Now What – Is The US Economy Doomed?

Well the $700 billion bailout plan was defeated. Wall Street didn’t like it and the market dropped a jaw-dropping 777 points. Was the bailout that vital to the health of the US economy?

Jim Rogers didn’t think so. Here’s a news report from the 25th of September ago:

Treasury Secretary Henry Paulson’s proposed bailout plan is “astonishing, devastating, and very harmful for America,” internationally-known investor Jim Rogers told The New York Sun.

Rogers says the current monetary climate in Washington reminds him of when then-Fed Chair Arthur Burns refused to let anyone fail.

Rogers insists Washington is making the same mistake again.

“We’re in for the worst recession since World War II, as well as higher long-term interest rates, higher inflation, higher taxes, a weaker dollar, and substantially lower stock prices,” Rogers says.

Even worse, Rogers believes it’s “embarrassing to see how little the presidential candidates know or grasp what’s going on, just like the current administration.”

But what about the almost 779-point boost in the Dow Jones Industrial Average that lasted for two days? “It’s only a matter of time before reality sets in and the market heads down again,” Rogers says.

“I wouldn’t buy now because it’s insane,” says Rogers, who believes investors “were foolishly sucked in by hysteria and a buying panic.”

Rogers, who bought dollars a couple of months ago, now thinks the greenback rally may have come to an end. He’s now buying more Chinese shares.

I’ve been insanely busy with college so I wasn’t even sure how the dynamic duo of Paulson & Bernanke came up with $700 billion. What were the calculations that led to that number? I couldn’t really find anything about it – most reports were rather vague. And if the risk-analysis departments of banks couldn’t figure out the worth of the toxic assets they owned, how did batman and robin figure them out?

A lot of people believe that printing money and turning on the cheap, easy credit spigot will keep the US from experiencing a 30s-style Depression. I really wonder if that is a likely scenario. It doesn’t seem to be working for Japan (although to be fair, they have cultural differences such as their not letting businesses fail, which is probably distorting their business cycle). Also, if its true that excess liquidity and cheap credit caused much of these problems in the first place, how can the solution be the same as the cause?

Here’s what Ron Paul said on the issue over the weekend:

This is Wall Street in big trouble and sucking in Main Street…and dumping all the bills on Main Street. You can’t solve the problem of inflation, which is the creation of money and credit out of thin air, by creating more money and credit out of thin air…

What they’re doing now, they’re propping up a failed system so the agony lasts longer. They’re doing exactly what we did in the Depression.

Saddling the American Taxpayer with an additional Trillion Dollars of Debt doesn’t seem like a good way of boosting the economy. The way things are going, the national debt is set to increase by a Trillion Dollars per year until 2017, after which it should increase by two Trillion a year!

If you still believe that bailing out foolish and greedy bankers is the right thing to do, check out my comments in  a previous post.  It’s a pretty interesting discussion.

So now that the bailout plan failed, is the US economy doomed? I don’t think so. Here’s an interesting article from the Heritage Foundation which suggests that the government is on a partially correct path regarding the financial markets.

And if you want something that’s even more optimistic about the US economy, I suggest reading Reality Check: The Unreported Good News About America by Dennis Keegan. He’s a hedge fund manager and he actually came and gave a speech to my class last week. While I don’t fully share his gung-ho optimism, he’s worth many millions and I’m not, so that should give you a good idea of whom to listen too! But he did say that chaos brings opportunities and people still make money in bad times, which I fully agree with.

And finally, Citi announced that it would be buying Wachovia. Isn’t that kind of strange considering that Wachovia was thinking of buying Morgan Stanley a week or two ago!

Lessons From WCI’s Bankrupcy

I just found out from The Declining Market that Florida luxury Condo builder, WCI Communities filed Chapter 11.

Over a year ago I shorted the stock at $17. Then that jackass Carl Icahn went and put in a bid to buy the company at $22.50 a share, in order to “unlock the hidden value” of WCI’s assets. That’s when I closed my position at a loss. Apparently, there is no hidden value in the assets and WCI’s stock is now completely worthless!

Sadly, I didn’t have the fortitude or the conviction to hold my position and I cried uncle at the first sign of trouble. That same scenario was repeated when I shorted Countrywide last April. The stock went up 10% and I closed my short position. Then it went straight down!

Right now, I’m short Capital One Financial (COF). But instead of entering my position fully, I decided to venture in slowly and buy more if it goes up. I’ve entered a 50% position so far and I’m hoping it goes higher so I can short at a higher price.

