This morning, we’ll get accelerated earnings announcements from Citigroup and Bank of America. They basically have to do this because the whispering and the uncertainty about both enterprises is starting to get really hard to ignore.
And BAC just became the recipient of a government-assistance deal much like what Citi got in December: $20 billion in new preferred equity, and a guarantee of $118 billion in bad assets.
This ad-hoc approach to dealing with bank near-failures has become the new normal. At some point very, very soon, regulators will have to decide how small a bank has to be before it can simply be allowed to go out of business.
You have to figure the answer is something like: “If there’s a bigger bank available that we can merge this piece of garbage into, then we’ll fail it. If there isn’t, we’ll nationalize it.
Very reminiscent of Japan in the early Nineties, what obviously isn’t being considered is to simply let banks fail altogether, under the weight of large clumps of toxic assets. But the way we’re doing this really isn’t that much different, as the equity of “rescued” or “assisted” banks goes more or less to zero.
Of course, it remains to be seen whether the ad hoc-bailout model will result in major transfers of taxpayer wealth to stakeholders of assisted banks (either the debt or the equity). One suspects the answer to this question will not be no.
Clearly, for all the hand-waving over the economic recession, we still haven’t solved the deep and worsening banking crisis that was the trigger for the recession in the first place. There is talk that we need to add more than another trillion dollars’ worth of “assistance” (in effect, new equity) to American banks.
(It just astounds me to be throwing these numbers around as it they were normal. Not too many months ago, a billion dollars was an awful lot of money. Now it’s more like a penny: something you add up a lot of, to get something more useful. The very fact that we’re talking this way has an eerie effect of making clear something that many people underappreciate: money has no reality in the first place. It’s all just computer blips. When this knowledge finally sets in among non-finance types, who knows what it will do for consumer confidence?)
All of this distress is actually the residue of the collapse of the housing bubble. The vast reduction in housing values has to go somewhere. It’s getting split between the public and the banks.
The fact that many people now own an asset that’s worth considerably less than they paid for it affects consumer behavior, and over many years it will necessarily act as a drag on consumption (and economic growth). This effect is a “hidden” one, because its impact is mostly indirect.
But the effects on the banking system are immediate. The assets resulting from writing mortgages that are now worth much less than par, impairs bank balance sheets and capital ratios now. There is a lot more banking crisis yet to come.
The talk now is that the original TARP proposal (purchasing mortgage and other asset-backed securities at an overvaluation) needs to be revisited.
And the tenuous arguments in favor of this idea are considerably stronger now than they were back in September.
Basically, have the Fed and/or the Treasury establish something that, in blog postings last September, I called the “First National Bad Bank of the United States.” This entity would establish a one-way secondary market for impaired assets that banks would like to get off their balance sheets.
There’s a huge technical problem with determining the purchase prices, and it might be interesting to create a quasi-hedge fund structure so that some smart but underemployed Wall Streeters can get rich finding the right prices. But whatever those prices turn out to be, they will have to be much higher than current market.
In this way, we’ll recapitalize the banking system with fresh public equity. How do you avoid saving the bacon of a lot of current bankers and debtholders? You don’t. You just accept that the biggest moral-hazard-creating event in world history is preferable to not having a banking system at all.
(Will there be a cost to this, in efficiency and returns to capital from private industry? Oh yeah, baby, you’d better believe that. And consequently you’d better avoid buying into the stock market for a lot of years to come.)
But let’s get down to brass tacks. Where will the equity of the First National Bad Bank come from? And what will its business model be?
Well, the last time I checked, the five-year US Treasury rate was a big, big, big 1.5 percent. Back in September when I first did this analysis, it had a 3 handle, if memory serves. The cost of funding this venture from the world’s investors has become damned attractive.
And this makes a lot of sense. Since September, a deep global recession has started that is freezing private investment and adjusting capital flows all over the world. There’s a huge amount of money out there that’s readily available for a systemic bailout of American banks.
Let’s go out there and get that money. The business model would be to charter an institution that would issue debt on a full-faith-and-credit guarantee, possibly with an agency-like imprimatur that would generate a few exra basis points of yield. It would be used to buy up maybe half a trillion dollars’ worth of asset-backed paper from banks, and simply hold to maturity. (That’s why I’m thinking of a three-to-five year term structure for the financing.)
As with a hedge fund, the point would be to capture the risk-adjusted yield from the asset portfolio and repay the investors. Risk is simply the credit risk of the portfolio, because the purchases would be non-leveraged. (The low cost of capital makes this possible.)
Downsides? Well, there’s the moral hazard of course. The banking system will never return to full-normal because everyone will know how rigged and nationalized it is. This effect will last for at least a generation. More than a generation, if the textbooks start getting rewritten to reflect a new dogma that private enterprise doesn’t really work in banking.
More practically, the downside is that the global capital that gets into this won’t be available for private investments until after the run-off period. We’re looking at tying down hundreds of billions of dollars in equity capital for a duration that will probably stretch out to three or four years.
But you’ve already been getting used to the idea of a New Great Depression to go along with Obama’s New New Deal. Haven’t you?
