Announcer:Welcome to Creating Wealth with Jason Hartman, President of Platinum Properties Investor Network in Costa Mesa, California. During this program, Jason is going to tell you some really exciting things that you probably haven’t thought of before and a new slant on investing, fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible.
Jason is a genuine self-made multimillionaire, who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it. And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
Jason Hartman: Welcome to another edition of Creating Wealth. This is Jason Hartman and today, I want to talk to you once again about some other aspects of my very favorite subject, and that subject is what? You’re all thinking, all you regular listeners, you know what it is. Inflation. Actually, this is about, “It’s Inflation, Stupid.” So remember that old campaign slogan against the first George Bush. Bill Clinton’s campaign advisors said say it’s the economy, stupid, and that really resonated well with people. So this one is about inflation.
You’ve got to remember that when it comes to money, dollars do not equal lifestyle. What equals lifestyle? What makes our life better? Well, what makes our life better is purchasing power. How much purchasing power do those dollars have? How much is that money actually worth? What can we buy with it? Nobody really wants dollars or money of any kind. They want what the money buys. So that’s what’s important to us as investors.
Remember that when we use debt, debt is like our inflation protection policy. It’s like our insurance policy against inflation because that leverage can be used, not abused, to actually create a lot of wealth for us. I want you to notice something in life. Notice that inflation is the ultimate wealth redistributor. Why do I say that? Why is inflation the ultimate wealth redistributor? Well, it’s because if you think about it, inflation redistributes wealth from older people to younger people, doesn’t it? Why is that? Why do older people become poorer through inflation and younger people become richer through inflation?
Well, the answer is because most younger people have more debt than older people. And inflation redistributes wealth from creditors to debtors. Debtors benefit through inflation. Creditors or lenders or savers really get hurt by inflation.
So what are we going to do on today’s show? Well, first of all, I want you to hear a little bit from Bloomberg News. I love satellite radio in my car because I can listen to Bloomberg, which has got some really great in-depth content about economics, about finance, and about inflation. It seems to be the big topic in the news today. So first, I want you to hear a little bit about how the original monkey-ing with the statistics occurred in the early 1970s when they started really reporting inflation differently, and here, you’re going to hear it from someone who was interviewed on Bloomberg News, who actually worked at the Federal Reserve and wanted to keep his job. And one of the requirements to keep his job was change the way the index is calculated. Is this a conspiracy?
Well, yeah, it kind of is and you know I think conspiracy theorists get kind of a bad rap in this world. Anybody who believes in a conspiracy, you know, who shot JFK, whatever it is, they get sort of labeled like some kind of a whacko. I mean look, all a conspiracy really is is more than one person doing something that they’re not telling everybody else about, right? Pretty simple. And I think in this case, you can clearly see there is massive evidence for something that isn’t that far out or hard to believe. It’s not Big Foot. It’s not UFOs. It’s not the Loch Ness Monster. It’s inflation, stupid.
So this conspiracy is just about how the government has a very vested interest in changing the numbers and having us believe one thing when another thing is really happening. And this affects every area of our life, so it’s really, really important. So let’s listen to a few minutes of this radio interview on Bloomberg News. It’s a fantastic, interesting interview. And then I want to have one of our new Business Development coordinators here at Platinum Properties Investor Network, Lorene Davis, share with you a little article that I will comment on, and then we will go back to where we have a prior guest back on the show, Randy Luebke, to talk a little bit about some of the internal workings of why banks fail and what goes on.
Stephen Roach, chairman of Morgan Stanley Asia, you’ve been writing a lot about inflation. It’s all of a sudden a big theme on the program. Russia, 14%; Malaysia, with inflation; really everywhere we look. Okay in the United States. You say we’re on the cusp here of an Arthur Burns-ian inflation. We should be focusing on headline inflation, correct?
Tom: Absolutely, Tom. One of the great sins that I was personally responsible for back in the days when I was a young pup, in the early ’70s, I was a staff economist at the Federal Reserve, heading up the section that analyzed the real economy and inflation trends. And at the bequest, if not a direct order, from then Fed Chairman Arthur Burns, as the U.S. went through its first energy shock and then nine months to a year later, we went through a major food shock, Chairman Burns ordered us on the staff to take out energy and food from the CPI. We challenged him on that. We said, hey, you know, Mr. Chairman, people eat. Do they drive their cars; heat their homes? How can you take it out?
