"Our" Banks, Warren? No, YOUR Banks

Warren Buffett's Freudian Slip

This land is your land
This land is my(?) land
From California to the New York island
From the red wood forest to the Gulf Stream waters
This land was made for you (and me?).

--Lyrics, "This Land is Your Land"; Woody Guthrie (tweaked by Ross Kaplan)

The first time I read "Pretty Good for Government Work," Warren Buffett's defense of the bank bailouts in The New York Times this week, it all seemed perfectly reasonable and logical: the system truly was on the verge of a melt-down in September, 2008, and doing nothing surely would have brought on -- if not a financial apocalypse -- something very, very nasty.

But re-reading it, I couldn't help coming back to a single, offending word: 'our.'

Here's the context:

Just over two years ago, in September 2008, our country faced an economic meltdown. Fannie Mae and Freddie Mac, the pillars that supported our mortgage system, had been forced into conservatorship. Several of our largest commercial banks were teetering. One of Wall Street’s giant investment banks had gone bankrupt, and the remaining three were poised to follow. A.I.G., the world’s most famous insurer, was at death’s door.

--Warren Buffett, "Pretty Good for Government Work"; The New York Times (11/16/2010)

I suppose if I owned tens of millions of shares in Wells Fargo, Wachovia, and Moody's (the credit rating agency); $10 billion in Goldman Sachs bonds that I very much wanted repaid; billions in credit default swap positions, etc. etc. -- I would start to think of the financial system as "our" financial system, too.

But in reality, it's "their" financial system.

They own it, they derive the lion's share of benefits from it, and they -- quite logically -- defend it.

Bailout Red Herring

The second canard buried in Buffett's apologia is the inference that critics of the bailout advocated doing nothing.

Hardly.

Away from the Op-Ed pages of The Wall Street Journal and The New York Times, there has been a deafening chorus -- nay, consensus -- on what government properly should have done -- in fact, should still do now -- in response to the Wall Street-engineered financial melt-down.

Of course, that's after acknowledging that the very best course of action would have been actually trying to prevent it in the first place (vs. enabling it).

In a mythical letter addressed to "Uncle Sucker," Blogger Barry Ritholtz puts it best:

When the crisis struck, you did not seem to understand the role you should play. Instead of stepping up to halt the financialization, to unwind it, you gave away the shop. You failed to extract concessions from firms on the verge of bankruptcy. Your negotiating skills were embarrassing. In the face of meltdown, you panicked.

You could have undone the decades of radical deregulation at that moment. You could have fired the incompetent management, wiped out the shareholders who invested in insolvent companies, gave the creditors and bond holders a major haircut for their foolish lending. Instead, you rewarded them for their gross incompetence.

The solutions you ran with were ad hoc, poorly thought out, improvised. You crossed legal boundaries, putting the Fed in the position of violating its charter and exceeding its mandates. You created a Moral Hazard, the impact of which may not be felt until decades in the future.

--Barry Ritholtz, "Dear Uncle Sucker . . ."; The Big Picture (11/17/2010)

There are no Pulitzers -- yet -- for blog posts, but if there were, I'd nominate "Dear Uncle Sucker."

Read Buffett's piece, then Ritholtz's in its entirety, and decide for yourself.

P.S.: Dear RE/MAX and Coldwell Banker Burnet: looking for an experienced -- albeit opinionated -- Twin Cities Realtor (and blogger)?

If my boss, Mr. Buffett, reads this, I may be available (Buffett is chairman of Berkshire Hathaway, the ultimate parent company of Edina Realty).

Housing Market "Beached Whales"

What's Wrong With This Picture?

You don't know who's swimming naked until the tide runs out.

--Warren Buffett

So, what's wrong with this Minnetonka home (pictured above)?

That is, besides that fact that the front (and most important) photo on MLS looks like the home is stuck in a winter time warp, and it's now almost May.

Actually, nothing.

I just showed the home, and it's very impressive.

Great floor plan; open, spacious Kitchen; great owner's suite (and three more bedrooms up).

So what is it, then?

The rest of the block.

Whereas this home, built in 2006, is selling for $649.9k, all the other homes on the block are easily 50 years older, less than half the size, and worth hundreds of thousands less.

As the locals say, "uff da!"

Housing Market Time Machine

What happened?

This home -- and hundreds of other homes like it in the Twin Cities -- was built in 2006 at the height of the market.

At the time, homes were appreciating 15% annually, and the sky was a(n almost) cloudless blue.

Developers were getting ever-more aggressive putting up "spec" homes, venturing from "sure bet" neighborhoods to ones (like this one) where prevailing home prices were dramatically lower and nothing had turned over yet.

Their thinking, no doubt, was that the whole block was a candidate for redevelopment, and that their smart, new home would soon be surrounded by other, similar homes.

But then all of a sudden . . . the tide went out.

For now, this is the only new home on the block.

From the street, it's hard to escape the image of a beached whale, now stranded a long way from the receding ocean.

Realtors, Barbers & "Haircuts"

Is it "Always a Good Time to Buy?"

Never ask a barber if you need a haircut.

--anonymous

Barber's corollary: never waste time on someone who isn't sure they need a haircut.

--Ross Kaplan

So, The New York Times ran a piece last week basically saying that -- surprise, surprise -- Realtors always think "now" is a great time to buy. See, "Great Time to Buy (Famous Last Words)."

No doubt there are some Realtors who do.

But for every Realtor who proffers such advice, there are probably at least three would-be Buyers who don't really know whether they want to buy something -- and are happy to eat up Realtors' valuable time while they decide.

In my experience, Buyers buy when they're ready -- not when their Realtors convince them to.

If it were otherwise, you wouldn't hear so many stories of Realtors spending months (or years) working with "clients" who decided they really didn't want to buy, after all -- or who "just couldn't find what they were looking for" after viewing dozens -- or hundreds -- of homes (effectively, the same thing as deciding not to buy).

