Commercial Real Estate Crash NOW

So much news , so little space and time

a sampling

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The Doctrine of Preemptive Bailouts and the Biggest Bailout you haven’t Heard About: The U.S. Treasury Plan C and the $3.5 Trillion You will be Paying.

Last week a story which gained very little traction hit the financial newswires.  The U.S. Treasury is working on an internal project informally called “Plan C” which seeks to deal with further problems in the economy before they occur.  The anonymous report came out stating the administration is reluctant to commit any additional money especially to the level mentioned in the report.  However this is a disturbing new development in our bailout nation since this is one of the first times that the U.S. Treasury will try to preemptively deal with a financial problem.

The issues with this Plan C is that it is setup to be a buffer on further deterioration in various loan categories but the big one is commercial real estate.  The commercial real estate market is gigantic and many of those loans are still active:

commerical real estate

Some $3.5 trillion in commercial real estate loans are out in the market.  The problem is complicated because commercial real estate holders simply rollover their debt into new loans.  That of course has changed since the economy and credit markets have shutdown and many of these properties are now severely underwater.  Take a look at how many loans will be turning over:

mbs

*Source:  ZeroHedge

The amount of maturing loans in commercial real estate will double in 2010 and will continue upward into 2010.  The chart is very clear and this is only for debt in CMBS and not held by regional banks which is over $2 trillion.  This is the next multi-trillion dollar bailout you have yet to hear about.  In fact, while many are discussing a second half recovery higher up officials are already planning a bailout for the commercial real estate industry.  The challenge with this bailout is you are asking a public with 26,000,000 unemployed and underemployed Americans to shoulder the debt of largely speculative plays.  To many it is palatable to bailout the residential real estate market because the public can understand that (even if it may be wrong) or bailing out the 2 large U.S. automakers.  Yet bailing out the commercial real estate market is going to be a political nightmare.

Of course the U.S. Treasury would like you to believe this is merely a precaution but most of the last precautions we have heard about have turned out to be trillions and trillions in full on commitments shouldered by the American public:

“(WaPo) We are continually examining different scenarios going forward; that’s just prudent planning,” Treasury spokesman Andrew Williams said.

The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.

Banks and other firms that provided such loans in the past have sharply curtailed lending.

That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt — some estimates peg the total at more than $3 trillion — that they will need to refinance. These loans were issued during this decade’s construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.

The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.”

The end of the road has been reached for commercial real estate.  Many regional banks jumped into the commercial real estate market since they had little chance of competing with big subprime and Alt-A mortgage factories like WaMu or Countrywide.  Many regional banks saw this as a way to stay competitive in local regions across the country.  This is a much more diverse problem and the tentacles of the commercial real estate bust will be felt in every state.

These loans were made on strip malls, doctor’s offices, and drive-through restaurants for communities that are hurting from the recession.  This is an enormous amount of debt that is out there that will surely default since there is no way to refinance this debt since many of these projects are literally underwater.  Take a look at the composition of over 8,000 banks and thrifts across the country:

fdic

Factoring in construction and commercial loans you arrive at a stunning 26 percent of all loans in FDIC banks and thrifts.  This is a staggering figure and the U.S. Treasury is well aware of this.  The question isn’t whether there will be major defaults here but who will shoulder the cost?  So far, each consecutive bailout has largely been taken up by the U.S. taxpayer.  The problem of course is the cost of all these bailouts will eventually catch up through a tanking dollar and possibly the long-term viability of our economy.  Plan C is a preemptive bailout on an entire industry.  The reason the government is devising  a plan is that these loans will start going bad in large amounts and they are gearing up on a process of dumping this large mess on the American people.  Yet it is going to be a politically hard sell for many to bailout a strip-mall from some large developer.

And make no mistake, the market for commercial loans is all but closed:

commerial-loans-quarter

You are reading the above graph correctly.  In the 1st quarter commercial loans fell by a stunning 50 percent on a quarterly basis.  And the amount of bad loans is only growing:

quality-of-loans

If you haven’t heard of Plan C you soon will.  The commercial real estate bailout is the next ploy from Wall Street and the U.S. Treasury.

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9 Comments on this post

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  1. Robert Thurber said:

    All I have to say is this ‘GREAT government we have (lol) is a f00king joke. Their motto is “Fail to plan or Plan to fail”

    Reality check folks

    July 14th, 2009 at 5:59 am
  2. Stu said:

    This is a wonderfully written article on where we are heading in terms of future debt. If you allow me to indulge myself, I would like to offer up some opinions on some of your comments.

    From your article you said:

    “However this is a disturbing new development in our bailout nation since this is one of the first times that the U.S. Treasury will try to preemptively deal with a financial problem”

    When did the U.S. Treasury get the power to set policy and dictate arrangements? I realize that our U.S. Congress is as dumb as a rock and totally incapable of managing, presiding over, controlling or any other form of being in charge, but they are the governing body… er they used to be any how?

    Your chart showed the following:

    CHART: “2015, 2016 & 2017 show vintage loans from the exact same period that the Subprime implosion was and continuing with Alt-A, Jumbo Prime, and Prime now blowing up” It says “Years 2005, 2006 & 2007 are the vintage dates of the majority of these loans”

    All I can say is WOW!!! We already know from history what we can expect from Subprime residential home loans and starting in 2015 we will be witnessing the equivalent in Subprime commercial building loans implosion which will be much worse than residential in so many ways. For starters can you say jobs…

    The residential home reset schedule takes us through 2015 if I am not mistaken, so we pick up right from there with commercial by your charts and estimates. That places us in a situation far worse than the lost decade of Japan. When we finally clear out the last of the residential housing debt losses (well maybe not in the banks via the Fed unfortunately) in roughly 2014 / 2015, we will be crushed in the next 3 years with unprecedented commercial loan defaults that will make the last 5 or 6 years look like childs play in terms of how to deal with it.

    This quote was quite commical:

    ” “(WaPo) We are continually examining different scenarios going forward; that’s just prudent planning,” Treasury spokesman Andrew Williams said”

    Try something called a balanced budget. I do believe it should be your main charter as an agency. Never allow printing / borrowing without the resources available within the vault. Our vault is empty… GET IT!!!

    This paragraph is stunning:

    “The amount of maturing loans in commercial real estate will double in 2010 and will continue upward into 2010. The chart is very clear and this is only for debt in CMBS and not held by regional banks which is over $2 trillion. This is the next multi-trillion dollar bailout you have yet to hear about. In fact, while many are discussing a second half recovery higher up officials are already planning a bailout for the commercial real estate industry. The challenge with this bailout is you are asking a public with 26,000,000 unemployed and underemployed Americans to shoulder the debt of largely speculative plays. To many it is palatable to bailout the residential real estate market because the public can understand that (even if it may be wrong) or bailing out the 2 large U.S. automakers. Yet bailing out the commercial real estate market is going to be a political nightmare”

    The American public has not come to terms with the reckless spending and mandated social changes to our society because they are not paying for it yet. The average joe doesn’t pay anymore than he used to in taxes or bills towards the payment of this reckless and criminal in my opinion behavior this administration is placing on peoples futures and their childrens futures… NO IDEA!!! Most people don’t pay attention until it affects them, and then they awake. By printing and borrowing money this administration has kept the general public and even the business area as well away from the feeling of the hit they will ultimately take. That is until now…

    People and more importantly small businesses are starting to add it all up. They are not buying the hype any longer and are realizing that they were sold a bill of rotten goods. When the amasses awake it is really tough to place them back into a slumber. A $600 / $1200 check won’t work, and don’t dear try another stimulas if this takes hold. Don’t forget boys 2010 is just around the corner but I digress…

    And finally this:

    “In the 1st quarter commercial loans fell by a stunning 50 percent on a quarterly basis”

    That is a number we will see replicated again and again and yet again I am afraid to report…

    God speed and thanks for sharing!

    July 14th, 2009 at 3:41 pm
  3. 3trillions is nothing said:

    3 trillions here 3 trillions there, that’s nothing we can’t auction.
    Obama have 4 trillions auctioned so far (7/14/2009) in less than 7 months. It only takes a printing press some paper and ink, oh and the ok from Bernanke or whoever owns the FED.

    July 14th, 2009 at 6:53 pm
  4. Stock Forecasting said:

    Thank you so much for such a nice detailed information…

    July 15th, 2009 at 2:04 am
  5. jimbo said:

    With low oil prices, oil companies are not investing in new production. In the meantime, current fields are entering a period of depletion. I personally believe in peak oil but what I just said is from an investment point of view. So whether or not there is/will be geological caused oil shortages, there will be under-investment caused oil shortages.

    July 23rd, 2009 at 7:21 pm
  6. Druff said:

    I believe that last 2 charts are not % changes, but $B changes (see LHS). Thus far we have seen nothing.

    It will get worse, but we have yet to see the real pain yet.

    July 30th, 2009 at 11:17 am
  7. Pissed said:

    Doesnt this pale in comparison to the derivitives problem?

    July 31st, 2009 at 11:38 am
  8. Deak Dementhe said:

    Got Gold???

    August 1st, 2009 at 5:52 am
  9. Joe in JT said:

    I bought my small house for cash. I wait for “deals” on used cars, desperate seller needing cash. I have several cars all paid for. So what’s the problem Pilgram?

    Anyone who takes out second and third mortagages then uses the money for a Carnival Cruise ride deserves to live in a cardboard box.

    August 1st, 2010 at 5:03 pm

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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

2012-CRE-chart

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:

mit-crew-april-2011-values-commercial-real-estate

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:

kj-06302010-chart-1

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:

federal-reserve-balance-sheet

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

double bubble

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.

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commercial-real-estate3

News about the economy has gone from apocalyptic to merely bad. Stock indexes and commodity prices have been on a five month tear. Hints are showing up that at least the worst of the home mortgage disaster might be over. Unemployment is still at scary levels, but at least the rate of its increase is slowing.

All in all, it would seem that maybe the Fed printing a stack of dollars one trillion high and throwing it at the banks might actually be working, if by “working” one means a long-term debasing of the currency to get a short-term boost in the economy, though I doubt B. Bernanke would explain it in precisely those terms. However, there is another major jolt on the way for credit markets, banks, and, by extension, the rest of the economy: commercial real estate.

It’s not too tough to find out that there is something amiss with commercial real estate. A quick walk around Manhattan does the trick, seeing the amount of prime first floor retail space currently seeking offers. The same is true when reserving a room in a hotel more expensive than a Super 8. I was in Boston for work a month ago and stayed in the hotel I usually use and the room that cost me (or rather, my employer) $375 two years ago was going for $149 and the parent company of the hotel was offering a “stay 3 days get one free” deal. However, the anecdotal evidence is nothing like a chart of hard numbers. Here’s one:

cre-crash1

Now that, friends and neighbors, is a steel-toe-boot-to-the-gonads chart if I’ve ever seen one. The word “freefall” comes to mind. Also, the text below the chart states matter of factly “July 22 , 2009 update: The latest results of the Moodys/REAL CPPI show a return of negative 7.6% in May for the all properties national index.” Probably a better way to write that would be “HOLY SHIT!” but I guess that’s not really MIT’s style. In addition—and I downloaded the spreadsheets to check this—that number is not annualized or year-on-year rate of decline, which is the way many top down economic numbers are reported. For example, when you hear that GDP “contracted 2% in the last quarter” what that means is that GDP contracted at a rate that would generate a 2% decline over a full year, or roughly .5%. The MIT/Moodys number is 7.6% down for the month of May alone, which seems really awful until one looks one cell up in that spreadsheet. Said cell cheerfully informs us that April was down 8.6%, meaning that two months in 2009 wiped out the same percentage of value that go-go 2005 was able to add. Put another way, if you were foolish enough to by a $100 million office tower on March 31, 2009, you now own a property worth about $84.5 million, which is a pretty rough couple of months in my book.

Making these glaringly awful numbers far, far worse is the way commercial real estate is financed. Most of the loans us civilians are familiar with a fairly long term. Home mortgages are usually for 20-30 years, while most commercial real estate is financed on a shorter note that we take out to buy a car. 3-year and shorter financing is common in the commercial real estate world, and banks were as eager to loan money to dicey commercial borrowers as they were to dicey home buyers and home speculators.

To get an idea why this is so crucial, here is how a more or less average real estate deal works, with very rough, back-of-the-envelope numbers. Using the $100 million office tower mentioned above, let’s assume that building is 85% leased and is generating $7 million of rent per year from tenants. The person/group/institution buying the building puts up 20% of the value and borrows the rest (a pretty conservative amount of leverage for 2000 era deals), taking on a four year note at 5.5%, meaning the borrower has to pay $4.4 million per year and in four years pay off the principal as well. What the real estate investor is hoping to do is lease up the rest of the building, maybe make some improvements to it to attract higher paying tenants, thereby increasing the cash flow servicing the debt. In an ideal world a combination of rising real estate values, increased cash flow, and longer leases will make the building itself worth more, so when the four year note is up the building might be worth $115 million while generating half again as much cash flow in rent. When that note is refinanced a nice chunk of it can go into the pockets of the investor for all of his hard work.

