Ultimate money magician in the Federal Reserve and the art of shadow bailouts – The continuing secretive bailout of the $3.5 trillion commercial real estate market.

The Federal Reserve is the ultimate magician in concealing bad bets for the flawed banking system.  Few in the history of the Federal Reserve have called them out on their shadow bailouts but people are starting to wakeup no thanks to the mainstream controlled media.  Think about how insane it is to have a central bank that does not even report to the people of the country it serves and is able to destroy the currency by bailing out bosom buddy bankers at the expense of the population.  How is that even possible?  Since this is the architecture of the system it becomes possible to create mega shadow bailouts like that occurring in the commercial real estate market (CRE). The CRE bailout is largely a sign of what is wrong with our broken financial system.  Sure, with residential real estate the argument can be made that this impacts most American families.  Of course even in that arena it has been a failure for the public but the CRE market is strictly a big money and big banking issue.  The market imploded from being valued at $6.5 trillion a few years ago down to $3.5 trillion today.  Yet why is it the responsibility for average Americans to bailout banks for bad bets on luxury hotels and failed strip malls?

The continuing bailout you are not hearing about

There is a false narrative flowing in the market that the bailouts are winding down and somehow we have turned a profit.  All we need to do is look at the Federal Reserve balance sheet to see that this is not the case:

*Update December 2011

The Fed balance sheet is at a peak nearly reaching $3 trillion in a mix of toxic loans and odd backdoor bailouts.  A large part of this is bad bets in the CRE market.  Think that the bailout money is only going to poor segments of our economy.  How about aiding the Ritz?

“(WSJ) The developers of the Ritz-Carlton Highlands hotel at Lake Tahoe apparently have leaned a little too far over their skis. Bank of America Corp., the lead lender in the hotel’s $157 million mortgage, has filed a default notice against the property.

Developer and owner East West Partners, based in Avon, Colo.,  is “talking daily” with its lenders to resolve the situation, East West senior partner Blake Riva said. At issue: $10 million of the loan has matured without being paid, and the lenders want East West to pitch in another $8 million of capital.

Otherwise, East West and Ritz-Carlton, a unit of Marriott International Inc., say the hotel is doing well. Like many mountain-resort businesses, the Ritz is temporarily closed and slated to reopen by mid-May, after the “mud season” passes and vacationers return to the area on the California-Nevada border.”

Isn’t it amazing that these shadow bailout are presented as some sort of method of keeping lending going to average Americans?  Instead, major CRE projects are defaulting and banks are simply ignoring the losses or are passing the bad notes over to the Fed as a sanctuary of bad bets.  The public does not have this convenient access of course.  Accounting trickery seems to be an area of expertise of the Fed and their fellow big bank friends.

Read the rest at My Budget 360

The Federal Reserve is primarily concerned with one thing and that is to protect the interests of the banking industry.  The Fed has no desire or need to protect the underlying economy.  If they can get away with allowing banks to jump from one bubble to another they will do so.  The success of the overall economy is only consequential if it aligns with the deeper interests of the banking cabal.  This weekend former Fed Chair Alan Greenspan mentioned that simply bailing out Greece was a temporary measure.  When pressed he went back into “Greenspeak” and rambled on in his typical obtuse language.  The reason why global banks fear Greece is not because of the country itself, but because the country has billions of dollars in debt that global banks hold.  These banks do not want to pay for their bad bets and would rather shift the cost to the overall population in general.  The Fed balance sheet here in the U.S. is now up to $2.84 trillion, another record that gets no airtime in the press.  The Federal Reserve continues with clandestine bailouts only to protect the interests of the banking elite.

Fed balance sheet reaches $2.84 trillion

The Federal Reserve balance sheet is now up to $2.84 trillion.  The Fed has become the silo for shadow bailouts including bailouts for the commercial real estate industry, toxic residential loans, mortgage backed securities, and even loans that have no business being on its books.  Yet all this is seen as providing more liquidity for the banking system in the country.  Since the crisis started four years ago little benefit has been seen in the underlying economy.  Keep in mind the fiscal stimulus which is a fraction of what the Fed now holds on its balance sheet is what many Americans see on infrastructure projects.  The total amount spent since August of 2008 approximates $550 billion (roughly 3 percent of GDP).  On the other hand the Federal Reserve balance sheet specifically targeted to the banks now is up to 20 percent of GDP.

