Commercial Real Estate Feels a Tremor

The first sense we had that there would be real trouble in the housing market was back in 2006 when a friend in the financial business was liquidating some companies with significant holdings in condominiums and housing developments. He was surprised that in a multiple set of geographic regions residential real estate had suddenly gone soft, and whereas deals could have been made easily before, there was a sudden dearth of buyers... at any price north of sixty cents on the dollar.

If you liked the housing bubble bust so far, the commercial real estate market is probably almost as overbuilt and overpriced, but is just starting to show the tremors ahead of the rollover. It might get some momentum as the recession in the US deepens.

You can track the commercial real estate CMBX bond indices here at Markit.

As an alternative viewpoint on the recession in the United States, Mr. Larry Summers thinks the recession won't be deep or prolonged, as stated in The Financial Times today Feb 24:

"The American economic outlook remains highly uncertain. But macro­economic policy is now properly aligned, as the economy will benefit over the next several quarters from fiscal and monetary stimulus. To the extent conditions warrant and inflation risks permit, monetary and fiscal policy are appropriately poised to provide further stimulus.
Policy towards America’s failing housing sector is in a far less satisfactory state. All honest analysts accept that policies adopted so far, such as the “teaser freezer” limits on resetting mortgage interest rates and increased federal support for mortgage lending, have had only a marginal impact on what may be the most serious crisis in housing finance since the Depression.

It appears house prices are down by 5-10 per cent from their peak, with derivatives markets predicting further declines of about 20 per cent. Price falls of this magnitude are likely to mean more than 10m would have negative equity in their homes and more than 2m foreclosures would take place over the next two years."

What struck us most about this was that US Housing market takes a ten percent correction in a generational bull market, and the economists are ready to crank up the New Deal, and start nationalizing banks. Uh, aren't resilient markets supposed to be able to accept the occasional ten percent correction in stride as a normal mechanism in a free market? Or is it that when you have propped, papered, and bubbled a Potemkin economy for so many years, an ordinary correction shakes its flimsy structure to the near limit of collapse?

Or is it that subrprime and CDOs are just the tip of the iceberg, a symptom of a much deeper problem. Perhaps they have taken a look at the dominos a little further downstream like the Credit Default Swaps multi trillion CDS derivatives at a ratio of 40+ to 1 against actual defaults covered, and trembled in despair.

Commercial property values in for steep drop, says loan liquidator
Banks starting to unload distressed real estate loans; some sellers taking 50 cents on the dollar

By Frank Byrt
February 22, 2008

In what may well be a sign of things to come, Mission Capital Advisors said it is accepting bids for a $131.2 million portfolio of non-performing loans secured by commercial mortgages foreclosed on by a Midwestern bank.

David Tobin, a principal at Mission Capital, which manages the sale of troubled mortgage loan portfolios and real estate assets for lenders, said that “with the market conditions as they are, we expect a significant increase in similar offerings throughout the year.”

“The pace of offerings has picked up dramatically over the past year,” which has been one of his firm’s busiest, he added. “We did $5 billion of debt sales last year, all of it seasoned performing, underperforming, or non-performing [loans].”

Mr. Tobin noted that “even the big investment banks are having trouble placing these [types of] loans, so we’re working twice as hard this year.”

More ominously, he predicted commercial property values are heading for a steep fall due to the rising tide of troubled portfolio sales by banks, as they move to get non-performing assets off their books.

It’s tough for banks to determine mark-to-market prices because commercial-loan backed packages being resold right now have to go through a price discovery process, Mr. Tobin said. Packages whose chief underlying assets are residential mortgages are getting bids of about 50 cents to 60 cents on the dollar, down from about 90 cents in late 2006 and early 2007.

The latest package of loans from the Midwestern bank, which Mission is putting up for bid in March, is secured by various commercial and residential real estate in Western Florida, including non-performing loans secured by various types of commercial mortgages and properties. Mission Capital is managing the sale in a sealed bid process, soliciting bids from prospective bidders for the purchase of individual loan pools, any combination of loan pools or the entire portfolio.

With bank lending drying up, commercial borrowers with older loans coming due are now also having trouble lining up refinancing. Some older loans are ending up being sold within the distressed packages. Eventually, Mr. Tobin believes the declines in the commercial real estate market could mimic those being registered in the residential market now.