That’s the ideal scenario, repeated thousands of times during the run up in real estate from 2000 until last year. When the getting was good, refinancing meant a chance to take some equity out of an asset that was accumulating value, but the leverage knife cuts both ways. If the asset loses value the bank still wants their money in four years, and they’re not likely to want to loan you money to refinance something losing north of 7% per freaking month. It’s like Paulie in Goodfellas, “Fuck you, pay me.” Negative equity for a homeowner certainly sucks, but on a longer time frame that home will probably appreciate in value and as long as the owner can afford the payments the loan is fine. With the shorter term financing used on the commercial real estate world, Paulie needs his principal back a lot sooner.

While every deal is different, and every submarket has its own dynamics for price (you might not want to own a mostly leased office tower in Brooklyn, but you’d take that over a half finished condo tower in Miami), looking at the MIT/Moodys numbers it would seem that even the more conservative, non-insane commercial real estate deals done between early 2005 and early 2008 almost have to be in some degree of trouble at least on paper, with a lot less value to prop up the debt. This is to say nothing of all of the “wild and crazy guy” deals done by insane people and insane banks.

So we have a few frothy years of loans on commercial properties that have to be at least suspect, how much is that? The answer is a whole fucking lot, though nobody seems to want to publish exactly how much. The best story I could find was from the Wharton School at Penn (http://knowledge.wharton.upenn.edu/article.cfm?articleid=2296). That article states that $400 billion of such loans are coming due in 2009 and that between now and 2012 the total will be $1.8 trillion, roughly half of which are owned by banks. Delinquency rates have doubled in the past year and the values of the underlying properties are, obviously, in freefall. It’s hard to put a hard number value on how much of this will actually have to be written off, partially because the banks have an incentive to put off the pain as long as possible by refinancing even when they shouldn’t, but it doesn’t take a particularly huge chunk of $900 billion going bad to put some serious hurt on our already stumbling banks.

Piled on to this is the fact that Wall Street was just as eager to slice and dice commercial real estate loans into mortgage backed securities, CDOs, CLOs, CDO squareds (love that name, it’s complete shit, to the second power!), and probably some other science lab stuff I’m forgetting now. Swimming in the ocean of securitized real estate debt are some very sick fish in the form of bad commercial real estate.

And what are the good gentlemen in Washington D.C. doing about this problem? Mostly nothing though some are covering their ears and screaming “I CAN’T HEAR YOU NAH NAH NAH.” Considering the job they did avoiding this mess, that’s probably the best thing anyway. However, the original TALF program was modified to allow its use when buying existing mortgage backed securities. In its first form it could only buy new loans. What followed was perhaps the funniest event in the world of finance I can ever remember. On July 14th Standard + Poors downgraded a whole class of 2007 vintage CMBS from AAA (the highest rating, what institutions like Harvard and the Treasury get) to BBB-, the lowest grade for something considered “investment grade,” i.e. not speculative. Bond nerds nationwide thought for a second that Standard + Poors might actually be doing their job for the first time in years. However, one week later they changed their minds and re-rated the bonds back at AAA again, prompting everyone where I work to refer to S&P as “Laurel & Hardy.” In a Bloomberg article about the “revision” Christopher Sullivan, chief investment officer (and budding standup comic) at United Nations Federal Credit Union in New York, said”

“It is a stunning reversal and certainly raises questions concerning the robustness of their revised model, it may engender further uncertainty with respect to ratings outlooks.”

Really? Ya think the ‘revised model’ might be of dubious robustness? The real reason, one has to guess, is that only AAA securities are eligible for TALF funding. So, thanks to the new Laurel & Hardy ratings the gubment will be loaning money on highly generous terms to the same sharpies who cooked those securities up, so that said sharpies can buy them back cheaper while risking very little of their own capital. In other words, we’re backstopping them as tax paying citizens.

Is this a great country or what?

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CMBS Conduit Market Volatility Continues

Volatility in the credit markets continued across the board this past week due to the ongoing sub-prime woes and worldwide credit liquidity issues. As a result, CMBS (Commercial Mortgage Backed Securities) spreads widened dramatically.

FOR IMMEDIATE RELEASE

PRLog (Press Release)Aug 17, 2007 – Newark, DE, August 13, 2007 – Volatility in the credit markets continued across the board this past week due to the ongoing sub-prime woes and worldwide credit liquidity issues. As a result, CMBS (Commercial Mortgage Backed Securities) spreads widened dramatically over the last couple of months, and, in particular, over the last few weeks.

Commercial Mortgage Backed Securities (CMBS) are derived from pools of commercial real estate loans. The securities are sliced and diced into multiple tranches. Recently, increased levels of subordination (the highest risk tranche that is the first to absorb losses) have been required by both the rating agencies and the AAA buyers and therefore overall yields climbed. However, AAA buyers are also demanding enhanced spreads. In addition, many bond investors seem to be fleeing to Treasuries as a “safe haven” and therefore liquidity is drying up and the remaining investors can easily demand greater yields.

Fortunately, treasuries have trended down recently helping offset some of the spread “pain.” Underwriting standards have tightened dramatically over the last couple of months and gone are the days of 10-year interest only periods and underwriting to projected cash flow. Real estate investors should tread cautiously over the next few months as only the better quality deals that are priced right and underwritten to normal parameters will be financeable in the CMBS space. In fact, some CMBS lenders have closed shop, at least for now, as the market is too unpredictable and they’re unwilling to absorb losses for loans that are priced incorrectly.

Alternatively, borrowers should consider other forms of financing. Balance sheet lenders offer a viable alternative now that benchmark spreads for CMBS financing are in the 200 basis points over range. Further, those financing with balance sheet lenders will obtain a more flexible structure compared to CMBS structures. Credit market volatility will likely remain for some period of time and only highly experienced borrowers, or those with advisors with strong and deep experience in the world of commercial real estate finance, should attempt to navigate on their own.

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About BroadCreek Capital:BroadCreek Capital is a leading specialist for multifamily and commercial real estate loans, including hospitality and owner occupied loans. Headquartered in Delaware, BroadCreek Capital has additional offices in Philadelphia and Florida and conducts business across the US.For more information on BroadCreek Capital, contact:Carl H. Kruelle, President
BroadCreek Capital LLC
One Innovation Way, Suite 400
Newark, DE 19711
302-438-5423http://www.broadcreekcapital.com

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John Paulson’s Interview With The Financial Crisis Inquiry Commission

Stone Street Advisors's picture

Submitted by Stone Street Advisors on 02/15/2011 19:08 -0400

John Paulson, of the eponymous uber-hedge fund did an hour-long interview with the Financial Crisis Inquiry Commission.  I listened to it (thanks to NYT Dealbook, although not sure where they got it from), and really, I got a kick out of it even though I think my carpal-tunnel is really flaring up now.  Anyway, without further ado, here’s what the man behind the Greatest Trade Ever has to say about the Financial Crisis…

When asked what he saw, when, and why he decided to get short, he said “First thing we noticed was that real estate market appeared very frothy, values rose very rapidly, which led me to believe real estate markets were over valued.”  That’s pretty simple/straightforward, no?  I think it’s pretty interesting that he said the 3 homes he’s bought were all out of foreclosure, and they’d increased in value 4-5x over a 2-3 year period through ~’2005.  Apparently the impetus for the research that led to The Trade was literally staring him in the face every time he got home from work!

He explained his approach, and the way he put it makes me really think the guys who didn’t leave their trading desks & “never saw the bubble/crash coming” really had their heads buried in the sand deeper than I previously thought.  As Paulson said, “Credit markets were very frothy, very little attention paid to risk, spreads were very low, we thought when those securities correct, it could present opportunities on short side.”

Their research approach was pretty straight-forward: Focus on subprime, where they were amazed at how low quality the underwriting was, and how low the credit characteristics were on the loans.  They found the average FICO  was around 630, and over half of the loans were for cash-out refi’s, which were based on appraised, not sales prices (so “value” could be manipulated).  For many of these loans, LTV was very, very high, 80, 90, 100% with many of them concentrated in California (no surprise there).  Close to have of the mortgages they looked at were of the stated-income, no-doc variety.

Those who did report incomes had D/I ratios of > 40% before taxes and insurance.  80% of them were ARMs, so-called 2/28’s with teaser rates around 6-7% for those first 2 years, but after they reset, the rates were L+ 600bps which at the point would have doubled the interest rate on these loans, and Paulson & Co thought there was very little – if any – chance borrowers would be able to afford the higher payments.

Once the rates reset, the only thing these borrowers could do would be to sell, refinance, or default.  These were people spending > 40% of their gross income on their mortgages already, once the rate jumped up after the teaser period, they expected that many borrowers would simply default, and the price of the RMBS into which these loans were securitized would fall drastically, while the price of the protection (CDS, etc) Paulson bought on them would skyrocket.

Paulson & co also went much further in their analysis, well-beyond what many of those on Wall Street were doing.  In May, 2006, they researched growth of 100 MSA’s and found that there was a correlation between growth and the performance of subprime loans originated within them.  As growth rates slowed, defaults rose.  From 2000-2005, they found that with 0% growth, there’d be losses of around 7% in the mortgage pools.

When they looked at the structure of the RMBS they found the average securitization had 18 separate tranches and that the BBB level only had 5.6% subordination, essentially, once losses surpassed that point, the tranches would become impaired, and if they reached 7% losses (what Paulson thought would happen once home price appreciation only slowed to 0%), the entire tranch would get wiped-out entirely.

By mid-2006, home prices not only had slowed to 0% but were actually decreasing, albeit slowly, only about 1%.  Even still, demand from institutional investors was so great, spreads tightened to 100bps. Why?  Because as Paulson went on to explain, institutional investors were buying up the BBB tranches (the lowest investment grade ones) in hoards.

While he didn’t say it, I will (for the umpteenth time!): This is what happens when institutions effectively outsource credit research to the Ratings Agencies, even though many had/have internal credit analysis groups (ahem IKB ahem).  They buy the highest-yielding security you can find that meets your investment guidelines, which meant that for many, they could only buy securities deemed by the brain trusts at the Ratings Agencies as “Investment Grade.”

Paulson started their credit fund in June, 2006, and as he explained, it wasn’t really as simple as it may seem. Historically – going back to about WWII – the average loss on subprime securities was 60bps, nowhere near what Paulson & Co expected was about to happen.  As he said “according to the mortgage people, there’d never been a default on an investment grade (IG) mortgage security.”  These same people were also of the mindset that they’ll NEVER get to the levels where the BBB tranches are impaired let alone wiped out completely.   These were also the same people who said that not since the Great Depression there hadn’t been a single period where home prices declined nation-wide.  These same people thought, worst case, home price growth would drop to 0% temporarily and then return to growth, just like before.

Why would “the mortgage people” expect anything else?  From their desks on the trading floors in Manhattan, Stamford, London, and everywhere else, things looked just peachy!  Spreads were tightening, demand for product was up, and more importantly, so were bonuses!  As far as they knew, the mammoth mortgage finance machine they’d created, based on their complex models and securities was working perfectly…

Paulson also made a distinction missed by many if not most: Everyone was looking at nominal home price appreciation, but real appreciation numbers were much different.  Going back 25+ years using real growth rates, they found that prices had never appreciated nearly as quickly as they had from 2000-2005, and that this trend was unlikely to continue for much longer, i.e. there would be a correction and then mean reversion.  Their thought was that once this correction came about, because of the poor mortgage quality and questionable assumptions/structures in mortgage securities, losses would be much worse than estimated.

Paulson was intent to make one distinction, one that must have been the cause of at least some frustration (followed by fantastic jubilation), that they did their own analysis, they weren’t really trying to attack “the mortgage people’s” views specifically.  Instead, they were trying to understand the conventional wisdom and understand why they had contrary viewpoints.  As myself and countless others have pointed out over the years since, the mortgage industry (I guess we’ll stick with calling them “the mortgage people?”) brushed Paulson off as “inexperienced, as novices in the mortgage market, they were very, very much in the minority…Even our friends thought we were so wrong they felt sorry for us…”

The mortgage people didn’t see any problems because there’d never been a default, except for one manufactured housing (mobile home) deal in the early 1990’s in California.

“The Ratings agencies – Moody’s – wouldn’t let you buy protection on securities from a particular state, because they ensured that the pools were geographically diversified, so they were essentially national pools, although California loans had the highest concentrations therein the pools correspond to the level of home sales in each state.”

