Pearl: Be aware of bubbles, scandals and scams

Everyone knows there have been financial and investment scandals, scams and bubbles as long as there has been the concept of money, and likely even before then. What we rarely take into proper account is that somewhere in the world, right now it is very likely a financial or investment scandal, scam or bubble is in progress. While many of these seem to have similarities, they nearly always present as being somehow new, different and unexpected. Historical attempts to rein in such scandals, scams and bubbles have been consistently disappointing, for regulation and enforcement are typically reactive to existing problems, rather than preemptive by design.

If you had any doubts about the foregoing, here is a brief listing of the scandals, scams and bubbles which easily came to mind in writing this article. For historical context, some of the more notable recessions and panics appear in the chronology below, also. The dates are approximate, and surely many good examples have been overlooked. If you notice below more scams and scandals recently than there were in past times, it is more a function of better short-term memory than long-term memory. At least that is the hope, for no one should hope for there to be more scams and scandals as we evolve.

The bottom line: If you are complacent in your investments ---irrespective of what they may be--- this is an invitation to put such complacency into historical perspective and see how things worked out.

If you are depending on industry or government regulations or regulators to keep your investments safe, well, good luck to you. There is ample proof that to do so flies in the face of a well populated list of losses.

Industry regulation is unreliable for the most basic of reasons. Honest companies will do things right without having to be told to do so, as they will probably have invested in internal systems which provide assurance they are complying with the tenets of basic business decency. Honest companies regulate themselves without external prodding, even from their own industry. Dishonest companies and dishonest people within otherwise honest companies are not likely to stop the presses to deal with anything but catastrophic crises. There may well be knowledge of internal problems and even resolve to improve things over time, but it is rare for a company to stop the presses in advance of the arrival of unavoidable catastrophe. In any case, it is unrealistic to expect industry regulation to be either effective or timely.

Government regulations are typically written to address present or previous cases of abuse. By definition these regulations are going to be one step behind the latest scam, scandal or bubble. They are fixing yesterday's problem and do not typically address the scam du jour. Also, regulations are written by bureaucrats and legislators rarely expert in the day-to-day practice of the businesses they are attempting to regulate. The result is most often outdated and ineffectual regulation.

Another factor is that government regulators, particularly higher-up regulators, are often attorneys. It is fair to assume that attorneys willing to work for public agencies earn less than private-sector attorneys. It is also fair to assume attorneys willing to work in the public sector fall into one of two categories. One category is the attorney who is altruistic and genuinely committed to doing good for the community. This type of attorney likely is not wired with a mind fluid in the art and science of scamming. The other category of attorney is simply not adept enough to survive in the presence of top-flight, private-sector competition. He or she will work for a regulatory agency because it is a relatively safe position to take. He or she likely is not going to be up to the task of keeping up with the most cunning and creative minds in the industry being regulated. Greed is, after all, a powerful and seductive motivator when it comes to dishonesty. In any case, it is unrealistic for you to count on this being a fair and even match of regulator to scam artist.

What does all this mean? Make sure you are constantly vigilant in understanding everything possible about your investments and those involved with them. Know what you are getting for your money ---exactly what you are getting for your money. There is no excuse for assuming things to be done correctly or honestly, and there is no one but yourself to blame for being victimized.

A good adage to keep in mind at all times: You never go broke on the deal you do not complete.

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There are two truisms about financial and investment conditions, and both of them play out more or less constantly in financial and investment markets, including and perhaps especially real estate markets.

The first truism is the human characteristic of believing that however conditions are at this moment, we tend to project them out into the future. If conditions are abundant and profitable presently, we tend to expect them to remain abundant and profitable into the future. If conditions are impaired and grim presently, we tend to expect them to remain impaired and grim into the future.

The second truism is that markets go up and they go down. There is a definite cyclical aspect to virtually every market, with the only consistent variable being the depth and duration of the cycles. Like the weather in Oregon, if you don't like how it is now, just wait a while and it will be different.

