Warning: This article contains other shocking images which may disturb those with exposure to U.S. debt or equity instruments.
I just got a chance to wade through the latest Federal Reserve Bank data on asset quality. Apologies, as these figures, which usually come out around the twentieth of the month after a quarter end were actually out November 16 and are now a few weeks stale. I haven't seen much written on these statistics in recent weeks, however and I personally like to track the bad debt debacle using this quarterly data for reasons I have outlined previously, not the least of which is the fact that these are not "mark-to-market" figures. These numbers represent debt at a large cross section of banks that has gone delinquent, i.e., the borrower has stopped paying, rather than write-offs of debt that is expected to go delinquent or has suffered a significant decline in market value. As the recent rally in credit markets has demonstrated, trading values of debt can display significant swings based on factors far removed from the credit worthiness of individual borrowers. You just have to look at what has happened recently with Dubai World's debt which recovered, post the world financial crisis, to above par only to crash to 40 cents on the dollar in a couple of days - to understand how volatile debt values can be in the marketplace.
Let's get right to the punchline. The Q3 bank delinquency data are awful in general. The only positive things that can be said about it are:
1) Delinquency rates, while at historically record levels for various types of bank loans, did not accelerate quarter to quarter across the board as commercial real estate and credit card delinquency increases slowed in basis point terms from the Q1 to Q2 09. However, all delinquent loans as a percentage of all loans at banks regulated by the Federal Reserve reached an all-time record high of 6.87%, eclipsing the prior peak of 6.33% in Q1 of 1991. The overall number did accelerate, increasing 72 basis points from Q2 to Q3, after a 45 basis point rise between Q109 and Q209. Call me Chicken Little, but I am still worried about the U.S. banking system, TARP or no TARP, stress tests or not. Seeing the FDIC run out of money, while these numbers are still getting worse gives me the willies.
2) Charge-offs have moved up much more aggressively in this cycle, versus the late 1980s, (View image) to early 1990s rolling real estate down cycle. This suggests that despite all of the "kick the can" debt restructuring going on, a lot of bad debt is being written-off. Which should bode well for a quicker resolution of the junk clogging up the system. However, it is very possible that banks are modifying loans, keeping owners in properties and taking a smaller charge-off today in hopes of avoiding a bigger one, if they took properties back today, took their lumps and sold them into a distressed buyers' market.
3) Credit card delinquencies look like they may have peaked two quarters ago (View image), which may be taken as a small ray of light indicating improving health for the critical "consumer economy". However, much more restrictive policies by credit card companies have definitely contributed to fewer better loans being made to better borrowers, which should be expected to produce lower loss rates.
On the other side of the coin are some more troubling trends:
1) Commercial & Industrial Loans which turned up late in this credit cycle, as a result of the Lehman induced economic free fall, continued to go delinquent at an accelerating rate (View image). With delinquencies rising 80 basis points quarter to quarter after a 51 basis point rise from Q109 to Q209. This suggests that un-employment trends may not yet be ready to turn the corner as banks may continue to be nervous about extending loans for new business expansion and creation for some time to come. C&I delinquencies have now surpassed the 2000 recession cycle peak of 3.93%, having reached 4.46% of all C&I loans in Q3, although they are still well below the 1990 cycle peak of 6.58%.
2) Residential delinquencies, which remain obnoxiously bad (View image), got worse at an accelerated pace in Q3, increasing 123 basis points quarter to quarter, versus a 44 basis point rise from Q1 to Q2 of 2009. This could have been a result of some catch up in foreclosure activity after a period of bank attempts at forbearance and loan restructuring earlier in the year. Nonetheless, this trend is especially troubling, after the long period of real estate price declines, and an apparent stabilization in the last six months with the help of much government impetus.
A: Interesting tag for it, but I am not sure I agree with it. While $80Bln is no small sum of money, it pales in comparison to the total credit losses taken since the start of this crisis; a total that is nearing $2 trillion. Yes, it was that much. Besides, already it seems that the UAE Central Bank will 'intervene' with a liquidity facility to calm the markets and contain the situation. What's interesting about the tagline for what occurred a few days ago in Dubai, is both the timing & situation that the 'debt service standstill' news came out in. That, and that alone, was the reasoning behind the carry trade discussions here on UrbanDigs about four weeks ago, a blog with a focus on Manhattan real estate.
According to Jim Bianco's, "Dubai – The First Credit Crisis Since March Market Recovery":
It appears this is the first credit crisis since financial markets began their recovery. So while many are trying to dissect the particulars of this case (Dubai gets its money from Abu Dhabi who will eventually bail them out), they are missing the larger issue. As we have been arguing for months, markets have been rallying non-stop on the back of cheap money. This carry trade has led to many bubbles in the markets. A solvency issue causes the dollar to rally (not good for the carry trade) and investors to “blink” from risk markets. This is not good when financing your entire position at 0%.Yes. Exactly. And this is why I stated:
This is more about the timing of the issue than the issue itself.
"Hard to time the end of this game or to predict the spark that may light the fire. Maybe its China? Maybe something else. Who knows - for now its ride the carry gravy train for as long as possible."...in my "Carry On! A search For Yield" piece only 12 days ago. That discussion focused on the $500bln or so that left Money Market Fund Assets to the outside of the curve, to stocks, to high yielding bonds, to securities tied to mortgages, to basically anything all in the search for yield! With the dollar as the funding currency and the fed/treasury backstopping and guaranteeing everything, the carry trade was on and getting dangerous. A number of events could have qualified as a spark to light the fire and cause a significant and notable unwind that hit global markets - and when global markets get hit, eyes open up. In this case, it came out of Dubai and the inability to service debt tied to some $80Bln in loans.
Now, in a housing marketplace where confidence was rebuilt on a weak foundation of a fed engineered reflation environment, the ripple effect to buyer confidence could be quick and noticeable. What I mean is, if this does sustain itself and prove to be a spark to a bigger fire, buy side confidence can quickly fall with the snap of a finger affecting our local markets for another brief period of time. That my friends is the reason why the carry trade was worth discussing here on this blog. Bianco is right, it is "more about the timing of the issue, than the issue itself".
I just wonder if this really qualifies as another credit crisis. With news that the UAE central bank is intervening, I'm sure the markets will get what they want; yet again. Therefore, at this point I think that calling this a 'crisis' is a bit pre-mature, although, worth keeping an eye on in the weeks to come. My eyes will be watching:
a) Libor - for interbank lending stress
b) Corporate bond spreads to treasuries - for corporate credit stress
c) TED spread - for interbank lending stress; flight to safety of treasuries
d) Countries CDS (credit default swaps) - for rising sovereign credit default fears
e) The US Dollar - for a flight to safety, sign of a sustained carry trade unwind
f) Commodities - for signs of a flight out of riskier assets, global growth concerns
g) RMBS/CMBS - for signs the reflation rally may be over
h) VIX - for signs of market nervousness and rising volatility
...all which could impact funding costs and the ability to rollover and finance existing debts. It gets bad when banks don't want to even lend to each other and short term lending markets start to freeze up. As of now, this is not the case from this event. I'll do a piece checking into these guys early next week to see if there was any jolt from this global situation. It'll be another credit crisis if the above noted indicators start to go haywire again. For now, its just too early and we don't know how the Dubai 'debt service standstill' may get fully resolved to sooth market jitters across the board. We will know more this evening when Asian markets and futures open for trading.
