CASTLE ARCH

REAL ESTATE INVESTMENT COMPANY

Opportunity in
Troubled Times
Finding the gems and thriving during
times of economic recession

By looking at the fundamental

underlying economics, the data of the
past can guide us through the future.
TABLE OF CONTENTS Page
Introduction
1. The Thing About Bears 1
2. The Data-Driven Eye of the Storm 3
3. Learning From the Past 4

History
4. Adam Smith 5
5. John Maynard Keynes 7

Psychology in the Market

6. A Tolerance for Stimulus 11
7. Hayek on Price 11
8. Confidence and Stock Price 12

Economics of Inflation
9. Money Supply and GDP 14
10. The Gold Standard 18
11. The Government View of Inflation 19
12. Buffer Inflation by Moving to Hard Assets 20

The Opportunity
13. RTC 22
14. The Eye of This Storm 23
15. Buying Below Replacement Cost 25
16. Conclusion 25

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

INTRODUCTION
1. The Thing About Bears
A few years ago, I was on a fishing
trip in Alaska. We made camp for the
night without a tent. Rather, we slept
on sleeping pads on the ground with
a rain fly pitched over us like a tent.
As we went to bed, I asked my guide
if there had ever been a problem with
bears in this area—it was bear country
after all. He reassured me that they
had been leading tours since 1966, and
they had never had a bear incident.
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
All the same, we had taken certain
precautions. We were packing mostly
freeze-dried meals that could be
reconstituted with water and eaten
with a cup and spoon. We placed all of
our food in a five-gallon container and
moved it away from our camp, along
with our trash, by 100 feet or so, and
went to bed.
During the night, a rustling in the
brush around our camp awakened
me. Still half asleep, I listened for
sounds outside our shelter and heard
some footfalls and then a rattling

as something disturbed my cup and
spoon, which had been left outside.
I woke my guide and indicated that
he should listen. We then heard the
plastic five-gallon container being
tossed around.
“What was that?” I whispered.
“Oh, it’s just a fox. Go back to
sleep,” my drowsy guide replied.
The footsteps retreated. Even if
it was a fox, my heart was racing; I
vowed to examine the tracks in the
morning. As it turned out I did not
have to wait. A few minutes later, I
heard footsteps again—this time right
around my head, just beyond the rain
fly. Then the thrashing sounds of our
camp being torn apart told us the
intruder was back. I woke my guide
again.
“Something is out there, and it
isn’t a fox!” I said.
My guide roused groggily and
lifted the flap on the rain fly. When he
turned back to me, I could tell even in
the dark that he was scared.
“There is a b-b-bear right outside,”
he said. At that moment, the enormous
head of a Kodiak Brown Bear stuck
itself through the rain fly.
Obviously, I survived the
encounter. At the time, I was all
adrenaline. Since then, I have had
time to reflect and the appearance of
that monstrous bear is not unlike the
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Page 2
sudden and unexpected appearance
of the current bear market—and
for many investors, not a bit less
distressing.
It can be a truly frightening time to
be an investor. The overall Market is a
big fat Grizzly Bear, and everywhere
you look the landscape seems littered
with more market casualties. The Dow
today (March 2009) is worth 46.1% of
what it was only a year and a half ago
at its zenith in October of 2007.1 The
S&P 500 has dropped by nearly 58%
over the same period.2 Navigating
such a volatile marketplace can be
justifiably harrowing and precarious.
You would have to be virtually
unconscious not to see that there are a
lot of reasons to be afraid; there are a
lot of reasons to take a “run for cover”
approach to the market.
In a normal downturn, it is
typical to see inexperienced investors
either paralyzed with fear, or selling
wildly. Even savvy investors tend
to want to “hunker down” and ride
out the storm. Preservation of capital
becomes the prevailing order of
the day. Who is truly worried about
growing their investments in a market
where breakeven is considered a
win? And the current downturn is
much more than a typical market
correction. Indications are that the

depth and duration of the trough will
be extensive.
Yet, even against such an ominous
and tempestuous backdrop, some
investors seem to thrive. During the
Great Depression, millionaires were
made. Certain investors have flown in
the face of the trends and capitalized
on every major recession. They seem
to be able to weather the storms in the
market not only without losses, but
almost as if the buffetings of the Bear
were actually fueling their growth.
Now the bear market is
unfortunately not as easily or quickly
dispatched as was the bear that
threatened our lives in the Alaskan
wilderness. Just like on that occasion,
survival depended on being prepared.
This article is about discovering
how to find and recognize the
opportunities that exist buried in
troubled economic times. The deeper
the trouble, the bigger the opportunity
for the investors who are prepared and
positioned to take advantage of the
changes in the market as it makes its
natural corrections.
2. The Data-Driven Eye of the
Storm
Nobody has a crystal ball.
Fortunes are made and lost playing
roulette with the peaks and valleys
of the market as investors try to beat
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Page 3
the market, try to outplay the system.
In times like these, the gamblers are
often thinned from the true investors.
I freely admit that I have no
crystal ball—no certain way to peer
into the future and forecast exactly
what the market will do. I cannot tell
you what the future holds, but as a
student of history and the trends in
the capital markets, I can point out
the data points that have driven the
market in the past. Just because we
cannot predict the future does not
mean we can’t be smart about how we
face it—does not mean that we can’t
take advantage of the tools we do
have.
Our time offers an unprecedented
access to information. The data
represented in the past and current
markets can give us the statistical
ability to put probability in our favor,
and that is wise investing.
At the center of a hurricane is the
eye—a place that is, by contrast, calm
The data represented
in the past … can give
us the statistical ability
to put probability in
our favor …

