Notorious R.O.B.

If you are at all interested in the real estate industry, then you need to be reading Dan Green on a regular basis. I just met him at RE Blogworld, and have put his blog into my reader ASAP (and linked it here). Dan is brilliant, and understands the financial markets and mortgage markets better than most people in the world.

And even he finds himself getting verbal whiplash these days from having to contradict himself more than Obama does.

Exhibit 1: Dan’s post of Sept 16, 2008 titled, “How Mortgage Rates Are Responding To Lehman Brothers, Merrill Lynch, And AIG” which says, in part:

It’s a shame because the post went deep on Wall Street’s recent troubles and how each piece of bad news actually helps everyday homeowners. When I went to publish, the post vanished. And by that point, markets were already open, mortgage rates were already plunging, and I wanted to be the phone with clients. I did manage to Twitter, however.

A one-paragraph recap follows:

The government’s takeover of Fannie Mae and Freddie Mac rendered mortgage bonds among the safest investments in the world. Therefore, when political or economic uncertainty exists, mortgage rates should fall in safe haven buying.

The post was especially timely because safe haven buying driving mortgage rates down yesterday. As the stock markets shed $800 billion in value, investors moved into safer instruments like bonds — including mortgage bonds. With more demand, prices were up and rate were down. And how.

Because mortgage debt is now government-guaranteed, the sell-off in stocks was terrific news for both active home buyers and for homeowners that missed last week’s gold rush. However, it did little to soothe Wall Street’s nerves. That job falls to Ben Bernanke.

Then, a mere seven days later, on Sept 23, 2008, Dan posts “Mortgage Rates Respond To A Rapidly-Devaluing U.S. Dollar” which says in part:

And lastly, the mortgage market got hit.   Because mortgage bonds are repaid in U.S. dollars, the value of those repayments dropped.  This forced mortgage rates higher because the only way to entice investors to buy devalued mortgage-backed bonds is to offer them with a higher interest rate.

If you’re wondering why conforming mortgage rates are up by 0.750 percent since last week, this is it — it’s because mortgage rates are responding to the expectations of a weaker dollar going forward.  This is the reverse of what happened in August.

Simply amazing, in part because Dan is spot on, and in part because politicians in government simply do not seem to understand the economy and markets, despite being Wall Street tycoons and brilliant academics and the like.

Why wouldn’t inflation rise when the government has just signed a blank check to big American corporations?  Of course it would.  And as inflation rises, interest rates — including mortgage rates — are bound to go up as well.  People don’t enjoy getting paid 10 years out in dollars that are worth half what they are worth today, do they?

This whole fiasco with the bailout reminds me of my favorite Thomas Sowell quote, “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”

At the Blogworld event that just happened, the panelists on the Financial Blogs panel were unanimous in excoriating the government — and they appeared to be politically all over the board — for its latest actions in intervention.  One panelist called it (paraphrasing) “the absolute triumph of socialism.”

I think we’re seeing the absolute triumph of idiocy as well — and all parties, all branches of government, are indicted in this.

Until things stabilize — and no one knows when that will be — we’re in for a wild ride.  The markets behave in unpredictable (although common-sensical) ways to economic shocks like a $700B bailout of financials by the government.

But a couple of things seem possible, at least when one thinks about our industry.

1.  If it was hard to find buyers who can afford to buy houses before, I’m thinking it’s going to get more difficult, not less, going forward.  Even if the removal of junk mortgages from the market (thanks to the taxpayer bailout) means banks can breathe easy again, the inflation-induced rise in mortgage rates (combined with the shellshock of banks coming out of this mess) likely means fewer buyers for homes.

Of course, that means home prices are about to take another pounding.  If I were a seller, I’d be shaving another several thousand dollars off the listing price right about now.

2.  Selling a house in today’s environment — unless you absolutely have to — became far more complicated and likely less attractive.  For example, I locked in 30-year fixed rates long  before this crash (something in the 6% range, I believe).  Inflation could very well hit 6-7% annually, as most financial experts appear to think the $700b figure is actually the floor not the ceiling of this bailout.  If inflation = my interest rate, then my loan is effectively free.  Unless I can get a bank to give me free money (zero-interest loans) to buy my next house, I just can’t see how it benefits me to be selling in this market.  At all.

