No doubt he has the tools to do so. The question is whether he has the will to do so expediently. Neither he nor Greenspan tightened quickly enough to prevent the huge housing bubble.

 

Leaving aside what the possible causes of inflation were in the 1970s, I believe Sprott is taking the simple but seemingly valid view that at some point curing the deficit problem will become so painful, the politicians will take the easy path and inflate their way out. We only have to understand Munger's views on the power of incentives to realise that self-interested politicians will find it hard to ask the electorate to take tough medicine. Letting inflation solve the problem is convenient - you can then blame the markets (and bankers and hedge funds) for it.

 

 

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Is there really any evidence that the govt deficits have been crowding out the creditworthy private sector's access to credit?

 

I found this in one of Hoisington's letters -- and couple that with Bernanke's frustration over the exploding deficits.  What exactly happens when the government borrows that is so painful to the private sector?  Why does that impair the private sector as Hoisington claims?  I realize that Bernanke has said this is only about controlling interest rates, but I don't believe they always tell the whole story when they speak publicly.  It might be a half truth.  Perhaps Hoisington is referring to the cost of servicing the debt, but I wondered what good it does for the economy when there is an increased supply of "safe havens" (Treasuries) for the private sector to purchase.  So I speculated that if you were to hoard the safe havens to yourself (keep them locked up by the Fed) then people would need to use their dollars for risk taking in order to generate return.

 

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

 

 

Are Massive Budget Deficits Inflationary?

Based on the calculations of the Congressional Budget Office, U.S. Government Debt will jump to almost 72% of GDP in just four fiscal years. As such, this debt ratio would advance to the highest level since 1950 (Chart 5). The conventional wisdom is that this will restore prosperity and higher inflation will return. Contrarily, the historical record indicates that massive increases in government debt will weaken the private economy, thereby hindering rather than speeding an economic recovery. This does not mean that a recovery will not occur, but time rather than government action will be the curative factor.

By weakening the private economy, government borrowing is not an inflationary threat.

 

 

 

 

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Isn't the real reason why private sector credit is shrinking because the people who can borrow don't need to, and the ones who want to, can't (because they are not creditworthy)? The former don't need help from QE and the latter won't benefit from QE.

 

People were saying that twelve months ago too.  I went out looking for a home loan.  I couldn't get one.

 

I wanted a 30% down loan.  The amount I wanted to borrow amounted to an annual mortgage payment of about 1% of my net worth.  So I told them... okay... I'm already giving you a 30% price cushion, I ALREADY have 100 years frigging years worth of payments saved up, and you're telling me it's too risky?  Actually, the real story is that because I have no job I'm not qualifying for a Fannie/Freddie program, so they have to carry my loan on the books.  This at a time when they are trying to de-risk to meet stricter capital levels.  They said it was because the secondary markets were not welcoming this kind of loan.  One of those banks that turned me down is Wells Fargo.

 

I gave up looking for a while -- for a brief time we thought of getting a house in Montana (and found a bank that would do it), but then we decided to wait on that too.  Actually, I haven't been out looking in 9 months so I'm not sure if the banks here in Washington state have healed yet.  Anecdotally I heard from a lender that Washington Federal was making such loans (I guess that's a solid hint that their balance sheet is healthy).

 

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Is that specific to your location or loan size? In November, I could obtain a 15 year fixed rate from Wells at 4.3% APR on a ~$400K loan, which also covered closing costs. This is in Pasadena, CA, where home prices have been less volatile than the greater Los Angeles area.

 

Also, you may have been hurt by the composition of your assets. If you maintain a large checking account balance for 6 months, your application is more likely to push through.

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At the end of 2009, the percentage of commercial bank assets (according to FDIC call reports, which covers bank holding entities) in reserve accounts stood at 5% from 1/4% before the crisis. On the other hand, the Fed issues a quarterly survey of senior loan officers that shows flat to declining loan demand, particularly at small banks and in commercial and industrial loans.

 

This link shows the distribution of loan officer responses from the October survey:

http://www.federalreserve.gov/boarddocs/snloansurvey/201011/table1.htm

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Is that specific to your location or loan size? In November, I could obtain a 15 year fixed rate from Wells at 4.3% APR on a ~$400K loan, which also covered closing costs. This is in Pasadena, CA, where home prices have been less volatile than the greater Los Angeles area.

 

Also, you may have been hurt by the composition of your assets. If you maintain a large checking account balance for 6 months, your application is more likely to push through.

 

Perhaps hurt by the composition of my assets.  I have it all in equities.  But put a 50% haircut on it and I'm still at 50 years of payments.   The real estate market here is actually relatively stable on Bainbridge Island.  This particular house was a short sale and at 50% of what it's new-build price was.  Nice house.

