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The 2nd Biggest Money Making Scheme in History is Taking Place and We Have to Be Grateful for It

By Andy Shaw | January 25, 2010

Originally Posted 16th October 2008

Firstly I’m going to explain something I’ve said before but has relevance to the article.

People say to me, ‘How am I going to pay off the mortgage (debt) on my own home? I can understand keeping mortgages on my investment property but with interest only I’ll never clear the debt on my own home? So how can I do it?’

I have many answers for this but the relevant one to this article is:

If your home is worth £500,000 and you have a £400,000 debt on it, then go and buy £500,000 worth of investment property, wait 10 years (while property doubles in value), then refinance the investment property and clear the mortgage on your own home. The exact time scale doesn’t really matter as long as you leave the investment for long enough.

So you end up with assets that are worth more than they were when you bought them and they have cleaned up the previous debt which was a liability, so as I’ve said many times before this somewhat beats the repayment mortgage model. Well a repayment mortgage involves all sorts of hardship and sacrifice that no one really wants to go through and frankly why should they have to when it is simple to get time and someone else’s money to pay of your liabilities for you?

So whatever size the debt is, what this method shows is the simple use of buying appreciating assets and then using leverage to increase your rate of return and effectively kill off your debt. Therefore whatever size the debt is, it is a simple process. Just imagine if you could buy those investment properties which are appreciating assets for £150,000 when it was really worth £500,000, then this leverage and time model produces huge profits. Then just imagine that you could control the market so that the people who own the £500,000 asset would not only be willing to sell for £150,000, but would be very grateful to you for buying at that price. Now we are starting to get really clever.

To achieve that would involve market timing to extraordinary levels, and realistically it would need an incredible control and influence over the market to pull off such a feat. I achieved it on a small scale when I did it in Worthing’s property market, but just imagine it on a slightly bigger scale, I’m talking trillions!

The biggest game play ever

Now to start…

But before that I should say that I could easily write a book on the events of the last two weeks (NB I wrote that on 1st October – the world got really busy shortly after that :-) ), let alone the events since the Northern Rock crisis, as these truly are interesting times.

The $700 Billion bailout plan has been incorrectly named. A more appropriate and accurate name would be a stabilization plan, or what it’s probably being called behind the most secret of closed doors, ‘OMG – Operation Money Grab’, as this is anything but a bailout plan. However, that’s how the Fed needs the banks to view it. Their only mistake was in the marketing of this plan to the American public (and it was probably a big mistake, as nothing is quite as it would seem right now, but I think they’ll recover from it).

The cleverness of this plan is truly astounding and really deserves absolute admiration and applause, especially as the spin that has been put on it has managed to get everyone standing in line and having to vote it through. I liken it to asking the question in such a way that we have to answer ‘yes’, even though we don’t want to, and even though I don’t like those situations I have to admire those who orchestrate them.

Now before getting to that situation for someone to say ‘yes’ to something that goes so wholeheartedly against the grain, you have to let them experience some real pain, so that the only solution is to do the unthinkable and agree to it. But before I come onto the OMG I need to explain the stabilization.

The survival of the world’s financial system is based on a very clever confidence game. (In other words it’s a con trick – don’t let anyone tell you otherwise and if you don’t believe me pull out a bank note and read what it says, ‘I promise to pay the bearer on demand…’)

The banks and the government gear all of their money and do not have gold backing up all of their promises. The banks lend to at least 12 times what they have in cash (this could be a lot more depending on where you get your info from). The government, to who knows what degree, are dependant on the price of what little gold reserves they have left and of course the hedge funds and selective investment banks who gear to 30 times cash invested. Not to mention of course that whilst the regulators back is turned for 29 days out of every month, they gear to much higher limits, like 45 times.

Is it any wonder that the financial system is in trouble, when you consider that if we take out an 85% mortgage then that is considered by most banks to be over-geared, yet that is only 6.7 x the capital invested. So we are over-geared when we are taking half the risk they are yet we are investing in an asset that we understand and can effect the value of. Whereas the problem currently is that the banks don’t know how to value some of the assets on their books and therefore this has brought about a complete loss of confidence and brought the system to its knees. Personally, I think only days away from collapse at anytime at the moment – but I think they realise this now (finally!)

