June 17, 2010

While Obama Kicks BP Ass, Justice Department Reports That U.S. Completely Unprepared for WMD Attack

I have seen way too much of the Congressional hearings on the BP oil spill and heard way too much from Obama on the subject of kicking some BP ass. The President proclaims that under his watch BP chief, Tony Hayward, would be fired for not doing enough to prevent the massive oil spill disaster and secondly, for not having a plan in place to contain the spill.

Well guess what ... Obama could use a good swift kick in the pants himself. Of course we already knew that. But the purpose of the ass-kicking today is the government's complete unpreparedness in the event of a weapons of mass destruction attack.

My purpose here however is not to proselytize, I'm going to let Peggy Noonan of the Wall Street Journal do that much more eloquently. In a recent editorial, Noonan exhibited a great deal of restraint in not making a comparison between Obama's unpreparedness and BP's disaster.

The basis of Noonan's editorial is an overlooked report from the Justice Department that illustrates just how unprepared we are to respond to an WMD incident. The government can't come up with a plan in 10 years? Listen up Mr. President and heed the warning. You could be leaving this nation facing a disaster far greater than the BP oil spill with no plan in place to respond. Like you say, the buck should stop with the CEO.

Below are a few excerpts from the editorial. Click here to read it in it's entirety.

The most important overlooked story of the past few weeks was overlooked because it was not surprising. Also because no one really wants to notice it. The weight of 9/11 and all its implications is so much on our minds that it's never on our mind.

I speak of the report from the inspector general of the Justice Department, issued in late May, saying the department is not prepared to ensure public safety in the days or weeks after a terrorist attack in which nuclear, biological or chemical weapons are used. . .

So how would Justice do, almost nine years after the attacks of 9/11? Poorly. "The Department is not prepared to fulfill its role . . . to ensure public safety and security in the event of a WMD incident," says the 61-page report. Justice has yet to assign an entity or individual with clear responsibility for oversight or management of WMD response; it has not catalogued its resources in terms of either personnel or equipment; it does not have written plans or checklists in case of a WMD attack. A deputy assistant attorney general for policy and planning is quoted as saying "it is not clear" who in the department is responsible for handling WMD response.

Workers interviewed said the department's operational response program "lacks leadership and oversight." An unidentified Justice Department official was quoted: "We are totally unprepared." He added. "Right now, being totally effective would never happen. Everybody would be winging it." . . .

The report was not the first of its kind. Six months ago, the bipartisan Commission on the Prevention of Weapons of Mass Destruction Proliferation and Terrorism gave both the Obama administration and Congress failing grades on preparedness for biological attack. It said, "the US is failing to address several urgent threats, especially bioterrorism." The administration soon announced it would speed up delivery of drugs that would be needed in the event of an attack.

Our eye is off the ball. The public, in spite of what it knows in the day to day, assumes the government is on the case. And certainly the government is on the case with regard to prevention: Not being hit again since 2001 means something, and our antiterrorism professionals, intelligence and law-enforcement agents, do impressive work. In New York the past week they picked up two apparent would-be terrorists who won't be playing jihad anytime soon. But public awareness of prevention success gives the impression the government is similarly capable in terms of readiness and response.

On 9/11 we were rocked but held together. In a second and more devastating attack, public safety and public unity would be infinitely more stressed. The event, having had a precursor, would be infinitely more painful. You'd think this would focus the government's mind.

We may be witnessing again a failure of imagination, the famous phrase used after 9/11 to capture why the U.S. government was caught so flatfooted and was so stunned that such a terrible thing could occur. They neglected to think of the worst thing that could happen, and so of course they did not plan for it. If agencies within the government now are having a second failure of imagination, it is not forgivable. We're not being asked to imagine a place we've never been, after all, we're only being asked to imagine where we've been, and how it could be worse, and plan for it.
Ronald Regan once said privately to a few aides, "Man has never had a weapon he didn't use."

"Reasonable Ability to Repay" Leaves Some Aghast

I just love this. File under "brilliance of stating the obvious." NPR with their classic sense of the ironic interprets financial reform reporting by the Wall Street Journal .

Dems from the House and Senate are hashing out a final finance-reform bill. Yesterday, they added a section that would impose new rules on mortgage lenders, the WSJ reports.

Among other things, it would enshrine into law what seems like the most basic tenet of banking: Lenders can only give mortgages to people who have a "reasonable ability to repay" based on their income, credit history and indebtedness.

The section a response to the securitization-driven mortgage mania of the housing boom, when an unemployed hamster could get a seven-figure, negative-amortization loan.

The banking industry has argued that it goes too far, and could make it harder for qualified borrowers to get loans, the WSJ says.

This goes too far? Did the banking industry really say that a loan qualifier of "reasonable ability to repay" goes too far? Nevertheless, the bill passed with a nonpartisan vote.

I'm sure we've missed the nuisances of the bill that caused objections from the banking industry, but still ....

June 4, 2010

Asking the Million Dollar Question or Laughing While You Sink

The European contagion is disrupting global confidence if you consider today's volatile markets. The million dollar question - or questions - posed in this video will most likely provoke a nervous laugh. Very nervous.

Two other questions:

How many millions in a trillion? A. A million million. (A billion is a thousand million.)

Is it time for that European vacation? A. Yes.

HT: The Real Estate Bloggers

May 21, 2010

Beazer Homes Selling Junk Bonds to Managers Parking Equity Profits

I just recently managed to regroup my dropped jaw after reading The Big Short by Michael Lewis. But this week's Bloomberg report on junk bonds left me in disbelief once again.

Atlanta-based Beazer Homes is adding more debt. Heaping more on their already over-laden plate will allow them to pay dividends to shareholders but at what eventual cost? "Kicking the can down the road" comes to mind.

Then there is the risk faced by investors partnered with the money managers purchasing these and other risky corporate bonds. Bloomberg tells the tale:

Even with housing starts hovering at their lowest levels on record, Beazer Homes USA Inc. managed to sell bonds this month on terms that allow it to add more debt. The Atlanta-based builder couldn’t even do that when it issued debentures at the height of the housing bubble in 2006 and its credit rating was seven levels higher. In a report last week Moody’s singled out CF Industries Inc., Standard Pacific Corp., AK Steel Corp. as borrowers offering debt on terms historically available only to higher-rated companies.

“We got ourselves in trouble with that in the past and here it is again,” James Kochan, the chief fixed-income strategist at Wells Fargo Fund Management in Menomonee Falls, Wisconsin, said of the trend toward looser debt covenants. “It’s not that surprising, but it is disturbing,” said Kochan, who helps oversee $179 billion.

Lenders are letting down their guard just as worsening government finances raise doubts about the sustainability of the global economic recovery. Money managers say they have little choice but to go along. They need to find a home for the record $29.4 billion that has flowed into high-yield bond mutual funds the past 16 months from retail investors seeking to join in a rally that has produced an average 69 percent return since the market bottom in March 2009.

About 60 percent of high-yield borrowers this year offered weaker investor safeguards than on debt they issued previously, according to Covenant Review LLC, a New York-based research firm that analyzes bond offerings. Those include no limits on the amount of debt companies can have and few restrictions on using assets as collateral for future borrowing, reducing what’s available to satisfy creditor claims in a bankruptcy.

“This trend represents more than an episode of ‘back to the future,’” Moody’s analysts including Alex Dill, the firm’s senior covenant officer, wrote in their report. “It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007.”

Beazer sold $300 million of 9.125 percent bonds due in 2018 on May 4 that carry lighter restrictions than its 2006 issue on the amount of debt the builder can add and how it can use money raised from selling assets. The terms also allow Beazer to double its capacity to pay dividends to shareholders even after a 90 percent drop in its stock, according to Covenant Review.

The company’s senior unsecured bonds are rated Caa2, which Moody’s defines as “judged to be of poor standing and are subject to very high credit risk.” Beazer was rated Ba1, one step below investment grade, in June 2006, when it issued $275 million of 8.125 percent 10-year notes.

Jeffrey Hoza, a vice president and treasurer of Beazer, and Chief Financial Officer Allan Merrill didn’t return calls seeking comment. Junk bonds are rated below Baa3 by Moody’s and less than BBB- by Standard & Poor’s.

Covenant Review
believes they have the right take on the junk bonds being offered up and issues a warning. Sounds eerily familiar …

“In 2008, all the companies that we said would screw the bondholders did it,” said Cohen of Covenant Review. “Now, it feels like 2007 to me. We’re telling them they’re going to get screwed and they’re not paying attention.”