Moe Lane
Steve Maley
KnightsofMalta
Dan Spencer
Dan McLaughlin
I'm Not An Expert By Any Means
Bourbeau Friday, January 16th at 7:45AM EST (link)But I can tell you this:
a. The banking system, particularly the large banks, are in significantly worse shape then we’ve been led to believe. It’s been almost a year that this problem has been balooning and they still don’t have their arms around it. If they don’t understand it, what chance is it that Chris Dodd, or Barney Frank undestand it..
b. This economic downturn is dramatically worse than anything we’ve experienced, simply because of the complexiity of our economy, the lack of understanding by the regulators and their failure to regulate, and the insane consumer driven orgy that’s gone on ove the past decade plus Add to this, the incompetence of the Congress, their inability to move quickly and decisively, and we’re in deep, deep trouble.
c. The politicians are doing what they always do – grabbing money; and they are grabbing so much of it now, it has become obscene. Wose yet, to date, it’s not working. A quick look at the list of goodies in the bailout package is enough to make you gag. Worse yet, no one asks the simple question – how long will it take for any action they take too get into the system? The system needs a major overhaul now, yet it’ll take a year or two for this to work itself out and they all act like it’ll be fixed tomorrow. We all forget one simple fact: government can’t fix anything – they invariably make it worse.
Two decades ago, when Japan’s financial system collapsed, the Japanse were criticized for mishandling the corrective action. The the U.S. experts said that a problem like that could never occur here, we were smarter. They said, our financial system of regulations and oversight were too strong to allow anything of that magnitude to occur. Really? I wonder where those expets are today, and more importantly, what they’re saying. I guess the only two factors not accounted for in the U.S. model were greed and stupidity; moreover, we seem to be falling back on those very two factors to fix it.
One difference between the early 90's and today is the concentration in fewer banks
6eorge Jetson (Diary) Friday, January 16th at 8:23AM EST (link)There’s always an unforeseen correlation problem when everybody does the same thing, and the number of very large banks makes that more of a problem.
Citibank is the biggest contributor to Obama's Inaugral Committee
Scope (Diary) Friday, January 16th at 7:59AM EST (link)http://www.newsmax.com/insidecover/citibank_obama_donors/2009/01/15/171703.html
Everyone take a look at the link above
Jack_Savage (Diary) Friday, January 16th at 11:41AM EST (link)It is important.
Looks like they should have been minding the store instead of sucking up to Obama.
What if after some period of stabilization,
6eorge Jetson (Diary) Friday, January 16th at 8:18AM EST (link)the claims of the First National Bad Bank were securitized and sold off?
Further, as to the banking system, I think the public would be well served if somehow the distinction between maximizing return (and the resulting allocation of capital) and risk management were explained.
It would take some political will, but after a period of recapitalization, an increased number of smaller banks IMO would reduce systematic risk. More capital allocating decision-makers would reduce the correlation of those decisions, somewhat in their views on the choice of asset classes, but especially in the degree of leverage chosen. But today’s large banks will have to be split up into chunks to get there, and I’m no expert on the legalities or shepparding the political will to do it.
As an aside, I’ll finish by framing my view of the proper role of govt
Why bother?
Francis Cianfrocca (Diary) Friday, January 16th at 8:20AM EST (link)Most of the portfolio will run off after three years. By five years, it’ll be almost all gone.
Ahh...and I suppose it depends on what price is paid
6eorge Jetson (Diary) Friday, January 16th at 9:24AM EST (link)for those assets, but I’d like to see less concentration in the mega-banks afterward.
I'd like not to have metastatic cancer and multiple amputations
Francis Cianfrocca (Diary) Friday, January 16th at 10:20AM EST (link)The world of banking is so completely different now from what it was twelve months ago that there’s just no comparison. The past was a dream.
It might have made sense to want less concentration in mega-banks back then, but now I don’t even really know what makes sense.
Question
VanishingNYRep (Diary) Friday, January 16th at 8:29AM EST (link)Dear Mr. Cianfrocca:
Isn’t your idea and the original TARP proposal similar to the Resolution Trust Company created by Bush 41 in the early 90s? Didn’t the RTC take the assets of the failed S&Ls, run them for a while, foreclose them and then finally dump them in early 92?
I was in banking in the 90s and the TARP seems very familiar to the RTC plan. I wonder what you opinion is.
At a very high level, it's a similar idea
Francis Cianfrocca (Diary) Friday, January 16th at 9:22AM EST (link)One difference is that I wouldn’t try to find buyers for the assets. Another difference is we’d frankly be buying out the assets at an overvaluation.
The idea isn’t to close down a lot of dead banks and clean up the mess. It’s more to keep a lot of teetering banks (including some very large and systemically important ones) from going over the edge.
It’s obviously not the way you’d want to do business if you had a choice. You being an RTC veteran, I’d like to hear your comments.
Do the bad assets have to actually come off the balance sheet?
ReallyBored Friday, January 16th at 12:42PM EST (link)Would it be possible to, instead of chartering a new bank, charter an entity that would underwrite some baseline partial insurance policy on the bad assets? So the gov’t guarantees some minimum portion of the coupon and final payments from the bad securities, setting a floor on the asset value. If the asset holder wants, they can purchase some additional guarantee (should be reasonably cheap, as the gov’t has a low cost of capital and is really only looking to break even). It would require a lower total cost, as the gov’t would only have to set up the PV of the future costs and hold a reserve against possible payments, rather than having to overpay for the assets directly.
