Commercial Sector At High Risk

Posted by urbandigs

Thu Jul 31st, 2008 02:15 PM

A: The natural evolution of this credit cycle would be to assume a few things. One, that what started out as subprime will soon spread to near prime and prime; this is already happening. Two, that what started out in residential will soon spread to commercial; the topic of this discussion. And three, that the credit cycle is coming in waves. Looking at the CMBX indices, it appears that investor sentiment on the commercial sector and subsequent commercial mortgage backed securities, is deteriorating quickly. It appears the next wave, whenever that may be, will be related to the commercial real estate sector.

First off, all of MARKIT's CMBX spreads have widened dramatically in the past 6 weeks. Take a look at the CMBX-NA-AAA index for a basic idea of the widening spreads (NOTE: A rising line graph is negative and is a sign of deteriorating investor sentiment for commercial mortgage backed securities):


Up is down. Click the link above and you can check in on all the classes of CMBX indexes that Markit offers; lower quality indexes show an even more dramatic deterioration. This is one reason why Lehman Brother's health is being questioned; as they have significant exposure to commercial real estate, mainly the buyout of Archstone-Smith for $22.2 Bln, near the peak of the housing boom.

CORRECTION (Aug 6th @ 11:42AM): Archstone Smith is residential firm. It was NOT this purchase that gave LEH their commercial exposure. LEH does have commercial exposure, but not from this transaction. This was simply an ill-timed transaction that contributed to the company's overall exposure to the housing market.

Calculated Risk pointed out 7 weeks ago:

This deal was announced in May 2007, but wasn't closed until October - after the credit crisis started. I bet Lehman and their partners wish they had paid the $1.5 billion break up fee! The Archstone-Smith acquisition was a negative cash flow deal from the start. To cover the interest on the $16 billion in debt financing, there was a $500 million interest reserve created.

This suggests that Archstone is burning through the interest reserve very quickly. Not mentioned in the WSJ article was that Fannie Mae and Freddie Mac acquired a total of $9 billion of the $16 billion in debt. Something to remember if this deal really goes south.
The problem here is very similar to when the Markit ABX indices started to shit the bed exactly one year ago! Last July, most people didn't have a clue of the severity of problems those cliff-diving ABX indexes were trying to tell us! Here, I'll remind you; In my July 2007 post, "Macro Check: Rates Holding" I stated:
While it's not making the major headlines as it did a weeks ago, the subprime mess that led to a disruption in the MBS (mortgage backed securities) markets is not going away. This is leading to a level of uncertainty that the tradable markets hate most! It is leading to a rise in safe haven plays, like gold and other commodites, and is still yet to reveal itself on just how bad the problem is.

Barry Ritholtz over at The Big Picture has a great post on this topic titled, "WTF is going on in the ABX markets":

"Its one thing when we see that the BBB bonds -- the junkiest sub-prime crap in the Residential Mortgage Backed Securities (RMBS) universe -- getting shellacked due to foreclosures."

"But today, we see that the AA and even the AAA are getting whacked. It looks like either a fund is getting liquidated across all asset qualities -- or someone is panicking."

The ABX index measures the risk of owning bonds backed by home-loans to people with poor credit. Just take a look at some of the charts he posts to get an idea of the sharp moves in these markets. Crazy.
Now the CMBX indexes are starting to really go off. If recent history is any guide, we will start to see big time rising defaults in the commercial sector. CR is all over this dynamic with 483 mentions to the coming CRE Bust which he states is now here! I have to give credit where its due.

banks-cmbs-holdings.jpgLooking ahead, FinancialWeek had an article last month about the I-Banks exposures to deteriorating commercial mortgage backed securities and guess the two firms that topped the list? BEAR STEARNS & LEHMAN BROTHERS! According to the story:
According to Fitch data, Lehman had $36 billion in commercial mortgage-backed securities in trading assets and commercial real estate loans held for sale, or 140% of tangible capital, as of the end of 2007. That was about equal to Bear Stearns' exposure of 143%, but once again much higher than Morgan Stanley's 44%, Goldman Sachs' 55% or Merrill Lynch's 80%.

Here too, Lehman has reduced its exposure to less than $30 billion, but the stress in the commercial real estate market is only beginning, and more is clearly on the way.
As you can see via the above-right chart, Lehman is right up there in the exposure to commercial real estate. The stock price (NYSE: LEH), currently down 6.75%, seems to show the 'no tolerance' trader mentality to over-exposed I-banks in this current environment. The bad news is, this has to happen as the cycle continues! The good news is, this has to happen for the cycle to end!

Jobless Claims Surge: EUC Program is Blamed

Posted by urbandigs

Thu Jul 31st, 2008 10:46 AM

A: Sorry for the lack of content lately, I'm just burnt out and trying to take some time off. Anyway, I wanted to just discuss today's data for a moment. First off, GDP came in below expectations but it was the negative revisions to 4Q 2007 that grabbed the headline. This could mean that the recession started at the end of 2007, but we won't get any official declaration until we are either nearing the end of the slowdown or out of it. More importantly, was the surge in jobless claims. There was an anomaly at work here called the Emergency Unemployment Compensation (EUC) program, so I want to just discuss this briefly so we can keep things real.

Now, readers of UD know of my beliefs in flawed government statistics. I mean, between the birth/death adjustment, the use of core instead of headline, and the seasonal component it is very hard to get a grip on what is really going on out there.

But when a headline shows a surge of 44,000 jobless claims to 448,000, we should read the fine print a bit. This time around, the Emergency Unemployment Compensation (EUC) program is being blamed for the surge (below via

Q: What is the federal Emergency Unemployment Compensation (EUC) Program (also known as the Extended Benefits Program)?
A: EUC is a federally-funded program which provides up to 13 weeks of extended unemployment insurance benefits in all states to unemployed individuals who have already collected all regular state benefits or have expired benefit claims and meet the federal eligibility guidelines.

Q: When does the Emergency Unemployment Compensation program begin and end?
A: The program began July 6, 2008 and expires on March 31, 2009.

According to Reuters:

The number of first-time claims filed in the week ending July 26 rose by 44,000 to 448,000, the highest level since April 2003.

The Labor Department said much of this increase is due to an indirect response to the 2008 Emergency Unemployment Compensation (EUC) program. The federally-backed extension provides additional unemployment benefits for up to 13 weeks for people who have already exhausted their regular unemployment benefits.

Labor said that many people contacted about the program actually qualified for regular unemployment insurance instead of the extension under the EUC program, since they had since worked enough to qualify for a regular claim. As a result, initial weekly claims rose.

'It is expected that claims will be higher than anticipated for several weeks as a result of this effect, but should decrease as the states work through the pool of claimants from the 'reachback' period of EUC,' Labor said.
From my other sources (which will remain anonymous), I get this section of a report regarding the EUC program's affect on jobless claims:
Several states have indicated that they are experiencing increases in initial claims as an indirect result of the EUC program. this is because a number of individuals who had exhausted benefits previously (as early as 2006) and were notified of their potential eligibility for EUC qualified instead for a new regular UI claims.

States were required to notify individuals who had previously exhausted their UI benefits that they might be eligible for EUC. Before an individual can qualify for EUC, the state must verify that s/he is not eligible for regular UI benefits. Some claimants who worked temporarily or part-time following establishment of their previous claim might have earned enough to qualify for a new regular UI claim. in that case, they must be placed into the regular UI program (with a new benefit year) as opposed to EUC. These claims would be correctly reported as new initial claims in the regular program.
This should help explain the surge, and explain why the next few reports are likely to be a bit artificially high as well. However, the number of people continuing to receive unemployment insurance is up 185,000; so that is certainly a weak spot. Continuing claims for the week totaled 3.282M, the highest since DEC of 2003.

All in all, we continue to see a weak jobs market and negative revisions to GDP. No matter how you slice it, we are in a slowdown. Call it what you want, things are just soft. Given the phenomenon of credit deflation, housing pressure, weak jobs market, and pesky commodity prices, the consumer will continue to be pressured. The story continues.

Deleverage Chapter 5: Price Discovery Continues

Posted by urbandigs

Mon Jul 28th, 2008 06:42 PM

A: And the story goes on. Fresh back from the real estate conference, I come back to more deleveraging and more capital raising, which leads to ding ding ding ding guessed it ---> more price discovery! And you are the winner of a brand new WRITE-DOWN!!!

This is how the cycle goes. A frozen secondary mortgage market leads to forced sales of assets that would not otherwise be sold. As firms stack their toxic holdings into the imaginary accounting blanket of Level 3 assets (which I told you back in NOVEMBER of 2007 would become a household phrase), some firm has to ruin the party and forcibly sell their bad holdings for a bad price in the bad open market that is not really very open anymore. And then, have the audacity to sell more shares and dilute current shareholder value. How dare they! And now, we get a fresh new glimpse at the price that the frozen marketplace will currently pay for assets that I both don't want to own or sell. Sweet, thanks, great job Merrill Lynch. Now I need to MARK DOWN my bad assets to the low level that you just sold them at! Damn bastards.

Okay, Noah, get out of the first person.

Here is the news out of Bloomberg's, "Merrill Has $5.7 Billion of Writedowns, Sells Shares", which probably explains why the stock was down some 11% BEFORE the news was announced, (you shady shady marketplace, you):

Merrill Lynch & Co. said it will record $5.7 billion of pretax writedowns in the third quarter because of additional losses on the sale of collateralized debt obligations and hedging contracts with bond-insurers including XL Capital Assurance.

The New York-based firm said today in a statement that it plans to raise $8.5 billion by selling shares in a public offering. Thain has had to raise capital to stave off credit- ratings downgrades and satisfy regulators that the firm can withstand losses.
Calculated Risk wisely adds on:
Here is the info on the CDO sale: On July 28, 2008, Merrill Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds for a purchase price of $6.7 billion. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion, and in connection with this sale Merrill Lynch will record a write-down of $4.4 billion pre-tax in the third quarter of 2008.

