November 28, 2009: Dubai Illustrates That Sukuks May Be Junk Bonds

Shariah compliant bonds skirt the Islamic dictum that no interest is to be received from loaning money by linking bonds to an underlying asset, say, real estate, that throws off income. This arms-length strategy is designed to permit Islamic investors to receive money on their investment that is not technically interest. Recently, as pointed out in the Financial Times, there has been growing concern about whether these bonds, called sukuks, are the conservative investment vehicles they were made out to be.

Enter Dubai. It seems as though shariah-compliant bonds issued to expand this Islamic Beverly Hills are deemed to have little asset quality behind them. One bond analyst stated on Friday "We are of the opinion that the underlying assets are worth very little." It appears that the biggest losses may be those investors that held sukuks in Nakheel, whose bonds went from $1.11 to the dollar on Thursday to 85 cents to the 40 cent level Friday.

Bondholders are getting lawyered-up and will likely demand that assets such as the QE2 liner and other so-called investments in entities such as the eclectic Cirque du Soleil be used to buoy the sukuk bonds' underlying value. Whether this will be successful remains to be seen.

In short, unless Dubai or their neighbor Abu Dhabi ponies up with government backing, sukuks as an investment may be in deep trouble throughout the Islamic investment community. So much for trying to do an endaround on a religious principle.

November 23, 2009: Is Sovereign Debt Stable?

An interesting point of view was articulated by FT's Assistant Editor Gillian Tett. According to Tett,"It is easy to imagine that some countries will end up eroding the value of their bonds by debasing their currencies." I believe he is correct.

Government bonds of the industrial world are believed to be a top drawer, AAA-rated safe investment. Investors have flocked to them. G-20 regulators are holding meetings in Basel to draw up new rules on how banks should protect themselves from another financial meltdown by investing a greater proportion of their in less risky assets such as stable government bonds.

Tett point out that this flight to safety through the accumulation of government bonds in itself may well be creating investment dangers. Government debt has skyrocketed to levels not seen before. Fiscal deficits are exploding across the western world. Sadly, the level of political commitment to "reign" in the deficits (pun intended) is not present, in large part because the yields are so low as to make borrowing practically free. With low interest, what domestic pressure is there on politicians to reduce debt?

Defaults on government bonds remain highly unlikely. But, there is little doubt that some countries will intentionally erode the value of their currency, and thus the total return of their bonds in the coming years. This almost guarantees igniting inflation.

Major industrialized countries will need to sell more than $12,000 billion dollars worth of government bonds next year to fund their current expense models. This is a rise of over thirty-three per cent over the past two years.

Investors who feel safe earning a miserly interest rate because they deem bond holdings safe will find their game plan ruined by inflation coupled with an intentionally debased currency. This will produce a significantly negative total return. Treasury inflation-protected securities(TIPS) will not be exempt from these type of losses, although at least the interest would rise to partially offset falling currencies.

Granted, there are arguments to be made to counter Tett's premise (deflation, high unemployment so there is not too much money chasing too few goods and services, etc.) but his thoughts are worth considering before the investor purchases government bonds. Receiving,say,70% worth of purchasing power when the investor receives 100% of the government bond at maturity is not the best of investments.

Some ETFs to be monitoring closely include Barclays's BWX, BWZ and WIP, iShares' IGOV, PowerShares' Sovereign Debt PCY as well as all U.S. Treasury Bond ETFs, especially those that are intermediate to long term.

November 17, 2009: More Perks For Lucky Homeowners And "Lucky" Taxpayers

Here are the rules contained in the new legislation regarding tax credits for homeowners and first time homebuyers. I believe that the new extension with added benefits will not cause a pop in sales as did the initial program, which expired November 6th. The reason is that homebuyers rushed to get into a home under the former program. That said, I hope I am wrong and that everything will be coming up roses for participants in the real estate transaction process, and for investors in the home construction sector(s).

Here Are The Rules:

1. The credit is available for homes purchased on or after November 6, 2009 and before June 30, 2010. Contracts must be fully ratified before May 1, 2010.