You have to get the assets off the balance sheet
Francis Cianfrocca (Diary) Friday, January 16th at 1:03PM EST (link)Otherwise, your balance sheet is just as big as before, and you can’t start lending money again (which is an asset-creating, balance-sheet-expanding activity).
The other way to make room on the sheet for more assets is to raise new private equity. The Treasury figured it could catalyze that process with the direct purchases of preferred stock, but that didn’t work.
Eh, good point.
ReallyBored Friday, January 16th at 1:32PM EST (link)Wouldn’t removing a significant portion of the bad asset risk spur private equity infusions, though?
This could work
jonathanswift (Diary) Saturday, January 17th at 12:59PM EST (link)Part of the problem is that derivatives are not necessarily “bad” investments but that they are “undefined” (in a mathematical sense) investments due to how the instruments were created. As some could “pay off,” they are not a bad risky investment.
There's only one thing I'm really "pretty sure" about
mbecker908 (Diary) Friday, January 16th at 9:11AM EST (link)right now.
In major real estate markets (SoCal, NorCal-Bay Area, AZ, NV, FL) we’re not close to the bottom of the market yet. CA especially. The idiots in the CA Legislature passed a bill extending the foreclosure processing time by several months last year. They, and the idiots who run the Real Estate associations, were blathering like crazy in the third and fourth quarters last year about the reductions in the number of Notices of Default – the initial step in the foreclosure process. Then December came and guess what? December’s NoDs were double Nov. And 50% higher than Dec 2007. Oopsie.
Oh, and the largest chunk of Option ARM adjustments are due to hit this year. That’s huge for SoCal and the Bay Area.
Oh, and did I mention commercial real estate values and CRE financing sucks?
The fed can print money till Hell freezes over. That won’t make a house that was sold in 2006 for $650,000 and is now valued at $350,000 worth more money or sell for more either. Plus, in major markets REO properties typically account for up to 50% of home sales.
This will be a long, rocky ride.
I think policymakers are going to do more long-term damage...
Francis Cianfrocca (Diary) Friday, January 16th at 9:26AM EST (link)..,by pretending that housing values are higher than reality would suggest. And then enacting policies to try to make the fantasy real.
That’s what’s behind Barney Frank saying that the second half of the TARP should be spent by Obama in “more appropriate ways.”
He really does want to use it to prevent foreclosures, which means the market won’t clear and we can’t start the healing process.
Stupid.
I absolutely agree with you Francis...
mbecker908 (Diary) Friday, January 16th at 9:53AM EST (link)At one point early last year in a discussion about “how long will it take…” I noted that we are in for a very, very difficult five years in both RE and credit market if the feds stayed out of it and more likely ten years if they got involved. I’m guessing ten. Or more.
As of right now, in the major housing markets, banks are taking back 95% of all property auctioned and about 50% of home sales is coming out of REO inventory at REALLY depressed prices. For instance, in big parts of Phoenix – the Northwest and Farwest Valley areas – houses that were selling in 2006 for $200-$250sf are resales at $85-$125sf, and going down. New home subdivisions are a thing of the past.
The fed can print money but they can’t print equity. And until we get to a point where housing prices have bottomed and start to move up again (and they will move slowly) we’re not going to see home resales because right now the only way most people could sell their home is if the bank agreed to a short sale, and while those are already available in large numbers it doesn’t do anything for the seller. They typically can’t buy a new house because they have no down payment and the short sale will be recorded and will not be looked upon with favor by a new lender. Oh, and did I mention the tax consequences of a short sale? If you lose your home in a foreclosure there are no tax consequences if the home sells for less than the loan amount. Not necessarily so with a short sale. The lender can issue you what is essentially a 1099 for the difference between your loan balance and what they agree to accept and you get to declare the difference as income. And have a debt to IRS to the tune of about 30% of that number that is NOT dischargable in a BK.
I’m sorry, I’m rambling. I’m also pissed that guys like Barney Frank and Chris Dodd, who don’t have the mental wherewithall to come in out of the rain, are the geniuses who are going to draft the legislation to “fix” this mess. I’m planning on living a really long time but I’m not sure I’ll live long enough to see the end of this one.
"The Fed can print money, but can't print equity"
Francis Cianfrocca (Diary) Friday, January 16th at 10:22AM EST (link)I like that line a lot. I’ll credit you when I use it.
mbecker, a clarification
Jack_Savage (Diary) Friday, January 16th at 10:59AM EST (link)When you say that banks are taking back 95% of all property auctioned, you mean that the minimum bid is theirs, the minimum bid is for what the borrower owes, and no one bids higher – right? The property is then put into the bank’s REO.
Question, pretty please – how is the REO property disposed of? Does it go through a regular process, like being listed for a certain period of time, then auctioned? Would I need to contact a local bank and ask for REO properties? Seems like they would want to keep that a big secret, but it would also prevent them from selling quickly to people like me.
I have bought a few from HUD, the VA, and at auction but I have never gone the REO avenue…
You've got the meaning right
JoeG Friday, January 16th at 11:12AM EST (link)If there are no buyers willing to pay what’s owed, the bank holding the primary will show up on the courthouse steps and pay what’s owed on the mortgage plus the back property taxes. Any other lean holders, they’re out of luck.
The bank will send a crew in to clean out the house, then it goes on the market with a real estate agent.
