Stuy Town / Peter Cooper Village CMBS Downgraded

Posted by urbandigs

Mon Aug 31st, 2009 12:12 PM

A: And here we go. Fitch ratings downgraded four CMBS transactions due to exposure to $4.5Bln in commercial mortgages tied to Stuyvesant Town / Peter Cooper Village. The downgrade reflected the likelihood of default as debt service cushions are almost depleted.

stuy-town-peter-cooper-village-tishman-speyer.jpgVia, "Fitch Downgrades Four CMBS Transactions on Likely Default":

Fitch Ratings downgraded four commercial mortgage-backed securities (CMBS) due to exposure to pieces of a $4.5bn commercial mortgage that is likely to default.

The loan secures Stuyvesant Town/Peter Cooper Village, a collection of 56 multistory buildings on 80 acres with a total of 11,227 apartment units. The Stuy Town loan continues to underperform, along with other loans in the affected transactions, Fitch says.

Of the $4.5bn loan, $3bn is securitized and the remaining $1.5bn of mezzanine debt held outside the trust. Fitch determined cash flow generated from the property remains well below the amount needed to service the current outstanding debt, and the borrower as a result must use debt service reserves to cover operating shortfalls. Fitch notes the general reserve and replacement reserve are “essentially depleted” and the debt service reserve balance fell to $49.3m, from $400m at issuance.

Tishman, along with the now bankrupt Lehman, also purchased Archstone Smith for $22.2Bln in what was the industry's largest public to private merger in the multifamily REIT sector. But it didn't end there, Tishman also went after the CarrAmerican real estate portfolio in late 2006 for $2.8Bln. Clearly they were on board the credit gravy train that ended up taking Lehman down. Add them all together and what you get is a story in Bloomberg last week that Tisman Speyer's real estate holdings fell by approximately 33.5% from peak. Ouch!

Whatever model the buyer used to rationalize the purchase at the time needs to be adjusted now that Manhattan real estate caught up with the credit dislocations that occurred less than one year after the purchase. Today's rental market is one that is trending down, while at the time of the purchase rents were rising to their ultimate peak around Fall of 2007. I would estimate rents today in that area to be down a minimum of 10%-15% from peak, with further downside possible as NYC's unemployment rate continues to rise.

The entire complex houses about 11,200+ apartments, 70% of which are rent stabilized. The rent stabilization rules require the tenant to use the apartment as their primary residence + earn less than $175,000 for two consecutive years + rent below the $2,000/month threshold. Tishman Speyer, along with the real estate arm of Blackrock, agreed to buy the land + buildings for $5.4Bln in late 2006. MetLife was the timely seller.

Tishman Speyer was sued by the Stuy Town tenants association earlier this year for improper practices to find tenants in violation of rent stabilization laws. The goal was remove as many rent stabilized tenants as possible so that market rate rents could be collected.

The reserve fund has about $49.6 million left and the burn rate quoted in the NY Post a week ago was $11.3M a month. However, this burn rate that is depleting the reserve funds should fall as we enter September. September is known to be one of the busiest rental months in Manhattan as the school year kicks off, so time will tell how many vacancies are filled and if rental rates stabilize.

Alex Finkelstein over at The Real Estate Channel chimes in:
"Based on current performance and the uncertainty surrounding ongoing litigation, we do not expect property performance to improve sufficiently to service the securitized portion of the $4.5 billion debt before reserves are depleted', says Fox. Capital expenditures for converting stabilized units to market rents have ceased because of a moratorium on conversion imposed by the Court of Appeals as a result of the litigation.

While this has reduced capital expenditures, the use of debt service reserves has increased because the Court also requires the borrower to separately escrow the difference between stabilized and market rents on former stabilized units, Fox says.

Previously, this difference was available for debt service. Once debt service reserves have been depleted, the borrower has the option to replenish them or cover the operating shortfalls out of pocket.

Fitch's analysis is based on updated expectations of limited unit turnover and stabilized expenses. Based on this estimate of cash flow, losses could be as high as 20% of the $3 billion A note balance.
This will be a story hitting headlines multiple times as the saga concludes.

Has Complaceny Set In? China Rolls Over

Posted by urbandigs

Mon Aug 31st, 2009 10:02 AM

A: One of the trickiest thing about equity trading is figuring out when stocks have fully priced in all available information - this is one reason why stocks are both not rational and not always right. The concept of when a stock has fully priced in or priced out information is one that will always baffle even the best traders and research teams. With that said, what type of recovery has this market already priced in? And has the market priced in future exit strategy announcements from our fed? Anyone watching the global markets probably has noticed the rolling over of China's Shanghai Index lately in response to the governments threat of pulling the punch bowl away from the banking sector. I find this very interesting because the Shanghai market seems to have been leading other markets in regards to the reaction to major stimulus and now the reaction to possible 'more restrictive' policy. Could this be a glimpse of how equities will react when our fed has to take the same path? Since policy actions taken to stem this crisis has been gargantuan to say the least, the debate will rage between whether the fed slowly and methodically conducts their exit strategy or if we are in for a swift pull of the punch bowl too.

shanghai-index.jpgChina's Shanghai index is now down 23% in the past month or so; shown on the chart to the right. This is worth watching because it looks like China will be the first test case of sterilizing uber lending that took place in the first half of 2009. Imagine if our Dow falls to 7,400 or so in a months time - do you think people would notice!

According to this Bloomberg article 10 days ago, "China plans to tighten capital requirements for banks, threatening to curb the record lending that’s fueled a 60 percent rally in the nation’s stock market, three people familiar with the matter said."

The gov'ts plan was to require the banks to 'deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital', forcing the banks to raise more capital and possibly sell shares. The immediate reaction was that this was the government's way of taking away the Kool-Aid that powered the equity markets up over 103% since the lows. China is taking a different route to toughen capital requirements to curb aggressive lending that was previously encouraged to re-stimulate the economy, and its equity markets are reacting to this new information. It's quite nice to see proactive actions taken to prevent another speculative bubble from forming.

2010 and 2011 will no doubt be the years that sees our unprecedented stimulus eased back in. So what will our fed do? Here are my thoughts in order.

1. First they will slowly remove emergency credit facilities, starting with those of least interest, which were aggressively used to curb the debt deflationary crisis on our banking system. The added liquidity kept our system afloat and avoided systemic collapse that would have brought a much more painful shock to the global financial system. Lehman Brothers was a mini-atom bomb test that showed the fed and gov't would could happen - seeing that result all but solidified the 'too big to fail' mantra.

2. Second, they will be forced to raise rates - that's right folks, 0% - 0.25% fed funds rates is getting closer and closer to being a hindsight policy. However, I still think rates stay low until early 2010 or unemployment proves to be stabilizing. As rates rise, watch gold for a move up on perceived future inflationary pressures.

3. Third, they can sell securities to primary dealers via POMO at the NY Fed, thereby draining liquidity from excess reserves. I think this will be a solid part of their exit strategy down the road - perhaps later in 2010 or early 2011. As of now, some $760Bln is being hoarded in excess reserves by depository institutions. That number will likely come way down once this process starts. The question is, will banks rush to lend money that was hoarded rather then be drained of freshly minted dollars from the debt monetization experiment. For now, this money is being hoarded to absorb future loan losses, cushion capital ratios and take advantage of the fed's paid interest on excess reserves - the banks choose to hoard rather then aggressively lend to a deteriorating quality of consumer/business amid a rising unemployment environment. This is a good move by the banks as the political cries for more lending grow louder. The last thing we need is for banks to willy-nilly lend to struggling borrowers that will only prolong the pain by later on.

4. And finally, as a final and more aggressive measure, we could see capital or reserve requirements tightened on banks to hold back aggressive lending that may cause inflationary pressures and money velocity to surge. Right now, banks must retain 10% of deposits as reserves and maintain capital ratios set by regulators. Either can be tweaked to curb lending and prevent $700bln+ from entering the economy and being multiplied by our fractional reserve system.

These are the things we will start to see in 2010 and into 2011. I do not think stocks have begun the pricing in of possible fed exit strategies. This cycle will prove much different than past ones and the fed may have to act aggressively to start the exit strategy, and then move to a slow and methodical approach to maintain the policy. Time will tell if the initial shock causes a disruption to this equity surge.

Whether we reach #4 (tightening of capital/reserve requirements) is a big question mark and when #3 (reversal of POMO operations to drain liquidity from excess reserves) happens is a question of later rather than sooner. For now, the stimulus remains in place and the fed is finishing off its outright coupon purchases through permanent open market operations at the NY Fed. Lets see whether our fed and banking regulators have the political will to do what they need to when the time comes to get this economy off life support as the equity markets price in future recovery.

I am in the double dip recession camp and I think the 2nd dip is a way off! First we have to get through the good economic data that comes from the side effects of a surging equity market, 'less worse' trends, restocking of inventories, gov't stimulus programs, and a dramatic improvement in credit. As a result, I expect the second dip to come in early 2011 or perhaps 2012 and the banks to deal with a second wave of pressures from losses associated with commercial, prime, jumbo, whole loans, private equity financed leveraged buyouts, etc.. - in addition to less accommodating decisions from the FASB regarding off balance sheet accounting rules. It started with the banks, it seems the banks are leading the way out now, and I think the banks will once again lead us into the second dip in a few years. I expect the next wave to be significantly less fierce than what we just experienced, but perhaps be more drawn out. For now, the banks raised a ton of money and the fed has engineered an environment for banks to earn their way to a healthier balance sheet. Will this go too far and has complacency set in? Now that we saw what happened to China's indexes, are we prepared for a similar fate?

Watch for good news to hit the headlines, but stocks to selloff - the opposite of what happened in early March when stocks rallied on bad headlines. That is when you know the market probably fully priced in the near term expectation and is now adjusting to the possibility that the expectation may not be sustainable for the longer term. After all, they don't say 'buy the rumor & sell the news' for nothing!

Bank Losses - CRE Sword of Damocles

Posted by jeff

Fri Aug 28th, 2009 07:12 PM

Apologies for the lateness of this post. I took a week's vacation and missed these Q2 numbers on commercial banks from the Federal Reserve. Noah already posted a composite graph of some of these stats from Calculated Risk in a prior post, but I thought it was worth digging into the data a little. I will keep this short and hopefully punchy. Here are the highlights:

All loan delinquencies have now hit levels as high as they have ever been measured in the Fed's historical statistics going back to the last real estate debacle (View image).