Discerning Motivation

Which is why one of the most important things for a Realtor to do is determine Buyer motivation.

In my experience, here's how motivation shakes out:

Real: Job transfer to another city; change in family size (bigger, smaller); newly married (or divorced); change in financial circumstances (worse, better); health/mobility issues.

Not Real: curious about "how much house 'x' can buy"; will buy only if they can get 'y' for their current home; current home needs remodeling or updating that they've been putting off (this can be a real motivation, but just as often it's a red herring -- especially if they've been mulling it over for years).

Market Predictions

"Yeah, yeah," I can hear you say, but, "is it a good time to buy??"

If Warren Buffett, the world's greatest investor, can't forecast short-term stock market moves (he's explicitly said so, many times), I'm not about to forecast short-term moves in the housing market.

And anyone who says otherwise is full of it.

Instead, my standard comeback is, "you tell me what interest rates, GDP, unemployment and inflation are going to be . . . and I'll give you an educated guess about housing prices."

While I can't predict future housing prices, I can (and do) promise to help my Buyers find the best home for their budget and criteria.

Or, if they're Sellers, I promise to help them get the most money that current market conditions allow.

SuperFreakonomics on Realtors

Still Casting Stones . . . But Now With (Lots of) Caveats

An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.

—Laurence J. Peter

[Editor's note: to see my rebuttal to Freakonomics, the predecessor to SuperFreakonomics, click here]

So, I finally finished off the (surprisingly short) section on Realtors in SuperFreakonomics.

Two things jumped out at me: 1) the authors, both economists, clearly have bored with attacking Realtors, and have moved on to other, fatter targets; and 2) they still think people who hire Realtors (as opposed to selling their homes themselves) are idiots, but this time they offer a lot of caveats.

Five, to be specific.

Here they are (my commentary follows in italics):

One. Even though Realtors don't do anything you couldn't do -- this seems to be the authors' mantra, by the way -- you still may want to hire one, anyway, if you don't have the time.

I spend anywhere from 40 to 100(!) hours per listing professionally staging my clients' homes, advising on disclosures, putting together professional marketing materials, doing pre-list networking -- and literally 37 other things.

And that's before their homes ever come on the market!

The professionals (and non-professionals) I work for would literally have to take a leave of absence from their day jobs to do what I do. Assuming they knew how.

Which leads to Caveat #2 . . .

Two. "Realtors don't do anything you couldn't do for yourself."

Oh, really? I've been selling real estate for almost 9 years. Before that, I was a corporate attorney and CPA, and have a Stanford economics degree. I have been successfully buying and selling stocks since I was 12 years old, and have started 3 companies.

I say none of that to brag (OK, a little), but to make the point that I'm not a dummy.

And yet every deal I do -- and I've now done about 70 -- I invariably learn something new.

It can be a contractual fine point; a negotiating insight; some arcane feature of a home that comes up on inspection; or even something as simple as "upgrading" to an especially talented, new photographer I heard about through the grapevine (in real estate like other fields, "who you know" can matter as much as "what you know").

The bigger point?

Suggesting that a novice could handle all the phases of a real estate transaction as expertly as a seasoned Realtor can is: a) uninformed; and b) insulting.

How much better?

It depends on the deal, the market, and who the ultimate Buyer is (assuming that I'm the selling, or listing agent).

But industry statistics (and common sense) suggest that the swing between having superior counsel and none at all (or poor counsel) easily exceeds 10%.

Which makes my commission -- substantially less than that -- a bargain.

Three. Madison, Wisconsin -- the market the authors cite as evidence that FSBO ("For Sale by Owner") Sellers do as well as Realtor-assisted ones -- may not be representative (call it the "your mileage may vary" caveat).

Yuh think!?!

Madison is a highly educated, college town with a metro population just over 200,000. It is about as representative of broader America as Manhattan is -- or Hollywood.

Notwithstanding Madison's experience with FSBO's, no other metro area has followed suit.

And even in Madison, FSBO's only account for 26% of home sales. That means almost three-quarters(!) of all homeowners there still list with traditional brokers.

In my experience, if something truly is a "better mousetrap," sooner or later people tend to discover it . . . and switch (assuming they have a choice, i.e., there's no monopoly provider).

Instead, FSBO's are now declining as a percentage of the market place nationally (about 12%).

Four. Self-selection. Or, as the authors put it, "the kind of people who choose to sell their own houses without a Realtor may have a better business head to start with."

At least in my experience, that statement is categorically wrong -- which, ironically, actually supports the authors' argument that FSBO's can do better, net of commission, selling themselves.

From what I've observed, what invariably characterizes FSBO Sellers isn't a "better head for business" -- it's a simple (if uninformed) desire to net more on the sale of their home, coupled with having some "extra time" on their hands (in economic-speak, their perceived "opportunity cost" is low).

Unfortunately, the vast majority of FSBO's don't have a clue as to how to go about doing it.

So, something like 9 out of 10 FSBO's egregiously overprice, while the 10th literally gives their home away (then brags that they "sold without a Realtor").

Which gets to caveat #5 . . .

Five. The authors' data and conclusions may be flawed.

To recap, the authors allege that Realtors selling their own homes (vs. clients') are more patient waiting for a deal, and (therefore) sell for more. They base that conclusion on a study of 100,000 homes sales in suburban Chicago -- 3,000 of which were sold by owner-agents.

Charge #2 is that FSBO Sellers fetch the same price that Realtor-listed homes do -- they just take a little longer (20 days on average) to sell. That's based on the aforementioned study of FSBO Sellers in Madison.

I couldn't find the Chicago study the authors refer to (anyone who knows, please feel free to point me in the right direction).

However, the study of FSBO Sellers in Madison was conducted between 1998 and 2004 -- a Seller's market there (and most of the rest of the country, too).

I doubt that FSBO sellers in Madison today would fare nearly as well.

Meanwhile, the authors' contention that more market time equals higher price contradicts what I've observed over thousands of deals covering the better part of a decade -- namely, the longer a given home is on the market, the lower the selling price. Period.