OK
Jack_Savage (Diary) Friday, January 16th at 11:37AM EST (link)So after the sale on the courthouse steps, the property is free and clear. How long are the REO’s normally listed by the RE agent? How long do banks want to keep them on the books?
Sort of what JoeG said.
mbecker908 (Diary) Friday, January 16th at 12:34PM EST (link)With respect to the opening bid, it doesn’t have to be the outstanding note balance plus fees, it can, and is frequently, significantly less. The lender may take $50 or $100K off the balance as an opening bid, and still they are getting no takers.
As far as listing, the lender inspects the property, changes the locks and puts the property on their REO list. It goes on the REO list instantly, everything else takes time. If the property was an investment property it may still have tenants in it and they will be evicted. It will go to a realtor at some point, but there is generally no rush – or so it seems – and the property resides on their list typically for months. The reason REO hangs on forever is the offer/counteroffer process takes forever.
OK - thanks
Jack_Savage (Diary) Friday, January 16th at 1:05PM EST (link)A few things come to mind:
1) Bankers just don’t seem to be all that smart these days
2) If I was suddenly in the real estate business, like banks are, I would either get into the real estate business, by golly, or get the hell out. This no man’s land of REO properties is insane, and doesn’t seem to help clear the market in a timely fashion at all.
3) If I were a banker, I would short sale everything I could (if the borrower were in trouble) and write a personal loan for the balance. Screw it. I would do this only for individuals, but it just seems so preferable to the foreclosure / auction / REO route. If the personal loan doesn’t get paid, then drop the hammer on their credit, but not until then. It becomes more of a win for the borrower.
4) If the banks are opening 50-100 K less than the loan amount and still getting no takers, this is far worse than I thought, and people are upside down to a point that is ridiculous.
Thanks.
What is the major downside of letting inflation solve this problem?
CrabCakes (Diary) Friday, January 16th at 9:58AM EST (link)It seems to me that propping up home prices while printing enough money to allow inflation to rise at a higher than usual rate might take some of the pressure off the housing market. I’m not talking about crazy Zimbabwe rates, but higher than we’re used to.
If this were done properly, home prices could remain stagnant, but their values would be allowed to drop.
What’s the downside to letting inflation do the dirty work for us?
That's pretty much what we're doing
Francis Cianfrocca (Diary) Friday, January 16th at 10:27AM EST (link)The problem (ignoring moral hazard, which no one seems to care much about anymore) is misallocation of resources.
The housing bubble misdirected an ungodly amount of capital into an industry (housing) that didn’t need it. If you try to inflate selectively so that housing values don’t fall to reflect reality, you’re sucking more and more capital right into the black hole.
And if you really are talking about Krugman-style or Zimbabwe-style hyperinflation (where there’s no expectation of a return on the misdirected capital), then you’re also talking about displacing consumption as well as capital.
What if salaries don't keep up with inflation?
csstudent Friday, January 16th at 11:56AM EST (link)I think the biggest risk of allowing inflation to rise to catch up with home prices is if salaries don’t keep up with inflation. If inflation starts running at 10-15% per year and I don’t get that kind of pay raise what will my reaction be? I can either put it on a credit card(which will happen on a cold day in you know where) or cut back on my spending.
I believe that one of the underlying causes of this problem and the reason house prices have to fall is that wages didn’t keep up with real estate prices. If house prices are going up 25% and your salary went up 5% and this pattern continues, you have a real problem on your hand. Without having low teaser rates, ninja loans, etc you wouldn’t have been allowed to get the house.
I believe the better approach is to simply let house prices fall to a level that people can afford. This will hurt people financially. However, I also believe it can benefit people too – for example, first time home buyers. This belief is also one of the reasons I wanted to throw something at my tv when I heard McCain talk in one of the debates about how important it was to prop up home values.
I also agree witih Francis that this path leads to a moral hazard as well which doesn’t seem to be discussed anymore.
Salaries?? Who will have a job left?
izoneguy (Diary) Friday, January 16th at 12:04PM EST (link)I am worried about how to get food once the whole system crashes.
I don’t think we will have to worry much about inflation.
The point cannot be made often enough: Modern liberalism, as embodied in the Obama presidency, is the defender of the status quo. And the status quo is a road to economic ruin. Political forces cannot redistribute the wealth that the economic system does not produce.
I agree.
csstudent Friday, January 16th at 12:12PM EST (link)I agree – I was just trying to point out why simply trying to print money and hoping for inflation isn’t a good solution.
You are right
izoneguy (Diary) Friday, January 16th at 12:38PM EST (link)“Get ready for the 4 worst years in American history”
You can quote me on that and let me know if I was right
on Jan 20th, 2013
I will be in hibernation starting Jan 19th, 2009
Thank God I just got a PS3 for my 50th BD and
a new subscription for NetFlix.
See you all on the other side as I go stock up on Jack Daniel’s.
Cheers!!!
The point cannot be made often enough: Modern liberalism, as embodied in the Obama presidency, is the defender of the status quo. And the status quo is a road to economic ruin. Political forces cannot redistribute the wealth that the economic system does not produce.
Will you have a country left
jonathanswift (Diary) Saturday, January 17th at 1:10PM EST (link)at the end? Wiemar and Zimbabwe don’t look like good models in that sense.
If you're a homeowner, it's essentially the same thing.
CrabCakes (Diary) Friday, January 16th at 2:48PM EST (link)If inflation takes off and your buying power is reduced, you take a financial hit. On the other hand, if your home value drops, then you also take a financial hit.