April 18, 2010

Goldman Sachs Requests Right to Foreclose on Bankruptcy Protected Sawgrass Resort

RQB Resort, LP filed for bankruptcy protection in March. They own Sawgrass Marriott Resort & Cabana Club in Ponte Vedra Beach, Florida, outside of Jacksonville. They also owe $196 million to the mortgage arm of Goldman Sachs on the Florida property.

Here’s the punch line … Goldman Sachs Mortgage Co. is asking the bankruptcy judge to allow them to foreclose on the property and possibly sell it, regardless of the bankruptcy. Goldman claims RQB’s debt of $196 million is more than the property is worth and that it has not demonstrated how it will meet its debt obligation.

Goldman acknowledges RQB has shown it can cover current operational expenses but not debt service. RQB has not paid Goldman Sachs since August 2009 according to the WSJ. Reuters reports that RQB Resort listed estimated assets and liabilities of up to $500 million according to court filings.

The Wall Street Journal reports Goldman’s position, "The debtors have thus failed to show that an effective reorganization is possible within any reasonable period of time."

The 65-acre Sawgrass Marriott Resort & Cabana Club claims the title as largest convention and resort property between Atlanta and Orlando. The property includes 508 hotel rooms, golf villas, restaurants, a spa and beach club on the Atlantic.

Most will be aware of the famous TPC Sawgrass which is the headquarters of the U.S. PGA Tour and site of the U.S. PGA Tour’s Tournament Players Championship. The prestigious tournament has a $9.5 million purse. The course is ranked ninth on Golf Digest’s list of America’s 100 Greatest Public Courses for 2009-2010 and ranked among the top 80 golf courses in the world by Golf Magazine. The bankruptcy filings does not include the TPC Sawgrass golf course properties.

The high-profile resort property was acquired at the height of the market with the downturn close on the heels of the closing. In court papers, RQB said that it had bought the resort in 2006 for $220.6 million and subsequently invested $30 million in upgrades. The company borrowed $193 million from Goldman with a current balance due of $196 million.

Another example of being the late to the party. Then there is Sea Island with troubles a little way up the coast. And probably some in between.

April 16, 2010

Goldman Sachs: A Moral but Profitable Dilemma

Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today charged Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter. SEC Press Release
Goldman Sachs brings me out of my cave today (back soon).

The Securities and Exchange Commission brought a civil fraud complaint today against Goldman Sachs. At the root of the charges is the role that subprime mortgages underlying mortgage-backed securities and other complicated financial instruments, played in bringing down our economic house of cards in 2008.

In 2007 when the housing and mortgage markets were first showing signs of distress, Goldman structured a synthetic collateralized-debt obligation (CDO) based on toxic residential mortgage-backed securities. The crux of the SEC complaint charges that Goldman defrauded investors by selling those subprime mortgage-backed securities in a CDO while failing to disclose that a large hedge fund that had selected and sold the MBSs to them, was shorting, or trading against, those same securities.

“The Financial Crisis Inquiry Commission chairman, Phil Angelides, likened the practice to selling a car knowing it has bad brakes and then buying a life insurance policy on the buyer.” New York Times

John Paulson, the heretofore unknown hedge fund manager and soothsayer of the painful end to the housing boom, handpicked poor quality B-rated mortgages to package as securities and sell to Goldman. Goldman did not disclose to investors that the collaterized-debt obligation they structured was populated with MBSs that were likely to fail and were chosen by Paulson who had “economic interests directly adverse to investors.” Goldman misled investors by representing that the securities "were selected by an independent, objective third party."

Goldman supposedly had knowledge that Paulson’s hedge fund was going to short the trade. Paulson - $10B: Investors - screwed. Goldman – the jury's still out - CNBC reported today that according to some sources Goldman was long the CDO they structured from the dubious MBSs which would make them NOT the smartest guys in the room but it might disprove their culpability. Hmmm…interesting.

Goldman denied the charges and said it will "defend the firm and its reputation."

Paulson did not directly market the securities to investors and was not charged in the SEC complaint. The SEC also named Goldman employee Fabrice Tourre in the complaint, saying he was "principally responsible" for creating the CDO. Tourre is a 31-year-old VP that referred to himself as the "Fabulous FAB." Oh yeah, and Master of the Universe.

Testifying in front of the Financial Crisis Inquiry Commission in January, Lloyd Blankfein, Goldman CEO, admitted his firm did no in-house due diligence on the underlying mortgages packaged into financial products, but rather relied on the rating agencies which slapped AAA ratings on many securities with underlying toxic loans. Rating agencies - more issues...

Are politicians set on making Goldman the “whipping boy” for Wall Street? The fraud charges against Goldman come right before financial industry earnings reports which are expected to be exemplary. The Washington Post describes the profits as an appearance of bad manners. Bad timing. In January, Obama called Wall Street's uncanny earnings as “obscene profits.”

Goldman Sachs, long known as the smartest, and most arrogant guys on Wall Street, are today the poster child for the economic crisis of 2008. Whether this case is a one-off situation or the prevalence of corporate duplicity is still to be determined. For now the stage is being set for a financial Spoon River Anthology – players yet to be chosen. Lloyd Blankfein, Fabulous FAB, and John Paulson (not to be confused with Hank Paulson, our hero) wander the stage waiting for the SEC director to appear. Stay tuned. This promises to be drama extraordinaire.

While the SEC charges are rocking Wall Street today with expectations of more heads to roll, Washington flexes political muscle and forges ahead with financial regulatory reform. They may even push a vote within two weeks. Remember the financial securities instruments heretofore have not been subject to any regulation. Caveat emptor, etc.

While this is a serious fraud case, the ramifications to the housing industry will be felt for years to come. The press coverage of the fraud case against the Wall Street firm that Main Street loves to hate can't help but further deflate the appetite for investors for these financial instruments backed by questionable mortgages. With the government pulling out of the business of buying mortgage-backed securities as of the end of March, the market will have to stand on its own shaky merits. Without a secondary market of private investors, credit will refreeze before a thaw shows results.

The Goldman fraud case will negatively affect investor appetite for mortgage-backed securities.

The Federal Reserve’s program to purchase mortgage-backed securities from Fannie Mae and Freddie Mac (which kept interest rates low and loosened credit for home loans) ended March 31. No extension is on the table.

Ronald Temple,
portfolio manager at Lazard Asset Management predicts that rates could rise by a full percentage point after the Treasury's purchases end and it would precipitate further downward pressure on house prices and more uncertainty.

It is doubtful that the private capital markets will reenter the MBS market with much enthusiasm, even with the current conservative lending practices. Moody’s recently released their worsening opinion of the value of 2005-07 RMBS products and although the 05-07 securities are a different animal from the worthiness of recent mortgages, the appetite for MBSs is still sour to many investors.

Federal reform and regulation for the mortgage-backed securities market promises to be a slow go. Capital generated by mortgage-backed securities is essential for the real estate industry’s recovery, both residential and commercial. And, before financing can regain a substantial foothold for real estate, a monumental remodeling will have to effected on the MBS market.

It is the fear of the unknown that will plague the market. And many fear that Congress, the FDIC and other regulators will impose such harsh restrictions on securitization that they will prevent it from regaining its role as a major provider of credit to to the U.S. real estate markets.

In all likelihood, it will take years to unravel the current MBS debacle and restructure a palatable new securitization model. Likewise, it may take years to peel the layers off the various levels of fraud or misdeed involving mortgage-backed securities of 2004-2007 vintage.

For now bets are being placed on whether Goldman will continue it's long lucrative run through SEC headwinds and financial reform. No doubt this will play out to a packed house.

March 15, 2010

Negotiating the Mortgage Market

The Wall Street Journal
compiled a list of the land mines you might encounter while negotiating the road to a new mortgage these days. The talking points were derived from various articles from the WSJ and the New York Times. If you're in the market or the business, it's worth taking a look...

