I’ve spent a lot of time thinking about residential real estate and the general incoherence with which people go about buying and selling it. There are a number of things about residential real estate that make it different from other asset classes like equity or bonds or commodities. Each of these qualities has particular implications for the direction of the housing market.

(Residential real estate is much different than commercial or agricultural real estate. For the rest of this article, when I refer to “real estate” I am referring to owner-occupied residential real estate.)

Illusions and Delusions about Real Estate

First, let’s dispense with the notion that real estate is an investment in any real sense of the word. Very often people will refer to their house or apartment as their largest investment. What these people really mean is that they expect to be able to sell their house or apartment for more than they paid, and generate a positive return on investment. Investments are things that can generate a positive return on investment; therefore, real estate is an investment.

But this facile argument ignores many of the aspects of real estate which militate against it being considered an investment. First, most people use mortgages to finance their purchases. This increases the purchase price due to interest payments. Second, the insurance costs are often not negligible on property. Third, property taxes are a big chunk of change. Fourth, maintenance and utilities are an ongoing, and often expensive, cost. A true calculation of one’s return on investment has to take all these not-insignificant costs into consideration. A proper accounting of one’s return on investment would be [ (Selling price) / (Purchase price + mortgage interest + insurance + property taxes + maintenance + utilities) ] – 1. In order to generate a positive return on your investment you have to assume that your selling price is greater than your purchase price plus all the ancillary costs.

Real Estate and Bad Tax Policy

The tax-deductibility of mortgage interest puts upward pressure on housing prices, as it creates an incentive for people to take on larger mortgages than they otherwise could afford. Brokers often tout this as “saving money”: the interest on a mortgage is tax deductible, so you are saving money by borrowing money. But this isn’t really true: the money that you are not paying in taxes is being paid in the form of interest, which, as we saw in the previous paragraph, increases your costs, often substantially.

Additionally, the tax-deductibility of mortgage interest is morally troubling because it means that all those people who choose not to own, or who cannot afford to own, property, are subsidizing those who choose to do so, or who can. In other words, the tax-deductibility of mortgage interest is a subsidy paid to the relatively well off people who own houses and apartments. Our tax laws ought not provide subsidies to people who do not need them.

An argument in favor of the tax-deductibility of mortgage interest is that corporations get to deduct their interest payments on debt. But this isn’t really a comparable situation: corporations that raise debt often do so because they are looking to expand their operations, and debt is a cheaper source of capital, generally speaking, than equity. Expanded operations provide jobs. Creating more homeowners does not create jobs, or really serve any useful economic function in the way that companies which raise more capital do.

(It is true, however, that leveraged buyouts abuse the tax-deductibility of companies’ interest payments, and often generate no real economic benefit.)

Real Estate and Interest Rates

Mortgages are really bonds that the issuer (the homeowner) issues, collateralized by the house. Therefore, banks which loan money in the form of a mortgage are taking on a fixed-income investment. Fixed-income investments, and the asset underlying them (in this case, real property) are inversely related to the yield curve. As interest rates increase, bond prices decrease, and as interest rates decrease, bond prices increase. What this implies, of course, is that when capital is cheap, house prices soar, and when capital is expensive (i.e., there is a bout of inflation), house prices crater. (While it is true that commercial and agricultural real estate are good hedges against inflation, it is not true of residential real estate.)

How many people buying residential real estate understand the relationship between house prices and the yield curve? How many people buying residential real estate understand what the yield curve is?

Not many.

Ah, but you may be saying to yourself: “Well, I have a fixed-rate mortgage, so I don’t have to worry about the yield curve!” Well, this is true, at least for now. A fixed-rate mortgage benefits the issuer (the homeowner) and so is more expensive (it charges a higher rate) in order to compensate the lender (the bank to whom you pay your mortgage payment every month). In other words, the benefit of the fixed-rate mortgage has a cost to the borrower in the form of a higher interest rate.