Merrill Lynch will provide financing to the purchaser for approximately 75% of the purchase price
So, lets do the math:

VALUED AT $11.1 Bln and SOLD for $6.7Bln = a 40% markdown

Did I interpret this correctly? Please feel free to correct me if I'm wrong. As these 'super senior ABS CDOs' start forcibly trading, it will result in price discovery of a marketplace that is very illiquid at the moment, and give insight into the latest valuations placed on these hard to sell assets! And, MER will finance 75% of the purchase price? So, lets see here, lend to the buyer of your own distressed asset? Oh yea, I like this.

Expect more deleveraging, write-downs, and unwinding in our near future. The cycle continues, and this is NOT news. As prices are discovered, bad marks will spread to outside held illiquid holdings. Anyone shocked by this news, is behind the curve. The story will continue. The good news? This has to happen to get past it.

Inman BULL vs BEAR Debate

Posted by urbandigs

Sun Jul 27th, 2008 11:59 AM

A: As usual, the Inman Real Estate Connect conference was lively, entertaining, educational, and filled with young entrepreneurs showing off their advancing applications. It was great to see old friends again, and a pleasure to speak on the 2nd Bull vs Bear debate. I don't have video of the debate, yet, so I'll try to muster up some damaged brain cells (thank you Red Bull & Grey Goose for that) and point out some of the topics discussed. Overall, it was still biased towards the bearish side, however, not as bearish as January's panel. In other words, less bearish with glimpses of hope seem to pop up.

John Williams - Definitely the most bearish on the panel, discussed the concept of dollar destruction and hyper inflation. His serious tone clearly was interpreted by me that he is a true believer in government bent statistics on inflation and unemployment, and that the worst is yet to come. If the US dollar really does go to 'zero', and hyper inflation sets in, we may be in store for Zimbabwe style currency notes.

I disagree with the total dollar destruction and hyper inflation, mainly because I do not see wage inflation and rather, we are experiencing the side effects of commodity inflation (food & energy inflation) that arises when a central banks' primary focus is on reviving economic growth at the mercy of the local currency. The best medicine for high commodity prices IS high commodity prices that cause demand destruction and eventually a speculative trading reversal. In my humble opinion and as I stated many months ago, our dollar will get a boost as foreign CB's are forced to eventually lower rates to combat their own slowdowns right at the time our CB will shift their rate actions towards inflation fighting.

Yves Smith - Bearish, yet a realist. We have debt problems, trade deficit issues, state budget issues, etc., and Yves takes all this into account. The current account deficit seemed to be her main concern as fears arise that foreigners may slow down purchases of our debt, sending treasury yields surging. This is definitely a possibility although we need to see the AAA credit worthiness of our government be called into question, and further dollar erosion for this to become more likely. I don't remember the other topics Yves talked about, so I need to get the video of the debate to refresh my memory.

Bill from Calculated Risk
- Fantastic on the panel and very down to earth. While he is putting the bottom of the housing downturn around 2010 - 2011, and recovery a few years later, he openly admitted his 'less bearish' stance on housing. In his words, "...there is a time element here. If you asked me in 2005 how bearish I was, I would have said much more bearish than I am today". Clearly Bill feels that we have experienced a good portion of the pain thus far, but likely to feel a bit more before its over. The contrarian in him seemed to come out as I got a sense that he is of the mindset that deals are to be had in the coming year or so, and investors' money is already being put to work buying distressed/foreclosed properties that are finally now CASH FLOW POSITIVE!

That is a very important element to clearing up inventory levels; a dynamic that must happen if we are to see a bottom. The following days existing home sales report confirmed what Bill mentioned, as it was revealed that a staggering 30% of all existing home sales were foreclosure purchases. Clearly, investors are finding value in homes priced at 40-50 cents on the dollar! I would be too!

Think about it this way, to pick the exact bottom you MUST buy while the asset is down & out, distressed, and the seller's fear/nervousness is still high. Only in hindsight will we see the bottom, which according to some law of physics, will mean you missed it!

Avram Goldman - This CEO of 12+ PAC Union GMAC realty offices was definitely the most bullish of the bunch. He is looking ahead to brighter times and seemed to believe that his markets have already bottomed, are seeing a reduction in inventory levels, and a pickup in sales volume. Certainly comforting statements.

I did question his rear-view mirror approach though about mid way through the panel, saying something to the extent that we still have a contracting credit system and rising unemployment that will put future pressure on housing affordability; thus we need to look ahead rather than behind us. I don't recall his response or if the moderator changed topics right after that. All in all, I thought Avram was a great addition to the panel and brought a more realtor/front line perspective to a heavily weighted economics led panel base.

Dottie Herman
- I got the impression that Dottie was a bit more bearish than she was last January, but in true fashion, the most composed of the bunch in terms of the worst being behind us. She did discuss the problem of credit, but addressed the pass down of wealth from parents and grandparents as a saving grace to contracting loan availability and tighter lending standards that we are dealing with now.

I sense that Dottie sees some issues still on the horizon, but that with problems comes opportunity.

Noah Rosenblatt - Yours truly. I tried to spice it up a bit and fight with my fellow panelists to get a lively debate going. I recall questioning with Avram on looking ahead rather than behind us at lagging statistics, and I disagreed with John Williams hyper inflation statement. Yes, I see inflation out there, but it's commodity inflation coming at the same time as housing and credit DEFLATION! The amount of credit destruction is astonishing and the shadow banking system has seen hundreds of billions of dollars destroyed by deflating toxic assets, that are consistently being written down to lower values.

I mostly discussed the issues I see ahead of us as a crisis of confidence in our banking system and GSE's (a mention to the potential problem of raising money could be devastating), continued pressure on jobs, the credit markets, and wages; all which affect affordability of a home purchase. Combine that with surging commodity prices, and the consumer is tapped out. I just think that these forces will take longer to play out, thats all.

My one bright spot, was the possibility of rising sales volume resulting in a stabilization or even reduction of inventory levels in our near future (a must for any recovery in housing), as potentially easing the credit markets! This didn't happen yet, but certainly is a possibility as house prices fall further and investors' eyes for cash flow positive properties light up. I agree fully with Bill on that dynamic.

But all in all, I think we still have pipeline pressure in housing reports amidst rising defaults and foreclosures. We still need to get these distressed transactions through the system and into the reports, which means we have more downside pressure to go through. As the cycle continues, I get more excited and less bearish.

I put my expectations on a mid-late 2009 bottom (not proven until 2010) and the potential beginning of a recovery in house prices on a national level to 2011. However, the recovery will not be a new bubble as over-regulation kicks in and housing as an asset class in general is looked upon quite differently.

Hopefully the video will be made available soon, so we can see the depth of the topics I discussed here. For now, this is what I remember. I thought the panel was great, although it went on some doomsday tangents a few times in terms of our deficit and our weak currency.

Did You Know...?

Posted by urbandigs

Mon Jul 21st, 2008 11:19 AM

A: Heading to Inman Conference in SF tomorrow, so I will not be blogging for the next 4 days. For today, as I go over my bullet points for the BULL vs BEAR debate, I figured to post a 'Did You Know' article that goes over some of the things that most people probably didn't know. Enjoy and as always, your two cents and any corrections are appreciated.

1) $450,000,000,000 - The approximate amount of write-downs to date from the financial sector stemming from the subprime crisis and housing market downturn

2) $325,000,000,000 - The approximate amount of capital raising to date in the financial sector

3) $9,500,000,000,000 - The approximate amount of the National Debt (source)

4) $5,600,000,000,000 - The approximate amount of total residential loans that Fannie Mae & Freddie Mac either own or guarantee (source)

5) $900,000,000,000 - The approximate value of the Fed's portfolio

6) $450,000,000,000 - The approximate amount that the Fed used of its total portfolio to help ease distress in the credit markets

7) $985,000,000,000 - The approximate amount of US agency debt held by foreigners; mainly China, Russia, and the oil countries (source)

8) $230,000,000,000 - The approximate amount of Fannie & Freddie debt purchased by foreigners in the past year

9) $710,000,000,000 - The approximate amount of the global US current account deficit last year; or 5% of US GDP (source)

10) $1,000,000,000,000 - The approximate amount of foreign money the US must import each year to support the current account deficit

11) $14,300,000,000,000 - US GDP (source)

12) $411,000,000,000 - The increase in the amount of foreign-owned assets here in the US, in the 1Q of 2008 alone, following an increase of $380.4 Bln in the fourth quarter (source)

13) Between $1,000,000,000,000 - $2,000,000,000,000 - The implied total credit losses predicted by Professor Nouriel Roubini (source)

14) $1,300,000,000,000 - The entire capital of the US financial system; as stated by Professor Nouriel Roubini (source)

15) $53,000,000,000 - The approximate total amount of funds held by the FDIC (source)

Needless to say, the topic of foreigners continuing to purchase our debt is becoming a media favorite! Feel free to offer your thoughts, opinions, corrections, updates, additional sources, or anything else to get a better hold on some of the astronomical numbers we are talking about here!

2008 Word of the Year: CRECESSION?

Posted by urbandigs

Fri Jul 18th, 2008 03:08 PM

A: How great would it be to coin a new term for how I would describe this period of economic activity: CRECESSION! Its not a recession (yet), its not a depression, its not stagflation (as long as wages aren't rising we have commodity inflation, not wage inflation or a growth in the money supply), its CREDIT DEFLATION that will lead to a credit based recession! A crecession - here's my first draft at a possible definition!