This time around it appears banks are actually dealing with problem loans more quickly than in the early 90s, with charge-offs as a percentage of all loans now well ahead of prior peak levels ( View image).

Residential delinquencies have been the driver of this bank solvency crisis. They remain at record levels and continue to rise, albeit at a slower pace(View image).

While I was wrong earlier in the year in thinking that credit card providers would get their delinquencies under control quickly, the broad (some would say indiscriminate) pullback in consumer revolving credit appears to be having an impact and delinquencies may be peaking(View image).

Commercial & industrial loan losses continue to surge and are now near levels reached after the Dot Com collapse, but are still way below the late 80s to early 90s level. Where corporate defaults are going is still an open question (View image).


In my mind the chart above is key to the current banking crisis. Commercial real estate delinquencies started this cycle at miniscule levels, turned up much later than residential delinquencies, but have escalated rapidly. They are still well below the levels of the refinancing crisis of the early 90s. That said, a huge amount of maturing and defaulting CMBS in the next 12 months will put more pressure on real estate prices, hammering rents as properties are turned over to those with much lower new basis costs who can afford to charge less to get their properties occupied. This will ultimately increase the severity of bank real estate losses on the properties they still hold. Banks seem to be oblivious to this and hope that somehow green shoots are presaging a jolly green giant of a recovery to save their ASSets. I'm not sure I'm that optimistic. Commercial real estate losses will likely lead to phase 2 of banking failures/bailouts, as presaged by the recent increase in the list of banks on the FDIC's watch list.

It's Times Like These When Money Returns To Its Rightful Owners

Posted by jeff

Wed Aug 26th, 2009 09:13 PM

"It's Times Like These When Money Returns To Its Rightful Owners": So said a banking executive from a conservative Midwest bank I heard speak recently. I'll admit it: I'm a lover of poetry and I even used to write some myself. No worries - I'll spare you. But there is something so poetic to me about the statement above and how emblematic it should be of our capitalist system. I have often commented that it's not the smartest guys/gals who make the most money, it's the guys/gals with the biggest cohones. This has apparently now been scientifically proven in a University of Chicago study reported on recently by Bloomberg News. My understanding is that newly appointed French pay Czar Michel Camdessus, who like the Chicagoans is a devout free markets disciple, is considering allowing French bank traders to keep their bonus payout ratios if they will just submit to castration.....dust off those guillotines.

But seriously, while those who are the most ardent risk takers often amass large sums of money, it is those who shepherd their capital wisely who keep wealth.....and pay the least taxes. It is the times of mean reversion when the cavalier surrender their ill-gotten gains to their more reticent skinflint cousins. There is a cleansing effect that goes along with this redistribution of wealth. The burning down of over-growth makes room for new green shoots that have room to grow. Profit margins in entire industries rise, because competition is thinned. But it is thinned by the exit of those who produced little or no economic value with the capital they controlled and their revenue is re-allocated to those who are much more productive with their capital. This brings our entire economy forward, and while there are times when grand using sock puppets to sell goods online.....are merited, so too are there times that the excesses need to be wrung out.


Unfortunately, I don't think my wise midwestern banker friend is right that now is the time when money will return to its rightful owners. In fact, everywhere I look I see barriers being erected to prevent this from happening. The government has bailed out the banking system and is subsidizing purchases of the toxic assets that do trade.....a precious few after more than six months into the effort to re-liquify the system. The stock market rally that has been engineered is allowing capital raising by a much wider group than the truly worthy. I could not have put it any more eloquently than this quote from today's Wall Street Journal article about why REITs will inherit the earth in the commercial real estate space.

"Everyone was predicting a have-and-have-not scenario, and that didn't play out at all," says Debra Cafaro, chief executive of health-care REIT Ventas Inc. "What happened was indiscriminate access to capital, which has buoyed the whole sector."

While the chart to the left clearly shows that overall REITs were much better stewards of capital, collectively being net sellers at the top of commercial real estate, versus other players who were net buyers, many were not good stewards of capital. This has apparently been overlooked in the recent capital raising orgy.

This is merely a microcosm of the world in general, where for various reasons the wheat is only being separated from the chafe during times of extreme distress, other than that sloppy stewardship of capital is being rewarded as markets fail to differentiate the good from the bad. I believe that this is due to an incredible shift to short-term thinking which has pervaded our society, as I discussed in my piece "Trading Mentality: The 8th Deadly Sin."


The chart to the left which I lifted from a Seeking Alpha article entitled Stock Return Dispersion and the VIX Forecast Alpha Dispersion demonstrates that differentiation in stock performance is highly correlated with volatility. What it does not explicitly say, that savvy Urban Digs readers know, is that volatility is more often than not associated with declining stock markets. So it is in bad markets that good is segregated from the bad. This is a trend that I believe is increasing to the increasing dominance of hedge funds, which are by nature trend chasers, due to their need to generate short-term performance, and particularly by the growth of statistical arbitrage strategies which buy laggards and sell leaders in a group such that the stocks are pushed back into their historical correlations, when they get out of whack. (I am sure that one of our physics PhD readers can correct my misrepresentation of statistical arbitrage, but while I am misrepresenting I should mention that this strategy is so crowded that it apparently now needs the help of front-running - flash trading - to keep producing returns.) Since stock markets historically go up much more often than they go down, historically stocks have lower full cycle return dispersions than bear market return dispersions. It's a self-reinforcing trend. Unfortunately, it is not in the interest of our capitalist system, where stocks are not just pieces of paper or mathematical ciphers; they represent businesses that either add efficiency to our economy or don't and are supposed to be winners or losers based on these trends. We have collectively created an environment where as long as you don't go under you win....and by the way, we have very little tolerance for anybody big going under. It's Trump world. We have created it. Can we undo it, or has the system gotten so far out of our control that we are doomed to be Japan without even really trying to be?

Putting Manhattan Into Perspective

Posted by urbandigs

Wed Aug 26th, 2009 10:57 AM

A: Everyone wants to know what is next for Manhattan. Geez, can't we even go a month or two and just focus more on where this market is now and put into perspective the wave down we just experienced? NAH, that's no fun! A few days ago I discussed why I think we will see quarter-to-quarter improvements in sales volume that will lead to a new round of bullish headlines and bottom calls - this is due to the delayed seasonality trends as a result of the first wave down in prices. But when it comes to analyzing real estate trends, its always best to put things into perspective by comparing year-over-year data to filter out any noise that comes from seasonality. In other words, how did the 2nd quarter of 2009 compare to the 2nd quarter of 2008 and so forth? The short answer is that regardless of how active this marketplace became after the wave down, the first half of 2009 has proven to be the weakest in the past ten years. Since real estate is about sales volume, commissions, and spinning of data to increase the number of deals, expect the focus to be on the short term trend and NOT on year over year comparisons.

Let me remind all of you what this downturn looked like in terms of # of sales so we can put our market into perspective:


That IS the data, and you can't deny the data. Clearly, the first half of 2009 for the Manhattan residential marketplace shows to be the most sluggish compared to the past 10 years. Take a close look at the above chart and do your best to focus on the relative performance of each color (representing a quarter); this makes it easier for you to dissect year-over-year trends. In doing so, you will notice the blue + red bars trend since the peak as being down.

We should be comparing Q3 2009 (green bar) to Q3 2008, in which case we would need to top 2,650 sales or so to represent an improvement from year ago periods. Instead, headlines will probably focus on comparing Q3 2009 data to Q2/Q1 2009 data in which case we only need to top 1,550 sales or so to support a bullish argument of three consecutive quarters of improving sales. That should be easy as pie to accomplish given the activity and contracts signed over the last few months that will ultimately get recorded in the upcoming Q3 report. For the record, I would expect sales for Q3 to come in around the 2,000 - 2,250 level or so.

Comparing the upcoming Q3 sales number to year ago levels, I don't think there will be enough umph in the pipeline to beat the 2,650 deals closed in the same period last year. Therefore, I think the y-o-y trend for the first 3 quarters over the past two years since peak will continue to be down.

We were expecting a wave down, and we got it. As a result, I am less bearish on our markets. It certainly is a better time to buy today than it was only 18-24 months ago as you get a discount due to general market conditions. Looking ahead, I expect this market to muddle around the comfort zone reached in the first wave down for a while, reflecting the new realities of our real estate marketplace and macro environment. Should a dislocation occur somewhere, I'll report on it here. For now, credit is still dramatically improved from the distress levels seen late last year. Buy for the right reasons, know where the market is and where your target product should trade off peak levels. Do not buy because a broker convinces you that three quarters of improving sales data warrants an uber aggressive bid over market value or else you will be priced out forever!

The decline in total inventory is being affected by:

1) removal of existing listings - 2,342 Manhattan listings removed from market since July 1st
2) fewer new listings coming to market - 1,696 new Manhattan listings came to market since July 1st
3) rise in contracts signed activity - 1,890 Manhattan contracts signed since July 1st

The first two are seasonal trends and the surge in activity is due to a delayed seasonality effect as a result of the first wave down in prices. The threat to activity levels sustaining itself lies with sellers' willingness to continue to do deals in the comfort zone range down from peak in the face of a surging equity market and a general boost in confidence now that Armageddon seems off the table. If sell side optimism rises too high and expectations increase for significantly more aggressive bids, its up to the buyers to play along.

Fed Ordered To Reveal Emergency Program Details

Posted by urbandigs

Tue Aug 25th, 2009 09:04 AM

A: Not quite the audit that many are looking for of the Fed's balance sheets, but a step in the right direction I guess. Manhattan US District Judge Loretta Preska ruled against the almighty central bank rejecting the notion that..."loan records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions.". The Fed's fear was that this information would rattle shareholders and possibly cause a run on any specific bank. Since we are currently in a fed engineered banking recapitalization environment, the last thing the fed wants is to disturb its efforts to help the banks earn their way back to health. This information is coming way way late (the way the markets like it), and I am most interested in who needed the most help and the quality of the collateral that was posted for the short term funding.