And that relationship holds whether the Seller is an owner-agent, a FSBO . . . or the man from Mars.

But the most significant weakness in the authors' argument is their assumption that it's possible to isolate differences between Realtor and non-Realtor sold homes by "carefully controlling along several dimensions -- price; house and neighborhood characteristics; time on market; and so on."

Unfortunately, that's notoriously difficult to do in practice.

Precisely to avoid such an "apples-to-oranges" problem, the housing market's leading price index, Case-Shiller, opts in favor of tracking "sale pairs" -- the same home across multiple transactions.

Echoes of Peter Lynch

The arguments in Freakonomics and now SuperFreakonomics ultimately recall Peter Lynch's best-selling book, "One Up on Wall Street," in which Lynch disingenuously tells retail investors -- "Mom & Pop" types -- that they can outsmart the pro's.

How?

By following their spouses and kids to the mall, being the first to notice the hot new, retail trends, then buying the companies positioned to profit.

Unfortunately, for every Apple Computer discovered that way, there are 10 -- or 100 -- "Krispy Kremes" (busts, flame outs, and one-hit wonders).

What Lynch omits is that, in his hey day, he traveled 300-plus days a year, personally talking to senior managers at thousands of companies; checking out their facilities; quizzing their employees and competitors; and relying on a battery of Fidelity analysts to analyze thousands of companies' financial statements.

Level playing field, indeed.

"If You Don't Know Who the Patsy Is . . " *

The authors of Freakonomics (and now SuperFreakonomics) perpetuate the same myth about real estate -- namely, that amateurs who do their homework can outsmart the pro's.

Who ultimately profits from that misconception?

Just as in the stock market, in the housing market the beneficiaries are the pro's on the other side of the transaction.

So, on behalf of Realtors everywhere, I suppose I should say: 'Thank you, Freakonomics!'

*It was Warren Buffet who said, "if you've been playing poker for 30 minutes, and you don't know who the pasty is . . . it's you."

Ahead for Berkshire Hathaway: Utility-Like Returns?

Warren Buffett's 2009 Annual Letter

Investors who expect Berkshire Hathaway's future performance to match its historic returns are guaranteed to be disappointed.

So who is the author of the above quote (paraphrase actually)?

Some money manager or securities analyst trying to making their "bones" with a rare "sell" call on Berkshire Hathaway? (Full disclosure: Berkshire is the ultimate parent company of Edina Realty, which I suppose would make Buffett my boss if I weren't an independent contractor).

A competitor, perhaps?

Try Buffett himself.

Blunting the sting at least a little bit: Buffett makes the same warning every year, noting that "the law of large numbers" -- which certainly applies to multi-hundred billion behemoths like Berkshire Hathaway -- makes it increasingly difficult to rack up market-beating performance, year after year.

Different this Time

And yet, careful readers of Buffett's letters through the years will discern a true watershed in this year's annual letter:

Berkshire Hathaway is slowing turning itself into a utility.

As such, its returns going forward are sure to be more utility-like: stable and solid, to be sure, but lower -- and subject to government approval (sufferance?)

Again, the words come straight from the . . . er, horse's mouth:

Permitting and construction periods for generation and major transmission facilities stretch way out, so it is incumbent on us to be far-sighted. We, in turn, look to our utilities’ regulators (acting on behalf of our customers) to allow us an appropriate return on the huge amounts of capital we must deploy to meet future needs. We shouldn’t expect our regulators to live up to their end of the bargain unless we live up to ours.

--Warren Buffet, 2009 Annual Letter to Shareholders

In fact, the following passage clearly seems addressed not to shareholders, but to Berkshire's regulators, who increasingly hold sway over the company's future performance:

With few exceptions, our regulators have promptly allowed us to earn a fair return on the ever increasing sums of capital we must invest. Going forward, we will do whatever it takes to serve our territories in the manner they expect. We believe that, in turn, we will be allowed the return we deserve on the funds we invest.

--Warren Buffett

So what is the template for future Berkshire investments and acquisitions?

More companies like capital-intensive -- and regulated utility -- Burlington Northern Santa Fe.

"Ever Increasing Sums of Capital"

As Buffett acknowledges, this historic shift to capital-intensive, regulated industries (albeit monopolies, to be sure) is a function of decades of compounding returns at 20%-plus. No doubt more corporations wish they had this problem.

Yet it violates one of Buffett's two heretofore cardinal investing maxims: 1) only invest in businesses you understand; and 2) avoid capital-intensive businesses.

The reason to avoid capital-intensive businesses is that they act like an anchor on investment returns; even Buffett acknowledges as much:

The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow.

That's still good advice for investors -- advice they eschew at the expense of their future returns.

Heir Apparent

The other under remarked tidbit in this year's annual letter is that Buffett clearly has anointed a successor: David Sokol, the co-head of Berkshire's Mid-American Energy subsidiary.

Sokol has been temporarily dispatched to stop the hemorrhaging at subsidiary NetJets, an aviation operation that offers fractional ownership of jets.

This represents a signal departure for Buffett, who famously leaves incumbent management alone.

Sokol's "special assignment" is a tacit nod that he's being groomed for more and bigger assignments prospectively. And who knows their way around regulated utilities -- the parent company's future -- better than the guy who successfully shepherded Mid-American for 15 years?

Lastly, no Warren Buffett letter is complete without one great, homespun quote.

Here is my candidate for this year's:

"Sing a country song in reverse, and you will quickly recover your car, house, and wife."

Chilling Reads

"Basically, It's Over: A Parable About How One Nation Came to Financial Ruin."

--Charles Munger; Slate (2/19/2010)

"The Fat Lady Has Sung."

--Thomas L. Friedman; The New York Times (2/20/2010)

Anyone else note the eerily similar notes struck by Thomas Friedman and Charles Munger?