Cre - cess - ion [cre-session]
- nouncrecession.jpg

a period of economic activity where available credit is contracting and the cost of credit is rising, leading to a disruption in the credit markets and difficulties for businesses that borrow short and lend long. The result will likely be a period of asset deflation leading to a lack of growth, rising unemployment, and rising commodity inflation due to pressure on the dollar

{Origin: 2008; by UrbanDigs}

Now, who do I call to coin this term; given that the definition probably needs refining? Seriously though, we are a society that thrives on credit and right now it is the very platform of credit that is being tested. The destruction of credit out there in the shadow banking system is enormous right now, and we still don't know how deep the rabbit hole goes. Things will change and the world as we used to know it is likely to be very different in the next few years. We will soon find out what its like to have lived through a crecession!

Don't Look Now: Financials Leading The Rally

Posted by urbandigs

Fri Jul 18th, 2008 09:39 AM

A: Oh what a difference a few days make! On Monday, with the Dow closing under 10,000 and what seemed like 6-7 weeks of constant selling, everyone I know in the hedge fund world and the credit world started to get a bit nervous! The VIX fear index rose to above 30, representing a great buying opportunity for those that are willing to take the risk and buy when most smaller investors are 'throwing in the towel'. I discussed the trading theory tied to the VIX seven days ago, as it reached the level where I normally would cover my shorts and start to get long beaten down equities. It is comforting to see the rally in the banks, as earnings estimates were taken down too low and stocks in big cap financials are seeing a short squeeze & value investors buying in on better than expected earnings reports. Will it last? Unlikely, unless housing turns around, defaults stop spreading to higher quality debt classes, and toxic assets get a bid and trade again at more favorable valuations; and I just don't see this happening.

Disclosure: This is a discussion, not investment advice! Readers of this site have learned that content I write sometimes has a trader feel to it; because that is what I am and that is how I view the markets. I am currently fully long equities and disclosed to you guys a week ago that I covered my shorts and started to get long about 2-3 weeks ago; building up the long position as stocks continued to fall. Turns out I covered shorts about 10 days early and should have waited for the VIX to hit 28 to start to flip the position.

Now that the disclosure is out of the way, I feel like I can openly talk about what I see going on here. I see another fierce bear market rally, as the financials lead the way. It is SO IMPORTANT that it be the banks and financials that lead the way in any rally; and it seems like they are doing so right now. However, and its a big however, I urge you to understand that this is a trading market right now, and in no way, shape or form has the dreary fundamentals changed in the past two days.

Why am I long? Because its a trade, thats why. I don't intend to hold these positions for that long, and my focus is still on the short side and when the next entry point for that play may be. The reason for this logic is that the forces that are taking control of the credit markets continue to be negative: housing is still under pressure, defaults are rising, foreclosures are rising, defaults are spreading to higher quality debt classes and fast, the jobs market is very weak, the securitization model on wall street is all but dead, more write downs of toxic assets as price discovery reveals most recent valuations, capital raising will continue and get harder at the same time, deleveraging continues, credit deflation, commodity inflation, etc..

None of this has changed, and we did get some confirmation of this in the past few days or so:

1. MERRILL is forced to sell core businesses to raise capital
2. MERRILL write down far exceeds estimates and gets a lowered credit rating
3. JP MORGAN CHASE admits that defaults in PRIME are rising fast
4. FANNIE & FREDDIE still in trouble and will have to raise capital; FREDDIE leaning towards stock sale
5. HOUSING STARTS continue to fall
6. HELOC credit lines are being cut off, as defaults are rising
7. BUILDER CONFIDENCE continues to decline

So, we really need to look at what is going on with an open mind; credit/housing deflation. We did get some good earnings reports from Wells, JP Morgan & Citibank; but this came on the verge of lowered estimates and beaten down stock prices. And the drop in the price of oil is helping too. But when I see the CEO of JP Morgan come out and say (via,

"Our expectation is for the economic environment to continue to be weak – and to likely get weaker – and for the capital markets to remain under stress," CEO Dimon said in a press statement.

In a surprisingly short conference call with analysts, Dimon suggested that losses in JP Morgan’s prime mortgage book could triple in the foreseeable future as the credit mess moves out of subprime and into Alt-A and jumbo loans. "Prime looks terrible," he told analysts on the call. "And we’re sorry, and there’s nothing else we can say."
...I take notice. Take a look at this chart showing the rise of delinquency trends for JP Morgans Prime Mortgage portfolio, via


Nothing goes in a straight line forever, and this rally is likely nothing more then an oversold bounce in a bear market. I think it will surprise most how long this rally lasts, if the financials continue to squeeze the shorts and drive higher. But it does not change the overall macro picture and I urge you to be wary of the false hope that a significant stock rally may produce.

The monoline problem is behind us and it seems most of the residual write downs from that event have been taken. So we must look forward again and now it is all about one thing: the spread of defaults to higher quality debt classes!

I have discussed this at length plenty in the past 12 months, and I'm afraid the next 12 months will show just how deep the problem has spread to. The amount of leveraged loans and debt out there in the near prime & prime category far exceeds those in the subprime arena. So, we must question the value of securitized assets held on the books of the financials should the problems spread to these higher quality debt classes.

In the end, we need housing to show signs of stabilizing and defaults to stop spreading to higher quality debt classes before we can declare ourselves in the clear. Problem areas seem to be HELOC's, option ARMS, credit cards, cosi/cofi loans, other negative amortizing loans, auto loans, etc..

Inman Real Estate Connect SF

Posted by urbandigs

Thu Jul 17th, 2008 08:47 AM

A: Inman Real Estate Connect conference is back in San Francisco July 23rd - July 25th. The event takes place at The Palace Hotel on 2 New Montgomery Street. Continuing on with the success of January's heated housing debate, which was picked up by CNN Money, I assisted in putting together a great panel to have the second BULL vs BEAR economics debate, with some of the great minds out there. I hope you can register and make it to the conference and this panel.

The last BULL vs BEAR debate, held in January, turned out to be a very timely discussion of the severity of the credit crisis, housing downturn, monoline bond insurers, toxic bank balance sheets, and psychology of investors during asset cycles. It was a lively discussion that got picked up by CNBC and this CNN Money article titled, "Housing: No room for bulls":

"We're facing the worst housing recession in U.S. history," according to Nouriel Roubini, an economics professor at New York University and co-founder of RGE Monitor, an economic research and analysis firm. He predicted peak-to-bottom national home price losses of 30 percent. The housing turndown, according to Roubini, was the initial trigger for a broad economic decline. "We're in an economy-wide recession already, one that will be much more severe than those of 1991 or 2001," he said.

Another bear on the panel was Barry Ritholtz, chief executive of market-watcher Ritholtz Research. He placed the real estate slump in the framework of Elisabeth Kübler-Ross' five stages of grief: anger, denial, bargaining, depression and acceptance.

Ritholtz said we've just about worked through the denial stage, which was exemplified by the National Association of Realtors first saying there was no housing slump, then that it would be contained (the soft landing scenario), and then that it would be limited to housing.

Now, said Ritholtz, "We're in the bargaining stage," where he said we'll promise to never speculate on real estate again if God will only let us sell our properties now. Next will come depression and finally acceptance. "That," said Ritholtz, "is when you should start to buy again."

The third bear was Noah Rosenblatt, founder of, a blog that covers macro-economic trends and their impact on New York real estate. He not only predicted a strong recession but said he's looking forward to it.

"If you're a value guy, are you buying now? No," he said. "It would be like catching a falling knife. It's a credit crisis and we're going to see a lot worse before it gets better." For Rosenblatt, a recession would clear out all the bad loans and foreclosure problems, and then the market could return to normal.
It was an awesome discussion to say the least!

Meet Me at Connect SF 2008Here is the info for next weeks conference:

Wednesday, July 23rd, 4:00 p.m. – 4:45 p.m.
The Housing Debate: Bull vs. Bear
Where are we in this housing cycle? Has recovery started or is it just beginning to show signs? Is there hope for an uptick by the end of the year? Join a lively debate between housing bulls and bears who present differing views of housing's future.

Noah Rosenblatt, Founder,
Bill of Calculated Risk (CR), Real Estate Analyst, Calculated Risk
Yves Smith, Author,
Avram Goldman, President & CEO, Pacific Union GMAC Real Estate
John Williams, Economist,
Dottie Herman, President & CEO, Prudential Douglas Elliman

I have not met any of my fellow panelists in person, but I have been in contact with Yves Smith via email a few times and have had some great conversations with Bill from Calculated Risk both via phone and email over the past year or so. Needless to say, Calculated Risk & NakedCapitalism are two very well respected and highly trafficked blogs that cover the housing markets, credit crisis, and the state of the economy in depth. Both have proven to be timely and savvy in predicting the current credit crisis and the severity of the situation that has been denied over and over again by corporate CEO's and passing economists. Time has proven both these site's to be an enormous benefit to readers. Now you can see us all in action at the conference.

Contributing to this talent, it looks like John Williams of and Dottie Herman were late additions to the panel! The debate should be heated, lively, and discuss housing/general economy/credit crisis and where we believe we are in the current cycle.

I greatly look forward to meeting these pioneers in person and participating in what will definitely be a great discussion! Hope you can make it!!

Manhattan Inventory Holding Steady

Posted by urbandigs

Wed Jul 16th, 2008 10:04 AM

A: Looking at the real time inventory charts for Manhattan, its clear that we are stabilizing around the 7,500 mark or so. This is to be expected for the summertime. Manhattan summers are usually slow, and see many listings come off the market and fewer listings come onto the market. This could explain the drop over the past 4 weeks. However, I must say that JUNE & JULY have been active months for me and when I talk to colleagues, these two months have been more active for them as well. So, I would expect this activity to contribute to slightly declining inventory for the next few months.