Rules of the game

So to get back to the cleverness.

First you need to have either a big problem to fix, or you just want to make a shed load of money.

Second you need a rule that can create chaos in the market almost on demand. That rule is that some companies that hold certain assets that have to be AAA rated. If at any time those assets are not AAA rated then the company must sell those assets immediately for whatever price it can get.

This is a beautiful piece of work. Think about it – you create a system whereby if you want to you can set about a loss of confidence (which is the foundation for all worldwide banking), and in doing so this causes a rush to de-leverage, which in turn causes increased leverage by causing de-valuation of the assets as the assets then fall and lose there AAA rating, therefore forcing the asset holder to HAVE to sell it at whatever the last fire-sale value of a similar asset was. So if the last sale was for 50% of purchase price, they just have to hope that they can get the same – yes, they really did buy into this con trick with their eyes wide open!

So to put it in our terms, if the property goes down in value and your gearing goes from 85% to 90%+ then you must sell that asset immediately for whatever price you can get for it and if that means you sell a flat that you paid £100,000 for 3 months ago for £50,000 today then you have done the right thing – is it me, or was this not predictable! I only found this out earlier this year, otherwise I could have shown it was just a time bomb with a random timer just waiting to go off.

You must remember that all the banks and funds signed up to this when they wanted to do business in that market. Would you get into property if you were forced to sell when the price went down? Well funnily enough, that is what we all sign up to on our mortgages but they’d have fun collecting that money!

Third you need to have a way that you can control the fallout as you switch on the chaos that will allow you to take the rule book and throw it out the window as and when you choose.

This is quite easy if you have enough money and allow things to go on that will fail automatically, because they never could work. What you are probably thinking now is why would anyone want to do that? Well, I’ll come onto that in a little while.

Fourth you need to get a precedent set that means that we don’t want to do this but we must if we are all going to survive. But the pill can’t be too bitter too swallow for the public or the politicians. However, you want the precedent to be set as high as possible so that when you keep going back and asking for more the people will think that at least they are not asking for that much again.

Pretty soon you have had three, four, five times or more what you originally set the precedent for, and each time it was accepted as a necessity, because it was a necessity as that was the plan of the trap in the first place.

Fifth you need at least one patsy to take the fall if play needs to go the wrong way. I.e. no plan is ever any good if it does not have an exit strategy. In this play I think there are literally dozens of patsies.

Now what I’m discussing here is obviously the American stabilization plan & the subsequent ‘New Plan’ of Gordon (patsy numero uno) Brown’s to buy shares in the banks. But other than saving the economy of the world (which is a pretty big reason – and definitely one hell of a smokescreen) why would they do it, what would they have to gain? And I’m not talking about a few extremely wealthy people benefiting here, I am talking about the US government finding a way to solve their biggest problem ever, and it has been a question I have asked myself dozens of times – How are they going to solve the problem of the US debt?

A BIG Problem

Let’s say you have a total debt in US Dollars of

Taken from one of the National Debt clocks – The Outstanding Public Debt as of 15 Oct 2008 at 05:52:18 PM GMT is:

$10,310,820,514,802.11 That’s 10 trillion US Dollas!

Which is no small amount of money to pay off, well that’s if you can’t find someone to pay it off for you that is…

You can’t raise taxes and you want to spend more than you are receiving.

You need to pay off the debt and you want money, then what is the best way to get that money? Buy undervalued income producing and capital appreciating assets, which you can gear up and get a leveraged return on. However, you can’t do that as that is going towards socialism and goes against the system. So you have to create a climate that allows you to buy assets like AIG for chump change or no money and have the public say it is in their interest to do so.

Side note the American citizens complained when their tax money was used to buy up AIG. If they understood what had happened then they would all be celebrating. AIG was bought with an $85 billion guarantee (in other words $0 money down. In return they received 80% of a business with assets worth over $100 billion).