And his comments were those are exogenous forces that have nothing to do with the internal dynamics of the U.S. economy and they’re due to weather disturbances, they’re due to politically inspired embargoes from Middle East oil producers. Take them out. If you don’t, we’ll find somebody who will. So we all wanted to hold onto our jobs, so we took these so-called “special factors,” as the chairman then called them, out and we actually created at the time, in the early ’70s, the first core CPI. It never existed until we were ordered to do that.
Unfortunately, Arthur Burns then set monetary policy in the U.S. in accordance with his perception of this underlying core inflation rate and allowed U.S. interest rates to be negative in real terms and that fed just a devastating inflationary spiral. It was reinforced by index wage increases that finally took Paul Volcker and a 19 percent funds rate in a massive hard landing in the U.S. to unwind the problem. I don’t want to see any country go through that again, especially China.
Tom: If you take headline inflation and you divide it by core inflation, we’ve had moments, we’ve had what are pointy points on the chart, folks, stochastic moments back in the ’60s where there were brief surges of headline compared to core. But now, it is permanent. I mean we have an eight-year width between the inflation my listeners are living in this so-called core inflation. Do you see any change in monetary economics back towards a pre-Burnsian and pre-Roachian reverence for headline inflation?
Tom: Well, I think that’s an active debate right now, Tom, and you know I think that’s a very important point you make. The idea of taking the special factors out is the presumption that any disturbances are short lived and there’s a quick mean reversion for whether it’s food or energy or some other component that gets temporarily shocked. What did you say; it was seven years, eight years?
Tom: We’ve been elevated for seven, eight years.
Tom: So that sort of belies the whole concept of a mean reversion, so you have to ask yourself what is it that causes that spread. And is it economic development? Massive countries out where I am now, in China and India, where all of a sudden, the level of prosperity is high enough, where the growth rates are rapid enough for a long enough period of time, where more people are eating two meals a day, who used to be eating one meal a day.
More construction’s going on. It takes a huge claim on industrial materials and energy, as is the case in China and India. And is that temporary? Is that going to be a mean reverting phenomenon? Is economic development mean reverting? The answer to that is no, so we’ve got to get away from this core inflation concept. It’s very dangerous, very risky, and a real threat to global price stability, I think.
Tom: Do you see a global move to restrictive central banks as we’ve had accommodation for X number of years? Are we going to come back to an era of just higher interest rates across the board?
Tom: Well, I think we’re going to need that for a variety of reasons. The problem is, though, in the developing world, you take a country like China, they’re afraid to be too restrictive, even though they know they need to be because they feel they need rapid growth to absorb the surplus labor in the productive side of the economy. So they are very reluctant to admit that they may have to slow their economies down to deal with inflationary pressure.
So what China does on the monetary tightening front is they do things like administrative controls on pricing and they raise bank reserve requirement. But they don’t raise their policy interest rates. Right now, the policy interest rate in China is below the headline inflation rate. They’ve got negative real interest rates, which is right out of the script of the 1970s in the U.S.
Tom: And you mentioned, literally, their CDs, their bank deposits are artificially set, correct? Not really set to market.
Tom: That’s exactly right.
Jason Hartman: Now, wasn’t that Bloomberg clip very interesting? That was just amazingly telling about the history that went on in the Federal Reserve under Arthur Burns in the early ’70s. That’s how we got to this point of what’s called the core rate versus the CPI or headline inflation, where they strip out the food and energy. Really quite a scam, frankly, the way that’s done.
In addition to that, of course, we know from listening to previous shows here that there are many other ways that the government monkeys with these numbers in terms of substitution, hedonics index, all sorts of other factors and things that influence the CPI and the inflation statistics more broadly, that are not mentioned in this. But at least this talked about that one thing of the stripping out of the food and energy, which I think is, of course, completely ridiculous saying that because, of course, none of us can live without food and energy.
A couple other comments on this Bloomberg clip. Well, so the concept where he talked about consumption in China and other developing countries, this is really a great thing for us, as we’ve talked about on prior shows, as investors in income properties because what we have here with this consumption is, of course, driving up the cost of these global commodity prices, the commodities which build the property – well, not the properties, but the structures sitting on the properties, that we are investing in, so the houses, the apartment buildings, the office complexes, the retail centers, etc, etc. So that’s very good news for us.
