A reality check on recent “good” news.

Human optimism has driven civilization to extremely challenging locations.

We humans are optimistic by nature. How else would civilization have spread to areas as extreme as the arctic north or the vast deserts of North Africa? Our optimism is in full force almost daily now as reporters and political figures claim recovery is here because fewer people are losing their jobs this month than last month. The billions in equity injections and commercial bridge loans by the government have so far only created a little friction in the fall. To be sure the situation has improved: inventories have been greatly reduced, housing price declines have more or less stabilized, and the all-important consumer seems to be more confident than before. And let’s not forget the eye-popping stock rally that’s come on the heels of all this “good news.” But before we break out the bubbly let’s be honest with ourselves.

In May the U.S. economy lost 345,000 jobs. That is well under the 504,000 jobs lost in April, but still not exactly something to celebrate. Imagine your personal investment manager came to you and said “Good news, I only lost 15% of your wealth this month, that’s less than the 25% of your money I lost last month. I’m doing much better.” I’ll guess the majority of us would not be overjoyed with that report. But somehow we’ve convinced ourselves less bad news is the same as good news. Human optimism at its best.

Unemployment continues to rise. Actual rates likely much higher than gov’t reports.

The fact is businesses are still shedding jobs; real estate prices are still falling; credit markets are still seriously locked up; GM, an icon of American industrialism, is in bankruptcy; and the federal government (as well as many state and local governments) are running major deficits. Some of the greatest optimists tend to be real estate professionals, most of whom have been calling the bottom of the market since before the market implosion of September 2008. As I previously outlined in Road to Recovery there is likely a lot more pain coming for the commercial real estate sector, albeit less so than the housing crash.

Commercial real estate will be somewhat protected since the industry has done a much better job this past decade of not over building. Nevertheless, with the economy in the doldrums and job growth not likely to return for a long time (perhaps a couple years) occupancy rates are going to remain under pressure and so will prices.

Our economy is tremendously resilient and we will recover from this mess, but let’s be realistic what that recovery looks like and how long it will take. For investors that do an honest assessment and take a patient approach the road to riches lay ahead. For those that don’t, the fate of sisyphus is a more likely outcome.

On Monday April 13th UC Berkeley’s Fischer Center for Real Estate and Urban Economics held it’s 14th annual conference in San Francisco. Keynote speaker and well known real estate guru Ken Rosen did not paint a rosy picture for a short term recovery.

“The world is structurally changed and it’s going to take a long time to get back to a system that is sustainable,” Rosen said. “The underlying assets are still going down at accelerating rates.”

Rosen predicts that both residential and commercial real estate values will continue to get pressured from three key dynamics:

• Unemployment will continue to climb, likely topping 10% in the near future (meaning millions of new job losses)
• The credit markets will remain constrained for some time, and interest rates will begin to rise.
• The newly conservative consumer is not going to return to the debt-addicted lifestyle and spending will continue to be curtailed.

With residential values continuing to plummet and some office values down 35%-40% conservative investing is key. Private mortgage lenders can protect their trust deed investors through conservative underwriting and low Loan-to-value lending. For equity investors with money this is a great time to buy as values are highly compressed.

Learning from the lessons of Lincoln.

President Obama feels a close kinship with Abraham Lincoln. To be sure there are many similarities. Both were born outside Illinois (Obama in Hawaii and Lincoln in Kentucky.) Both men became lawyers and served in the Illinois State Legislature.

US National Debt continues to skyrocket with new budget.

Each served only a single term in Congress before ascending to the Presidency. And both men were (are) powerful orators who catapulted onto the national political scene and became commander-in-chief with no previous military experience.

President Obama often looks our 16th president as a model and source of inspiration, and as inspirational models go he makes a good choice. I would encourage number 44 to look to Mr. Lincoln even further however, for inspiration in substance as well as form. President Lincoln also governed during very turbulant times in our history. And as he so eloquently put it:

This quote is as relevant today as it was 140 years ago. Most people agree that our current crisis was brought about in great part by horribly irresponsible abuse of debt – by our banks and other financial institutions, by our government, and by the American people (as we argued in Save the World.)

So what are we doing? We are discouraging thrift, taxing the wage payer and spending WAY more than we earn. We, the American people, shoulder a hefty chunk of responsibility for our current mess, but we also seem to know when the party is over and how to make the necessary choices. The household savings rate hit 5% in January according the Department of Commerce, the highest level in almost 14 years. Meanwhile our government is ramping up its deficit spending to the tune of $1,750,000,000,000. Our government “for the people” needs to take a cue “from the people” – they owe it to us.

When people are doing well they travel more, go out to nice dinners, buy new cars. When times are tough we eat in, enjoy “staycations,” and just do the regular maintenance to keep our cars running well a few more years. We seem to understand that discretionary spending is a luxury of strong economic times. Shouldn’t we expect the same of our government?

Savings and Long-Term Investment is the Path to Sustainable Recovery

There is no shortage of opinions on how we ended up in this global economic meltdown: greedy Wall Street executives, lack of government regulation, capitalism was doomed to consume itself. Who always seems to get off scot-free is the American consumer. Ok, maybe not scot-free since the average American is certainly suffering, but the free-spending, debt-addicted consumer shoulders a hefty portion of responsibility for our current troubles (As we stated in “It Wasn’t My Fault.”) Post Depression through about 1980 the savings rate averaged around 8%. All through this period America thrived and the standard of living rose considerably. New financial products were created allowing people to take advantage of the American Dream, and still we saved.

From 1980 through 2005 we kind of lost our rational compass. The saving rate dropped below 1% and even went negative at time. (Meaning as a nation we were spending more than we were making.) This fueled tremendous economic growth but even a 5th grader could see that it’s not sustainable. (And we’re all smarter than a 5th grader, right?) All through this period the pundits howled about the low American savings rate and how much more the rest of the world saved. We were becoming a nation of debtors.

Suddenly the party ended and in December 2008 the savings rate climbed back to 3.6%, and is forecast to go much higher throughout 2009. This is a good thing, right? Personal savings is a primary domestic source of financing for capital investments – those investments that drive long-term economic growth.

But wait! Apparently the government now thinks we’re not spending enough. “Please Mr. and Mrs. Consumer, don’t pay down your existing debt, spend more money to save short-term jobs.” (I think it’s the politicians jobs their most worried about.) I get it. Americans think in very short time horizons. We want next month to be better than this month, and 5 years from now is too far off to worry about. But think about it; if overspending got us in to this mess in the first place, who in their right mind thinks it will get us out? (I’ll bet not your 5th grader.)

There is no short-term cure for a long-term problem. American’s need to save, and we need to invest. What we don’t need to do is spend more. Be more thoughtful about daily expenses. Invest in your retirement! (It’s coming sooner than you think.) Borrow money wisely and for good purposes. Buy or improve your real estate, start or run your company, get your kids, or yourself, an education, but stop paying 28% interest to buy a pair of jeans when you already have 10 pair in the closet. And if your 3 year old car is running fine, drive it for a few more years.

Let’s save the economy and our country’s future by saving ourselves and saving our money. We saved, grew and prospered for 35 years after WWII. We can have balance again and, more importantly, sustainable economic growth and prosperity.

Author’s Note: The irony of being in the private mortgage lending business and pushing people to save is not lost on me. I am a big proponet of the wise use of debt, and lower leveraged real estate investments can create tremendous long-term wealth for genertions to come. (That new bass boat however…)