Of course little is discussed in the press about the Fed balance sheet.  The Federal Reserve has specially focused on bailing out the banking sector and this has worked well.  The too big to fail banks are now larger and profits are back to record levels.  Their biggest success was ripping off the public and more specifically have kept most of their hidden secrets buried deep in the belly of the un-audited Federal Reserve balance sheet.  We know that the Fed is holding $2.84 trillion in various “assets” but what exactly is being held?  They would like the public to believe that only pristine assets are being held in exchange for U.S. Treasuries but in reality the Fed is purchasing every questionable asset under the sun.  The Fed is ignoring the needs of the economy and simply focusing on protecting the interests of the banking elite.

Read More at My Budget 360

Day of reckoning for commercial real estate in 2012 – largest amount of loans maturing next year as $150 billion in CRE debt comes due. Federal Reserve running out of options in hiding financially disastrous real estate loans.

The Federal Reserve has tried its best to hide the secrets of past banking blunders deep in its balance sheet.  Commercial real estate (CRE) loans made in haste during the real estate bubble are part of this national disgrace in banking folly.  As the Federal Reserve and U.S. Treasury digitally print the dollar into oblivion the bad CRE loans still linger in the Fed balance sheet.  As it turns out the Fed has become the dumping ground for all things real estate and has traded toxic loans for quality liquidity to fuel the banks back up.  CRE debt in the form of empty shopping malls, failed hotels, and tumbleweed occupied strip malls is only a flavor of what the Fed is taking on.  Yet many of these loans are still occupying the balance sheet of many banks.  As it turns out, there was so much junk in the CRE market that the Fed could only balloon their balance sheet and still not encompass one half of the CRE market.  Many CRE loans are coming due in 2012.  Is the day of reckoning for CRE coming in 2012?

$150 billion coming due in CRE loans in 2012

Over $150 billion in CRE loans are maturing in 2012 bringing the day of reckoning closer.  Why is this a problem?  First, the CRE market has completely imploded:

Source:  MIT

CRE values just like residential real estate have cratered and are down over 50 percent since their peak.  Much of these properties require actual economic streams of income coming in for example in strip mall rents or hotel occupancies to keep servicing the debt.  Unlike a home that has other sentimental values a CRE property is strictly a business decision.  The Federal Reserve is seeing the tanking of valuations at the absolute worst time.  The Fed treating the crisis as one of liquidity simply exchanged U.S. Treasuries for toxic CRE debt to drinking buddy banks.  After all what is the harm in keeping the junk for a few years and when prices recover, a simple hand off and the public has no idea what happened except they just have to contend with greater goods inflation as their purchasing power falls through the floor.  However the bailouts of 2007 never helped the overall economy because the crisis is one of solvency, not liquidity.  The working and middle class are struggling because their purchasing power has washed away over the decades and the bailouts were simply geared to the too big to fail banks.

CRE is a giant problem because the number of buyers vying for a strip mall is relatively small.  Unlike a residential property, if the price drops low enough on a home the market will respond.  If a strip mall was poorly built in a bad location you may have no buyers regardless of cost.  And make no mistake banks have shut the door on CRE fairly hard:

Source:  World Property Channel

The fiasco in CRE can only last so long.  The Fed balance sheet has exploded during this crisis and you can rest assured billions of dollars in CRE loans are floating in the un-audited figures:

CRE is merely following the pattern outlined by the residential real estate bubble effectively creating a situation where a double bubble developed:

Source:  The American

2012 is looking like the day of reckoning for CRE debt.  First, you have an American public that is absolutely frustrated by the ineffective handouts to the banking system of the country.  The hunger for a full Fed audit is getting louder and louder.  Politicians will sway in the way of their financial backers but only to the extent they feel they can get away with their smoke and mirrors and deceive the public.  That shell game is becoming harder and harder to maintain.  At what point does the government step in and do what is best for the economy and not the big banking interests?  How does bailing out a failing hotel or empty strip mall really help the average working American?  It doesn’t.  Banks were eager to make these loans and profited handsomely during the bubble.  Now they don’t want to deal with the consequences of taking on too much risk so they rather socialize the losses on the public.  This is not capitalism but a banking corporatocracy.  CRE debt will come due in large amounts in 2012 and unless prices soar to the sky in the next year, some major rebalancing will need to occur.

There is no inflating out of the real estate mess and CRE is no exception.  Unless household incomes go up disposable income is going to get tighter.  We are already seeing more money being eaten up by food and energy and baby boomers will definitely see more money flowing into the healthcare industry complex.  From one frying pan to another it will become about priorities and CRE will move lower on the list.  The day of reckoning for CRE is coming next year and only time will tell how the market will respond.

