Thursday, July 9, 2009

Commercial Real Estate

When things go bad, things go really bad. Like the uncovering of the Ponzi schemes of Bernard Madoff and Allen Stanford. One domino falling takes down others. Here's a report about the US Congress worried that the coming implosion of the commercial real estate market. Here's a report by NASDAQ:
U.S. lawmakers rang alarm bells about the troubled commercial real estate industry, which has been walloped by the credit crunch and an implosion of property values.

"The commercial real estate time bomb is ticking," Joint Economic Committee Chairman Rep. Carolyn Maloney, D-N.Y., said in opening remarks to a hearing before her panel Thursday.

U.S. Sen. Sam Brownback, R-Kansas, said he was distressed about the situation the industry is facing.

Banks have yanked back on lending to developers of shopping malls, apartment complexes, hotels and office parks. Meanwhile, the securitization market - a key source of funding for the commercial real estate industry - has been in a deep freeze since last year.

The situation is fueling concerns that property developers won't be able to refinance roughly $400 billion in commercial real estate debt coming due this year. Property values have plunged about 24% since their peak in 2007, further hampering developers' ability to obtain refinancings or loan extensions.

...

A wave of defaults of commercial real estate loans would deal a blow to the already weakened banking industry. The U.S. commercial real estate market is roughly $6.7 trillion in size and is underpinned by about $3.5 trillion of debt.

The Federal Reserve has taken steps to get lending flowing to the industry. On June 16, it announced it would accept as collateral new issuance of commercial mortgage-backed securities as part of its emergency program to thaw the securitization market. As early as next week, the Fed is expected to extend that to existing, or "legacy", CMBS already held by investors.
From the San Francisco Business Times, here's an example of how the recession has crushed property values:
A downtown San Francisco office building that sold for $400 a square foot in 2006 has traded for just $172 a square foot, a 57 percent decline that industry experts see as an important milestone in establishing new, recession-era values for financial district property.
The bottom will be found. But like the Great Depression, this can drag of for years. The only way to shorten the pain is for government to step in and inject spending into the economy. The Right keeps making noises about inflation and big deficits and a building debt, but the alternative is a decade of depressed economic activity. The tragedy is that economists know how to end this disaster, but the politicians won't listen because they are being drubbed by the Right and they are fearful that the taxpayers will believe all the worries that the Right is feeding them.

Roosevelt listened to these voices in 1937 and created a mini-depression as the US economy was pulling itself out of the Great Depression. The tragedy right now is that the US (and world) economy is still falling -- no longer in an absolute free fall, the fall is slowing -- but nowhere near a recovery and already the the Right wants to javascript:void(0)rein in stimulus.

The following shows the effect of stopping the stimulus in order to "balance the budget". Look at how unemployment suddenly jumped in 1937:


The Right's argument makes no sense. The population has just suffered massive blows: jobs are lost, income is down, housing wealth has evaporated, and investment/pension wealth has gone up in smoke with the collapse of the stock market. The consumer can't spend us out of the collapse. So the federal government has to step in and provide the spending that will put a floor to this collapse. Once that is in place, the federal government can withdraw and let the natural growth of the economy slowly replace federal spending with consumer spending. But the Right ignorantly refuses to understand this. They want "balanced budgets" and to hell with unemployment or suffering. They don't care.

The Right loves to use the analogy to the household and claims you must never spend more than you earn. But that is silly. Most young adults take on a mortgage to afford a lifestyle that their earnings will catch up with in a decade or two. Rather than live like a student for two decades trying to earn enough to have a home, you get a mortgage and pay off the debt over time. You finance your early life with debt and then retire that debt in your middle years, and finally live off the assets in your retirement. This unbalanced accounting regulates debt and income to provide a more stable lifestyle.

But the Right wants to preach a "value system" of penury to avoid the moral evil of debt. Crazy! It is too easy for the affluent to preach abstinance. It would be sad if the American population buys this hogwash from the Right.

2 comments:

Unknown said...

A home was purchased and lived in for a lifetime. It was possible to pay it off, but now we have flipping. We have people buying to sell; just like in the stock market. There is not a lot of long term investment in anything. There is a lot of speculation, and we are continuing to pay more and more for false value and false equity growth. Why does the value of an acre of ground have to increase? Why is a gallon of milk worth more today than last week? There should be a set value for land and commodities. There has to be a formula for this similar to calculating calories. Land could be valued at how much food could be grown on it in a year. A set value would lead to a stable economy.

RYviewpoint said...

Thomas: I sympathize, but there is a benefit to a little bit of inflation. It means that holding onto assets is not as profitable as investing for the future. A dynamic economy requires people being a little scared and trying to stay ahead of a creeping inflation.

Humans lived in stagnant economies for thousands of years. Fathers handed their occupation to their sons. There is something comforting about that but the reality was one of a starvation economy.

Putting a little inflation into the economy is good for debtors and bad for holders of non-productive assets (think bags of money). It forces everyone to look for places to grow the wealth. This is hard on the individual, but good for the society because it encourages innovation.

Marx had the view that the just price of things was the labour put into it (e.g. eggs for 1 hour of work, a bicycle for 20 hours, etc.). He ignored risk and management. Marx's view was pleasing to the workers, but it didn't encourage a dynamic society.

Capitalism is cruel. That is why you need government to regulate it and means to ensure that those who are not good "competitors" are not simply left behind. But you do want to encourage the risk takers and the innovators. You just don't want to turn them into a new aristocracy, especially an entrenched aristocracy. That's why I like Warren Buffet. He publicly gave away something like 99% of his money and left very little to his kids. He wanted them to have enough to be comfortable, but not to be like Rockerfeller's kids: titans who could use their inherited wealth to stay atop the social heap.

There is something appealing about a static society with all its routines and guarantees. But if you are at the bottom of society, do you really want to condemn your kids to being left at the bottom? Don't we want kids to dream? Don't we want each generation to reach for the stars and believe that in their society they can have a better future?