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Archive for March 2nd, 2010
Commercial Real Estate Problems in Financial Purgatory – $3.4 Trillion Debt Market and Expansion of Interest Only Loans to Finance CRE Deals. CRE Debt Found its way into Pension Funds.
March 2nd, 2010 | 
Author:
Posted by mybudget360
The Congressional Oversight Panel put out a daunting report regarding the commercial real estate market. Commercial real estate is an enormous market with $3.4 trillion in debt secured by office space, malls, and apartment complexes to name a few examples. Commercial real estate does a fairly good job as being a barometer for the actual recovery on the ground that most average Americans will feel. If middle class Americans feel ready to spend again and are expanding their consumption, then more and more office space will be occupied. But looking at current vacancy rates we get a diverging picture of the recovery we keep hearing about but seem to escape the grasp of 95 percent of the population.
One of the troubling findings in the report is the lax lending found in residential real estate was mirrored in the commercial real estate market:
In fact, the amount of interest only or partial-interest only loans was even bigger in CRE than in the residential market which in itself is a rather stunning accomplishment. In 2007 at the height of the CRE bubble, nearly 90 percent of all loans were interest only or partial-interest only loans. This number is astounding. But what is even more disturbing is the recent ramping up of interest only loans. In other words, banks are rolling over loans with the absolute minimum payment possible to keep borrowers above water. Why does the bank want millions of square feet in empty office space? They don’t so the shift here probably has something to do with that. The commercial real estate market is in a giant form of financial purgatory.
The lax lending standards that came into the CRE market also show that during the boom due diligence was an afterthought on most loans. Keep in mind many of these deals were multi-million dollar deals and in some cases, billions of dollars were at hand. This wasn’t a $90,000 subprime loan, which is bad in itself with weak underwriting, but here you had millions being thrown around as if somehow banks forgot the actual value of a dollar. The standards in CRE deteriorated rather quickly:
As more and more money bounced around the system lending standards became more and more generous. Of course this led to the massive expansion in CRE space even when demand did not warrant it but has now led us to this current precipice where the market is flooded with too much inventory. As is the case in most bubbles prices have corrected heavily in the CRE market:
CRE values across the board are down by 40 percent from their peak values, a steeper decline than even the residential housing market. Yet banks holding onto these loans have been spared the stock market drubbing many banks took in 2008 and early 2009. The loans are equally as bad so why then is the market responding so favorably to what seems to be disastrous data? In March of 2009 it seemed the entire financial system was going to implode and finding a bid on any asset at one point seemed to be an act of futility. Now this might have been extreme given how quickly we were approaching zero. But today, the opposite is the case. Many are overvaluing the actual damage that is going to hit the system in the next few years courtesy of the CRE market. This is an enormous market where most of the loans are held by already weak banks:
The large amount of this debt is held in commercial banks. These are the same commercial banks that are backed by the insolvent FDIC fund. The FDIC now lists over 700 banks as “troubled” but it is very likely that when this crisis is over (which can be years away) we will have at least 1,000 bank failures. Most of these banks now have CRE loans that are not being serviced or are being serviced at lower levels that don’t even cover principal and interest. To paraphrase, if you owe the bank $1 on credit card debt that is your problem, but if you owe the bank $10 million in CRE debt it is the bank’s problem. Many banks are in a position where they are now realizing that the borrower is calling the bluff of the bank. You want your CRE back? Go ahead and take it! So banks would rather let the borrower hold onto the CRE even if it is bleeding on a monthly basis instead of forcing actual write-downs on their books.
And what is troubling is that many so-called conservative investment funds ate up this toxic waste:
So you might be thinking, “I don’t own any CRE so why should I care?” You might not own any of this CRE debt but your pension might. Now when things get this systemic, it is bound to roil the system just like subprime was the fuse that lit off the economic crisis. Today, no one thinks that subprime was the cause of this entire crisis but was merely the most obvious first domino to fall. CRE is equally as toxic but it seems that the market has chosen to ignore the problems inherent in the system. Eventually the system will have to realize what is going on either through a market correction or by funneling more bailout funds to inefficient components of the economy.
The market is probably mispricing the actual problems in the system because it assumes that the bailouts of the banking industry will protect the problems with this mess. Yet someone will be paying for this. Wall Street is simply assuming it will be the middle class yet again. Take a look at the concentration of CRE debt with the too big to fail:
At the core of this problem was the shifting of debt to the global markets by securitization. To repeat an often misused quote, real estate is local. So how can an investor in Norway really have a good sense of CRE in Houston Texas? They don’t and clearly this is the same inefficient spreading of risk (and gambling) that led us into this crisis:
For 40 years securitizing debt was only a Wall Street trader pipe dream. Suddenly in 2000, this was the way to make mounds of money on what used to be boring real estate debt. CRE was only another asset class that was once relatively stable and suddenly became another slot machine in the Wall Street casino. It is no mistake that over the past decade the middle class in America have lost ground seeing wages stagnant while a smaller portion of our economy goes to those in the government sanctioned casino knows as Wall Street.