My Budget 360

Part of the success that the Federal Reserve has achieved with boosting up large banks stems from its secretive ability to forge shadow bailouts of residential and commercial real estate loans.  The more secretive of the previous two comes from the commercial real estate (CRE) industry.  During the height of the housing mania in the United States CRE values were estimated to be worth $6.5 trillion.  A hefty sum no doubt and with $3.5 trillion in loans securing these properties, a significant cushion of equity was in place.  Yet with the crash in all real estate values, banks were left holding a smoldering portfolio of empty shopping malls, luxury hotels, and in some cases fast food outlets.  Today CRE values are estimated to be at $3 to $3.5 trillion putting many loans in a negative equity position reminiscent of many individual homeowners.  This issue of bailing out CRE was never discussed openly with the American people because it would have never carried any political muster.  So what the Federal Reserve accomplished was to create a system where banks were able to exchange toxic loans in place of U.S. Treasuries without taking up an open dialogue with the public.  In other words a clandestine bailout.

The continuing shadow bailout

The problem with bailing out the commercial real estate industry is that it shifts costs from businesses and more crucially big banks to working and middle class Americans.  The value of money that Americans now carry is becoming worth less each day with these continued actions.  Do Americans make the direct connection?  I think the Federal Reserve is making the bet that most will not understand this convoluted connection and simply go on with their daily lives blaming whatever other topic of the day is filtering in the financial press.  Without a question however the Fed is making Americans poorer.  The values of CRE have fallen dramatically and if we look at the current chart of their values, we see that they are making no immediate comeback:

Source:  MIT

CRE values are down by 50 percent from their peak only a few years ago and if we are to actually adjust for inflation the figure gets even more dramatic.  It is hard to imagine how values can go up.  If you built a shopping mall in say an Arizona suburb that never drew the expected traffic, then it is likely the loan will not be serviced and the bank and borrower would be in serious trouble.  This has happen thousands of times over across the United States.  Most of the CRE troubles are coming online in the next few years:

Source:  ZeroHedge

However instead of these loans going into default and becoming issues for banks, these are now on the Federal Reserve balance sheet and will cause problems for taxpayers.  In many ways we are already seeing this being reflected through higher commodity and a weaker dollar.  As the Fed talks about how open they are and how transparent their accounting is we simply need to look at their overall balance sheet and realize that most of the bailouts are still lingering in their hidden books:

Source:  Cleveland Fed

What is interesting is that we are given an overall eagle eye view of their portfolio but we are not given deeper knowledge of what is in that $2.75 trillion portfolio.  It would be a big difference between a shopping mall that is fully occupied from one that has zero traffic.  In the first case you can get an actual value and it would be worth something.  There are many shopping centers and malls built in the mania that really have no value and even serve as a piece of real estate blight in local communities.

One piece of CRE that does not fall in this category is a Ritz hotel:

“(WSJ) The developers of the Ritz-Carlton Highlands hotel at Lake Tahoe apparently have leaned a little too far over their skis. Bank of America Corp., the lead lender in the hotel’s $157 million mortgage, has filed a default notice against the property.

Developer and owner East West Partners, based in Avon, Colo.,  is “talking daily” with its lenders to resolve the situation, East West senior partner Blake Riva said. At issue: $10 million of the loan has matured without being paid, and the lenders want East West to pitch in another $8 million of capital.

Otherwise, East West and Ritz-Carlton, a unit of Marriott International Inc., say the hotel is doing well. Like many mountain-resort businesses, the Ritz is temporarily closed and slated to reopen by mid-May, after the “mud season” passes and vacationers return to the area on the California-Nevada border.”

I find it fascinating that we are bailing out a place where 99 percent of Americans will never be able to afford yet are using their future earnings in taxpayer dollars to bailout this hotel.  As banks talk about the wonderful economic recovery their production of loans tells you another story:

Banks are making fewer loans in the CRE world while pushing more and more of the toxic debt onto the Federal Reserve balance sheet.  People need to remember that the Fed is a quais-governmental body that is mainly concerned with protecting the too big to fail banks.  From its inception in 1913 this system was never designed for the mom and pop investor or the small town bank.  The purpose of the Fed was to protect giant banking interests by consolidating banking power.  As the Fed talks about economic success many Americans are asking, “economic success for whom?”