Some non-core assets that Dubai debtors hold and may hit the auction block here in Manhattan include (via NY Post):
I know that on Thanksgiving day it is incredibly impolitic to turn the attention away from the season's favorite bird, but I want to interrupt your holiday mirth with a warning. Risks in world markets are rising and it is now time to contemplate positioning for what could be a coming "echo bust". While my contrary nature had me looking for a bottom in the markets all too early and I turned reluctantly bullish this summer (Bull Market Break Out On Tap?), I am now becoming quite nervous about stock market performance in 2010. I am usually early, and I have been a reluctant bull and scale seller of stocks throughout this bull market and more heavily as of late. But if I learned anything in my years as a portfolio manager it was never to argue vociferously with the markets once a trend change was confirmed, but also to start thinking about what could cause a trend change before it comes, in order to be "mentally prepared" for it. So it is in that spirit that I share with you today, what has been on my mind lately.
I have been operating under a scenario, which may or may not be correct, but so far appears to be reasonably predictive of what has taken place in the markets. The scenario is that we had a lending bubble worldwide which popped in 2006 to 2007, helped by worldwide increases in central bank lending rates. What the markets really didn't understand as the bust unfolded was how interlinked world markets were, how much leverage (often off balance sheet) was in the system, and how dependent on fragile links and counter-party solvency some widely used financial products were (think mortgage and bond insurance, CDOs etc.) Likewise we didn't appreciate how much of the worldwide growth in prior years had come from "mal-investment" and how unsustainable the U.S.'s dealer/addict relationship with China was. The stock market which didn't appear to be wildly over-valued (by 1987 standards) at the top, in retrospect was very expensive in light of how much of the prior cycle's growth was unsustainable in nature.
The final leg of the stock market crash produced very cheap valuations, and was brought on by visions of Armageddon in financial markets (money market funds going bust and commercial paper markets nearly shutting down). This was all topped off by a "CNN Effect" in October and November of last year, when people were literally cowering at home afraid to spend any money.
Since that fateful time, governments and central banks around the world have taken debt off of consumer, corporate and bank balance sheets and moved it to their own. This has relieved the liquidity crisis, prompted a scorching rally in debt and equity markets and allowing significant debt refinancing and equity raising. Under my scenario, the reversal of the "CNN Effect" would lead to better consumer and economic performance than expected and could fuel a larger rise than many might have expected. I think that performance is now largely in the past (remember that the stock market discounts about 6 months to a year in advance) and it is now time to contemplate a future with a lot more heavy lifting.
We all know the list of challenges that continue in front of us:
Unemployment above 10%, with little hope for a significant reversal from any growth sources that can currently be identified.
Continued over-supply in residential real estate and a backlog of foreclosed properties overhanging the market, threatening the modest price recovery and presenting potential for another downward spiral.
Commercial Real Estate price collapse - with prices now down to 2002 levels according to a recent study by Moody's.
Recently several factors are beginning to make me feel that imbalances are again getting to tipping points, where the tactical moves that have been made by governments around the world may soon be set to run out of gas, throwing us back into a maelstrom of reasessment of the sustainability of the current world economic order and the band aids and duct tape approach taken so far to ameliorating the crisis.
After bankrupting Fannie and Freddie in the real estate run-up, the government brought forward its last best agency to try to hold back the flood waters of the real estate collapse - the FHA. The FHA continued the unsafe practices which produced the real estate debacle, namely "no money down lending". Officially the FHA requires 3.5% down, but you can finance part of this and with the $8,000 new home buyer credit, your at essentially zero down...again. Now the FHA is heading into a tailspin.
The FDIC, which acts as the backstop for bank failures is beginning to be overwhelmed by the cavalcade of corpses it is presiding over. Soon the FIDC will also become a member of the un-dead.
Now there is no guarantee that these well known and predictable issues will result in disaster, and I am not calling for that, however, the markets are beginning to sniff out the problems with already over-levered governments dealing with any additional asset deflation.
Credit default swaps on Dubai's and Greece's debt are starting to widen.
We are seeing increasing action/worries about sovereign debt downgrades (here and here).
Gold has entered the one-way trade zone - it goes up when markets go up and people put on risk and it trades flat to up when markets go down and people shun risk. As Noah has opined here before the rally in Gold reflects a loss of confidence in fiat money and governmental efficacy in dealing with today's economic problems generally.
Warning bells are beginning to ring and it is best to pay them heed considering the "Less Worse nature of this bull market". The fiscal first quarter is a seasonally weak one for many companies. The consequent lack of a steady drumbeat of sequentially better corporate and economic performance data will be a big test for the markets. It will be interesting to see if the market can subsist on easy comp driven, strong year-to-year growth numbers alone.
Lastly as notable from the chart of the S&P 500 on the left here, the market is getting close to major resistance levels from the period prior to the post-Lehman collapse. This is a natural point for us to see the kind of churning action of the last few weeks. the question becomes, whether this will turn into a real correction, something we have seen little of in this monster rally, or whether it might even turn into something nastier. Many are already wedded to the idea of a Japanese style lost decade, I am not yet in that camp, believing that our destiny is still in the hands of our leaders. However, I believe that we are coming into a period of much greater skepticism about what has been achieved so far.....in terms of market action. So be careful out there and have a safe and happy Thanksgiving.
A: I realize this is not a direct discussion of Manhattan real estate, but then again, when the ABX's started to plunge in the fall of 2007 that was also a topic I felt worth discussing as a sign that maybe a problem could be brewing in the secondary mortgage markets that could possibly signal a credit event and a stress to the banking system; a ripple effect that could and did ultimately hit out our markets. We have to continue to think outside the box and talk about the stuff that is not in the rear view mirror, but that may lie ahead of us and impact our markets. This is not a fear tactic, its a discussion of one possibly big unintended consequence of policy actions that were taken to stem the debt-deflationary episode we just went through to avoid a second depression. The latest warning comes from China's chief banking regulator. Meanwhile, Money Market Mutual Fund Assets continued their decline to almost $500Bln YTD.
I discussed the extreme positive carry that trade that is on a few weeks ago:
"With the fed guaranteeing everything and engineering such a low interest rate environment (basically to recapitalize our banks), almost all assets got a strong bid; yes, the crappy ones too. AN EXTREME POSITIVE CARRY TRADE IS ON!!Two days later, doom & gloomer Professor Nouriel Roubini released a statement on how 'the mother of all carry trades faces bust'. Now, China's chief banking regulator comments on the massive speculation built on the foundation of a dollar carry trade that is powering asset prices across the world. The WSJ reports "China: Loose US Policy, Weak USD Creating Speculation":
China's chief banking regulator on Sunday sharply criticized loose U.S. monetary policy, including the weak U.S. dollar, saying the situation is creating massive speculation in global asset markets.At some point this will end! For now, wall street is too focused on maximizing profits while the game is still on.