Bloomberg reports, "Court Orders Federal Reserve to Disclose Emergency Loan Details":

The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under 11 programs, most put in place during the deepest financial crisis since the Great Depression, saying that doing so might set off a run by depositors and unsettle shareholders. Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued on Nov. 7 on behalf of its Bloomberg News unit.

“The Federal Reserve has to be accountable for the decisions that it makes,” said Representative Alan Grayson, a Florida Democrat on the House Financial Services Committee, after Preska’s ruling. “It’s one thing to say that the Federal Reserve is an independent institution. It’s another thing to say that it can keep us all in the dark.”

The judge said the central bank “improperly withheld agency records” by “conducting an inadequate search” after Bloomberg News reporters filed a request under the information act. She gave the Fed five days to turn over documents it told the reporters it located, including 231 pages of reports, and said it must look for more at the Federal Reserve Bank of New York, which runs most of the loan programs.

The U.S. House may vote as soon as next month on a bill to require the Fed to submit to audits by the Government Accountability Office, said Representative Scott Garrett, a New Jersey Republican on the Financial Services Committee.
What is interesting to me will be the quality of collateral posted under all the short term repurchase agreements and swap programs that these banks held to maintain liquidity when crisis struck. I believe most of the liquidity swaps were with other central banks but the repurchase agreements were mostly with commercial banks who needed cash fast. We know now that the quality of many of those assets were not anywhere close to the AAA rating stamp provided by the rating agencies. Yet at the time of crisis, its clear that the quality of the rating on the collateral being posted was not the main focus. The main focus was to get the liquidity programs in place and save our banking system. This is why many believe the fed to have compromised its balance sheet for the short term when the crisis hit its peak.

Bank repurchase agreements hit $120Bln in late 2008 and are way way down from those levels today. If this court order came out 10 months ago when the facility was being used to prevent a liquidity crisis, trust me the banking world would probably look a lot different today. Its not surprising that this news comes out now, when the credit markets have improved so dramatically as a result of these emergency facilities. Always remember, a healthy banking system does not need rescue plans, bailouts, shotgun marriages and a host of lending facilities to provide liquidity to prevent systemic collapse. We are where are right now because of unprecedented policies combined with insane amounts of fiscal and monetary stimulus. Many tend to ignore how we got here and just assume that the economy is naturally healing itself. That's not quite the case here.

As an out of sight - out of mind economy, it is no wonder this news comes out much later and at a time when it will matter much much less for the tradable markets. Who cares if Wells Fargo or another big bank posted complete garbage as collateral 10 months ago when they needed access to cash! We are at now now and now is much better than 10 months ago - the rest is behind us. Out of sight, out of mind continues, until the markets can handle the news. Calls to audit the fed will no doubt rise as this information is dissected and reported on.

Oh by the way, Bernanke was re-appointed to a 2nd term yesterday. Timely.

A Bird is Flipped in Williamsburg

Posted by jeff

Sun Aug 23rd, 2009 02:21 PM

The%20Bird.jpgI was intrigued by recent articles in The New York Observer and Crain's New York Business on the oft-delayed "Finger" building in Williamsburg. The articles discuss the star-crossed development, whose planned height at 16 stories was deemed so obscene by community members that is was dubbed "The Finger" building, as if the neighbors were all being flipped the bird by original developer, Mendel Brach of North Seven Associates. The articles recount how new sponsor GFI Development Co. has stepped in to take over the project and renamed the project The Albero (Italian for tree).

What interested me were the apparent economics of the deal and what it says about the Williamsburg market and bank losses on projects in the area. Note that according to a recent issue of Real Estate NEW YORK magazine, July Department of Buildings data showed 18 stalled construction projects in Williamsburg. According to an earlier Crain's article, sales of condos in Williamsburg fell at a 70% annual rate in Q1 2009. So let's face it Williamsburg is a disaster for new developments from a supply/demand standpoint. Imagine my surprise when I read that the new developer of the "Albero", recently received a $13.2 million construction loan from CIBC. Now just hearing about someone getting a construction loan for a condominium project (which I assumed this still was) is something to take note of, but in Williamsburg....fuggedabboutit!

So I did a little recon work on ACRIS. Here is the story as best I can put together from the articles and evidentiary documents I could find:

Mendel Brach's North Seven Associates borrowed $19.2 million from HSBC for this project way back in 2005. Looking at the tax map information on the lots in question, my guess is that the loan, which was reportedly for a 16-story building would have resulted in approximately 105,000 sq feet of sellable space, or roughly $180 per square foot of debt. Assuming a 70% loan to cost construction financing, which was likely available at that time, it would have put the full project cost at about $27 million, or $257 per square foot (seems low to me even by 2005 standards, but maybe the land was bought from the Indians and the project was undoubtedly a non-union job). If I am anywhere close on the numbers (I am working off incomplete information and making some assumptions that could be a little off), this is a project that should have worked out just fine, assuming sell outs of Williamsburg condos in the $550 to $650+ per square foot range at the peak. My guess is that the going rate is now in the mid $400s to mid $500s. According to Jonathan Miller's data,Brooklyn condos overall sold for an average $471 per square foot in Q2 2009.

Now the "Finger" was delayed, and as a result likely had significant cost overruns etc. The Observer article claims that the building was foreclosed on and acquired by GFI. That's not what it looks like to me. I'm no lawyer (insert your favorite lawyer joke here), but it looks like this was a "deed in lieu" deal. It appears that GFI's entity CBSH Debt LLC, assumed a $19.2 million mortgage and an additional $1.9 million mortgage from HSBC in December of 2008 (hard to say if the larger mortgage subsumed the smaller). In June of 2009, GFI's Gabriel Realty acquired the deed for a reported $10.00 of consideration. Interestingly, the real property transfer report that was filed showed value of $7.5 million as the sale price. My guess is that this is the equity that North Seven had invested in the deal....which added to the HSBC loan, comes to just about my full project cost guesstimate of $27 million. I am guessing yet again, but I believe that the new $13.2 million CIBC "construction" loan is to be used to both pay off HSBC's mortgage at a discount and finish the building. The project has reportedly been scaled back to 14 stories from the original 16 planned and is reportedly currently an unclad 10 story shell. If GFI's all in cost for this project is not much above the $13.2 million construction loan number, this is probably a pretty good deal.

The finished product will likely be a 14-story building with 90,000 sellable square feet and a cost of $150 per square foot. It would certainly work as a condo project even with sell outs in the low $400s per square foot - with the only wrinkle being sales velocity. More likely, if it were developed as a rental, using a reasonable $30 per sq foot in average rent (a $2.7 million rent roll) a 45% expense ratio (implying a $1.5 million NOI) and a very reasonable 7.5% cap rate, you would have a building worth roughly $20 million. If all of my hypothecations are correct, this is actually a pretty good loan for CIBC to be making and my hat is off to them (let me know if you guys have an appetite for more of these kinds of deals). As for HSBC's $19.2 million mortgage, it's hard to say how much of the money was spent and what HSBC is getting from GFI for its troubles. I think it's safe to assume however, that it's no more than $13.2 million. I'm sure the $6 million+ loss will be easily mopped up by the UK governments' version of TARP. God Bless the Queen!

I certainly hope that The Albero deal works out for GFI (feel free to give us the real story and economics behind the deal if you're reading this). It's good to see some progress being made in New York City's commercial real estate market in the form of projects being completed and properties being transferred into the hands of those with a reasonable enough basis cost to make a decent risk-adjusted return, while supplying consumers with a quality product.

Expect Significant Quarter-to-Quarter Improvements

Posted by urbandigs

Fri Aug 21st, 2009 12:46 PM

A: Manhattan real estate is seasonal, like all local real estate markets, and should be analyzed on a seasonal basis to ignore the noise and trend mis-interpretations that come from month-to-month or quarter-to-quarter moves. However, you cannot deny the activity that this local market has had starting in late April and the coming media effect that will come from next quarters improved report. Combine the lagging effect of our marketplace and what you have is a Q2 report that defined the downturn and an upcoming Q3 report that will look much improved when compared to the prior quarter. Expect significant quarter-to-quarter improvements when the report comes out in early October and a number of bullish arguments and bottom calls to hit media headlines.

We have to keep it real and can't deny the action that has been going on for about 4 months now. When the data is compiled and compared to the prior Q2 report it will probably show:

a) a surge in contracts signed when compared to prior quarter
b) perhaps a rise in prices when compared to prior quarter as our market priced out fear
c) a notable decline in inventory when compared to prior quarter

When the Q2 report came out on July 2nd, it defined the downturn and the sharp tiered price declines this market saw. I cautioned readers NOT to mis-interpret the very negative report as what was actually happening at the time in the field - "Manhattan Q2 Report Thoughts":

The biggest mistake one can do is to read one of these quarterly reports, and just assume this is exactly what is going on right now! The thing is, the market today is significantly more active than what this report suggests because Armageddon has been priced OUT of this marketplace over the past 7-9 weeks or so - something not reflected in this report.

When you hear, 'sales volume plunges 50% from year earlier', you may immediately assume today's market is completely dead - not so. So, make sure you understand this lag and acknowledge that this market did equalize from the frozen months of OCT - MARCH. The bulk of the pickup in activity occurred between mid-April to end of June - as confidence rose with the equity rally and a wave down in prices.
It surprised some to hear me say these things, but in the end I will always do my best to keep it real on this fast paced marketplace. I was a bull turned bear in Fall of 2007, then turned 'less bearish' in late 2008; and continue that stance today. I try not to let my bigger picture opinions influence front line reports in our marketplace. For the bigger picture, I still have my worries that a 'W-shaped recovery' lies ahead - although the double dip is looking to be a late 2010 or 2011 concern with inventory restocking and stimulus effects yet to fully play out in the macro data.

Since Q2 was the report that defined the downturn, expect a MUCH IMPROVED REPORT when the third quarter data is released and compared. A part of me thinks we may have to wait for Q4, but I'm more confident than not that it will show up in next quarters data. Consider this your real time heads up for it!