My Budget360

The media has done a fantastic job painting over the enormous sinkhole of a problem that is commercial real estate (CRE).  U.S. banks hold over $3 trillion in commercial real estate loans on properties that were once valued at over $6 trillion.  Today those values are down to roughly $3 to $3.5 trillion depending on what metric you believe.  How is it possible for a market that has lost $2.5 to $3 trillion to become largely hidden in the dark from the mainstream media?  We constantly hear about $3 billion deficits or other issues but is the trillion dollar figure just so enormous that they don’t even bother investigating?  It is probably more likely that the Federal Reserve has concealed massive failures in CRE by allowing banks to play a game of extend and pretend that continues today.  The shadowy problems of empty shopping centers, vacant car dealership lots, and misplaced strip malls is largely a taxpayer problem now.  Banks made these irresponsible loans but had the Fed hand over taxpayer loot in exchange for worthless real estate.

“Another empty strip mall”

CRE bringing down FDIC banks

Source:  MIT

CRE values are still hovering near their trough and are likely to move lower.  The only reason these prices haven’t moved lower is because banks are more generous with the borrowers of CRE debt since these holders are grappling with multi-million dollar cuts in each deal.  Banks would rather pretend a mall is valued at $100 million instead of marking it to a real value of $40 million or less.  The fact that the Federal Reserve allows this to happen is financial chicanery.  Can you pretend to the government that you really don’t make $100,000 a year so instead you will act as if you make $30,000 a year and act accordingly?  This is what is happening here.  Banks are essentially allowing these toxic loans to be laundered through the system in exchange for taxpayer dollars.  The Fed is betting that the public doesn’t wake up to this scam.

CRE is a giant and pernicious problem.  With residential real estate it hits directly home and many American families are considered home owners.  This bubble has garnered most media attention as it should.  Yet CRE debt is enormous, larger than every state budget deficit combined by many times!  In fact, the losses on CRE loans is larger than the state budget issues.  Of course the Fed wants the public to look away from the real culprit behind the decline of the American middle class.  The scheme was to build junk and pawn off the loans to average Americans whether they wanted to accept the debt or not.

The cost of CRE problems

Banks have no faith in this recovery.  Look at the above regarding commercial loans.  Banks continue to claim that the reason for the taxpayer bailouts was to help the American public weather the economic storm and for banks to continue lending to average Americans.  Instead, as you can see above, commercial loan lending has collapsed and banks have hoarded money and speculated on the stock market casino on the taxpayer dime.  This money was used to shore up bad balance sheet problems and for gambling on the stock market to boost profits.  In short it was one giant swindle perpetrated on the public.

And think about the supposed recovery we are experiencing.  If we were truly growing and expanding don’t you think there would be healthy demand for loans as businesses expand their workforce?  Wouldn’t it be logical to conclude that commercial loans would reflect the supposed increased demand from a booming American economy?  Of course the only boom occurring is for the top 1 percent who are siphoning off the wealth from average Americans to spin their continuing speculation in the stock market.  Many are starting to wake up from this collective sleepwalk where taxpayers were robbed in open daylight.

The problems are coming up

Source:  ZeroHedge

What is even more problematic is many of the CRE loans are going bad in the next few years.  Just like residential real estate is now experiencing a second collapse, CRE will have another move lower.  Banks can only carry fantasy paper for so long.  So far we have been paying for it through QE1, QE2, TARP, and other convoluted programs to launder money and devalue the U.S. dollar and decrease the quality of life of average Americans.  The public did not sign up for this.  The banks talk about shared responsibility and many are paying for it by losing their homes and going bankrupt.  Millions are facing this economic “responsibility” on a daily basis.  What penalty for the banks?  Instead, they get bailouts and continue to pretend the junk loans they made on concrete disasters are worth inflated values only to shovel them off to taxpayers.  How is it that there are no buyers for these supposedly highly priced items?

CRE debt exposes the worst aspect of the bubble.  Pure profit motive by supposed sophisticated investors on both sides of the coin with no financial responsibility or ownership.  This isn’t some poor family in a low-income neighborhood taking out a subprime loan.  This is actually a supposed responsible bank and a supposed financially savvy investor.  There is no justification for one penny of a bailout here.  Yet the Federal Reserve continues with their hidden bailout where they support malls in Oklahoma to Chick-fil-A.  Don’t expect to hear about this on your nightly news.