and unharried, even though it resides
right in the center of massive swirling
destruction.
That is an apt metaphor for what
I am going to describe. Today’s
catastrophic markets are a “perfect
storm,” created by the alignment of a
number of errors and manipulations.3
By taking a look at the data and
attempting to discern the underlying
principles that affect the market, I
believe that today’s investors can
place themselves near the eye of that
storm—in a position that offers the
greatest probability for reaping the
rich rewards of the opportunities
hidden within this recession.
3. Learning From the Past
As an investor, I am politically
informed, but agnostic when it comes
to political parties. I have voted for
both Republicans and Democrats,
and while the right tends to be
viewed as more favorable to the
business and investment community,
I have personally made more money
under Democratic presidents than
Republicans. My point is that while
politics plays a role in the economy,
the data rather than sentiment or
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Page 4
allegiance to one political platform or
another is where the historical value
lies.
We are still early in the Obama
administration. Whether you view
Obama as a savior or a charlatan,
the principles operating behind our
economy are bigger than a single
president, bigger than a party or a
platform. I will discuss some of the
economic policies and strategies used
by various political figures, including
President Obama, but the discussion
will be data-driven. Emotions,
including political leanings, tend to
undermine good investing decisions,
and one of the keys to thriving in a
down market is keeping emotions in
check.4
The first thing we need to
understand is how we got here and
what the market has done in situations
like this in the past. I believe it
behooves every investor to also be
a student. Let me guide you through
a little history, a little economics, a
little psychology, and hopefully to
an understanding of the principles
at work behind what we see in the
current market reset.
HISTORY Page 5

4. Adam Smith ideas in economics. There is a lot to

In 1776, a few months before the
United States declared independence,
Adam Smith, a Scotsman often
referred to as the father of economics,5
published a double volume that he
had written over the previous twelve
years. The book was titled An Inquiry
Into the Nature and Cause of the
Wealth of Nations6 and it represented
one of the earliest works on the
subject that would become modern
economics.
A lot of
water has
passed under
the bridge since
then. Smith’s
ideas have
been further
developed and
also derided
by the ranks
of economists
Adam Smith 1723−1790 that have
followed. But,
his concepts are so compelling, that
nearly every idea in economics put
forth since Adam Smith is cast against
the backdrop he established in The
Wealth of Nations.
In my opinion, whether
diametrically opposed, a devotee, or
a piecemeal believer, Adam Smith
remains a measuring stick for modern
learn about contemporary markets in
his principles that have endured this
past 230 years.
Prior to Smith, the prevailing
philosophy was called Mercantilism7
and it held that there was a fixed
amount of wealth in the world.
Governments naturally deducted that
if such a notion were true, then the
only way to get more wealth was to
take it from someone else and rashes
of war and colonialism resulted, as
well as generally poor conditions for
working people in the system.
Smith, in contrast believed that
Freedom for individuals, Competition
within the system, and Justice in the
administration of an economic system
would create a condition in which
people were free to seek their own
self-interest—in other words pursue
their own wealth instead of that of
their sovereign, and that by providing
these conditions for its people,
governments could actually foster the
creation of wealth.
The Wealth of Nations has
become a canon for advocates of free
trade. Smith believed that free trade
in a competitive environment (ie.
not blunted by monopolies) with a
framework for justice (a court system
that upheld and enforced contracts
and prevented dishonesty) was better

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for everyone. People would have
access to cheaper goods and higher
standards of living, while the volume
of transactions would increase and
wealth throughout the system would
grow.
He also believed that freedom
among the people would lead to what
he called a division of labor. We
would call it specialization, meaning
that people can develop specialized
skills because a market exists for
them. In other words, we will develop
computer, mechanical, and electrical
engineers, not just engineers. We will
have technicians that specialize in
repairing appliances, and a different
cadre of technicians that repairs
automobiles, and yet another set that
repairs industrial machines, and on
and on.
Walk into any Wal-Mart and
you will see this principle at work:
a wide variety of cheap goods
(accessible to the poorer classes as
well as the richer) made as a result of
cooperative, specialized labor from
countries all over the world.
China provides an interesting
example of specialization. American
workers have specialized into higher
valued, higher paying labor—fields
like management, engineering,
and business. In China, they have
abundant unskilled labor. This is the
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Page 6
resource that draws manufacturing
firms from around the world. If you
want to hire people to pound widgets,
China is a great place to look.
However, much to the dismay of the
Chinese, nobody is boasting about the
quality of Chinese engineering. Sure,
manufacturing is done in China but
the majority of the good manufactured
were designed by engineers in
Western Europe or the U.S.
China, Mexico and India are like
the cheap labor overflow valve to
countries who are further along on the
specialization curve like Japan, Korea,
Western Europe and the United States.
And, as a result, nations providing
both types of labor specialty are far
wealthier than they would be without
each other.
India offers another insightful
example. India, like China, has plenty
of labor force, but a democratic
government, a higher degree of
personal freedom, and a resulting
higher level of education than China.
India is providing not merely cheap
labor, but inexpensive labor in more
skilled capacities: call centers, basic
computer programming, etc.
Now at this point, some of you
will be saying, wait a minute, I work
with, or went to school with, or was
hired by professionals from both
China and India who are operating