It's hard to generalize on the entire Manhattan real estate market because I only see my own business trends. As far as that is concerned, I have bids coming into my sales listings after reducing the price enough to stimulate interest. As I said before, this is a market of proper pricing! For those out there trying to test the market because your apartment is worth more than everyone else's, well, you face the risk of a longer time on market and having your listing go stale. You will notice over time that bids are coming in at low levels, because buyers are pricing in what they consider to be a safe bid.

Here is the chart of Manhattan real estate inventory over the past 6 months:


For a quick fix, lets take a look at the handy DATASET tool that I had installed under the charts so that we can see the percentage change of certain categories of data here in Manhattan:


You can see that although inventory levels are up 51% over the past six months, we have dropped about 3% over the past four weeks and the rate of acceleration of inventory has dropped significantly over the past three months. What does this mean?

It means we had a very sluggish start to 2008 in terms of sales volume and inventory rose as a result. The slowdown in the rate of acceleration could be due to the seasonal effect of our local market (as summertime is generally slow and many listings do come off the market), or a pickup in sales volume over the past 4-8 weeks. The CONTRACTS SIGNED data does not show this as being the case, as the weekly average for this dataset is showing a drop in activity; however, this category is way more exposed to anomalies than inventory data is because of the fact that many agents do not update their web pages once a contract is signed in the hopes of getting future calls from potential buyer clients. The data is only as good as the agent that both enters it and updates it!

Never forget that! Since Manhattan has no standardized MLS system, we use what we have at our disposal to try to make this market a bit more transparent. I'm trying my best here guys and it takes a lot of time to do all this. So far, I am very happy with the accuracy of inventory data, new listings and price reductions data. I think the contracts signed dataset will be more useful once we have 12+ months of data stored.

As of right now, it really is a market that separates the serious buyers from those that are wishful thinkers. As prices get reduced and buyers pick up on the desperation level of any one particular seller in their price point, serious buyers are bidding cautiously but wisely and finding value. At the same time, there is a subset of buyers out there that are throwing out bids some 30%-50% below current asking prices, thinking this market is like Miami. They find out quickly that sell side desperation is no where near what it is in some seriously distressed markets outside NYC. There is nothing wrong with trying, but reality will set in for those that throw in super low-ball bids for multiple properties, that they are not getting the response they wish for.

As for inventory, anyone expecting levels to surge will be disappointed. I expect inventory to hang around these levels for another few months, with no big moves coming until the end of 2008. Let's see how it ultimately plays out.

Ackman on Saving The GSE's & Us

Posted by urbandigs

Tue Jul 15th, 2008 08:59 AM

A: Short-seller Bill Ackman was on CNBC this morning with his plan to save the GSE's, whose leverage comes in at a stunning 129:1; doh. The jist of it goes against the recent plan by Paulson to buy equity in the GSE's or extend a line of credit and rather, brings Fannie & Freddie equity to zero. As he puts it, its "...a way for these institutions to be re-capitalized without the government writing a check!"

Disclosure: Ackman is SHORT the junior debt & equity of FNM & FRE

The PLAN: First off, Ackman says the plan announced by Paulson is NOT a bail out plan and rather, is Paulson building up the troops to potentially take action later on; which he ultimately disagrees with. He says that the balance sheets should be 'fortress balance sheets' as their core earnings power allows them to 'earn their way through this mess'.ackman-plan.jpg

Ackman proposes that Fannie can raise about $86 billion in capital by giving investors in $750 billion of senior unsecured notes 90 cents on the dollar in debt of a new company, with the balance in equity. The senior unsecured debt holders around the world will basically become the owners of this new company; with 99% of the equity going to these owners.

Subordinate debt holders would would be exchanged with warrants. The government would then put in place a "stand-by purchase commitment" for the new common stock for three years. Common equity shareholders will get wiped out as the stocks will ultimately go to zero. Ultimately Ackman believes the government will "...never write a check", and that he would " a buyer of Fannie Mae" under this plan.



Quite intriguing. Ackman has a very smooth way about him and certainly the plan sounds logical, but I am in no position to criticize or applaud this plan because I just don't know enough about restructuring debt or the GSE's balance sheets. What you should know is that Ackman has been talking to Senators, fed officials, and senior officials at the Treasury about this plan.

In this plan, Ackman stands to benefit as his shorts on the common equity would fully pay off. Why not remove the conflict of interest? Well, according to Ackman, "...I need good shorts to offset my longs". Works for me!!

Thoughts on this?

What Could Possibly Go Right?

Posted by jeff

Mon Jul 14th, 2008 11:02 AM

A buddy of mine who is an institutional stock broker e-mailed me yesterday that he hadn't shaved and he was so bearish he was sick of hearing himself talk about the stock market. He felt the same two months ago when I told him I was looking to buy stocks and he was right as were several of my other bearish Wall Street bretheren.

So I must confess to poor timing for the piece I wrote a couple of months ago called "Introducing the Less Worse Bull Market". At the time the stock market was poised just below the 200 day moving average, corporate bond spreads and the ABX indexes were was Spring. I was surprised that the market had not gotten hit harder during the Bear Stearns crisis and had merely retested it's prior low. I introduced the concept of a stock market that could start to do better on bad news becoming less bad than the general outlook had become. By that time the disaster scenarios that were being crafted on investment web site regarding the ultimate credit losses in this cycle had gotten absurd. I did note that the "Less Wrose" bull market might not happen until one more test of nerves had taken place - but I am not ready to say that it has taken place yet. As I admitted my timing in introducing a more positive scenario was pretty bad, the stock market started to tank within a week of my original piece as oil went ballistic. Here we are again with credit spreads blowing out, the market breaking having gotten shellacked and doom and gloom pervading. But let's back up for just a minute and get some perspective.

Last Spring a wrote a piece called Black Monday 20 Years Later, the gist of which was, things are too good, there are lots of risks percolating around (increased interest rates, a weak dollar, corporate profit growth slowing, inflation threatening) and people are engaging in top making kinds of transactions and behaviors. At that time few were worried.

Over the following weeks and months Noah and I wrote pieces that brought up the risks of commodity price inflation, the many unforeseen tentacles of the housing crisis/credit debacle, the bubbles in stock and property markets in India, Spain, China and the UK, the likely State budget shortfalls to be reckoned with and even the risk of policy changes by a new president. Today the sum of all these fears is being manifested "on the tape" that's trader speak for "The news is out in the headlines and therefore it is far too late to trade on it". Remember the Wall Street adage buy the rumor, sell the news, or in this case sell the fears that the Utopian bull market could end and buy when everyone knows about all the horrible problems we face.

So what could possibly be the bull case for the economy and markets?

First a couple of assertions, which you may or may not agree with, but I believe to be axiomatic. You cannot have a wage price spiral form when people are being thrown out of work. You will experience a decline in consumer spending as consumers are thrown out of work. You will experience a decline in fuel usage as prices rise.


The Chinese, Indians and other fast growth Asian economies have begun to cut fuel subsidies.

Growth rates in India and China are expected to slow markedly and stock market bubbles have popped.

Eurozone growth is slowing and while it will take longer for inflation to slow there due to their socialist ways and slower losses of employment, they will not need to hike rates much further.

The housing market is getting down to a base level of activity supported by only those who really need more space and have the money to afford it. The likelihood that demand will plummet from here is low and new supply continues to be slashed. Eventually inventory will start to be worked down.

Subprime debt defaults are not as bad as people are modeling, nor as bad as the "mark to markets".

Bank loan losses are well below where they were in the early 1990s, when there weren't just risks of bank failures but actual bank failures. Mark to markets will prove to have been overly pessimistic before any major banks fails....the government may actually get involved in monitoring bank cash flows and adjusted capital bases as opposed to marked to market capital bases, before huge fund raising are required.

My Bull Case:

World growth is slowing and will take the edge off the commodity driven inflation picture. The consumer will get weaker and unemployment will rise which will be a good thing, as those with jobs start to save more and the fed is able to hold rates steady or cut, rather than raise them. Note that this recession has begun with the slowest loss of jobs that has been seen in several cycles, my belief is that it's because the housing related jobs were already lost and many other jobs are sustainable without a major growth in the economy as very few domestic jobs were added by companies since 2000 and those that were added are fairly critical. The dollar will gain strength again as a safe haven as other countries start to get worried about their own economies and bubbles. The loss of housing buyers and increase in sellers that result from the US recession will pale in comparison to the decline in home buying interest and increase in home selling that has already happened and the housing market will enter a long period of sleep, but won't implode from here.

This could all be complete poyannish thinking and we are headed into a long and painful recession with inflation that will be the ultimate payback of all our profligacy and immorality. However, it didn't happen in 1987, it didn't happen in 1990, it didn't happen in 1998 and it didn't happen in 2000 and each time you could have made a dire case for markets and the economy. I remember a famous stock market strategist coming to my office talking to us about the huge threat of suitcase bombs and the apocalyptic outlook for the country and markets after 9/11.

I am not recommending that anyone invest money based on what I am saying. But as a long-term investor I learned through several cycles that when its really hard to imagine a horrific fall in the market, you should be exploring what events could cause one, and when you can't imagine how things could ever get better, you should start formulating what a bull case could look like.

Spreads Tighten On Treasury/Fed Moves

Posted by urbandigs

Mon Jul 14th, 2008 09:31 AM

A: Noah back here. The discussion that I linked out to on Sunday intrigued me because of the reference to the spread between FNMA paper and 5 Year Treasury yields. This spread is an indication of risk and health in the debt markets. Historically, the spread is about 50 bps, but when the markets get ancy and nervous, it widens. With Freddie's $3Bln auction set for today, it does matter how the debt markets receive it! Lets take a look at what happened to this spread now that the Treasury & Fed announced their moves to back Fannie & Freddie.