My Budget360

The massive commercial real estate market is already plaguing the weak balance sheets of banks.  It is the case that each Friday, we are likely to see one U.S. bank fail because due to high levels of commercial real estate (CRE) debt on their books.  This market is likely to cause the failure of hundreds of banks and put the economy down into another real estate funk.  The amount of commercial real estate transactions shows no sign of recovery in this market.  And why would there be any recovery?  This is an area for hotels, strip malls, condos, and other projects that usually reflect a healthy and growing economy.  We do not have that and the problems embedded in CRE are going to stifle any growth for years to come.

First, we should look at the trend in commercial real estate prices:

Source:  MIT

The above chart is extremely helpful in showing how quickly bubbles can grow but also, how fast they can deflate.  It took 7 years for prices to peak and only one year for prices to collapse.  We have seen similar trends in the residential real estate market.  The crash is rather obvious but why did it happen?   The reason prices collapsed so fast was that it was a speculative boom.  Lending became much too easy with the Federal Reserve flooding the system with easy capital trying to find a home.  In more sober times, CRE deals were scrutinized with a due diligence and it was inspected to produce cash flow from day one with sizeable down payments and strong financial reports.  But this is not the case and many of these giant deals ended up going the way of the little to nothing down world of residential real estate.

The market in CRE is enormous.  This market is over $3.5 trillion and is likely to damage the regional banks much more deeply than larger banks that have a taxpayer safety net:

Source:  T2 Partners

The current weakness in the economy is a realization that problems are still deep in the system.  Think of how large the CRE market is.  Roughly $3.5 trillion in debt secured by casinos, strip malls, empty condo projects, and other real estate that likely is underwater.  Keep in mind that at one point this market was over $6 trillion in value.  The CRE market looks to be valued at $3.5 trillion to $3 trillion with the same amount of loans outstanding.  In other words, the market sector is underwater.

The problems with commercial real estate have shown up in prime locations like San Francisco to Chicago.  These CRE debt problems are not a reflection of poor areas as we are at times led to believe.  These were high flying speculative bets that were only successful as long as the pipeline to greater fools was in place.  When that line quickly dried up, so did the system and all the funding that kept the game going.  It was the perfect definition of a bubble.

If we really want to see how quickly things have dried up in this market take a look at the following:

Source:  Real Estate Channel

“At the peak in 2007 $522 billion in sales transactions took place.  In 2009 it collapsed to $52 billion, a drop of 90 percent.”

This is why the CRE market is the next shoe to drop and with so much debt outstanding it is going to put an incredible amount of pressure on already weak balance sheets.  What is even worse is that the U.S. taxpayer is going to be likely on the hook for all these speculative bad bets.  If you haven’t noticed the bailouts don’t do much for the real economy except shoring up the investment banks on Wall Street.

The amount of lending in this market has dried up and so have profits in this arena.  Now the piper needs to be paid but with what money?  How can you service your commercial real estate debt if you don’t have any money coming in?  This is where delinquencies are spiking.  It is also the case that the peak years for CRE debt maturities won’t hit until 2011 and 2012:

Source:  Real Estate Channel

Unless CRE prices miraculously recover the problems are only going to get deeper in this market.  Commercial real estate unlike residential real estate has quicker turnover rates on their loans.  That is, many of the loans need to be rolled over every 5 to 7 years.  Normally on a cash flowing property this is no problem but with trillions of dollars underwater, this is a major issue coming down the road.  The FDIC with a negative deposit insurance fund is taking over banks on a weekly basis and is having a firsthand look at the tremendous amount of bad debt on bank balance sheets.

Banks clearly understand what sits on their balance sheet and if anything, nonperforming loan volume has shot up:

Source:  Bankregdata

Throw in CRE debt, troubled residential mortgages, defaults with credit cards, auto repos, and all other debt instruments and you can understand why the chart above is spiking.  But think of it this way; the credit card market is approximately $850 billion in debt outstanding while CRE debt is up to $3.5 trillion.  What do you think is going to cause bigger pain down the line?

My Budget360

Vincent Fernando

Here is an interesting email from “JL” about the architecture industry.

“JL” writes:

Hi Mish-

A while ago, you published a stat from the American Institute of Architects (AIA) regarding architecture businesses and billing increases and decreases. I thought that was a good indication of future construction growth and I checked it out. It looks like it ticked up marginally for December but it’s still terrible according to the Wall Street Journal article Architecture Billings Tick Up, but Still Show Decline.

The Architecture Billings Index moved slightly higher last month, although the index remained below 50 for the 23rd consecutive month. The score in December was 43.4 compared with 42.8 in November. The December reading indicates a continued decline in demand for design services.