in very high-level specialties. Then
ask yourself where you interacted
with them? In the U.S.! There is
nothing about being Chinese or being
Indian (or any other nationality, for
that matter) that prohibits high-level
specialization. On the contrary, Adam
Smith would say it is primarily a
function of the government’s ability
to provide the conditions for creating
wealth in the specific location.
Let’s examine China again.
China has a somewhat schizophrenic
appreciation for Adam Smith. China is
currently very interested in promoting
the idea of free trade in response to
some of the terms within the Obama
administration’s stimulus package.
China is threatened by the terms it
perceives as protectionist (ie. the
U.S. looking out for number 1).8
China, however, is much less ready
to completely adopt the notion of
free trade when it comes to its own
citizenry.
Even more radical than the
notion that free people would create
individual wealth, Smith believed
that masses of people driven by their
own self-interest would naturally
promote the public interest as well.
In other words, if everyone tries to
get ahead, the country at large will
also get ahead, driven by the engine
of its people’s own ingenuity, drive,
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Page 7
and motivation to improve their
condition. He described an “invisible
hand” that moved the whole along
as the individuals within it moved
themselves. The ingenious thing is
that this “invisible” hand concept
deftly explains an incredibly complex
system of interactions with a simple
metaphor.
I believe the “invisible hand”
metaphor also works when describing
the capital markets. The markets are
not merely the sum of their expansive
parts, but the sum of the intentions of
the parties that work within them.
5. John Maynard Keynes
Among the subsequent economic
thinkers, perhaps none has had as
profound an influence on economics
throughout the 20th and early 21st
centuries as John Maynard Keynes.9
Adam Smith, while not championing
a complete laissez faire (hands off)
role of government in the economy,
was positing
that natural
forces
within the
market
would
stabilize it
at a point of
equilibrium.
He believed John Maynard Keynes 1883−1946

that a government with a very light
hand would best facilitate the creation
of wealth. Keynes, however, believed
that the role of government was to
massage the economic system into
maximum efficiency and that the
market itself would not and could not
produce that level of efficiency alone.
Keynes was born 5 Jun 1883.
Before his death in 1946, his
philosophy gained great momentum
throughout the world due to the
adoption of his approach by President
Franklin D. Roosevelt, or more
specifically by the economic scholars
in President Roosevelt’s advisory
Brain Trust.
After the U.S. sank deep into
the Great Depression, Roosevelt’s
New Deal (essentially a collection of
economic stimulus programs enacted
between 1933 and 1938) was credited
with bringing about an end to the
Great Depression and ushering in an
economic boom. The U.S. policy was
viewed as the ultimate test case, and
was touted as prima facie evidence
that Keynes was right. As a result,
Keynesian Economics became the
dominant economic philosophy
of the majority Western European
governments and the government of
the United States, until about 1979.
Keynes believed that
unemployment and attending
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Page 8
inefficiency in the economic system
was caused by too much individual
saving, and that spending—including
government intervention to encourage
spending, and government deficit
spending—was the antidote for
economies in recession.
However, Keynes’s popularity
waned toward the end of President
Jimmy Carter’s administration as the
U.S. slipped into a serious recession
(caused in large part by the impact
of the Oil Crisis in 1973). The rival
philosophy of Monetarism10 became
dominant in the U.S., the U.K. and
other European nations. Keynesian
Economics did not disappear,
however, and supporters of Keynes
remained ensconced throughout
the world’s major economies, but
Monetarism remained dominant until
2007.
I hope that this recent date begins
to illuminate why this historical thread
is so relevant to understanding the
conditions of today’s marketplace.
From 2007 until now, 2009,
Keynesian Economics has enjoyed
a bipartisan resurgence. The modern
financial crises have done much to
throw cold water on the belief in self-
regulation of the markets. The markets
have not been abandoned to laissez
faire, but in the conversation around
regulation of the financial markets

one side claims the regulation that did
exist was too much, while the other
claims that the meltdown argues for
greater regulation.
The breakdown of the financial
markets that occurred with the
bursting of the dot com bubble and
the current housing bubble that has
spilled over into virtually every other
sector in the economy are looked at
by supporters of more regulation as
catastrophic failures of the market
to govern itself. Frankly the pain
from these bursting bubbles makes it
easy to recruit supporters who look
at regulation as a safety mechanism.
The prevailing opinion appears to
be that this is a clear sign that the
level of government intervention was
inadequate.
The economic stimulus
legislations of both the
administrations of President George
W. Bush and President Barak Obama
reflect an approach to government
intervention in the economy that is
heavily influenced by Keynes.
On February 13, 2008, President
Bush signed the Economic Stimulus
Act of 2008.11 This represented
approximately $152 billion in
stimulus in the form of tax rebates, tax
incentives, and increases in the sizes
of mortgages available for sale to the
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Page 9
secondary mortgage giants Fannie
Mae and Freddie Mac.
Unfazed by this stimulus, the
economy continued to unravel
throughout 2008. At the end of 2008
(which also represented the end of
the Bush presidency), President
Bush initiated another stimulus bill.
Economists claimed that the stimulus
enacted earlier that year was simply
too small to counter an economic
crisis of the magnitude that the
country was looking at. Essentially,
they were calling $152 billion a band-
aid on a gunshot wound.
Secretary of the Treasury Henry
Paulson with support from Federal
Reserve Chairman Ben Bernanke
proposed legislation in a letter to
Congress which would authorize the
U.S. Treasury department to spend
an unprecedented $700 billion in
an effort to staunch the collapse of
both the U.S. and global financial
systems. The Emergency Economic
Stabilization Act of 200812 was signed
by President Bush on October 3,
2008. This bill is commonly referred
to as the first “bailout” bill. It is this
legislation that created the Troubled
Asset Relief Program (TARP).
In an apparent confession of his
switch to Keynesian philosophy,
President Bush said (commenting on
the bill),

“I’ve abandoned free-market
principles to save the free-market
system, to make sure the economy
doesn’t collapse. I am sorry we are
having to do it.”13
On February 18, 2009, President
Obama signed another $787 billion of
economic stimulus into law.14 This bill
was titled, The American Recovery
and Reinvestment Act of 2009.15
Obama defended his stimulus
bill by claiming that lending leads
to spending, inferring in Keynesian
fashion that ultimately increasing
spending is the road to recovery for
the economy. In his first address to
Congress, he said,
“…when credit is available
again, that young family can finally
buy a new home. And then some
company will hire workers to build
it. And then those workers will have
money to spend, and if they can get
a loan too, maybe they’ll finally buy
that car, or open their own business.
Investors will return to the market
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Page 10
… confidence will return, and our
economy will recover.”16
These three acts total over $1.6
trillion in new government spending
with the purpose of stimulating the
economy and shortening the recession.
I have to say that this represents
an unprecedented commitment to
Keynesian Economics and certainly
the biggest test of Keynes’s approach
ever conceived.
If Smith is the father of
economics, then Keynes
is the father of stimulus
packages.
Truly, if Smith is the father of
economics, then Keynes is the father
of stimulus packages.
PSYCHOLOGY IN THE MARKET Page 11