If you didn't know, Munger is Warren Buffett's long-time right-hand man and sidekick at Berkshire Hathaway.

Buffett, of course, is better-known as the the Wizard of Omaha, the nation's most successful investor, and it's second-wealthiest citizen.

One last little tidbit: Edina Realty is owned by a chain of companies that ultimately are owned by . . . you guessed it!

Munger's piece is harrowing, sobering, and extremely cautionary.

The tone is leavened only a little bit when you realize the title is a play on the "mythical" country, "Basicland," that Munger describes.

Too bad there's not an easy way to dismiss Friedman's headline.

P.S.: And no, I couldn't bring myself to post this at 11:59 p.m. -- I changed it to 12:01 a.m.

Can't Anyone Write a Headline Anymore?

Misleading, Sensationalized Headlines

Just days ago, Barry Ritholtz called out The Wall Street Journal for its (increasingly) misleading, out-of-context headlines.

I just ran into another example yesterday on the otherwise credible RealClearMarkets.com, which aggregates the top 30 or so business-related print and blog pieces daily (mine have appeared more than a dozen times in the last two years!).

Compare this headline on RealClearMarkets (look under "Evening Edition" for Jan. 26):

"Looks Like the S&P Is Going to 1,200 or Higher" -- Jeremy Grantham

With this quote, directly from Grantham's (excellent) piece:

I thought last April that the market (S&P 500) would scoot up to 1,000 to 1,100 on a typical relief rally. Now it seems likely to go through 1,200 and possibly higher. The market, however, is worth only 850 or so; thus, any advance from here will make it once again seriously overpriced.

Just in case the foregoing is too subtle, Grantham continues:

Equity markets almost always peak when rates are low, so moving in desperation away from low rates into substantially overpriced equities always ends badly.

See my point!!?

P.S.: If you haven't read Grantham's missives, you should; they're every bit as pithy as Warren Buffett's. In particular, his "Lessons Learned in the Decade" at the end of his most recent quarterly newsletter is full of great nuggets.

In fact, when it comes to "pithy financial insights," these two are really on a plane of their own (Michael Lewis and Thomas L. Friedman also write at this altitude, but, unfortunately, they both cover business all too rarely).

Buying a Home: Is Now a Good Time?

Not Following the Herd

Be fearful when others are confident and confident when others are fearful.

--Warren Buffett

Of all Buffett's quotes, the one above might be the most popular; it's certainly the most cited the last 2-3 years (and was quoted frequently by Ben Stein at Edina's annual meeting Wednesday).

So, is now a good time to buy a home?

No one really knows for sure.

Instead, ask yourself: 'is the prevailing mood more optimistic or pessimistic?

That one, at least, is an easier call.

As every investor, from Buffett to Ben Graham to George Soros on down knows, there are more and better investing opportunities in a cautious, "cool" market than a hot one (unless you're shorting).

(More) Naked Swimmers

"Botttom's Up" Real Estate Recovery

You don't know who's swimming naked until the tides goes out.
--Warren Buffett

3,500 FSF is the new 5,000 FSF.
--Ross Kaplan

The housing recovery is happening from the bottom up.

As any active Realtor can readily report, the lower the price bracket, the stronger the housing market; the higher, the weaker.

Clearly, that's why Congress is now extending tax incentives to so-called move-up Buyers, rather than just first-time Buyers.

Upper Bracket Woes

So where does that leave owners of upper bracket homes? (In the Twin Cities, three years ago I would have put the threshold for upper bracket homes around $800k; now . . . it's a lot lower.)

In many cases, straining under too-big mortgages on houses that have depreciated in value.

Most at risk are those who bought roughly between 2004-2007, using a lot of leverage; who have jobs or are in businesses most exposed to the recession; and whose other assets, like stocks, are down significantly (although less than last Spring!).

For those folks, the tide is continuing to run out.

That's why I expect the foreclosure pain to continue moving "up market," at least in the short run.

P.S.: one more aggravating factor for would-be sellers of larger, upper bracket homes: Americans' love affair with "big, bigger, biggest" is at least temporarily on hold. I call this phenomenon, "3,500 (square feet) is the new 5,000."

Jeremy's Jeremiad

"Redesigning the Financial System" -- Or Not

In a world with few wise men -- financial or otherwise -- Jeremy Grantham certainly makes the cut (Paul Volcker, Warren Buffett, and John Bogle also come to mind).

It's hard to improve upon Grantham's own words, from his 3rd quarter letter to shareholders (his fund manages a measly $87 billion for investors).

Here are a couple choice excerpts:

In general, countries with simpler and less aggressive banks have had much less pain in the recent crisis . . . “Oh!” say the bankers, “If we become smaller and simpler and more regulated, the world will end and all serious banking will go to London, Switzerland, Bali Hai, or wherever.” Well, good for those other places. If that means they will have knee-buckling, economy cracking, taxpayer-impoverishing meltdowns every 15 years and we will be left looking like a boring back water, that sounds fine to me.

And this nugget, capturing the current mindset towards reining in a clearly out-of-control financial sector:

I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship’s construction, of the company’s policy, or of the captain’s competence.

“No one could have seen this coming,” would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises.

Grantham's take on Alan Greenspan, Ben Bernanke, Geithner, Goldman Sachs and a long list of others is bracing, infuriating, refreshing -- and most of all, accurate.

Financial Res Ipsa Loquitur

Comparing Guns, Credit Derivatives

Guns don't kill people, people kill people.

--NRA bumper sticker

Credit derivatives don't blow up financial systems, people do.

--Wall Street mantra du jour

Despite the incalculable harm wrought by credit derivatives on the U.S. -- and global -- financial system the past two years, Wall Street is clearly resistant to the idea that credit derivatives are a destructive force that need to be reined in. Or simply banned.

Wall Street's argument?

Using credit derivatives to hedge risk is a legitimate financial function. Things go awry when credit derivatives are misused.