The U.S. Federal Reserve's promise to keep U.S. interest rates at extraordinarily low levels for an extended period "has already led to a massive U.S. dollar carry trade and massive speculation," Liu Mingkang said at the International Finance Forum in Beijing, which began just hours before U.S. President Barack Obama was scheduled to land in China on his first ever visit.
Liu said that the weak U.S. dollar and low U.S. interest rates are creating "unavoidable risks for the recovery of the global economy, especially emerging economies" and that the situation is "seriously impacting global asset prices and encouraging speculation in stock and property markets." In such a trade, investors sell currencies with low interest rates to buy higher-yielding units - a common theme in the foreign exchange markets that has already put the dollar under pressure in recent months.
The only reason credit is flowing in the short end, in libor, in agencies, in everything for that matter is because of the gov't guarantee that nothing will fail. Liquidity started with the fed and was multiplied by the street and global investors. Fed policy, post Lehman, is clearly that no large firm will be allowed to fail and as a result, excessive risk is being taken as investors are being forced to the outside of the curve to get return. It is no different than the last time. Money market fund assets are dropping like a stone as investors take on risk such as high yield junk bonds, stocks...basically everything all in the search for yield!
Here is a chart courtesy of my old trading buddy Anthony over at Momentum Trading Partners, showing us the YTD decline in money market fund assets as dollars chase yield:
*Click For Larger Image
Now that is money looking for return! Another clear of example of this is the disconnect between plunging commercial real estate prices and rising defaults in the commercial sector all while bids for CMBS surge. All asset classes have been affected.
Hard to time the end of this game or to predict the spark that may light the fire. Maybe its China? Maybe something else. Who knows - for now its ride the carry gravy train for as long as possible. One thing I learned about speculative episodes is that it they usually last far longer than people think and well after the alarm bells first start to go off. The unwind then occurs when the story is too dated to make headlines.
I am in St. Thomas right now and have been trying to find a way to weave the thoughts I’ve had on the island with some smart insights for UrbanDigs readers. What, oh what, do St. Thomas as NYC have in common … To generate some good blog fodder, I attended (for the first time ever) a timeshare presentation while bracing myself for whatever heavy sales pitch would follow.
… and what was the main thrust of the pitch? Rent vs. buy! (In this case, it was the idea that if you’re normally vacationing for 2 weeks/year over the course of 20 years, you’re paying $100k to rent your vacation, while you could be spending a similar amount to actually own something.)
Our previous post, A Kiss is Just a Kiss, An Ask is Just an Ask, generated so much discussion in the rent versus buy category that I saw this presentation as a sign to formally continue it.
So, let’s recap a few of the factors that are good, standard ingredients in a healthy rent/buy debate recipe, shall we?
• ½ cup: The rental price versus mortgage payments + carrying costs
• 1/3 cup: Tax and other government-subsidized benefits
• 2 Tablespoons: The above comparison with different down-payment scenarios
• ½ cup: The opportunity cost of that down-payment (careful of 20/20 hindsight)
• 1 Teaspoon: Transaction costs (and their amortization over time)
• A dash: The cost of capital, itself
• A pinch: Leftover liquidity
• 1 cup: Expectations on rising vs. falling real estate values over time
• 1 Tablespoon: the emotional benefits of owning
These are our standard, go-to, ingredients.
What I still can’t get my head around is where the heat comes from in these debates. It could just be that UD readers are passionate people who enjoy a meaty back and forth (though the heat is by no means limited to the UD playground). It seems to me, though, that people’s positions are relatively static over multi-year periods. An avid renter is not going to be convinced into buying over the normal course of the next year. Further, an outright buyer won’t be debated out of buying, regardless of what the numbers say.
I’m not finding similar debates on leasing vs buying cars, purchasing timeshares or [insert your preferred debate of choice here] I would personally love to hear from you three things:
1. Do we have all of the ingredients covered, above? Anything missing? The lack of availability of cheap and exotic loan products perhaps?
2. Where do you feel the heat comes from? What is it about the home purchase/rent debate that pulls those emotional strings?
3. Whatever your position in the debate, is there anything the “other” side could say that would sway you?
A: This may be true unless one area of the tradable markets force the fed's hands to raise rates earlier. Imagine a world with surging equities and oil/commodity prices on a souped up reflation trade - can $100 oil, $1,200 gold, and surging commodity prices impact the fed's thinking? How will that help anyone; especially the latter right as unemployment climbs to its ultimate peak for this cycle? As I mentioned before, in my opinion inflation will first come in the form of higher food, higher energy, higher metals, higher commodities across the board, higher taxes, higher rates, higher health care costs, etc..all the stuff that pinches corporate profit margins and squeezes consumers wallets. I don't see wage inflation being a problem for many years.
From David Rosenberg's Toast With Dave:
FED CAN'T RAISE RATES UNTIL AFTER 2011So, the main point is that the fed must continue to engineer a bank recapitalization environment for another 14+ months as commercial debt matures and future loan losses continue to be absorbed. This was part of my Wave 2 concerns that I put off until later 2010 and into 2011.
The reason — there is a wave of mortgage refinancings coming in the housing market for one, and not only that, but in the commercial space, there are 2.7 trillion of debt coming due through 2011 and another 1.5 trillion of leveraged loans (see page 24 of Thursday’s FT). In other words, the default rate is going to rise even further and the Fed tightening policy would only aggravate that situation. In other words, the Fed is simply immobile for at least the next two years.
I am of the camp that the fed won't raise rates until unemployment is shown to be stabilizing or at the very least, recovering. That may be a ways off but I wasn't thinking 14 months off. Maybe mid 2010 we see the first fed move. Since monetary policy works at a lag and we are coming from a ZIRP, is a 0.5% or 0.75% fed funds rate really considered a tight policy? If it is, then man, what a world we transformed into when only 3 years ago the FFR stood over 5%. In the meantime, I wonder if the markets will force the fed's hand early into raising rates before they really want to.
You can subscribe to Breakfast With Dave here.
A: A very touchy topic to discuss in an industry where brokers are viewed as 'salesman' who are incentivized to get deals done. While I will admit that many listings are overpriced to trade fast near ask, there are times when you must know to get aggressive to land a solid product. Now when I say 'get aggressive' I don't mean go out there and throw out peak level bids and ignore the adjustment that took place in this marketplace. What I mean is, adjust your tolerance a bit during negotiations when you find a property that has those special features that are so hard to find. I'm talking about properties with superb views, amazing outdoor space, or just the perfect layout and renovation of your dreams for your needs; something that sets it apart from the pack. Let me discuss.
This post comes straight from the field. Most of my buyer clients are in the $2M - $4M price point, searching for unique loft space in trendy neighborhoods or family homes that are in the right school district that still possess the most desirable unchangeable property features. These include views, location, raw space, wood burning fireplaces, private outdoor space, etc..