6. A Tolerance for Stimulus? addict require more of it to reach the

In the three months following the same euphoric “high.”
$152 billion stimulus, the Dow Jones 7. Hayek on Price
Industrials climbed from 12,500 to
In September, 1945, economist
just over 13,000. When the market
and Nobel Laureate, Friedrich A.
started its dramatic plunge in October,
Hayek published an article entitled
neither of the two subsequent stimulus
The Use of Knowledge in Society.18 In
acts have been successful in turning
his article, Hayek makes an interesting
the market around in the short term.
case around how price summarizes the
Why? Shouldn’t the markets respond
relationship between the macro and
positively to the unprecedented
micro levels of activity in a market.
infusion of cash represented by this
legislation?
Perhaps some of the reason is that
President Obama has made it clear
that (until his recent about-face)17 he
is not a friend of Wall Street. Perhaps
his rhetoric is motivated by a desire
to appeal to Main Street Americans
who are unfamiliar with the
machinations of the financial markets.
Or, perhaps the Wall Street reaction
is a fundamental lack of faith in the
efficacy of the stimulus approach,
or its execution and administration
under the new President. (The Friedrich A. Hayek 1899−1992
election of President Obama directly
on the heels of President George W.
Hayek uses the market for tin
Bush’s passing of the first “bailout,”
as an example, saying that rising
creates a strong argument that market
demand for tin (caused by a new
reaction to the bills is entirely based
use for tin) is communicated to tin
in the faith of financiers in President
buyers throughout the market in the
Obama’s disposition on both Acts.)
form of increased price. Essentially,
Or perhaps the markets have built up
even though tin buyers do not have
a tolerance for stimulus, and like an

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a granular analysis of all the factors
impacting the market for tin, the price
functions as a summary of all these
factors. Price is able to communicate
the essentials of a remarkably
complex system. Here is an insightful
excerpt:
“The whole acts as one market,
not because any of its members survey
the whole field, but because their
limited individual fields of vision
sufficiently overlap so that through
many intermediaries the relevant
information is communicated to all.
The mere fact that there is one price
for any commodity—or rather that
local prices are connected in a manner
determined by the cost of transport,
etc.—brings about the solution which
(it is just conceptually possible) might
have been arrived at by one single
mind possessing all the information
which is in fact dispersed among all
the people involved in the process.
“The most significant fact about
this system is the economy of
knowledge with which it operates, or
how little the individual participants
need to know in order to be able to
take the right action.”
What I believe Hayek is saying is
that price is much more than simply
what we pay; it is like a signpost with
the power to convey the most essential
information about the system at work
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Page 12
behind it. Now, this is not a perfect
system. Price can be manipulated in
ways that undermine its ability to
communicate accurate information
(for instance the price of homes at
the height of the bubble), but there
is a principle here that I think is very
useful when it is adapted to finance.
8. Confidence and Stock Price
Consider what information is
communicated by the price of a
company’s stock. Securities operate
a little differently than goods and
services, in that they are essentially
promises. As such, confidence or faith
in the promise represented by the
security drives demand.
Every individual investor in a
company has positive or negative
confidence in the value of the stock.
The sum of the confidence of every
investor (and even perhaps those
investors on the sidelines who are
choosing not to invest) is reflected in
the price.
Unlike the price of goods and
services, where an extensive and
complex system is summed up
in the price, stock prices actually
communicate something essential
about the relatively simple mechanism
that creates them. The system
behind stock prices is no more than
the decision-making capacity of
 Page 13

human beings. Even if the investor parts, but the sum of the intentions of
is an institution, the manager who the parties that work within them.
makes investment decisions for the
institution is a real live person.
The advantage that this gives
us over a simple exploration of the
The markets are … the
prices of goods and services is that we sum of the intentions of
have more than simply an objective
description of the system, the
the parties that work
mechanism can teach us something within them.
predictive, can give us a basis for
understanding the probability of
future events. That mechanism is the This means that understanding
individual psychology of investors.19 the micro-market, understanding the
As I mentioned earlier, my psychology and resulting behavior of
application of Smith’s “invisible investors, you can get a sense of the
hand” is that the markets are not macro-market.
merely the sum of their expansive

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THE ECONOMICS OF INFLATION
Inflation can be described as
systematic increases in the price of
goods and services. The cause of
inflation is nearly universally accepted
as growth in the Money Supply that
outpaces economic growth (typically
measured as the GDP).
9. Money Supply and GDP
This discussion has often
referenced Money Supply. What is
Money Supply and how can we tell
when it is growing faster than the
GDP? We intuitively understand that
Money Supply means all the money
in the economy, but is it more specific
than that?
Figure 1: Types of Money Supply in the U.S.
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 14
In fact, the government measures
Money Supply according to a
number of “money types” which are
classifications described as M-0, M-1,
etc.
M-0 is called the monetary base
and includes currency in circulation
and held by banks in the form of notes
and coins.
M-1 is everything included in
M-0, plus demand deposits. Demand
deposits include checking accounts
(accounts drawn upon via checks
or debit cards, etc.), and traveler’s
checks.
M-2 is everything included in
M-1, plus savings deposits and other
“time deposits” (like a CD that cannot