“The delinquency trend is obviously increasing,” he said. “But when a loan out for 10 years can’t get refinanced, that tells you we’re giving back a lot of the gains of the past several years.”

Monetize the Bad Debt, Let the Public Pay

Let the government buy the bad mortgages. Its too complicated to try and fix it. Just save the homeowners.

As predicted, this is how they are going to wrap this one up for your consumption. Save the homeowners. Bring back The New Deal. Its a complex problem. The solution is so effiiecent and inexpensive compared to the alternatives. Many economists are already flocking to it as a human, practical, and much cheaper solution than allowing any banks to suffer losses.

The problem is that it pegs the financial losses to all holders of US dollars in the most regressive and unjust of all taxes, inflation.

And it fixes nothing, inviting the banks to do it all over again, from the S&L Crisis, to Enron, to IPO bubble, to Subprime and CDO fraud.

This isn't the New Deal. This is the Raw Deal for the public and the Sweetheart Deal for the financial industry.

The only way to resolve this is that any government intervention to resolve this must include:

1. Glass-Steagall restrictions on ALL banks doing business in the US including multinationals.


2. A significant set of Congressional hearings and the appointment of a special prosecutor assigned to investigate, with FBI support, the pervasive frauds in the US financial industry from Enron to Subprime, with special attention to RICO statutes and individuals as well as corporations.


3. A return to the concept of regional and local banks through a reinstatement of laws limiting bank ownership across state lines


4. A national usury ceiling for all interest rates and fees on all debt, both revolving and non-revolving, to prevent banks from perpetuating predatory interest rate schemes based on extending individual state laws.

February 24, 2008
Economic View
NY Times
From the New Deal, a Way Out of a Mess
By ALAN S. BLINDER

THE question of the day seems to be this: Are we in, or heading for, a recession? But so much attention is focused on that question that we may be losing sight of an even greater danger: the possibility that powerful headwinds may prevent a strong recovery from any slowdown.

Most of the potential headwinds stem from the housing slump and related financial crises that began — but, unfortunately, did not end — with the subprime mortgage debacle. Wounded financial markets are supposed to cure themselves: asset prices fall, bargain hunters rush in and markets return to normal. But so far, that doesn't seem to be happening much. Instead, house prices keep dropping, the mortgage-foreclosure problem grows and new strains in the financial system keep popping up like a not-very-funny version of Whack-a-Mole.

While the problems are multifaceted, I have several reasons for focusing on just one aspect of the mess: the potential tsunami of home foreclosures. First, it strikes home, literally. Foreclosures throw families — some of whom were victims of deception — into the streets. They erode home values, damage neighborhoods and reduce the values of other properties, thereby intensifying the decline in housing prices that underlies many of our current problems. And they might even cut into consumer spending, which would really throw us into recession.

A second reason is that reducing the wave of foreclosures would mitigate the closely related financial crises in home mortgages and the alphabet soup of financial creations based on them (M.B.S., S.I.V.'s, C.D.O.'s, etc.). If those markets perked up, other beleaguered credit markets probably would, too.

A third reason for focusing on foreclosures is that we've seen this film before. During the Depression, President Franklin D. Roosevelt and Congress dealt with huge impending foreclosures by creating the Home Owners' Loan Corporation. Now, a small but growing group of academics and public figures, including Senator Christopher J. Dodd, Democrat of Connecticut, is calling for the federal government to bring back something like the HOLC. Count me in.

The HOLC was established in June 1933 to help distressed families avert foreclosures by replacing mortgages that were in or near default with new ones that homeowners could afford. It did so by buying old mortgages from banks — most of which were delighted to trade them in for safe government bonds — and then issuing new loans to homeowners. The HOLC financed itself by borrowing from capital markets and the Treasury.

The scale of the operation was impressive. Within two years, the HOLC received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages. (Adjusting only for population growth, the corresponding mortgage figure today would be almost 2.5 million.) Nearly one of every five mortgages in America became owned by the HOLC. Its total lending over its lifetime amounted to $3.5 billion — a colossal sum equal to 5 percent of a year's gross domestic product at the time. (The corresponding figure today would be about $750 billion.)