What I found surprising from the interview is that Paulson actually praised the mortgage underwriting/originating practices of the big established banks like Wells Fargo and JP Morgan, which he said generally had the best underwriting standards and controls.  The worst were from the New Centuries and Ameriquests, eclipsed in their lax standards only by the mom & pop type shops who were really just sales businesses who made money on the volume of product they originated and sold to Investment Banks like Lehman and Morgan Stanley that didn’t have their own origination network.

These smaller “rogue” mortgage originators were mostly private entities who weren’t under the same scrutiny of their larger, publically-traded “competition.”  Their sales teams were compensated purely on quantity of loans originated with little-to-no care for quality.  These were the guys who routinely falsified documents, appraisals, incomes, assets and/or encouraged borrowers to do the same.  These were the kind of places that made Countrywide’s standards and controls look almost honorable by comparison.

The FCIC then asked Paulson about the infamous ABACUS debacle.  Paulson’s tone when responding to questions from the FCIC here was so, so, awesome; you could hear it in his voice, like he wanted to just say “are you guys freaking kidding me?  Seriously?!?!  REALLY?!??!” every time they asked him about how CDO’s got made.  He basically said (paraphrasing) “If ACA and IKB or Moody’s didn’t like the ~100 subprime reference securities we helped pick for the deal, they could have…not bought the deal or – get this – replaced them with ones they liked better…I couldn’t have gone short if they hadn’t gone long, they agreed on the reference portfolio, it got rated, boom, done”  It sounded like he just wanted to say something like “Hello morons?!  This is how Finance works, HELLOOO!!!”

The ABACUS conversation ended pretty awkwardly (as you might imagine), and then the FCIC moved onto asking Paulson about his Prime Brokerage relationships and what he thought about the Banks.  Interestingly (to me, at least), Paulson had much of it’s assets with Bear Stearn’s Prime Brokerage primarily because the way Bear was structured , the PB assets were ring-fenced from the rest of Bear’s assets in a separate subsidiary, so even if Bear went down, the PB assets would theoretically be safe.  The rest of Paulson’s assets were with Goldman’s PB.  When Bear’s Cioffi/Tanin-run internal hedge funds failed, Paulson saw that as the proverbial canary in a coal mine; they knew the crap that Bear, Lehman, and everyone else had on their books.  They didn’t pulled all of their cash balances from their prime brokers and set up a contra-account at Bank of New York, where, by the time Lehman went Bankrupt, they were holding most of their assets in Treasuries there.

Next, the FCIC asked him about regulators and banks and what people could (or, better, SHOULD) have done that might have prevented the crisis.  Paulson called out the Fed for not enforcing the mortgage standards that were already in effect.  He mentioned that pre-2000, no-doc loans were only given to people who could put 50% down and only represented about 1% of the mortgage market, but only a few years later, originators were “underwriting” NINJA loans with 100% LTV!

Paulson went on to explain how simple fixes, so-to-speak, just enforcing existing regulations like requiring income/asset verification, that homes were owner-occupied, and a downpayment, as low as 5% would have made a huge difference.  Most of the mortgages that failed didn’t have those characteristics.  Excessive leverage and poor understanding of the credit, problems Paulson also say brought down Bear and lehman.  They were leveraged (total assets: tangible common equity) on average, 35:1.  At that sort of massive leverage, a 3% drop in assets would wipe out every $ of equity!

Even if that ratio was brought down to 12:1 and you increase their capital ratio to 8%, the banks still couldn’t hold some of the riskier, more illiquid assets like Private Equity interests, equity tranches of CDO’s, lower-rated buyout debt from many real estate deals, and other assets that themselves were already highly-leveraged.  Adding further leverage to assets themselves already levered an additional 12:1 is just lunacy.  No financial firm should be able to do that, at max those assets should only be allowed to be levered 2:1 (similar to the max leverage for stocks due to Fed Regulation T).

He went on (this is pretty much verbatim, emphasis mine): “Under those scenarios, I don’t think either bank would default.  AIG FP was absurd and exemplified the derivative market where you can sell protection with zero collateral.  AIG FP Sold $500bn in protection with $5bn collateral, 100:1 collateral.  ACA was collateral agent, they were like 120:1 leveraged.  $50bn protection on $60mm collateral.  You have to hold collateral, we need margin requirements for both buying & selling protection.  It’s not the derivative itself that’s the problem, it was the margin requirements (or lack thereof).  We need something like Reg T (max 2:1 leverage at trade inception).  What these guys did would be like like buying $100 of stocks with $1 of equity, a tiny downward move is a huge loss of equity.  In all, these four things would have likely prevented the crisis:

  1. Mortgage underwriting standards, simple & logical
  2. Higher bank capital ratios
  3. Higher capital against risk assets
  4. Margin requirements against derivatives

Paulson was then asked about the Ratings Agencies and what role they played in the bubble/crisis.  Regular readers know where I stand on them & NRSRO regs, and no surprise, Paulson is similarly critical, particularly of the issuer-pays compensation structure, calling it the perverse incentive that it really is, despite whatever nonsense rhetoric RA executives say.

That, combined with being public (or part of public companies) and they were in this race to keep pace with their competitors, to keep up earnings growth with their derivatives business, which he called a “perverse economic incentive that may have led to their laxness in rating securities”

He went-on to explain this same – in the immortal words of Citi CEO Chuck Prince – “keep dancing while the music’s still playing” – incentive structure led the Banks to take similarly short-sighted actions as they struggled to keep up earnings, growth, and of course, bonuses.  At that point, the only way to do that was to grow their balance sheets, add more leverage to earn spread.  In Paulson’s words “Once things go up like that, you don’t see any downside, so at top of market they just weren’t looking at the downside, just upside, became more and more aggressive until they blew up.”

Paulson said the Fed certaintly could have cracked-down on lax-underwriting standards, eliminated negative-amortization loans, stated-income, 100% LTV, IO’s, etc where most of the problems developed.  On the banks and more broad financial services industry, he said “…people became delusional, ‘we can leverage AAA 100:1…’ if you had margin requirements against derivatives, AIG could have NEVER happenedIf they held higher equity against risky investments, they would have never defaulted. Constructively, that’s what Basel 3 says, 8% equity/capital and higher risk weightings for illiquid risky type assets.  I think adoption of those rules will lead to a safer financial system.”

When asked about the role of Fannie May & Freddie Mac, he pointed out the problem was largely similar to what brought down the banks and AIG: excessive leverage and poor oversight/underwriting. “They deviated from their underwriting standards as a way to gain share in alternate mortgage securities, of poor quality & higher losses.  Second, they were also massively leveraged 80-120:1 if you include on-balance sheet assets & guarantees which is way more than any financial institution should have.”

Yea, I think 120:1 leverage is just a wee bit more than prudent, just a bit though…

From this interview it seems painfully clear that those with whom the safety of the Financial System rested were in a deep coma at the helm, Bank executives, regulators, Congress, institutional money managers, all of them.   It’s clear that the nonsensical argument put-forward by Tom Arnold & Yves Smith that those who were shorting housing, subprime, etc were NOT IN ANY WAY, SHAPE, OR FORM remotely responsible for causing the crisis.  Institutional managers were not gobbling-up BBB-rated RMBS CDO tranches because shops like Paulson & Co were shorting them. Like I said before: they wanted the highest yield they could get away with holding!

As Paulson said, anyone who looked at the data he did should have noticed the impending doom, but apparently, either very, very few people did that type or analysis or they did and just, like Chuck Prince said, kept on dancing until the music stopped.

These traders thought tight spreads indicated safety, which is just wrong in so many ways.  These are the same morons who – thought they should know better – constantly confuse correlation with causation.  Low spreads may have been historically correlated with low default and loss rates, but low spreads do not cause low losses/defaults.  Spreads, like stocks, trade as a function of supply and demand, and all low spreads indicate(d) is that, as Paulson noted, institutional managers were swallowing up as much of these MBS and derivatives (for reasons I explained above), and, like a bunch of lemmings, all thought history would continue despite significant evidence suggesting this time, it was actually different.

One other thing that critics and the public at large probably doesn’t know is that Paulson & Co had a MASSIVE internal, independent research effort wherein they did crazy things like *gasp* look at loan-level data.  Imagine that!  This enabled them to hunt for CDO and other product that contained an inordinate amount of crap for them to short.  This same work also helped them to buy RMBS/CMBS etc when the market turned in 2008 and 2009. They had done the work, and knew what they were willing to pay once it was time to go long.

I’m not saying there’s anything necessarily wrong technical, momentum, and quantitative trading strategies.  There is, however, something very wrong, and very dangerous about relying on these strategies alone while ignoring fundamentals, as evidenced by the housing crisis.  Those who did the hard work like Paulson & Co. made the greatest trade ever, while those who ignored or were otherwise blind to the fundamentals got absolutely crushed.

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by Zero Govt
on Tue, 02/15/2011 – 21:53
#965566

John Paulson set up his fund in 2006, one year after Michael Burry of Scion Capital first told his investors he was shorting sub-prime and why. In fact Burry can almost entirely be credited with pushing the big WS Banks to set up the CD instruments for shorting sub-prime.

Has John Paulson gained credit for being an ‘innovator’ or does he acknowledge being a copier of the real searing genius behind shorting sub-prime, Michael Burry?

Just for accuracy and the history books it would be nice to set the record straight.

http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004

by MrBoompi
on Tue, 02/15/2011 – 22:06
#965595

While reading this long post I figured out the best and brightest among us will not use their intelligence to protect the public, they’ll use it to extract enormous sums from us. I’d be laughing at the dumb regulators too. The scam is explained long after the billions have been safely tucked away somewhere offshore.

by highwaytoserfdom
on Tue, 02/15/2011 – 22:10
#965606

 You have to be kidding…   Paulson levered up to make the trade with Goldman Cronies while the regulators said we could not short the financials. Now Paulson is backing the banks that hold 230 T…in level III derivatives. The trade was a crony trade that informed investors could not make. TARP / AIG should not have paid the capital requirements of Hankey Paulson, J Paulson’s Goldman trade was illigal.. Goldman has 40T in this crap sitting on level III, JP Morgan 70T and Bank America 40T.. Heck the US residential is estimated at ~ 48T or it dropped 25%..  Paulson is buying the Banks?  Is there any morals or for than mater arithmetic left?  BLAMING IT ON SUB PRIME IS BLAMING IT ON THE SHELTER NEEDERS NOT THE USURY DEBT PUSHERS.

by Zero Govt
on Tue, 02/15/2011 – 22:49
#965653

Big Boy John Paulson also gave evidence that smaller “rogue” mortgage originators were mostly to blame for lax mortgage origination who weren’t under the same scrutiny of their larger, publically-traded “competition.” Namely the Big WS Banks were some sort of innocent victims. If we are to believe Big Boy Paulsons account mortgages would have been originated so much better if only the Big Boys of WS had applied their so much higher standards.

Of course WS’s ‘higher standards’ appears to have willingly accepted these crap mortgages (without any 2nd thoughts, bit sloppy from the Big Boys!) and it was their ‘slice and dice machine’ that was demanding (ie. cause) of this laxness, a laxness their own claimed standards to investors they were driving a horse and coaches through.

So if Big Boy John Paulson is to be believed we must assume the Big Boys of WS were so much better with so much higher standards than these smaller private enterprises. ‘Big and Good’ versus ‘Small and Sloppy’ is of course the exact opposite of all evidence in commercial organisations throughout history.

So then we come to usurping State Law with another butchers yard, MERS. This allowed the WS Big Boys to usurp State Property Law and pump their own AAA rated system with an identical (coincidence?) laxness in documentation also entirely for the same reason of speeding the pumping of their slice and dice AAA rated fraud machine. The Big Boy factory of MERS drove a horse and coaches through and indeed run rings around Property Law. Indeed Washingtons rules were specifically laid down to stop national Govt intervention and carve ups (ie. corruption) by giving its States autonomy over property rights and transfers.

MERS was and is the very personification of Big Govt, Big Corp lawlessness running riot across the country. The usual fuking collusion of Big Govt and Big Corps driving a horse and coaches through the Laws of the Land with State quangos Fanny and Freddie riding as cavalry and also owning a slice (shares) in this large factory for sloppy (not to mention totally illegal) paperwork.

I’d love to believe John Paulson that the little companies were responsible for lax and sloppy standards but all the evidence shows sloppiness and lawlessness runs all the way through the Big Boys of WS’s entire business process while all along trying to give the patently false impression everything is AAA. The motivation was entirely driven by the usual Big Bad Corps and their absolutely predictable Big Bad, Big Greedy, Big Lawlessness Behaviour. Big Boy Mr Paulson is talking his book (shit)

by ebworthen
on Tue, 02/15/2011 – 23:04
#965712

Your article is much too long.