And then also, they make another comment about how this is bad for price stability and the concerns about price stability and I just want to go on record saying that I do agree with that. When it’s talked about in terms of the broader economy, it is not good. But of course, as prudent investors in smart income properties in diverse markets around the U.S.A and potentially later around the world, we know how to benefit from this. So things that are bad for the broader economy can actually be very good for us. Very interesting interview and I just thought I’d share that with you. I’ve got a couple other clips that I want to share with you on future shows as well.
Now, let’s go back to the next part of the show.
So Lorene Davis is here with me and I’d like her to share an article that I read. One of our prior guests, Mark MacVay, who was on the show, sent this article to me a few months ago, entitled, “It’s Inflation, Stupid” by Peter Schiff. Lorene?
Lorene Davis: Holding onto its “all is well” bias like a terrified cowboy on an enraged bull, Wall Street has managed to convince itself, and much of the world, that inflation is a non-issue. When confronted with facts to the contrary, their rationalizations come fast and thick. Nowhere is this spin more pronounced than in their dismissal of the surging price of gold as a relevant indicator.
Rather than favoring the logical conclusion that the rise in gold prices results from an inflationary expansion of money supplies around the world, Wall Street has credited its rise to other factors. The most common explanations include economic growth –
Jason Hartman: Not in the U.S.
Lorene Davis: – rising jewelry demand, speculative buying, higher oil prices, the weak dollar –
Jason Hartman: That’s for sure.
Lorene Davis: – terrorism, uncertainty, Middle East tensions, volatility, supply and demand, etc. Every possible explanation is offered save one, inflation.
Jason Hartman: Thank you! Inflation.
Lorene Davis: Some explanations, such as a weak dollar, have some validity, but miss the point that the dollar is weak as a result of inflation (i.e. too much money creation by the Fed). In my commentary from September 30, 2005, I noted that rising gold prices were the inflationary equivalent of the canary in a coalmine. However, rather than fleeing for better air, Wall Street miners merely go about their business confident that the bird succumbed to natural causes.
Given Ben Bernanke’s promise yesterday to supply interest rate reductions, despite his believe that the U.S. economy is not headed toward recession –
Jason Hartman: Yeah, right.
Lorene Davis: – (a claim that even the Fed Chairman obviously does not believe,) –
Jason Hartman: I don’t think he believes a lot of the stuff he says.
Lorene Davis: – inflation has been given much more room to run. Basically, the Fed is sending the message that inflation is going to get a whole lot worse and that it couldn’t care less.
Jason Hartman: That’s for sure.
Lorene Davis: As the price of gold continues to climb as a result, look for more excuses to minimize the significance of the move.
Jason Hartman: Well, thank you, Lorene. I hope you didn’t mind my snarky little comments there. You know the one thing we haven’t talked about on the show is, of course, what’s in the news extensively is these bank failures. And of course, as investors, if we have money in the bank, we need to smart enough to never put more than $100,000.00 or let any account grow to over $100,000.00 in any of our bank accounts and make sure we’re under the FDIC insurance limits. And you can also invest in different names and so forth to get $100,000.00 of insurance on each account.
I’m here with Randy Luebke of Nations Home Funding. He’s been on the show before and Randy, welcome back.
Randy Luebke: Thank you, Jason. Good to be here today.
Jason Hartman: Good. I want to talk to you about the perilous, very scary economic news that is going on. Boy, are we in a different world or what? It is really amazing what’s going on. Talk to us, Randy, about the credit markets and about the deleveraging that is occurring in the financial markets.
Randy Luebke: Yeah, Jason, I think there’s just a lot of anxiety out there. You turn on the newsreels at night. You see lines of people standing in front of IndyMac.
Jason Hartman: Haven’t seen that for a while.
Randy Luebke: Yeah, I mean it’s like watching that movie, “It’s a Wonderful Life” and the bank run, right?
Jason Hartman: Yeah, but Jimmy Stewart was a lot more honest than most of these crooks on Wall Street.
Randy Luebke: Well, he did end up with cash. But the point is it’s like newsreel after newsreel, house markets are declining, jobs are being lost, people standing in line wondering if they’re going to get the money. And what I thought I’d like to do today is just spend a few minutes with you really debunking this whole idea what this credit crisis/crunch is all about, making it simple so people can understand it, and realize that this is really an opportunity in front of them and they want to take advantage of it.
Jason Hartman: Yeah, it really is. Just a couple things I’d like to say at the outset. No. 1 and we’ve said this before on the show, but it shows the complete ignorance of what goes on in the media and these so-called experts that get up and talk about the housing market, as if there is such a thing in a country as large and diverse as the United States as America. There are many, many housing markets.