It is not uncommon for me to work with a buyer for up to 6-12 months before finding the right property to go after. In these situations, we know the target market very well and can instantly determine how well any one property is priced. We also know whether or not there is any artificial inflation in unit features for marketing purposes - which is why it's never a good idea for brokers or sellers to fluff square footage to make the price look more attractive.
In the end it's always the buyers decision, but as their broker, I do my best to give honest opinions on a relative basis without swaying their decision for any one property over another; that is their call, not mine! But when you are out there looking at all the classic 6s and 7s in any one given neighborhood for a period of six months or more, its fairly easy to know a great deal for a great product when one ultimately pops up. And that is the impetus for this discussion.
When you see a product that stands out and is priced at or near where it should trade, all of a sudden the older units you already viewed seemed to 'help sell' the superb one. This is when you must:
a) overcome any emotion you might have to get a pre-determined discount off the list price
b) overcome any buy side anchoring to 'fear trade' levels or that your price point is trading down x% and your not willing to pay a penny more - we cannot deny the improvement in bids from fear trades 8-9 months ago as a liquidity driven reflation trade has taken hold
c) overcome any emotion that you are bidding against yourself
Sometimes a product is priced to sell and the strategy was to generate interest, create a sense of urgency, and get a solid deal done quickly. You and your broker should know how to do a property valuation and determine if a property is priced right. The key is to maintain discipline and avoid a situation where you let emotions drive you to bid at a level that is significantly dislocated from the current marketplace - i.e., paying peak level prices.
Nobody wants to lose a stellar product because they were not aggressive enough or unwilling to pay close to a sellers listing price, out of principle. The Manhattan real estate market is a living, shifting entity that is constantly adjusting to maintain equilibrium between buyer & seller - macro forces and psychology do play very big roles. In the end, its all about where the bids are coming in!
Here is an example: 11 Riverside Drive, Apartment 12JW
Here you have a nice sized 4-room standard 2BR property in the PS87 school zone of the Upper West Side. The only drawback is the 1-bathroom but since I have seen these lines before I know that 14JW installed a 2nd bathroom in the right closet area off the foyer; leading me to believe you can do the same upgrade to the same JW line two floors lower. The property has a western exposure with direct river views and a terrace off the living room which the kitchen has a window to. I saw 14JW earlier in 2009 which entered contract just under 2 months of the listing, and sold for just under the full ask. Another example of a solid product with excellent views that moves a bit quicker in this marketplace. Apartment 12JW was priced correctly and it showed by entering contract within 3 1/2 weeks of the listing date. I'm not sure exactly what the total cost of the 2nd bathroom install would be, maybe $30K in all or so, but a great upgrade that will pay off both in functional use for the owner and at resale. This was a product worth getting aggressive for.
Another example: 62 Beach Street, Apartment 3E
Here you have a 2,159sft 7-room loft in Tribeca with a stunning renovation, great location, corner exposures, charming cobblestone street views, and flooded with sunlight. These kinds of units usually start off with an asking price closer to $1,400-$1,500/sft, and linger on the market for a while. Finding a property with the special features, layout, and that overall trendy feel to it in this neighborhood of Manhattan is never that easy to do.
Usually you find a few things that bother you about a place that makes you want to 'pass & move on'. This one just seemed to have the right stuff. Priced at $1,273/sft, it garnered multiple bids within the first week and sold for about 3.5% under full ask. This was another product worth getting aggressive for.
I have another great example for a 7-room direct river view property with a full renovation in the UWS, but since its my client and we are in contract I will save it for after the closing. That was a deal where we acted aggressively & fast, and thankfully so as I know multiple strong offers came in when we were just days from full contract execution.
The point is if you are going to get aggressive you might as well do it for a place worth getting aggressive for! You know whether you are a serious and motivated buyer and you know your timeline to own, affordability range/comfort zone (all tied to your net worth, job security, salary, etc..), better than anyone else. So get the job done when you find that product that itches you the right way! That doesn't mean to willy nilly throw money around and pay peak level prices; that would be a mis-interpretation of this discussion. Rather, understand that it is not easy to find the perfect place in this market that meets all your needs/desires/dreams - so when you do find it, don't 'play it' the wrong way to try to secure a deal x% below the peak if you have to go a bit higher to get the deal done! In the end, you will end up paying $2M, $3M, or $4M for another property that may not have the superb features of the key property that you should have got aggressive for in the first place. Plus, you get to live in it and enjoy it!
A: At least its heading in the right direction! Another 10%-15% reduction will bring it closer to where it probably should have started out, around 7.495M - $7.95M or so. I still have my bets on between $6M - $6.5M for a final sale price though. If there really is no board review as I have heard on the street, maybe a bit more. Cmon New Yorkers, the Madoff victims need some help here! Call the "foreigners", talk about the "weak dollar", "buy now or be priced out forever", our market is on an "island and limited in supply"; will no broker phrase help this thing sell for near the new ask of $8,900,000.00???
Where do you say it trades???
Christine Toes here!
We used to tell buyers and sellers that "it takes 10 days to 2 weeks to close" after co-op / condo approval or after a 30 day notice in a new condo had been issued.
After my last four sales took what seemed like forever to close, I took a survey of Corcoran agents to try to figure out if it was the banks I was recommending, if I needed to take a closer look at the mortgage bankers I work with, or if it was an industry-wide problem.
The consensus from my colleagues is that it now takes 3 weeks to close. "Its like pulling teeth" and "I'm tearing my hair out" were common statements about clearing deals to close.
Bank of America and Wells Fargo received the most votes for being "the worst." The problem is that they often give the best rates, so a lot of us recommend them all of the time and therefore the results are definitely skewed. One of the mortgage bankers I work with left Wells Fargo because they had laid off so many people that it was frustrating to get deals done. But he went to Bank of America which seems to be just as slow.
One comment was that "Chase was bad for a while but they're catching up. Citibank is fine. HSBC too." But another agent said Chase was slow also. Chase/Citibank's rates seem to be higher than Wells and B of A, so I don't usually refer them, but if they're faster getting deals to close, I might have to start!
One great comment came from my colleague, Gene Keyser:
"Delays are because of multiple iterative approval and re-approval processes stemming from a new rule where any loan that a bank floats into the secondary market must be bought back by the issuing bank in the event of a foreclosure. They have a lot of skin in the game now." (And hense are being a lot more cautious).Doug Heddings over at TrueGotham.com also recently blogged about the longer timeline to close in today's market:
"...it is imperative to mention that banks are also slowing the process considerably these days with tighter lending standards.In the last year, I have seen banks asking for more and more information and underwriter after underwriter is reviewing and re-reviewing the mortgage file. A new HVCC change also isn't helping as regulators try to separate the appraisal process from the lending institution - now you are seeing out of towners commuting to Manhattan from all over to conduct appraisals. For a more detailed explanation on this, I refer to Andrew Goodman, owner of Gotham Valuation:
So realistically, one should expect a closing of a Manhattan co-op to take approximately 2-4 months from the time a contract is sent out. Having said that, things like holidays, vacations of Board members and other pressing business that a Board may have to address are all factors that can lead to further delays."