You need to shorten it to three paragraphs maximum.

Summary:

John Paulson saw the game, could not believe there was such corruption and lust for mammon running amok, and went short at the right time and got filthy rich.

Loan originators, appraisers, Real Estate agencies, title companies, banks, politicians, etc., etc., etc. – all inflated and sold crap to make the fee, commission, or leverage and speculate upon the crap mortgages (bundled with the mortgages of responsible folk) or to get elected.

When the SHTF the banks, insurers, and Wall Street got bailed out for their malfeasance, while the responsible folk of the U.S. of A. got screwed.  Nothing has changed.

by Stone Street Ad…
on Wed, 02/16/2011 – 13:40
#967233

That’s actually an awesome summery, excellent!

by PulauHantu29
on Tue, 02/15/2011 – 23:21
#965765

Hopefully they don’t say a year from now when the Municipaly Bonds crash,”We never saw it coming.”

by Vendetta
on Tue, 02/15/2011 – 23:54
#965819

yeah … sure.  Paulson was the only one who saw it coming … except the office of federal housing enterprise oversight with multiple warnings of systemic risk in the housing markets sent to congressional chairs on the committee on banking, housing and urban affairs and committee on financial services in 2003 and 2004

http://www.fhfa.gov/webfiles/1145/sysrisk.pdf

Note: Bush canned Armando Falcon and replaced him in a day with a hear-no-evil, see-no-evil financial sector lackey.  Word back then had it Goldman Sachs had Falcon canned and I happen to believe it.

Yep… nobody saw it coming but Paulson.

by StychoKiller
on Wed, 02/16/2011 – 08:52
#966249

Barney Frank (Congressman) 2003:  “I want to roll the dice a little bit more in this situation toward subsidized housing.”

Barney Frank 2008:  “I think this is a case where Fannie and Freddie are fundamentally sound, that they are not in danger of going under.”

Maxine Waters (Congresswoman) 2003:  “If it ain’t broke, why do you want to fix it?  Have the GSEs (Freddie and Fannie) ever missed their housing goals?”

Chris Dodd (Senator) 2004:  “This [Government Sponsored Housing] is one of the great success stories of all time…”

Paul Krugman (Economist) 2002:  “The basic point is that the recession of 2001 wasn’t a typical postwar slump… To fight this recession the Fed needs more than a snapback… Alan Greenspan needs to create a Housing bubble to replace the Nasdaq bubble.”

When Politicians tinker with the tax code to favor the sorts of investments
they think people should make (i.e., Housing), we should NOT be surprised
if market distortions result!

With fscksticks like these in charge, who needs enemies??

Comment viewing options

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Wasn’t commercial real estate supposed to crash?

beverly_hilton.gi.top.jpgBy Heidi N. Moore, contributorJune 8, 2010: 11:22 AM ET

FORTUNE — During the long years of the financial crisis, the American economy has been like a retelling of the Somerset Maugham story “Appointment in Samarra,” in which a man unsuccessfully runs from city to city in attempts to avoid a run-in with Death — who, of course, is one step ahead of him. Similarly, investors have now spent years dodging disaster in one area of the markets, only to find their investments coming to a bad end elsewhere.

Oddly, however, there is one sector that has been outrunning the reaper since 2007, and it’s the last place you’d expect to have survived so long: commercial real estate. For much of 2008 and 2009 CRE was awash in red ink, and yet it hangs on. Richard LeFrak, chairman of the LeFrak Organization, said at the Milken Institute Global Conference in April, “The failure that we were all anticipating in the commercial real estate market, it kind of didn’t happen. We blinked, it went away.”

The only question now is how long it can keep up the sprint while the ghosts of boom-time leverage haunt the sector, and $1.4 trillion in loan maturities loom three years over the horizon.

To crash or not to crash: Which side is right?

There is a sharp disagreement among experts in how things will play out. Some predict foreclosures, loan defaults and a national crisis of disastrous proportions. In that corner is Elizabeth Warren’s Congressional Oversight Panel, which flatly predicted this year that commercial real estate loans are heading for a crash that will bring down small banks, destroy small-business lending and create “a downward spiral of economic contraction,” in her ominous words.

On the other side, investors in commercial properties and buyers of commercial mortgage-backed securities believe that the commercial real estate market will continue to suffer until it hits a bottom, but it will never crash in the way that the residential market collapsed. They believe that commercial real estate will be an example of how a market can take the hits and keep on ticking, that not every spot of trouble results in a crisis, that an industry can actually, somehow, stop a crisis if it acts early enough and has enough support.

Peter Roberts, Chief Executive Officer of the Americas for property giant Jones Lang LaSalle (JLL), put it this way: “We’re not going to see a ‘crash’. We’re going to see a long work-through.” Roberts believes commercial property values are in the process of bottoming out and will get to the ground floor by early 2011.

He credits the government’s support programs in capital markets with reversing the psychology of nervous markets in 2009: “The powers that be are very focused in making sure that we don’t have a crash in the real estate market. That has infused the mindset of investors.”

The Hilton maneuver

Investors are making the most of their good luck while they can. There have already been deals of several different varieties that show us their plan for addressing the problem of high-water mark commercial mortgages coming due.

Of them, there’s no better example of temporarily sidestepping the debt monster than Blackstone Group’s clutch move with Hilton Hotels. The PE firm’s $26 billion buyout of Hilton in 2007 — with $20 billion of outstanding debt due by 2013 — is a prime example of the sweaty palms that high leverage deals can cause even savvy investors.

But in April, Blackstone (BX) bought back $1.8 billion of Hilton’s debt and restructured another $2.1 billion to turn it into preferred equity. Blackstone also pushed off the maturities of the remaining $16 billion until 2015, buying itself two whole years of breathing room. Hilton is still debt-laden, but it’s not dead — and hedge-fund investors speak approvingly of Blackstone’s decisions to face its problems early.

The deal has kicked off a quiet trend of what one real-estate investor at a hedge fund calls “mini-Hiltons” — a pending wave of real estate investors seeking to buy back and restructure their own debt to stay alive until the recovery.

In another pattern, auctions for distressed assets are becoming more and more competitive, giving troubled assets quick homes. One of the most notable was the acquisition of Corus Bankshare’s $4.5 billion real estate portfolio, sold for a mere 60 cents on the dollar in an FDIC auction to a group of real estate investors and hedge funds including Barry Sternlicht of Starwood Capital Group, TPG Capital, WLR LeFrak and Perry Capital. The FDIC kept the majority of the portfolio, but gave the buyers zero-percent financing — a sweet deal for any investor.

Unhinged loans

Since properties have become so hard to buy, many investors have turned with voraciousness to the bundles of securitized loans known as commercial mortgage-backed securities, or CMBS. If anything in commercial real estate stands ready for a reckoning, it is these securities.

Despite CMBS hurtling toward higher default rates, however, investors who have faith in them are practicing some serious compartmentalization. They say that there are only some CMBS — and some tranches of CMBS — that will be hurt. They believe that the highest-rated tranches, rated triple-A, are in no danger.

They also say that CMBS could never create as much havoc as their residential cousins because of their structure: They are made of whole loans that haven’t been chopped up as much in the Wall Street sausage factory, and are based on stronger assets.

The tranches most likely to be hurt, of course, are those with the worst ratings – the triple Bs. These were the biggest victims of lax underwriting standards. According to Commercial Mortgage Alert, the boom years of 2005 through 2007 saw a total of $602 billion in CMBS issuance. (The CMBS written during those three years, by the way, account for a whopping 49% of all CMBS written over the past 20 years.) Those are likely to be the problematic securities. The CMBS written before and after don’t have as much leverage put on them, say investors.

CMBS, however, accounts for only about 20% of the total loan market, according to Jones Lang LaSalle’s Roberts. The bigger danger to the capital markets — and to banks — are speculative commercial loans, like those in construction and land loans. Those aren’t backed by firm assets and are a key part of the reason that many smaller banks have failed in recent years. It is these loans, in particular, that worry Warren and others, and could yet bring a reckoning to CRE.

There is a lot riding on the outcome of commercial real estate’s do-it-yourself salvation. If the sector can escape the same kind of crash that took down residential real estate, then we have a case study in how investors and government can prevent a crash before it happens. If it doesn’t work, however, the economy could be hit again at a moment when it is least able to bear the punch. To top of page

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Is The United States Headed For A Commercial Real Estate Crash Of Unprecedented Magnitude?

Will commercial real estate be the next shoe to drop in the ongoing U.S. financial crisis?  While most eyes are on the continuing residential real estate disaster, the reality is that the state of the commercial real estate market in America could soon be even worse.  Very few financial pundits are talking about this looming disaster but they should be.  The truth is that U.S. commercial property values are down approximately 40 percent since the peak in 2007 and currently approximately 18 percent of all office space in the United States is now sitting vacant.  That qualifies as a complete and total mess, but the reality is that the commercial real estate crisis is just starting.

In fact, the commercial real estate market is likely to get a whole lot worse.  It is being projected that the largest commercial real estate loan losses will be experienced in 2011 and the years following.  Some analysts are estimating that losses from commercial real estate at U.S. banks alone could reach as high as 200 to 300 billion dollars.  To get an idea of how rapidly the commercial real estate market is unraveling, just check out the chart below….

Does that look like things are getting better to you?

And unfortunately, all indications are that the commercial real estate market is going to get much worse.

According to Real Capital Analytics, the default rate for commercial property mortgages held by all U.S. banks more than doubled in the fourth quarter of 2009 and may reach a peak of 5.4 percent by the end of 2011.

But even that estimate may be way too conservative as we shall see in a moment.

According to a recent report by the Congressional Oversight Panel, approximately 3,000 U.S. banks are currently classified as having a risky concentration of commercial real estate loans.  All of them are small to mid-size banks which have been already severely weakened by the recent financial crisis.

So could the crisis in the commercial real estate market lead to a massive wave of failures among small and mid-size banks?

Count on it.

In fact, the FDIC has acknowledged that the number of banks on its “problem” list climbed to 702 at the end of 2009.  To get an idea of just how bad that is, keep in mind that only 552 banks that were on the problem list at the end of September 2009, and only 252 banks that were on the problem list at the end of 2008.

Are you starting to get the picture?

So how are banks responding to this commercial real estate quagmire?

They are rapidly raising loan standards and they are dramatically reducing the number of loans they are making.

Just a few years ago, the number of commercial real estate loans was exploding, but now the bubble has burst, and as the chart below reveals, commercial real estate lending has absolutely fallen off the map….

What is making things even worse is that owners of commercial real estate are starting to walk away from properties that are heavily “underwater” just as many residential homeowners have been doing.  This has caused default rates to start shooting through the roof.

One of the latest and most high profile commercial property owners to do this is Vornado Realty Trust.  Earlier this month Vornado indicated that it would walk away from two heavily underwater loans totaling $235 million.

In the past commercial property owners would be very hesitant to do such a thing, but the reality is that the stigma has faded for these kind of “strategic defaults”.  Just as with residential real estate, these kinds of defaults have almost become accepted practice now.

The number of defaults is likely to skyrocket even further with so many commercial real estate loans scheduled to rollover in the next few years.

You see, commercial real estate properties typically carry mortgages with lives of 5 to 10 years.  A vast array of commercial real estate loans made between 2000 and 2005 are coming up for a rollover, but because credit standards have tightened, borrowers may find that they simply do not qualify for refinancing.

In fact, a report entitled “Commercial Real Estate at the Precipice” estimates that even under lenient lending standards, approximately 57 percent of existing commercial real estate mortgages will not qualify for refinancing.

That is a nightmare.

But if you apply more conservative lending standards, it is estimated that almost two-thirds of all commercial real estate borrowers will not qualify for a rollover.

So what is going to happen to the U.S. commercial real estate market when large numbers of borrowers start walking away from their “underwater” loans and about half of those who want to rollover their loans don’t qualify for refinancing?

What do you think that is going to do to commercial real estate prices?

Somebody better do something, because both the commercial and the residential real estate markets in the U.S. face a crisis of unprecedented magnitude.

But most Americans still have no idea that the great economic machine that their forefathers built is falling to pieces all around them.  They would rather numb the pain by watching the latest episode of American Idol or by catching up on the latest round of celebrity gossip.

But that is not going to stop what is about to happen.

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7 comments to Is The United States Headed For A Commercial Real Estate Crash Of Unprecedented Magnitude?

  • Tim

    Michael,

    Thanks for another great article. I think you are right about what is coming.