Expect bigger problems to hit in the CRE market. From the report:
“(COP) Between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present “underwater” – that is, the borrower owes more than the underlying property is currently worth. Commercial property values have fallen more than 40 percent since the beginning of 2007. Increased vacancy rates, which now range from eight percent for multifamily housing to 18 percent for office buildings, and falling rents, which have declined 40 percent for office space and 33 percent for retail space, have exerted a powerful downward pressure on the value of commercial properties.”
In other words, get ready for more bailouts or dollar devaluation.
Posted in Banks, commerical real estate, Corruption, Economic Crisis, Economy, Financial System, Securitization | 
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See What $1.6 Trillion In Deficits Buys?
See What $1.6 Trillion In Deficits Buys?
Posted by Karl Denninger
Funny how the numbers seem to line up:
Real disposable income decreased 0.6 percent in January, in contrast to an increase of 0.2 percent in December. Real PCE increased 0.3 percent, compared with an increase of 0.1 percent.
Yeah, we’re not making anything in actual income, but the government is forking up billions in things like unemployment and such.
The fun part of this, of course, is that the only thing that has held up the economy is that deficit spending. But for it, as I noted in my missive of Feb 23, we’ve borrowed and spent 14% of GDP over the last 18 months – or roughly 10% annualized.
The premise behind all of this is that if you can “prime the pump” it will lead to sustainable growth.
The error in the premise is that borrowing has to pick up but we never destroyed the excessive debt leverage that was in the system originally. As such there is no borrowing capacity – recall that one must have both a willing lender and a willing and able borrower.
There is no recovery. Buffett is on CNBS this morning talking about a “slow recovery” but he’s being intentionally misleading – or he’s gone insane. He talks a good game about “strong medicine” but in point of fact he then says that he’s seen little evidence of an actual turn-up in the economy as a whole.
Well Warren, which is it? Either there’s no recovery coming – the economy is simply being propped up until the government becomes unable (or unwilling) to continue to spend at double its tax inputs, or you’re wrong.
Me? I go with the data, which says that not only is the government “stimulus” not working to produce sustainable output gains, it can’t work because the excessive debt that led us into this mess is still there as a direct and proximate consequence of our government refusing to allow those who made bad loans to go out of business – both on the borrowing and lending side.
Balance Sheet Fraud Is Not Just For Enron (Or Banks)
Balance Sheet Fraud Is Not Just For Enron (Or Banks)
Posted by Karl Denninger
Oh, look at what the Zerohedge cat dragged in this time!
Yet a 2001 report prepared by Gustavo Piga, in collaboration with the Council on Foreign Relations and the International Securities Market Association, not only fits that particular smoking gun description, but the report itself was damning enough of another country, a country which used precisely the same off-market swap arrangement to end up with an interest expense of LIBOR minus 16.77% (in essence the counteparty was paying Italy 16.77% of notional each year as a function of the swap mechanics), in that long ago year of 1995. The country – Italy (for confidentiality reasons referred to in the report as Country M), was at the time panned as the Enron of the European Union due to precisely this kind of off-balance sheet arrangement by the Counsel of Foreign Relations. The counterparty bank: unknown (at least in theory, since the swap was highly confidential, and was referred to as Counterpart N), but considering the critical similarities in the structuring of the swap contract to that used by Greece in 2001, and that ISMA cancelled Piga’s press conference discussing his findings out of fear for the academic’s life, we can easily venture some guesses as to which banks value their recurring counterparty arrangements more than human life.
Uh, Libor minus 16.77%?
A hedge huh?
This was identical to you walking into your bank and taking a cash advance on your VISA card – at a rather high interest rate – and concealing it for the explicit purpose of being able to show a wad of cash at the end of the year on your books.
That is no hedge, it is a loan. It was done to cook the book and, in my opinion, falsely present the “health” of the nation – in this case Italy – involved. It was done over the counter with no paper trail or exchange trading for the explicit purpose of secrecy, so that nobody would discern that the government in question had borrowed the money.
The problem should be obvious here. If I cannot trust the balance sheet of a sovereign government because I have discovered one “tricky deal” such as this, I have no means to know how many more “tricky deals” there are, what the liabilities might be, what the credit exposure is, and whether I will ever get paid back if I loan that government money.
The allegation is made that Goldman was on the other side of this deal. That, if true, raises a further question: how many more of these hinky lending deals is Goldman involved in? (Note that FT seems to think it was JP Morgan. Not that the identity matters, by the way – the point is that the institution involved knowingly made a loan in a form that was intentionally designed to mislead those not involved in the transaction.)
The entire report by Zerohedge is well worth reading, although it’s fairly thick. The essence of it, however, is that these deals were loans and were written “off balance sheet” using hinky derivative transactions for the explicit purpose of misleading investors about the strength of the nation involved – and that, unfortunately, directly implicates the Euro as a currency.
Buckle up folks.
Posted in Balance Sheet, Banks, Corruption, Economic Crisis, Economy, Enron, Financial System |
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