* The options are limited for those whose loans are too big for government backing ($417,000 and $729,740, depending where you live.) Smaller lenders and credit unions often can be more flexible because they know their customers and local market better or may have a prior relationship with the borrower. (WSJ)

* The smallest misstep can set back the process. Lenders check credit reports at the beginning and toward the end of the process, any changes are scrutinized and could be cause for dropped financing. A mix-up with a cable bill sent one couple back to the drawing board after the wife’s score dropped. (NYT)

* Even if your credit is spotless, your building may have issues. Many of the buildings in New York City don’t meet Fannie Mae and Freddie Mac guidelines: That some condos carry more insurance, for example. Another catch: A new IRS rule keeps Fannie from acquiring mortgages made in buildings where more than 20 percent of the square footage is commercial. Most of these requirements aren’t new, they are just more of an issue now when Fannie and Freddie are pretty much the only ones willing to buy mortgages from banks. (NYT)

* To qualify for a mortgage, you will need a job and at least two recent pay stubs. You also will be asked for two years of W-2 forms, proof of other assets and either your tax return or a form allowing the lender to get your return from the Internal Revenue Service. That means that items that reduce your adjusted gross income, like business expenses or IRA contributions, can reduce the loan for which you qualify. (WSJ)

* With home prices still falling in many markets, an appraisal below the purchase price puts the deal in jeopardy. That is because a low appraisal means the buyer must come up with more cash or the seller must lower the price to keep the deal alive. (WSJ)

* If you put down between 20% and 25% of the purchase price, you will find yourself in a strange middle ground: You will avoid mortgage insurance, but you will pay extra origination fees because Fannie Mae considers this group to be its highest risk at a time when home prices may decline. (WSJ)

March 13, 2010

Jumbo MBS Showing Signs of Life

Although players were not named, The New York Times reported yesterday that a few firms were venturing back into mortgage bond market. The mortgage-backed securities market has remained stalled since the housing bubble burst in 2008, sparking the nation’s credit crisis. Outside of the mortgage bonds guaranteed by Fannie Mae and Freddie Mac the MBS investors have sat out participation in the heretofore risky mortgages underlying bonds. But now a new generation of marketable mortgages with squeaky clean underwriting guidelines are re-entering the bond market.

These new scrubbed mortgage-backed securities probably deserve the highest ratings of any bonds in years, but buyers are still wary and sellers are not in the catbird’s seat. As a matter of fact sellers of MBS may face a loss for the time being.

Institutionally generated mortgages may be far less risky than two years ago with larger down payments, strict ratios and more conservative appraisals. But there is still some degree of risk with home prices not yet proven to have found a stable bottom and unemployment showing few signs of substantial relief.

Jumbo loans have been much more difficult for homeowners to acquire and they have carried substantially higher rates than conforming loans. The bonds in the works are generally these non-conforming loans, i.e. jumbo loans, that Fannie and Freddie will not accept. Bonds guaranteed by Fannie and Freddie are paying record low returns and investors are seeking new places to invest. Risk acceptance is making a comeback.

Here’s a glimpse into what the jumbo MBS market looks like today. It’s a start to loosen jumbo financing.

Prospective buyers of new jumbo mortgage-backed securities will want assurances the loans have all the proper documents and proof of income. They’ll probably want borrowers to have put down as much as 40 percent of their own money. And they’ll expect that, even if house prices have dropped since the mortgage was made, the average loan balance is still no more than, say, 60 percent of the property’s value.

What’s more, any deal will have to be over-collateralized to withstand losses on the underlying mortgages of, say, at least 15 percent before investors in even the lowest-rated slug of bonds take any hit at all. New bonds might still need to be priced at a discount to entice buyers.

That poses a problem for institutions working on the deals: under those conditions, they’re likely to lose money. But the cost of reopening a key market could be worth it. While banks might not rush to securitize nonstandard mortgages right now, that should change as the market regains equilibrium. Those who pioneer its rehabilitation will be in line to help bring in future deals. New York Times

February 6, 2010

Restructuring Securitization – Follow Up to Capital Flows

This is a short follow-up of Wednesday's post on The Emerging Trends in Real Estate - Capital Flows. In particular it is more on the needs and concerns of restructuring the mortgage backed securities market, particularly in light of Washington's participation. It promises to be a slow go.

There was unanimous agreement amongst the almost 900 respondents to the Urban Land Institute’s Emerging Trends in Real Estate 2010 survey that the capital generated by commercial mortgage backed securities is essential for the industry’s recovery. And, before financing can regain a substantial foothold for commercial real estate, a monumental remodeling will have to effected on the CMBS market ... (it bears repeating)

The next big fix will be the commercial mortgage backed securities. Assuming a recovery of the financial sector, the real estate industry will have to figure out what to do with the collapsed CMBS market, “a classic example of a good idea gone horribly wrong.”

Unenviable Task for the American Securitization Forum

Last week the American Securitization Forum, for issuers, bankers, lawyers and investors involved in creating and buying asset-backed securities, met to tackle the unenviable task of cleaning up and reviving the market for MBS, both residential and commercial.

ASF Chairman Daloisio’s opening words, to a subdued group, were an understatement. "Never before has the future of securitization depended so greatly on the decisions which will be made this year in Washington.”

Members of the ASF fear that Congress, the FDIC and other regulators will impose such harsh restrictions on securitization that they will prevent it from regaining its role as a major provider of credit to to the U.S. real estate markets.

Michael Barr, assistant secretary of the U.S. Treasury, said that securitization is an "essential vehicle for providing credit to consumers and firms.” But he said legislative reforms, currently moving slowly through Congress, are needed before private securitization can return in a meaningful way. "We cannot rebuild the securitization markets on the old infrastructure," Mr. Barr said.

The Obama administration wants better disclosures on the assets backing the securities and provisions that require issuers to keep "skin in the game," or retention of some of the default risk.

No hope was offered for speedy action from Washington.

Before the private mortgage securities market can recover, issuers and investors need clarity about the regulations they will face. A bottom in real estate prices for both residential and commercial markets is also necessary for a resurgence.

This year's Forum convened in a Washington suburb instead of the glitzy Las Vegas location of years past. With the focus on regulation, they wanted easy access to the policy makers. Ironically, the meeting convention center choice for this year contained no casinos.

What a difference a few years make. Three years ago, the headline speaker was Jay Leno: this year Howard Dean and Newt Gingrich were introduced as “the entertainment.”
As concluded in Emerging Trends, “it will take years to unravel the current CMBS debacle and restructure a palatable new securitization model.”
About the American Securititization Forum from their website:

  • The ASF advocates the securitization industry’s interests in various market practice, legal, accounting, tax, regulatory, legislative and policy issues.
  • The ASF builds consensus, coordinates advocacy efforts, and informs and educates the securitization community and related constituencies on issues of broad importance to the industry.
Important issues for the ASF include bank capital adequacy regulations, accounting standards governing the recognition, derecognition and consolidation of assets conveyed to securitization vehicles, federal securities registration, disclosure and reporting rules, legal investment laws and restrictions, and a host of other topics that present challenges and opportunities to the domestic securitization market and its participants.

February 3, 2010

Emerging Trends in Real Estate: Capital Flows - Where's The Money?

Emerging Trends in Real Estate 2010 - Part III

My view of real estate is organic based on market-driven developments with profits generated from the successful execution of fundamentals. Huh? You know, finance it, build it, sell it, and go to the bank. But that was yesterday. Today developers are sidelined on the links with TaylorMade replacing shiny towers. Financing for new projects is as elusive as a hole in one.

So where flows the trickle of capital that lurks out there? The lead statement on Capital Flows from the Emerging Trends in Real Estate 2010 suggests that investors must get ahead of available capital in order to score:

“The key to success in real estate investing is to follow the capital flows, not the fundamentals. Anticipate what capital wants and be there.”
The hens are chasing the fox. The play has changed but the game changer is still leverage.

ET predicts it will be a slow comeback for lenders in 2010. Debt markets will start to resuscitate but will remain “far from normalized in the wake of unprecedented deleveraging.” The survey respondents agree that the debt markets will bottom this year and any lending will be “conservative, expensive, and extended only to most-favored relationships.”

With credit on a shoestring, commercial real estate markets in 2010 will be led by all-cash investors buying quality properties from distressed borrowers or directly from lender’s REO portfolio. Distressed sales will help the market find firm footing in a bottom and form a foundation for a recovery.

Before financing can regain a substantial foothold for commercial real estate, a monumental remodeling will have to effected on the CMBS market ...
The next big fix will be the commercial mortgage backed securities. Assuming a recovery of the financial sector, the real estate industry will have to figure out what to do with the collapsed CMBS market, “a classic example of a good idea gone horribly wrong.”
Lenders loosened underwriting standards and off-loaded risky loans into securities markets, fueling deals, ballooning prices, over-borrowing and over-building. “Ironically, CMBS was a solution for recovering from the last real estate debacle, but got us caught in a worse trap because the structures became too complex.” Now mired in litigation hell, special servicers and multitranched borrowers will fight it out for years.