The difference is that if your home value drops to a level below what you owe, the only logical thing to do is to mail the bank. Hell, if my home’s value dropped to below $190k, I’d stop making payments tomorrow and start looking for apartments.
Once folks start doing that at a high enough rate, home values drop even faster, resulting in more folks being underwater, more keys being mailed to the bank, etc.
People are going to have to take a hit somewhere, the the question is how to minimize the snowball effect.
Of course, an inflation hike without a salary hike will result in decreased demand, which will result in a decreased demand for labor and therefore lower salaries, which will result in a decreased demand, etc., which introduces a snowball of its own. One would hope, though, that the stabilization of property values would calm the economy, keep demand up, and allow salaries to increase as inflation takes off.
mail *the keys to* the bank
CrabCakes (Diary) Friday, January 16th at 2:50PM EST (link)nt
I'm not sure it's the same thing.
csstudent Friday, January 16th at 3:53PM EST (link)‘The difference is that if your home value drops to a level below what you owe, the only logical thing to do is to mail the bank. Hell, if my home’s value dropped to below $190k, I’d stop making payments tomorrow and start looking for apartments.”
I’m not sure this is correct. Let’s say that I bought a house a few years ago using a 30 year fixed rate mortgage. It appraised for $250k and that was also the purchase price. Since it’s early in a 30 year mortgage, I essentially still owe about $250. Now the housing crisis hits and my house value plummets 50% so it’s worth $125k.
In this scenario, on paper, you have lost a lot of money. But I think this ignores the idea that over the long term house prices will go up. This is the same thing with the stock market. My 401k and private investments have been taken a huge hit over the past few months. If I got out now, I’d lose a lot of money and I’m confident enough that over the long term, these investments will go up in value.
The key difference is that you don't eat the loss if you walk; the bank does.
CrabCakes (Diary) Friday, January 16th at 7:41PM EST (link)If you sold out of your portfolio right now, you’d have to sell out at market price. You don’t have the option not to take the loss at all with stocks.
Your house is different, since the bank put up the money for the house. If you walk away, the bank takes the loss. It would be like if someone loaned you money for a stock, you bought the stock, the stock tanked. You could either a) keep paying the loan back or b) hand the guy the (now worthless) stock you bought with his money.
In other words, I’m not talking about selling the house at a loss. I’m talking about letting the bank take the loss. The only loss you take is any equity you already have in the house, and if you are currently upside down in your mortgage, that equity is has already been wiped out.
The downside of walking away is that your credit takes a serious hit, and you probably can’t buy another house for a few years. The upside is that there’s a decent shot that you’ll be able to buy a house very similar to the one that you owed $250k on for $150k in five years. In addition, you’d have the extra money that you would’ve been shelling out for your mortgage (since renting is a cheaper monthly payment) that you could sock away to save up a decent down payment.
I can see no reason that anyone who is currently upside down in their mortgage by more than $20k should continue to pay their bill. Mailing the keys to the bank and letting them have the place is a smarter financial decision.
Why?
jonathanswift (Diary) Saturday, January 17th at 1:11PM EST (link)You still have a house and the Bank now has an incentive to talk to you about your loan.
Additionally, you still have the tax benefits of ownership, etc.
"Ninja Loans"
jonathanswift (Diary) Saturday, January 17th at 1:08PM EST (link)Someone told me most of the “Ninja Loans” went to people who were employed in the “underground” economy or people who were “straw men” for overseas speculators. Any truth to this?
So the Housing Crash WAS a Bush tactic to bankrupt the Blue States ;)
6eorge Jetson (Diary) Friday, January 16th at 9:52AM EST (link)There’s a silver lining in everything
Other than Az and Fl
JoeG Friday, January 16th at 11:14AM EST (link)it is hitting pretty much the blue states.
Who in there "right" mind would move to CA right now?
izoneguy (Diary) Friday, January 16th at 10:04AM EST (link)My parents lived there in the upswing of the late 80′s early 90′s.
My Dad could not wait to get out. They did quite well and then moved
to NV for 5 years. They finally came to their senses and are now retired living in central Texas.
Kalifornia business’s are leaving and I don’t see a big rush of new companies & jobs to full the void. For all intensive purposes Kalifornia has seen it’s heyday and it is all downhill from there. Of course you will still have an elite core of business’s that will never leave Kalifornia, but at the end of the day it will be a state of stark contrast bewteen the have’s and have not’s.
The point cannot be made often enough: Modern liberalism, as embodied in the Obama presidency, is the defender of the status quo. And the status quo is a road to economic ruin. Political forces cannot redistribute the wealth that the economic system does not produce.
I think the interest
jonathanswift (Diary) Saturday, January 17th at 1:01PM EST (link)rate reduction will help somewhat with commercial defaults.
Not much, if at all.
mbecker908 (Diary) Saturday, January 17th at 1:21PM EST (link)First of all, mortgages tend to be keyed on LIBOR more than prime and the fed can mess with the interbank rates till hell freezes over and it has pretty much no effect on LIBOR.
Second, there’s just darn little money around to be lent on real estate, period. Unless you can prove you don’t need it (banker joke).