  • John O’Neill

    Bob Chapman from the International Forecaster has an interesting take on what could happen when the dollar is devalued. He said the elite don’t always do what seems to be logical, meaning in the case of a hypothetical scenario of the dollar being devalued 3:1; the elite may elect to keep the value of all loans at currency rates prior to the devaluation. I can’t imagine the elite getting away with this, but just in case, in might be a good idea to get as much out of debt as you can, just to be safe. People who are out of debt are going to be able to ride this storm better than those who are leveraged too high. How high is too high? If your debt is more than 10% of your total income, I would suggest trying to pay your debt down if you can. Either way, it’s going to be a rough ride for all of us. Make sure you have storable food, filtered water, guns and ammo, and if possible gold and silver.

  • primrose

    We are watching a slow train wreck of biblical proportions. The sad part, too many are in denial and believe the “government” will take care of everything. Yeah, right!

  • nice article, looks like a second sub-prime will be on out hands. btw ive linked to you blog from mine, maybe you can do the same for me.

    regards

  • I don’t think the American Public has any idea what is about to hit!
    An economical collapse, simuliar to Argentina’s melt down, is fastly approaching. No public assistance, insufficient medical care, food supply shortages, rampant crime levels, water shortages, energy and fuel supplies thinned to desperate levels,…and that is just the beginning of the end of the US dollar and it’s society! I feel like we were soft, and set up by the people use to depend on. New Orleans was nothing compared to what the American people are going to endure in the next decade! Nitty gritty, blood sweat and tears…

  • Czeslaw

    yes it was a big pleasure to reading it!

  • I fear that this is very close to what is happening all around the US. Here in Australia, we have been cushioned a lot better than the US due to our mineral resources…not the mining companies but our nationally owned mineral resources.

    Commercial real estate has been a sadly overlooked commodity only because of the enormity of the residential property market and keeping a population housed.

    Until Wall Street is brought to undertsnad the human consequences of their greedy actions, and until some commonsense regulations are instigated, I can only see the US commercial real estate market going belly up.

    The US must start producing things again rather than just moving money around through digital points. Once this happens commercial real estate will then be needed again.

>

Commercial Real Estate Apocalypse 2011-2012

Housing-Market / US HousingFeb 22, 2010 – 01:06 PM

By: Mike_Shedlock

Housing-Market

Best Financial Markets Analysis ArticleInquiring minds are digging deep into a 190 page PDF by the Congressional Oversight Panel regarding Commercial Real Estate Losses and the Risk to Financial Stability.

Executive Summary

Over the next few years, a wave of commercial real estate loan failures could threaten America’s already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.

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.

The largest commercial real estate loan losses are projected for 2011 and beyond; losses at banks alone could range as high as $200-$300 billion. The stress tests conducted last year for 19 major financial institutions examined their capital reserves only through the end of 2010.

Even more significantly, small and mid-sized banks were never subjected to any exercise comparable to the stress tests, despite the fact that small and mid-sized banks are proportionately even more exposed than their larger counterparts to commercial real estate loan losses.

A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American. Empty office complexes, hotels, and retail stores could lead directly to lost jobs. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.

It is difficult to predict either the number of foreclosures to come or who will be most immediately affected. In the worst case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession.

Present Condition of Commercial Real Estate

The commercial real estate market is currently experiencing considerable difficulty for two distinct reasons. First, the current economic downturn has resulted in a dramatic deterioration of commercial real estate fundamentals. Increasing vacancy rates and falling rental prices present problems for all commercial real estate loans. Decreased cash flows will affect the ability of borrowers to make required loan payments. Falling commercial property values result in higher LTV ratios, making it harder for borrowers to refinance under current terms regardless of the soundness of the original financing, the quality of the property, and whether the loan is performing.

Second, the development of the commercial real estate bubble, as discussed above, resulted in the origination of a significant amount of commercial real estate loans based on dramatically weakened underwriting standards. These loans were based on overly aggressive rental or cash flow projections (or projections that were only sustainable under bubble conditions), had higher levels of allowable leverage, and were not soundly underwritten. Loans of this sort (somewhat analogous to “Alt-A” residential loans) will encounter far greater difficulty as projections fail to materialize on already excessively leveraged commercial properties.

Economic Conditions and Deteriorating Market Fundamentals

The health of the commercial real estate market depends on the health of the overall economy. Consequently, the market fundamentals will likely stay weak for the foreseeable future. This means that even soundly financed projects will encounter difficulties. Those projects that were not soundly underwritten will likely encounter far greater difficulty as aggressive rental growth or cash flow projections fail to materialize, property values drop, and LTV ratios rise on already excessively leveraged properties. New and partially constructed properties are experiencing the biggest problems with vacancy and cash flow issues (leading to a higher number of loan defaults and higher loss severity rates than other commercial property loans).

For the last several quarters, average vacancy rates have been rising and average rental prices have been falling for all major commercial property types.

Current average vacancy rates and rental prices have been buffered by the long-term leases held by many commercial properties (e.g., office and industrial). The combination of negative net absorption rates and additional space that will become available from projects started during the boom years will cause vacancy rates to remain high, and will continue putting downward pressure on rental prices for all major commercial property types. Taken together, this falling demand and already excessive supply of commercial property will cause many projects to be viable no longer, as properties lose, or are unable to obtain, tenants and as cash flows (actual or projected) fall.

In addition to deteriorating market fundamentals, the price of commercial property has plummeted. As seen in the following chart, commercial property values have fallen over 40 percent since the beginning of 2007.

For financial institutions, the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks that have higher concentrations of, and exposure to, such loans than larger national or money center banks. The impact of commercial real estate problems on the various holders of CMBS and other participants in the CMBS markets is more difficult to predict. The experience of the last two years, however, indicates that both risks can be serious threats to the institutions and borrowers involved.

Although banks with over $10 billion in assets hold over half of commercial banks’ total commercial real estate whole loans, the mid-size and smaller banks face the greatest exposure.

The current distribution of commercial real estate loans may be particularly problematic for the small business community because smaller regional and community banks with substantial commercial real estate exposure account for almost half of small business loans. For example, smaller banks with the highest exposure – commercial real estate loans in excess of three times Tier 1 capital – provide around 40 percent of all small business loans.

Foresight Analytics, a California-based firm specializing in real estate market research and analysis, calculates banks’ exposure to commercial real estate to be even higher than that estimated by the Federal Reserve. Drawing on bank regulatory filings, including call reports and thrift financial reports, Foresight estimates that the total commercial real estate loan exposure of commercial banks is $1.9 trillion compared to the $1.5 trillion Federal Reserve estimate. The 20 largest banks, those with assets greater than $100 billion, hold $600.5 billion in commercial real estate loans.

Figure 17: Commercial Real Estate Loans by Type (Banks and Thrifts as of Q3 2009)

As seen in the Foresight Analytics data above, the mid-size and smaller institutions have the largest percentage of “CRE Concentration” banks compared to total banks within their respective asset class. This percentage is especially high in banks with $1 billion to $10 billion in assets. The table above emphasizes the heightened commercial real estate exposure compared to total capital in banks with $100 million to $10 billion in assets. Equally troubling, at least six of the nineteen stress-tested bank-holding companies have whole loan exposures in excess of 100 percent of Tier 1 risk-based capital.

Risks

In the years preceding the current crisis, a series of trends pushed smaller and community banks toward greater concentration of their lending activities in commercial real estate. Simultaneously, higher quality commercial real estate projects tended to secure their financing in the CMBS market. As a result, if and when a crisis in commercial real estate develops, smaller and community banks will have greater exposure to lower quality investments, making them uniquely vulnerable.

As loan delinquency rates rise, many commercial real estate loans are expected to default prior to maturity. For loans that reach maturity, borrowers may face difficulty refinancing either because credit markets are too tight or because the loans do not qualify under new, stricter underwriting standards. If the borrowers cannot refinance, financial institutions may face the unenviable task of determining how best to recover their investments or minimize their losses: restructuring or extending the term of existing loans or foreclosure or liquidation.

On the other hand, borrowers may decide to walk away from projects or properties if they are unwilling to accept terms that are unfavorable or fear the properties will not generate sufficient cash flows or operating income either to service new debt or to generate a future profit.

Delinquent Loans

Although many analysts and Treasury officials believe that the commercial real estate problem is one that the economy can manage through, and analysts believe that the current condition of commercial real estate, in isolation, does not pose a systemic risk to the banking system, rising delinquency rates foreshadow continuing deterioration in the commercial real estate market. For the last several quarters, delinquency rates have been rising significantly.

The extent of ultimate commercial real estate losses is yet to be determined; however, large loan losses and the failure of some small and regional banks appear to some experienced analysts to be inevitable. New 30-day delinquency rates across commercial property types continue to rise, suggesting that commercial real estate loan performance will continue to deteriorate. However, there is some indication that the rate of growth, or pace of deterioration, is slowing. Unsurprisingly, the increase in delinquency rates has translated into rapidly rising default rates.

The increasing number of delinquent, defaulted, and non-performing commercial real estate loans also reflects increasing levels of loan risks. Loan risks for borrowers and lenders fall into two categories: credit risk and term risk. Credit risk can lead to loan defaults prior to maturity; such defaults generally occur when a loan has negative equity and cash flows from the property are insufficient to service the debt, as measured by the debt service coverage ratio (DSCR).

If the DSCR falls below one, and stays below one for a sufficiently long period of time, the borrower may decide to default rather than continue to invest time, money, or energy in the property. The borrower will have little incentive to keep a property that is without equity and is not generating enough income to service the debt, especially if he does not expect the cash flow situation to improve because of increasing vacancy rates and falling rental prices.

Broader Social and Economic Consequences

Commercial real estate problems exacerbate rising unemployment rates and declining consumer spending. Approximately nine million jobs are generated or supported by commercial real estate including jobs in construction, architecture, interior design, engineering, building maintenance and security, landscaping, cleaning services, management, leasing, investment and mortgage lending, and accounting and legal services.

Projects that are being stalled or canceled and properties with vacancy issues are leading to layoffs. Lower commercial property values and rising defaults are causing erosion in retirement savings, as institutional investors, such as pension plans, suffer further losses. Decreasing values also reduce the amount of tax revenue and fees to state and local governments, which in turn impacts the amount of funding for public services such as education and law enforcement. Finally, problems in the commercial real estate market can further reduce confidence in the financial system and the economy as a whole. To make matters worse, the credit contraction that has resulted from the overexposure of financial institutions to commercial real estate loans, particularly for smaller regional and community banks, will result in a “negative feedback loop” that suppresses economic recovery and the return of capital to the commercial real estate market. The fewer loans that are available for businesses, particularly small businesses, will hamper employment growth, which could contribute to higher vacancy rates and further problems in the commercial real estate market.

Conclusion

There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public. An extended severe recession and continuing high levels of unemployment can drive up the LTVs, and add to the difficulties of refinancing for even solidly underwritten properties. But delaying write-downs in advance of a hoped-for recovery in mid- and longer-term property valuations also runs the risk of postponing recognition of the costs that must ultimately be absorbed by the financial system to eliminate the commercial real estate overhang.

Any approach to the problem raises issues previously identified by the Panel: the creation of moral hazard, subsidization of financial institutions, and providing a floor under otherwise seriously undercapitalized institutions.

There appears to be a consensus, strongly supported by current data, that commercial real estate markets will suffer substantial difficulties for a number of years. Those difficulties can weigh heavily on depository institutions, particularly mid-size and community banks that hold a greater amount of commercial real estate mortgages relative to total size than larger institutions, and have – especially in the case of community banks – far less margin for error. But some aspects of the structure of the commercial real estate markets, including the heavy reliance on CMBS (themselves backed in some cases by CDS) and the fact that at least one of the nation’s largest financial institutions holds a substantial portfolio of problem loans, mean that the potential for a larger impact is also present.

There is no way to predict with assurance whether an economic recovery of sufficient strength will occur to reduce these risks before the large-scale need for commercial mortgage refinancing that is expected to begin in 2011-2013.

The Panel is concerned that until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.

Reflections on the Report

At 190 pages, that was a very detailed report. One key take away is the huge numbers of banks at risk of failure as noted in Figure 19. There are 358 banks in the size of $1 to $10 billion with excessive CRE concentrations. There are an additional 2,115 banks in the size of $100 million to $1 billion with excessive CRE concentrations. Only 1 of the top 20 banks (greater than $100 billion) has excessive CRE concentrations. However, because of size, that 1 is important as well.

Certainly not all of those banks will fail, but hundreds of them will. Moreover, of all the banks, a whopping 2,988 out of 8,108 have excessive CRE concentrations. With inadequate loan loss provisions as noted in the following chart, is it any wonder banks are not lending?

Assets at Banks whose ALLL exceeds their Nonperforming Loans

The above chart courtesy of the St. Louis Fed.

Because allowances for loan and lease losses (ALLL) are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated.