As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC's borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944. The HOLC closed its books in 1951, or 15 years after its last 1936 mortgage was paid off, with a small profit. It was a heavy lift, but the incredible HOLC lifted it.

Today's lift would be far lighter. And a good thing, too, because our government is far more timid and divided than Roosevelt's.

Contemporary mortgage finance is also vastly more complex. In the 1930s, banks knew all of their customers, and borrowers knew their banks. Today, most mortgages are securitized and sold to buyers who do not know the original borrowers. Then mortgage pools are sliced, diced and tranched into complex derivative instruments that no one understands — and that are owned by banks and funds all over the world.

But this complexity bolsters the case for government intervention rather than undermining it. After all, how do you renegotiate terms of a mortgage when the borrower and the lender don't even know each other's names? This is one reason so few delinquent mortgage loans have been renegotiated to date.

Details matter, so here are a few: First, any new HOLC should refinance only owner-occupied residences. Speculators can fend for themselves — or go into default. Similarly, second homes or vacation homes should be ineligible, as should very expensive real estate. (Precise limits would vary regionally.)

Third, mortgages obtained via misrepresentation by borrowers should be ineligible for HOLC refinancing, but cases of fraud or deception by the lender should be treated generously. Fourth, as the original HOLC found, not all bad mortgages can be turned into good ones. Where families simply can't afford to be owners, the new HOLC should not be asked to perform mortgage alchemy.

What about the operation's scale? Based on current estimates, such an institution might be asked to consider refinancing one million to two million mortgages — proportionately less than half the job of its predecessor, and maybe less than a quarter. If the average mortgage balance was $200,000, the new HOLC might need to borrow and lend as much as $200 billion to $400 billion. The midpoint, $300 billion, is one-seventh the size of Citigroup and would rank the new institution as the sixth-largest bank in the United States.

Given current low interest rates, a new HOLC could borrow cheaply and should find it easy to earn a two-percentage-point spread between borrowing and lending rates, for a gross profit of maybe $4 billion to $8 billion a year.

What about loan losses? A 10 percent loss rate, or $20 billion to $40 billion, spread over the life of the institution, seems incredibly pessimistic. (The original HOLC experienced a 9.6 percent loss rate during the Depression.) So the new HOLC seems likely to turn a profit, just as the old one did. But even if it loses a few billion, we must remember its public purpose: to help the economy recover, not to make a buck. By comparison, the new economic stimulus package has a price tag of $168 billion.

It is said that history never repeats itself. But sometimes there are sequels. Now is the time to re-establish the Incredible HOLC.

Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians

Saving AMBAC, the Homeowners, or the Banks?

AMBAC had a long term business as insurers for state and municipal government bonds, which is apparently a lucrative and stable business even today. Indeed this is the part of the business Warren Buffett would like to take over. Its also the part of the business that Elliott Spitzer, governor of NY State, characterized as unnecessary extortion.

What IS a problem is that AMBAC and other monolines insured groups of bonds that were NOT local government bonds, but rather were these Collateralized Debt Obligations (CDOs) that were bundles of mortgages that were apparently misrated at high levels like AAA that did not adequately reflect their risk. That risk factor is now coming home to roost with a vengance, as large numbers of mortgagees start to default (estimate is now in the ten percent range). Its a mixed problem of poor credit lending criteria AND falling home values. Why pay a loan on an asset that is now worth much less than what is owed?

In order to get those AAA ratings, the banks contracted with AMBAC to insure them in the event of default, which is happening now. On a default, AMBAC is obliged to pay the principal and interest to the bondholders. What do you think would be happening if the bondholders were you all, the general public?

The government folks do not wish AMBAC to lose their own high credit ratings, because if this happens it will impact the municipal and state bond market negatively. Since most agree that so far defaults in this part of the business are no problem, and the business itself is healthy enough for hard-nosed capitalists like Warren Buffett to covet it and indeed offer to take it as it is, we probably can remove that concern from the table for the time being.