Third, commercial real estate is more sensitive to business cycles than residential RE. CRE does really well in times of business formation and expansion, cap rates go up, investors gobble up available space and rent to new/expanding businesses. And in about the middle of that cycle, in comes the developers who start building more commercial space to take advantage of the boom (that will, of course, last forever). New space hits the market and a little while later the business expansion cycle slows down, reducing demand etc.
We’re not even close to the bottom of the current business cycle. I don’t know where you live, but in Phoenix we’ve got lots of empty manufacturing/warehousing space (very large buildings), and strip malls with empty spaces that have been that way for 12+ months and no hope of filling them any time soon. There’s a strip mall half mile from my house with two empty fronts (very nice space, BTW) that were realtors 18 months ago. There’s also three other empty fronts where service business were, and an empty ustabe supermarket that, rumor has it, will finally be about half rented to a new Fresh ‘n Easy store sometime in the second quarter. That one’s been empty for three years.
Commercial RE is most likely to get much worse before it gets better simply because nobody is forming/expanding business in the major RE markets.
BTW, if you’d like to own a city, in another year or so you can probably get a good deal on Detroit. (Although I will admit that “good deal” and “Detroit”) is an oxymoron.
My experiance is that
jonathanswift (Diary) Saturday, January 17th at 2:19PM EST (link)commercial leases are also usually easier to renegotiate and that commercial loans are also easier to “work out.”
I think a lot of rents are going to drop and a lot of loan terms are going to get more generous because, “an empty house” isn’t necessarily “better than a bad tenant.”
All of this adds to deflation of course, but that may be where this needs to go.
True, but...
mbecker908 (Diary) Saturday, January 17th at 2:26PM EST (link)You can’t “work out” a loan or a lease with a company that is out of business and that’s where we are in the cycle. And, at least in the markets I’m familiar with, demand is about zero.
Not really with
jonathanswift (Diary) Sunday, January 18th at 2:21PM EST (link)a lot of commercial businesses in malls. Demand is down, but not out. Discounters are doing well.
We need to deal with Barney Frank in “more appropriate ways.”
izoneguy (Diary) Friday, January 16th at 9:33AM EST (link)That man has done more damage to American housing than just about anyone else.
Hey, Hey, Ho, Ho, Barney Frank has got to go!!
Hey, Hey, Ho, Ho, Barney Frank has got to go!!
The point cannot be made often enough: Modern liberalism, as embodied in the Obama presidency, is the defender of the status quo. And the status quo is a road to economic ruin. Political forces cannot redistribute the wealth that the economic system does not produce.
...or for Treasury appointee Tim Geithner...
6eorge Jetson (Diary) Friday, January 16th at 9:45AM EST (link)Tax Evader !!!!! CLAP, CLAP, clap-clap-clap
my parents live in MA-04
MGamo (Diary) Friday, January 16th at 10:49AM EST (link)and i would love to move back there to run against him, but a conservative republican in that district is viewed as satan, and Frank is their angel.
“A man who never quits is never defeated.” – Fred D. Thompson
That right there
itrytobenice (Diary) Friday, January 16th at 11:02AM EST (link)says a lot about the D party. I’m not sure if they are only our political opponents. The fact that they re-elect Frank may mean that they are our enemies.
Proper grammar saves lives.
Let’s eat Grandma.
Let’s eat, Grandma.
The fact that they re-elect Frank may mean that they are our enemies.
izoneguy (Diary) Friday, January 16th at 11:04AM EST (link)Yes, Yes, Yes!!!
The point cannot be made often enough: Modern liberalism, as embodied in the Obama presidency, is the defender of the status quo. And the status quo is a road to economic ruin. Political forces cannot redistribute the wealth that the economic system does not produce.
Another downside besides the moral hazard...
itrytobenice (Diary) Friday, January 16th at 9:48AM EST (link)We’re going to have moron politicians making operating decisions about an enormous US National Bank.
Just imagine if Barney Frank was President of the New York Fed and Chris Dodd was the Chairman of the Federal Reserve Bank. And when you quit retching, add the other board members, Barbara Boxer, Charlie Rangel, Jessie Jackson Jr., Chuck Schumer, John Kerry, Joe Biden, and Bernie Sanders.
If consumers were intelligent, our consumer confidence index should be around 6. And only that high because Tom Coburn, Jeff Flake and a few others exist.
Proper grammar saves lives.
Let’s eat Grandma.
Let’s eat, Grandma.
Bingo
Francis Cianfrocca (Diary) Friday, January 16th at 10:29AM EST (link)n/t
I crave the "bingo" from Francis
Jack_Savage (Diary) Friday, January 16th at 10:53AM EST (link)Nice work, itrytobenice.
And FWIW, my consumer confidence level IS around 6.
That high, Jack Savage? You optimist, you!
janis (Diary) Friday, January 16th at 10:58AM EST (link)Mine’s somewhere around -10, much like the weather these days.I know at least 4 close friends who had their own small businesses and chose to close or retire rather than to keep swimming upstream against a bear of a current. All of them are everlastingly grateful that they made the choices they did this past year.
I am a bit of a pollyanna, I know
Jack_Savage (Diary) Friday, January 16th at 11:24AM EST (link)If you will indulge me, I have some personal stories related to this whole crisis I will quickly share.