From Sunday's link out, I added this chart which shows you the 101 bps spread between FNMA 5 YR paper and 5 YR Treasury Yields BEFORE the announcement from the Treasury & Fed:


Now, take a look at this same spread as of 9:20 AM this morning AFTER the announcement from the Treasury & Fed:


The spread has tightened some 23 basis points already. Clearly a sign of easing distress. However, is this going to last or is it just another band-aid on a gunshot wound? The discount window being open to the GSE's doesn't mean they will tap this source of lending. It is just there. As I said yesterday when the actions were announced:

The actions here are directly focused on restoring investor confidence, and I think both the debt markets and the equity markets will react favorably tomorrow. If it does, stock markets will rally back as financials get a bid, and the spread between FNMA and US treasury (101 bps) that I just discussed earlier today would tighten.
Now, lets see if this lasts or is just delaying the inevitable for a later time.

Treasury Extends Credit To GSE's; Discount Window Open

Posted by urbandigs

Sun Jul 13th, 2008 06:06 PM

A: Treasury Secretary Paulson's statement issued minutes ago. In addition, the NY Fed has officially confirmed access to the discount window for Freddie & Fannie. Equity futures for tomorrow's open rally with DOW up 89, S&P up 12.60 as of 6:24PM.

Full text via Bloomberg:

Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.fannie-mae-freddie-mac.jpg

GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards.

I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.
Freddie has a planned $3Bln auction set for tomorrow, and if that went badly it would have seriously disrupted the credit markets causing who knows how much pain. Clearly, something had to be done. The actions here are directly focused on restoring investor confidence, and I think both the debt markets and the equity markets will react favorably tomorrow. If it does, stock markets will rally back as financials get a bid, and the spread between FNMA and US treasury (101 bps) that I just discussed earlier today would tighten. Let's see how the markets react tomorrow.

The news about access to the discount window was the rumor that led to a brief rally on Friday; which fizzled out as the fed declined to comment on the rumor. According to the
The Fed's Board of Governors met Sunday in Washington and voted to grant the New York Fed authority to lend to Fannie Mae and Freddie Mac "should such lending prove necessary," the central bank said in a statement. The move would effectively give the two companies access to the Fed's discount window if necessary, providing a backstop in case the firms were to face a short-term funding crisis down the road.

The Sunday move was in part designed to head off fears about Monday's auction of Freddie Mac notes, which while small, had assumed an outsized importance as a test of investor confidence. Freddie should be able to find buyers for its three- and six-month notes, market analysts said, but there is a chance that some financial institutions and investors may demand to be paid higher-then-usual yields on the notes.
The moral hazard argument will be revived again around the blogosphere. The real question has to be, is this just another temporary fix that is only delaying the inevitable collapse of these enterprises? Time will tell.

Sunday's MUST Read

Posted by urbandigs

Sun Jul 13th, 2008 09:25 AM

Call today a lone linkfest! I did not write this piece, and rather I have links below to the original writer and the site that linked to it. They key point I got from this discussion was the spread between FNMA paper and US Treasuries; so I added a visual in the middle of the article to explain this very important indicator of the debt markets.

Found on: Precious Metals forum of

Found via: Words of Wall Street

Ok, PLEASE take 5 minutes and read this discussion on how our system works and what the current situation regarding Freddie & Fannie means along with potential options that our government has. I am still digesting this but one of the key components that stuck out in my mind is the reference to Fannie Mae paper and the trading spread over treasuries as an indication of risk. The comment was:

"HERE'S THE TEST the GSE's have to pass. As long as they can continue to issue debt on a timely basis and in the amount that is required to fund their business at a REASONABLE INTEREST RATE SPREAD over treasuries, then things will be okay (no matter what the financial media says). If they can't, then the sh#t will truly hit the fan. Here's an example of what I'm talking about. Let's say that 5 year FNMA paper historically has traded at 50 basis points over 5 year treasuries. If that spread blows out to 150 -200+ basis points because the bond market vigilantes no longer trust the implied government guarantee that historically has supported it, then the game is over. The government will then have to step in."
The Article: Please pay attention. This might be the most important post you read for a while (even though it does not involve energy directly).

The level of understanding about how our capital markets work in this country (including these talking heads on CNBC and in the media) is pathetically inadequate. For those here, I'm going to try and correct that. The basis of my understanding of this subject did not come from a book. It came from working at Salomon Brothers during the 1970's (a firm - now part of Citibank - that dominated the taxable fixed income markets during that period). I started out as a money market and government securities salesman. My next to last job there (before I left to start my own firm) was as their global money market and government securities sales manager. As a result, I think I know what I'm talking about.

Following the concept of KISS (keep it simple, stupid), I'm going to try and walk you thru what exactly is going on right now as it pertains to Freddie Mac and Fannie Mae. I'm going to go slowly and keep it as simple as I can (at the possible cost of exact technical correctness). Hopefully I will be able to tie everything together at the end in a way that makes this complicated financial situation understandable.

(1) What role does the Treasury Department play? - It is the role of the Treasury to make sure that the U.S. government has enough money to fund the obligations of the U.S. government. Whether the government is running a fiscal surplus or deficit, it is their responsibility to determine how much money should be raised and when. It is also their responsibility to determine what the maturities of this debt should be. The amount of each offering is set by the amount of debt maturing (thus requiring refinancing) as well as any additional debt that may be needed above and beyond that (i.e. to fund that year's deficit). If you check, this is done thru weekly Treasury Bill auctions, quarterly refundings and other periodic treasury auctions such as the monthly two year note. These auctions are not conducted by Treasury. They are conducted by the Federal Reserve Bank of New York thru their network of recognized government securities dealers. The important thing to note here - these Treasury financings have absolutely no impact on the money supply. They simply determine how much Treasury debt is outstanding (i.e. the national debt).

(2) What role does the Federal Reserve play? Besides facilitating the Treasury's effort to fund the operations of the government, the FED is charged (along with many other things) with determining how much money is in the system. So how does the FED expand or contract the money stock? SIT DOWN AND PAY ATTENTION. All they have to do to create more money is to buy a Treasury bill, note, or bond from one of the recognized government securities dealers (i.e. $1MM treasury security goes to FED, $1MM is released into the system as payment). IT IS JUST THAT SIMPLE. It is from this money stock creation/contraction (that can be raised or lowered at will by the FED simply by buying or selling treasury or GSE agency securities), that then gets circulated throughout the financial system, that is the starting block for determining such things as M1, M2, and M3. POINT TO REMEMBER - only the FED can monetize debt and THIS IS HOW THEY DO IT.

(3) With (2) above in mind, The FED right now has a portfolio of around $800B (my numbers are probably off, but the magnitude isn't). That means that they have created $800B of "money" (which gets multiplied many times over as it winds its way thru the banking system thru the mechanism of bank deposits and bank loans (less reserve requirements)). Up until the Bear Stearns bailout, all of this $800B of "money" was backed by a portfolio of U.S. Treasury and Agency securities. With all of these "clever" new financing vehicles that were created by the FED to bailout Bear Stearns and to keep the IB's and money center banks afloat, roughly half of this $800B AAA+ portfolio has been loaned out thru the Discount Window in exchange for toxic waste garbage (sub prime MBS, etc.). [It should be noted here that the FED does not own this garbage. It is simply financing it for the street since no one else will. The hope is that they will be able to get their original securities back (and get the garbage off their books) when the credit markets normalize.]

(4) What role does FNM and FRE play? - These two GSE's [government sponsored entities] are the only reason that we have a functioning 30 year fixed rate mortgage market. Reason? As government sponsored enterprises, they have long enjoyed a competitive advantage in terms of how they can fund themselves. They have historically paid only a slight premium over the level of treasury (i.e. risk free) interest rates (for any given maturity) for their money. As a result, they have been in a much better position than any private sector mortgage provider to be able to "lend long" and "borrow short". It should also be noted that FRE/FNM are the bedrock of the secondary mortgage market in the country (since they own roughly half the residential mortgages in the country and process many others in one way or another). I haven't looked in a long time, but it is my guess that the average duration of FRE and FNM's 5T of debt is under 3 years (REMEMBER THIS POINT).

So let me cut to the chase and try to tie all of the above together as it pertains to the current crisis that FNM and FRE and the FED and the Treasury now face and what options the government really has at its disposal to attempt to solve this problem..

So as we sit back this weekend and try to figure out what the government's options are in regards to Fannie Mae and Freddie Mac, let's look at some of the options being proposed by some of these financial, talking head bozos on CNBC and elsewhere:

(1) Open the Discount Window - This ranks as the dumbest idea ever. Why? Simple. The FED's balance sheet is only $800B. Half of that has already been exchanged for toxic waste to keep Wall Street afloat. They are probably going to need the other half when Lehman Brothers or someone else starts to seriously sink (which will most certainly happen). In addition, how is opening the discount window going to solve the GSE's problem of rolling over their $5+ TRILLION in debt when it matures? Keep in mind that this massive debt also has a very short duration. The ONLY way the FED could do this would be to MONETIZE whatever the $ amount the GSE's came to the discount window for by going into the market and buying massive amounts of treasury securities. We're talking potentially TRILLIONS here since this action (i.e. the GSE's going to the discount window) would in all probability shut them out from issuing any additional debt into the debt markets at anything close to a reasonable spread to treasuries.

LESSON LEARNED - No way is the FED going to open the discount window to the GSE's.

(2) Nothing changes - business as usual. According to Paulson, the government has no current plans to "takeover" the GSE's. They're just going to monitor the situation closely. This might work. It might not. HERE'S THE TEST the GSE's have to pass. As long as they can continue to issue debt on a timely basis and in the amount that is required to fund their business at a REASONABLE INTEREST RATE SPREAD over treasuries, then things will be okay (no matter what the financial media says). If they can't, then the sh#t will truly hit the fan. Here's an example of what I'm talking about. Let's say that 5 year FNMA paper historically has traded at 50 basis points over 5 year treasuries. If that spread blows out to 150 -200+ basis points because the bond market vigilantes no longer trust the implied government guarantee that historically has supported it, then the game is over. The government will then have to step in.