In the words of Jerry Webman, Oppenheimer's chief economist, credit derivatives are no different than gasoline. The same gasoline that powers your lawn mower can just as easily blow up a Molotov cocktail.

Examples of legitimate uses of derivatives include airlines that need to hedge their fuel cost; farmers who need to lock in the price of their harvests; and oil producers who need to sell their output.

Flaws in the Argument

The problem with the foregoing argument is that it ignores reality -- recent, catastrophic financial reality.

Imagine hearing the dirigible industry defending hydrogen as an inert gas, safely used with the right precautions . . . the day after the Hindenburg blew up.

The public wouldn't buy it.

So why, in the aftermath of AIG, Lehman Brothers, Bear Stearns, etc. isn't there a massive public groundswell demanding regulation of credit derivatives? Why hasn't Congress taken action?

Two reasons stand out: 1) credit derivatives aren't well understood outside Wall Street (and perhaps, inside as well); 2) Congress isn't protecting the public, but rather the financial industry.

Financial Res Ipsa Loquitur

When a patient emerges from surgery with a scalpel left in their back, they don't need to prove negligence because of a legal principle called "res ipsa loquitur" -- the thing speaks for itself.

In practice, res ipsa loquiter shifts the burden of proof from the patient, who normally must prove that the surgeon was negligent, to the surgeon, who must now prove that he wasn't.

Something similar is now needed to weigh the utility of credit derivatives. In this case, the surgeon is Wall Street; the patient would be . . . us (as in savers, investors, and taxpayers).

Society doesn't allow assault weapons on school playgrounds.

There's no reason to permit what Warren Buffett famously labeled "financial weapons of mass destruction" to wreak havoc on our financial markets ever again.

Warren Buffett, Revisited

Swimsuits and Tides

Today's recession-slash-financial crisis may not have a name yet, but it clearly has a signature parable: Warren Buffett's now-infamous observation that "you don't know who's swimming naked until the tide goes out."

If you're looking for a bookend, it would be Buffet's equally famous pronouncement that credit derivatives are "financial weapons of mass destruction." [Full disclosure: Buffett is Chairman of Berkshire Hathaway, which is the corporate "great-grandparent" of Edina Realty.]

Well, the tide's definitely gone out . . . and by now, we (pretty much) know who's been swimming naked.

In light of these events, you'd think that policymakers' focus would be to round up some swimsuits. Instead, my read is that they've been trying to get the tide to come back in.*

The former task is limited in scope, has a finite cost, and is actually achievable.

The latter?

We're in the process of finding out . . .

*I suggest a corollary to "a high tide raises all ships": 'first, they have to be floating.'

Foreclosure Feeding Frenzies

Banks Price Low to Elicit Multiple Offers

Real-estate brokers say multiple offers on certain homes have recently become more common in parts of California and Arizona and the Washington, D.C., and Minneapolis-St. Paul metropolitan areas. . . Brokers say banks appear to be deliberately setting asking prices low in some cases to provoke bidding battles

--James Hagerty, "Bidding Wars Are Emerging on Foreclosures"; The Wall Street Journal (4/23/09)

I can personally vouch for the "deliberately setting asking prices low" part of the above quote: I'm working with a client who is now zero-for-three bidding on foreclosed homes in the last two weeks.

In each case, my client saw the property within hours of the property hitting the market (I'm watching like a hawk); submitted an offer for as much as 25% over asking price by the end of the day; waived all Seller disclosures, agreed to buy "As Is," etc. . . . and still lost.

In at least one of these deals -- all in Minneapolis -- the Seller had failed to provide a mandated (non-waivable) Truth-in-Sale of Housing disclosure. That's a big "no-no" that can be fined up to $1,000.

According to a Realtor representing one of the banks, the purpose is to create a feeding frenzy -- and a rash of instant offers -- that the bank can pick and choose from.

It may accomplish that, but it leaves lots of Buyers feeling chafed, and convinced that the system is "gamed."

Hard to argue that they're wrong . . .

P.S.: just underscores the wisdom of an astute Buyer like Warren Buffett, who never, ever gets into multiple offers on companies he wants to buy.

"Alimony," Not Bailout

Can We Afford Wall Street?

I've got a way to make palatable the $3 trillion (or is it $4 trillion? Or $6 trillion?) injected into Wall Street (so far).

Don't think of it as a bailout, think of it as alimony. Yes, alimony.

As in, what you pay to divorce someone -- or in Wall Street's case, something -- that has become an increasingly expensive and bad match. Indeed, someone who is a parasitic drag on your daily existence and threatens your very well-being (no, I've never been through a messy divorce).

Lost in the uproar over AIG bonuses, second and third (and fourth and fifth) helpings of bailout money, etc., is the fact that modern Wall Street fails the most basic test for economic utility: cost-benefit.

Direct Costs

It's possible that, like a bad dream, "the current unpleasantness" will pass, and the Federal Reserve and Treasury will somehow be made whole on trillions in guaranties, "term facilities," equity "investments," open-ended loans -- and God knows what else taxpayers have spent on Wall Street's salvation. But I wouldn't hold my breath.

Assuming, conservatively, that Wall Street simply doesn't lose any more taxpayer money, the tab already easily exceeds $3 trillion.

Not only is that a staggering sum, it exceeds all the profits Wall Street has ever made, combined.

Warren Buffett famously observed that the airline industry, in almost a century of operation, has cumulatively operated at a net loss. The same is now true of Wall Street.

Indirect Costs

Sadly, all the money spent so far is just for clean up; it omits the long-term costs likely to result from the financial Chernobyl that modern-day Wall Street has become.

Such indirect costs are likely to include: ramped-up regulatory oversight (if you thought Sarbanes-Oxley was expensive and intrusive, just wait); billions in unemployment benefits to recession casualties; increased government transfer payments to destitute citizens whose savings and investments have suddenly been decimated, etc.

However, that's nothing compared to perhaps the biggest -- albeit incalculable -- cost of all: grievous damage to the trust and confidence that are the foundation of a capitalist economy (and fiat currency).