 

They classified it as "asset based lending" because I have no earned income, and would only assign me some arbitrary yield of about 1.5% (it was 1.x%, I don't remember exactly what the fractional amount was) on my loan as "income".  I told them I could put a zero percent yield on the assets and they would still get their money back -- because even if I spent 1.5x my prior salary on living expenses for the 30 year loan term, and additionally paid the mortgage all along the way, I'd still have a lot of money left over at the end of the 30 years.  Plus, this was for an amortizing mortgage... every year they've have it partially paid off, so that initial 30% margin of safety would get larger and larger.  So for arguments' sake if I defaulted after year 10 or 15 or 20... what have you... I'd have sunk so much principle into the loan by then that the margin of safety would be well beyond 30%.  They still said no.

 

Then Stumpf gets on the news saying they have a problem with demand for loans!  I was going to pay them about 6% interest, and it was only about 3 yr fixed rate, then adjusting... so they carried little interest rate risk -- still not profitable?

 

At that point, I said "okay, let's say I put down 35%".  Nope.  How about 40%.  Nope.  All those pencil-heads cared about is the paltry 1.5% or so yield they'd give me for my assets in order to count it as income.  I said how about I just put the entire thing into Treasuries (for arguments' sake) and get 4% yield?  That would have given them automatically a risk free yield that was more than double what they would grant me in their projections.  Or how about I invest in blue chip stocks like JNJ so that you can in effect be lending against a AAA rising income?  And that income would likely rise faster than your typical earned income paycheck in this environment?  Nope.

 

Bottom line is no matter how silly, they wouldn't lend.  Now, if the secondary market had been more accomodating there would not have been a problem.

 

The person with no assets and an income (a pink slip away from foreclosure) is a better risk than a person with 100 years of payments ALREADY in the bank.  That person with the income... are they going to work for the next 100 years?  It's bizarre.  

 

 

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"The person with no assets and an income (a pink slip away from foreclosure) is a better risk than a person with 100 years of payments ALREADY in the bank.  That person with the income... are they going to work for the next 100 years?  It's bizarre."  

 

 

No, it just feels that way sometimes. . .  Thanks for the very telling anecdote.  This is really indicative of a topsy turvy mortage market.  Government backed distortion.  So much of our economy now is not about true credit risk or business sense, but about playing this or that government program, for this or that government backing, or this or that government tax rebate, or this or that government preference, etc.  This framework just is not efficient at allocating capital, regardless of one's political stripes. 

 

Here is another anecdote for you.  Something like a third of the small businesses my partner and I help start (we're small business lawyers) have to do with gaming some government program, or structuring it to obtain a government preference status.  Think about that.  From my little perch on the world, fully 1/3 of people starting new businesses are trying to "get their fair share" of government largesse --- for their living.  I'm really not trying to make this political, and hope it doesn't get into all that, or at least not much.  I'm just saying it is disturbing to me that so many people are clamoring to feed at the government trough.  And this is the entrepreneurial group I'm talking about.

 

I just read on the Rasmussen website today that 28% of the American electorate think the government should manage the entire economy -- not part of it, but the whole thing -- a la China or the Soviet Union.  While 24% think the government should be out of the economy entirely.  Then there are the 45% or so in the middle that think the government should take an active role in managing crises and downturns (I'd probably put myself here most of the time, for the record).  Those are eye-opening stats for the American electorate.  Maybe if Europe continues to erode and China's bubble bursts people will rethink some of those beliefs in government management of the economy.   

 

I think most people on this board who appreciate Buffett's and Watsa's capital allocation skills (and how difficult that skill is to obtain and maintain) can agree that this constant playing against government policy is not a good way for a society to allocate capital, for the simple reason that it incentivizes people based upon political interest groups and lobbying rather than sound business judgment, sound credit risk, and merit of ideas rather than "pull". 

 

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Guest broxburnboy

Unfortunately, the government/Fed already is managing the whole economy through the twin levers of fiscal and monetary policy. The markets respond instantly to every manipulation in interest rates, tax cuts and government spending to favored sectors.

Favored sectors and companies are "bailed out", banks owe their "profitabilty" to government blessed accounting fraud, insolvent individuals and enterprises are kept afloat, continuing to destroy wealth.

The blessings are spread out unfairly, but the tab is distributed evenly to all who hold US dollars through dillution of purchasing power.

No wonder its tough to get ahead for those not so favoured...I'll settle for breaking even in real terms.

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Bottom line is no matter how silly, they wouldn't lend.  Now, if the secondary market had been more accomodating there would not have been a problem.