The HVCC is a new code adopted by Fannie Mae, that has been in full effect as of May 1st, 2009. The objective of the HVCC is to change the way which appraisers are engaged by lenders originating most loans. Whereas appraisers were previously engaged by loan originators (mortgage brokers), the HVCC mandates that appraisers now be hired by third party appraisal management companies which have no vested interest in the outcome of the appraisal.Banks have also lost co-op stock certificates or UCC forms and instead of taking 2 weeks, it is taking up to a month to find them. In the last few months, clearing to close seems to be taking longer and longer.
The effect of this legislation has not all been positive. In many instances appraisal management companies are engaging appraisers who lack required Manhattan specific market knowledge. In these instances it is not uncommon for properties to be either under or overvalued.
Now that I know that 3 weeks is the new 10 days, I can prepare my buyers and sellers accordingly! When they've identified the property and are shopping around for the best rate, I can send them a list of representatives from the four most frequently used NYC lenders, plus one mortgage broker who can shop smaller banks for them. Buyers may have to choose between a speedier transaction and lower rates.
One word of caution here is that you don't want too many banks to run your credit report because it will lower your credit score! Usually we recommend that people go to a max of three lenders within a short time span, which generally will not lower your FICO score.
Since I know that this isn't just a problem that I am facing with my own deals, I can stop tearing my hair out. What I am hearing from mortgage bankers is that in the next six months, depending on transaction and refinancing volume, banks should start ramping up the number of employees they have, which should help transactions move more quickly. Additionally, if the pendulum starts swinging back the other way to make getting financing easier, the process should be less frustrating for everyone involved.
Keeping my fingers crossed (but not holding my breath!)
Tips for getting your closings done as quickly as possible:
Toes says: if you paid cash for your apartment or paid off the mortgage on your co-op, put your stock certificate and proprietary lease in a safe place! Make sure your attorney knows where these documents are. If you lose them, it can slow down the transaction.
Toes says: if you are selling your apartment and you have a mortgage on the property, make sure your attorney contacts your bank as soon as possible to locate the stock certificate/proprietary lease. Some banks will "search" for these items for four weeks before they will declare these documents "lost" and issue new ones.
Toes says: If you purchased an apartment in one name, and you are now using a different name, ie, your married name, you must notify your attorney! Title / lien searches may need to be done in BOTH names. It is frustrating when everyone thinks you are cleared to close and it turns out that the title or lien search was done in a different name than what is on the stock certificate / proprietary lease or deed. New title / lien searches will have to be ordered, delaying the closing.
Toes says: Keep your condo/co-op offering plan, HUD settlement statement, stock certificate / proprietary lease / deed (depending whether it is a co-op or condo) in a safe place. Also keep any amendments to the offering plan as well as the past two years of building financial statements that are given to you in that same "safe place." If you lose your offering plan, it can be around $150 to replace. If you lose your copies of the building's financial statements, a management company will charge between $25 and $200 (!) for each year of financials that you need. When selling your apartment, the buyer's attorney will need at least two years of financial statements as well as the offering plan and any amendments.
Although closings are taking longer these days than they used to, being organized can make a big difference in the time it takes to close.
(PS - Special thanks to my attorney, George Kontogiannis, for assisting with this post!)
Jeff asked me to help spread the word for the upcoming Nordoff-Robbins concert charity event on Monday, November 16th at Steinway Hall. The concert event is in celebration of 50 years as the world's leader in music therapy for autistic and disabled children and adults. A great cause.
If you are interested in going to this, please email Jeff at firstname.lastname@example.org to reserve tickets. Thanks!!
I had the pleasure of attending Goldman Sachs' Global Industrials Conference last week. I will spare you the details on the various updates from the manufacturing and cyclical company managements, as well as the railroad execs' reactions to Berkie's bid for Burlington Northern Railroad. Suffice it to say that the corporate executives were generally in accord that the bottom of the "great recession" had been seen; so too were they in general agreement that there was no "V" shaped recovery in sight. Perhaps the most interesting comments came from the Goldman executives who served as the lunch speakers at the conference. I believe some of the commentary yielded insights into the economy's impending peregrination through the valley of debt.
On Wednesday the lunch speaker line-up consisted of three Goldman Sachs executives: cyclicals I-banker, Matt McClure; Bruce Mendlesohn, a leveraged transaction restructuring advisor; and cyclicals private equity fund manager, Jack Daly.
McClure, the banker, told the audience what you would have guessed, that with great gobs of cash on corporate balance sheets, a sense that the crisis has passed and not much in the way of organic growth opportunities, corporate acquirers are again entertaining transactions.
I would aver that this trend, if allowed by the now more vigilant antitrust regulators, portends more industry consolidation, and increased layoffs in the near term. This to be followed by continued productivity growth but ultimately increased pricing power.
Daly, the private equity investor who actually was last to speak, cracked wise that normally the restructuring consultant would bat clean-up to the LBO artists. He admitted that private equity investors generally were up to their eyeballs in alligators due to now problematic pre-crisis deals in their portfolios. He noted (with graphics depicting comparisons of 2007-era leveraged loan rates and corporate bond rates) that his ilk no longer enjoyed a cost of funding advantage over corporate acquirers, who would be more likely to lead the charge in the current wave of M&A. In answer to an audience question he confessed that in some cases private equity funds were being asked by their limited partners not to draw on committed capital to do any deals in the current environement. Basically private equity investors are still hiding in their bunkers, but they are starting to put up periscopes and survey the battlefield for opportunities.
By far and away the presentation that was most interesting to me, and gave the greatest insight into likely future trends in the economy, was given by Bruce Mendlesohn, a managing director in Goldman's leveraged restructuring advisory group. Mendlesohn addressed the aforementioned mountain of LBO debt to be repaid or refinanced over the next three years (see chart).
This "wall of debt" has an uncanny resemblance to the mountain of commercial real estate loans and CMBS debt under similar circumstances(View image). So it was of no small interest to me when Mendlesohn went through the extensive tool box being utilized to cope with this massive problem. These strategies included distressed debt open market buybacks, asset sales, exchange offers, refinancings and amend/extend agreements that are all being utilized prior to the last resort of bankruptcy filings. He discussed the strategies and bargaining tactics being utilized by various players in the capital structure to try and protect their interests - much like the "tranche warfare" being witnessed in the commercial real estate market. Mendlesohn mentioned in his presentation that despite the severity of the current downturn, 48 month default rates on corporate debt was running at 17%, which is much less than the 30.2% and 30.6% levels seen at similar points in the 1992 and 2003 recession years.
He did not opine on whether it was in fact creditors' unwillingness to "take their medicine" which had resulted in this better performance, but he did aver that he expected to be very busy for several years to come. That said, Mendlesohn illustrated graphically how the efforts of restructurring artists were putting a pretty decent dent in the "wall of debt," and how if you projected forward the current rates of debt rehabilitation, you can actually visualize a non-catastrophic conclusion to this situation.