Benefits

On the plus side of the scale is . . . what, exactly?

Wall Street's investment bankers supposedly allocate capital -- wisely and efficiently -- to the most deserving.

Yet their recent track record in that department is abysmal: witness the billions directed to all the neophyte "dot.com's" that promptly crashed and burned, taking investors and the '90's bull market with them (notably spared: all the VIP's -- typically the banks' largest customers, and coveted future customers -- who routinely received allocations of shares at wholesale prices that they quickly flipped).

Commercial banks have hardly performed any better.

Until Glass-Steagall was dismantled a decade ago, they took in deposits, and then used that money to make profitable, socially productive loans to business and consumers.

At least that was the theory.

In practice, while many banks behaved conservatively, the biggest ones OD'd on toxic securities and are now either illiquid, insolvent -- or both. The cost to the FDIC (and ultimately, taxpayers): more hundreds of billions.

Alternatives

In today's high tech, Internet-based world, it's not at all clear what Wall Street's "value-added" is.

Google famously went public with very little help from Wall Street, using the Internet and something called a "Dutch Auction."

Was its IPO well-priced? Perhaps not: the stock quickly trebled, suggesting that it was underpriced.

However, that's one of Wall Street's dirty little secrets: it hardly matters how underwriters price an IPO, because they only set the initial price, and then only for a small percentage of a company's outstanding stock: once the stock begins trading, the market takes over.

But surely Wall Street's role in mergers and acquisitions is indispensable, right?

Actually, no. Warren Buffett, arguably one of the most successful M & A practitioners around, famously eschews Wall Street advice and deals directly with the target company's management.

So how about Wall Street's role helping to seed start-up companies?

Actually, it doesn't do that. Venture capitalists do. Coincidentally or not, their Silicon Valley headquarters is about as far away from Wall Street as you can get (in truth, the location is due to Stanford University, and the hub of entrepreneurs located nearby).

Finally, we've just had a decade-long experiment in letting fee-hungry banks (and Wall Street-created non-banks) decide who gets mortgages. The results haven't been pretty, to say the least. Of course, now that it's raining, as the saying goes, lenders predictably want their umbrellas back.

So what's a better way to decide who should qualify for a mortgage?

The Fair-Isaac Corporation, a for-profit entity, calculates a "FICO" score that already forms the foundation for most underwriting decisions. Take good FICO scores, add a relatively high down payment -- ideally 20% -- and, Voila!, you've got the makings of a credit-worthy borrower. An independent appraisal adds further protection.

Lump-Sum Payment

There's a name for something that doesn't create value, is levied involuntarily, and ultimately serves only to redistribute wealth: it's a called a "tax."

Aside from being manifestly unfair, the "Wall Street Tax" also saddles the U.S. economy with a cost that impairs its ability to compete in a "flat," hyper-competitive world marketplace.

A financial crash is a very high price to pay to learn we have a "legacy" financial system that is devouring our resources, and threatens our very way of life.

However, if the trillions we are now giving Wall Street hasten the arrival of a better, fairer, and more efficient system, the price will arguably be justified.

All that's left is to make sure that Wall Street knows it's received a lump sum payment. (Don't like "alimony"? Call it a severance payment.)

Longfellow Feeding Frenzy

Multiple Offer Premium > Discount?

Where: 30XX 43rd Ave South, in Minneapolis' Longfellow neighborhood (and just 5 blocks west of the Mississippi)
How much: $17,900
Tax assessed value: $143,000 (land - $44,200; building - $98,000)
On Market: 3/13/09
Off Market: 3/16/09

So what are the chances that the ultimate Buyer is actually going to pay $17,900 for this foreclosed property? Not very high.

Which is the whole point in listing it so low.

While the house is described as a mess, a lot alone in this location is likely worth at least $30k-$40k. By pricing so low, the bank (and Realtor) precipitate a feeding frenzy intended to drive the selling price above market value.

So do I recommend such a strategy to my selling clients? No, for three reasons:

One. If you put blood in the water . . . don't be surprised if you attract sharks.

More often than not, "giveaway" list prices attract, shall we say, aggressive Buyers who will resort to dubious tactics to win the inevitable bidding war. That's also why reputable Realtors avoid using language like "must sell," "make an offer," and other language designed to convey desperation (real or not).

As a listing agent, the best way to control a three-ring circus is not to create one in the first place.

Two. Not only do such circuses attract the kind of Buyer you likely don't want, they can repel the type of Buyer you do want.

In his current letter to shareholders, Warren Buffett makes a point of saying he will never participate in a bidding war to buy a company. Similarly, many disciplined, well-qualified home Buyers will simply walk away rather than get caught up in a bidding war where their pocket books can become hostage to their emotions.

Three. Feeding frenzies like this have a high "wash-out factor."

Once the excitement and frenzy subside, more than one winning bidder has been known to experience buyer's remorse and reconsider. They belatedly realize they made a hasty decision (they did) and/or are unhappy with the price they agreed to pay.

So, they (mis)use the Inspection Contingency to get out.

Or, to win the bidding war, the Buyer overstated their financial wherewithal (surprise, surprise) and can't perform.

Either way, the deal falls through, and the whole process starts over.

I've found that the best way to sell homes is fairly, openly, and in an atmosphere of (professional) trust to Buyers who have the same expectations.

Creating feeding frenzies is at odds with those values.

Not Your Father's Bankruptcy

What's So Bad About Bad Credit??

For many consumers, preserving one's credit rating is one of those sacrosanct, preserve-at-all-costs values.

But what if you don't plan to buy anything? Or are afraid to? Or simply can't afford to?

Then, a trashed credit rating really may not matter so much. Especially if it means ditching a whopper monthly mortgage payment on a house that has plunged in value.

In the new economic landscape that many Americans already inhabit, maintaining a high credit score is a luxury they literally can't afford. In fact, torpedoing one's credit by defaulting on a "legacy" mortgage may be quite rational, for five reasons:

One. Credit scores don't matter if there's no credit to be had.