The curious point in all of this is that these two truisms interact counter-intuitively and generally so as to disadvantage the average investor. The average real estate investor, whose investments are typically affected by leverage, which exacerbates the effect of the cycles, is particularly affected. On the one hand we expect things to remain the same, and on the other hand we have amazingly convincing proof things never stay the same for long. It is not rocket science to project investment failure without the benefit of knowing what is likely to occur next in investment cycles.

All real estate brokers or investors should know where their investments fit in the overall investment cycle. This is true for many reasons, not the least of which is that the value, appeal and viability of their investments will tend to fluctuate in accordance with the dictates of the overall investment cycle.

The cycle consists of four basic phases. Each phase has its own distinctions, some tending to be better than others with respect to real estate.

Richard Band, author of Contrary Investing and former editor of Personal Finance, a subscription newsletter for investors, expounds the following economic theory. It has been many private real estate investors' experience that Band's business cycle theories have helped them time their investing, anticipating with some accuracy the trends which will soon affect the value of their property, and the general direction of interest rates in the coming cycles. Band says:

Phase One. The cycle begins at the bottom of a recession, when the government feels it must do something to “get the economy moving again.” The Federal Reserve lowers interest rates by aggressively purchasing Treasury securities from commercial banks (bidding up prices). When the Fed buys securities, it credits the banks' reserve accounts at the Fed---creating “money” out of thin air.

Bankers aren't fools. Rather than leaving this new money on deposit with the Fed at zero interest, the commercial banks lend out as much as they think they prudently can. The money supply expands, and the economy picks up as bank customers spend their loan money. Prices of raw materials stop falling and head higher.

Phase Two. Eventually, the economy speeds up to a point where businesses begin to make unwise investments. Interest rates still seem low enough, so businessmen decide to build factories and buy equipment “to keep up with the demand.” Capital spending by business bids up loan demand and interest rates.

Prices also start to rise more rapidly. The price increases spread from machinery and equipment down the production chain---until they hit the consumer.

Phase Three. Now inflation is rearing its ugly head. The government moves to combat rising consumer prices by raising interest rates. The Fed gets stingier and stingier about supplying funds to the banking system. Consumers reach their personal borrowing limits and slow their spending. A recession begins, exposing all the mistaken investments by businessmen who thought the boom would go farther than it did.

Phase Four. As the recession progresses, credit demand surges as businesses run low on cash. Consumers pay down their debts. Business lays off workers and slashes inventories to bring production into line with demand. Raw materials prices fall sharply and, after a lag, consumer prices slow their relentless climb. Finally, when the pain of recession grows too severe for the government to tolerate, the Fed eases credit and the cycle begins all over again.

Band goes on to point out that certain types of investments tend to perform better or worse in each respective phase of the cycle.

Real estate, Band says, tends to do best in Phases Two and Three, fair in Phase One, and poorly in Phase Four. The reasons are obvious.

Income-producing investments, such as secure mortgage investments, tend to perform best in Phases One and Four, and fair in Phase Two, and poorly in Phase Three.

If you're interested in subscription information for Personal Finance, contact them at KCI Communications, Inc., 1101 King Street, Suite 400, Alexandria, VA 22314-2980.

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Pearl: Understand what the heck happened in the real estate and financing markets 1998-2008

There is perhaps no better example of a disintermediated (messed-with) real estate market than was in evidence from 1998 to 2008. There was a national/political/social effort to make housing more available, particularly to first-time or previously ineligible buyers. There was unprecedented freedom given, whether intended or unintended, to financial institutions to create liberal/easy-to-obtain home financing. There was national effort to create incentives to invest in America in the aftermath of the 9/11 attacks. There was a demonstrable absence of effective regulation of financial products and systems. There was a national ---even global--- unbridled infection of greed, over-stimulated by easy money. Most important, there was a fundamental and pervasive lack of financial accountability on many levels.