To give you some information just from my small circle of friends and family in Architecture:

• All architects I spoke to said business was terrible and some in coma mode.
• My wife, an architect, has almost no business.
• Leads typically fade off when the bids come in and inquiries stop or get outright canceled.
• Construction sites around Berkeley post signs on the mobile offices saying “NO-WE ARE NOT HIRING!”
• Survey and discussion among architects and contractors revolve around how many carpentry shops have laid everyone off or shut down.

It hasn’t been this bad since the 70′s. Moreover, in the 70′s and 80′s there were some lucky firms would make a name for themselves with big government projects such as museums, embassies, government offices and such. We just don’t see that work anymore.

Moreover, the BLS employment numbers last week had a big drop in construction employment, yet again.

I expect that AIA number will fall off horribly in the near future.

As a personal anecdote, a neighbor who is an architect for his own business tells me much the same thing. He had full a time employee helper that became part-time, that became zero-time (laid off), and now he has nowhere near enough architecture work to keep himself busy.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

What Isn’t Happening with the $3 Trillion Commercial Real Estate Market: Loans Falling and Vacancy Rates at Record Heights at 10 Percent.

With commercial real estate, you can learn a lot from what isn’t happening.  We all know that the $3 trillion commercial real estate market is already taking a drubbing in terms of pricing.  CRE prices are down over 40 percent from their peak elevated levels.  Yet with commercial real estate you don’t have the typical headline grabbing stories of individuals being forced out of their homes in foreclosures.  With CRE it is seen as a more calculated business move and those losing their shirts are those who should have known better.  Now this is how things should be but the U.S. Treasury and Federal Reserve have already back stopped the entire banking system so implicitly, the failing of any real estate is now a direct burden to all taxpayers.

What is not happening is a natural stable demand from the market.  Why?  Just like the residential market, commercial properties were over built.  We have years of excess to work off.  That is why I simply don’t buy the notion that we will somehow be back on the run by tweaking a few balance sheet numbers.  The problem is many structures are now built and are sitting vacant yet the loans still need servicing.  Who is going to pay for it?  The U.S. Treasury has already had low key talks about a preemptive bailout for this industry labeled Plan C.

While banks tell the public all is well, their actions speak louder:

If things were improving in the overall economy it is likely you would see a natural demand for CRE loans.  People want to build something or start a new business and loans are easily available so long as you can fill the building.  The chart above shows a very clear pattern.  Less and less loans are being made in this sector.  Do banks know something the public doesn’t?

Larger housing complexes fall in the commercial category.  Typically these are places with more than 4 units at least on the residential front.  Assuming a market demand, you would expect to see permits rise:

The above chart clearly shows anything but this.  This is an important indicator because those who sense the economy is turning are more likely to build additional housing units.  This is a large part of our economy since banking heavily relies on real estate for profits.  That is largely a reason for the gigantic banking bailout while the vast majority of Americans wonder what they got for the $14 trillion in financial backstops.  The chart clearly shows one thing and that is there is virtually no demand for large unit housing complexes.  We are at record keeping demand lows even after all the bailouts.  Why?  Well most of these larger complexes are rental units and the market seems to be flush with these units:

The market is saturated with rentals.  Anyone that is both a landlord and renter will know this.  Many places are offering free HDTVs with a one year contract or even better, a few months of free rent.  Rentals always have a higher vacancy than regular homes because that is the nature of the property.  Renters are more mobile and vacancies are just part of the game.  But the current vacancy rate at nearly 10 percent is putting downward pressure on rent prices.  In fact, the BLS uses an owner’s equivalent of rent and this has been falling:

The interesting thing about the BLS data is that it understated the housing bubble because most people during the bubble shifted to buying overpriced homes while the data series was still focused on rental equivalents.  Now, with such a high rate in rental vacancies and large numbers of foreclosures the BLS is adjusting quickly to the downside and making it look like we are having massive deflation since housing makes up over 30 percent of the BLS CPI measure.  Why is this important?  This factors into many things including the cost of living adjustments many receive.

So all this adds into the fact that commercial real estate has very little pricing power in today’s market.  So what are the too big to fail banks doing?  They are laying the problem off on the public.  This was seen when Morgan Stanley simply walked away from the debt obligation in a San Francisco CRE deal:

“(WSJ) So we’ve discussed the ethics of individual borrowers walking away from their mortgages. (Some say we’ve over-discussed it.) If it’s immoral, as some would say, for a borrower to walk away their mortgage, is it any different for a bank?

Morgan Stanley is doing just that. News reports on Thursday said the bank plans to give back five San Francisco office buildings to its lender-just two years after buying them at the top of the market.