With the bubble blown sky-high, hundreds of billions of dollars of CMBS loans will come due over the next five to 10 years and there is ZERO appetite by bond buyers to return to the CMBS orgy. In virtual unanimity, the Emerging Trends respondents agree that the overall real estate industry revival depends on reconstituting the CMBS markets and restoring confidence. But there is no quick fix on the horizon. “Reinventing a new detranched, ‘back-to-basics’ CMBS model could take several years at least.”

The unraveling of the CMBS market may require government intervention for survival. Most of the respondents believe that the government will come to the rescue to backstop the mass of loans coming due. After all the feds came to the aid of Fannie and Freddie. The difference being that Fannie and Freddie is the darling child of every politician in this country and the American Dream, although battered, is still alive and well.

Here are the top capital markets’ lessons learned by investors as they scramble to stay alive:
  • Diversification doesn’t overcome systemic risk.
  • In the global marketplace, all regions and credit markets inextricably link.
  • High credit ratings don’t necessarily mean high-quality investments.
  • Mathematical models cannot fully simulate or manage risk.
  • Risk of borrowing short to invest in illiquid assets cannot be hedged.
  • “Tails” on bell-shaped curves exist for a reason.
Here’s some very good advice from one respondent:
“When you justify a deal based on financial engineering, it’s the kiss of death,” says an interviewee. “The industry did leverage entirely wrong, putting increasing amounts of debt on riskier and riskier deals. For leverage to really work, you should put it on the least-risky deals in the early part of market cycles.”
For the small sliver of the debt market that is still in the lending business, the loans look like a different species from the issuances of prior years. We’re talking about 60 to 65 percent loan to value ratios, 7 to 7.25 percent interest rates and 1.4 debt-service coverage. The recent aggressive financial models for commercial real estate deals can’t be supported on the shoulders of the “New Deal.”

Currently in its 31th edition, Emerging Trends in Real Estate 2010 is collaboration between the Urban Land Institute and PricewaterhouseCoopers and is a highly anticipated annual industry review. The report was based on surveys and interviews with more than 900 top industry professionals including developers, investors, brokers, analysts, researchers, appraisers, and academics.

January 28, 2010

Emerging Trends in Real Estate 2010 - Next-Generation Projects

Emerging Trends in Real Estate 2010 - Part II

While developers are hitting the links waiting out the real estate recovery, they will surely be contemplating the projects they will build in the future. What will buyers, consumers and businesses demand in a few years?

Here is the Urban Land Institute’s dream for the future as reflected in the Emerging Trends in Real Estate 2010:

Next-generation projects will orient to infill, urbanizing suburbs, and transit-oriented development. Smaller housing units – close to mass transit, work, and 24-hour amenities – gain favor over large houses on big lots at the suburban edge. People will continue to seek greater convenience and want to reduce energy expenses. Shorter commutes and smaller heating bills make up for higher infill real estate costs. “You’ll be stupid not to build green.” “Operating efficiencies and competitive advantage will be more than worth “the minimal extra cost.”
This sounds like utopia populated with a single-minded, idealistic human race. But then it is called a “dream for the future.” Unfortunately the only way this vision will be realized is by a combination of legislation or other forced governmental issues like zoning laws, utility availability and/or infrastructure, along with financial considerations like high gas prices. And last but not least, it will be driven by resulting profits.

ULI’s vision of urbanization is my point of departure from their philosophy. Our differences however are probably a matter of semantics. ULI says this is what should be built by developers. I say if developers rely on urban projects offering homes to a cross section of the population, they will fail except for a few cities. Most cities are not ready to sustain a substantial migration into the innermost rings.

As far the new urban movement, it is a grand ideal conceived by planners with lofty goals to reduce our carbon footprints and create communities, but our last round of city-bound mixed-use developments with towers of unoccupied units and empty retail spaces points to the difficultly and in some cases, sheer folly of such ambitious developments. With the cost of urban land, these dense and massive projects are called for in order for developers to earn an acceptable return. But the pitfalls are huge.

With the residential market in the tank and condos at the top of the trash heap, at least in most markets, it is a mighty task to make a 24-hour urban happening scene with an overly stressed housing component. The lack of integrated customers from the high-density residential sector, coupled with a challenged economy, means the retail will definitely suffer if it even gets off the ground initially.

ULI comments here on the on the place making process to create a centralized community to encompass live, work and play:
“Place making offers developers, public officials, and consumers unbeatable opportunities to collaboratively create thriving, profitable, sustainable environments to live, work, and play. Great place making requires bold vision, entrepreneurial business models, and long-term commitment from private and public sector players. Optimizing these opportunities can challenge even the most inventive professionals.”
Through our years of real estate prosperity we convinced ourselves that the urbanized mixed-use, town center concept of developing new communities was the way of the future. These communities would waggle a magic wand and create walkable, 24-hour, sustainable living centers, giving us all a new reason for being. We called this smart growth. The problem with this concept is it is probably the single most difficult type development to pull off with any degree of success.

ULI’s vision of place making is an ideal worth pursuing but let’s be realistic. We had much of this decade to test the effectiveness and profitability of high density urban and even inner-ring suburban mixed-use projects that were large enough to encompass the live, work and play concept. Here are some of the problems as I see it:
  • Many cities lack a vibrant downtown sufficient to capture and sustain a quality lifestyle beyond a subject mixed-use development. If a social and civic environment (good schools, recreational parks, libraries, transportation, and security) already exists within an urban area, a developer can capture those amenities as a value-added element. If that does not exist, development would have to be self-contained and restricted in complete opposition to the community building concept (which by the way, nobody is talking about these days according to the Emerging Trends report.) In our current market, I think we will see more of the smaller, but expensive, infill projects where city infrastructure will take the place of the web of a large development.
  • It takes a very strong and committed developer to acquire suitable land, obtain complicated financing, and risk there will still be demand when the development comes to market. And in the case of the largest ventures, that it can sustain multiple cycles over the term of completion. Without resounding initial success, the debt service can easily spiral beyond the probability of profitable containment. It spells tremendous risk. But then there are always the developer stories that defy the market with solid success. To them I offer kudos. Maybe it’s just a matter of guts, lots of cash, tremendous vision and exceptional execution and extraordinary luck.
  • Mass transit is crucial to this type of urban living where live, work, and play converge. In many of the major markets mass transit is a marginal effort at best. Take Atlanta for instance. You will lead a very frustrated life if you rely on mass transit for transportation in this metropolitan area of 5 million. But in all fairness, even if Atlantans were offered an excellent mass transit system, I’m not sure how many would give up their cars. We have yet to find a strong enough incentive, although we’re in a death struggle to strangle the city with traffic congestion.
  • During this last decade baby boomers were expected to flood the cities, buying condos and giving up their large family homes for a scaled down urban lifestyle. Didn’t happen. You obviously can’t count on those unpredictable baby boomers to fulfill your expectations. We’re too busy pretending to be 40 again.
  • These ideal developments require a massive, I mean massive, demand for residential occupants. Never mind the current market debacle facing us, how will these mammoth projects with thousands of units fare in a normal old run-of-the-mill, mid-1990s-type real estate market – not off the charts but just an OK market.
  • Call me a cynic, but I just can’t see families not seeking a more “wholesome,” green grass, bicycle-riding, playing outside unsupervised, environment. Once the kids arrive on the scene, hard core city dwellers sacrifice anything to inhabit a family-friendly community. When the kids grow up they may, or may not move back to the city. Speaking of cynicism, how do we change human nature (at least as I’ve observed it) that continues to strive for big, bigger, best? When the economy roars back, one of these days, how will consumers react? Big houses, big cars are my bet, tempered only by financial restraints. The only concession I see is a complete conversion to small lots. If we have anything, it is a short memory of the ill effects of overindulgence.

These days most markets are stressed in several of the components that comprise mixed-use developments. It may be a while before the planets are once again properly aligned signaling that it is OK to come out of the woods.

How Smart is Green?

Smart growth policies graced real estate headlines prior to 2006 and real progress was marching toward mainstream development. Smart growth basically meant higher density, urban-type centers, with mass transit reducing automobile dependence. A greener way of thinking and living. The smart growth policies haven't gone away and they have widespread support, but in most cases the current market will not support their ambitions. The Urban Land Institute, rightfully so, is still all about urban living and building green.

I have a great deal of respect for ULI, but I have to question the viability of building green in today’s market. The financial feasibility depends on whether we’re talking about housing or hotels or office. But the moral obligation of green is without question.