This is a very complicated story, and it requires some of your time to understand all the moving parts. CNBC created a comprehensive and seemingly balanced report on the subject, called "House of Cards."  Click here for a link and watch it carefully, for not withstanding many experts saying this could never happen again, build into your planning a virtual certainty it WILL happen again . . . just not in exactly the same form. This is not a dire or political statement, the proof being obvious and evident even in the recent past. Just look at the section above about some historical scandals, scams and bubbles.

The point is this: If you do not learn history, you are doomed to repeat it. The degree to which you do not have to repeat painful parts of history will determine how successful your investing is likely to be.

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Pearl: Deal in benefits and resources, not money

It is seemingly natural to jump at bargains or to be repulsed by over-priced offerings. Why is that so? I believe we tend to most obviously respond to prices rather than to benefits and resources. We tend to judge something to be good or bad, acceptable or unacceptable, on the basis of its dollar-denominated value. However, look beyond the dollars and you will find benefits and resources associated with the product or service. That distinction opens huge opportunity for you as a real estate broker, for it allows you the freedom to identify what fundamentally best serves your client, and that information will help you move toward a solution not necessarily tethered by dollars.

You may have a client who owns a difficult-to-sell property in which his cost basis exceeds its present market value. He's buried in the property, so to speak. One option is simply to continue to own the property and hope prices rise. Another option is for you to spend your time and money trying to find someone willing to pay too much. These options are, of course, undesirable. This situation is an invitation for you to fully understand your client's needs, desires and resources. When you do fully understand your client's resources, there may well be an opportunity to apply those resources in ways other than simply waiting for an offer on an over-priced property. Perhaps your client has the ability to add cash to his property to buy another, more acceptable property. Perhaps your client has services which could be added to the mix. Perhaps your client can take on additional debt. Perhaps your client can re-negotiate existing debt. Perhaps your client can intensify the use of the property. Perhaps your client can take on a partner and keep what he has or join hands in a new and larger property. You see the kind of thinking I am referring to here, and it does not directly deal with money. Money is the unit of measure, to be sure, but dollars are not necessarily the solution. The solution has more to do with the benefits of owning ---or not owning--- property. Ask yourself: What benefit does this property really represent in my client's life, and how do and can his/her resources come into play? The answer to that one question cultivates solutions. Sometimes those solutions do not involve selling property, but they always involve serving your client.

This "pearl" leads directly into the following "pearl," for understanding the benefit your client seeks from real estate must in some meaningful way be applied to the situation.

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Pearl: Real Estate Counseling Memory Jogger

The following list is by no means complete or reliable. It is intended to stimulate your thinking about solutions to everyday real estate-related problems. Many of these solutions apply outside a strict real estate environment, too. After you have determined the benefits and resources associated with your client, run through the following list of real estate counseling memory joggers and see what emerges for you. Be sure to go through both columns. No doubt there are many more options to put into play, but this is a good place to begin. You will also notice that some of the solutions are applicable both to properties and clients. Give it a try!

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Pearl: Accountability

There is no way to overstate the value of accountability. History has repeatedly demonstrated that accountability cannot be successfully legislated or regulated, however noble attempts to do so may have been. If you are accountable in your actions, the products and services you provide will ultimately stand up. If you are not accountable in your actions, your products and services will not. It is as simple as that. Be vigilant and persistent in fully and comprehensively understanding your craft, and you will have at least the opportunity to be accountable and successful. For those who are looking for a quick profit or to ride an investment wave, best advice is to try doing so in a profession other than real estate brokerage. The profession expects and demands more, and ultimately anything less than full accountability will result in disaster. So do your homework, constantly improve your skills, do not fear asking questions or showing ignorance, and always ask yourself: Is this the best I can do? If the answer is anything but a resounding "Yes," then it is time to rethink what you are doing.

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Pearl: Private enterprise or government intervention: Either way we are doomed

Here is a bedtime story for you:

"Once upon a time, there were two companies vying for our affections and business at all times.