Having spent the last few weeks studying up on the U.S. commercial transportation industry, the recent debt exchange offer by YRCW Corp. (The old Yellow Freight), the nation's largest Less-Than-Truckload (LTL) trucking company, seems instructive particularly in light of Mr. Mendlesohn's presentation. YRCW took on a bunch of debt and made a big acquisition a couple of years ago, which was never fully integrated. The company has subsequently been on the ropes since the economic implosion began a year ago. During the course of the year, despite what was becoming a more and more obvious inability to meet a large debt payment due in early March 2010, the bank lenders to the company made a multitude of concessions regarding debt covenants, payment of fees, asset sales, etc.
The bottom line was they didn't want back the trucks and warehouses that represented their collateral (and were about the only thing that wasn't nailed down, which the company had not sold). In a market that is swimming in oversupply, about 18% according to estimates by Stifel Nicolaus & Co. Inc., what would such collateral be worth in liquidation anyway? (Note that few shippers would stay with a bankrupt trucking company that might see severe declines in service levels). Of course, once the banks did take back their collateral, they would have to actually take the full hit to their capital bases. So last week, after many unnatural acts by the banks and even the Teamsters Union which represents the firm's workers, the mangement of the company was actually able to persuade its note holders (lesser secured debt holders) to accept about 95% of the equity of the company in exchange for their debt. In one fell swoop the equity of the company was basically wiped out outside of bankruptcy court, while a pile of debt that was not converted to equity remains on the company's balance sheet.
Ok Jeff, so why do I care? The seemingly extraordinary story of YRCW (and trust me, both Mendlesohn's tactics and the YRCW solution are relatively extraordinary vis-a-vis the traditional "workout" models of the past) is happening all around us on a gargantuan scale in corporate and commercial real estate debt. It is time to contemplate the impacts of this kind of dissolution of debt.
In this respect, the comments of YRCW competitor Con-Way Freight on their recent earnings call after the YRCW debt restructuring was announced are enlightening.
According to Con-Way CEO Doug Stotlar, "as long as we are in a situation where there is excess capacity in the LTL marketplace, pricing is going to be difficult to come by."
I think that it is becoming clear that rather than choking on the twin walls of leveraged corporate and real estate debt, the markets, with the help of an army of lawyers, bankers and restructuring artists as well as regulators' blessings, will push these maturities out, convert them to equity and preferred equity and otherwise defer the ultimate paying of the piper. While this will prevent a second meltdown of the financial system, it also traps capital in inefficient investments that don't promote growth in employment or productivity, while preserving a corrrosive environment of over-capacity and aggressive pricing, as the assets age in place. In the case of commercial real estate, which never goes away no matter what happens to the owner, we will likely just see a longer period of negative rent trends, rather than a swift decline from properties being re-based in distressed dispositions.
Tune in for my next piece on the second leg of the commodity boom as foretold by Goldman's commodity economist. In it I will consider what happens when raw material inflation meets infarcted bank lending markets and excess productive capacity. I'll ponder the question, will Uncle Sam be forced to do a debt for equity swap?.....So you've got that to look forward to.
From the Blogosphere:
The Worrying Wall of Debt
A Look at Commercial Real Estate Debt
FDIC Calls For Debt Restructuring
Up Against a Wall of Debt
We talk about trends and we generalize in the process of empowering ourselves and our readers with information that’s relevant and real. At end of day, though, a sale occurs when one individual seller and one individual buyer have a meeting of the minds. This means, as is always the case when humans are involved, that markets are not efficient and they are subject to the whims and oscillations of human behavior. As behavior is not always rational or efficient (yes, this point can be argued by die-hard theorists), neither are the real estate markets.
Why this quasi-pedestrian intro? Because it all seems to go out the door in the negotiations process and it all starts with the asking price.
On the buy side:
Though we often advise buyers to consider the “value” of the property as a stand-alone data point, this rarely happens. It’s oh so easy to anchor yourself to the asking price and work from there. Many buyers, encouraged by this buyer’s market, approach properties with a standard 10% or 15% haircut off the top no matter what the ask. This strategy (if we could call it that) neglects the simple fact that all asking prices are not created equal. Some are priced above, some at, and others below market (yes, it happens).
Further, there is the “value” of the property and then there’s the minimum that the seller will actually sell it for … ergo, the difference between seller and buyer expectations that Noah has so eloquently been discussing. (The reason I keep placing “value” in quotation marks is because a property is only worth what a buyer is willing to pay for it, just like any other asset.) The bottom line for the buy side is to treat each property individually to yield the most fruitful negotiations.
On the sell side:
Considering the buyer mentality, what is a seller to do? It’s tough for sellers in this market, because every buyer wants to feel like they’re getting a deal. This is an important distinction: they don’t just want to get a good deal but they want to FEEL like they “won”. As such, sellers have three options:
1. They can price high to test the market and bring the price down later. The negotiation cushion is huge but traffic is very limited and the staleness clock is ticking after the first few weeks.
2. They can price at market and hope that people understand this. Traffic is good but there’s little wiggle room in the price to accommodate those 10-15% automatic discount expectations.
3. They can price below market and hope to god the property gets bid up to the true “value”. Traffic is tremendous, low-ball offers are still made but the smart money prices the property where it should be in the shortest timeframe.
The bottom line for the sell side is that intellectually the third option is the winner, but emotionally it takes quite a leap of faith to go there. Most sellers we’re seeing are just not ready to jump. They’re saying: “but what if someone bites at a higher price? I won’t know unless I try, plus I can stay in the market for a while longer.”
For buyers, asking prices should be relatively meaningless; for sellers, it's everything. Whichever side of the equation you’re on, the buy side or sell side, we’d love to hear your perspective.
Buyers: are you willing to get in a bidding war, as we’ve heard so much about? How are you deriving your offers and how would you react to a seller who will not budge on their asking price at all?
Sellers: what is your reaction to option #3? What drove your decision on where to price and how is it working out?
A: Just wanted to provide some recent thoughts on the marketplace as seen through this broker/blogger's eyes.
The Real Deal reports that "buyer are back to more rational behaviors":
A year after the financial crisis, Manhattan real estate brokers report that the market is finally returning to normal. But they don't mean the lightning-fast sales and skyrocketing prices of the recent real estate boom. They're talking about a more moderate, predictable real estate market, the likes of which hasn't been seen in Manhattan for years.My opinion on today's market is fairly simple. There was a surge in activity as prices fell far enough to peak buyers interest; this surge lasted about 4 months (May-Aug) or so and saw monthly contracts signed volume similar to peak levels in 2007. Over the last month or two volume declined a bit to more normal levels. Properties that are priced correctly for their price point, are trading. Inventory levels seem to be muddling in the mid 9,000s; although my new data source has it closer to the 10,300 level. My business the past few months has been on the stronger side.
"The last three years have been very interesting," said Jill Bane, an associate at Leslie J. Garfield & Co. Before the market cratered as a result of the subprime crisis, "prices were very high and there always seemed to be several competing bids," she said.