The most likely properties to be developed and built with a LEED's certification are income producing properties where the owner is responsible for the usually substantial expenses of the building including utilities, i.e. office buildings and hotels. Where operational expenses are passed along to the tenant or homeowner, the motivation to go green greatly diminishes, i.e. residential housing, retail, and industrial.

There are studies that show LEED office buildings will sell for a substantial premium over a non-green property. But there is virtually no meaningful data available on the cost or returns on building green residentially.

Everyone will agree that green building in whatever property class is a good thing and it is very important that we do our part to protect the environment. But developers and builders must find the profit in green before it will become mainstream. At the end of the day, green is self-serving. Only when energy efficiency and carbon emission reduction is mandated by the market or by government regulation will we see the real estate industry embrace the world of green with consistency.

One thing is for sure. The next-generation projects will be driven and formed by the devastation caused by today’s real estate market. Ideals will be put on the back burner, unfortunately. When prices are diminishing, there is a scrap for every dollar.

BTW, this was not penned by Machiavelli

January 27, 2010

Emerging Trends in Real Estate 2010: Coping With Pain

Emerging Trends in Real Estate 2010 - Part I

Currently in its 31st edition, Emerging Trends in Real Estate 2010 is a collaboration between the Urban Land Institute and PricewaterhouseCoopers and is a highly anticipated annual industry review. The report was based on surveys and interviews with more than 900 top industry professionals including developers, investors, brokers, analysts, researchers, appraisers, and academics.

The sentiment of the respondents over the last four years has tracked the housing market meltdown, the financial crisis and the recession. The Emerging Trends’ theme for each of those years follows the gradual disintegration of the real estate market and the economy:

2007 - “Nothing Lasts Forever” (a strained smile)

2008 - “A Dose of Fear” (a look of utter consternation)

2009 - “Forget the Quick Fix - Hold On & Try To Loose Less” (“deer in the headlights” look of frozen fear)

2010 - “Coping With Pain” (downright tears).

This year’s prognosis is pretty darn grim with precious few green shoots in real estate. But as in previous recessions there are opportunities to be availed in troubled times for those with cash in their pockets.

IF you have cash,
and IF you have little debt,
and IF you are selective,
and IF you are patient,
you could “score generational bargains on premium properties” in 2010.

”Despite this enveloping gloom and the dramatic fallout from the unprecedented early-2000s credit binge, 2010 and 2011 could be ‘the opportunity of a lifetime,’ a limited window to cash in one of the best acquisition environments ever. ‘The overall negativity paves the way for winners playing against overall sentiment.’ ”
Lifeboats are reserved for those late to the party holding overvalued properties and those laden with overzealous leverage. All bets are off as to the losses mounting on the other side of the balance sheet. 2010 will be a test of the survival of the fittest and most proactive. “Waiting is a bridge to nowhere since fundamentals won’t come back fast enough.” 2010 looks like an unavoidable bloodbath for a multitude of “zombie” borrowers, investors, and lenders.

In the midst of the carnage, real estate players are waging a paradoxical war with themselves rejecting the private equity paradigm based on leverage which predicated the downfall (“we will be more cautious and conservative…next time”) and wanting to make up for the losses as quickly as possible which would entail aggressive leveraging of assets - again. A conundrum for sure.

Has real estate as an asset class been turned into a commodity to be traded? One veteran analyst sizes it up, “Let’s face it, without leverage, the asset class doesn’t provide core, value-add, and opportunity type funds is largely determined by how much leverage you put on, not particular property acumen unless you get into development.” Low interest rates make leveraging up very alluring, particularly at today’s prices. Will this create another bubble when new commercial loans come due in five to 10 years when interest rates will be inevitably higher? Of course this is assuming that commercial real estate loans will be available when the market settles.

Real estate, however, is much more than a financial plan based on leverage. This year the respondents see the need to get back to basics. Real estate for 2010 is “a good business for B students who work hard, not for PhDs with computer models.” … “Nobody mentions investing in neighborhoods or place making for future generations anymore. Relationships among far-flung owners, lenders, tenants and communities have disaggregated.”

Employment Not a Pretty Picture

Hovering at the top of “Not a Pretty Picture” are big fears about a jobless economic recovery. Many experts now project that there will not be a return to healthy employment until at least 2012. “Shockingly, America’s standard of living may have begun to fall – wages quiver, health benefits shrink, and companies slash pension plans.

Only a few high-paying employment generators that could spur any form of real estate recovery were identified by those in the survey. Sorry, but I find this not at all encouraging. Nevertheless, here is what our best hopes are pinned on according to the report:

Technology – Engineers and scientists will be highly coveted. New high-tech products can increase U.S. exports to burgeoning global markets.

Health Care – Can the needs of the baby boomers save the overall economy? Well, the need will be big.

Education – High-grade teachers are desperately needed to educate engineers, scientists and physicians for high-paying brainpower jobs. (I guess low pay for educators was a little short sighted.)

Housing – I’m losing hope already. “Homebuilders will recover eventually – the U.S. population grows by 3 million annually and all these people need places to live.” Apartments may be the overall winner.

Wealth Management – It’s good to know there is still wealth out there that needs to be managed.

The Long Road Back

The 1,000 strong industry professionals that participated in the ULI survey predict a “prolonged,” “not very robust” U-shaped recovery. Bye, bye V-shaped hopefuls.

The Emerging Trends interviewees offered some landmarks on the rocky road to recovery …

Housing Leads. The respondents pinned the bottom of the housing market in 2009 with a very, very slow upward trek. Obstacles, like tough-dealing lenders, still dull buyer appetites.

Huge Writedowns. Over-leveraged borrowers “must lose their shirts” and banks must swallow losses on commercial real estate.

Government Intervention. Respondents see need for more federal assistance to “pave the way for rationalizing balance sheets.” “Without capital from securitizations, real estate won’t recover.” Confidence needs to be restored to the investment quality of CMBS.

Cash Buyers. Cash is king and cash buyers will dominate in coming years, enjoying pricing power. Winners will be vulture funds buying trophy properties at the perceived market bottom, equity stakes to shore up troubled borrowers with prime assets and purchasing loan portfolios at cents on the dollar.

IPOs. Investment bankers go back to the early 1990s playbook to structure public offerings to rescue failing equity funds and private real estate companies earning big fees - and a piece of the action along the way.

Litigation Mess. The unwinding of “incomprehensible” CMBS and collateralized debt obligation structures (CDO) will create a world of lucrative work for workout specialists and lawyers. Bottom tranche positions of CDOs may be worthless. Figuring out who owns what could take “an eternity” to resolve.

Rate Hurdles. Rates have nowhere to go but up to control inflation pressures from government borrowing. But the only way out of debt problems is inflation. Huge conundrums are lurking within.

“Absolutely No Demand.” Debilitated property owners who were counting on increasing cash flows to meet expensive debt service are facing tenants downsizing and cutting space costs to survive prolonged economic downturn. True for retail, apartments, office and warehouse owners.

Development. Forget about it. If you’re a developer, get a fishing pole and find a hut on a coastline and come back in a few years, probably 2013. Dream about the future, the next-generation projects.
"For 2010, enormous problems will begin to morph into unique opportunities. It’s all about timing the cycle.”

January 23, 2010

Shakespeare Nailed Obama's Bank Tax - "Much Ado About Nothing"

Below is a guest post from Joe Rollins, an excellent commentary on the new "bank tax" as well as other ineffectual attempts to lighten your pockets and complicate your life, curtesy of the Obama administration.

If It's Thursday, It Must Be Time For a New Tax

From the Desk of Joe Rollins

It seems like once a week, the current administration finds a new tax to put on businesses. This reminds me of the old movie from when I was in college, “If it’s Tuesday, This Must Be Belgium,” a silly film that centered on a group of tourists on a motor coach tour of Europe where they visited a different country every day of the tour. If you’ve ever been on a European tour, I’m sure you can relate; when you wake up in the morning, you’re not quite sure which country you’re in that particular day, but it starts just like every other day before it. Almost every week, I get the same experience when I see the Obama administration proposing a new tax or a new regulation that will hurt the U.S. economy rather than help it.

Last week I wrote about the Wall Street Debacle and President Obama’s proposed “Financial Crisis Responsibility Fee” (Wall Street Debacle – Was It Really Greed? and “We Want Our Money Back, and We’re Going to Get It”). This week, I want to discuss the new regulations proposed on banks. What’s so interesting about these populist proposals by the administration is that there’s almost no chance that any of them will pass Congress. Even if they did pass, which is highly unlikely, they would have very little effect. I’ll try to explain why in today’s post.