Who paid for that? The shareholders and the company was literally given away to get round its cashflow problems. This was a stunning business deal, absolutely stunning and allowed Henry Pullson to make literally a fortune for the government! Yet taxpayers were disgusted at the use of public funds, they are not blind yet they cannot see! And the shareholders, well they took the risk didn’t they? Unfortunately, they weren’t ready for OMG.

But this phenomenal business deal/swindle pales into insignificance compared to Fannie Mae, Freddie Mac and all the banks to come, not to mention hedge funds and pension funds that are about to let them buy up their assets at what I expect to be no more than 65 cents on the dollar.

Fannie & Freddie are a better deal by far to that of AIG though. They each own around $800 million in mortgage loans and guarantee the credit worthiness of another $3.8 trillion in mortgage backed securities. If these are held to maturity they will be worth a lot more than was paid for them (and we are not talking just a few million more!). What did this cost Mr Paulson? $2 billion in cash that he borrowed at 3–4 % and $200 billion in guarantees that cost him nothing.

Not a bad deal. $2 billion to get hold of $5.4 trillion in mortgages and guarantees. And as the $2 billion wasn’t his money anyway then he just bought £5.4 trillion worth of property for no money down! Makes you feel like a real amateur when someone new to property investing pulls of the deal of the millennium on their first time out.

This bitter pill will be helped along the way by the government, saying to banks when they start to announce that they will be buying them, that is (I wrote before Gordon’s announcement that he would start taking shares in banks), ‘now don’t you worry, we are not going to force you to show that loss on your balance sheets, in fact we are going to give you time to go out and make more profits so that you can support that loss, that you made!’ They’ll pat them on the back and send them back to work, and the banks will be grateful and we should be grateful to that they did too. This is a glimpse at how beautiful this plan is.

Now let’s look back. What has the government got? Well, it’s got billions and trillions in asset values that it has paid somewhere between 2cents and 65cents on the dollar for. It has funded it all with further debt which it borrows at 3-4% (via the sale of treasury bonds) and has a yield producing a prospective 10-15%. So a fantastic tax free revenue. Then, if it waits and holds onto these geared investments, while holding a high percentage of the business but not enough to not make the entrepreneurs do their stuff and make further profits, then in ten or fifteen years they sell these assets back at a huge profit and pay off their national debt.

Of course, depending on who is in at the time will determine on whether the money is used to clear the debt, but when faced with a huge windfall of cash, a politician can either pay off debt which will win him a few votes, or he can do something popular that will get him re-elected. So you can have two guesses if you need them as to what will happen to the profits. That’s assuming of course that whoever is in at the time doesn’t decide to offload these assets before they have reached a peachy return.

So who better to orchestrate such a wonderful bailout of the US debt than the former CEO of Goldman Sachs, who ran one of the largest funds on the planet? This guy is phenomenally clever (not usually a necessary skill for a member of Bush’s administration, but this guy is a master with money).

And why do you think Warren Buffet said, ‘If I had $700 billion I’d buy all those loans?’ He even offered to fund 1% of the deal – it’s that good even Buffet wants in. Afterall, Mr Paulson is going to buy another $2-$3 trillion of assets for $700,000. This guy really knows his stuff and could very well be the cleverest money man I’ve ever seen! So for some guarantees and some borrowed cash this makes this series of deals the best trades ever done by far.

Then moving onto the plan to buy up parts of the banks, Mr Paulson decides to follow that forward thinker Gordon Brown with his idea to buy up the banks. Oh come on, talk about a patsy play, Gordon Brown has never had an original thought in his life and is so inept that to be able to even consider a man with his lack of intelligence could come up with such a clever play is the most ludicrous element of this whole event thus far. Still the US public bought it and so have everyone else from what I see on the news and in the papers. Anyway I’ll move on and not dwell on this point.