And No. 2 is that these kinds of crazy economic times are when fortunes are made and it is really amazing. When people can really exploit these little cracks in the marketplace and little nuances that are going on and hopefully that’s what we’re doing here at Platinum Properties Investor Network is teaching people how to do this. And we’ll do that a little bit in the presentation talk with you today, but good opportunities out there. As Warren Buffet says, be fearful when everyone else is greedy. Be greedy when everyone else is fearful. So now’s the time to be greedy, huh?
Randy Luebke: I think it’s a great opportunity.
Jason Hartman: All right, well, from your chair, Randy, what do you see?
Randy Luebke: Well, first of all, let’s talk about some definitions. I think a lot of times we get hung up or caught up in the sound bites that we hear on the news as well. So we hear this thing, credit markets are deleveraging. That’s kind of how you started this thing, right? So let’s just explain first of all that credit actually means debt. We’re talking about the ability to lend money, so from the bank’s point of view, they’re a creditor, and they’re lending money, so that’s what debt is. And deleveraging simply means paying it off. So basically, what’s happening is all of the institutions that have been lending money so loosely over the last 15 – 20 years are now starting to pay off the debt.
And the real question is why? Why are they going around doing that? So the best way to understand why is for everybody here to really understand leverage. Now, I think in your teachings, in your podcasts and, certainly, in your live events, you do a great job of explaining the benefits of leverage, so what I’d like to do is to take a minute and explain how leverage works. Is that okay?
Jason Hartman: Sure.
Randy Luebke: Okay, excellent. All right, so let’s just say I have $100,000.00 to lend you, Jason, and I can lend it to you at a 6 percent rate of return. At 6 percent, I get a $6,000.00 profit. Real simple, right?
Jason Hartman: Six percent interest.
Randy Luebke: Six percent interest.
Jason Hartman: So $6,000.00 per year would be your gross return on investment.
Randy Luebke: Exactly. So if I took $6,000.00, divided by the $100,000.00 I invested, I would have a 6 percent return on investment, ROI. That’s exactly what they’re talking about. So we do this and you like it and you tell a friend, and they want to borrow some money, too. So now, I have my first problem. I have more borrowers and I need more money. So the solution is I’m going to go borrow some money myself from other people, right? Well, if I’m a bank, where do I go borrowing that money or how do I go borrowing it?
Jason Hartman: The good ole Federal Reserve System and they have a thing that makes it very convenient for you to borrow called fractional reserve banking, which allows you to borrow much more than you have in assets and you can create inflation doing that. But kind of another subject we’ve discussed on other podcasts. Go ahead.
Randy Luebke: Well, so, if I’m a bank, I’m going to borrow money from my customers in the form of checking accounts, savings accounts, and CDs because if you think about it from the bank’s perspective –
Jason Hartman: A deposit is a loan to the bank.
Randy Luebke: Exactly. So now I have a liability to you, but I also have more money and that’s what I need. So let’s say in our example I need $100,000.00 and I get somebody to buy a CD from me and I’ll pay them a 4 percent rate of return, which is reasonable today. So my cost for that $100,000.00 over the course of a year, of course, would be $4,000.00, $100,000.00 at 4 percent. So now let’s do the math. I have $6,000.00 I’m going to earn when I lend the $100,000.00 out. Subtract from that the $4,000.00 cost. I make a $2,000.00 net profit.
Jason Hartman: Sounds pretty good. You’re playing the margins and one thing I want to just inject here, Randy, so you as the bank are playing the margins, so you have earned a good rate of return. You’ve profited by $2,000.00 or in essence, 2 percent ROI, right?
Randy Luebke: Well, 2 percent ROI, except for the fact that I leveraged that rate of return. So before, when I gave you my $100,000.00, I made $6,000.00, my ROI was 6 percent. But now, I only had to invest $4,000.00 of my money and I made a $2,000.00 profit. So $2,000.00 profit divided by my $4,000.00 investment, now what’s my ROI?
Jason Hartman: Fifty percent.
Randy Luebke: Yeah, so I love leverage.
Jason Hartman: Yeah, that’s really good. And here’s the question that we did answer on a prior podcast, but I just want to make sure we mention this to our listeners again because this is really important. Many, many listeners to the podcast say to me, well, we talk a lot about inflation, as you know. If the true rate of inflation is 8 percent, 10 percent, 12 percent, whatever it is and it’s different for everybody because everybody spends differently, so why would a bank loan you money at 6 percent when it’s below the rate of inflation? And the answer is what you just said, Randy, because the bank, as long as they can attract depositors at 4 percent, they don’t care what the rate of inflation is. They’ve got a margin.