be withdrawn for a certain amount
of time) which are less than $100
thousand in size, and money market
accounts. Most economists look at
M-2 as the primary indicator for
inflation.
M-3 represents everything
included in M-2 plus large “time
deposits” and institutional money
market funds. The definition in use for
M-3 varies from country to country,
but is generally considered to be the
most inclusive measure of Money
Supply. The Federal Reserve in the
United States stopped publishing
information relative to M-3 in March
of 2006, a decision over which there
is a little controversy. However
reasonably accurate estimates of M-3
are available and I have incorporated
them into the data you see here.
The chart at Figure 1 illustrates
the proportionate relationship of each
Money Supply classification for the
U.S.
If Money Supply is so influential,
what role does GDP have to play
when it comes to inflation? Isn’t an
increase in the Money Supply alone
enough to cause inflation? Well, it
is not accurate to simply say that
more Money Supply equals more
inflation. Growth in the GDP provides
a mechanism for absorbing additional
Money Supply. In fact, increasing the
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 15
Money Supply is a good thing up to
the point at which it begins to outpace
growth in the GDP. Increased Money
Supply up to that point actually fuels
economic growth.
Here is a simplified example
(Figure 2). Let’s say there are two
people in an economy who wish to
trade with one another. Each one has
Figure 2: Money Supply Equilibrium
a dollar for the exchange (we will
assume that they are producing goods
or services which are then consumed).
They can both make the transaction
because they have enough money
to make the trade. They can trade as
much as they want, because there is
enough money supply in the system to
facilitate their desired transactions.
Now let’s say a third person shows
up, wanting to trade (Figure 3). But
there are still only two dollars in the
economy. The money supply is not
adequate to facilitate all the desired
 Page 16

Figure 3: Money Supply Shortage Figure 4: Inflation Equilibrium

transactions. If someone trades with

the newcomer, then he or she is
probability of inflation becomes a
has no assurance that the other two
critical factor. The principles we just
will reciprocate. In this economy,
outlined force us to ask about the
the money supply is restricting the
potential for inflation on the heels of
potential for growth.
major economic stimulus legislation
If we consider this relationship
in the form of a supply and demand Figure 5: Inflation Curve
curve, our starting point is equilibrium
(Figure 4). Demand represents the
GDP, Supply represents the Money
Supply, Price represents the value of
the currency, and quantity shows us
the point where supply and demand
meet.
Figure 5 represents an increase in
Money Supply with a stagnant GDP.
Notice that the Price, or the value of
the currency falls.
As we look to the future, with
an eye for finding opportunities in a
market that is having seizures—the

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

 Page 17

Figure 6: Money Supply (M-3), GDP, and Inflation

that will have a heavy impact on the produce and consume the same
Money Supply in combination with amount as before, then they will
recessionary slowdowns in GDP experience inflation. They can still
growth. transact with each other, but each
The chart at Figure 6 shows the transaction will now require two
average annual growth rate in both dollars instead of one. Prices have
Money Supply and GDP against become inflated.
historic inflation. The pattern is tough So, for workers, inflation is bad.
to miss. It is very reasonable, based on The same wages they were paid
these data to assume that the U.S. is prior to inflation will buy less after
headed for a period of some measure inflation. Workers have effectively
of inflation.
But wait a minute, isn’t inflation Figure 7: Inflation in the Economy
bad? Essentially, everything we buy
costs more than it used to because
we are buying it with dollars that are
worth less.
To use our example of the two-
person economic system, if we
increase money supply (sufficiently
that they have two dollars each),
but assume that they can still only

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED


been given a pay cut when they
experience inflation. (One of the
philosophical arguments around the
2009 stimulus bill is whether the
reduction in payroll taxes touted
by President Obama is sufficient to
outweigh the potential inflation caused
by injecting stimulus money into
the system, or did taxpayers just get
hoodwinked.)
So, inflation is bad for workers …
but it is not bad for everyone. Let me
explain why it isn’t necessarily bad
for the government and why they are
not rushing to take steps that would
prevent it from occurring.
10. The Gold Standard
Since the 1830s, the United States
followed the practice of establishing
a “gold standard” for its paper
currency.20 That is to say that where
historic currencies were generally
issued in coins minted from precious
metals, paper currency was “backed”
by gold and actually gave the bearer
the right to redeem it for its face value
in gold.
Effectively, the gold standard
meant that even though commerce
was conducted with paper currency,
the money supply was still tied to
gold, to the value of gold, and to the
quantity of gold in the government’s
possession. When the entire Money
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 18
Supply of the country—or rather the
amount of Money Supply required
to fuel growth by keeping up with
the GDP—was less than the amount
of gold in the treasury, the gold
standard provided an extra layer of
security behind the currency. But
once the Money Supply needed to
exceed the amount of gold bullion in
the coffers, the gold standard placed
an artificial constraint on economic
growth by limiting the Money Supply
to a resource that was naturally and
physically restricted. As soon as the
GDP equaled the amount of gold in
Fort Knox, the limited Money Supply
would begin strangling the economy
After WWII, the Bretton Woods
Agreements21 tied many currencies to
the U.S. dollar and thereby to the U.S.
gold standard. Effectively it was no
longer gold that backed the U.S. dollar
and those currencies dependent upon
it; it was the solvency of the U.S.
government and economic system. In
fact, the gold standard had actually
been briefly dropped several times in
its history, notably during wartime and
during FDR’s New Deal period. It was
finally eliminated in the U.S. in 1971
by President Nixon and with it, the
artificial constraints on Money Supply.
With the repeal of the gold
standard, the U.S. dollar became a
fiat22 paper currency, whose value