I can’t help but think that in some regards, all of these new proposals are a smoke screen to cover up the other issues that now appear to be dead. As I discussed in my January 21st post (“The Health Care Bill is Officially Dead”), the proposed health care reform as written is completely dead. Even though we’ve not had the eulogy on the “Cap and Trade” legislation, it is also dead. A title of “Cap and Tax” would’ve been more appropriate.

Even though no one can argue the importance of saving the environment, the worst way of doing so is by regulating every piece of business in America with a new, prohibitive tax. Of course, the smoke screen is most prevalent on the economy, where the stimulus act has been an incredible failure and unemployment continues to be stubbornly high with no relief in sight.

I suspect that in President Obama’s State of the Union address next week, we will hear a lot of rhetoric concerning his attempt to get the federal deficits under control. As evidenced by the result of the Massachusetts Senatorial election, that is the number one issue on the minds of America. If Obama really wants to deal in populist politics, then he must address the deficits at some point. There is no more important time than now for him to do so.

I’ve written extensively on the TARP and the positive benefits it brought to the financial system in America in 2008. I’ve also pointed out that all the major banks in America have now repaid their TARP loans with significant interest and a premium for their options. The banking industry has done their part to make the TARP whole, even though they continue to be the whipping boy for new taxes in America.

The reason I point this out is because the current administration continues to use TARP money for pet projects that have nothing whatsoever to do with the financial stability of the banking industry. As you recall, the TARP was specifically restricted for the purpose of the financial institutions, and by law, dictated that when the money was repaid to the TARP, that it must be refunded to the federal government. However, that didn’t prevent the current administration from using the money for massive bailouts in the automobile industry and for AIG. Even though neither of those companies were financial institutions, it was clear that the money was used for purposes other than what it was intended.

U.S. Secretary of the Treasury, Timothy Geithner, recently announced that the need for the TARP was over. He said that the financial controls were now in place and the banking industry was stable. In spite of that, the Senate took a vote yesterday about whether or not to wind down the TARP and return all the unused money to the Treasury to reduce the deficit. The Senate voted 53 to 45 to close down the TARP, but the provision failed since it did not have 60 votes.

The purpose of this is to point out that even though your representatives give lip service regarding deficit reduction, it is absolutely clear that they intend to use the rest of the TARP money for their own pet projects. Mark my words that you’ll soon see the balance of the TARP money being spent for pork barrel projects that will do nothing to help stimulate the economy. In essence, the new stimulus money will be designed to bailout the old stimulus money, which has been a categorical failure.

Yesterday, the Dow Industrial Average went down 2% after President Obama’s speech wherein he proposed new regulations on the major banks. That was a classic case of “speak first, think later.” Reports of earnings for this quarter have been spectacular – we’ve seen sterling earnings reports from IBM, Intel, McDonald’s, Google, Goldman Sachs, and J.P. Morgan Chase, among others. Given the current economic environment, earnings have truly been incredible. Even with yesterday’s loss, the market is still up for 2010. It seems strange that the market would react so adversely to a proposal that, as I will demonstrate, will likely be meaningless.

Congress recently asked Secretary Geithner whether proprietary trading had anything to do with the financial meltdown in 2007 and 2008. He responded that proprietary trading had virtually nothing to do with the meltdown; rather, it was due to poor lending habits. Duh?!?! Why would new regulations be proposed if that wasn’t the problem?

I find it interesting that the current administration continues to blame the large banks for the financial meltdown when they didn’t even cause the problem. The source of the problem is clearly traced to the sub-prime lending market that Congress basically created. Congress forced Freddie and Fannie to provide the sub-prime loans that ultimately led to the financial meltdown.

Every problem that we can identify today regarding the financial meltdown is traced to the sub-prime loans created by Freddie and Fannie, which were ultimately syndicated by the brokerage houses and sold into the public market. In spite of that, none of the current administration’s proposals have anything to do with regulate the real bad guys – Congress, Freddie and Fannie. It seems that since our representatives cannot take responsibility for their own failures, they’ll simply find someone else to pin the blame on.

Isn’t it interesting that combined, Freddie and Fannie have lost a staggering $250 billion over the last three years. It’s also interesting that Freddie’s former CEO walked away with a total compensation package of close to $90 million when he left to join the administration. I find it incredibly confusing that the presidents of both Freddie and Fannie each received annually bonuses equaling $6 million for 2009, when they lost a combined $50 billion for 2009. No one complained about their compensation. Why?

On Friday, Congressman Barney Frank recommended that Freddie and Fannie be eliminated in its current form – a very good start. It seems that Congress has its focus on all the wrong people in this matter. Rather than the major banks being the problem, it was Freddie and Fannie, the auto companies and AIG, and they are not being assessed new taxes or new regulations.

Philosophically, who wouldn’t support the proposal as advertised? It’s doubtful anyone would support money that carried a government guarantee being utilized by the financial institutions that would then use those funds for proprietary trading or high risk taking at the government’s expense. However, that’s not occurring now anyway.

The four major banks in the United States that have government-guaranteed deposits are Bank of America, J.P. Morgan Chase, CitiBank and Wells Fargo. When I say “government guarantees,” I mean FDIC insurance on the deposit accounts in these major banks. As reported by The Wall Street Journal, of these four banks, Bank of America has 1% of its total revenues in proprietary trading accounts. Likewise, J.P. Morgan Chase has only 1% of its companywide revenue in proprietary trading accounts. Wells Fargo has no proprietary trading accounts at the current time, and only CitiBank (which is 30% owned by the U.S. government) has 5% of its revenues in proprietary trading accounts.

Because of President Obama’s speech, all of these stocks except Wells Fargo took a major beating on Thursday. This happened even though the purpose of the proposed regulation is moot because these accounts are basically a non-existent portion of the banks’ annual revenues. The fear isn’t this particular item; rather, investors are concerned with what other types of regulations the government may institute that will bog down banking and prevent them from loaning to businesses that need money to expand and increase employment.

There are only two remaining Wall Street firms – Morgan Stanley and Goldman Sachs, which represent the only true brokerage houses left in the U.S. Only 5% of Morgan Stanley’s gross revenues and 10% of Goldman Sachs’ revenues are in proprietary trading accounts. Interestingly, neither of these firms takes customer deposits, and therefore, they do not have government guarantees on their accounts. Each owns a very small bank in order for them to qualify for federal banking protection, and it would be easy enough for them to sell those small banks to avoid all the regulations being proposed.

As for the four major banks discussed above, each of them has brokerage divisions. It would be easy for them to reposition the proprietary trading accounts into their brokerage divisions and avoid the proposed regulations. As such, even though the administration made a big deal yesterday regarding these proposed regulations, from an economic standpoint they mean absolutely nothing. Again, the concern is what these types of regulations ultimately lead to in our economic landscape.

As I think will be demonstrated, the Congress today is less in the mood to restrict business since they need to stimulate employment. Given that they’ve wasted an entire year with proposed legislation that will not pass and which would have hurt business and employees, such as health care and Cap and Trade, now is the time for them to do something worthwhile.

I wonder if we could get through a few weeks without the current administration proposing a new tax or a new regulation that would hurt employment rather than improve it. It seems to me that the focus should be entirely and completely on increasing employment, but 12 months into the new administration, it appears that employees have been totally ignored.

About Rollins Financial Counseling:

Rollins Financial Counseling, Inc. is a SEC registered investment advisory firm that was established in Atlanta, Georgia in 1990 by Joseph (Joe) R. Rollins. Joe along with partners Robert (Robby) E. Schultz, III and Edward (Eddie) J. Wilcox offer independent investment management services for individuals, small businesses and corporations.

Visit www.rollinsfinancial.com or email at mail@rollinsfinancial.com.

Conan's Exit An Inspiration

Conan goes out like a champ. What a class guy with an excellent message. You might want to save this one.

January 22, 2010

Doldrums Likely for 2010 Housing

While there are signs of an economic recovery rolling into 2010, keeping a foot in the winner’s circle could prove tenuous. If the recovery we are seeing today is sustainable, it is happening without the help or health of the housing market and employment. Without the participation of housing or employment, the underpinnings of the positive trends could prove fragile. Wagers on a smooth, clear road to recovery should be made with caution.

“May the wind be ever at your back, may the sun shine warm upon your face and a smooth road to your door.”
For now, housing continues to take it in the chin and there are still significant challenges ahead.