Total inventory is declining as a result of:

a) more listings being removed from the marketplace (seasonality)
b) fewer new listings hitting the marketplace (seasonality)
c) surge in contracts signed (combination of delayed seasonality and first wave down)

When I say 'delayed seasonality' what I mean is the first wave down distorted the period of time that our marketplace is usually more active - or the seasonality effect got delayed. The usual period of high action in Manhattan is right around the wall street bonus season, or the time between late January to late May or so. Those 4 months or so are typically much more active than during the summer period. We are in summer now. As the first wave down occurred, buyers RAN AWAY and the bids disappeared - the downturn began. This lasted for about 6 months starting around mid-September and ending around late March; overlapping and influencing the first few months of our busy season!

Because of the deeper forces at play during this wave down, our normally active period that starts in January was pushed back to around April. So, what we are seeing now is in my opinion a delayed seasonality effect mainly due to the first wave down.
What makes this action more compelling is in fact the lower prices that are re-stimulating interest in our markets products. Manhattan is a very different animal than most other markets out there, and certainly is much more fast paced. The amount of wealth and the depth of the buyer pool in this city always surprises me. While this market has proven not to be immune from this crisis, it certainly is reacting to it at a lag and stabilizing from it quite quickly. What took other markets a year or more to fall 25-30%, we experienced in a short 4-6 months. Consider this market to be trading at the higher end of the first comfort zone reached from this first wave down.

Q3 will report action from the months of July / August / September and likely the closing prices of contracts that were signed in May / June / July (all very active months that priced OUT Armageddon)! This lag is one reason why Manhattan's downturn, while discussed in detail here in late 2008, was not defined until the Q2 report.

Manhattan Charts / UrbanDigs LLC Its Own Brokerage

Posted by urbandigs

Thu Aug 20th, 2009 09:26 AM

A: UrbanDigs Manhattan Charts that follow total inventory / price reductions / new listings / contracts signed are now fixed and working again. We apologize for the delay. The charts tell the same story that is being reported here in regards to the front lines of Manhattan real estate: it is still active out there, fewer new listings are hitting the marketplace which is in line with seasonality trends, inventory as a result has come down, and contracts signed trends are still active although down from the levels seen in May & June. Lets get right into it.

As was announced in The Real Deal article last week, UrbanDigs is now its own entity!! UrbanDigs LLC will be doing business as UrbanDigs Analytics & Consulting and is currently in development of a suite of analytical tools for enhanced analysis of Manhattan's residential marketplace. We expect launch and BETA testing to begin in Q1 2010. I would love to say it will be sooner, but Id rather be conservative.

My partner Jeff Bernstein, an investor in UrbanDigs, will be an integral part of this new project. "We expect radical changes to the New York City residential real estate brokerage market, driven by the Internet and the new realities of New York City's most important asset class", says Mr. Bernstein.

Mr. Bernstein adds, "Already an acknowledged thought leader on New York City residential real estate with a focus on transparency, UrbanDigs hopes to be a catalyst for change through the roll out of information centric software tools, market data/analysis and a la carte consulting and education services to the residential markets. UrbanDigs will enter alpha test of its first set of tools within six months and expects to be in live customer beta testing by the first quarter of 2010. Other tools and services will be rolled out on a continuous release basis, thereafter."

Certainly exciting times. The charts we display now is only a fraction of what we hope to offer in the very near future, to analyze and interpret trends as they happen here in Manhattan. So lets get right to it. Here is a look at Manhattan Total Inventory trends over the past 6 months:


The combination of seasonality, removal of listings, fewer new listings hitting the marketplace and above normal activity for this time of year are all contributing to the decline of total active inventory. For now our system only goes back 6 months but our new system will certainly expand time coverage.

Moving on to the weekly moving averages (to remove spikiness of data) of New Listings vs Contracts Signed trends:


I see a chart like the one above and it reminds me just how valuable having access to real time analytics could be for buyers & sellers of Manhattan real estate. Buying when fear is high, transactions are low (represented by the wide gap above in FEB/MAR) and supply is adding pressure to the sellers certainly can be looked upon as a contrarian move that in hindsight usually turns out to be a great opportunity.

As you can see the gap between new listings hitting the market and the pace of contracts being signed has narrowed significantly over the past 5 months. This is one reason why buyers who did not pull the trigger yet may have noticed some of their top value listings go into contract. As I stated 10 days ago in my quick update, "The market is still considerably more active than it usually is for this time of year yet, it doesn't seem as crazy as it was during the months of May & June". This statement still stands today.

Make no mistake about it, lower prices were the main catalyst to the surge in buyer activity. While the equity rally helped in boosting confidence and removing the Armageddon fears, it was the wave down to the first comfort zone that was most responsible for the activity over the past 3-4 months. Pricing is still the key to moving property and just because activity has been solid doesn't mean sellers should expect near peak level prices again - if you price right you will move your unit, if you don't you will find bids coming in closer to comfort zone discounted levels. More on this another day.

No Inflation in Manhattan Office / Mixed-Use Markets

Posted by urbandigs

Wed Aug 19th, 2009 09:54 AM

A: Hyperinflationists' need to explain their logic to me when it comes to the mixed use and office market in Manhattan. News that came out a few weeks ago from from Massey Knakal and yesterday from CB Richard Ellis, reminds us of the deflationary environment that has hit all segments of the Manhattan property market. Hit especially hard was luxury residential high end, mixed use, and office markets. Due to the nature of the downturn, the lower end price points have not been as affected. Its hard to argue that hyperinflation is just around the corner when your dollars can buy twice as much mixed use & office space as it could only 18 months ago. There will be a time to talk about the unintended dangers of uber-stimulative policy, but for now that policy is in place as a desperate attempt to stop a deflationary spiral.

If you get into an argument about how inflation or hyperinflation is very near, just remind them of what is actually going on out there and the increase in purchasing power of their dollars as a result of deflationary pressures on our housing markets.

Case in point, Massey Knakal's report from a few weeks ago discusses how "Manhattan Mixed-Use Property Values Fall by Half":

A buyer could get twice as much mixed-use space in Manhattan in the first half of 2009 than in the same period a year earlier, according to a new citywide mid-year report from commercial sales firm Massey Knakal Realty Services. The prices for mixed-use properties fell 53 percent to $535 per square foot from $1,135 per square foot in the first half of 2008, the firm's data show.

Company Chairman Robert Knakal said he expected prices would continue to fall even as the numbers of transactions increased. "Even with a significant increase in volume, we expect prices to continue to drop as fundamentals deteriorate, caused by continuing increases in unemployment,” he said in a statement.

Sales in the first six months of the year in Manhattan, in all categories of buildings priced higher than $500,000, were down 82 percent to $1.9 billion, from $11 billion in 2008, and $30.8 billion in 2007, the firm reported. The transaction volume fell 74 percent from the first half of 2008 to 95 sales, totaling 122 buildings.
Here is the Massey Knakal 1H2009 report and a quick check on cap rates that are being pressured by lower rents:


As for the office market, Bloomberg reports "Manhattan Office Sales Ground to Halt in First Half":
Manhattan office sales came to a near standstill in the first half, with less than one-tenth the average number of transactions seen during the same period in the previous five years, CB Richard Ellis Group Inc. said.

Three office buildings valued at more than $30 million sold from January to June, down from an average of 32 in the first six months of the prior five years, said the Los Angeles-based firm, the largest publicly traded commercial real estate broker.

Buyers and sellers are far apart on bids while low interest rates on existing loans mean many sellers can afford to wait, CB Richard Ellis said. “When the CMBS market shut down, that really shut off the financing mechanism that allowed a lot of these large transactions to get done,” said CBRE’s Enoch Lawrence, senior vice president of capital markets in New York.

In the near term, most property sales will be forced by distressed financial conditions, CB Richard Ellis said.
1/10th the volume compared to the same period average over the past 5 years. Ouch! Securitizations for CMBS is still not functioning properly forcing the fed to extend the TALF program by 3-6 months for newly issued CMBS. The program was set to expire DEC 31st as $165Bln in commercial mortgages come due this year. Under the TALF program, the fed 'lends to investors to purchase new asset-backed securities as well as commercial real-estate debt'.

CMBS issuance has been virtually non-existent for about a year now after peaking in early to mid 2007 - the height of the credit bubble. Since charts sometimes tell the whole picture, take a look at Commercial MBS Issuance By Type via the Atlanta Fed:


Calculated Risk says it all when he states..."The increase in cap rates suggests more than half off the peak prices of a few years ago - and probably even more since rents have fallen too (reducing operating income) and vacancy rates are rising sharply (pressuring rents more)."

Does this look like inflation or deflation to you guys? With the fierceness of the destruction, you can't expect the pace of these levels of decline to continue. Naturally, the market will react to an overshoot on the downside that will cause many to mis-interpret this equalization as a new trend supporting sustainable upside in prices. Falling 53% and then rising 5% is the market adjusting to a dislocation - overshoots to the downside are common in these scenarios.

After all, we saw it in our residential marketplace as prices overshot to the downside in FEB-MARCH, and then naturally rebounded slightly as buyers got comfortable again in the months of MAY-present - in essence, pricing OUT Armageddon. It would be silly to use the 'slight rebound' from this overshoot as a bullish argument to support a new bull market ahead. I should also add that as bad as this looks and as painful as the cycle is to consumers and our banking system, it is healthy, it had to happen, and lower prices and lower rents will ultimately stabilize the markets. It is for these reasons that one must be 'less bearish' today than 18 months ago when the excess was not yet purged from our marketplace.

Some Color on Delinquency Rates

Posted by urbandigs

Mon Aug 17th, 2009 03:49 PM

A: Calculated Risk, a daily read by the way, delves into the latest Fed data on delinquencies at Commercial banks. No sign of green shoots here, folks. So for those not really into a dose of reality, look away.

From CalculatedRisk via latest Fed Report:


Here is a quick summary:

RESIDENTIAL DELINQUENCIES: 8.84%, up from 7.85% in Q1 and 4.45% in Q2 2008

: 7.91%, up from 6.46% in Q1 and 4.19% in Q2 2008

: 3.73%, up from 3.12% in Q1 and 1.74% in Q2 2008

: 6.7%, up from 6.68% in Q1 and 4.86% in Q2 2008

Expect the fed to maintain stimulus until unemployment stops rising and delinquencies start to level off. Since the two are inter-related, the fed is pretty much likely to maintain a zero interest rate policy until unemployment stops rising. I would expect them to know more information than us, or at least earlier information. So, if we see the fed raise rates the first thing that will pop into my head is their confidence that the unemployment rate is nearing its peak for this cycle.