was backed not by gold, but rather
by the “full faith and credit” of the
United States of America. The ability
for the U.S. dollar to depart from the
gold standard, and to become in and
of itself the standard to which the
majority of the world’s currencies are
pegged, depends upon participants
within the system having a reason to
believe in the full faith and credit of
the U.S.
The United States offered several
compelling reasons to believe in its
currency. First, the citizenry of the
U.S. voluntarily subject themselves
to paying taxes. (Now some readers
may question how “voluntary” paying
taxes is when you are under threat of
jail or confiscation of assets if you
don’t—but the vast majority of taxes
are paid without coercion, and without
even a collection process other
than the Public Accounting service
industry.)
The second reason to believe
that the United States can honor its
obligations is that it possesses a strong
military. A strong military makes for a
strong currency, in effect leveling the
playing field so despots and dictators
cannot ply an unfair advantage by
simply taking assets from the U.S. by
force of arms.
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 19
11. The Government View of
Inflation
In theory, a government could
subsist with no taxation of its
people. The theory requires that the
government printing just the right
amount of new money supply to
keep pace with growth in GDP. That
In theory, a
government could
subsist with no
taxation …
amount of Money Supply would be
the budget allowed to the government
for executing all of its operations,
and paying for those operations is
how that Money Supply enters the
economy.
However, it takes a lot of money
to run a government—especially one
the size of that in the United States.
The government is unable to cover its
needs with only the additional Money
Supply entering the system, so they
turn to taxation. New Money Supply
and taxation still do not provide
enough for the government to pay
for all it wants to do; the country is
running a budget deficit. So, where

does it go to get the money? It
borrows it. The government sells
bonds to its citizens or foreign
governments.
By borrowing money, the
government essentially splits its
obligations between the citizens and
its creditors. Although it is good for
citizens to experience low inflation,
high inflation actually works in
the government’s favor once it has
borrowed money. It has borrowed
money at pre-inflation values, but
will be paying it back at post-inflation
values, which are less.
In order to help inflation along, the
government repays its debts by simply
printing new money and injecting it
into the system.
Sometimes this effect can be
mitigated using TIPs. Treasury Index
Price (TIP) bonds are typically
inflation-adjusted according to the
Consumer Price Index (CPI). CPI
represents the government stated rate
of inflation and this type of bond is
generally purchased at a premium.
Notwithstanding the fact that many of
the bonds used to raise money in order
to support the “bailout” acts may
have been TIPs, the point remains
that the government looks at inflation
differently than you and I, and the
economics of inflation remain intact.
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 20
12. Buffer Inflation by Moving to
Hard Assets
As I have suggested, over the next
few years it is reasonable to expect
that all the extra money injected into
the system with negative GDP will
produce inflation. Currency will be
worth less. In other words, it will
require more dollars, to pay for all of
our goods and services.
Historically, during times of
inflation wise investors try to convert
as much of their asset base as possible
to a class that is less impacted by the
inflation of the currency. And, what
is the asset class least affected by
inflation? It is hard assets.
We have discussed gold as it
relates to the gold standard. But gold
(and other precious metals) is a hard
asset. Inflation will tend to drive up
the price of gold. Another hard asset is
real estate.
In other words, when inflation
means that it takes more dollars to buy
a house tomorrow than it did today,
you want to have houses, not dollars.
Now, there are a lot of people in this
market who are terrified of real estate.
They view the real estate market as
radioactive for investors because of
the role real estate has played in so
many facets of the current recession,
be it the housing bubble, sub-prime
mortgage crisis, credit crunch, or

Figure 8: Cash versus Hard Assets
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 21
whatever. But the case I am building
is in favor of real estate investing (the
right kind, of course) in this economy.
The example of our
microeconomy ends up looking like
Figure 8. One party has a house; the
other has cash. Inflation works to
alter the balance of value between
the parties in favor of the one in hard
assets.
THE OPPORTUNITY
The true opportunity in this
market, as I see it, is in distressed real
estate.
Hang on, you say. Isn’t it the real
estate market that got us into this mess
in the first place? Isn’t it the sub-
prime mortgage crises compounded
by collateralized securities that
started this avalanche in the financial
markets? Isn’t it the folly of investors
who were burned in the Internet
bubble of the dot com era, flooding
into real estate that landed us in this
mess we are in?
The short answer is, yes. It
certainly was misguided, manipulated,
and malignant investment in real
estate that lies at the heart of the
world’s current economic woes. But,
that same crash—that same reset
from inflated values to market values
that we saw with the dot coms—is
beginning (note I say beginning)
to show itself in real estate. And
buried in that economic catastrophe
is an unprecedented opportunity. An
opportunity that represents a timely
chance to swim upstream and both
participate in and profit from the
correction.
History has kindly given us
a sampling, albeit a scaled down
version, in the 1980s and early 90s of
what to expect. Those who were in the
real estate business during this period
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 22
still refer to this period in time as “the
old RTC days.”
13. RTC
In the 1980s and 1990s, 747
Savings and Loan associations (S&Ls)
in the United States failed. It was one
of the most serious failures of the
banking system in our lifetime (yet
thin and dilute by comparison to our
current banking meltdown) and losses
totaled over $160 billion.23
In response to the threatened
failure of the banking system, the U.S.
Government formed the Resolution
Trust Corporation (RTC), which
served as an asset management
company with responsibility to
liquidate all the assets of the failed
S&Ls. These were primarily real
estate owned (REO) properties and
were valued at over $394 billion.24
The flood of real estate into the
market at rock-bottom prices caused
real estate values to fall precipitously
and housing starts to drop from 1.8
million to only 1 million between
1986 and 1991.
If you were in the real estate sales
or construction industry during this
time, you either got very creative
or found a new line of work. Yet
some, including Sam Zell,25 owner
of the Chicago Cubs and currently
boasting a net worth over $3 billion