When credit is flowing, good credit scores can open the vault doors. Now, however, those vault doors are slammed shut even for many good credit risks -- and there's nothing behind, them anyways. (At least not until Uncle Sam replenishes the banks' coffers.)

The "Pay-As-You-Go Economy"

At some point, even the profligate U.S. government is likely to find its own access to unlimited credit curtailed.

In his current letter to Berkshire Hathaway shareholders, Warren Buffett pronounces U.S. government debt the next big bubble, following in the wake of the Internet and housing bubbles.

Once that bubble pops, the government will discover what many consumers already know first-hand: it's increasingly a "pay-as-you-go" world.

Two. No one's buying anything. At least not big ticket items, anyways. And if you're not buying a big-ticket item . . . you don't need credit to finance it.

In many U.S. housing markets now, prospective Buyers have a adopted a "show me" attitude, triggering a vicious cycle: wary of being stung by falling values, Buyers are waiting for the market to clearly bottom, but while Buyers stay on the sidelines, housing prices inevitably fall more.

In the mean time, with more people renting instead of owning, fewer consumers need a good credit score to qualify for a mortgage.

Three. In the land of the bankrupt, the marginally solvent are . . . welcome.

Look around -- it's a recession. People's balance sheets have been hollowed out by falling home and stock prices, and now are being kneecapped by rising unemployment. Exactly who has pristine credit these days?

Beggars can't be choosers, and that's exactly what many retail companies catering to consumers are right now. If it's a choice between selling to marginal customers or not selling at all, many companies will choose the latter.

Four. Perversely, defaulting can increase borrowers' leverage.

Lenders receiving federal bailouts are under increasing pressure to "modify" (read, relax) mortgage terms for distressed borrowers.

How does a borrower signal financial distress? By not making their mortgage payments. Ironically, someone who's current on their mortgage is unlikely to get their lender's attention.

Five. Bad credit can be rehabilitated.

Credit scores aren't static, like college transcripts, but dynamic, like one's health. As consumers handle more credit more responsibly, their credit scores increase; if they miss payments or have multiple delinquencies, they decline.

Over time, most people's credit scores recover from a major default -- just like they recover from a major illness.

Given the epidemic number of foreclosures today, the federal government might logically take steps to shorten that recovery period.

Buffett's Negotiating Secrets

Berkshire '09 Annual Letter -- Part Two

For investors, perhaps the most tantalizing -- and useful -- part of Warren Buffett's 2009 letter to shareholders is a little tidbit that's appended to the end.

Actually, it's a solicitation, addressed to perhaps a few hundred people in the world.

Who? People who run or have large minority stakes in a specific kind of company. One that Buffett might want to buy next.

Specifically, the desired company should have: a market value of $5 billion to $20 billion, ballpark; top-flight management in place; and be able to earn more than $75 million annually pre-tax, through "thick and thicker," as Buffett might put it.

Buffett also stipulates two negotiating prerequisites: 1) the Seller must have a firm selling price -- and be able to deliver it (thus, no consultants or other go-between's; only principals need respond); and 2) there must be no other suitors -- no auctions.

Buffett's Negotiating Secrets

What can Buyers learn from Buffett? Three things:

One. Never negotiate against yourself.

That's what you do when you open negotiations by announcing what you're willing to pay -- as opposed to insisting that the Seller announce its selling price (and indeed, commit to being sold).

Two. Never negotiate against other would-be suitors. That's what an auction is.

Buffett doesn't do auctions because he knows that a skillfully run auction will raise the price (savvy home sellers and their Realtors know that, too!).

One of two things happens in an auction (at least when the prize is gold, not dross).

Either you prevail, in which case you'll likely have overpaid.

Or you lose, in which case, you'll just have helped drive up the price the winning bidder paid.

No thanks.

So why would a choice, up-and-coming company -- and Buffett doesn't covet any other kind -- pass up the opportunity to "play the field?"

Several reasons, actually.

Berkshire Hathaway is like a beneficent -- and distant -- ruler. A very rich and patient ruler, with an unusual commitment to building long-term value and actually investing and creating capital, not sucking it out.

For an ambitious and capable manager, there are worse places to be than part of Berkshire Hathaway's corporate fold.

Oh . . . and negotiations will be simple, quick, and painless (Buffett doesn't do hostile deals). And cheap! (remember, no go-between's). That's actually Lesson #3 -- "keep it simple and friendly" -- for anyone who is counting.

"We can promise complete confidentiality and a very fast answer — customarily within five minutes — as to whether we’re interested," Buffett promises.

I'll bet Buffett gets two corporate takers by this July 1 -- three if the market's down significantly before then (Berkshire's pretty good shelter in a storm).

Warren Buffett's Crystal Ball -- & Rearview Mirror

Memorable Quotes from
Berkshire's '09 Annual Letter

In 75% of [the last 44 years], the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

--Warren Buffett, 2008 Berkshire Hathaway Annual Report

Substitute "housing market" for "stock market," and you've got a pretty good long-term outlook . . .

If you've never read one of Buffett's letters, I highly recommend it; they're probably the closest thing capitalism has to Mao's "Little Red Book."

At least in my view, here are the most memorable quotes from this year's letter (last year's top line was an instant -- and much quoted -- classic: 'you don't know who's swimming naked until the tide goes out'):

"Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition."

"At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

"Beware the investment activity that produces applause; the great moves are usually greeted by yawns."

"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000's. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

"Participants [in derivatives contracts] seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with."

*Through its subsidiary, MidAmerican Energy, Berkshire Hathaway is the ultimate parent company of Edina Realty.

2009 "Dear Client" Letter - Part 2

Rational Moves in an Irrational Market

Cont. from Part One:

--Two. If you're a Buyer, take advantage of a soft market to upgrade. That's what stock market investors do during a bear market. Specifically, they buy blue chip stocks that are temporarily "on sale."