MY ADD-ON ---> To visualize this, I went to the Vanguard Bond Yields page and superimposed a chart of US Treasury's onto a chart of US Government Agency yields, to see what the spread is between 5 YR FNMA paper and 5 YR Treasury yields; as you can see, it is about 101 basis points (4.30% - 3.29% = 1.01% spread or 101 basis points):


(3) The government steps in - The options here are numerous.

(A) The government puts an explicit government guarantee on all of the GSE's outstanding debt. The benefit to this is that it will insure that the GSE's can continue to fund themselves in the debt market (which is ABSOLUTELY crucial). The downside is that it will officially add this debt to our national debt. [The national debt is currently nearly 10 trillion$. Adding the GSE debt instantly increases the national debt by 50%.]

(B) Congress authorizes the Treasury to raise $100B (for example) in additional debt and to invest those funds into the GSE's (in some form or fashion, you're guess is as good as mine). The good news is that this will preclude all of the GSE's debt from landing on the national debt. The bad news is how big are the real losses that the GSE's will face going forward? Will this $ amount (whatever it is) be enough? Will they still be able to fund themselves at a reasonable spread over treasuries?

(C) Some sort of convoluted public/private bailout scheme that might be attempted by the government in order to save face. This could come in many forms, and I'm not smart enough to figure out which ones (if any) might make sense.

The bottom line to all of this is that whatever happens in regards to FRE/FNM, it won't be a quick easy fix. The problems the government now faces in this regard makes the Bear Stearns bailout look like a walk in the park.

In conclusion, I saw something like this coming. That is why I'm so heavily overweight in gold stocks (38% of my portfolio). Having said that, I never dreamed that the GSE's fall from grace would either be as swift or as stunningly complete as it has turned out to be. We could very easily be looking at a "Black Monday" market situation if the government doesn't get its act together quickly.

JMO. I hope this helps others here understand exactly what is going on in terms of the GSE's.


IndyMac: 2nd Largest US Financial Firm To Fail

Posted by urbandigs

Sat Jul 12th, 2008 05:25 PM

A: Well, here we go again. In a crisis of confidence, we just experienced another 'run' on a bank as IndyMac was shut down by the FDIC, and assets seized. With IMB stock trading at $0.28 at the close on Friday and the company's credit rating cut by S&P this past Wednesday to just a few levels above default, this news is not as shocking as one may think. However, the media distribution of this news will not help consumers confidence in our banks and this can not possibly come at a worse time. The last thing we need right now, is a deepening crisis of confidence sparking additional 'runs' on banks just as Fannie & Freddie face the music. It's going to be a wild week.

The news via Bloomberg:

IndyMac Bancorp Inc. became the second- biggest federally insured financial company to be seized by U.S. regulators after a run by depositors left the California mortgage lender short on cash. "This institution failed due to a liquidity crisis," OTS Director John Reich said in the statement.

The Federal Deposit Insurance Corp. will run a successor institution, IndyMac Federal Bank FSB, starting next week, the Office of Thrift Supervision said in an e-mail yesterday. The Pasadena, California-based lender specialized in so-called Alt-A mortgages, which didn't require borrowers to provide documentation on their incomes. The demise adds to the crisis caused by the subprime collapse and may mean regulators will have to raise more money to support the federal deposit insurance program that repays customers when a bank fails.
Some are blaming remarks by Schumer as causing the 'run' on IndyMac, leading to the liquidity crisis. I do not think this is fair blame. IndyMac's executives, loose lending standards, and toxic assets are to blame for the mess that they are in, NOT someone acknowledging the distressed condition of the company.

The question is, with this cockroach squashed how many more are hiding behind the walls? Its fairly clear, that 2008 & 2009 will see more bank failures and chances are rising that the names of the institutions that fail, are well known ones.

Below is a pic of a woman taking out funds from an IndyMac ATM machine, with a nearby corporate advertisement stating, "YOU CAN COUNT ON US"; how ironic!


IndyMac's total assets as of the end of March was $32.01 Billion. They had $11.9 Billion in loans held, and $184 Billion in loans serviced. The FDIC is now in control of the assets and customers with individual accounts exceeding the $100,000 guaranteed limit will have a very rude awakening; the FDIC has stated that it will pay 50% of any amount that is not insured. As Mish points out:
Anyone over the FDIC limit at IndyMac can kiss it goodbye. There has been ample warning. Alt-A loans (AKA Liar Loans) and ridiculous lending policies did this company in.

We are very close to the point where any bank can fail at any time. If you are over the FDIC limit at Wachovia or Washington Mutual (or for that matter anywhere), do something about it immediately if not sooner.
Photo via OC Register

Vix Hits $28 - Fear Level Rising

Posted by urbandigs

Fri Jul 11th, 2008 11:35 AM

A: I don't want to cut and paste all of the doomy credit news as of this past week, as I'm sure most readers of this blog are aware of them; Freddie & Fannie to be nationalized, Lehman worries, Foreclosures, WaMu's ALT-A problems, Wachovia's problems, and on and on and on. After twelve months or so of discussing this credit crisis in depth, I have to say, I'm getting tired of it. Not because I want it to go away, I do, but because its emotionally draining discussing the problems that our financial system is facing right now. Looking away doesn't help, and keeping your head in the sand is a side effect of the powerful force of denial. With stocks getting wrecked, main street is seeing first hand how bad it hurts. Which brings us to what could ultimately prove to be one positive thing, the rising VIX!

It's not that rising fear is a good thing, it's that rising fear usually means the selloff is nearing its end. I mentioned the VIX a number of times on this site as an indicator of fear, and a signal to traders as to when MAY be a good time to cover your shorts and open new long positions. The theory goes, buy when the VIX rises and fear is high and sell when the VIX is low and complacency sets in. It works because generally speaking, fear is high when markets are in turmoil and getting hit; at the same time the vix is low when complacency sets in and euphoria/stocks is high. So, you are buying low when stocks are out of favor and selling high when stocks are flying. When a capitulation occurs, that is a fierce selloff where many investors 'throw in the towel', that is usually when the best money making trades are available. The problem is finding the exact bottom which nobody knows.

When I see the VIX above 28 or so, that is when I like to start methodically covering my shorts and begin opening some new long positions for an eventual bounce. It takes discipline to trade this way, and I must admit, I lacked some discipline in the past few weeks and didn't follow my own advice this time around; I covered my shorts when the VIX hit 25, about 15 days too early and got caught with my longs in this extended downrun. Oh well, live and learn. If I did what I usually do, I would be covering shorts now, and start to get long around here.

Here is the VIX as it just passed through 28, indicating a rising level of fear:


As I see it over the past 2 months, here is the performance of the major indices:

DOW ---> Down about 2,000 points or 15%
S&P ---> Down about 190 points or 13%
NASDAQ ---> Down about 280 points or 11%

Ugly. However, recall all the analysts that told us to buy at much higher levels because all the talk of the credit crisis is clearly not hurting stocks and therefore the recession is expected to be short & shallow. Well, that didn't work out too well. I'm not here to tell you to go out and buy stocks, I will never give you advice like that here. But I do want to point out that the markets are a discounting mechanism and are in the process of pricing in the hit to corporate earnings that is to come, in addition to the uncertainty caused by the ongoing credit crisis, problems with the GSE's and financials, high oil prices, asset/credit/housing deflation at the same time as commodity inflation, and so on. It really is a perfect storm.

The only positive I can say comes from the trader in me. With the VIX above 28 and rising, and fear levels high, we may be close to a short term bottom in stocks assuming an event does not occur. By the way, I would certainly consider the nationalization of Freddie & Fannie an event. Let's see if the trading theory tied to the VIX works out over the next month or so, or if the fear level leads to another crisis of confidence causing another shock to our system.

Harlem Real(i)ty Check: Still Hot, But Less So

Posted by jeff

Fri Jul 11th, 2008 09:08 AM

Last summer I wrote a piece called "Why Harlem is Hot Hot Hot" which cataloged the significant demographic and psychographic changes taking place in Harlem and mapped out the many planned condo developments uptown. At the time I opined that "the Harlem Renaissance is for real, it's here to stay and things will only get better from here. While in a downturn Harlem like other "growth" areas, could get hit hard."

I followed up with a piece in the spring called Real(i)ty Check - Harlem", in which I checked in with a number of brokers to see how the spring selling season had kicked off and what the prospects were for the absorption of all those new condo units. In the piece I noted that I had written previously on Urban Digs that "I am bearish on the boroughs and Harlem in the intermediate term, due to new supply trends and my feeling that improving Manhattan values will keep more people in midtown and downtown. I also feel that certain markets like Harlem and Long Island City will offer great long-term appreciation potential to those who take advantage of the expected price correction." But I concluded the piece by noting that "My take on Harlem is that so far it is holding up better than I expected considering deliveries from the pipeline of 1,345 condo units from 2007 and some portion of the 1,506 units that were started in 2006. It speaks to Harlem's attractiveness as an up and coming neighborhood."

So where is the Harlem market today? In a lot of ways, the fundamental underpinnings of the Harlem Renaissance continue. Retail and shopping opportunities are improving. In particular, the eventual opening of East River Plaza, which now finally looks on track for September 2009, is expected to be a boon to East Harlem, which has lagged behind central and West Harlem in gentrification. The new Target is seen as a central attraction and becoming a selling point with brokers, but Best Buy, Marshalls and Home Depot (or Costco) will also be important additions to the neighborhood. The luxury Dancy Power Automotive Group car dealership, opening in the ground floor of The Lenox Condominium at West 129th Street, is another example of what is possible in the new Harlem. And according to New York Real Estate blog Curbed,Starwood Hotels recently confirmed the development of an Aloft Hotel is a go at 2296-2308 Frederick Douglass Boulevard, with a targeted opening date of June 2010. Note as a counterpoint, however, there is strong community resentment to local businesses getting priced out of Harlem and there is a risk to Harlem losing some of its historic and cultural appeal if some protections are not instituted, Last month's upzoning/rezoning of the 125th Street corridor provides both risk and opportunity for the neighborhood, as noted recently in the New York Times.