Credit card delinquencies seem to be stabilizing but commercial delinquencies are really surging. Not sure about you, but I will be glued to the CMBX indexes for a while!

For now, as unemployment continues to rise and insurance benefits set to expire for so many without work, expect delinquencies to continue to rise. With U3 at 9.4% and U6 at 16.3%, there is a reason it feels worse than what some green shoot headlines suggest. One difference with this cycle versus past recessions is the massive growth of part-time workers; as 8.8 million people are working part-time for economic reasons. Checking in with the Atlanta Fed, you can see how different this recession is from previous post WW2 cycles:


This is not your average recession and is the deepest slowdown we have faced since TGD. It is what it is.

Brace For a Rough Open

Posted by urbandigs

Mon Aug 17th, 2009 06:29 AM

A: Futures are under pressure as global equities plunge on news the V-shaped recovery that stocks seemed to be pricing in, is not revealing itself. For now, it seems out indexes are a bit lucky as China was down 6%, Japan down 3% and most European indexes down close to 2%. If we were to trade down 3% like Japan, that we would mean our DOW closes down around 280 points and the S&P down around 30. For now, equity futures with a bit of fair value working in their favor, seem to point to a down 1.8% open. Is 'less worse' no longer enough for markets? Does a new wave of foreclosures actually still mean something? As money flies to safety of treasuries and dollars, will credit indicators once again get hairy? Are whole loans really a problem? Will animal behaviors kick in and feed on itself? These are the ultimate tests for the strength or weaknesses of the markets - and this market has been strong like bull for over 5 months now. Lets see how it handles the pressure today.


Remember to keep your eyes on the credit markets (especially at corporate bond spreads if treasuries surge via a flight to safety) for signs that this may be something other than a healthy correction after a 50% surge. Its not uncommon for stocks to be wrong and get way ahead of themselves. Afterall, stocks were very wrong in October 2007 by ignoring the credit markets and very very wrong in May 2008 by assuming the fed removed all systemic risk by organizing a rescue of Bear Stearns. Wall street has a severe case of ADS as investors/traders frequently forget about the past. Being so wrong not once, but twice since this crisis began all but seems forgotten at this point as people once again look at stocks as being rational and the ultimate predictor of a strong recovery ahead. Stocks are not rational.

CMBXs Acting Hairy Again?

Posted by urbandigs

Fri Aug 14th, 2009 11:07 AM

A: Take a look at what is going on with the CMBXs lately. This entire rally once again followed the lead of credit, which came in big time from monstrous stimulus and targeted programs by the fed. It seems logical that just as credit markets overshot to the downside last year, driving fear levels to insane levels, they could have overshot to the upside in reaction to fed policy. Mish is correct that corporate bond spreads are key to this rally, as are some other credit indicators. Keeping your eyes on LIBOR, TED spreads, CMBXs, ABXs, and CDS spreads too will help paint a very good picture of coming change. Its worth keeping an eye on. These are the same indicators used when discussing the threats we faced in October 2007. For now, its just too early to tell if its a sign of another wave that ultimately feeds on itself.

CMBXs are a group of indexes made up of 25 tranches of commercial mortgage-backed securities (CMBS), each with different credit ratings. The pricing is based on the spreads themselves rather than on a pricing mechanism.

Credit came in huge as this fed engineered bank recapitalization period kicked into high gear - a ripe environment for stocks surging after a destructive 60% plunge. Therefore, the concept that "Stocks Lag the Credit Markets" written about back in February of 2008, still applies. For CMBXs, they improved as credit improved.

But now take a look at some of the moves lately according to the MARKIT CMBX indexes:


This can all feed on itself, especially after stocks posted 50% gains in five short months. Should these indicators start getting hairy again, it could cause a ripple effect flight to safety into cash and treasuries. If the trend continues, and you see corporate spreads widen (partially because treasury yields are falling), TED spread rise, CMBXs start a cliff dive, etc..fear levels will no doubt rise further feeding the cycle. So its worth keeping your eyes on as Mish suggests!

The end effect could be temporary distortions in debt markets causing the inability or difficulty in continued capital raising for those entities that are severely pressured - CIT, Corus, and Colonial BancGroup come to mind as 'toxic loans may push 150 more banks to the point of no return'. While Armageddon seems off the table as the min-atom bomb test in Lehman showed us what could happen if a big boy fails, a less severe disruption can still occur and traders will react accordingly. Will we see a natural adjustment after credit improved so much or could it be a sign of something else? Its too early to tell right now, but worth watching.

PS: China, which led the global equity market surge mainly in response to stimulus, is showing some clear signs of weakness lately. I wonder if this is having an effect as well. China's Shanghai is down just under 7% for the week after rising almost 75% year to date.

You Mean Real Estate Agents Have An Image Problem?

Posted by urbandigs

Wed Aug 12th, 2009 05:11 PM

A: Good old Jonathan Miller reminds me today that I am at the bottom of the bucket in terms of professions, the scum on the street, the lowest of the low! Just kidding JM, you now I love ya! But in all seriousness, the fact that real estate agents have such a tarnished reputation is one reason that drove me to take out time in my schedule to blog here on UrbanDigs. That way, maybe you can learn a little about me and my view on the markets and Manhattan real estate before putting me into the tarnished category of lowly real estate agent. But that is for you to decide. In a commission based industry with little transparency, huge competition amongst peers, and high production expectations, it should be little surprise that real estate agents push to get a deal done. Afterall, their salary is entirely dependent on getting that deal done and while some view good service as the way to go, others view it as a game of sales that must be mastered.

Jonathan Miller's Matrix discusses how, "Real Estate Brokers/Agents Have An Image Problem":

Firefighters are at the top (one of my sons is a firefighter!) as well as scientists, doctors, nurses, teachers, military officers and real estate bloggers (ok, ok that last one I slipped in to see if you were payin’ attention).

At the very bottom of the list were real estate agents/brokers after accountants, stockbrokers (no surprise there), actors (surprising given our celebrity culture) and bankers (yep, thats for sure).
Here is the survey results:


The problem with this industry is a lack of will for change (excluding brokers like Douglas Heddings and Tom Demsker who clearly understand the inevitable changes that lie ahead). On the one hand, I thoroughly enjoy taking time out of my schedule to blog here on UrbanDigs and to answer calls from buyers & sellers that are already committed to another agent. On the other, I have to accept that what comes with this path that I have chosen is plenty of pro bono work and a customer that is very cost conscious and very aware of the fragility of this economic environment; and rightfully so as this is probably the biggest purchase they will make. Go back a few years and you will see a much different tone for discussions here, something that doesn't really help a broker close deals.

Here is an example: After I wrote the July 8th piece, 'Low Ball Bids & Cold Feet' I sent a note out to my buyer clients that I thought the Manhattan market has disconnected from what was going on in the credit markets:
"Expect 2008 to be the year inventory rises, and 2009 the year that shows the price drops; with both years showing sluggish sales volumes."
I didnt know what would be the spark (Lehman, Merrill, GSEs, WaMu, Wachovia, etc.) or when it would happen, but I advised my buyers to wait it out and re-sign their leases. Then Lehman failed in September two months later with several warnings prior to that discussed here & here. The result was that I did not do any deals between July of 2008 and February of 2009. I even disclosed this in the public round table discussion published in NOV 2008 for NY Mag and you can see Dottie Herman's response:
N.R.: I don’t expect to do a deal in the next three or four months. It’s not that I don’t want to. But my clients know what’s going on. If I said, “Buy now, you’re going to miss it,” I’m going to insult their intelligence.
D.H.: I have to disagree. If you’re going to live there and raise a family, and you try to wait for that perfect time, you might miss something you like. [But] if you expect to become rich in a day or two, forget it.
Now that was months after I gave the note out to clients; something not many brokers would do as it all but secures that you will not get a sale anytime soon. The best buying opportunities came about 3-4 months after that article was published.

In a sales based industry, the longer term is often sacrificed for the sake of getting some deals done today! And there is absolutely nothing wrong with this - it is what it is and you cant fault brokers for trying to make a living. Its all a matter of the agent's model for their own business and whether they are more concerned with the long term and building a solid referral based business with a high quality foundation, or doing as many deals as possible today by mastering the art of selling. There are some great salesman out there and we shouldn't fault them for that. After all, being a good salesman is one major ingredient for success. But when its overdone it is counterproductive and the customer probably will choose to work with someone else.

In my opinion, the best service an agent could offer me is information on what is going on in the market real time and where it is trending so that I could better assess what is happening with property values and how to bid when the time is right. The internet has gotten transparent enough where listings are only a mouse click away - no longer do you really need a broker to see what is available for sale. What I don't want is someone insulting my intelligence by telling me to 'buy now or be priced out forever' or that the market 'can't fall more than 5% because of sideline buyers & foreigners' - that to me is the kind of shit that adds to the poor reputation of agents as a whole. And that stigma will be hard to break. This industry has work to do or change ahead of it - either way, better business will win out and in the end its the consumers that will benefit!

Transparency is GOOD!

Bank COPs and Bank Robbers

Posted by jeff

Wed Aug 12th, 2009 11:56 AM

Keystone%20Cops.jpgWe have been seeing and feeling the impact of the bank robbers for a couple of years now. It is time that we contemplate the reactions of the bank cops. Noah's post on the accounting shenanigans going on in the banking industry are part of the age-old back and forth of real estate cycles, financial market crises and banking system resuscitations. For those with a mind for history it is worth noting that the real estate market, which was riding a wave of speculation centered on Florida, peaked in 1926, 3 years before the stock market peaked and well before the Depression set in. Only after the Depression set in did waves of bank failures follow.