All in all, I have a feeling that realtors are going to have to get educated on this in a hurry.  Some of them really understand finance, the markets, and macroeconomic factors and may be able to help clients make the right decision.  But the ones who think “yield” is only a street sign are going to have a tough time getting people to trust them as real estate experts.

As Alex Periello likes to stress, real estate markets are all local.  That remains true, of course.  But giant macroeconomic factors will play a role, at least if your client is paying in (or looking to get paid in) U.S. Dollars.  It’s high time to get boned up on financial matters.

-rsh

From National Real Estate Investor comes news that loans for commercial multifamily projects have dropped 63% year over year:

Commercial and multifamily mortgage loan originations continued to fall on a year-over-year basis in the second quarter, according to the Mortgage Bankers Association’s (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. Second quarter originations were 63% lower than during the same period last year. Conduits for commercial mortgage-backed securities (CMBS) registered a 98% drop compared with the same period last year.

“The slowdown in originations has come from both a decrease in the supply of capital available and a decrease in the demand for new mortgages,” says Jamie Woodwell, MBA’s vice president of commercial/multifamily real estate research. “It is likely volumes will remain muted until buyers, sellers, borrowers, lenders and their expectations of rates and terms match closely enough for transaction activity to pick back up.”

I don’t quite get this.  There has to be more to this story.

We’re in the midst of a severe downturn in the housing market.  The people who are in a position to know are saying they don’t know when things will turn around, as transaction sides and home values are both down in the pits.

This should be absolute boom times for multifamily, no?

I mean, people may no longer be able to get a mortgage to buy a house.  People might be losing their homes to foreclosure.  But they have to live somewhere, don’t they?  I suppose it’s possible that all those unsold homes are now being rented out, but that doesn’t make a lot of sense.  Someone who wants to sell a house doesn’t necessarily want to take on tenants who may stick around for a year at least.

I would think that demand for rental multifamily would be enormous.  So what gives?

/scratch head in puzzlement.

-rsh

I don’t normally write much on financial matters connected to real estate, because I recognize it as an area where frankly, I have no real expertise. I know generally how mortgages, CDO’s, subprime and so forth work, but beyond the basics, I get lost. Tanta, over at Calculated Risk, however, does not get lost. In fact, you might say he illuminate the path. I think this site is a must-read for serious real estate industristas.

His latest post discusses a story in the New York Times reporting an effort by various gargantuan banks to get the feds to bail them out of their current financial woes. Tanta’s analysis of the proposals by the banks to create “a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.”

According to this proposal, with Bank of America’s name on it, there are some $739 billion (that’s Billons, not their low-rent cousins on the wrong side of the tracks, the Millions) worth of mortgages that are at moderate to high risk of default. So the thought is that the Federales should step in and bail out these banks and borrowers to avoid foreclosures and so forth.

The New York Times itself argues against such a bailout:

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

Let’s leave aside for the moment how amusing it is (in a deeply unfunny way) how “news” articles in the Gray Lady have a tendency to make arguments. As if the New York Times were a partisan in the matter. Which, I guess, it is — if you’re honest with yourself, at least. Because in this case, Keller’s boys and girls have a point.

And Tanta expands on the undesirability of such a bailout by pointing out the institutional barriers to executing such a grand plan:

Nobody is going to create a functioning new agency with the relevant expertise and staffing and funding and clear mandate out of thin air fast enough to do what this wants to do, if what we want to do is stave off recession. FHA probably has the expertise to credibly attempt the loan-level workouts, but not enough hands to get saddled with $739 billion worth that has to be dealt with before everybody’s lawns go brown. Ginnie Mae is, in my view, one of the most efficient and quietly professional government agencies ever: they run a highly successful program with a tiny staff. I can’t imagine Ginnie Mae is ready to manage reporting and remittances on a brand-new government-owned pool o’ junk of this size with existing resources.