It’s kind of like saying, well, couldn’t you sell this widget for $10.00? Well, maybe you could, but who cares? If you’re buying it for $5.00 and you can afford to sell it for $7.00 and sell more of them at $7.00, there’s still a profitable business there because all you’re doing is playing the margins, the margin between where you borrowed in the form of deposits to the bank and the margin of what you loaned out in the form of income to the bank.
Randy Luebke: That’s right. And leverage amplifies everything. So here we took our 6 percent rate of return, amplified it through leverage to 50 percent.
Jason Hartman: Good stuff.
Randy Luebke: Thank you. The story gets better. I got $100,000.00, remember? So I can take that $100,000.00 and I know that I can, with each CD, pay out $4,000.00 in expense, so therefore, I can create 25 of these $100,000.00 CDs.
Jason Hartman: That’s fantastic. It’s kind of like fractional reserve banking.
Randy Luebke: That’s exactly correct. So now, let’s do the math. I have $2,000.00 profit from every one of these deals I do and now I can do 25 of those deals with the same $100,000.00 I was only able to loan out once. So now, instead of making $2,000.00 for my money or $6,000.00 for my money, I’m able to earn $50,000.00 net profit from that same $100,000.00.
Jason Hartman: You know what, Randy? This makes banks look so darn profitable. It makes you wonder why a bank could ever fail.
Randy Luebke: Well, we’re going to talk about that.
Jason Hartman: All right and by the way, this podcast is in light of, largely, the IndyMac Bank failure, second largest bank failure in U.S. history.
Randy Luebke: Absolutely and we’ll tie that in at the very end here. So here’s what happened. We started out with $100,000.00. We found a bunch of people that wanted to borrow the money, so we found 25 more people to give us $100,000.00. We loaned out all that money to all those people and we’re making lots of money. We’re real happy with that.
But now, I’ve got a new problem to deal with. That’s this. So I borrowed the money from my customers in the form of a CD for a term of one year, a one-year CD, but I loaned the money out to my other customers for 30 years on a 30-year loan. So I have a problem there because what if I need to pay one of my depositors back before 30 years is up?
Well, Fannie Mae and Freddie Mac to the rescue. This is where they come in because what Fannie Mae and Freddie Mac will do, which they’re called GFCs, by the way, which stands for Government Sponsored Enterprises. They’re privately owned businesses that are backed and insured by the federal government.
Jason Hartman: So they’re these pseudo, quasi-governmental entities in a way and they’re, as we know now, potentially too big to fail, so the government bails them out.
Randy Luebke: That’s how it works. So what Fannie and Freddie say to me is this: Listen. If you’re willing to “conform” – and I put that in quotes – if you’re willing to “conform” to my rules in the way you lend out at that money, I will buy all of your loans for you and still let you keep a small profit. So let me say that again. As long as you’re willing to make loans in the size I say, into the standards I ask you to make them in, I’ll guarantee to purchase every one of those loans from you and let you keep a small amount of the profit.
So now what happens is that $100,000.00 I had that I could loan out once in the first time we went through this, 25 times when we found people to buy CDs from me, now I literally have an unlimited amount of loans I can make because I can recycle that $100,000.00 over and over and over again. That’s what we call credit expansion or leveraging.
Jason Hartman: And what does that do? It creates inflation.
Randy Luebke: Well, it certainly does and also can bring a new problem into play, which is what we’ve been experiencing as of late. Now, we talked about this earlier. First of all, we know that leverage amplifies everything, which means we took our 6 percent rate of return up to 50 percent, but it also can amplify your losses. In fact, I like to always say that a little bit of leverage can do a lot of good. Too much leverage or leverage used in a way that’s not proper or appropriate can cause a lot of problems and this is what we’re experiencing.
What if one of my borrowers stops paying on their mortgage? That’s called a default. One of the rules that Fannie and Freddie says is that if one of your loans, if one of your borrowers stops paying on your loans, you need to buy that loan back from me. You need to give me my $100,000.00 back. I say okay Fannie and Freddie; I have no problem. I have a whole bunch of loans on my books. I will sell one of those loans to somebody else that wants to buy it and I’ll take that cash and pay you back.