Systemic Risk

The report noted that “Treasury officials believe that the commercial real estate problem is one that the economy can manage through, and analysts believe that the current condition of commercial real estate, in isolation, does not pose a systemic risk to the banking system.”

The key words in that paragraph are “in isolation”.

  • What about credit card defaults?
  • What about another wave down in housing?
  • What about the cumulative effect of banks being so undercapitalized they could not lend if they wanted to?
  • What if more businesses decide to walk away for properties?
  • What happens to mortgage rates and rates for commercial loans when the Fed stops buying mortgage backed securities?

A quick look at the above questions shows risk is overwhelmingly to the downside.

Here is the key question as far as the “recovery” goes. Where is the source of jobs with all the above constraints and questions?

As I suggested in Yield Curve Steepest In History: Is The Meaning Different This Time?

Those who think the steep yield curve guarantees the economy will soon be humming are in for a rude awakening. In the aftermath of a deflationary credit bust, credit conditions, debt levels, and attitudes are far more important than a steep yield curve, and those conditions are god awful.

Add commercial real estate to the list of conditions that are god awful.

Perhaps the economic miracle fairy waves her wand and cures all of these systemic risks, but I would not bet on it.

By Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific’s Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2010 Mike Shedlock, All Rights Reserved.

© 2005-2011 http://www.MarketOracle.co.uk – The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Comments

>

Commercial Real Estate Apocalypse in 2011-2012

Inquiring minds are digging deep into a 190 page PDF by the Congressional Oversight Panel regarding Commercial Real Estate Losses and the Risk to Financial Stability.

Executive Summary

Over the next few years, a wave of commercial real estate loan failures could threaten America’s already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.

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.

The largest commercial real estate loan losses are projected for 2011 and beyond; losses at banks alone could range as high as $200-$300 billion. The stress tests conducted last year for 19 major financial institutions examined their capital reserves only through the end of 2010.

Even more significantly, small and mid-sized banks were never subjected to any exercise comparable to the stress tests, despite the fact that small and mid-sized banks are proportionately even more exposed than their larger counterparts to commercial real estate loan losses.

A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American. Empty office complexes, hotels, and retail stores could lead directly to lost jobs. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.

It is difficult to predict either the number of foreclosures to come or who will be most immediately affected. In the worst case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession.

Present Condition of Commercial Real Estate

The commercial real estate market is currently experiencing considerable difficulty for two distinct reasons. First, the current economic downturn has resulted in a dramatic deterioration of commercial real estate fundamentals. Increasing vacancy rates and falling rental prices present problems for all commercial real estate loans. Decreased cash flows will affect the ability of borrowers to make required loan payments. Falling commercial property values result in higher LTV ratios, making it harder for borrowers to refinance under current terms regardless of the soundness of the original financing, the quality of the property, and whether the loan is performing.

Second, the development of the commercial real estate bubble, as discussed above, resulted in the origination of a significant amount of commercial real estate loans based on dramatically weakened underwriting standards. These loans were based on overly aggressive rental or cash flow projections (or projections that were only sustainable under bubble conditions), had higher levels of allowable leverage, and were not soundly underwritten. Loans of this sort (somewhat analogous to “Alt-A” residential loans) will encounter far greater difficulty as projections fail to materialize on already excessively leveraged commercial properties.

Economic Conditions and Deteriorating Market Fundamentals

The health of the commercial real estate market depends on the health of the overall economy. Consequently, the market fundamentals will likely stay weak for the foreseeable future. This means that even soundly financed projects will encounter difficulties. Those projects that were not soundly underwritten will likely encounter far greater difficulty as aggressive rental growth or cash flow projections fail to materialize, property values drop, and LTV ratios rise on already excessively leveraged properties. New and partially constructed properties are experiencing the biggest problems with vacancy and cash flow issues (leading to a higher number of loan defaults and higher loss severity rates than other commercial property loans).

For the last several quarters, average vacancy rates have been rising and average rental prices have been falling for all major commercial property types.

Current average vacancy rates and rental prices have been buffered by the long-term leases held by many commercial properties (e.g., office and industrial). The combination of negative net absorption rates and additional space that will become available from projects started during the boom years will cause vacancy rates to remain high, and will continue putting downward pressure on rental prices for all major commercial property types. Taken together, this falling demand and already excessive supply of commercial property will cause many projects to be viable no longer, as properties lose, or are unable to obtain, tenants and as cash flows (actual or projected) fall.

In addition to deteriorating market fundamentals, the price of commercial property has plummeted. As seen in the following chart, commercial property values have fallen over 40 percent since the beginning of 2007.

For financial institutions, the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks that have higher concentrations of, and exposure to, such loans than larger national or money center banks. The impact of commercial real estate problems on the various holders of CMBS and other participants in the CMBS markets is more difficult to predict. The experience of the last two years, however, indicates that both risks can be serious threats to the institutions and borrowers involved.

Although banks with over $10 billion in assets hold over half of commercial banks’ total commercial real estate whole loans, the mid-size and smaller banks face the greatest exposure.

The current distribution of commercial real estate loans may be particularly problematic for the small business community because smaller regional and community banks with substantial commercial real estate exposure account for almost half of small business loans. For example, smaller banks with the highest exposure – commercial real estate loans in excess of three times Tier 1 capital – provide around 40 percent of all small business loans.

Foresight Analytics, a California-based firm specializing in real estate market research and analysis, calculates banks’ exposure to commercial real estate to be even higher than that estimated by the Federal Reserve. Drawing on bank regulatory filings, including call reports and thrift financial reports, Foresight estimates that the total commercial real estate loan exposure of commercial banks is $1.9 trillion compared to the $1.5 trillion Federal Reserve estimate. The 20 largest banks, those with assets greater than $100 billion, hold $600.5 billion in commercial real estate loans.

Figure 17: Commercial Real Estate Loans by Type (Banks and Thrifts as of Q3 2009)

As seen in the Foresight Analytics data above, the mid-size and smaller institutions have the largest percentage of “CRE Concentration” banks compared to total banks within their respective asset class. This percentage is especially high in banks with $1 billion to $10 billion in assets. The table above emphasizes the heightened commercial real estate exposure compared to total capital in banks with $100 million to $10 billion in assets. Equally troubling, at least six of the nineteen stress-tested bank-holding companies have whole loan exposures in excess of 100 percent of Tier 1 risk-based capital.

Risks

In the years preceding the current crisis, a series of trends pushed smaller and community banks toward greater concentration of their lending activities in commercial real estate. Simultaneously, higher quality commercial real estate projects tended to secure their financing in the CMBS market. As a result, if and when a crisis in commercial real estate develops, smaller and community banks will have greater exposure to lower quality investments, making them uniquely vulnerable.

As loan delinquency rates rise, many commercial real estate loans are expected to default prior to maturity. For loans that reach maturity, borrowers may face difficulty refinancing either because credit markets are too tight or because the loans do not qualify under new, stricter underwriting standards. If the borrowers cannot refinance, financial institutions may face the unenviable task of determining how best to recover their investments or minimize their losses: restructuring or extending the term of existing loans or foreclosure or liquidation.

On the other hand, borrowers may decide to walk away from projects or properties if they are unwilling to accept terms that are unfavorable or fear the properties will not generate sufficient cash flows or operating income either to service new debt or to generate a future profit.

Delinquent Loans

Although many analysts and Treasury officials believe that the commercial real estate problem is one that the economy can manage through, and analysts believe that the current condition of commercial real estate, in isolation, does not pose a systemic risk to the banking system, rising delinquency rates foreshadow continuing deterioration in the commercial real estate market. For the last several quarters, delinquency rates have been rising significantly.

The extent of ultimate commercial real estate losses is yet to be determined; however, large loan losses and the failure of some small and regional banks appear to some experienced analysts to be inevitable. New 30-day delinquency rates across commercial property types continue to rise, suggesting that commercial real estate loan performance will continue to deteriorate. However, there is some indication that the rate of growth, or pace of deterioration, is slowing. Unsurprisingly, the increase in delinquency rates has translated into rapidly rising default rates.

The increasing number of delinquent, defaulted, and non-performing commercial real estate loans also reflects increasing levels of loan risks. Loan risks for borrowers and lenders fall into two categories: credit risk and term risk. Credit risk can lead to loan defaults prior to maturity; such defaults generally occur when a loan has negative equity and cash flows from the property are insufficient to service the debt, as measured by the debt service coverage ratio (DSCR).

If the DSCR falls below one, and stays below one for a sufficiently long period of time, the borrower may decide to default rather than continue to invest time, money, or energy in the property. The borrower will have little incentive to keep a property that is without equity and is not generating enough income to service the debt, especially if he does not expect the cash flow situation to improve because of increasing vacancy rates and falling rental prices.

Broader Social and Economic Consequences

Commercial real estate problems exacerbate rising unemployment rates and declining consumer spending. Approximately nine million jobs are generated or supported by commercial real estate including jobs in construction, architecture, interior design, engineering, building maintenance and security, landscaping, cleaning services, management, leasing, investment and mortgage lending, and accounting and legal services.

Projects that are being stalled or canceled and properties with vacancy issues are leading to layoffs. Lower commercial property values and rising defaults are causing erosion in retirement savings, as institutional investors, such as pension plans, suffer further losses. Decreasing values also reduce the amount of tax revenue and fees to state and local governments, which in turn impacts the amount of funding for public services such as education and law enforcement. Finally, problems in the commercial real estate market can further reduce confidence in the financial system and the economy as a whole. To make matters worse, the credit contraction that has resulted from the overexposure of financial institutions to commercial real estate loans, particularly for smaller regional and community banks, will result in a “negative feedback loop” that suppresses economic recovery and the return of capital to the commercial real estate market. The fewer loans that are available for businesses, particularly small businesses, will hamper employment growth, which could contribute to higher vacancy rates and further problems in the commercial real estate market.

Conclusion

There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public. An extended severe recession and continuing high levels of unemployment can drive up the LTVs, and add to the difficulties of refinancing for even solidly underwritten properties. But delaying write-downs in advance of a hoped-for recovery in mid- and longer-term property valuations also runs the risk of postponing recognition of the costs that must ultimately be absorbed by the financial system to eliminate the commercial real estate overhang.

Any approach to the problem raises issues previously identified by the Panel: the creation of moral hazard, subsidization of financial institutions, and providing a floor under otherwise seriously undercapitalized institutions.

There appears to be a consensus, strongly supported by current data, that commercial real estate markets will suffer substantial difficulties for a number of years. Those difficulties can weigh heavily on depository institutions, particularly mid-size and community banks that hold a greater amount of commercial real estate mortgages relative to total size than larger institutions, and have – especially in the case of community banks – far less margin for error. But some aspects of the structure of the commercial real estate markets, including the heavy reliance on CMBS (themselves backed in some cases by CDS) and the fact that at least one of the nation’s largest financial institutions holds a substantial portfolio of problem loans, mean that the potential for a larger impact is also present.

There is no way to predict with assurance whether an economic recovery of sufficient strength will occur to reduce these risks before the large-scale need for commercial mortgage refinancing that is expected to begin in 2011-2013.

The Panel is concerned that until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.

Reflections on the Report

At 190 pages, that was a very detailed report. One key take away is the huge numbers of banks at risk of failure as noted in Figure 19. There are 358 banks in the size of $1 to $10 billion with excessive CRE concentrations. There are an additional 2,115 banks in the size of $100 million to $1 billion with excessive CRE concentrations. Only 1 of the top 20 banks (greater than $100 billion) has excessive CRE concentrations. However, because of size, that 1 is important as well.

Certainly not all of those banks will fail, but hundreds of them will. Moreover, of all the banks, a whopping 2,988 out of 8,108 have excessive CRE concentrations. With inadequate loan loss provisions as noted in the following chart, is it any wonder banks are not lending?

Assets at Banks whose ALLL exceeds their Nonperforming Loans

The above chart courtesy of the St. Louis Fed.

Because allowances for loan and lease losses (ALLL) are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated.

Systemic Risk

The report noted that “Treasury officials believe that the commercial real estate problem is one that the economy can manage through, and analysts believe that the current condition of commercial real estate, in isolation, does not pose a systemic risk to the banking system.”

The key words in that paragraph are “in isolation”.

  • What about credit card defaults?
  • What about another wave down in housing?
  • What about the cumulative effect of banks being so undercapitalized they could not lend if they wanted to?
  • What if more businesses decide to walk away for properties?
  • What happens to mortgage rates and rates for commercial loans when the Fed stops buying mortgage backed securities?

A quick look at the above questions shows risk is overwhelmingly to the downside.

Here is the key question as far as the “recovery” goes. Where is the source of jobs with all the above constraints and questions?

As I suggested in Yield Curve Steepest In History: Is The Meaning Different This Time?