Now, what if interest rates increase? The fixed-rate payer ends up getting a better deal than the variable rate payer because his monthly interest payments are less for the same mortgage balance than the guy whose variable rate mortgage is suffering under the weight of higher interest rates. But, if interest rates stay at historic lows, then the fixed-rate payer is screwed, and he is paying more in interest than his less creditworthy fellow homeowner with the variable rate mortgage.

Finally, if the fixed-rate mortgagee wants to refinance his debt at any point in the future, and interest rates are higher, he may find himself paying even more in interest payments than he does currently.

All of this suggests that the relationship between real estate and interest rates is very complex. Should the government really encourage uneducated and financially illiterate borrowers to be subject to the caprices of the yield curve? Prudence suggests not.

Conclusion

What I have tried to do in this rather long blog post is indicate some of the complexities and distortions inherent in real estate. Real estate is no sure thing, it is subject to the caprices of both government intervention and the yield curve, and most people who buy houses and apartments are not sufficiently educated to parse all of these issues.

David Friedman is the Editor of our new Wall St. Watchdog platform. Click here to follow Wall St. Watchdog on Twitter.

The Washington Post recently did some excellent journalism about the expanding new industry Top Secret America. This new industry is unprecedented in American history and raises some critical questions about who reigns over our nation’s security and deepest secrets.

Which services are too important to outsource? Which services are “inherently government functions“?

At the moment, there’s a bull market in the private contracting of national intelligence. Here are some of the basic stats:

Apocalyptic bears take note: current conditions are hardly as hellish as when markets crashed in 2008.

Despite a long secular bear market with a powerful recovery rally for the financial markets, we now look at some contrarian data points which may keep markets from falling in a second leg down.

6) The BP Failure is Not The Credit Crisis Failure

Once sporting a $180 Billion dollar market cap, British Petroleum (NYSE: BP) is now valued under $90 billion just 2 months later. Even if bankruptcy is imminent due to the magnifying environmental catastrophe, BP’s failure is still no comparison to the Credit Crisis Collective of AIG, Ambak, Bear Stearns, Citigroup (NYSE: C), Fannie Mae, Freddie Mac (NYSE: FRE), Lehman Brothers, MBIA Inc (NYSE: MBIA), Merrill Lynch (NYSE: BAC), Wachovia (NYSE: WFC), WaMu (NYSE: JPM). These financial cancers caused well over $1 Trillion in market cap losses.

In the case of BP, there are Dow components and blue-chip companies like Chevron (NYSE: CVX), Exxon Mobil (NYSE: XOM), Shell (NYSE: RDS-A), Proctor & Gamble (NYSE: PG) and Marathon (NYSE: MRO) gaining market share as beneficiaries of the BP Bust.

5) Global Liquidity

The $1 Trillion E.U. Stimulus package delayed by European bickering will likely play out like the famed $787 U.S. stimulus package. In February 2009, the U.S. stimulus bill became law and consequently the markets bottomed a month later. In May, the E.U. initiated the same, yet larger, stimulus-saving injection into the European economy. Once that money hits the system, a similar playbook could take effect.

4) Upcoming Congressional Elections in November

Extension of the first-time home buyer tax credit is a vital necessity to give the housing market sustainable signs of support. The wake up call for politicians was the latest May new homes sales figure dropping 33%. Right now, politicians are seeking out the best policies for re-election, and the tax credit extension for first-time home buyers is a simple vote-grabber for any politician who wants to strengthen chances for victory this Fall. Thus, future housing relief policy announcements should come to the forefront as a price floor to the overall housing markets.

3) CEO Hiring Confidence Reaches 3-year High

This week, the Business Roundtable — a group of CEOs from large U.S. companies — shared their survey showing 39% of CEOs expect to hire new employees in the second half of 2010. In conjunction with positive double digit sales growth from a high number of companies so far this year, private employment numbers could see a significant and surprising rise. Also, 79% of CEOs surveyed said they expect sales to rise in the second half of 2010. If you rewind the picture to the March crash period of 2009, both the sales numbers and sentiment has improved dramatically since then.