However, recent media coverage of the Harlem condo market confirms my initial supposition that the absorption of new condo units could be problematic. According to a recent CNBC article, the developer of the The Fitzgerald, a condo renovation project at 257 West 117th, is offering below market mortgages to buyers of the property condos. Certainly this is a sign of a developer straining to boost the velocity of sell outs in a building. In the case of The Bridges condo in East Harlem, the developer caved on trying to sell the 18 condo units, deciding to reposition the property as a rental building. According to a recent article in The Real Deal, which examined data from Street Easy on price adjustments of new condo developments, "Upper Manhattan fared the worst in terms of the number of price reductions with 75, compared to only 14 increases. Harlem had 52 price decreases and six price increases." The article goes on to note:

"People who wanted to be on the Upper West Side were getting priced out and went farther north," said Sofia Kim, vice president of research at StreetEasy. So developers started building aggressively to meet demand. At the same time, current market conditions are putting pressure on prices in fringe outlying neighborhoods including Harlem.
The slowdown and softening in the market is evidenced in a recent article in Crain's stating that "the average price of a Harlem apartment fell 2% during the second quarter from the year-ago period to $652,000 while the number of units sold plunged 49% to 158," according to data collected and compiled by Corcoran and Property Shark.

I checked in with a couple of brokers on the ground in Harlem and got the normal optimistic feedback about the long-term prospects for the market, but I also got some straight talk about current market conditions, for which I thank them. According to Willie Kathryn Suggs of the eponymous residential brokerage firm, "We are in the summer doldrums, but make no mistake market activity is down significantly year to year. Showings are down 50% and inquiries are way down. There is no fluff left in the market, the buyers who are out looking are not here to drink Starbucks and window shop, they want and need to buy and they aren't fooling around. We still have a few sellers who are being unrealistic, but they are starting to see that buyers are driving the process." Suggs specializes in townhouses and avers that prices are holding in this market, the highest sale price recently was $2.89 million. There are several brownstones listed at $4 million she thinks will have a hard time selling, but she sees a bunch selling in the mid 2s this year and one or more for over $3 million. The real trouble is at the low-end where mortgage availability becomes an issue and FICO scores rule, the subprime option is gone and even those with decent credit have to clean it up to pristine levels to get loans. Suggs has been avoiding showing much in the way of new construction condos due to some issues with quality she has seen.

I was able to grab a still busy Shimon Shkury (I consider him Mr. Harlem on the development and investment property sales end), who said, "The market is softening, but not as much as one would think. This is because product uptown is very cost competitive with the rest of Manhattan. We don't do residential sales but we monitor it closely and condos in the $450 to $700k range are selling, even above these levels, we see $1MM product selling on 114th on the West side and 113th on the East. Larger apartments at higher prices are slowing. There is no new construction so you can expect that the product available will be absorbed without much new competition." This lack of future competition is key as Shimon also noted that there is a low inventory of development sites for sale. He says "Owners have no debt and have sat on these properties for years so they don't have to sell until the market is better. Most of the sales we are making are to business owners and users and the occasional long-term bullish developer and in many cases we are getting the prices a condo developer would be paying. The opportunity in Harlem today is to understand pricing in the next 5 years, not in the next 2 years." Shimon believes as I do that some of these user/buyers will eventually develop these sites or sell to developers and make a nice return. In terms of the rental market, Shimon noted that rents have gone up, but oil and taxes are up too and this has held back income growth. Still he says multifamily is still the investment class du jour and values are still up.

Urban Digs says....Harlem is still coming on strong in a long-term sense. While some condo softness has arrived, as expected, it may have something to do with individual projects and quality issues, so be careful if you are looking at one of these bargains. Long-term, land values in Harlem will be going up and will move the market along with them, especially in light of the significant drop off in development activity.

From the Blogosphere:

1595 Lexington Avenue - High Design Coming Uptown, East Harlem

Harlem Resisting Displacement

The Bridges Goes Rental

Preparing For Price Reports w/out New Devs

Posted by urbandigs

Wed Jul 9th, 2008 10:35 AM

A: Three months ago I discussed why 2008 will not show any significant price drops here in Manhattan. The reason lies in the collection of pricing data at closing, not contract signing, and how a market with plenty of new developments in general works. In short, as contracts were signed in 2007 for buildings that were in construction or conversion, it is only now that these deals are being closed and counted in the price data. This 'lagging effect' often misleads us to believe that the current market is similar to the one when the contracts were originally signed. So, I want to discuss the likely reversal of Manhattan price data as high end buildings and expensive new developments are no longer there to upwardly skew the data. Expect to see ugly year-over-year comparisons and average price drops starting in 2-3 quarters; I would say starting as early as 4Q 2008, but more likely around 1Q 2009!

Manhattan, the creme-de-la-creme of local real estate markets, was never totally immune to market forces; its a market like any other and market forces do work here. While this market has its protections and unique mix of buy side demand, recessions do occur here. Nobody likes to talk about it though for fear of scaring buyers away. It's funny how its OK to discuss a bullish marketplace, with tight inventory, bidding wars, and rising price data; because everybody likes the boom times and the favorable press! But switch that around and discuss the threats to this marketplace or what is likely to occur down the road, and you earn the title of Dr. Doom! Nobody likes a downer. Some will even blame you for having an agenda to bring down the market so that prices get cheaper; love that one as I did get a few of those emails over the past 8-10 months. I have to laugh.

Anyway, as with all datasets, there are anomalies. Over at, Peter Comitini publishes the Corcoran 2Q Manhattan report where CEO Pam Liebman states:

"New development closings typically lag behind the market by one-to-two years and are therefore a poor barometer of what happens when a seller lists the home she has lived in for ten years on today’s market. Moreover, brand new, highly-amenitized luxury properties are much more likely to sell at a higher price point than the average property competing on the open market. In this report, therefore, we examine re-sales in isolation while our colleagues at Corcoran Sunshine analyze new development property sales."
Its a good idea to separate the two sectors and even in doing so, the report looks bullish excluding the decline in Q2 sales activity that is significantly below previous Q2 activity! But I wonder how it will look when 4Q 2008 and 1Q 2009 is released and compared to the past year. Here is why.

As new developments and condo conversions started to close, the prices paid at contract signing started to get counted into the data reports. Sales of two buildings in particular, 15 CPW & The Plaza, really skewed the data to the upside. While it was fine to see Manhattan average prices rise 17% due to closings at these high end buildings, it certainly won't be fine when reality takes OUT this temporary anomaly and prices show a drop of 15%! This of course did not happen yet, but it will as the quarter with the upside (4Q of 2007) is compared with the future quarter that doesn't include these high end sales anymore.

As with the seasonal component for BLS inflation data, new developments and condo conversions have skewed the price data significantly HIGHER! I urge you to watch out for this concept: WHAT GOES IN WILL EVENTUALLY COME OUT!

What I mean is, as 15 CPW, The Plaza, and hundreds of more expensive new developments close (units sold for $1,400+/sft skew median prices higher) and get counted in the pricing data released to us, when this wave is over, we will see a correction! What went in, will ultimately come out! Now, human nature is likely to mis-interpret this as a free-fall in Manhattan real estate when the data catches up. Most data is analyzed year over year, comparing say 4Q 2007 to what 4Q of 2008 brings to see the difference in price, sales volume, time on market, and inventory. The year over year data that is coming will show data WITHOUT closings from these high end new developments and condo conversions.

Take this NY Times article that came out January 3rd, 2008, and described the 4th Quarter of Manhattan real estate in 2007, "Apartment Prices in Manhattan Defy National Real Estate Slide":
The average price for an apartment reached $1.4 million in the last quarter of 2007, up 17.6% from the fourth quarter of 2006, according to data tracked by the brokerage firm Prudential Douglas Elliman.

The number of apartments that sold for more than $10 million tripled in the past year, according to data tracked by two other brokerages, Brown Harris Stevens and Halstead Property. Many of these deals were at 15 Central Park West and at the Plaza, two buildings in which 94 of the 1,342 condos sold in Manhattan in the fourth quarter are located.

Gregory J. Heym, an economist who prepared the reports for Halstead and Brown Harris Stevens, said that sales at those two buildings helped drive up average condo prices by $500,000
Now, the article does discuss the impact of high end sales on this data, but the point is the headline and the whopping 17.6% GAIN in the average price of an apartment that is errantly interpreted by readers to mean that all apartments appreciated at this rate! Wow, amazing right? If you bought an apartment in OCT 2006, and sold in OCT 2007, you made 17.6% even in the face of the young credit crisis that was going on at the time. Ummmmm, no! That is not the case.

Fast forward to the coming 4th quarter of 2008 (OCT-DEC), whose data will be released in JAN of 2009. The likelihood of that report NOT including high end sales of new developments and conversions is very high; yet we will compare it to the above report from 4Q 2007!

That year over year comparison will be ugly, and the media will go nuts with it. What comes in, will eventually come out. That 17.6% gain, will eventually result in a equal and possibly wider loss down the road! It is only when we will compare existing re-sales, excluding high end developments and conversions, will we see what bloggers like myself have been saying for so long. Price data is lagging and misleading, and just as it mislead on the upside and brought unwarranted happiness to many homeowners out there, it will also bring unwarranted depression and media headlines! Be prepared, be ahead of the curve, and understand that when it happens it will probably cause interpretations to be exaggerated as a market that just eroded!