Those who think the steep yield curve guarantees the economy will soon be humming are in for a rude awakening. In the aftermath of a deflationary credit bust, credit conditions, debt levels, and attitudes are far more important than a steep yield curve, and those conditions are god awful.

Add commercial real estate to the list of conditions that are god awful.

Perhaps the economic miracle fairy waves her wand and cures all of these systemic risks, but I would not bet on it.

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

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Commercial Real Estate Apocalypse in 2011-2012
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Commercial real estate maturities will peak in 2012 – $350 billion in loans coming due and hundreds of additional bank failures. Bank lending in the CRE market collapsing.

The commercial real estate disaster is sinking banks on a weekly basis.  Talk of a V-shape recovery is now largely a moot point since we are past the point of a quick and strong recovery.  The question now revolves around what we are going to face for the next few years.  Commercial real estate really is a harbinger of what went wrong in the last decade.  Banks and builders hungry for massive profits overestimated the demand for Starbucks and Macys locations around the country.  After all, you actually need money to spend and many average Americans are struggling just to pay their monthly bills.  The only way commercial real estate (CRE) was going to do well is if we had a booming population of young and wealthier professionals with more disposable income.  Yet that did not happen.

Even though the claim of building and bottom talk is now out there in the open, banks that actually lend the money for these projects have different ideas:

Lending for commercial loans has collapsed.  Even though banks would like you to believe that all is healthy and strong they have a front row seat to the carnage in the CRE market.  And with CRE locations you get an actual real feel of the economic problems we are facing.  Many Americans have pulled back on their spending and without spending many places simply cannot move forward.  Banks are also taking scissors to American credit cards and access to other people’s money is slowly going away.  The CRE market at one point was valued at $6.5 trillion.  Today it is closer to $3 to $3.5 trillion.  The loan amount at the peak was roughly $3.5 trillion so you had a nice equity cushion.  Today, the balance is nearly the same but the value of the collateral has collapsed:

Although you see a slight increase, this is largely due to the massive amounts of government stimulus and bailouts.  The increase on the supply side also has to do with many businesses cutting inventories to rock bottom levels during the dark days of the crisis when the stock market seemed to be at a free fall.  Businesses restocked and this provided a nice little short-term boost but that was it.  Now we are burning through that and realize that we have an enormous amount of unused capacity in our economy.  In other words, there is little need for all the CRE out there in the market.

If we are to carefully examine the bank balance sheet of a too big to fail bank, what we find is that banks are now shifting their energy from funding new businesses to actually investing in the stock market casino.  Let us take a look at the balance sheet for Bank of America:

“The above tells you more of what is going on than what any media outlet will tell you.  What you see is a clear reduction in loans outstanding with BofA.  At the same time, you see a massive increase in more investment activities.  Wall Street has learned to leverage the easy money from the Federal Reserve to speculate on Wall Street instead of lending it out to Americans.”

Do you remember any U.S. Treasury head saying this was the actual plan?  Of course not but that is exactly what is happening with the trillions of dollars now backstopping the banking system.

The CRE market is a reason for that reduction in loan amount.  Many of the properties are defaulting and have to face the realization that they are worth a lot less than once thought.  Many of the borrowers bought the properties with optimistic cash flow scenarios that would never materialize.  You can buy a property for cash flow or appreciation purposes.  It looks like the vast majority bought for appreciation and we entered a period where prices crashed.  That is what we are now living through from a poorly calculated bet.

And the reality is we are merely entering the first few stages of the CRE bust with CRE loan maturities coming due:

Source:  CREonline

Does the above chart look daunting?  It should.  The peak won’t hit until 2012 when nearly $350 billion in CRE loans will come due.  And just look at the amount held by banks and thrifts.  This is why predicting another 1,000 bank failures (at least) is within the cards.  The connections between the banking sector and CRE run deep and we have a long way to go before we can say we are out of the economic woods.

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  1. steve said:

    So let me see if I can read between the lines… don’t invest in any bank stocks for long term growth, because the upcoming payment due date in 2012 for commercial real estate is not going to be able to be paid, and banks will lose cash flow, and fail…

    Maybe that is why the big banks are gambling in the stock market, because they predict that CRE payments are going to fail, so they are trying to gain profits from stock trades, to make up for the losses from CRE defaults.

    So will Citigroup C, stay around $4 a share, or will it drop back down to $1 in 2012? I guess I’ll start saving my dollars to make a big buy in 2012 after their stock dips.

    4

    August 4th, 2010 at 12:53 pm
  2. theyenguy said:

    Because of FASB 157, the banks are entitled to value the properties at mark-to-manager’s best estimate rather than mark-to-market. As the economy withers, the strip malls and other office parks start to vacant and the developers fail to make payment. These properties usually lie dormant until the bank folds and the FDIC takes a loss when it closes the bank. As time goes on the rating agencies will downgrade US sovereign debt and the banks as well. Then the US will face failed Treasury auctions and the banks will not do any kind of lending.

    Then, I believe that “Credit Bosses”, that is credit seigniors, will oversee the disbursement of credit both in the US and Europe.

    Here in the US, I envision, a Financial Regulator, will exercise Discretionary Governance, and announce a Home Leasing Program administered by the banks on their REO properties and those of Freddie Mac, Fannie Mae and the US Federal Reserve. Mortgage lending and securitization of loans will cease, and leasing of homes will be a public private partnership cooperative endeavor. Companies that have done servicing mortgage-backed securities, such as Anworth Mortgage Asset Corporation, ANH, will quickly disappear from the economic landscape, as mortgage bond funds such as Goldman Sachs Mortgage Bonds, GSUAX, tumble in value.

    I also envision that this Credit Seignior, perhaps in public private partnership with American Express, AXP, and Capitol One Finance, COF, will provide seigniorage for credit. He will issue credit mostly to those companies which serve strategic national needs.

    In Europe, I see a new role for the President of the ECB. I envision that in response to severe credit contraction and banking ill-liquidity, that he also will be Credit Seignior, as he accepts sovereign and other debt and issues credit to Eurozone member banks thereby keeping some degree of money liquidity flowing.

    The European Financials stock market rally is over and the Euro is falling lower, as the chart of the European Financials EUFN shows it to be topped out and falling 1.2% lower today. And the chart of the 2x Euro ETF URR shows it falling 5.6% lower; thus both stock deflation and currency deflation is underway.

    And Bond deflation has commenced as well, as can be seen in the 2x US Government Bond ETF UBT falling lower.

    So a total debt deflationary vortex has formed with stocks, currencies and bonds all trading lower. Today, August 4, 2010, the world has entered into Kondratieff Winter, that is the final season of economic and political experience where wealth will be exhausted and liberty destroyed as regional governance will rise to provide for political security and economic sustainability.

    August 4th, 2010 at 1:47 pm

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2012 Total Collapse Of The U.S. Economy

This is my site Written by ysdata on March 26, 2009 – 7:39 pm

Gerald CelenteIs Gerald Celente the new Nostradamus? He believes so much in his predictions that he has the domain name “thecollapseof09.com“. So, What are Gerald Celente predictions? Total collapse of the U.S. economic system by 2012.

Gerald Celente Armageddon Predictions:

  • The employment rate will triple
  • Vacant strip malls
  • Commercial real-estate collapse
  • Food riots
  • Rising crime
  • Tax revolution

Who is Gerald Celente? Gerald Celente is the Founder and Director of the Trends Research Institute. He is also the author of Trends 2000: How to Prepare for and Profit from the Changes of the 21st Century and Trend Tracking: The System to Profit from Today’s Trends. Gerald Celente has forecast the Panic of 08, The Fall of the Soviet Union, Gold Bull Market, 2001 Recession, the Dot.com Crash and many other trends to hit. He has been predicting trends since 1980.

2012 collapse of the u.s. economy

Gerald Celente said — the bailout bills and stimulus packages will not work. He believes that you can’t print money based on nothing. I agree with that statement. He also said — This will be the greatest Depression. He thinks by 2012 there will be a new third party system.

The only way for the U.S. to avoid the 2012 collapse is to come up with a new alternative energy source — something ground breaking. So, what does Gerald Celente recommend for us common folks? Gerald Celente recommends that we save every dollar we can!

What do you think of Gerald Celente and his predictions?

http://www.ysdata.com/blogger/2012-total-collapse-of-the-us-economy/221

See it >

US economy will totally collapse

Economics for Dummies

Worst that Great Depression

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The Doctrine of Preemptive Bailouts and the Biggest Bailout you haven’t Heard About: The U.S. Treasury Plan C and the $3.5 Trillion You will be Paying.

Last week a story which gained very little traction hit the financial newswires.  The U.S. Treasury is working on an internal project informally called “Plan C” which seeks to deal with further problems in the economy before they occur.  The anonymous report came out stating the administration is reluctant to commit any additional money especially to the level mentioned in the report.  However this is a disturbing new development in our bailout nation since this is one of the first times that the U.S. Treasury will try to preemptively deal with a financial problem.

The issues with this Plan C is that it is setup to be a buffer on further deterioration in various loan categories but the big one is commercial real estate.  The commercial real estate market is gigantic and many of those loans are still active:

commerical real estate

Some $3.5 trillion in commercial real estate loans are out in the market.  The problem is complicated because commercial real estate holders simply rollover their debt into new loans.  That of course has changed since the economy and credit markets have shutdown and many of these properties are now severely underwater.  Take a look at how many loans will be turning over:

mbs

*Source:  ZeroHedge

The amount of maturing loans in commercial real estate will double in 2010 and will continue upward into 2010.  The chart is very clear and this is only for debt in CMBS and not held by regional banks which is over $2 trillion.  This is the next multi-trillion dollar bailout you have yet to hear about.  In fact, while many are discussing a second half recovery higher up officials are already planning a bailout for the commercial real estate industry.  The challenge with this bailout is you are asking a public with 26,000,000 unemployed and underemployed Americans to shoulder the debt of largely speculative plays.  To many it is palatable to bailout the residential real estate market because the public can understand that (even if it may be wrong) or bailing out the 2 large U.S. automakers.  Yet bailing out the commercial real estate market is going to be a political nightmare.

Of course the U.S. Treasury would like you to believe this is merely a precaution but most of the last precautions we have heard about have turned out to be trillions and trillions in full on commitments shouldered by the American public:

“(WaPo) We are continually examining different scenarios going forward; that’s just prudent planning,” Treasury spokesman Andrew Williams said.

The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.

Banks and other firms that provided such loans in the past have sharply curtailed lending.

That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt — some estimates peg the total at more than $3 trillion — that they will need to refinance. These loans were issued during this decade’s construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.

The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.”

The end of the road has been reached for commercial real estate.  Many regional banks jumped into the commercial real estate market since they had little chance of competing with big subprime and Alt-A mortgage factories like WaMu or Countrywide.  Many regional banks saw this as a way to stay competitive in local regions across the country.  This is a much more diverse problem and the tentacles of the commercial real estate bust will be felt in every state.

These loans were made on strip malls, doctor’s offices, and drive-through restaurants for communities that are hurting from the recession.  This is an enormous amount of debt that is out there that will surely default since there is no way to refinance this debt since many of these projects are literally underwater.  Take a look at the composition of over 8,000 banks and thrifts across the country:

fdic

Factoring in construction and commercial loans you arrive at a stunning 26 percent of all loans in FDIC banks and thrifts.  This is a staggering figure and the U.S. Treasury is well aware of this.  The question isn’t whether there will be major defaults here but who will shoulder the cost?  So far, each consecutive bailout has largely been taken up by the U.S. taxpayer.  The problem of course is the cost of all these bailouts will eventually catch up through a tanking dollar and possibly the long-term viability of our economy.  Plan C is a preemptive bailout on an entire industry.  The reason the government is devising  a plan is that these loans will start going bad in large amounts and they are gearing up on a process of dumping this large mess on the American people.  Yet it is going to be a politically hard sell for many to bailout a strip-mall from some large developer.

And make no mistake, the market for commercial loans is all but closed:

commerial-loans-quarter

You are reading the above graph correctly.  In the 1st quarter commercial loans fell by a stunning 50 percent on a quarterly basis.  And the amount of bad loans is only growing:

quality-of-loans

If you haven’t heard of Plan C you soon will.  The commercial real estate bailout is the next ploy from Wall Street and the U.S. Treasury.

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  1. Robert Thurber said:

    All I have to say is this ‘GREAT government we have (lol) is a f00king joke. Their motto is “Fail to plan or Plan to fail”

    Reality check folks

    July 14th, 2009 at 5:59 am
  2. Stu said:

    This is a wonderfully written article on where we are heading in terms of future debt. If you allow me to indulge myself, I would like to offer up some opinions on some of your comments.