2) Technology is Driving Innovation Out of the Recession

Mobile is quickly becoming the future. Sprint (NYSE: S) is feeling the pent up demand for their new Evo 4G mobile phone. I was recently at a retail Sprint store location in Chicago and asked a sales rep if any Evo 4G mobile phones were available. She said they were sold out and on back order. This is a great sign. Moreover, Microsoft’s (Nasdaq: MSFT) breakthrough joystick-free 3-D Gaming Technology is slated to be a December holiday hit. Intel (Nasdaq: INTC) is entering into the world of Google TV. Google (Nasdaq: GOOG) has positioned itself as the small business savior success story in the Great Recession. There are now over 234 million living websites on the internet while online ad spending increases and entrepreneurs utilize Google’s more efficiently expanding toolkit for making money.

1) The Consumer is Not Dead

Retail is showing signs of life. Adobe (Nasdaq: ADBE) reported strong revenue growth of 34% year-over-year. Additionally, Oracle (Nasdaq: ORCL) delivered a 39% rise in revenues from $6.86 Billion to $9.51 Billion. Apple (Nasdaq: AAPL) has sold over 3 million iPads in less than 3 months, with swarms of demanding consumers lined up for the iPhone 4 release. Amazon (Nasdaq: AMZN) is still glowing from their expanding online shopping dominance, 46% worldwide revenue growth in their Q1 2010 report. Even though private employment numbers were weak, strong government hiring is still putting money in people’s pockets. Consequently, consumers remain in line for breakthrough gadgets like the iPhone 4.

Conclusion: Japan’s Lost Decade Was Not a Crash

I expect choppy waters as we undergo a turbulent period of uncertainty and volatile swing action. Even with a hurting housing market, a failing BP catastrophe, and the EU sovereign debt crisis, the U.S. economy in June 2010 is beyond the lows of March 2010. U.S. companies were the first to implement cost-cuts and ultimately they will be the first to lead the future hiring rebound.

The Wall St. Cheat Sheet Premium newsletter has delivered 15 out of 16 winning picks since inception in November 2008. Let the Hoffman Brothers give you their best investing and trading ideas: click here now for your free trial.

As we have all witnessed the tragedy of habitat destruction over the past 50 days, it is important to digest and rethink your energy portfolio this morning.

How can anyone feel ‘good’ about owning BP (NYSE:BP) stock right now? Why would anyone want to stop at a BP gas station to continue supporting BP’s wallet with our money?

BP recently spent $50 million dollars on an advertising campaign to improve their image during a time of crisis. However, BP needs to apply that money directly to the problem: the gushing hole they created.

Right now, I strongly believe you should be reshaping your energy portfolio with companies that are in no way agents of this disastrous oil spill, but beneficiaries of BP’s market share. Here are 7 stocks you need to consider as a boycott to BP:

Chevron (CVX): $70.45 per share

Proctor & Gamble (PG): $61.19 per share

ExxonMobil (XOM): $60.48 per share

Shell (RDS-A): $51.23 per share

Occidental Petroleum (OXY): $79.49 per share

Marathon (MRO): $31.19 per share

Natural Gas (UNG): $8.19 per share

Your investment in other energy companies besides BP improves the future of our energy infrastructure and the environment in which we must live.

If you are interested in detailed entry and exit plans for low risk-high reward stocks which meet our proprietary standards, click here for a free trial to our Wall St. Cheat Sheet Premium newsletter written by the Hoffman Brothers.

Click for Larger Image

(Source: Kiplinger)

What business on Earth can operate at a Trillion dollar loss for three years in a row? The one Uncle Sam chairs.

Yes. It’s true. The AP reports:

The [US] deficit in 2011 would drop to $1.27 trillion under the administration’s plan, the third straight trillion-dollar-plus imbalance. The budget gap would fall to $828 billion in 2012 but would remain at levels surpassing any previous deficits through 2020.