By the way, why don't the States and their associated municipalities just self-insure? Why isn't this covered by something similar to FDIC, but for states? The flaw in the current scheme is obvious. In the event of a black swan failure no small private corporation can possibly cover something as large as a state government in default. Some of the US states are like not-so-small countries. Its insurance that is only good when it isn't needed. Hence the 'extortion' definition by Spitzer.

It seems that the real heart of the problem is that AMBAC was being used as a "cover" by the banks which originated these bundles of mortgages to get their mispriced ratings. Now that the mortgages are failing and the banks are stuck with them, AMBAC cannot possibly pay, they cannot cover the debt. And the banks don't wish to mark these CDOs to market because they are probably at best worth 60 cents on the dollar, but are being held by the banks on balance at roughly par. That's a 40 percent haircut on enough debt to sink every bank involved in this situation (see list below). Indeed for all intents and purposes if marked to market these banks are now insolvent.

So, the banks will provide capital to AMBAC, which they will use to pay the principal and interest on the CDOs which is presumably much less than 40 percent and can be paid out over time BACK TO THE BANKS. Or, the banks can just rip up the insurance and let AMBAC off the hook for a piece of the company.

Does anyone else see the problem with this? What about the failing CDOs that are the core of the problem? Forget the insurance, because unless an uninvolved entity picks up the tab (Joe Q Public and the foreign government Sovereign Wealth Funds, etc.) its just a game of passing money around.

This bad debt will be covered by printing money, period. Its merely a question of who takes the hit for it in wealth erosion, and to what degree.

So why are the banks engaging in this charade? This looks like an attempt to extend the payouts on a vast Ponzi scheme gone bad that is starting to collapse, with no fresh capital being put in by the sucker. The banks have been caught with their pants down, and a UK style bailout such as we saw in Northern Rock is not palatable to the American Public, particularly in an election year. It would also catch the shareholders and management of the banks in a bad way.

And that's the real heart of this. Its to help the owners and shareholders of the banks. Pure and simple. It does not fix the problem. It gives them time to lay off their exposure to 'someone else.' The Treasury and the Fed (they are owned by these same banks as you may recall) support this because it gives them time to try and work out the real fix, by essentially printing money, but at a more gradual rate so as to not break the buck or the bond.

At the end of the day this is a Ponzi scheme that has failed. Our objection to the solutions as proposed is that while it does create a good by not triggering a destructive systemic failure in our financial system, it is being done in very opaque fashion which is permitting the same people who caused the problem to extricate themselves from the negative fallout, and not only shift it to the public, but to further enrich themselves by using their knowledge of the situation to make further profits through speculation in the equity, currency and bonds markets.

And to make matters MUCH worse, there is little doubt that having done this now several times, unless the situation changes the banks will invent a new scheme, and take us back to the same place again. From LTCM, to Enron, to the IPO bubble, to the Housing Bubble. Settlements and wristslaps do not work.

The only way to resolve this is that any government intervention to save 'homeowners' from foreclosure must:

1. Glass-Steagall restrictions on ALL banks doing business in the US including multinationals.


2. A significant set of Congressional hearings and the appointment of a special prosecutor assigned to investigate, with FBI support, the pervasive frauds in the US financial industry from Enron to Subprime.


3. A return to the concept of regional and local banks through a reinstatement of laws limiting bank ownership across state lines


4. A national usury ceiling for all interest rates and fees on all debt, both revolving and non-revolving, to prevent banks from perpetuating predatory interest rate schemes based individual state laws.

And a modest proposal from Bank of America from Tanta at CalculatedRisk: The Bank of America Bailout

"A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates."

And the news item from Marketwatch referenced above:

Banks may recapitalize Ambac to save AAA rating
Capital boost from counterparties may be simpler than splitting bond insurer
By Alistair Barr, MarketWatch
Last update: 6:43 p.m. EST Feb. 22, 2008

SAN FRANCISCO (MarketWatch) -- A group of eight banks that are major counterparties to Ambac Financial Group may recapitalize the struggling bond insurer in a bid to save its crucial AAA rating, two people familiar with the situation said Friday. The negotiations have progressed in recent days, the people said, on condition of anonymity.

The plan could be unveiled Monday or Tuesday, according to one of the people. But the other person said no firm timetable has been set. Both also noted the plan isn't a done deal.