    From your article you said:

    “However this is a disturbing new development in our bailout nation since this is one of the first times that the U.S. Treasury will try to preemptively deal with a financial problem”

    When did the U.S. Treasury get the power to set policy and dictate arrangements? I realize that our U.S. Congress is as dumb as a rock and totally incapable of managing, presiding over, controlling or any other form of being in charge, but they are the governing body… er they used to be any how?

    Your chart showed the following:

    CHART: “2015, 2016 & 2017 show vintage loans from the exact same period that the Subprime implosion was and continuing with Alt-A, Jumbo Prime, and Prime now blowing up” It says “Years 2005, 2006 & 2007 are the vintage dates of the majority of these loans”

    All I can say is WOW!!! We already know from history what we can expect from Subprime residential home loans and starting in 2015 we will be witnessing the equivalent in Subprime commercial building loans implosion which will be much worse than residential in so many ways. For starters can you say jobs…

    The residential home reset schedule takes us through 2015 if I am not mistaken, so we pick up right from there with commercial by your charts and estimates. That places us in a situation far worse than the lost decade of Japan. When we finally clear out the last of the residential housing debt losses (well maybe not in the banks via the Fed unfortunately) in roughly 2014 / 2015, we will be crushed in the next 3 years with unprecedented commercial loan defaults that will make the last 5 or 6 years look like childs play in terms of how to deal with it.

    This quote was quite commical:

    ” “(WaPo) We are continually examining different scenarios going forward; that’s just prudent planning,” Treasury spokesman Andrew Williams said”

    Try something called a balanced budget. I do believe it should be your main charter as an agency. Never allow printing / borrowing without the resources available within the vault. Our vault is empty… GET IT!!!

    This paragraph is stunning:

    “The amount of maturing loans in commercial real estate will double in 2010 and will continue upward into 2010. The chart is very clear and this is only for debt in CMBS and not held by regional banks which is over $2 trillion. This is the next multi-trillion dollar bailout you have yet to hear about. In fact, while many are discussing a second half recovery higher up officials are already planning a bailout for the commercial real estate industry. The challenge with this bailout is you are asking a public with 26,000,000 unemployed and underemployed Americans to shoulder the debt of largely speculative plays. To many it is palatable to bailout the residential real estate market because the public can understand that (even if it may be wrong) or bailing out the 2 large U.S. automakers. Yet bailing out the commercial real estate market is going to be a political nightmare”

    The American public has not come to terms with the reckless spending and mandated social changes to our society because they are not paying for it yet. The average joe doesn’t pay anymore than he used to in taxes or bills towards the payment of this reckless and criminal in my opinion behavior this administration is placing on peoples futures and their childrens futures… NO IDEA!!! Most people don’t pay attention until it affects them, and then they awake. By printing and borrowing money this administration has kept the general public and even the business area as well away from the feeling of the hit they will ultimately take. That is until now…

    People and more importantly small businesses are starting to add it all up. They are not buying the hype any longer and are realizing that they were sold a bill of rotten goods. When the amasses awake it is really tough to place them back into a slumber. A $600 / $1200 check won’t work, and don’t dear try another stimulas if this takes hold. Don’t forget boys 2010 is just around the corner but I digress…

    And finally this:

    “In the 1st quarter commercial loans fell by a stunning 50 percent on a quarterly basis”

    That is a number we will see replicated again and again and yet again I am afraid to report…

    God speed and thanks for sharing!

    July 14th, 2009 at 3:41 pm
  3. 3trillions is nothing said:

    3 trillions here 3 trillions there, that’s nothing we can’t auction.
    Obama have 4 trillions auctioned so far (7/14/2009) in less than 7 months. It only takes a printing press some paper and ink, oh and the ok from Bernanke or whoever owns the FED.

    July 14th, 2009 at 6:53 pm
  4. Stock Forecasting said:

    Thank you so much for such a nice detailed information…

    July 15th, 2009 at 2:04 am
  5. jimbo said:

    With low oil prices, oil companies are not investing in new production. In the meantime, current fields are entering a period of depletion. I personally believe in peak oil but what I just said is from an investment point of view. So whether or not there is/will be geological caused oil shortages, there will be under-investment caused oil shortages.

    July 23rd, 2009 at 7:21 pm
  6. Druff said:

    I believe that last 2 charts are not % changes, but $B changes (see LHS). Thus far we have seen nothing.

    It will get worse, but we have yet to see the real pain yet.

    July 30th, 2009 at 11:17 am
  7. Pissed said:

    Doesnt this pale in comparison to the derivitives problem?

    July 31st, 2009 at 11:38 am
  8. Deak Dementhe said:

    Got Gold???

    August 1st, 2009 at 5:52 am
  9. Joe in JT said:

    I bought my small house for cash. I wait for “deals” on used cars, desperate seller needing cash. I have several cars all paid for. So what’s the problem Pilgram?

    Anyone who takes out second and third mortagages then uses the money for a Carnival Cruise ride deserves to live in a cardboard box.

>

The trillion dollar bailout you didn’t hear about – Commercial real estate values plummet again yet banks hide losses. A $3.5 trillion financial disaster in the making. We are now proud owners of an AMC theater and Chick-fil-A.

The latest data on existing home sales should tell you exactly where we are in this so called recovery.  Average Americans are unable to purchase big ticket items without massive government subsidies.  It is also the case that all the too big to fail banks are standing only because of the generous support of taxpayer money.  Without large tax credits and the Federal Reserve buying down mortgage rates the housing market is extremely weak.  Yet very few of the housing “analysts” actually bother to ask why they are weak in the first place.  The employment market is in disarray and wages have fallen for everyone outside of the top 1 percent of income earners.  The bailout fatigue is running out of steam but banks are using clandestine methods to offload trillions of dollars of commercial real estate to taxpayers.  The next giant bailout is already happening but you probably haven’t heard about it.

Commercial real estate values continue to slide:

cre values

Source:  MIT

For the latest month of data prices fell an additional 4 percent.  Now this is coming at a seasonal time when real estate values usually see price increases.  But people are pulling back and spending less money on discretionary items.  This is happening for a couple of reasons including the fact that wages have been stagnant for over a decade and the underemployment rate is still near peak levels.  Commercial real estate in places like Las Vegas has crashed because who is out buying million dollar condos in this market?  Very few and that is why you are seeing many places having vacancy rates of 50, 60, or even 70 percent.

vacant condos

TALLAHASSEE — Condo bills have flooded the Capitol.

More than five dozen have been filed during the legislative session, as Florida grapples with its real estate crisis. But boil down the language of the proposals to help cash-strapped condo dwellers, and there are only a handful of ideas:

Make it easier for investors to buy multiple units in empty buildings. Delay state-mandated upgrades. Discover ways to punish owners who don’t pay skyrocketing association dues.”

So instead of letting prices correct and allowing markets to set the actual price based on lower incomes, the government and specifically the banking and housing industry are trying to do everything to keep home prices inflated.  Ironically they are using agencies that were intended to help low to moderate income buyers purchase, in essence, affordable housing.   And if the prices don’t stay inflated, they offer big discounts only to their crony friends.  So how exactly is this benefitting the typical American family?

Over a year ago, the U.S. Treasury was secretly discussing “Plan B” about gearing up for a giant commercial real estate bailout.  Not much was said about this in the mainstream media.  Yet now we know that banks specifically the Fed are taking on incredible amounts of CRE loans onto their books.  In other words, the bailout is already happening.  Think this isn’t the case?  We now own a mall out in Oklahoma:

mall

Source:  NPR

“(NPR) As part of the bailouts of AIG and Bear Stearns, the Federal Reserve Bank of New York spent more than $70 billion to buy toxic assets the companies owned. Last week, prompted by a lawsuit filed by Bloomberg News, the Fed finally told the world exactly what it bought.

The Fed now owns loans to Hilton hotels in Hawaii, Puerto Rico, Malaysia and Trinidad. It owns loans to the Miami airport, and the Civic Opera House in Chicago.

It also owned a loan to Crossroads Mall in Oklahoma City. Then, when the owners of the mall couldn’t make the payments, the Fed foreclosed. So now it owns the mall, which includes a Chick-fil-A and an AMC theater.”

How much demand exists for this out in the current market?  There isn’t much if you look at current CRE values.  But prices are continually distorted as more and more money is filtered to the banking sector of the economy.  Keep in mind that many banks have incredible amounts of CRE debt.  As we just saw with existing home sales, without massive tax subsidies the market is still overpriced.  CRE values are coming down to reflect their true values yet the suspension of mark to market and the ability of banks to roll over bad loans keeps price discovery hidden long enough to devise additional ways to push this toxic waste to taxpayers.

The fact that the entire banking system is now held up by taxpayer money, we have in effect nationalized the banking system with no actual benefits of nationalization.  That is, all the profits go to banks while all the losses hit the taxpayer.  This goes for Bank of America, JP Morgan, Wells Fargo, AIG, Goldman Sachs, Fannie Mae, Freddie Mac, FHA, and every other entity that is a ward of the state in one way or another.

Commercial real estate has gotten zero play in the mainstream media even though this is a $3 trillion market.  Does the public drive by an empty condo building or strip mall and think about the larger implications?  Maybe they don’t and that is why the government and banks are working together to slowly work their shadow bailout.

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Ben Cohen

Ben Cohen

Editor of The Daily Banter.com

Posted: November 20, 2008 11:24 AM

The Two Trillion Dollar Bailout You Don’t Know About

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If you thought the $700 billion bailout bill was bad, think again. The Federal Reserve is apparently handing out two trillion dollars in loans to companies and financial institutions effected by the credit crisis — and it won’t disclose where the money is going to.

According to Naomi Klein:

“We don’t really know who they’re handing the money out to, because, apparently, it’s a secret. They could be handing it out to a range of other corporations — I think they are — but they’re saying that they won’t disclose who has received these taxpayer loans, because it could cause a run on the banks, it could cause the market to lose confidence in the institutions that have taken these loans. Once again, that represents an additional $2 trillion.”

What are the implications of these secret loans? Well, more than anything, it is a serious crisis in democracy. The loans do not come from nowhere — they exist in the form of taxpayers money and loans taken out from foreign investors that must be paid back by, you guessed it, the taxpayer. Another huge problem with the massive bailout is that the tax payer is getting literally nothing in return for it. Says Klein:

“These terrible equity deals that are so much worse than what Gordon Brown negotiated in Britain. I mean, let’s remember, Gordon Brown got voting rights at the banks that they bailed out, seats on the boards, 12 percent dividends for US tax — for UK taxpayers, as opposed to the five percent negotiated in the US and no voting rights and no seats on the board. Other thing Gordon Brown did is he got it in writing that the banks had to start lending, as opposed to Henry Paulson, who didn’t get it in writing, and the banks are not lending.”

There aren’t really words to describe how utterly outrageous this is. It is an utter failure of the democratic process and a shocking snap shot of just how corrupt the monetary system is that we live under. The United States is currently over $10 trillion in debt, a level that any other nation would collapse under. But as George Monbiot explains, the U.S. designed global money system is rigged so that it doesn’t matter (for now at least). The consequences of perpetual debt, privatized profits and socialized risk are stark. As Noam Chomsky states:

“The crisis is real, it’s not manufactured. Exactly how serious it is, one doesn’t know. Some of the most credible specialists like Nouriel Rabbini who have a very good record of accurate prediction think it’s an extremely serious crisis and that the system might just freeze up. There is also a good deal of controversy about whether the current proposal will do more than put a band aid on a serious problem.”

Bloomberg News is suing the Federal Government to disclose the collateral being spread in secret, and hopefully some light will be shed on where taxpayers money is going. If the case is rejected, public protest is an absolute must. The Bush Administration is literally looting the taxpayer on its way out, and awareness must be raised to stop it.

Ben Cohen is the Editor of The Daily Banter.com

Follow Ben Cohen on Twitter: www.twitter.com/thedailybanter

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11:57 PM on 11/20/2008

Tell this to everyone you know. Do not let up.

The collapse has not even started to hit main street. And it is going to be worse than anything we have ever seen. Slow Christmas season! What a joke. There are going to be bread lines and homeless, unemployed people all over this country. By this time next year it is going to be a new world in America.

The people of America must understand and be angrier than they’ve ever been at who did this to them.

Bush and the Republican­s that gave him all the power in the world to destroy our country and our future.

07:53 PM on 11/20/2008

It’s more than two trillion. The Fed has handed out two trillion and the Government has authority to back 2.8 trillion more in assets. The U.S. will be bankrupted and Obama is walking right into it. Stimulus programs being touted by left leaning economists will add even more to the debts. Make no mistake this is the product of years of Republican malfeasanc­e but the crunch will be on Obama’s watch. The Wall Street robbery will bleed this Nation to death and Obama will be left holding the bag.

>

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