The rolling regional real estate crashes of the mid- to late 1980s, precipitated a savings and loan crisis that dragged on and on, but the true credit crunch didn't hit until the early 1990s well after the stock market crash of 1987, when recession finally took hold. It was during this period that regulators "got tough." It was actually 1989 when the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) regulation went into effect. It was following this that bank regulators began cracking the whip on financial institutions, in effect forcing the clean-up of the toxic assets that had been collecting for half a dozen years. Some would argue that they also precipitated the credit crunch. In fact, banks eventually ended up reversing billions in charge-offs they were forced to take by regulators in those days.

It is clear that bankers are anticipating a repeat of history this time around. Unfortunately I think they are likely to be wrong and I will discuss a few reasons why in a future piece. Today let's just focus on the current state of affairs in the banking system.

The cataclysmic mix of Lehman and AIG going under, interest spreads blowing out, credit default swaps imploding and money market funds busting the buck collaborated to force the government to switch from a policy of remediating bad debt through "resolution" as they did in the 1990s, to throwing a TARP over them so that banks could claim solvency and forestall a massive bank run. As noted in the recent report by the Congressional Oversight Panel (COP) on the continued risk of troubled assets:

Given such market conditions, Secretary Paulson and Chairman Bernanke
recognized that Treasury needed to use the authority and flexibility granted
under the EESA as aggressively as possible to help stabilize the financial
system. They determined the fastest, most direct way was to increase capital
in the system by buying equity in healthy banks of all sizes. Illiquid asset
purchases, in contrast, require much longer to execute......

Now, ten months after its creation, TARP has not yet been used to purchase
troubled assets from banks, although the capital infusions have provided breathing space for
banks to write-down many of these assets and to build loss reserves against future writedowns
and losses.

The report goes on to comment on the undesirable effect that TARP is having on bank lending (as predicted here way back in our January 5 2009 piece entitled "Excess Reserves Go Berserk As Lending Flatlines")

The uncertainty created by the financial crisis, including the uncertainty attributable to the troubled assets on bank balance sheets, caused banks to protect themselves by building up their capital reserves, including devoting TARP assistance to that end. One byproduct of devoting capital to absorbing losses was a reduction in funds for lending and a hesitation to lend even to borrowers who were formerly regarded as credit-worthy.

The report rightfully points out the continued risks to the economy and financial system that are not being addressed as long as losses are not taken and cleared off banks' books. But why clear these loans if you are not forced to and you believe that these assets will be worth more in the future?

If the economy worsens, especially if unemployment remains elevated or if the
commercial real estate market collapses, then defaults will rise and the troubled assets will
continue to deteriorate in value. Banks will incur further losses on their troubled assets.
The financial system will remain vulnerable to the crisis conditions that TARP was meant to

The problem of troubled assets is especially serious for the balance sheets of small
banks. Small banks' troubled assets are generally whole loans, but Treasury's main
program for removing troubled assets from banks' balance sheets, the PPIP, will at present
address only troubled mortgage securities and not whole loans. The problem is
compounded by the fact that banks smaller than those subjected to stress tests also hold
greater concentrations of commercial real estate loans, which pose a potential threat of high
defaults. Moreover, small banks have more difficulty accessing the capital markets than
larger banks. Despite these difficulties, the adequacy of small banks' capital buffers has not
been evaluated under the stress tests.

Why will the banks who were stupid enough to make these loans....and we all know now that it wasn't just sub prime credits or highly leveraged corporate buyout loans, but also aggressive lending across the board from credit cards to commercial real smart enough to predict when these values will come back?

Circling back to Noah's piece on the changes to GAAP accounting for loan losses, the COP report also touches on the negative effects of letting the foxes guard the proverbial chicken coop of bank accounting:

The details of these accounting issues are less important than their impact. As a
result of the crisis, asset values are uncertain. By increasing bank managements' use of
discretion in valuing assets, the new rules reinforce the underlying uncertainty in valuation,
especially because banks may not apply the rules in a uniform way. Thus, there is no way
of knowing whether a bank's assets are of a sufficient realizable value to support the bank's
liabilities, let alone to preserve the capital necessary to support lending. To lower the risk of
this uncertainty, banks, especially large banks, have reduced participation in the credit
markets. Whatever the merits of the new accounting rules, their application adds to the sort
of uncertainty on which financial crises feed.

I will make a prediction right now. At some point the government, unhappy about further deterioration of banks' balance sheets and or their inability to lend to individuals and businesses who at some point will want to borrow again, will force the issue through the use of regulatory pressure. When this happens we will see another leg of the liquidity crisis. The tough love approach was untenable during the heat of the financial crisis of late 2008, but the Treasury was later forced to make a show of its largesse being justified, through the "stress tests" that followed the bailouts.

Until regulatory reform is accomplished, following the obligatory turf wars of course, the persecution of the banks will not begin. So we have some time before the bell tolls for the banks. In fact, we may go right through the period of inventory restocking and "renormalization" of the economy to a new equilibrium level of GDP and consumer deleveraging. Of course, bankers' optimism relative to loan values will only increase over that time, making them more recalcitrant in dealing with their likely losses.

Prechter: Next Wave Down May Be Bigger

Posted by urbandigs

Wed Aug 12th, 2009 08:28 AM

A: The Elliott Wave International founder that was a bear turned bull in Feb 2009, just weeks before the market made its most recent lows and started a fierce 50% surge lasting 5 months, is now turning bearish again. The wave technician is most famous for calling the 1987 market crash and most recently telling shorts to cover in FEB as he predicted a sharp rally in the S&P to about 1,000 - 1,100. Well, we hit just above 1,000 and now he is changing his tune again calling for a bigger wave down. Is he right? Will the next wave be bigger than the first?

Now Prechter has not been so good at his short term calls for equities and recent calls for gold, so lets not just ignore the critics of his calls. But to get the general calls right starting from the rally into the summer of 2007, turning bearish in July 2007 (a bit early) and then turning bullish in late Feb 2009 (spot on) predicting a large B-wave rally, is noteworthy. Now he expects the rally to be near its end and for a larger wave down to be ahead of us. The problem with technical analysis is the backward nature of it and the lack of clarity upon making interpretations. What may look like an a-b-c corrective price movement could in effect prove later on to be something totally different. So, you always must use caution. Nevertheless, calling to take profits and to exit long positions after a 50% move up is simply very hard to argue; even if you miss out on another 10% upside.

Before the next wave down comes though we must first get through the 'restocking of inventories' and the natural leveling off of the pace of economic declines (the so called second derivative). The fierceness of destruction we experienced simply was not sustainable. As you see data get less worse, markets equalize and appear to be on the road to recovery - behavior changes and optimism grows further feeding the move. It seems the 'less worse bull market' that Jeff predicted over a year ago has been in full gear since early March - a 45% move higher and here we are wondering what's next?

If anything, I think the next wave down will be more drawn out and will usher in the next phase of this crisis that gets into the unintended consequences of policy actions already taken to stem the first wave of this crisis - at the same time that we have fundamental pressures with balance sheets. This is where you see bankruptcies soar, unemployment reach its peak, defaults reach their peak, state budget issues coming to a head, govt contraction of jobs after almost 2 years of surging job creation, rising tax implications of such high deficits, spreading of toxic assets to higher quality debt classes, fed unwinding of stimulative policy, and accounting changes reversed that helped us through the first wave. I am still in the deflation camp for 4 major reasons, with inflation concerns largely just that, only concerns, right now. Commodity inflation is quite different than inflation created by credit expansion, wages rising, and capacity constraints causing too few goods - just because the price of oil rises, doesn't mean we face inflation problems like we did in the 70s; we learned that lesson big time last year. I recall many arguing to the death that speculation played no role in $145 oil, and that it was all supply & demand - ha, yea right! How could you have inflation when your dollars today can buy almost twice as much house (in the most hard hit markets) and only a few months ago almost twice as much stock as you could near the 2006 & 2007 peaks respectively? Food for thought.

I think this episode of severe debt deflation will come in stages and the next stage may be defined by pressures on banks in the following ways - again, timing is the unknown:


a) whole loan (accrual) book marks coming down as these assets do not have to be marked to market
b) commercial mortgage back securities
c) prime, jumbos
d) financed private equity LBOs


e) off balance sheet accounting changes that may see assets moved back onto balance sheet, and affecting capital ratios
g) continuing problems in alt-a
h) alt-a recasts, NOT resets
i) loan modification re-defaults
j) credit cards

Now, should these pressures manifest itself in another wave we will likely see the following happen as traders start to trade out, delever to raise cash, and rush to safety:

1) Dollar Will Strengthen
2) Treasuries Will Rise

Recall Fisher's Debt Deflation Theory that sees dollar strength during the course of the deflationary episode. A strengthening dollar can put pressure on future earnings for the large multinationals and that could feed the down move further - recall that during the period of July 2008 to March 9th, the US Dollar rallied about 25% while equities fell about 45%. Clearly the markets didn't like a strong dollar as the fear level hit its peak and investors rushed for the safety of the almighty greenback.

In regards to the fed printing and the dollar negative policies of the administration, that is where I am torn. On one hand, I think that these policies are very dollar negative and will produce unintended consequences yet on the other hand this money is being partially sterilized and hoarded in excess reserves - not lent out; therefore it is NOT producing the multiplier effect that our fractional reserve banking system was designed to do. So, if credit is contracting, defaults/unemployment rising and printed money is being hoarded, how could you support an inflationary argument? If we do have another wave down the deleveraging process that is usually ridden with fear will have the 'Lutnick Effect' of constraining treasury yields. So a rush to dollars and a rush to treasuries may make credit indicators once again go out of whack, thereby feeding the animal behaviors that engulf the tradable markets.

I dont think the wave down will be nearly as fierce as what we just experienced, but I do think it could be more drawn out and painful as the real effects of this debt deflatonary tsunami take hold. We just need to go through it and heal balance sheets by writing down toxic loans properly, getting through the defaults, restructuring, and reorganizing the business to this new world. We cant expect a 'less worse' dynamic to yield a sustainable new boom; thats just silly. Markets are not always rational and they may temporarily ignore the depth of this crisis that will last years, not quarters. If all was well again with our banking system, we would not need a zero interest rate policy, a quantitative easing policy, and 19 other credit facilities to help provide more liquidity to the credit markets. Yet we continue to see those policies in place. Why? Because the banks continue to need to be recapitalized back to health and the fed is trying to engineer an environment suitable for that to happen. The unwind of all these policies and the rising of rates may in fact be the catalyst that sends us into that double dip. The question is when do we feel it?