For the past several years, my brothers and I have bought distressed properties and rent or sell, depending. One or two a year, sweat equity, not a big deal. We know to the dollar what the properties are worth and what the rental market is. The purchase price + renovations never got above 70% of market value – not appraised value, market value. About three years ago, several of our renters left. When I asked my brother why, he said, “They’re BUYING.” We required credit apps from everyone, so I knew what their finances were like, and most of them were barely able to rent from us. And now they were BUYING? To add to that, they were buying in the same neighborhood for prices that were 80 – 140% higher than market value. Appraisers were playing ball and banks didn’t care – Red flag #1.
The Democrats won in 2006 – Red flag #2.
Last year I was geting stock tips from people I met in MailBoxes, Etc – Red flag #3.
I am in commercial construction, so I am privy to vacancy rates and other info most people don’t care about. Our product is also used in condos. During a meeting two years ago, our salespeople on the SC anf FL coasts started adding up how many condo towers were planned for immediate construction or under construction, and the answer was well over a hundred. A HUNDRED – Red flag #4.
My wife and I love the Parade of Homes. We get a babysitter to watch the kids and we go see homes under construction and all the cool new stuff that people are doing. They are normally spec homes, and we noted the prices two years ago were very, very high for our area. My wife said “How can people afford these homes?” and in a moment of clarity, I stopped and said, “They can’t”. The school districts these homes were located in, the adjacent neighborhoods, the income level of the area simply could not support half of the prices they were asking – Red flag #5.
So what did I do? I am not a brain surgeon, but I could see a storm of doo-doo was fast approaching. We shelved plans to buy a house, decided to keep our car, saved six months of cash, got into cash in our 401Ks, and eliminated all our debt save our mortgage.
And felt stupid for one year.
Now we have the money to buy the car and the house, and could easily afford it since prices have come back in line. But I am dead set against it. I don’t think we have seen the worst of this by a ling shot, and mbecker’s comments about government intervention vs non-intervention are spot on. There will need to be absolute capitulation by markets and politicians before anything begins to get better. Just like you, the business people I have talked to have either shut their doors for good or could also see the storm coming and set enough aside so they can shut the doors and be OK if it comes to that. Unions will be the final straw for most – they will simply close. Business is hard enough anyway.
So to finish, Obama and his little mental dwarfs are going to go headlong into fixes that, again, will only prolong and worsen what they wanted to have happen so badly during the election. You’re right – +6 is WAY too high…
I appreciate your response, Jack Savage. I have a question
janis (Diary) Friday, January 16th at 12:12PM EST (link)for everyone:
Given the fall off in the worth of real estate these days, what happens to property taxes? I know no local governments are going to voluntarily lower them, but just how much of a hue and cry would it take for them to be forced to given the no longer applicable worth of these properties?
Good question
Jack_Savage (Diary) Friday, January 16th at 10:16PM EST (link)There will be a significant lag time, for sure, but faced with declining revenues all around I would suspect more speeding tickets and not much property reassessment in the near term.
This makes NY a Red State.
jonathanswift (Diary) Saturday, January 17th at 1:16PM EST (link)Nothing will be done because the school districts are budgeted for more money. Can you say “Howard Jarvis,” I thought you could.
Red Flag #6
ss396 Friday, January 16th at 9:59PM EST (link)When there is a plethora of Get-Rich-Quick books hitting the market pretty much simultaneously there is a crash a-coming in that sector, generally within two to three years. This time it was all about real estate. In 2006 The Donald Trump was making radio ads, and was out on the speaking circuit, flogging his vaunted real estate expertise. The lecture circuit is some pretty desperate action for a guy like Trump.
From that, I gave it about two years for the bubble to burst. And, yes, I missed it by a year.
If you pay someone to sit on his butt, you can’t be surprised when he does.
Stock market tips
JustLeaveMeAlone (Diary) Friday, January 16th at 10:06PM EST (link)Whenever a company builds a new headquarters building, or puts a fountain in front of an old one, sell the stock.
Whenever a CEO writes a book about how great he or his company is, short the stock. (Think T Boone Pickens and Mesa MLP, circa late 1980s.)
Whenever your barber or hairdresser asks you what stocks to buy, or, God forbid, tells you what stocks to buy, pull your money of the market and bury it in the backyard in a mayonnaise jar.
These same principles can be applied to the bond market, the real estate market, etc.
BTW, speaking of The Donald, I have laying on my desk an invitation from him to a seminar on buying real estate. He’s consistent, at least.
“To compel a man to subsidize with his taxes the propagation of ideas which he disbelieves and abhors is sinful and tyrannical.” Thomas Jefferson
Ah yes
Jack_Savage (Diary) Friday, January 16th at 10:14PM EST (link)“Flip This House”, anyone?
I know what you mean.
itrytobenice (Diary) Friday, January 16th at 11:00AM EST (link)My head just swelled up so big I’ll never get my shirt off.
Thanks, Blackhedd.
Proper grammar saves lives.
Let’s eat Grandma.
Let’s eat, Grandma.
Bailouts work about as well
10ksnooker (Diary) Friday, January 16th at 10:44AM EST (link)As another Democrat specialty, making home loans to people who cannot afford to pay them back.
'Hedd, on Mankiw's blog
MGamo (Diary) Friday, January 16th at 11:07AM EST (link)he quickly talks about the Ted spread, and its below 100 basis points.
“The Ted spread, the difference between the interest rates on interbank loans and T-bills, is one gauge of how much fear is gripping the financial system. Its decline suggests that the TARP is working and is certainly good news.”