Tanta’s conclusion is that the Feds ought to find some smart private company or two and outsource the administration of the whole thing to them. I think that’s very smart.

However, I have a different question on the issue.

What’s in it for US?

And I use the word US in two senses — “US” as in the United States, and “us” as in the taxpayers who are funding these bailouts.

In theory, I suppose the benefit is that using taxpayer dollars to provide welfare to Bank of America, Goldman Sachs, and other ginormous financial institutions would increase stability in our financial markets, soften a recession, etc. etc. Seems kinda remote. And a terrible investment.

So I have a better idea.  Well, probably a better idea.

If we’re going to do a bailout of any kind involving $739 billion, I suggest we do it as an equity investment in these large and wealthy banks and hedge funds and insurance companies. The Feds ought to go to Warren Buffet and tell him, “Okay, we’d like you to identify the banks, Wall Street firms, and insurance companies who have large exposure to subprime debt — then buy them on behalf of the people of the United States. Here’s $750 billion to work with, Warren. Get us some good deals.”

Rather than buying BofA’s crappy debt, let’s just buy BofA.  Bank of America’s market cap is only $189B or so, and their stock price hit a 52-week low on Feb 22.  Seems like it’s a bargain, maybe, for the taxpayers to snap up.  That way, the Federales are backing BofA’s debt as well, and the taxpayers could be stuck with hundreds of billions of nonperforming loans. But at a minimum, once the loan losses are written off, the good loans rescued, and the market turns around, and BofA starts to throw off billions in profits, the gubmint will share in that turnaround as well. And the gubmint can use that money to (a) issue a profit-share to each taxpayer on a pro-rata basis, or (b) reduce taxes (which amounts to the same thing).

As it stands, BofA had profits of $14.9 billion in 2007, and $21.1 billion in 2006.  And the bank executives are crying in their beers.  Okay, so let’s buy ‘em out, and see if profits in 2008 go back to $21 billion, and go up from there.

Add in JP Morgan, Citigroup, Morgan Stanley, and any other financial institution who wants some of the government handout, and we’re looking at what may possibly be a pretty good investment for the American people.  Yes, this does mean dilution for existing shareholders — their choice is to accept the dilution, or watch the stock price float to zero as the bank gets overwhelmed by bad mortgage debt and CDO instruments.

Seems to me that the troubled banks can get over this hump with an injection of capital to the tune of $739 billion from the Feds. In return, the Feds get huge chunks of these very valuable, very profitable financial institutions. In all honesty, the employees of said financial institutions might find their annual bonuses curtailed a wee bit to pay the new owners their fair share of the pie. But that’s better than looking for a job after one or more of these banks go under, no?

Since none of us want a nationalization of our money center banks, the investment can have very specific mandatory out-clauses. At a certain price level in the stocks of these companies, or at a certain profit multiple, the Feds will start to liquidate the holdings in banks by selling shares to the private market.  That has the added benefit of capturing any appreciation in the stocks of these banks, which then can be used to pay down the government’s debt (probably incurred in the course of trying to bail out these banks in the first place).

So, the Rob Hahn plan for bailing out our mortgage banks.

1.  Go hire Warren Buffet.

2.  Invest $750 billion in 2008 into these banks who want government welfare, as equity — and only as equity, not as loans or loan guarantees.  Yes, this probably means dilution for all of the current equity holders.  Too bad, so sad, guys — you knew what you were doing when you invested in financials.
3.  $750B buys you, in today’s valuation, the following financials:

• Bank of America ($189B)
• JPMorgan Chase ($148B)
• Countrywide Financial ($4B)
• Citigroup ($125B)
• Wachovia ($67B)
• U.S. Bancorp ($57B)
• Wells Fargo ($103B)
• American Express ($52B)

4. Make money, use the money to lower taxes (which has the benefit of stimulating the economy, thereby making recovery faster), then sell the stocks once certain triggering conditions are met.

I’m sure someone more versed in the arcana of the financial markets will point out various flaws in this plan.  But as you do so, please then answer the question: What’s in it for US in any bailout plan?

-rsh