“This isn’t a default or foreclosure situation,” spokeswoman Alyson Barnes told Bloomberg News. “We are going to give them the properties to get out of the loan obligation.”

Sound familiar?

Morgan Stanley bought the buildings, along with five others, in San Francisco’s financial district as part of a $2.5 billion purchase from Blackstone Group in May 2007. The buildings were formerly owned by billionaire investor Sam Zell’s Equity Office Properties and acquired by Blackstone in its $39 billion buyout of the real estate firm earlier that year, Bloomberg reports. One analyst estimates that the buildings are now worth half of what Morgan Stanley paid.”

Now this is fascinating coming from an industry leader who has had its champion in the U.S. government moralizing that people shouldn’t walk away from their debt obligations.  The CRE market is in for a long and troubled road ahead.  Right now much of the data on retail sales is being championed as great but we are comparing it to data that was down in the abyss:

When you hear of those wonderful year over year gains we are going back to early 2009 when the economy was flying off a cliff.  So sure, things are up but what are we comparing it to?

The Federal Reserve has over $2 trillion in questionable assets that they are fighting to keep from an audit.  It is likely many loans in their portfolio are now commercial loans.  The fact that vacancy rates are so high and the employment situation is still dismal, where will the demand come from?  If anything, the best we can hope for is that current spaces get leased out and we start reaching more equilibrium levels of vacancies.  But we are so far away from even that.

What isn’t happening in the CRE market is very telling.  2010 is expected to bring much pain in this market and so far, we have had very little evidence pointing to any upsurge in this market.   And with $3 trillion at stake, any small movements mean big bucks.

WASHINGTON – The U.S. Department of the Treasury released the
text of identical letters sent today from Secretary Tim Geithner to
Speaker Nancy Pelosi and Senator Harry Reid outlining the
Administration’s exit strategy for the Troubled Asset Relief Program
(TARP) established by the Emergency Economic Stabilization Act of 2008
(EESA). The text of the letter to Speaker Pelosi follows.

December 9, 2009

The Honorable Nancy Pelosi
Speaker          
U.S. House of Representatives
Washington, DC 20515

Dear Madam Speaker:

I am writing to update you on the status of the Obama
Administration’s financial policies, including programs initiated under
the Troubled Asset Relief Program (TARP) established by the Emergency
Economic Stabilization Act of 2008 (EESA), the results they have
achieved, the challenges ahead, and our plan for exiting TARP.

These policies are working.  When the Obama Administration took
office, the financial system was extremely fragile and the economy was
contracting sharply.  The Administration’s financial and economic
policies have helped to shore up confidence in our financial system. 
Credit is starting to flow again to consumers and businesses, and the
economy is growing.  Further, private capital is replacing public
capital in our major institutions.

As a result of improved financial conditions and careful stewardship
of the program, losses on TARP investments are likely to be
significantly lower than previously expected.  We now expect a positive
return from the government’s investments in banks.  These banks will
soon have repaid nearly half of the TARP funds they received.  We also
expect to recover all but $42 billion of the $364 billion in TARP funds
disbursed in FY2009.  Further, we plan to use significantly less than
the full $700 billion in EESA authority.  As a result, we expect that
TARP will cost taxpayers at least $200 billion less than was projected
in the August Mid-Session Review of the President’s Budget.

But significant challenges remain.  Too many American families,
homeowners, and small businesses still face severe financial pressure. 
Although the economy is recovering, foreclosures are increasing, and
unemployment is unacceptably high.  Businesses are still cautious in
the face of uncertainty about the strength of the recovery, and many
small businesses face very difficult credit conditions.  Although bank
lending standards are starting to ease, many categories of bank lending
continue to contract.  This contraction has hit small businesses very
hard because they rely heavily on such lending, and do not have the
ability to substitute credit from securities issuance.  Commercial real
estate losses also weigh heavily on many small banks, impairing their
ability to extend new loans.

Further, the recovery of our financial system remains incomplete. 
And near-term shocks to that system could undermine the economic
recovery we have seen to date.

Exit Strategy for TARP

Our exit strategy for TARP balances the mandate of EESA to address
these challenges with the need to exercise fiscal discipline and reduce
the burden on current and future taxpayers.  There are four broad
elements to our strategy.