I’m convinced that if people can’t pay their mortgages, then they’re sure not going to be paying the credit cards. However, there’s a chance I might be early, so I should be willing to set a wider stop-loss and be willing to hold my position for 6 months.

On my short positions, I usually set a 10% stop loss, because there is an inherent bullishness to stock prices. This bullishness does not come from my expectation of a continued rise the profitability of stocks, but rather due to inflation. Inflation causes price increases, which leads to slightly higher profits, which leads to slightly higher stocks prices!

One lesson we should all take from WCI’s bankruptcy is that even rich people make mistakes. Carl Icahn was wrong about WCI – there simply wasn’t an value to be had from its assets. Billionaire Jerry Lewis also made a mistake in buying a large chunk of Bear Stearns early this year at nearly $80/share. I was soon sold for only a couple of bucks a share to J P Morgan.

Don’t blindly buy a stock just because some famous investor is buying it!

Fannie Mae & Freddie Mac Collapse

About 5 weeks ago I suggested that both Fannie Mae and Freddie Mac were going bankrupt and their shares were going to hit single digits in 12 months. Well it looks like the market believed that too and their shares were punished. Instead of having to wait a year, the stocks dropped like bricks within the month!

According to Nouriel Roubini, renowned Professor of Economics & International Business at NYU’s Stern Business school, this is the worst financial crisis since the Great Depression and the worst U.S. Recession in the last few decades.

The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient to cover the hole from the biggest banking crisis since the Great Depression

Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

Wow, those are strong words! Practically every stock in the financial sector has jumped today, probably due of extreme oversold conditions and not because of any underlying change in the fundamental scenario.

Sadly, my beloved Oil & Gas stocks are down. It may be a sector rotation out of energy stocks and into the financials. But so long as my Canadian Income Trusts continue to provide me with dividends and passive income, I’ll continue to hold them.

But I might enter new short positions in the financials if the stocks rally significantly above these levels. Fed Chairman, Ben Bernanke announced today that FNM & FRE were “in no danger of failing”. I don’t know if I believe him – sounds just like a few months ago when the government telling us there’s no recession. Meanwhile everything (except housing) is getting more expensive and unemployment is rising. And as Jim Rogers says that “the only people Bernanke cares about are his buddies on Wall Street”!

There's Still No Recession!

Time To Buy Online Retailers?

Online retailers have been fairing better than their brick-and-mortar counterparts. One school of thought is that affluent buyers make up a bigger portion of online buyers and they fare better during recessions, which means online retailers are likely to do better.

Another line of reasoning suggests that there is a perception among buyers that there are better deals online than in stores. So its the bargain hunting, not the higher incomes that is driving people to shop online. I think there’s some truth to this.

Last week, I needed to replace the battery on my motorola KRZR cellphone. The battery was no longer holding charge and had developed a slight bulge in the middle as well. I went to the Verizon store and they told me I was out of luck, and would have to buy a new battery for $40 plus tax.

Instead, I bought a cellphone battery online for only $6.41 delivered! I had to wait 2 days, but I got a whopping 85% discount!!!

For some reasons, retailers think that replacement batteries should cost 40-50% of the cost of a new electronic item. If you’re willing to spend a few minutes doing the research and wait 2-3 days, then you can usually save at least 60% of the cost. Now whether your time is worth that 60% in savings is another question.

Incidentally, that battery link goes to a niche store I built initially to buy cheap iPod batteries, which cost a ridiculous $79 plus tax at the local Apple store. I bought my battery replacement kit for $20 online instead!

But getting back to my main point, I think that with inflation eroding the purchasing power of the average American, more people will turn to online shopping. And with gas prices being so high, people are more likely to limit they’re driving to the mall.

So there are two lessons to learn here.

1. If you own stocks of retail stores, ditch them and buy online retailers instead.

2. Look online for bargains.

Maybe it’s time to look at Amazon’s stock (AMZN)?

How Passive Is Your Passive Income?

I’ve been lumping in my online income with my passive income, but it isn’t really passive. It may not be very strenuous and it gives me geographic flexibility and I don’t have to show up for work every day, but there is some effort involved. Unfortunately I’m not as clever as Courtney Tuttle, who says he has a site that makes $3,500/month with no ongoing maintance. (If you’d like to buy an existing site that generates income, check out the online businesses for sale on my business & investment store). I’ve just had some limited success with Domain Parking, buts that the extent of my truly passive online income.

Simply put, my online income isn’t really passive. It’s a lot more passive than the website and seo consulting work I do by a huge margin, but its not as passive as dividneds or royalty checks.