Well, that works great until another loan goes into default and another loan goes into default, and the next thing you know, I continue to sell off loans, trying to pay off the bad debt. Now, that whole process of selling down these loans and paying off the debt, that’s called deleveraging, and that’s exactly what we’re doing today.
Jason Hartman: Yeah, and the issue here is when they sell those bad loans to some agency other than Fannie and Freddie, they’re selling them at a substantial discount, right?
Randy Luebke: They’d be selling them potentially at a discount if they weren’t selling them to Fannie and Freddie in a good market, but certainly, in a market where home values are declining and people are already in default on their loans, you bet. They’re selling them at a big discount.
Jason Hartman: Yeah, here’s another thing I want to mention about that and I don’t have any specific statistics. It’s more of an impression anecdotally and I’ve been saying this for a long time, that the sort of high-risk loans for the lenders, and when I say that I mean adjustable rate loans that have significant backend increases in their payments and their interest rates, those are largely in the high land value, what I call yuppie markets, California; to a lesser extent, Arizona, Nevada. To a high extent, California, New York, a lot of Northeast Boston, probably Hawaii, the areas that have high real estate values, sort of yuppie populations, high white-collar, people that like the good life, if you will.
You see more of that sort of instant gratification, live for today type of attitude, where people have this sort of optimism and think that it will go on forever, and of course, these high land value markets are the very risky markets. Go back and see my podcast on the Risk Evaluation Methodology for more on this. But you have more of an occurrence of this, so these are the markets that are really declining in value and the hardest hit in terms of depreciation.
So would you agree with that that these loans are largely concentrated in – when you look at this map that you brought me today, these are concentrated more so in the areas of this type of market, high land value, yuppie population, etc.
Randy Luebke: I do agree with you, Jason. Again, the question is why. You always want to ask why. And we’re talking about this conforming to my Fannie/Freddie guidelines. Well, if you look at the home values across the population of the United States, the bulk of the United States will have loans that will fit inside the conforming loan limits. Once you got outside of these conforming loan limits into the “jumbo loans,” now all of a sudden, we had all of these loans that were being created on Wall Street and they fit the market with these high home prices. So one kind of contracted the other.
Jason Hartman: Yeah, exactly. It’s a domino effect, no question.
Randy Luebke: Absolutely. So let’s go back to the story here. So what’s happening is I’m having some defaults on my loans and, at first, I’m okay with this because I’m able to sell these loans to other people, get the cash. I’m going through the leveraging process. This is what we call a credit contraction. So we go back to the beginning of the story, I lend out more and more money. That’s credit expansion. Now we’re going through paying off all those loans. We’re going through credit contraction.
Now, in a normal business cycle, that’s fine. That’ll happen all the time and we would expect loans to be bought and sold and paid off and new loans made. Problem is at one point, somebody may stop buying my loans altogether and that’s exactly what happened, and it came to a head, really, in August of 2007.
Jason Hartman: Yeah, I remember. Last August is when we really saw the big first signs of this when they stopped buying these loans and that was the beginning of the really, really heavy part of the meltdown, right?
Randy Luebke: That’s right. That’s when a credit contraction became a credit crunch.
Jason Hartman: Okay. Good definition, contraction versus crunch.
Randy Luebke: Versus crunch. Now we’re –
Jason Hartman: So contraction, would you say, is a normal part of the business cycle, versus a credit crunch is a disastrous part of the cycle.
Randy Luebke: Absolutely. Another analogy is that the credit markers were frozen like ice and that causes that crunch. The whole market depends on this ability to create fluid money cycles. If the money can be loaned, resold, re-loaned, resold, re-loaned, everything works. But the second that cycle breaks, you’ve got a crunch.
Jason Hartman: Right.
Randy Luebke: And that’s what we’re experiencing right now. So what ultimately happens is now my little bank that was doing so well and making all that money and I thought I was so smart because I leveraged, leveraged, leveraged, all of a sudden, my liabilities are greater than my assets. In other words, I owe more than I own. And then that little fellow that we see on TV all the time, that little bald guy steps in from the Federal Reserve, our friend Mr. Ben Bernanke, right, and he says you’re insolvent, Mr. Bank, so we are going to shut you down. We’re going to take you over. And that’s exactly why the lines were forming outside of IndyMac Bank, second largest bank failure in the history of America.
So this is the idea, that leverage certainly makes sense, but the proper use of leverage that we talk about and you talk about in your live trainings as well as your podcasts, is the proper use of leverage that really makes sense.