Now, however, "a sense of normalcy has returned to the market," said Bane. Bane represented a townhouse at 17 Bank Street, on the market for $10.5 million, that recently went into contract. "People are buying; they are just not as irrational as the prior two to three seasons."
In the wake of the financial crisis, the last few quarters have been characterized by unpredictable swings in activity. The fall of 2008 saw the market at a virtual standstill; spring began to thaw, and summer -- normally one of the slowest seasons of the year -- brought an unusual frenzy of sales.
By contrast, the level of activity this fall seems to be relatively normal, settling back into its predictable seasonal pattern. Brokers, upbeat as always, say prices are at or close to their lowest point.
I still believe that we have 1 or 2 more quarters of positive reports ahead of us, as deals in the pipeline close. These reports will be compared to beaten down reports in the same period one year earlier and likely provide support for broker statements that the market has indeed bottomed and is on the path to recovery.
My opinion on that topic is a bit different. Fundamentally, we still have a weak labor market and are yet to experience any of the unintended consequences from actions taken to stem the crisis we just went through. Higher rates is likely one unintended consequence. Higher taxes or change to the tax code is likely another unintended consequence. Restrictions/deferred stock on bonus pay and regulation on wall street are a few others. However, I do NOT see a jolt to the market like we had when Lehman failed. Rather, there are things that can play out that constrain our market from seeing longer term sustainable price appreciation.
What made me significantly less bearish in June than I was in late 2007 is the simple fact that the adjustment has occurred in a fast & furious way. Lehman failed and boom, the market froze and the adjustment took place. That was healthy. So healthy in fact that about 8 months later we started to see sales volume typical of the peak year in 2007! The main reason was lower prices, continued low lending rates and higher confidence in the asset class as a reflation trade mentality sunk in to buyers of Manhattan property.
As this trend continued and became clear sell side optimism started to outpace the improvement in bids - discussed in the 'It Takes Two to Tango' piece in early August. That is when sales volume started to slow again! It takes two to tango and brokers hate when buyers' bids stop improving yet sellers optimistic expectations keep on rising!!
As a seller you get access to way more information then any one buyer does. Sellers know traffic levels and where interest is for their property; assuming they require real time reports from their hired agents. Sellers also know where the bids are coming in! After a while both the broker & seller should get an idea on where a deal is going to happen at - and sometimes a solid early bid will have been overlooked and regretfully dismissed!
Its not a surprise that when brokers discuss the increase in activity over the course of 4-5 months that maybe, just maybe, sellers are going to get a bit too optimistic on a stronger future bid to come in. This is where I see the market today. A slight healthy improvement in our marketplace as Armageddon was priced out from deals signed during the fear trade months of Feb-April - buyers react one way, sellers react another and here we are.
Since I am only one man and Manhattan properties vary so much, I can only estimate the improvement in bids lately; it would look something like this:
IMPROVEMENT IN TRADES FROM EARLY 2009 (by price point)
HIGH END ($5M+) - bids improved from down 25%-40% from peak to down 25%-32% from peak
HIGH/MIDDLE ($2M - $5M) - bids improved from down 28%-33% from peak to down 23%-28% from peak
MID END ($1M - $2M) - bids improved from down 20%-30% from peak to down 18%-23% from peak
LOWER END (Under $1M) - bids improved from down 17%-25% from peak to down 13%-18% from peak
Something along those lines and most of the action has been in the lower end. I can't deny the improvement in bids just like sellers shouldn't deny that there is a limit to this improvement. It's impossible for me to see the entire market and since the contract price is kept a secret until closing to protect the parties involved in the transaction, I have to estimate based on my experience in the field and talks with colleagues that I trust.
Every property is different and those with special features such as park/river views, private outdoor space, wood burning fireplace, or an exquisite renovation will retain their value better than properties without them. Dark apartments with little or no view and properties that require an extensive gut renovation are still hard sells. This is the most real time update I can provide; sorry its not more specific but you can't get too specific in a market like this where products have so many varying features attached to them! I don't see much in the way of major changes unless the tradable markets have a surprise for us down the road!
If you have any observations on where bids are coming in, feel free to share your stories!
A: I am happy to introduce a new member of the UrbanDigs writing team. It is always difficult to find and add new writers, to expand the scope of content on this site, because I want to keep the quality of the content at a very high level. There needs to be a passion to 'get yourself out there', as this is a very time consuming hobby that takes a while to see the rewards that motivates one to continue blogging. I think I found a nice new addition here who has that very passion. Hopefully you guys will speak out and interact with the topics that Ana Maria discusses here on UrbanDigs.
My plan is to add one or two more writers with the upcoming relaunch of the site sometime in the first quarter of 2010. For now, here are some details about Ana.
Ana Maria is co-founder of A+M Real Estate Advisory Partners. Prior to her real estate career, she consulted to Fortune 100 C-level executive leadership teams on articulating, aligning on and executing their business and human capital strategies to enable sustainable change.
Ana-Maria developed her change management skills as Vice President of Retirement Plan Investments at American Express, where she led the redesign, rebranding and subsequent launch of the company's retirement benefits program, responsible for $6bn in retirement assets. She also worked in the Global Investments Group of American Express Bank as Director of Investments, re-branding its global product platform and upgrading its sub-advisory relationships. She joined American Express from Bear Stearns' Private Bank, where she consulted to retail and institutional clients on wealth and asset management strategies. Earlier, she evaluated and managed private equity partnerships at Hamilton Lane Advisors for the firm's pension and endowment clients.
Ana-Maria holds an MBA in Change Management from the Wharton School of Business, an MA in French Literature from Bryn Mawr College, and a BA in Comparative Literature from Haverford College.
Along with her partner, Marie Espinal, Ana-Maria will be discussing topics related to:
Good to have you Ana-Maria!
It’s always nice to experience so much of what we’ve talked about. A few weeks ago, Christine talked about a shift in the lower end of the market and seeing significant signs of pick-up in activity. Considering the relatively limited inventory of <$400k properties, it’s not surprising that first time home-buyers may be using this time to swoop into the market and take advantage of historically low interest rates. The question is: is the shift spreading upwards to higher price-points or is this just a last hurrah before the expected anemic holiday months arrive?
Though far from arguing that this is representative of the market as a whole, here is one recent on-the-ground example to chew on:
- The property: A $750k 1-bedroom in West Chelsea, on the market for a mere three weeks from listing to a signed contract.
- Three open houses were held: 14, 2 and 6 visitors, respectively, with an overlay of 5-8 showings per week excluding open house traffic.
- Five offers altogether (one direct, four co-brokes); interestingly, yet as expected, all offers were generated from the first week of showings and inquiries. Further, three of the five offers came from investors, with only two representing first time home buyers.
- The kicker: the final price (upon closing) will have been less than 3% away from ask. And no, this particular property did not represent a distressed situation, nor is the buyer flush with cash.