So what are the best ways to earn really Passive Income?

1. High Dividend Stocks
There are a lot of stocks that paying quarterly or yearly dividends. Over time, the power of compounding (with a little help from inflation) can substantially increase the value of your dividends. My mother bought the Indian subsidiary of Unilever (Ticker: UL) called Hindustan Lever about 20 years ago. She’s being reinvesting most of her dividends and today her annual dividends are larger than the value of the original stock purchase. American Capital Strategies (ticker: ACAS) has been growing its dividends approximately 10% every year. According to The Dividend Investor,

If we invested $100,000 in ACAS on December 31, 1997 we would have bought 6906 shares. Your first quarterly check would have been $1,726.50 in March 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $17,095 by December 2007. For a period of 10 years, the quarterly dividend has increased by 300 %. If you reinvested it though, your quarterly dividend income would have increased by 890%.

Yes, reinvesting the dividends in companies that have historically kept increasing their dividends is key. Even though you might get only 2.5% return today, eventually with the increase in stock price and rise in dividends, your annual return should be greater than 12%. This concept is very well explained in Prof. Jeremy Siegel’s excellent book, The Future for Investors, which I highly recommend.

2. Oil & Gas Royalties

While there is a lot of fraud and speculation in direct oil drilling programs, they can be very, very lucrative for investors. Charlie Munger invested about a $1,000 in such an oil drilling program in the 60s and he’s estimated that its paid out over $500,000 in royalty payments since then. Apparently it still pays out $2,000 a month. Of course, most people NEVER see these sort of returns, but for the average person, investing in Canadian Oil & Gas Royalty Funds (or Income Trusts) is the next best thing. I’ve invested quite a bit of money into both the direct oil wells and the Canadian Income Trusts (or Canroys) and the overall result has been pretty positive in both (which is in excess of 12%).

3. Royalties on Books and Patents

Royalties on Books and Intellectual Property Rights can be even more lucrative. However writing a best-selling book or creating a something thats worth patenting can extremely time consuming and expensive. For most authors and inventors, its a labor of love – something that they would pursue even if there was no monetary reward to it. But many ebook writers who sell get-rich-quick books about “making money online” are getting very wealthy. Most of these books are garbage and the only people getting rich are their authors and resellers. Not a very ethical way to make money.

4. Rental Income on Properties Bought at the Bottom of a Real Estate Cycle.

If you bought rental buy and hold property in California, Nevada, Arizona or Florida during 2005 and 2007, my heart goes out to you. A lot of smart people got suckered into buying at the top of the market and are paying for it. However, if you buy correctly, preferably at the bottom of a real estate cycle, real estate can provide excellent passive income and fantastic tax advantages as well. According to Charlie Munger at the 2008 Wesco Financial Annual Shareholder meeting, “most real estate investors don’t pay any income tax, except once every 20 years or so“. Bought correctly (that is based on value, not speculation), rental properties can provide a steady stream of cashflow that is somewhat inflation-indexed. I say somewhat, because in the short-term anything can happen, but over a long period of time, real estate is going to match the rate of inflation.

5. Investing In Timber

Similar to Canroys, there are companies that grow trees specifically for timber and pay pretty decent dividends. There are also direct tree-planting programs where you can invest a minimum of $5,000 and own a portion of a timber operation. The company does all the work for you and supposedly cuts you a check once a year after a specific time interval. The endowment funds of Harvard and Yale have apparently been investing in timber for several years now with great returns.

6. Domain Parking (or Embarking)

There are many people who buy and hold hundreds of domains (I know a guy who owns 750). They either park them with Sedo or another domain-parking service. These services stick relevant (and sometimes not-so-relevant) ads on your site. The idea is that if someone comes to the site through browser type-in traffic and clicks on an ad, you get paid a portion of this ad revenue. I had hosted several sites with Sedo and made a whopping 2 cents per month. I’ve recently been trying out a new service called Domain Embarking that is working pretty well for me.

1st Carnvial of Dividends & Passive Income

Welcome to the very first edition of carnival of dividends and passive income.

I’m going to kick it it off with my own submission on How I Made $2,667 in Passive Income In March. Of course, if you’ve already read it, you can read about the Tax Benefits of Passive Income or about Earning Passive Income from Domains.

Dobromir presents Emerson Electric (EMR) Dividend Analysis posted at Create Rising Passive Income From Dividend Paying Stocks.

Geoff presents How did I make 5-figure Passive Income in 2007? posted at Wealth Monkeys.