Similarly, today's real estate downturn has lowered the entry point for many desirable Twin Cities neighborhoods by $20k, $50k, or more. Dropping home prices, plus cheap mortgages, spells opportunity for millions of younger Buyers. Meanwhile, if you're a move-up Buyer, you're likely to be pleasantly surprised by how much house you can afford, in neighborhoods you wouldn't have dreamed of looking at before.

If you're a Seller, consider taking your lumps. Casting aside all the forecasts -- a good idea, I might add -- no one really knows whether housing prices are headed up, down, or sideways the next 12-18 months.

That depends on interest rates, the national and local economy, unemployment levels, etc. -- complex, inter-related variables that even the pro's get wrong (forget about predicting the future; most economists can't even get the present right: witness the one-year lag diagnosing the current recession).

So if your life circumstances dictate making a move this year, you may just want to . . . move. If you're buying something else, whatever you lose as a Seller may very well come back to you as a Buyer.

In that vein, if you're a prospective downsizer contemplating becoming a renter . . . you may want to consider buying something smaller instead.

Psychologically, it's a lot easier to pull up stakes where you've lived for decades if you're excited about where you're headed. Given today's historically low rates and record-high inventory, the odds of finding a great townhome or condo are a lot better than finding something equivalent in today's increasingly crowded, picked-over rental market.

If you're a longtime homeowner, keep in mind that, while you may be getting less than you might have 2-3 years ago, you're still getting more than you would have 5 years ago -- let alone 20 or 30. Thanks to residential real estate's favorable tax treatment, all of that gain is likely tax-free for most Sellers (no capital gains tax is due on the first $250k of gains for qualifying singles, and $500k for couples).

Three. Read my blog, City Lakes Real Estate (http://www.citylakes.blogspot.com/). Ok, that may not qualify as a "tried-and-true" strategy, but it's still a good one.

Since I started the City Lakes blog more than a year ago, I've posted almost 200 pieces discussing emerging real estate trends, both local and national; market tips for Buyers and Sellers; and how to think about and make sense of broader economic issues.

It's been both gratifying and thrilling to see the City Lakes blog cited by a variety of influential news sources and opinion leaders, both online and off, including The New York Times, RealClearMarkets.com, The Star Tribune, and even Edina Realty senior management (it's spelled K-A-P-L-A-N, guys).

I'm confident that you'll profit from reading my blog. However, just to make sure, if you subscribe by January 31, I'll mail you a $5 Target gift certificate (Dunn Bros., if you prefer). Don't worry, the subscription's free.

While no one knows what the future holds, it's also true that no one needs to simply wait for it, passively. One of my favorite cartoons shows two vultures sitting on a tree limb, with the caption, "To hell with all this waiting -- let's go kill something."

Wishing you good hunting, and a happy, healthy 2009!

Ross

2009 "Dear Client" Letter - Part One

Rational Moves in an Irrational Market

Warren Buffett, Chairman of Berkshire Hathaway (the ultimate parent company of Edina Realty), writes a renowned annual shareholders' letter read by tens of thousands. Buffett's letters contain nuggets of wisdom, pithy quotes (his line about credit derivatives being "weapons of mass destruction" was from 2003), and his general take on market conditions.

In my capacity as a Twin Cities realtor, I write an obscure annual letter that I send to a couple hundred people offering . . my general take on market conditions. Here is the most recent edition, headed to clients this weekend:

Dear Client:

Happy 2009!

As the year begins, consider some of the more unusual -- if not unprecedented -- features of today's financial and real estate markets, and the economy in general:

--Zero per cent. As of mid-December, that is the Federal Reserve's target number for short-term interest rates (the one it controls). That's also the interest rate on U.S. T-bill's (actually less than zero, net of fees).

--From $60 a barrel to $150 to $38 to . . .??? After their moon shot during the first half of 2008, commodity prices -- including oil -- suffered a historic collapse the second half of the year. At $1.80 or so per gallon (less at Sam's Club and Costco), gas prices are near their lowest in 5 years, and more than 50% off their $4-plus peak last Summer (seemingly another lifetime ago).

--Falling stocks and housing. Unless you're over 80 years old and started buying stocks when you were a (very small) child, you just experienced your worst-ever year in the stock market: down 40% over all. By comparison, housing turned in a stellar performance: only down 15% nationally, and now 20%-25% off its 2006 peak (again, nationally).

--Not everyone has savings and investments, but fortunately, most people have jobs (almost 93%, to be specific). However, with the economy clearly slowing, many experts predict that the unemployment rate will be significantly higher in 2009.

Comforting, huh?

"Lemonade Recipe" (or, Rational Moves in an Irrational Market)

When things are so uncertain, it's tempting to do . . nothing. In fact, depending on your circumstances, doing nothing may be the smartest move of all (it worked for Seinfeld).

However, even in a sour economy -- perhaps especially in a sour economy -- there are three tried-and-true strategies most people should at least consider. In that vein, here is my 2009 realtor's advice to clients -- past, present, and, hopefully, future -- on how to turn today's, shall we say, challenging environment to your advantage.

--One. Take advantage of cheap money. The flip side of anemic rates on savings are historically low borrowing costs. Long-term mortgage rates have literally collapsed since Thanksgiving, falling from over 6% to 4.75% or even lower. If you plan on staying in your home long-term, you'll easily recoup the expenses associated with re-financing. Even if your time horizon is as short as 5 years, you may still benefit, depending on your current interest rate and mortgage balance.

Talk to a lender to find out. Better yet: talk to two or three (money is fungible), and be sure to ask for the required disclosures: the Truth-in-Lending ("TIL"), and Good Faith Estimate of Settlement Costs. Also ask whether the lender offers a re-lock option: in an environment of volatile (and for now, falling) rates, paying a nominal fee for a "second bite at the interest rate apple" can be a good idea.

Cont: 'Dear Client Letter - Part Two'