So here are a few take-aways:
For do-it-yourself sellers: a vast majority of activity comes from customers engaging buyer’s brokers. In this case, 80% of the offers came from this sub-segment (lower than the 85%-90% we normally see). If you are listing the property yourself and not getting the traffic you’d like, visit the open houses of comparable properties in your area and gauge their activity. If they’re hopping and you’re not, consider at least welcoming buyers with representation (i.e. paying their broker’s fee). For that matter, consider open listing with 1-2 firms to get that additional exposure that could well make the difference. If that doesn’t yield material results after a couple of weeks, officially list your property to get on the brokerage radar screen. [This is what happened with a $1.5mm seller whom we were advising; the disparity between his open house traffic and that of broker-represented comparables he toured was so great that it served as the tipping point to finally list.]
For all sellers: it’s worth repeating that the first two to three weeks of a property’s life on the market are the most critical (here’s an UrbanDigs oldie but goodie as a reminder). Don’t squander it: maximize open house success and test different times on both weekends and weekday evenings. Lastly, be flexible with when your apartment can be shown (i.e. last-minute and evening requests); in this market, every show counts. Your highest & best offer usually comes in those first 2-3 weeks!
For buyers: it’s understandable that you want to test the price elasticity of the property you like by starting out low in negotiations. That said, try to determine the maximum price you’d be willing to pay on the property BEFORE fully engaging (though clearly after having done your due diligence). This will not only help you avoid getting sucked into the emotional trap of bidding the property up just to stay in the game, but will allow you to confidently present your last and final offer, knowing that it’s just that: your last and final (preferably with an expiration date).
We’d love to hear from you. Do you see activity (and more importantly, conversions) oozing up into higher price-points or are examples such as the one above exceptions rather than the rule?
A: As discussed right here 3 days ago when talking out loud about the extreme positive carry trade that is on what may happen if that reverses!! Professor Roubini gets into details.
Professor Nouriel Roubini discusses, "Mother of all carry trades faces an inevitable bust", in FT:
Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.Told ya he goes into details! The professor lists 4 main reasons WHY the carry trade will 'unravel':
People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.
The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic open market operations. Some central banks, concerned about the hot money driving up their currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble will get worse: if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.
But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.
1. The US $ cannot fall to zero
2. The fed cannot suppress volatility forever
3. Markets might force the fed's hand into tightening on better than expected data
4. A flight away from risk and into safety
All would trigger a dollar rally and hurt those aboard the carry trade gravy train. I discussed #3 above a few weeks ago. Who knows what may force the fed hands...
So how do we know if it might be happening? You'll know. The US dollar will make a fast and fierce move to the upside on practically no news feeding the unwind further. Then other markets can react. Similar to how new highs make usually make higher highs as shorts cover positions which further powers the upward momentum - the same trading pressures can occur on an unwind of a very crowded trade.
A: Well, I would think part right. But the core of the argument is that banks have not been lending and taking enough risk in the US consumer. With such excess and buildup of debt over the past decade, Im not sure increased lending and risk is what you want for a US consumer that is in the process of repairing their balance sheet and struggling with a rising unemployment environment. Seems counter productive to me. Time is what we need. Debt restructuring is what we need. Reorganization is what we need. And over time the write downs must be taken and the balance sheet repaired. Over the course of the process, everybody cutbacks. Hence the deflationary pressures. Fighting the natural order of things will only artificially heal things and likely lead to another crisis down the road. In the end, we'll have to finish the repair.
Bloomberg reports that "Stiglitz Says U.S. Is Paying for Failure to Nationalize Banks":
“If we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai Oct 31. “They would be lending and the economy would be stronger.”So in hindsight, was more lending the answer? Lending right now to a consumer that is facing the toughest labor market in decades and who is ridden with debt already? I'm not sure if its me or not, but it seems such a simple concept to grasp that you cant solve a debt problem by issuing more debt. When the consumer and small business is in bad shape, we will see them start to save, reorganize, and possibly file for bankruptcy protection to restructure existing debts. Well, that is exactly what is happening.
Did you know the Personal Bankruptcy Filings are up 41% compared to Sept 2008? Calculated Risk shows us the steady surge in filings since 2006 (click chart for larger picture).
Now we see CIT Group finally filing for bankruptcy. Its the right thing. As painful as it may be for small businesses across the country, its what needs to be done. The US Treasury never should have injected funds for CIT preferred equity and warrants to begin with; and they would have saved about $2.3Bln from the TARP pool. Now the "government investment is likely to be wiped out, said people familiar with the matter." In the end, the same outcome prevailed.
“The big risk we face now is that banks are going to overcorrect and not take enough risk,” Geithner said. “We need them to take a chance again on the American economy. That’s going to be important to recovery.”This has been a continuing risk for the past 18 months. Credit has been contracting as excess is in the process of being purged. This is one reason why the M1 Multiplier has plunged:
Our fractional reserve system of multiplying money is not working the way it was designed to because of the flaws embedded in the system itself.
Stiglitz then gets the chord right:
“We have this very strange situation today in America where we have given banks hundreds of billions of dollars and the president has to beg the banks to lend and they refuse,” Stiglitz said. “What we did was the wrong thing. It has weakened the economy and has increased our deficit, making it more difficult for the future.”The bailout did not cure the entire problem and the banks still have toxic assets held. Yes bids for most assets, especially those tied to securitized mortgages, have been propped up with a massive liquidity driven rally, but just how real is that? And will an extreme positive carry trade reverse itself in a painful way down the road? The fed & govt successfully avoided a systemic banking event that could have led to a very painful global disruption. The failure of Lehman was the closest we got. But we still don't know at what cost this avoidance comes with. We will find out over the years.
Banks simply need to take the write-downs, restructure the debts, reorganize the business models, and come out stronger at the end of the day. If that means bankruptcy or nationalization, so be it. Mike Mayo was back at it again Friday reporting on Citigroup facing another $10Bln writedown ahead on tax deferred assets.
The risk of not doing this is a lost decade with subpar lending even when the US consumer sees a stabilizing or better yet, a growing labor market. Thats the thing, at some point the labor market will stabilize and start to grow again; but how strong will the foundation be and how healthy will the banks be at that time? Accounting gimmickry and 'extend & pretend' can only take you so far! In the end, it all will come out. Bary Ritholtz also chimed in:
"One of the major complaints I have had about the bailouts and faux regulatory reform has been that it spurned the proven solution — the Swedish model — and instead embraced the worst example on the planet: The Japanese model. The refusal to force insolvent banking entities into bankruptcy is a large part of the reason, but its not the only one."Yes. But one thing the banks actually got right was to CUTBACK LENDING & TIGHTEN UNDERWRITING STANDARDS TO WHOM THEY LEND TO & ELIMINATE EXOTIC MORTGAGE PRODUCTS THAT WERE DESIGNED TO ENHANCE AFFORDABILITY AND CUT CORNERS IN UNDERWRITING!
My main point is, it was prudent for banks to slow lending to a US consumer that was already heavily in debt with housing prices looking for a bottom, in a rising unemployment environment. Arguing for more lending in this type of environment would have kicked the can down the road for another day. A contraction in lending is, while not the American way, one of the healthier things the banks could do given the environment we are both in now, and just went through.