If the housing recovery is still weak and on life-support, what will happen when government removes the supports? The picture is not encouraging. Having said that, I hold out that now is THE time to buy residential real estate. If I needed or wanted a house and had the ability to buy, now is time I would jump in. The convergence of low housing prices and low interest rates are not historical bed mates and the opportunity to take advantage of both will not be long lived. I venture to predict that the end of 2010 will bring an end of this bullish buyer’s market.

My biggest fear is that interest rates will continue to rise, even if slowly for the time being. The current low interest rates cannot and will not last. As housing prices approach bottom, interest rates will continue to raise the bar for affordability. When confidence returns to the housing market, sales and prices are likely to spiral upwards quickly given the amount of pent up demand the recession has sidelined.

But for now housing has several hurdles if not downright roadblocks.

Loan Modifications and Foreclosures
The government’s war on foreclosures has failed and except for a small percentage of successful modifications, has only delayed thousands of inevitable foreclosures. The Wall Street Journal comments, “As hard as they try, the banks and the Washington establishment seem unable to get a grip on a housing market that continues to spiral downwards. Delinquencies continue to increase while government programs intended to stem the tidal wave appear to be failing miserably. Realistically, we may just be getting another reminder that governmental fixes rarely work that well and the market ultimately sorts out the mess.”

Lenders brought in 728,000 borrowers through November for trial loan modifications under the Obama program. Just 31,000 have received a permanent fix so far, or fewer than 5% of those eligible.

The number of struggling homeowners is steadily mounting. According to the Mortgage Bankers Association, one in seven mortgages was either delinquent or in foreclosure at the end of September. Prices have fallen 29% from their July 2006 peak to October 2009, based on the S&P/Case-Shiller Home Price Index, which tracks home values in 20 cities.

Some owners are defaulting because they have lost their jobs. Some are walking away from their homes and mortgages because the value is less than what they owe. Twenty-three percent of homeowners are now underwater according to the National Association of Home Builders.
We’re looking at another dreadful year of defaults and foreclosures. Clearly, the problem is not abating. More people are unable to afford their homes and given employment opportunities, there is little chance that there will be a quick turnaround in their ability to pay their mortgages.

The Wall Street Journal reports on the pressures on the rental housing front. “Apartment vacancies hit a 30-year high in the fourth quarter, and rents fell as landlords scrambled to retain existing tenants and attract new ones. The vacancy rate ended the year at 8%, the highest level since Reis Inc., a New York research firm that tracks vacancies and rents in the top 79 U.S. markets, began its tally in 1980.”

While apartments share the black hole with "for sale" housing for now, it is likely that the industry will emerge from the doldrums well before a sales recovery for homes. Watch for Emerging Trends.

Tax Credits
Without a tax credit to benefit homebuyers and without artificially low interest rates will there be a double dip in the housing recession? When the first tax credit for first-time homebuyers was over there was a stark difference in home sales, particularly in the lower price ranges. The second housing tax credit is set to expire April 30, 2010 (for contracts signed) and there is no reason that sales will not once again decline without the tax benefit.

FHA, who went from insuring three percent of all home loans at the height of the housing boom to now backing about 35 to 40 percent of new loans, has just locked the gates and tightened their underwriting guidelines as a result of runaway defaults and reserve deficits.

Fed Purchases MBS
Although unlikely, it is possible that the Federal Reserve could pull the plug on buying mortgage-backed securities from Fannie and Freddie (to bring down interest rates and loosen credit for home loans) after the March deadline. Word is that if need be, depending on conditions in the economy, housing finance and in financial markets, the central bank is prepared to contemplate an extension, for the second time, of the March deadline.

Ronald Temple, portfolio manager at Lazard Asset Management predicts that rates could rise by a full percentage point after those purchases end and it would precipitate further downward pressure on house prices.

If the government stops buying the MBSs, it is doubtful that the private capital markets will reenter the MBS market with much enthusiasm even with the current conservative lending practices. Moody’s released this week their worsening opinion of the value of 2005-07 RMBS products and although the 05-07 securities are a different animal from the worthiness of recent mortgages, the appetite for MBS is still sour to many investors.

(Moody’s last revised its loss projections in March 2009, to 13%, 30%, and 36% of original balances on 2005, 2006 and 2007 vintages, respectively.Since March 2009, when Moody’s last announced a revision to its subprime loss projections, serious delinquencies (loans that are 60 or more days delinquent, including loans in foreclosure and homes that are held for sale) in subprime pools from 2005, 2006, and 2007 have increased to 48% from 43%, 56% from 51%, and 55% from 47%, respectively (reported as a percentage of outstanding pool balance).)

Organic Sales Weak
Anecdotal reports of late indicate that cash-in-hand investors and vulture funds are buying rock bottom deals to flip. Here we go again… There are no reports to pin precise numbers to the investor activity, but the threat that their numbers are skewing reported sales numbers, both for new and existing housing inventory, does not bode well. When those properties are resold by investors they will be counted again.

Blocks of distressed condominiums are being purchased by investors which creates a double whammy by screwing up the possible financing under the strict regulations instituted for condos last year by Fannie Mae.

Organic sales are needed for a sustainable housing recovery but prospects are very soft. “With the substantial headwinds of rising unemployment, epic levels of foreclosure and delinquency, mounting bankruptcies, contracting consumer credit, and falling wages, an overhang of inventory and still falling home prices, the environment for “organic” home sales remains weak and likely very fragile.”

At the forefront of the recession, predictions were that housing was the first in the tank and would lead the nation out of the recession. But that was not to be. Despite the high foreclosure rate and sluggish sales of the real estate market in 2009, it’s encouraging that the economy isn’t relying solely on the housing market to rebound. As the economy improves the housing market will benefit. As the employment picture brightens and buyers re-enter the market our real estate world will begin to slide back to normal. The unanswered question is just what will the new normal look like?


Wall Street Journal
Mortgage Bankers Association

National Home Builder's Association
Market News

January 19, 2010

WLI at an 82-Week High - Market Indicator for Smooth Recovery

Below are a few optimistic words on the economy from the Economic Cycle Research Institute:

A weekly gauge of future U.S. economic growth continued its climb in the latest week, though its yearly growth rate dropped again, a research group said on Friday.

The steady upticks in the leading index suggest, however, an enduring smooth recovery, the Economic Cycle Research Institute said.

The New York-based independent forecasting group said its Weekly Leading Index climbed to an 82-week high of 132.1 for the week ended Jan. 8, from an upwardly revised 131.6 the previous week, which was originally reported as 131.5.

The index's annualized growth rate edged down to a 17-week low of 23.5 percent from 23.8 percent the previous week, which was also revised higher from 23.6 percent.

It was the lowest yearly growth reading since the gauge reached record highs in October.

"The ongoing recovery in U.S. economic activity is poised to continue in the months ahead," said Lakshman Achuthan, Managing Director at ECRI, who recently told Reuters that the index's steady growth points to improvement in economic activity and the jobs market in the near future. Reuters

How the Banks Bundled Your Honor and Sold It to Wall Street

In a continued attempt to find something to make you smile, I offer up this clip from The Colbert Report called "Honor Bound". SC examines in his own style the moral question of "walking away" from your house and mortgage. It makes for another excellent companion piece to an earlier blog, Confessions Financial Crisis Contributors.

H/T to Mish

January 17, 2010

Pigeon Impossible

I emailed this Pigeon Impossible video to friends and the response was so enthusiastic that I decided to share it here. It's pure entertainment! Enjoy ...

Click here if the video does not appear below.

CNN's Jack Cafferty on Nancy Pelosi

There appears to be no end to the ambiguities of "Do as I say, not as I do" when it comes to the behavior of our Congressional representatives. Just watch the video clip; there's no need for further commentary.

January 15, 2010

Ten Predictions for the 2010 Housing Market

Check out the 10 predictions for the 2010 housing market in a client note from David Goldberg, UBS' home-building analyst: H/T Wall Street Journal

1. Fundamentals will remain ‘choppy’ in the first half of the year, with conflicting data points making it difficult to ascertain whether we’ve actually reached the trough in housing.

2. Headline risk, primarily driven by the government’s efforts to extract itself from the mortgage market, will drive the homebuilding stocks down 15% or more from current levels. With the longer term path for fundamentals offering limited clarity, we expect the homebuilding stocks to remain quite volatile and extremely sensitive to news flow.