Jason Hartman: Absolutely and you know, Randy, this is another thing I want to kind of mention that ties into this concept. I would much rather be the landlord than the lender, and the reason is because I find that like when I’ve invested in notes and trust deeds, I am always having a tough time getting paid back. But when I rent my properties, I get paid. I’ve only had one eviction in 21 years, where I’ve had evict a tenant, and that’s a pretty darn good record considering as many tenants as I’ve had over the years. And the key is when you look at these bank failures, they did not sustainable assets backing their leverage.
And so what we say is use leverage prudently and properly, but we do like leverage a lot. Leverage is a very powerful tool for good, but if you don’t have it attached to something sustainable, in other words, a rental property that makes sense the day you buy it, you’re going to get yourself into trouble and on a personal level rather than a bank level here, this is what has happened to people in California, Arizona, Nevada, Florida. They bought these properties with a ton of leverage and the properties never made sense in the first place. I mean, folks, what is there to say that you don’t get here? It’s so simple.
It’s like everybody’s sitting around wondering, well, why is this happening to me? My life is ruined. Well, you bought something that never worked the day you bought it. It wasn’t a sustainable investment. So it’s got to be sustainable and if you want more information on this, go back and listen to the other podcasts where we’ve talked about evaluating risk, evaluating properties, evaluating cash flow. We’ve got a whole body of work here in 60 prior shows that you can listen to on this, all right?
But Randy, what else on this?
Randy Luebke: Well, let’s just kind of wrap this up here because I think the listeners are probably asking, okay, this is good. I understand how the system works. I understand what happened now. So what can I do? What should we do in light of what’s going on? And my lesson here is really this: that adversity equals opportunity and right now, we’re definitely in an adverse situation. Would you agree with that?
Jason Hartman: Absolutely and that’s where the opportunity comes in. The Chinese have the symbol for crisis and it’s the same as the one for opportunity, and they say crisis is an opportunity riding the dangerous wind. That’s the literal translation for that symbol. And this is when opportunities are created, but not everybody will qualify for the opportunities right now, right?
Randy Luebke: Well, that’s absolutely true. In fact, I think it was Baron von Rothschild that stood in the streets of Paris during the French Revolution, right, who said buy when there’s blood in the streets. There’s blood in the streets right now.
Jason Hartman: Yeah, there really is. Yeah.
Randy Luebke: So I have an action acronym. I love acronyms and it’s CBS, okay? That should be an easy one for everybody to remember. C, get your credit in tiptop shape today. B, start buying investment-grade real estate, real estate that makes sense now and Stop waiting because, really, now is the time to act while others won’t.
Jason Hartman: CBS, good acronym. Credit, buying, and stop waiting. So get your credit in tiptop shape, work on your credit. It’s a major asset. Start buying sensible properties that make sense the day you buy them and don’t wait because the opportunities right now are really, really phenomenal, as long as you do it right and you do it in the right locations. Randy, thanks so much for being on the show again. We’ll have you back soon. And if you want to reach Randy Luebke, you can visit www.jasonhartman.com and on the website in the financing section, there’s a profile and some information about Randy there, as well as a web form where you can contact him. Randy, can people also reach you by email?
Jason Hartman: Excellent. Thanks for being on the show.
Randy Luebke: Thanks.
Jason Hartman: You know we’ve been a little behind on answering questions, so let’s try and catch up on a couple of them real quickly if I can. First of all, I got a great question from Monica. Monica thanks for your question. She says, “I’m relatively new in the workplace and I’ve been in my career for about three years. I’ve been listening to your podcast, including all of the podcasts you’ve done for new investors, and you have made me so excited to start investing. I really appreciate your podcast, you philosophy, but most of all, your integrity. My question is that with my graduation came a ton of student loans and some credit card debt that I’m feverishly working to pay off. I have a small savings and I know how much you hate savings accounts.”
Yes, I do because they eat you up by inflation.
“But I’m not sure what I should be doing in order to get help with what little I have to grow that faster and get me to the point where I can begin to buy property. Is there someone in your firm who might be able to guide me?”
Well, of course, there is, Monica. Just give us a call. We’ll be happy to do that and I think you may have spoken to one of our investment counselors already.
“I have a first rate account, but I’ve been a bit afraid of investing in the stock market. Thank you again for your wonderful work. I’ll try to make it to one of your seminars in the future.”