(recently listed at #205 on the Forbes
Billionaire list)26 and Joseph E. Robert
Jr.,27 amassed great fortunes during the
“RTC days.”
14. The Eye of This Storm
Foreclosures are up everywhere.
A recent article in the Wall Street
Journal claims that at the end of
2008, 11% of all households with a
mortgage are either in foreclosure
or at least a month behind on their
mortgage payments,28 and that nearly
10 million homeowners are struggling
to make their mortgage payments.29
ABC News reported one in eight
homes were in trouble combined
with joblessness at a 16 and a half
year high.30 In May of 2008, fully
25% of sub-prime mortgages were
in foreclosure.31 And an official
report put out by the Congressional
Oversight Program (COP) claims that
“the rate of foreclosure in the U.S. is
now three times higher than at any
other time in recorded history.”32
Defaults and foreclosures are
exacerbated by high unemployment.
An article in the Washington Post
stated that unemployment in the U.S.
is currently (March, 2009) 8.1%--the
highest it has been in over 25 years.33
The same source stated that “Each of
the last three months now shows more
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 23
jobs lost than in any single month
since October 1949.”34
Joblessness is causing foreclosures
to spread beyond just sub-prime
mortgages. In fact the growth
in foreclosures has been highest
among prime borrowers.35 There
is no indication that this rash of
foreclosures will abate any time soon.
In fact, the sheer scope of the housing
bubble means that the market has a
staggering volume of foreclosures to
absorb.
There has been plenty of
government talk about taking action
to help stave off the avalanche of
foreclosures.36 Banks have been
modifying loans—sometimes on their
own, and sometimes with aid from
the government. Unfortunately there
are signs that this is only delaying
the impact of the crisis and that no
amount of tinkering is going to save
many of the mortgages slated for
foreclosure.
In remarks made before the OTS
3rd Annual National Housing Forum
in Washington D.C., Comptroller of
the Currency, John C. Dugan reported
the disturbing trend that data collected
in 2008 suggested that modified loans
defaulted at an even higher rate than
initial foreclosures.37 He reported that
within three months 36% of borrowers
had re-defaulted. Within six months

Figure 9: 2008 Redefault Rates (Source: OCC)
and eight months, the numbers were
53% and 58% respectively (Figure 9).
When Comptroller Dugan was asked
to explain his findings, he was of
the opinion that the rate was so high
“because the modifications did not
reduce monthly payments enough to
be truly affordable to borrowers.”38
The evidence suggests that
foreclosures are a necessary part of
the market reset. The evidence is also
strong that the market forces at work
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 24
are very difficult, maybe impossible,
to counter. What appears nearly
inevitable, is that we are entering
a period like the RTC era where
foreclosures will set the market price
become the dominant feature of the
real estate market—foreclosures
are set to establish the terms of the
housing market reset.

15. Buying Below Replacement
Cost
This far, we have discussed
the economics of inflation and the
indicators that point toward a period
of inflation in our imminent future.
We have addressed how the way to
protect investments from the effects
of inflation is to move them to hard
assets like gold and real estate.
Considering real estate as an option
in an inflated economy, we have
discussed how foreclosures are rising
and, as a result, prices are falling.
So, if prices are falling what makes
real estate an attractive place for
investment? How can we know that
we are buying at or near the price
floor?
I believe the true opportunity is
in distressed real estate—the very
bottom of the market. Because
foreclosures are essentially liquidated
bank inventory, the prices are dictated
by a highly motivated seller in an
increasingly competitive market.
The downward pressure on prices is
tremendous. One of the data points
that essentially communicates a
relationship with the bottom of a value
trough is the relationship between
prices and replacement costs.
We are already seeing bank
REO properties being sold below
replacement cost. In other words,
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 25
a builder could not construct the
home at cost for the sales price
of the property. This means that
market conditions have limited the
availability for new supply to enter the
market (ie. home builders do not have
an incentive to sell new homes at a
loss). Consider the basic relationship
between supply and demand. If supply
becomes constrained, demand is then
the most significant indicator of price.
The U.S. has seen some
contraction in “migration,” or the
numbers of people moving from place
to place around the country. This is
consistent with the unemployment
statistics—one of the big reasons
people move is to follow new jobs.
But, the population is still growing by
3 million people a year. These people
are going to need a place to live. What
housing do you think is going to be
snatched up first? The full-price new
homes, or the low-price leaders?
16. Conclusion
My aim in this article is more than
just outlining the economic forces that
are at work in the current economic
downturn. These principles have been
at work in the market for eons. The
truly unique thing about the factors
operating in the current recession
and the attendant opportunities is the
magnitude of it all. Sure things have

been bad before, but not this bad, for
this many people. And likewise, there
have been opportunities before, but
none this big.
Just as I survived my harrowing
experience coming face to face
with the largest bear species on
earth, investors in today’s volatile
markets can survive the gigantic
downturn by being prepared. The
key is understanding what you are
dealing with, including the underlying
economic principles and then using
that knowledge to get probability
working in your favor. At the end
of the day, knowing what is at work
in the market means nothing if you
cannot relate it to your own investing
situation.
COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED
Page 26
In my opinion, investors need to
be investing in REOs and need to be
involved in facilitating the housing
market reset by moving properties
from the banks foreclosure rolls
to a new “fair valued” market. It
is simply too big to ignore and if
you end up choosing to stay on the
sidelines waiting for the investment
opportunities you are used to, that is
okay, but I truly believe that when you
see the market play out, you will wish
that you had been a part of it. If you
are not a part of buying up these over-
sold assets, you will certainly wish
you had been. 
ABOUT THE AUTHOR
Kirby Cochran is the manager of Castle Arch Opportunity Partners, a series of real estate
investment funds specializing in REO acquisition and disposition. Responsible for hundreds of
millions of dollars worth of real estate transactions, he has served as the CEO of Castle Arch Real
Estate Investment Company for over 5 years.

Mr. Cochran is also an educator, speaker and thought leader in the fields of management,
finance, and real estate and is a leading expert on capital structure and shareholder value. He has
been teaching new venture financing and entrepreneurship to graduate students for over a decade.
Kirby currently serves as an adjunct professor in the Finance department of the David Eccles
School of Business at the University of Utah.

In his new series of articles entitled Leadership Insight, Mr. Cochran makes sophisticated
investment methodologies used by successful investors, accessible to novice and intermediate
investors with his pragmatic approach to communicating in plain English. This information has
always been difficult and painful for investors to acquire, found only in the ruthless university of
experience and obtained through costly tuition at the school of hard knocks.