Barclays PLC, BNP Paribas, Citigroup Inc., Royal Bank of Scotland Group, Societe Generale, UBS AG, Wachovia Corp., and Dresdner Bank, are the banks involved in the talks, the two people said. The group recently hired boutique bank Greenhill & Co. to help with the negotiations.

"We have a lot of alternatives. A capital raise has always been an option to stabilize the rating," said Vandana Sharma, a spokeswoman for Ambac in an interview. "We're trying to do the best by all constituents, including policy-holders, shareholders and counterparties." Sharma declined to comment on specific plans.

Bond insurers agree to pay interest and principal on debt in a timely manner in the event of default. The $2.4 trillion business relies on AAA ratings to win new business. But those top ratings are in jeopardy now because of concerns insurers like Ambac and MBIA will have to pay big claims from guarantees they sold on complex mortgage-related securities known as collateralized debt obligations (CDOs).

If the situation gets bad enough, regulators including New York State Insurance Superintendent Eric Dinallo are considering splitting bond insurers in two. That would separate their steady muni bond businesses from the more troubled structured finance units, which are being pummeled by CDO exposures.

Indeed, FGIC, a big rival of Ambac and MBIA, submitted a plan with some of those attributes last week. However, splitting up bond insurers would be difficult, pitting policyholders against shareholders of the bond insurer holding companies. "The lawyers have already begun gearing up on that one," said Josh Rosner, a managing director at research firm Graham Fisher & Co.

Injecting capital

So Dinallo and others have also been working on other solutions that focus on attracting more capital into the industry. As part of that strategy, the New York regulator has been trying to persuade big banks that are counterparties to the industry to help boost bond insurers' capital.

Many banks have tried to hedge CDO exposures by buying guarantees from bond insurers in the form of credit default swaps (CDS), a type of derivative. If lots of bond insurers are downgraded or if some collapse, these banks may suffer more write-downs because these CDS contracts will be worth less. See full story.

One proposal involves banks injecting roughly $5 billion of capital into specific bond insurers and also providing a $10 billion line of credit.

Another idea involves commuting, or effectively tearing up, CDS contracts between banks and bond insurers. In return for dropping their claims, the banks would get a preferred equity stake in the bond insurer.

"Putting capital into an insurer is more of a contract issue between the companies involved, rather than a regulatory issue," said James Gkonos, vice chairman of the Insurance Practice Group at law firm Saul Ewing. "That would be the simplest and most efficient way to do this."

A forced splitting up of a bond insurer by a regulator such as the New York State Insurance Department would be an "extreme scenario" that would involve public hearings and litigation and take a long time to complete, he explained.

Still, any re-capitalization of Ambac by bank counterparties would present its own problems too, because it could dilute existing investors in the company.

Such a plan would also use up capital that banks may need to help them through other problems thrown up by the global credit crunch.

"Sometimes there are problems that just can't be solved," Rosner said. "At some point, the market is going to realize that there is not always a best solution. There is often just a least worse solution."

Alistair Barr is a reporter for MarketWatch in San Francisco.

Are Commodities in a Bubble?

Are the commodity markets in a pricing bubble? Many people's judgement tells them that they are, as they look at the short term price movements of certain commodities like gold, wheat, copper.

Granted, they might think that the weak dollar is just making the problem a little worse with a monetary inflation if they are multidisciplinary thinkers. But as you probably know by now, we think that judgement is good, as long as it is informed by solid data. Let's take a look at a few of the commodity charts. As always, you may click on any of the pictures or charts to see a larger version.

Sure looks like an impressive growth in price, and a potential bubble. How much of that might be attributed to the fact that the CRB is priced in dollars?














Here is the CRB Index deflated by Euros. That casts a little bit different light on things. It looks as though commodities are rebounding from a low period and going back to retest some prior highs. Historically, just how high WERE those highs?

Here is a long term chart of the CRB Index deflated by Euros. With this perspective it seems clear that the prior high was just a test of the upper bound of a longer term trendline that shows a gradual rise in the price of commodities that clearly is NOT a bubble. Just looking at this chart, we must conclude that the trend will continue, which implies higher priced commodities in terms of the dollar, until it is broken.