Well, Monica, first of all, thank you for your kind words. The thing I would say is check your student loans. You may not want to actually pay those off and you may not want to be worried about them. I don’t know what the interest rates are, but go back and listen to the show, if you haven’t already, on negative interest rates and getting paid to borrow because it may actually be the best plan for you to keep those loans in force as they are because you may be paying an interest rate lower than the rate of inflation, so that will benefit you.
The other thing I would say is remember that you can get into properties, of course subject to qualifying, with as little as about $15,000.00 each. You also might consider, since you’re just starting out, partnering with someone, where you each put up $7,500.00 and buy a property together. Now, you may have heard me talk about my grandmother’s famous quote, the hardest ship to sail is a partnership. And I do agree with that. However, I think that a real estate partnership, so long as neither partner actually lives in the property, could be a very good way to go. I have had many real estate partners and I’ve never had any big disputes or any problems with my real estate partners because it’s a pretty simple investment. As long as it’s arms length, nobody lives in the property, all you’re doing is really sharing expenses and tax benefits.
Anyway, I hope that helps and I think you’re talking with one of our investment counselors here, so we’ll help you with details there.
This one comes from Matthew. Matthew says, “I’m a little confused about cash-out refinancing. I buy $100,000.00 property and finance $90,000.00 over 12 years. The value goes to $200,000.00 and I have a mortgage balance of around $75,000.00. Please walk me through the process of how much money I’m able to cash out and how much the new mortgage balance would be.”
Well, simply put, it would be 80 percent most likely, or of course, predicting the future 12 years from now, we’re not exactly sure what types of loans will be available and so forth, but I think historically, with history as our guide, we can assume that we will get 80 percent cash-out refi. Right now, you couldn’t do this because, of course, the banks are kind of overcorrecting. But over the course of history, that shouldn’t be too darn difficult.
Assuming that 12 years from now, in 2020, you can get an 80 percent cash-out refi, you would be refinancing for $160,000.00, and then you would pay off whatever mortgage balance you have. In this case, it sounds like you amortized the loan and believe that your mortgage balance will be around $75,000.00. So that would be the difference between $160,000.00 and $75,000.00 would be your tax-free proceeds. Based on current tax laws today, there’s no tax on borrowed money. So that’s a very good deal.
And then you go on to say, “From what I’ve read, it seems like I would have to increase the mortgage to about $125,000.00, for example, if I would want to cash out $50,000.00. That increases the monthly payment substantially, which I don’t like. That’s not how you described it in the podcast, so this is where some confusion comes from.”
I think what you’re getting to here is the concept of when you refi, you will be in a position of where, of course, your payments increase and as your payments increase, you can expect your rents to increase in the future. Remember people only have three options. They can either rent, buy, or be homeless, and with these options, remember if interest rates are higher or housing is more expensive 12 years from now, for example, then your rents will be higher, too. These should track together. Okay? So hope that helps and thank you for the question, Matthew.
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Listen to our podcast, go to the website, and request our free CD at www.jasonhartman.com. And if they invest with us per the terms listed on the website, you will get a referral fee. We have lots of agents, brokers, and mortgage people that receive surprise referral fees that they weren’t even expecting. They get a check in the mail and they are just happily, happily surprised. It’s a nice extra supplement to your income. So be sure to take advantage of our broker cooperation. Agents are welcome. We cooperate with outside people and we’d love to help you with your investor clients.
Hey, I just wanted to announce a couple of quick things for you. If you are able to come to one of our live events, we would love to see you and meet you in person. We’ve had people fly in from all over the U.S. for them. So hopefully you can join us for some of those events.
I wanted to mention to you that we have a new offering, a free CD, a free audio CD, that you will really, really like. We’ve had so many people that have given us really good comments about them, and you can go to our website at www.jasonhartman.com and just fill out a little quick web form and you can either download it or you can have the physical CD mailed to you in the postal mail. But get the free CD, especially if you are a new listener. You need this. And if you are a regular listener and you’ve listened to all the other old shows, you don’t need the CD so much, but it will be a nice review for you either way. But if you’re a new listener, you definitely want to go to www.jasonhartman.com and request the free CD.
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And this particular one that we just loaded in the video podcast is about Naked Short Sales and what goes on with this short sale and manipulation of the stock market. It’s a very interesting report from Bloomberg News and I think you’ll really learn a lot from that. So be sure to tune in and watch that.
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Anyway, we’ll talk to you next week. Thanks for listening.
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Duration: 46 minutes