Credit Markets Reign Supreme Once Again

Posted by urbandigs

Tue Jul 8th, 2008 09:22 AM

A: Ugh, it sure is ugly out there in the credit markets, which is putting pressure on the equity markets. While the fear level seems to be contained, even as stocks fall 15% in 4 weeks, I get the feeling that investors feel the fed will always be there to bail us out; or bail the failing company out. When I look at the credit markets, I see CDX spreads widening, ABX's down big time, credit default swap spreads on MER/LEH/MS trading at highest since March, and the new fear around the GSE's (Fannie & Freddie) need for capital due to a coming accounting change. It all adds to uncertainty around the financials, the write-downs, the need for money, the economy, oh and oil is still around $140/barrel even after a brief selloff.

The fed has all but runout of bullets, after using 325 basis points of umph juice to stimulate the financial sector and the economy. They can't cut rates anymore because of the effect it will have on pushing commodities higher and the dollar lower. Instead, they just announced an extension of the PDCF lending program into 2009; the Primary Dealer Credit Facility included investment banks as an emergency measure to ease the credit crisis. The extension of this program is an admission by our fed that the credit markets are not fixed, and will need this support as we enter next year!

According to Bloomberg:

Bernanke, who prompted expectations for a rate increase when he said last month the Fed would "strongly resist" a rise in inflation expectations, said today officials may extend the securities dealers' access to loans into 2009 as long as emergency conditions "continue to prevail."

The Fed started the PDCF in March, invoking its powers under "unusual and exigent circumstances'' to forestall a collapse in confidence after the near-bankruptcy of Bear Stearns Cos.
Moving on to what is going on in the credit markets, take a look at CDX spreads and how they widened in the past few weeks! The below chart is via Markit and shows the CDX.NA.IG Series 10 Spread:


As corporate spreads widen, investors see increasing risk between corporate debt and the safety of treasuries; hence the widening! The rate investors demand for corporate debt rise, as the yield for treasuries fall, widening the gap between the two! It's a sign that distress is back in creditville. As Bloomberg states:
Credit-default swaps on Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley debt are trading close to their highest since March. The contracts let investors bet on the risk that a company will default on its bonds.

Another gauge of financial stress watched by the Fed has also remained elevated. The difference between the overnight indexed swap rate, a measure of what traders expect for the Fed's benchmark rate, and three-month interbank loans in dollars was 0.78 percentage point yesterday, about the same as the start of May.
The notional value of the CDS market is a bit scary, at around $65 Trillion or so. For more on Credit Default Swaps, visit Accrued Interest who frequently discusses the topic:
Credit-default swaps (CDS) pose the greatest systemic risk to the worldwide financial system. Housing and oil may be what's pushing the U.S. into a recession currently, but the economy has a way of dealing with these kinds of shocks. Were the CDS market to suddenly collapse, it would truly threaten the very existence of the financial system.

A CDS is very much like a put on a particular credit. If a company defaults on its debt obligations, owners of CDS protection can, in effect, sell one of the defaulting company's bonds to the seller of protection at full face value. This is similar to an equity put, which gives the owner of the put the right to sell the stock to the seller of the put. Both a long CDS position and a long put position express a bearish view on the underlying security. Both can be used to hedge long exposure to the underlying.

This is not the only indicator of distress in the credit markets, here are the others:

a) TED Spread still around 1
b) ABX's continue to freefall
c) Corporate Spreads widening
d) 3-MTH LIBOR is about 79 basis points above Fed Funds Rate; 1-MTH LIBOR about 46 bps higher

If you are trading equities, it would be wise to keep an eye on the credit markets for buy/sell signals of your positions. I know most of you do not trade, but for any traders that read this site, the credit markets continue to lead the equity markets! I do not see this trend changing anytime soon. At this point, with treasury yields falling and commodities possibly correcting, perhaps there will be some money available to be put to work in equities around these levels; giving us a bounce. After a 15% straight selloff, a painful one for many, I wouldn't be surprised to see a bounce assuming an event doesn't occur; say for example, LEH being taken under at $15/share because of insolvency.

As for us real estate junkies, all of this means that the fall in 10-YR bond yields (some 36 basis points) recently probably will NOT result in a comparable fall in lending rates, as risk continues to be re-priced in the mortgage markets. As long as the credit markets are fragile like this, lending rates will behave independant of the bond market; as it did from AUG 2007 to March 2008 when the fed cut rates so aggressively yet lending rates stayed put. Read my post back in NOV 2007, "Bond Yields & Mortgage Rates No Longer Related" if you want more details on this side effect of the credit crisis.

Low Ball Bids & Cold Feet

Posted by urbandigs

Mon Jul 7th, 2008 09:02 AM

A: That is how I would describe today's Manhattan real estate marketplace. If you come here mostly for the front line, real time conditions here in Manhattan, I would have to describe the buyer confidence level as one of low ball bidding and cold feet. Sellers seem to be waking up to this reality, and entertaining lower bids with more seriousness. To see what I'm saying in the numbers, we must look at sales volume trends, both quarter to quarter and year of year, and you will see exactly how the drop in confidence is affecting our local marketplace.

cold-feet.jpgI have always stated that 'its all about the buyers, and buyer confidence' when it comes to a local real estate market. Today is no different. Some will argue that interest rates are what drives a real estate market. Others will argue that it is inventory, or lack thereof, that powers the housing market. Or is it jobs? The stock market? The lending environment? Fact is, all of these things play a role in the overall trend of any local housing marketplace, but in the end, its all about buyer confidence. To put it simply, if there are no buyers, how will product move without a significant reduction in the price? The question of WHY buyer's lost their confidence, brings us to answers like higher rates, tighter lending, will the asset depreciate, job insecurity, negative wealth effect, etc..

Today's Manhattan real estate market is one of caution and proper pricing. Show me a good deal, and I will show you a buyer. Price it high and try to offset it by offering brokers' incentives as Toes discussed, and watch it sit
. With a few waves of the credit tsunami behind us, we are now experiencing the after-effects of the major credit hurricane that has been hammering our economic and financial system for 8-10 months now. As has been the case since last August, the credit markets are leading the stock markets; the preferred gauge as to the health of the overall economy. As stocks fall, the risk of a recession and the slowdown in general becomes more real.

Like after a very powerful hurricane, the economic/credit recovery will be painfully slow. Buyers, especially wall street buyers, and those in the higher echelons of the affordabaility range here in Manhattan, know first hand how bad it is out there. After all, these are the guys on the front lines of wall street with jobs in the fixed income & derivatives trading desks. You know the old saying, "its a recession when your neighbor loses a job, and a depression when you lose your job"? Sadly, plenty of high wall street earners are about to enter a depression as we go from job cut announcements to actual pink slips. By this time next year, it is estimated that 100,000 wall street jobs will be lost and with the damage embedded deep within the financial system, these job's ain't coming back anytime soon.

On the streets, brokers are learning very quickly these days that the used car salesman approach to selling properties doesn't really work anymore; and in fact, only makes the agent using the tactic look like an idiot and way behind the curve. I am finding buyer's to be very savvy these days, very cognizant of what is going on around them, even if they do not fully understand the depth or severity of credit deflation that is currently occurring. It all adds up to the same thing, continued decline in buyer confidence. This results in cautious bidding. If the bid happens to get accepted, the chance of that buyer backing out because of cold feet during the diligence phase of the transaction, is considerably higher than in years past.

At the right price, buyers are there. At the wrong price, buyers are pricing in potential downturn risk via low ball bids. The true motivation of the seller comes out at this time. In the past 3-4 years, a bid 10%-15% below ask would result in a convincing NO RESPONSE by the seller; unless there was a desperate situation on the sell side. Today, that is generally not the case. A bid 10%-15% below the ask is now getting a response most of the time. Every bid must be considered in today's environment and it is up to the seller's level of motivation to decide just how that bid is responded to. In the seller's mind, the risk of not getting another bid at that level for a while, is far greater.

A serious buyer who is financially qualified and ready to go, is gold right now; in my humble opinion. As a broker, in past years it was prudent to focus your business on gaining new sales exclusives; as more listings equals more power and allows the agent to have a credible sell side business that ultimately generates its own buy side business as prospective buyers come to see the listings. Today, personally, I would much rather work with a ready, willing and able buyer than an overpriced, unrealistic seller! Not that I am avoiding new sell side business, just trying to explain to you the current environment that I see out there right now.

This environment is not unexpected, and certainly not a shock for UD readers. I've been discussing the credit crisis in depth since last July because of the severity and future risk it posed for our local market. Now that it is here, many agents are realizing that times have changed and that they need to tweak their business model to adjust.

The data seems to confirm everything that I have been discussing here since late 2007, up until today. Sales volume is down, inventory is up, and pricing continues to defy logic for reasons discussed. Expect 2008 to be the year inventory rises, and 2009 the year that shows the price drops; with both years showing sluggish sales volumes. According to the Q2 2008 Market Report:

The number of closings has continued to decline. The number of closings has dropped to about 3,085, a decrease of 20% since last quarter, and 44% since this time last year.
But what about prices? How can sales volume fall, inventory rise, and prices be up? Well, look no further then the power of high end development and conversion closings finally hitting the datasets. By the way, did you know that 30% of closings in the 2nd Quarter were new development/conversion units?

Eventually, this will cause a media problem for us; because what went into the price data to skew it upwards, will eventually come out and skew it downwards. As the upside data came out, it painted a misleading upside picture. When the downside data ultimately comes out, it will be equally misleading as a market that just fell off a cliff. I will do a piece on this topic tomorrow. For now, feel free to speak out on what you see out there in the streets of Manhattan real estate.

Related Bidding Discussions on UrbanDigs

Timing A Low-Ball Offer

When Good Bids Go Bad

The Sellers First Response: The Probe Bid

Bidding When The Price Is Right

Bidding Strategy 101: Reverse Psychology

For Sellers: How To Handle A Bidding War