Writers Coin presents Why I Quit One Source of Passive Income posted at The Writer’s Coin, saying, “Moral issues far outweighed the desire to make money by deleting emails”

Will presents Why I Still Love Real Estate Investing: Being A Landlord posted at Your Finish Rich Plan, saying, “I’m a sucker for passive income. My idea of financial freedom is that of rental and dividend income totaling roughly twice my expenses, leaving me free to pursue other interests (which may very well be other money-making ventures). That’s why despite everything that happened in the real estate market the past couple of years (or maybe because of it), I want to be a real estate investor, and more specifically, a landlord.”

The Dividend Guy presents Considering REITs In a Dividend Portfolio posted at The Dividend Guy Blog.

Tyler McKinna presents Dividend Growth Fund Stratgies Revealed posted at Dividend Money, saying, “An article outlining dividend growth investing strategies and how major mutual fund managers approach stock selection.”

KCLau presents How to Identify and Invest in the Hot Stocks of Tomorrow posted at KCLau’s Money Tips, saying, “A review of the book “Finding the Next Starbucks by Michael Moe””

Mark @ TheLocoMono presents Tracking Your Prosper Portfolio with Money Plus posted at Just Personal Finance, saying, “Using Money Plus to track your Prosper income can help you simplify your knowledge of how much money you are making and project your cash flow/growth.”

FIRE Getters presents Etrade’s Quickplan – Personalized & Easy Retirement Planning! posted at FIRE Finance.

Lulu presents Got My Repayments from Lending Club posted at How I Save

We end with an article about music and money, which not quite relevant, is still pretty good nonetheless. Jeremy Zongker presents All I Really Needed to Know About Managing Money I Learned From Music posted at Destroy Debt.

That concludes this edition. Submit your blog article to the next edition of Carnival of Dividends and Passive Income using the carnival submission form. The next edition of this carnival will be on the 7th of May, 2008.

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Investing In AeroGrow’s Gourmet Herb Gardens

The had a very interesting article on a company called AeroGrow that makes Kitchen Crop Appliances, based on a technology invented by NASA called aeroponics. In aeroponics, plants grow at an accelerated speed because nutrients are sprinkled directly onto their roots, which dangle in the air instead of being planted in soil.

According to the Economist, these systems have been widely used by commercial pot growers but this is the first time it is being adapted from home use to grow tomatoes, lettuce and herbs.

AeroGrow’s Aeroponic AeroGarden Herb Garden KitI checked out AeroGrow’s Herb Garden on Amazon. For around $150 you get a really neat little garden. The picture doesn’t actually do it justice. Check out the AeroGarden Video. The kit allows you to grow herbs superfast all year round. Quite a phenomenal product!

The Economist article mentions that the company has spent 4 years developing this product. It’s almost idiot-proof and they claim a 99.9% success rate for the herbs, which is pretty spectacular considering I’ve killed mint, which is a pretty hardy weed and tough to get rid of. There are also sites that have “sprung up” detailing how to modify to for a different type of weed too. While the company doesn’t endorse that usage, they do have a pretty nice range of salads, herbs and even roses.

The first thing that came to mind was whether I could make any money of this idea. The stock price of AeroGrow [AERO] has plummeted from around $9 in October 2007 to about $3.30 today. That’s a pretty steep 65% drop in less than 6 months. However at this price the company is trading for just over 1 times sales, which seems pretty low for a small cap growth company, and a forward PE of 15. It also looks like the insiders are nibbling at the shares too. The CEO, Bissonette, thinks aeroponics will become a $1.5 Billion industry. So far in the last quarter of 2007, AeroGrow had $14 million in sales ( a 300% increase from the year before) and is close to profitability. Definitely seems worth looking into.

Maybe it’s time to invest in this stock? Or instead I should put my money where my mouth is and buy an actual AeroGarden Kit! What would you guys choose?

January’s Dividend Income & How The Subprime Mess Has Affected Me.

I’ve been traveling for the past month so this post is a little late. I had already posted my online income which was $778. I finally got a chance to add up my monthly dividend income from my stocks, Canroys, CDs and savings accounts.

The grand total for January was $764.10 from a dozen different stocks. Its lower than it was for December because some of my stocks pay out quarterly dividends. But overall, the amount of dividends is trending up due to the Dividend Reinvestment Program (DRIP).

A DRIP allows you to re-invest your dividends back into the stock. You don’t have to pay a brokerage fee for this, so if you don’t need the income its a good way to put your make back to work. Not only that, but many companies will actually give a discounted share price on stock purchases made through DRIPs.