I am trying very hard to understand how the US economy will genuinely rebound with this much debt over the next decade. The plan is to pay down the debt when good times return, but how many politicians will forgo new programs (in their districts) to cut a payoff check to creditors holding US Treasuries?

I am in Palm Beach this week. Everywhere I look I’m reminded of the insane Social Security and Medicare entitlements which will vest over the next 15+ years. From which level of the Ponzi triangle will the money come?

I know the sun will eventually rise. But there are a lot of clouds on the economic horizon.

Michael Panzner is author of Financial Armageddon.

While most eyes were focused on the better-than-expected gross domestic product data for last year’s fourth quarter, this week’s report from the Commerce Department’s Bureau of Economic Analysis also included details on U.S. personal income.

Along with wages and salaries, dividends and interest income, this category includes personal current transfer receipts, which the BEA defines as “income payments to persons for which no current services are performed and net insurance settlements.” That is, government social benefits (and, to a very minor extent, net transfers received from businesses).

As you can see from the following graph, while the relationship between personal income and GDP has not changed all that much over the course of the past six decades, the share of income accounted for by transfer payments has jumped more than 200 percent.

The latest data also confirms that the financial crisis has played a major role in boosting Americans’ dependence — for lack of a better word — on government largesse, with the run-up over the past two years accounting for around a quarter of the relative increase since 1947.

With an ever-greater share of Americans receiving some sort of financial assistance from the government, the obvious question is how — or whether — this shift will affect the political landscape, especially when it comes to making tough choices about social programs, in particular, and public finances, in general.

If and when policymakers decide, for example, that the time is right to rein in spending and cut back on public sector borrowing, will the political will be there to see those efforts through? Or, as cynics might suggest, is a financial crash landing the only real “exit strategy” that is on the table right now?

I guess we’ll find out soon enough.

Michael Panzner is also the author of the acclaimed book:

Despite thousands of years of anecdotal evidence, we now have scientific proof that those in positions of power tend to become hypocrites.

Researchers at the Kellogg School of Management at Northwestern University “sought to determine whether power inspires hypocrisy, the tendency to hold high standards for others while performing morally suspect behaviors oneself. The research finds that power makes people stricter in moral judgment of others – while being less strict of their own behavior.”

Now, who is going to start studying whether people in government tend to use their positions for personal gain?

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Wall Street Journal Editor David Wessel Talks Waning Trust in the Federal Reserve

Congressman Alan Grayson

This was one of our 10 Best Interviews from 2009:

In May, a cool and collected Congressman Alan Grayson questioned the Federal Reserve Inspector General about the trillions of dollars lent and spent by the Federal Reserve. Inspector General Elizabeth Coleman said she had no idea where the money went. Two months later, Congressman Grayson asked Federal Reserve Chairman Ben Bernanke the same questions. Here is the exact exchange:

Grayson: “So who got the money?”
Bernanke: “Financial institutions in Europe and other countries.”
Grayson: “Which ones?”
Bernanke: “I don’t know.”
Grayson: “Half a trillion dollars and you don’t know who got the money?”

As you can see, like Congressman Ron Paul, Congressman Grayson is one of the rare voices asking the most important questions on behalf of the US Taxpayers. Most importantly, Congressman Grayson understands the Fed’s secretive transfer of wealth from taxpayers to private interests as “The story of the millennium.”

If this sounds like the stuff of conspiracies, simply look at any chart of the US dollar and you can see it has lost over 95% of it’s value since the Federal Reserve was created in 1913.

I caught up with Congressman Grayson to better understand the problem with our Federal Reserve, the rising momentum for the Federal Reserve Transparency Act of 2009 (H.R. 1207), and how we can make the Fed more accountable to their four government delegated duties …

Damien Hoffman: Congressman Grayson, I recently penned an article called “Has the Federal Reserve Failed?” in which I looked at their four government delegated duties and concluded they simply have not done their job. What is your proposal to make the Federal Reserve more transparent and accountable?