 

The person with no assets and an income (a pink slip away from foreclosure) is a better risk than a person with 100 years of payments ALREADY in the bank.  That person with the income... are they going to work for the next 100 years?  It's bizarre.  

 

Isn't this why we got into the crisis in the first place? The loan reviewers in North America are "robots." Everything is systematized to make loan approvals quick and easy. The drawback is that the systems are not designed to deal with rare and unusual cases like yours. When I first moved here, I faced the similar problem of not being able to get a credit card - because I did not have a credit history. (Same story with mortgage). Doesn't matter what your net worth is or how much money you have in the bank - they only understand "credit score." If I had kept on using cash to pay for stuff, I probably would still not have a credit history today and still be unable to get credit.

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Guest broxburnboy

Bottom line is no matter how silly, they wouldn't lend.  Now, if the secondary market had been more accomodating there would not have been a problem.

 

The person with no assets and an income (a pink slip away from foreclosure) is a better risk than a person with 100 years of payments ALREADY in the bank.  That person with the income... are they going to work for the next 100 years?  It's bizarre.  

 

Isn't this why we got into the crisis in the first place? The loan reviewers in North America are "robots." Everything is systematized to make loan approvals quick and easy. The drawback is that the systems are not designed to deal with rare and unusual cases like yours. When I first moved here, I faced the similar problem of not being able to get a credit card - because I did not have a credit history. (Same story with mortgage). Doesn't matter what your net worth is or how much money you have in the bank - they only understand "credit score." If I had kept on using cash to pay for stuff, I probably would still not have a credit history today and still be unable to get credit.

 

Credit scores are not a measure of ones ability to repay the loan, but of the chance that the loan will be profitable to the lender. That's why people who are likely to pay the loan off in advance have lower scores instead of higher ones. There are real up front costs to the lender (like sales commissions) which must be charged against the total profit of the loan.

I have a very low credit score because I rarely take loans and when I do I have a history of stiffing lenders by paying off the loan before its full term.

The credit score is an attempt to screen out both potential deadbeats and potential early payers. In the upside down world of contemporary credit risk assessment, people with solid balance sheets like Ericopoly are deemed a poor risk to pay the full pound of flesh.

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Bottom line is no matter how silly, they wouldn't lend.  Now, if the secondary market had been more accomodating there would not have been a problem.

 

The person with no assets and an income (a pink slip away from foreclosure) is a better risk than a person with 100 years of payments ALREADY in the bank.  That person with the income... are they going to work for the next 100 years?  It's bizarre.  

 

Isn't this why we got into the crisis in the first place? The loan reviewers in North America are "robots." Everything is systematized to make loan approvals quick and easy. The drawback is that the systems are not designed to deal with rare and unusual cases like yours. When I first moved here, I faced the similar problem of not being able to get a credit card - because I did not have a credit history. (Same story with mortgage). Doesn't matter what your net worth is or how much money you have in the bank - they only understand "credit score." If I had kept on using cash to pay for stuff, I probably would still not have a credit history today and still be unable to get credit.

 

Credit scores are not a measure of ones ability to repay the loan, but of the chance that the loan will be profitable to the lender. That's why people who are likely to pay the loan off in advance have lower scores instead of higher ones. There are real up front costs to the lender (like sales commissions) which must be charged against the total profit of the loan.

I have a very low credit score because I rarely take loans and when I do I have a history of stiffing lenders by paying off the loan before its full term.

The credit score is an attempt to screen out both potential deadbeats and potential early payers. In the upside down world of contemporary credit risk assessment, people with solid balance sheets like Ericopoly are deemed a poor risk to pay the full pound of flesh.

 

Thanks for that explanation -- I hadn't taken account the repayment risk to the lender.  Had I thought of that at the time I might have offered to pay them cash for their commission upfront.

 

I wonder if I were 64 years old and 1 yr from retirement -- would I qualify for the Fannie/Freddie program?  Likely I'd be dead long before the 30 yr maturity -- and almost certainly not able to work for much longer.  I wonder if common sense is applied, or whether for political reasons they don't want to age discriminate.  

 

 

 

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Sprott's argument on silver sounds very much like the argument for natural gas.  NG is 6:1 BTU content to oil, was trading at 12:1, and many including Southeastern's Hawkins and Cately argued that it would trade back to 6:1.  It didn't.  Now it trades somewhere between 15 to 20:1.

It's just a mean reversion to a historical relative ratio.

 

Well, to be fair, the reason natural gas hasn't mean reverted is because, in the United States, we have a large increase of supply via shale gas.  Correct me if I'm wrong, but isn't natural gas much higher in other areas of the world where there's not an abundance of shale gas?

 

In silver, it doesn't seem like a similar story is likely to play out...

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