Company A represented private enterprise. It was a good company in that it was run efficiently. Company A also occasionally did bad ---even evil--- things in acting improperly, damaging its clientele and/or the public in the process.

Company B represented bureaucratic government. It was a bad company in that it was run inefficiently. Company B also occasionally did very good things, looking out for the disadvantaged and aggrieved.

And they all lived happily ever after."

Well, no, they didn't actually live happily ever after. It is instructive to keep both companies in mind, however, for surely you are under the influence of at least one of them right now. Whether under the influence and control of Company A or Company B, we are doomed to at least the probability of some sort of catastrophe.

What does this tell you? Be aware that you and you alone are responsible to be vigilant in managing your investments. Depending on private enterprise to always do the right thing is about as lame as depending on bureaucratic government to get anything done in a helpful, meaningful or timely way. You truly are on your own, so best conduct yourself accordingly.

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Pearl: Nothing is simple

In July, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act is nearly one-half the size of the combined Old and New Testaments of the Bible, just to put into perspective the immensity of the challenge in trying to understand it. Contained in the Wall Street Reform and Consumer Protection Act is Title XIV, the Mortgage Reform and Anti-Predatory Lending Act, which is over 200 pages of regulations affecting residential real estate loans and ancillary residential real estate services.

Being directly affected by the Lending Act because of my being a licensed mortgage originator and co-owner of a mortgage company, it was mandatory for me to understand all aspects of the new law. The very first thing I needed to know about the new law was its effective date, which seemed to be a fairly straightforward task . . . just look up the heading entitled "EFFECTIVE DATE" and read it. I expected what followed the heading "EFFECTIVE DATE" would be one word (a month of the year), two numbers (a day of the month and a year) and one comma (separating the date and the year). Unfortunately, that was not the case. Here, in case you are interested, is the stated effective date of the Mortgage Reform and Anti-Predatory Lending Act of 2010:

"Effective Date- The regulations required to be prescribed under this title or the amendments made by this title shall (A) be prescribed in final form before the end of the 18-month period beginning on the designated transfer date; and (B) take effect not later than 12 months after the date of issuance of the regulations in final form - except as provided in Paragraph (3), a section, or provision thereof, of this title shall take effect on the date on which the final regulations implementing such section, or provision, take effect - a section of this title for which regulations have not been issued on the date that is 18 months after the designated transfer date shall take effect on such date."

Your guess is at least as good as mine in trying to figure out what the foregoing 122 words are attempting to say. It took our Founding Fathers only 52 words to express the essence of our form of government in writing the Preamble to the United States Constitution. This observation only amounts to silly trivia, perhaps, but it also serves to illustrate the frustration honest private enterprise encounters in dealing with governmental regulations written by lawyers who pretty obviously did not reasonably anticipate actually having to implement the mandates set out by the law they were writing. I am unmoved by any notion that the legislators who voted for this law actually read it, much less understood it, prior to obligating 300 million Americans to deal with its consequences.

In the case of our mortgage company, I contacted six attorneys (two in Eugene, one in Portland, one in Georgia and two in Washington, D.C.) with specialized knowledge of mortgage lending and/or real estate, finding only one who had any specific answers and willingness to help us through the process of understanding the new law and how to implement its mandates. We came to the conclusion that our company could no longer make real estate loans to borrowers who resided in the homes securing our loans. Consequently, our company now only makes loans for the business purposes of our borrowers. Essentially, we have been regulated out of residential lending, and the ages-old and sadly accurate adage about banks only lending money to people who don't need it has now become law. Our company is collateral damage in all of this, but the main damage is done to those homeowners who can no longer borrow from lenders like us. It is fair to say that in its zeal to protect borrowers, Congress has effectively diminished credit available to the very borrowers it sought to protect from losing their homes. Nothing is simple.

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Pearl: GSEs and sense of Congress about them

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