If the company doesn’t have a DRIP, your brokerage company should be able to set up automatic dividend re-investment for you. Unless you’re getting a few thousand dollars a month in dividends, this is a cheap way to reinvest your money. According to Prof. Jeremy Seigel’s excellent book The Future for Investors, you should avoid trendy growth stocks in favor of stable companies with sustainable cashflows which is returned in the form of dividends. Using historic data, he also proves that the reinvestment of such dividends is the true source of superior stock returns.

Added in this $764.10 is the $31 in interest payments that I received from my Prosper loans. In addition to the $31, I also received another $158 in principle repayments.

I was also receiving about $300/month from investments in various commercial real estate projects that were diversified by being in different projects in various states. Unfortunately, I’ve been informed that the funding for commercial lending has taken a severe hit and the developers are unable to refinance to cash me out. This means, that my money is going to be tied up for a while. I’ll get more info when I get back, but I caution everyone against lending money for any sort of real estate projects. This also includes borrowers on Prosper who are lending for real estate investments or related projects. I was hoping to put this money to good use to buy more Canroys, some of which are yielding 15% right now. Thats not likely to happen soon. 🙁

I had stayed away from investing in trust deeds on residential properties thinking that they would have a higher likely of default. But in the past few months we’ve seen that subprime mess has caused the market to lose faith in the credit rating system. This has caused lending for everything to dry up, including municipal bonds, which has prompted Buffett to offer to buy these AAA rated bonds at a discount and thus “rescue” the borrowers. Unfortunately, its also negatively impacted commercial developers.

Hopefully I can get my principle back from the developers. If not, my loan will convert to an equity stake in the project and it’ll probably be a long time until I get cashed out. Let’s see how this pans out.

Good News For Canroys?

I’m a big fan of Canadian Royalty Trusts, also called Canadian Income Trusts or Canroys. But lately, they have been under a lot of selling pressure. Coupled with the sell-off in global equities is the overhanging tax change that the Canadian government implemented last year. According to the change, canroys will lose their tax-exempt status and from 2011 there will be the usual double taxation that affects most companies (except for US REITs).

Accordingly, the share prices of most canroys have dropped considerably from their peaks and their valuations have become quite attractive at these levels. But there’s some good news for canroys.

Growing discontent with the ruling Conservative party has created a situation where the Labor party might come into power. The Labor party has promising to either extend that conversion deadline to 2017 or to significantly decrease the trusts’ post-2011 tax rate. Either of these would represent huge positives for the trusts. This strange situation of the liberals becoming energy trust saviors has even encouraged many life-long conservatives from the Albertan energy patch to help bring down the current Conservative government.

If this becomes a reality, canroys should see renewed interest and a spike in the share prices. Lets see how it plays out. Till then, I’m happy to keep collecting my dividends!

Bank Of America Buys Countrywide To Save On Taxes

Bank of America (BAC) recently announced it would be buying Countrywide (CFC) for $4.1 Billion putting an end to rumors that CFC was considering bankrupcy.

Apart from gaining access to CFC’s technology, banking business and god-only knows what it has thats of any worth, Bank of America will also inherit it’s losses. According to tax guru Robert Willens, the tax break could total about $500 Billion dollars over the first five years and may even be worth considerably more from the sixth year, depending on how big Countrywide’s losses are when Bank of America formally acquires it.

This isn’t the first time this has happened. In 1988, Bank of America purchased the failed FirstRepublic Bank of Dallas in auction. Using a complex tax strategy allowed Bank of America to save $1 Billion in taxes.

Willens estimates that Bank of America will be able to deduct $270 million of Countrywide’s losses annually for the first five years it owns the firm, which would total $1.35 Billion! If Countrywide’s losses turn out to bigger, Bank of America gets to write off even more of its profits.

CFC’s CEO Mazillo will get a going-away present of $115 million, including company jet time and country club fees. Its not enough that he had been pumping the stock on CNBC for the past 18 months while simultaneously dumping $100 million worth of stock. He should be investigated by the SEC for painting a rosy picture of his company’s business when he must have known the stock was going to drop like a rock. If not illegal, it was definitely unethical.

On the other hand, Bank of America which currently owns 9.7% of US deposits will be breaking the law when it acquires CFC. Countrywide’s Bank has savings deposits which will push Bank of America over the federally regulated limit preventing individual banks from possessing more than 10% of all deposits. I guess they’ll just have to give the depositors some of their money back! It’ll be like a reverse bank-run.