First, we will continue terminating and winding down many of the
government programs put in place last fall.  In September, Treasury
ended its Money Market Fund Guarantee Program, which guaranteed at its
peak over $3 trillion of assets.  The program incurred no losses, and
generated $1.2 billion in fees.  The Capital Purchase Program, through
which the majority of TARP investments in banks have been made, is
effectively closed.  Before this Administration took office, nearly
$240 billion in TARP funds had been committed to banks.  Since January
20, we have committed about $7 billion to banks, much of which went to
small institutions.  Major U.S. banks subject to the “stress test”
conducted last spring have raised over $110 billion in high-quality
capital from the private sector.  And banks will soon have repaid $116
billion of TARP funds

Second, we will limit new commitments in 2010 to three areas.

• We will continue to mitigate foreclosure for responsible American
  homeowners as we take the steps necessary to stabilize our housing
  market.
• We recently launched initiatives to provide capital to small
  and community banks, which are important sources of credit for small
  businesses.  We are also reserving funds for additional efforts to
  facilitate small business lending.
• Finally, we may increase our commitment to the Term
  Asset-Backed Securities Loan Facility (TALF), which is improving
  securitization markets that facilitate consumer and small business
  loans, as well as commercial mortgage loans.  We expect that increasing
  our commitment to TALF would not result in additional cost to taxpayers.

Beyond these limited new commitments, we will not use remaining EESA
funds unless necessary to respond to an immediate and substantial
threat to the economy stemming from financial instability.  As a nation
we must maintain capacity to respond to such a threat.  Banks are still
experiencing significant new credit losses, and the pace of bank
failures, which tend to lag economic cycles, remains elevated.  At the
same time, many of the Federal Reserve and FDIC programs that have
complemented TARP investments are ending.  This creates a financial
environment in which new shocks could have an outsized effect –
especially if an adequate financial stability reserve is not
maintained.  As we wind down many of the government programs launched
initially to address the crisis, it is imperative that we maintain this
capacity to respond if financial conditions worsen and threaten our
economy.  However, before using EESA funds to respond to new financial
threats, I would consult with the President and Chairman of the Federal
Reserve Board and submit written notification to the Congress.  This
capacity will bolster confidence and improve financial stability,
thereby decreasing the probability that it will need to be used.  This
is the third element of our exit strategy.

In order to accomplish these goals, pursuant to Section 120(b) of
EESA, I certify that I am hereby extending the authority provided under
the Act to October 3, 2010.  This extension is necessary to assist
American families and stabilize financial markets because it will,
among other things, enable us to continue to implement programs that
address housing markets and the needs of small businesses, and to
maintain the capacity to respond to unforeseen threats, as described
above.

While we are extending the $700 billion program, we do not expect to
deploy more than $550 billion.  We also expect up to $175 billion in
repayments by the end of next year, and substantial additional
repayments thereafter.  The combination of the reduced scale of TARP
commitments and substantial repayments should allow us to commit
significant resources to pay down the federal debt over time and slow
its growth rate.

Even with this extension, we expect that TARP will cost taxpayers at
least $200 billion less than was projected in the August Mid-Session
Review of the President’s Budget, including $25 billion in potential
costs from new TARP commitments in 2010.  We expect that the vast
majority of these potential costs would come from mitigating
foreclosure for responsible American homeowners as we take the steps
necessary to stabilize our housing market.

The final element to our exit strategy is how we manage equity
investments acquired through EESA while protecting taxpayers.  We will
continue to manage those investments in a commercial manner and seek to
dispose of them as soon as practicable.  We will exercise our voting
rights only on core issues such as election of directors, and we will
not interfere in the day-to-day management of individual companies.  In
addition, as the steward of taxpayers’ funds, Treasury will continue to
manage investments in a manner that ensures accountability,
transparency and oversight.  And we will work with recipients of EESA
funds and their supervisors to accelerate repayment where appropriate. 
We want to see the capital base of our financial system return to
private hands as quickly as possible, while preserving financial
stability and promoting economic recovery.

History suggests that exiting prematurely from policies designed to
contain a financial crisis can significantly prolong an economic
downturn.  We must not waver in our resolve to ensure the stability of
the financial system and to support the nascent recovery that the
Administration and the Congress have worked so hard to achieve. 
Improvements in the financial performance of EESA programs put us in a
better position to address the economic and financial challenges many
Americans still face.  I look forward to continuing to work with you to
achieve these
goals.                                                               

Sincerely,

Timothy F. Geithner

Identical copy of this letter sent to:
            The Honorable Harry Reid

cc:       The Honorable Barney Frank
           The Honorable Spencer Bachus
           The Honorable David Obey
           The Honorable Jerry Lewis