For the record, I do feel that the recession that started in DEC 2007 is likely over or will be declared to be over within a month or two from now
. That would put this recession length at about 21-22 months or so, the longest since WW2. Looking ahead, we can easily see stimulus / restocking of inventories induced growth for 3-4 more quarters before seeing that die down and the pressures I noted above revealing themselves again - fundamentally you can't call America healthy yet. Don't forget how much money the banks raised over the course of this rally that could get them by for a while longer. Looking ahead, double dippers will have to push out their predictions for a 2nd, less fierce recession to the 2011 - 2012 timetable. That is about where I am at now.

Marking The Whole Loan (Accrual) Books

Posted by urbandigs

Tue Aug 11th, 2009 03:48 PM

A: When CSLA analyst Mike Mayo warned about the whole loan (accrual or 'hold') books on the banks balance sheets back in early April, he got the idea right but not the timing. Putting yourself back into time & place, the call had merit but when looking back today in hindsight many may say Mayo didn't know what the heck he was talking about. Afterall, if he was right then how the heck could the market and the bank stocks see the whopping rallies they have seen over the past 4 months. Now here is the deal - banks actually have wound down and marked down tons of mortgage backed securities that were supposed to be marked to market. When the FASB tweaked the accounting rules for assets marked-to-market, something the banks lobbied heavily for, I'm sure the behavior stopped or slowed big time. But nevertheless, most of the marks for these securities have been drastically lowered. What has NOT been significantly lowered, in terms of book valuations, were the whole loan books that are accounted for as 'accrual' or 'hold to maturity' books and do not require a daily mark to market adjustment. Rather these books are marked down as the whole book starts to nonperform and loan losses are provisioned on a quarterly basis. Is this where the meat of the concern should be?

First a quick explanation on "Mark-To-Market" vs "Accrual Book" accounting tactics from a quant trader over at

"...a mark-to-market book will always be changing value. Usually trading books and hedge funds are marked-to-market. All liquid products and futures are marked-to-market. It usually means you have to fund the positions via some funding rate because you're probably not just putting cash up directly. You may have margin calls on the marked positions. For exchange traded securities the exchange closes are used as daily marks. For illiquid assets (i.e. those illiquid sub-prime mortgage securities that everyone's whining about), you often mark to market as well (by getting dealer prices on a daily basis, for example). A mark-to-market book must be sensitive to the daily changes in risk and PnL.

An accrual book does not need to worry about a lot of the above. The assumption is that the assets being held are not held for risky reasons, they are being held for accounting reasons. Thus it is less likely the assets will need to be quickly liquidated. These accounts tend to hold stuff longer, make bigger moves and not be as concerned about the daily PnL of the book. On an accrual book, the long term view is the most important. Traders and portfolio managers will make sure their macro view is correct and their liabilities are hedged for the long term."

This was the basis for Mayo's argument in April as he stated:
"New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average."
That '$0.98 on the dollar' remark was in regards to the whole loans held on accrual books of the banks balance sheets - NOT the pools of loans that were securitized and held as mortgage backed securities and marked down big time. The damage that we saw in 2008, with all those write-downs, was mainly from marks being adjusted to these securities (not the whole loans) as they were adjusted to the market price that happened to be severely pressured. The damage was done and the marks were reset until the FASB put a stop to the madness with the suspension of M2M accounting requirements. But the whole loan books didn't have to be adjusted. I refer to the NY Times, "Are Bailouts Part of the Problem?":
"Thus far in the crisis, banks have mainly written down the value of securitized products that were backed by pools of loans including mortgages. Accounting rules generally forced financial institutions to take multbillion-dollar hits to their balance sheet by marking down the value of those securitized products to market prices. But banks aren’t required to write down the trillions of dollars in whole loans on their books, because they are classified as being “held to maturity.” As such, they can keep the full value of the loan on their books until the loan term ends — or the borrower defaults."
That is how I described it to you back in April after seeing Mayo's comment about loans only being marked to 98 cents on the dollar - "but from what I am hearing many of these loans are marked down more and sitting on 'accrual (hold) books', which are marked on the spot based on loan defaults and overall book performance. Loan loss provisions are done on a quarterly basis, not as assets stop performing. If the total loans in the book deteriorated 5%, well then the entire book is remarked down 5% from the previous mark or par. It's backward looking".

So, how much is out there in the whole loan book world? Trillions! Where are those books valued? How unrealistic are the valuations? When you hear talk about a 'lost decade' or 'zombie banks', it is stuff like this that makes the problem never seem to go away. Could the whole loan books be the source of this prolonged problem? Quite possibly.

Today we see 3 headlines ushering in concern over the banking sector after a fierce 5-month rally:

a) Bob Prechter Calls For a 2nd Larger Wave Down Ahead
b) Dick Bove Says Bank Earnings Wont Improve in 2nd Half
c) Congressional Oversight Panel Warns of Continued Risk of Troubled Assets

The Congressional Oversight Panel uses this phrase on the future risks:
"The nation‟s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and that are very difficult to sell without banks experiencing substantial write-downs that can trigger a return to financial instability. Whatever values are assigned to these troubled assets for accounting purposes, their actual value and their potential impact on the solvency of the banks that hold them are uncertain and will likely remain so for some time; the degree of uncertainty is difficult for anyone to estimate confidently."
What are your thoughts? Have the bank stocks moved too far too fast in reaction to the fed engineered recapitalization environment? Or, are the Whole Loan Books a whole lotta nothing to worry about?

Quick Manhattan Update

Posted by urbandigs

Mon Aug 10th, 2009 09:50 AM

A: Content will be light for a while folks as Jeff & I work on the next phase of UrbanDigs. For now, here is a quick update on the Manhattan market as this one broker/blogger sees it. The market is still considerably more active than it usually is for this time of year yet, it doesn't seem as crazy as it was during the months of May & June. My thoughts on that are a combination of the timing of sharply lower prices, buyer control during negotiations, reflation trade mentality, and a confidence boost that the deep recession is nearing an end as stocks surge and price in recovery. By far the most important part of the equation was lower prices across all price points. In short, this market had a wave down in prices once thought impossible that reached a comfort zone where buyers were confident enough to jump back in and buy property.

The change in psychology affects both buyers & sellers; buyers, while more confident with Armageddon seemingly off the table, still want the discounts that this market seems to offer and sellers want the highest price possible now that stocks have rallied and green shoots are being discussed everywhere. It takes two to tango so if either buyer or seller psychology get altered too much in one direction, we may see another disconnect in our marketplace leading to much slower sales volume than what we saw over the last 4 months or so. The rise in contracts signed + the number of listings removed from the market has had an effect on total active inventory; with what appears to be a 15% drop since the recent top of about 11,200 listing in early June.

Here are a few month-to-month comparisons (comparing the periods of Mid-June to Mid-July against Mid-July to present) of important metrics for all Co-ops & Condos in Manhattan; this is the closest thing I have to real time information as it happens so do your own interpretations - generally speaking, for seasonal markets its best to derive interpretations from year over year trends to filter out a seasonality effect:

- $1,391,247, or down 0.42% comparing prior two 4-week periods
NUMBER OF PROPERTIES SOLD - 731, or up 51% comparing prior two 4-week periods
LISTINGS REMOVED FROM MARKETPLACE - 1,348, or up 50% comparing prior two 4-week periods
NEW LISTINGS - 942, or up 0.21% comparing prior two 4-week periods
CONTRACTS SIGNED - 1,030, or up 4% comparing prior two 4-week periods
LISTINGS WITH PRICE CUTS - 955, or down 15% comparing prior two 4-week periods
AVERAGE PRICE PER SFT - $1,088, or down 0.91% comparing prior two 4-week periods

Again, imagine if you have two four week periods (6/15/2009 - 7/13.2009 against 7/13/2009 - 8/10/2009) and you want to compare how the market has changed. Above is the answer and unfortunately I don't have any access to more data prior; I wish I did!

So what are we seeing:

a) average listing price is down
b) number of properties sold is way up - this is reflecting contracts signed 2-3 months prior and shows the activity we had during the months of May & June compared to the frozen few months before; never forget the lag this market has between contract signing and closing.
c) basically the same amount of new listings hitting the marketplace
d) big increase in listings removed from the marketplace either for personal or seasonal reasons; this is certainly affecting inventory trends too
e) significant drop in price cuts - hmm, interesting, perhaps sellers really are getting less motivated to lower their prices with the recent surge in equities and MSM's green shoots
f) still a healthy number of contract signed that will likely lead to a solid Q3 and even a Q4 report when they come out; the Q4 or Q1 report will be especially interesting as it is compared to Q4 of 2008 and Q1 of 2009 that were practically frozen and defined the correction

All in all, it's proof that more activity is not a sign of rising prices. Prior to Lehman, prices were still near peak levels and were disconnected from the reality of this crisis. The market froze up and buyers disappeared UNTIL prices came to a zone that were more in line with the reality of our new world. That freeze up lasted roughly six months, perhaps with denial playing a big role for sellers in the beginning of that corrective wave down - leading to such light sales volume. Then reality set in, sellers were willing to accept that the market was discounting their property at a certain % down from peak levels, and deals started to happen! The natural forces of the marketplace at work - a wonderful and healthy thing.

With the average listing price still down, real sellers know that the market is still trading in that comfort zone reached with the first wave down in prices. If that comfort zone represented a range 'down from peak' (see my tiered price adjustment opinions here), then I would argue that this market recouped some losses and is trading at the lower end of those ranges down from peak depending upon price point. This was the markets way of equalizing itself from the Armageddon / Fear trades that occurred in February & March - in short, the market has priced OUT Armageddon as it overshot to the downside when it was pricing in Armageddon earlier in the year.

That's the best I can offer you guys right now. Working on delivering a better system for you in the future!

Here Comes the Long Hangover..But First a Few More Drinks

Posted by jeff

Mon Aug 3rd, 2009 08:52 PM

Doing%20Shots.jpgI'm feeling better about the economy! Despite the fact that my wife was recently laid off and our world is being rocked by forces beyond our control, I am actually feeling much better about life for the rest of Urban Digs readers, in the short term.