2. The full $8000.00 Tax Credit is for first-time home buyers (either spouse if filing jointly) who have not owned a principle residence during the three year period prior to the purchase. Ownership of vacation/leisure property or rental property does not disqualify home buyers from the program.

3. The maximum credit is $8000.00 or 10% of the home purchase, whichever is less.

4. To qualify for the full tax credit, married couples' modified adjusted gross income (MAGI) must be under $225,000.00 (raised from $150,000 under the prior program). Single filers' MAGI must be less than $125,000.00 (raised from $75,000.00 under the prior program). Partial tax credits are available for married couples with MAGI incomes of over $225,000.00 but under $245,000.00 and single filers with incomes of over $125,000.00 but under $145,000.00. If married couples who qualify for the first-time tax credit file separately, they would both claim 5% of the home purchase or $4000.00 (whichever is less) on their tax returns.

5. The is no recapture or repayment clause if the home is owned for at least thirty-six months.

6. Current Homeowner(s): An individual (if married, the individual's spouse) who has owned and used the same residence as a principle residence for any consecutive-year period during the eight year period ending on the date of purchase of a new principal residence will be eligible for a $6500.00 tax credit ($3250.00 if filing separately).

7. The full amount of the eligible tax credit is refunded to the buyer, regardless of whether the buyer has paid an equivalent amount in taxes.

8. There is a home purchase cap of $800,000.00. There was no cap in the previous program.

9. Special exemptions and extensions for military, members of the Foreign Service of the United States, and employees of the intelligence community: If the individual serves on official extended duty outside of the United States for at least ninety days between December 31, 2008 and May 1, 2010, the deadline for entering into a binding contract to purchase a home will be extended to April 30, 2011. Closing must occur before July 1,2011.

10. The credit is only available to purchasers eighteen years of age and older.

11. The home purchaser(s) must attach a copy of a properly executed settlement statement used to complete the purchase to the tax return.

November 12, 2009: Home Buying Slips in October. Now What?

The Credit Suisse National Survey of monthly real estate traffic throughout the country by city and region is in, and the results are continued weakness despite the home buyer's credit that expired. This credit scheme was recently extended for another several months (along with tax write offs for current homeowners who meet basic residence longevity criteria).

October traffic slipped from September levels as a whole. The stats do not tell the whole story, however. Traffic early in October was above September levels as last-minute buyers driven by the tax credit hurried to close deals. Later in the October, traffic declined significantly. There is concern that with credit still tight, many first-time buyers have already acted and there will be fewer people participating in the extended tax credit purchase program. Consensus opinion indicates that the tax credit pulled forward demand and that there will likely be a lull in buyer traffic at the end of 2009 into 2010.

A key to what happens next will be homebuyer traffic in late November. If traffic levels improve from current numbers, it would be an indication that the slowdown in traffic may void the consensus view expressed above for early 2010 and beyond.

Selectively, there was a meaningful decline in traffic within the Minneapolis and Seattle areas, whereas most other markets were relatively stable. The best market according to key price and traffic data in October? Las Vegas. The highest levels of traffic were experienced in Ft. Meyers, Orlando, Los Angeles, the Inland Empire and Washington, D.C. Upward pricing trends were noted in Washington, D.C., Ft. Meyers, Los Angeles, Sacramento, San Diego and San Francisco. That stated, the stats strongly indicated that stability and slight improvement in the housing market remains generated on low-end homes and foreclosure transactions. Investors have stepped up to the plate (with a high percentage using cash) to buy distressed property.

Interestingly, as investors gather up single family homes, the rental vacancy percentage is trending higher as renters who qualify for the tax credit, or see a real deal on a short sale/foreclosed home, flee their unit to become homeowners.

It is incumbent for the investor to keep abreast of actual trends versus media hype and carefully monitor home ownership data and the predicted next wave of foreclosures coming in early spring of 2010. Another piece of data to be mined will be the number of homeowners who had their mortgage reset this year and failed to meet the renegotiated terms. Estimates of upcoming flops are as high as 70%. This may set in motion a new housing price downdraft, with the government out of ammunition to stop further mayhem. Investors must be alert to data on all major aspects of this sector.