Congressman Grayson: H.R. 1207 is one of the simplest bills imaginable. Unlike the healthcare bill which is over 1000 pages, H.R. 1207 is a page and a half. The bill lists the existing exclusion of the Federal Reserve from oversight by the Government Accountability Office (GAO) and allows the GAO — an independent body — to audit the Federal Reserve Bank.

The Federal Reserve Bank has not had an independent audit since it was created almost 100 years ago, and it needs an audit. Many times we have exposed gross acts of irresponsibility on the part of the Federal Reserve. So, we need to dig in and get details.

Just a few weeks ago, while Chairman Bernanke was testifying to Congress, we examined the Fed balance sheet and P&L statement only to find what looked like the Fed handing over half a trillion dollars to foreigners. This was very surprising! When I asked Chairman Bernanke if this was true, he said, “Yes.” When I asked him who got the money, he said, “Fourteen foreign Central Banks.” And when I asked to who did they give the money, he said, “I don’t know.” “I don’t know” is not good enough when you’re talking about $500 billion. That’s $1700 for every man, woman, and child in this country.

Damien: What is the status of the bill?

Congressman Grayson: I am very sure the bill will pass — possibly by the end of September, but more likely by the end of October.

Damien: Congressman, what do you say to the primary criticism that auditing the Fed’s book is like exposing confidential information which can lead to harm?

Congressman Grayson: The Fed made that exact same argument in court and recently lost across the board in the case of Bloomberg LP v. Board of Governors of the Federal Reserve System [U.S. District Court, Southern District of New York (Manhattan), No. 08-9595.]. The judge looked at the facts and noted that shining a spotlight on what the Federal Reserve’s actions will only be a good thing. So, that argument has been demolished based on the evidence.

Damien: Congressman, while we are waiting for a Fed audit, does anyone know what the Fed has been doing given that they have not fulfilled their government delegated duties as listed on the Federal Reserve website?

Congressman Grayson: They are performing a truly remarkable, surreptitious transfer of wealth from public to private hands. They are taking their ability to print money and shore up failed banks. They are simply stuffing money into the pockets of private interests.

In the case of the half a trillion dollars, they stuffed the money into foreign private pockets. In the case of another $230 billion, it has been tracked as a secret bailout to Citicorp in the US. The fact is the Federal Reserve continuously puts all of us on the hook for decisions they make to play favorites with private interests to the tune of trillions of dollars.

Source: Zerohedge.com

Damien: Congressman, what do you say to those who call your allegations a conspiracy theory?

Congressman Grayson: Something I found very intriguing was the Semi-Annual Report from the Federal Reserve to the Congress. That’s a mother-load of secrets if you read it very carefully and ask the right questions.

Since it looks like the Federal Reserve may soon be subject to the Freedom of Information Act, that opens many opportunities for the public to see the facts.

These are not conspiracies. The Federal Reserve’s own website has some incredibly interesting information about the general state of the US economy and the distribution of wealth in our country. I was recently reading our national wealth capped out at $62 trillion two-years ago has crashed to $50 trillion since. Those are Federal Reserve statistics on their website.

Damien: Congressman, I know you have another interview in a moment, so thanks for your time. I would love to follow up with you on this story sometime soon.

Congressman Grayson: Super. This is the story of the millennium. There are very few stories you can ever write about where the numbers involved have 13 digits in them. I look forward to staying in touch.

As part of his larger spending plan, President Obama introduced a new proposal last week that would reimburse homeowners who purchase energy-efficient appliances and insulation. The new scheme is intended to stimulate the economy and reduce the energy bills of those who take full advantage of it by 20%.

Exact details of the new program weren’t elaborated on, but according to a source involved in writing the bill, homeowners may be eligible for a 50% rebate on qualified purchases, potentially coming out to a maximum of $12,000. At the moment, income remains an irrelevant factor in determining how much a household is able to receive.

Many questions remain unanswered about the proposed program expected to cost nearly $10 billion: how will it be administered, and how will it be protected from swindlers who may take advantage of these newly available funds?

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