It won’t stop there though as Paulson’s onto a good thing and will make us all suffer a little while longer whilst he takes probably more than enough money in guarantees from the US tax payer to make enough money to pay off the debt. Well, maybe ;-)

However, let’s not go assuming that this money will be spent in the direction that it was intended. Henry Paulson will probably be a distant memory and the new President (or the one after) will probably see this windfall as a great way to impress the public by his generous spending plans.

The next day

I woke up this morning to hear that the bill had been passed. So now we are onto the next phase. The precedent has been set and what will happen is that this will not work from day one. This will take time and as Paulson knows that this wonderful technique has already delivered a potentially huge pay day, he’ll be hungry for more, just so long as he can hold off financial meltdown. However, this will be a dangerous game and if he makes a similar mistake to the marketing of the ‘bailout plan’ then he may just not pull it off.

Which of course could be absolute disaster. So even though I feel I can see through to the true agenda, along with every other armchair economist I am left with no choice other than to welcome in this new order and hope that he pulls it off and isn’t too greedy.

Finally this is good news for us as property investors. However, we will have to endure more pain before this drama shows signs of really slowing. All that happened yesterday was that they brought the patient back a little from the brink of death, the patient is still in intensive care. The patient will survive, but he may spend the next 5 years in a convalescent home.

This means for us that there is going to be less competition and more deals. However, the property investing plate that has been wobbling and which will require more work for the next year or so is definitely the mortgage plate. But as I have said many times before, there will always be one area in property investing that isn’t working correctly and that is to your benefit, as if every area was working, then everyone would be able to do it and so take advantage of whatever the shifts in the market show you.

The Future

Thanks to the inaction when it was necessary to avert recession, we are now faced with one coming at us full on. And I note now that other economists are predicting sub 1% inflation next year. So I have to ask where the hell were they when I was yelling about we need rate cuts and stuff inflation? Well the public has a short memory and at the moment they don’t even fully realise how close the world has come and in fact how close it still sits right now next to financial meltdown.

People will carry on making their own assumptions (as I have here) about what is happening and blaming whoever Paulson chooses to blame for this crisis, whilst the true goal was achieved and went almost unnoticed. Am I right? Well, who knows, and at the end of the day, who cares, as what does it matter? But if I am right, then the American people will owe a debt to Henry Paulson that they can never repay for finding a way to rid America of the biggest milestone ever and all they had to do was use OMG to take from the rich and give to the richest.

Seriously though, what matters to us at our level is that we stay flexible and play by the rules that they lay down for us. Property investing is like sailing, the skill is learning to be a good enough sailor so that you can sail in any weather. At the moment the scared property investors are the ones who are like poor sailors.

One of my favourite Warren Buffet quotes is, ‘I get fearful when others get greedy and I get greedy when others get fearful.’ This is a man who just bought shares in two enterprises, Goldman Sachs and General Electric. The deal he did means that he will probably double his investment in under five years and as he has also bought the assets at an all time low compared to value, he could end up making yet another sweet, sweet deal. This is a man who is not scared by the term ‘credit crunch’, who instead is out spending and not hoarding cash, because he knows now is the time to get a great deal.

Will the shares in those two entities go down more? Probably, but he doesn’t care because he is an investor and not a speculator. He has taken a position in those companies, as we do in a property, and is in this for the long term. He understands the value of his assets. This is the secret to investing. Get to know the value of your assets and then you will no longer be fearful when others are.

Best wishes


PS Expect to see some more interest rate cuts soon as their ‘dead cat’ bounced the other day, but it’s still a dead cat. When they realise this, then they will act again. This will make our lives easier. Also keep an eye out for the 3 month Libor rate, as that will tell you when the storm is calming down.

One of the greatest financial errors of all time was when they raised interest rates in the Great Depression; rest assured even our politicians are not that stupid and even Mervyn knows where he can stick his fight on inflation (and it is not as sunny there as it is in Cyprus – I won’t bother saying I told them so, as it really is too painful that they missed it!)

PPS If you don’t know what the number one biggest money making scheme of all time was, and still is, then I’ll give you a clue, it was operation FED.

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