ACKNOWLEDGEMENTS
Chad Jardine, my close associate and friend, was responsible for much of the leg work and
physical writing of this article. His contribution allowed the principles and practices of my real
estate investing process to come to life in book form and bring my insights, personal experiences
and unique “voice” to a new audience via the printed page.

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

1. Yahoo! Finance. 2009. Dow Jones Industrials. http://finance.yahoo.com/q?s=^DJI&=
2. Yahoo! Finance. 2009. S&P 500. http://finance.yahoo.com/q?s=^GSPC
3. Note: See the article in the Leadership Insight series titled Anatomy of a Meltdown for a more
thorough treatment of how the markets built up to the crashes of September and October
2008.
4. Note: See the article in the Leadership Insight series titled The Psychology of Investing for an
in-depth look at how psychology affects investment decisions.
5. Wikipedia. 2009. Adam Smith. http://en.wikipedia.org/wiki/Adam_Smith (accessed Mar 13,
2009.)
6. Skousen, Mark. 2007. The Big Three in Economics: Adam Smith, Karl Marx, and John
Maynard Keynes. New York: M.E. Sharpe, Inc. p.4
7. Library of Economics and Liberty. 2009. Mercantilism. http://www.econlib.org/library/Enc/
Mercantilism.html
8. Roberts, Dexter. 2009. Business Week. China Worried After Lending ‘Huge Amount’ to U.S.
Mar 9, 2009. http://www.businessweek.com/globalbiz/content/mar2009/gb20090313_131621.
htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis (accessed Mar 17,
2009.)
9. Wikipedia. 2009. John Maynard Keynes. http://en.wikipedia.org/wiki/John_Maynard_Keynes
(accessed March 17, 2009.)
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2009.)
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congress/bill.xpd?bill=h110-5140 (accessed Mar 18, 2009.)
12. U.S. Department of the Treasury. 2008. Emergency Economic Stabilization Act. http://www.
treasury.gov/initiatives/eesa/ (accessed Mar 18, 2009.)
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breitbart.com/article.php?id=081216215816.8g97981o&show_article=1 (accessed Mar 19,
2009.)
14. The Wall Street Journal. 2009. Obama Signs Stimulus Into Law. February 18, 2009. http://
online.wsj.com/article/SB123487951033799545.html (accessed Mar 18, 2009.)
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public_review/ (accessed Mar 18, 2009.)
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templates/story/story.php?storyId=101117656
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Mar 2009. http://online.wsj.com/article/SB123785266231219605.html
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of Economics and Liberty. 2002. http://www.econlib.org/library/Essays/hykKnw1.html
(accessed Mar 18, 2009.)

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

19. Note: see the article in the Leadership Insight series titled The Psychology of Investing for a
more in-depth treatise on this topic.
20. Wikipedia. 2009. Gold Standard. http://en.wikipedia.org/wiki/Gold_standard (accessed Mar
16, 2009.)
21. Wikipedia. 2009. Bretton Woods System. http://en.wikipedia.org/wiki/Bretton_Woods_
Agreement (accessed Mar 18, 2009.)
22. Wikipedia. 2009. Fiat Currency. http://en.wikipedia.org/wiki/Fiat_currency (accessed Mar 25,
2009.)
23. Wikipedia. 2009. Savings and loan crisis. http://en.wikipedia.org/wiki/Savings_and_loan_
crisis (accessed Mar 16, 2009.)
24. Wikipedia. 2009. Resolution Trust Corporation. http://en.wikipedia.org/wiki/Resolution_
Trust_Corporation (accessed Mar 16, 2009.)
25. Wikipedia. 2009. Sam Zell. http://en.wikipedia.org/wiki/Samuel_Zell
26. http://www.forbes.com/lists/2009/10/billionaires-2009-richest-people_The-Worlds-
Billionaires_Rank_9.html
27. McManus. Real Estate Forum. 2009. http://www.reforum-digital.com/reforum/200901/?pg=31
28. Hagerty, James R. 2009. Overdue Mortgages Increase. The Wall Street Journal. 6 Mar 2009.
http://online.wsj.com/article/SB123630052006746901.html#pr...3/6/09
29. Williamson, Elizabeth and Ruth Simon. 2009. Plan to Cut Foreclosure Rate Clears
Key Hurdle. The Wall Street Journal. 9 Jan 2009. http://online.wsj.com/article/
SB123144562914865337.html
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Mar 2009. http://abcnews.go.com/Business/Economy/wireStory?id=7013689
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mortgage_crisis
32. International Property Investment. Weblog. 9 Mar 2009. http://
internationalpropertyinvestment.com/elizabeth-warren-says-u-s-foreclosure-rate-threatens-
entire-economy
33. Wilgoren, Debbi. 2009. U.S. Unemployment Rate Jumps to 8.1 Percent. The Washington Post.
6 Mar 2009.
34. Ibid.
35. Reckard, E. Scott. 2008. Foreclosures, delinquencies skyrocketing among ‘prime’ borrowers.
Los Angeles Times. 24 Nov 2008. http://articles.latimes.com/2008/nov/24/business/fi-prime24
36. Luhby, Tami. 2009. Obama foreclosure fix open for business: Federal officials release details
of $75 billion loan modification and refinancing programs. Borrowers can start contacting
loan servicers. CNN Money.com. 4 Mar 2009. http://money.cnn.com/2009/03/04/news/
economy/guidelines/
37. Dugan, John C. 2008. Comptroller of the Currency: Administrator of National Banks.
Remarks. 8 Dec 2008. http://www.occ.treas.gov/ftp/release/2008-142.htm
38. Ibid.

COPYRIGHT © 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

Castle Arch Lease-To-Own Income Fund: Executive Summary, March 3, 2009

12
© 2009 Castle Arch Real Estate Investment Company, LLC