3. The previous prediction notwithstanding, the government is going to do everything in its power to protect home prices. In the end, we believe that concerns about higher rates and declining mortgage market liquidity won’t amount to much. In our opinion, the government has continually made it clear that it is working to limit further home price declines given the serious ramifications these declines would have for both consumers and lenders.

4. Although we forecast that as many as 7 million foreclosures are likely to occur over the next several years, we believe the pace at which these homes will come to the market will be consistent with current levels. As such, the concerns around the negative impacts of rising inventory levels are overdone.

5. An improvement in unemployment is the single most important predictor for the longer term health of the housing market—only by focusing on this variable can we truly understand the timing for a recovery.

6. An improving jobs picture will drive greater price stability and better demand. That said, given the level of excess inventory, the pace of price appreciation will be below trend for some time.

7. The builders will see sequential improvements in their quarterly results.

8. Given the limited amount of high quality, finished lots coming to market, we expect the builders to increasingly consider purchasing undeveloped parcels, which represent a greater value. This trend will be magnified if conditions start to accelerate more meaningfully in the near term as builders look to rebuild their operations over time.

9. Although residential construction lending standards might loosen in 2010, liquidity will be insufficient to drive starts towards current consensus estimates. (Mr. Goldberg writes that lenders are reluctant to commit new capital to residential construction. Consensus for 800,000 single- and multi-family starts is “too aggressive,” he writes, putting the figure at between 700,000 and 720,000. Wall Street Journal comment)

10. The longer term outlook for housing will increasingly dominate investors focus toward the end of 2010.

January 14, 2010

How Banker's Think via The Big Picture

I couldn't resist this as the perfect pairing to my last post. George Ricker sent this on from The Big Picture. It says it all:

Thanks my friend!

Confessions of Financial Crisis Contributors: Life After 2008

I am now on a first name basis with Jamie, Lloyd, John, Vikram, Dick and Ken – or at least I think I should be after completing five books on the financial crisis. My new friends of course are J.P. Morgan Chase CEO Jamie Dimon, Goldman Sachs CEO Lloyd Blankfein, , Morgan Stanley Chairman John Mack, Citigroup CEO Vikram Pandit, Lehman Brothers (bankrupt) CEO Dick Fuld, and Bank of America CEO & Chairman, Ken Lewis (now replaced by Brian Moynihan).

I have not been MIA the last couple of months with my face buried in these books, not exclusively anyway. I am no longer income producing due in part to the misdeeds of my friends listed above, although as a flea-size participant in the creation of the housing bubble, I accept some blame. For 30 years I was hard at work getting as much new housing product as possible on the ground at the highest price the market would bear.

On or about October 31st my own personal bubble burst when I admitted that my five readers simply could not push my modest blog to the heights of revenue generation. So I pouted, threw a pity party, then launched into an extended lesson on credit crisis to find out just how I lost all that money that I made while pushing the housing bubble. I was a small player on the bloody battlefield so I decided to turn to the pros to see how they screwed up the gravy train.

My texts for my self-taught course were as follows (and read in this order):

Street Fighters: The Last 72 Hours of Bear Stearns
, the Toughest Firm on Wall Street, by Kate Kelly

Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street, by Janet Tavakoli

The Sellout, by Charles Gasparino

Too Big to Fail, by Andrew Ross Sorkin (my personal favorite)

The Dollar Meltdown, by Charles Goyette

One of the most consistent traits between all of the men populating these books (women made up about .00000001% of the Wall Street boardrooms – just an observation) was the use of their favorite word, “F**K”. Their second favorite utterance – a distant second – was “call Hank”, followed by “call Buffett.” Caveat: I never read that Bernanke used any expletive.

You can imagine my delight yesterday morning when, on the heels of my recent studies, I tuned into the first Congressional hearing of the Financial Crisis Inquiry Commission. This 10-member nonpartisan commission, with a budget of just $8 million, “is charged with delivering a comprehensive report to President Obama by Dec. 15 on 22 factors associated with the crisis, from mortgage fraud to regulatory failings.” This was going to be my day!

In this first session, of what promises to be thousands of hours of testimony and interviews, four financial rock stars of Wall Street prepared to testify as to their role in the 2008 financial meltdown. The financiers included the heads of J.P Morgan Chase, Goldman Sachs, Morgan Stanley and the new chief of Bank America, Brian Moynihan.

Yesterday’s Congressional hearing ranks as a 10 in my book – at least in comparison to prior “grill sessions” by the banshees on the Hill. This session on the financial crisis, was actually productive in drilling down to the forces behind the meltdown that rocked our economy . The committee members for the most part asked intelligent questions and seemed to be prepared to squeeze the truth out of the crisis. Can Congress bear the truth when part of the blame will be laid on their doorstep?

The financial titans admitted that they did not foresee the potential implosion of the housing market. They never thought home prices would take a precipient dive? Yes, they would do things differently now. Yes, they are deleveraging, somewhat. Yes, clawbacks of some sort are in future compensation plans. Yes, we promise to be good boys from now on. We’ve learned our lessons.

The Commission’s line of questioning, while covering the gamut (except for “did you arrive in Washington on a private jet?”) centered on the problems with the financial products, mortgage backed securities and credit default swaps. Lloyd Blankfein found himself on the hot seat right off the bat. Of course, Goldman Sachs, has suffered scrutiny and raised eyebrows from many corners regarding their success before and after the bailout. Taibbi of The Rolling Stone raked them over the coals to much acclaim.

The attention focused on Goldman was probably encouraged by Rothkin’s (Too Big to Fail fame) New York Times article published the day before the hearings that disclosed an email from a Goldman exec that suggested the firm sold MBS products and then turned around and shorted the stocks of the firms taking receipt. In other words Goldman sold the equivalent of toxic loans under the guise of AAA ratings knowing the poor quality of the loans and then placed bets on the losses from those products.

Last month, the Securities and Exchange Commission and Congress began investigating how Goldman and other firms had created bundles of mortgages known as collateralized debt obligations, or C.D.O.’s, that were sold to investors at the same time that the banks had privately bet against the instruments. Some of these C.D.O.’s later fell in value, creating losses for those clients who bought them — and profits for Goldman. Commission chairman, Phil Angelides, likened the practice to selling a car knowing it has bad brakes and then buying a life insurance policy on the buyer. New York Times
Goldman’s culpability has not been confirmed. Disclosures in small print notified buyers of these products that Goldman may take a contrary position to the MBS. Even if not technically illegal, the ethics of such a practice is certainly questionable. Tangled webs beyond comprehension.

Blankfein admitted that they did not complete in-house due diligence on the underlying mortgages packaged into financial products but rather relied on the rating agencies which slapped AAA ratings on many securities with underlying toxic loans.

The Inquiry Commission’s hearings promise to be some of the best theater of the year. I for one will be tuned in. It’s interesting that the first crises participants to testify were four bank leaders that repaid TARP funds and to a large extent are responsible for the $50 billion profit the government made from TARP funding.

President Obama this morning declared his new Bank Tax Plan and vehemently declared he intended to collect money owed to U.S. taxpayers for TARP from these banks that are making “obscene” profits (that would be our four heroes of yesterday). Interesting posturing Mr. President. No mention of the TARP funds paid to GM and Chrysler, Fannie Mae and Freddie Mac which have a snowball’s chance in hell of being repaid. But I get ahead of myself.

This is going to be an interesting year as Congress chases bank profits from the front porch while those same banks fund the politicians with massive contributions from the back porch. The self righteous shall inherit the world: some things inevitably get turned upside down. This should be the year of the turtle, not the year of the tiger. But I’m learning not to second guess the Chinese who seem to be besting us when it comes to capitalism.

More About the Financial Crisis Inquiry Commission (FCIC):

The bi-partisan 10-member Financial Crisis Inquiry Commission was created by Congress and is charged with examining the causes of the financial meltdown. It is also examining causes of the collapse of major financial institutions that failed or would likely have failed had they not received exceptional government assistance. The Commission is comprised of Chairman Phil Angelides, Vice Chairman Bill Thomas, and Commissioners Brooksley Born, Byron Georgiou, Robert Graham, Keith Hennessey, Doug Holtz-Eakin, Heather Murren, John W. Thompson, and Peter Wallison. Findings and conclusions are to be presented in a formal report to Congress and the President by December 15, 2010. Huffington Post

Here is the testimony by Lloyd Blankfein, Goldman Sachs:


Voices That Dominate Wall Street Take a Meeker Tone on Capitol Hill, New York Times

Goldman E-Mail Message Lays Bare Trading Conflicts, New York Times

Panel Rips Wall Street Titans, Wall Street Journal