I was driving back from a long weekend upstate when Bloomberg played some interviews with Timothy Geithner and the Maestro himself, Alan Greenspan. Geithner was interrogated by ABC's "This Week" interviewer George Stephanopoulis on the budget deficit and how the administration was going to deal with our staggering debt load. Now my predilection, from reports about Geithner prior to this crisis, was to like him. My understanding was that he was a fair-minded individual, firm in his convictions and adult in his conduct. But hearing him interviewed, I couldn't help but feel he was another silver-tongued bureaucrat (and apparently not always so). Despite being completely backed into a corner by the interviewer and asserting several times that "We will do what must be done" regarding not only decreases in spending but also the obvious need to raise government revenue, Geithner steadfastly refused to admit that taxes needed to be raised. He was clearly hiding behind the idea that once the economy is stabilized then we will do what must be done, when he said:

“We can’t make these judgments yet about exactly what it’s going to take and how we’re going to get there.”

That attitude unfortunately seems to embody a relentless optimism that still lurks in the American psyche - one that I am not sure is justified, given the financial pickle we're in. I see this optimism in banks that are routinely reporting much higher non-performing assets, but raising their charge-offs much less than those increases. It seems that they think that when they get the properties back and sell them, they will end up being made whole. This thinking rests on the idea of a durable recovery that boosts rents and convinces buyers to lower the risk premium they are currently demanding to provide liquidity of any kind in this environment. It also embodies a belief that debt to bolster purchases of assets will be made available, by someone whose balance sheet hasn't blown up (anyone fitting this description please contact me, particularly if your current plan isn't to sit on the sidelines for a good long time before putting any of your carefully shepherded capital at risk).

Of course, fixing healthcare was paramount on Geithners' list of what the administration hoped to do to address the long-term financial problems of the U.S., but paying for the "fix" was not something he would elaborate on. Geithner had only praise for even the detractors like Robert Altman, the past Deputy Treasury Secretary, and the office of OMB, who are challenging the fuzzy math on healthcare reform and deficit reduction. He explained why they didn't get it and the administrations' great respect for all dissenting opinions (at least when they come from persons who might matter to public opinion).

The Geithner interview was followed by an interview with The Maestro, who in his prior appearance averred that the financial system meltdown was by far the worst he had ever seen and still had a long way to go (this was of course right about the time of the bottom in world stock markets). I know it will come as a great relief to all of you that Greenie the Great One now says that "collapse, I think, is now off the table." While he worries about a potential double dip in the housing market which could cause "a significant acceleration in home foreclosures," Greenspan believes that we have likely already hit bottom on the economy and that we will soon see positive year-to-year growth in GDP, as soon as this quarter, albeit accompanied by continued, though decelerating, job losses. Greenspan, though noting Geithner's praiseworthy diplomacy, voiced certainty that the government will need to eventually raise revenue in order to fund the Medicare shortfall being imposed by the negative demographic effects of aging baby boomers. His belief being that the least-worst solution would be a VAT (value added tax). Greenspan also speculated that interest rate increases could be needed sooner than Ben Bernanke's forecast of a couple of years out.

So with the S&P 500 just points away from a 38% Fibonacci retracement of its recent crash, let's step back and reassess. Economies overshot on the downside due to the CNN effect of collapsing markets. Inventory liquidation, coupled with a lack of financing for big-ticket items, caused a draconian cutback in industrial production, well below even recession-adjusted demand. Let's do a little quick math on how this worked. As an example, in the U.S. we scrap about 12 million cars annually due to obsolescence and we add about 2 million new drivers each year, so base demand is maybe 12 million automobiles per year. If we knock 1 million off this for a wicked recession, we get to base demand of 11 million units per year. Now the rate of sales fell to an annual rate of less than 10 million earlier in the year.


With some rays of light on the economy shining through, some return of financing and the cash for clunkers program (pulling forward future demand), JP Morgan analyst Himanshu Patel says demand could rebound to a 13 million annual sales rate. This situation has occurred throughout supply chains across the world. Electronic supply chain management and just in time inventory practices almost assure that in a shock situation - which few would deny the Lehman/AIG/Money Market Funds debacle was - inventory and production will be cut well below sustainable demand, even when that sustainable demand has been significantly reduced.


As I have discussed here recently ( "Every Upturn Starts with Restocking") it's going to take quite a restocking effort to get back to a reasonable rate of economic activity despite the actual decline in consumer purchasing power. Not only that, as Greenspan pointed out in the interview, consumer purchasing power is highly variable, as the stock market has just re-instated some $3 trillion of consumer wealth that was previously taken away.

It is for this reason that I believe that we will see at least a couple of more quarters of strong economic rebound and one to two quarters of public companies surprising to the upside on earnings estimates. Let's look at the puts and takes:


  • Inventory rebuilding

  • Continued stock market increase and wealth effect

  • Capital raising/balance sheet bolstering

  • Exports and commodity demand

  • Stimulus money still to come

  • Restructured industries regain pricing power/margins (e.g., banks, brokers, auto dealers)

  • Negatives:

  • Business cash flows which are paradoxically bolstered by declining needs for working capital while shrinking, start consuming working capital as they begin to gear up production again

  • Energy/Commodity cost rebounds

  • Interest rate increases

  • Increased savings rate

  • Continued losses on longer-tailed assets like real estate hamper banks' ability to provide credit to meet additional demand

  • Government size/budget deficit reduction a drag on the economy

  • State size/budget reduction drags

  • Higher taxes
  • My guess is that the stock market will begin to figure out that the opposing forces at work in the economy will result in very slow GDP growth and a modest future outlook, sometime before year-end and markets will begin to adjust. I don't think it will look anything like the bear market we have just been through, but it could be the beginning of a multi-year period of ups and downs, like the 1970s or the last Japanese decade. But first let's party like it's 1998, just one more time.

    It Takes Two To Tango: Are Buyers On Board?

    Posted by urbandigs

    Mon Aug 3rd, 2009 09:08 AM

    A: It takes two to tango and to make a deal happen both buyer & seller must have a meeting of the minds. So we went from a frozen market in late 2008, to a fear based market in early 2009, to a reflation trade market over the past 4 months. Is it right? Who knows, its the market and the best I can do is tell you what I see out there now and where we may be in the cycle. I don't see a sustainable uptrend in bids just because stocks say so, as buyers don't seem to be fully on board the gravy train. But this fierce equity rally may just be enough to alter the psychology of sellers and slow this market down a bit. Unless buyers change too we will see a disconnect again leaving brokers and those same buyers wondering what the heck is going on.

    We had a nice down move with prices more accurately reflecting the macro pressures than they did at this time last year; even though the warning signs were everywhere in AUG 2008. So, the process started and that is healthy. But as equities rallied, and rallied hard I might add, we saw a surge in deals recently and a subsequent 15% drop in active inventory - below is a 6-month chart of Manhattan Active Inventory:


    Is the bottom in? Well no doubt there are real arguments to be made about that with Jeff's 'less worse bull market' seemingly in play - a great call almost 3 months ago by Jeff. Given the amount of fiscal/monetary stimulus in the system we no doubt will see improving economic data outside of the unemployment rate - which will lead most, including me, to think that the worst is behind us. I actually can see this spurt lasting a good 3-4 quarters and who knows how confidence will be affected. But why doesn't it feel over? Well, because unemployment is rising, people are cutting back spending, jobs are not so easy to find, some developments are stopping work, retail is showing signs of the distress, etc.. So for many, there is no reflation. But for stocks, reflate away!

    Combine reflation hopes and less worse data with an unstoppable equity market and it could easily affect both buy side and sell side confidence in the following ways:

    1) Buyers - buyers could be convinced to throw in a stronger bid or be motivated to pull the trigger on reflation and recovery hopes; the old 'buy now or be priced out forever' is likely to be replaced with the broker tagline 'buy now or miss the bottom'.

    2) Sellers
    - sellers may not be as willing or motivated to hit a bid that is deemed too low and otherwise depicts where our market currently is trading. As stocks fly and reflation hopes dig in deeper, this mental change may be exaggerated. Crazy, but true. Pricing in downturn risk gets increasingly difficult when stocks surge as sellers don't bite if they feel their property was improperly valued with the first wave down. Sellers will look to anything to rationalize that their property is worth more than it was only 3-4 months ago.

    Combine the two and you have confused buyers and more hopeful sellers. Which will be the stronger force? Its all fine & dandy if the effects on both sides of the deal are equal, but in my humble opinion they are not. I am finding buyers to be very confused right now and choosing to be cautious rather than aggressive in dishing out a strong bid to entice the seller to accept. While buyers seem fine paying market value for properties today, they do not seem fine paying a premium over that just because stocks are flying - yet some sellers are demanding that. This has happened a few times to me in the past couple of weeks - as sellers seemed to change their tone and expect a bid significantly higher than only a few months ago to move property. Has the market really bounced that much OR is this market simply pricing out fear and equalizing itself? My bet is the latter. Stocks and real estate are two different animals and just because one is rallying doesn't mean the other has to. Real estate is more closely tied to the jobs market, incomes, lending rates/affordability, credit, rental rates, supply trends, and confidence in the asset class. Stocks can move for a variety of different reasons.

    Keep in mind one thing: this equity rally may have an unintended consequence for Manhattan sales volume IF buyers refuse to get on board with the reflation gravy train! This is what may surprise some out there. Its easy for a homeowner to argue for higher housing prices but if your a potential buyer, you need to have strong beliefs to put your hard earned money where your mouth is. And in the end, it's all about the buyers willingness and capacity to pay higher prices and close that deal.

    You need two to tango so if sellers get more optimistic, buyers must too or we will have a stalemate/disconnect! For now, the 'less worse' rally continues and this spurt will feed on itself and likely produce better numbers in the near future that can ingrain the recovery mentality. Those expecting a double dip, including myself, must push back any predictions for a 2nd wave down by at least multiple quarters as it is easier to dip down from much better levels than it is from uber-distressed levels - now is the process that sees data get better or less worse, what I question is the sustainability of it over the longer term.