How much faith should we put in that?
“A man who never quits is never defeated.” – Fred D. Thompson
Well, in normal times, the TED spread is usually about a dozen BPs.
Francis Cianfrocca (Diary) Friday, January 16th at 1:12PM EST (link)I’ve been saying here for a few weeks now that the TARP and the alphabet soup of Fed programs have indeed taken a lot of the crisis mentality out of the interbank markets.
I give the TARP a lot more credit than most people do.
...Here's a wild, off-the-cuff, out-of-the-box component...
6eorge Jetson (Diary) Friday, January 16th at 11:39AM EST (link)The TED spread is the market’s perception of the the difference in demand for the (assumedly) safer Treasurys and 3-month LIBOR Wikipedia TED Spread. Normally, one interprets the spread in terms of a credit difference with the Treasury risk constant at “zero/not at all” and the LIBOR risk “the smallest of the best banks”.
But in unusual times, the Treasury curve may not be “fixed”. For example, back in the late 2000 under Treasury surplus conditions, the TED/Swaps spreads widened in response to the novel condition that there might not be much Treasury debt to go around, and so those who wanted this risk-free instrument had to “pay up”.
What, rather than a decline based on a downward move of the bank LIBOR curve, the decline was based on a (relative) upward move of the Treasury curve based on the realization that the two will eventually become the same as banks are just not going to be allowed to fail? (as Francis notes above).
Just an off-the-cuff thought. Not a lot of conviction behind it.
Oh, and if you click on the link, you’ll see a chart showing how the TED spread peaked wildly after the Lehman collapse. Just as Bush gets little credit for the lack of a terrorist attack, similarly, Paulson/Bernanke/Bush are getting little credit for the lack of a calamity.
"that of the best banks" is what I meant nt
6eorge Jetson (Diary) Friday, January 16th at 11:40AM EST (link)Keep in mind that the credit ratings of banks are artificially inflated
Francis Cianfrocca (Diary) Friday, January 16th at 1:21PM EST (link)That’s because the monetary authorities here and in London have all but guaranteed interbank payments. Back in September, you would have had a hell of a time borrowing money even overnight. Now, three-month dollar LIBOR is in the neighborhood of 1.10%. Of course, with the corresponding Treasury rate at 11 bips, that’s still a historically huge spread.
This is what I’m talking about when I say the banking system is frozen in amber. No one is willing to bet that any given counterparty, regardless of who it is, is safe from default. Without official guarantees, we wouldn’t have a banking system at all right now.
And that would have frozen the economy solid, far worse than what actually has been the case. That’s what Bernanke was talking about back in September when he warned that without the TARP, there’d be no more economy by Monday morning.
Could you get a little more into this one Francis?
Jack_Savage (Diary) Friday, January 16th at 11:44AM EST (link)“Will there be a cost to this, in efficiency and returns to capital from private industry? Oh yeah, baby, you’d better believe that. And consequently you’d better avoid buying into the stock market for a lot of years to come.)”
Basically, the banking system has been nationalized in all but name
Francis Cianfrocca (Diary) Friday, January 16th at 1:30PM EST (link)That means that investment and risk-management decisions will be made by government officials rather than by business people. As a very general rule, bureaucrats always make decisions that reduce their risk. And when they do decide to extend credit, they’ll favor people who are politically well-connected.
That means that a lot of good projects have no chance of being funded, and a lot of garbage will get all the money it can eat. The normal credit-intermediation process of private finance, which is dead as a doornail now, will never come back. That reduces the returns on privately-invested capital because there will be no good market sources of leverage.
It seems clear enough that some new system of finance will grow up around the edges. Possibly an extension of the private-equity sector into the commercial paper market? (That would require major regulatory changes, though, as private-equity firms are generally not allowed to own credit-creating entities.)
Of course, the government could easily squelch such innovation, because it would “unfairly” compete against the new national banking industry. Maybe the Brits will be smart enough not to let that happen in London, and the world center of finance will move there again, as in the 19th century.
As Dick Enberge would say
Jack_Savage (Diary) Friday, January 16th at 10:19PM EST (link)“Oh my”.
It is becoming very clear now – the market will wallow in a trading range for about a decade.
As usual, thanks. Can I get a subscription, by the way…?
There are some signs
jonathanswift (Diary) Saturday, January 17th at 1:20PM EST (link)it is doing that now.
So will banks just use the bailout to pay for tax increases?
bk (Diary) Friday, January 16th at 4:49PM EST (link)Just saw this posted on Drudge. It says the Dems proposing eliminating tax breaks that encourages solvent banks to buy failing ones.
I know I’m cynical and I’m sure I’m oversimplifying, but it looks almost like we’re saying, “Here’s $X billion for you. Now write me back a check for $X billion for your tax hike.”
Off topic, but Francis you might find this amusing
bk (Diary) Saturday, January 17th at 4:15AM EST (link)The BBC reports that Zimbabwe has rolled out a Z$100,000,000,000,000 note worth about $30 US and no doubt dropping by the minute.
What I like about Zimbabwean inflation are the stories...
Francis Cianfrocca (Diary) Saturday, January 17th at 9:29AM EST (link)…about signs posted in public toilets prohibiting the use of banknotes in place of toilet paper.
But what can you do about it? Banknotes are less expensive than toilet paper.