by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
Last Monday, Sean Purcell and I hosted Top Dawg Greg Swann on Mortgage Mondays on Bloodhound Blog Radio. We discussed what real estate agents and lenders can do in a post-Bailout world.
The bailout bill passed today after the Senate signaled its support to the House. President Bush signed this bill into law and the world is safe, once again.
Interesting points in our conversation:
1- The Community Reinvestment Act (original sub-prime loans), conceived in 1977 and super-charged in 1995, was the actual starting point of the “toxic loan” revolution that took our economy down.
2-The Bailout may be an instrument to keep people into homes through the “loansharking collection” principle.
3-Greg talks about his strategy of working with investors (and why it works).
4- Predictions about the convergence of low-priced and mid-priced homes through financing caps.
5- Strategies for REALTORs to find ready, willing (and most importantly) and ABLE clients.
If you run an 8-minute mile, you can get a 10K in while you listen to this on your iPod. Mere mortals should just download the podcast and try to get 3 miles in on the treadmill whil listening to the three of us.
chris e says:
You just witnessed a criminal act against the people of America by the senate,congress and Bush.It is incredible to me that 360 million people we were terrorized, and taken by our “representatives” for our “own good”for a ride.Pakistan was able to chaise way from power a corrupt ruler,here we are supporting them.I cannot believe the bustards were posing with smiles congratulating them selves.
This is the culture we have allowed to flourish.It seems to me that the more people you screw out of their money the more rewards you receive.Shame
October 3, 2008 — 6:19 pm
Connie Clark says:
I certainly feel Chris’ pain and I don’t think I’ve ever been so angry about anything in our government. I think it’s that for many of us we feel totally helpless. We called and emailed…did our part…and they still shoved it in our face anyway…absolutely amazing!
I was just reading a very interesting article about all that is in this new bill that we DIDN’T know about…especially some interesting new laws passed for the IRS. If you haven’t read this one, it’s definitely worth the longer read…very eye opening!!!
http://news.cnet.com/8301-13578_3-10057618-38.html?tag=nl.e433
October 3, 2008 — 11:31 pm
Joe Strummer says:
First, as to whether the government can ever recover on its $700 billion “investment”, it can’t. If government owns 1 out of 4 homes in some of these suburban Phoenix communities for 5, 10, 15 years, it means that rather than face a 1-time downturn in the market that results in a 60-70 percent reduction in value, followed by quick recovery, those communities are going to face a somewhat shallower downturn, but the recovery is going to be a long time coming as the federal government continues to unload its stock.
October 4, 2008 — 8:41 am
Robert Kerr says:
The Community Reinvestment Act (original sub-prime loans), conceived in 1977 and super-charged in 1995, was the actual starting point of the “toxic loan” revolution that took our economy down.
“Starting point?” What does that mean? Does it mean “caused?” “Started?”
I hear a lot of talk these days about how the CRA caused this mess but the evidence doesn’t support the claim.
Was the CRA a factor? Yes, a minor factor. Low-income families didn’t buy 20 spec homes with stated income ninja finance.
Whom do I see as the major culprits?
Well, I blame Greenspan for driving dump trucks loaded with trillions at 1-2% up to banks. When you flood lenders with cheap cash, guess what … they lend! And when all the qualified borrowers have enough, they lend the rest of the market. The CRA certainly enabled and, arguably, encouraged lending to the unqualified.
Many others share in the blame as well, including the President (totally clueless) and the current Congress which directed the GSEs in August of 2007 to help “rescue” Wall Street by taking hundreds of billions worth of their failing mortgages onto the GSEs’ books.
The CRA? A minor factor, IMO. Remove the CRA from the mix and we have the same credit bubble, followed by the same painful collapse.
Buckle up. With September’s loss of 160K jobs, it’s going to get a lot worse before it starts getting better.
October 4, 2008 — 9:37 am
Brian Brady says:
Joe,
I’ll disagree with you. The Treasury won’t be buying homes, they’ll be buying home loans…at a .
If it’s judicious about the purchase price of that home loan (50-65 cents on the dollar), they could actually profit from this debacle. It worked in the 30’s.
October 4, 2008 — 9:42 am
Joe Strummer says:
If the treasury buys mortgages, those are collateralized by the home. (If not, then what is the treasury buying, except a promise to pay – i.e., debt – that is unsecured. And if it buys debt that is unsecured, it’s worthless, and the Treasury has no hope of “recovering” whatever value it claims it wants to recover.”) So “taxpayers” are never going to see a “return” on their $700 billion “investment.”
Now, if the Treasury bought mortgages that are collateralized by the home, then the Treasury is in the same position as the bank vis-a-vis the home, which is to say that if it’s going to be sold short, the Treasury gets to decide if yes, and then how short.
That means that that housing stock is under the control of the government and if the treasury wants to ride out a bad market, it can do so, but at the cost of a slowly recovering market over the next 15 years.
Phoenix has been through this before, although much milder. This is going to take a long time to correct given that the government is going to trickle out the the homes over a 15 year period.
And if that housing stock isn’t in fact controlled by the Treasury, then in effect the government just gave $700 billion to banks and said “here’s some free money for you.” And if it did that, then there are far worse problems, namely: Moral Hazard.
There is a ton of housing stock in Phoenix, and although Greg is right that people will be moving there to get out of the snow, I’d like to know just what the total housing stock is vs. the population.
October 4, 2008 — 12:02 pm
Brian Brady says:
Joe:
If the Treasury buys at 65 cents, it’s got SOME built in downside protection if it must foreclose; not all of the loans will be 100% LTV.
“The CRA? A minor factor, IMO. Remove the CRA from the mix and we have the same credit bubble, followed by the same painful collapse.”
Remove the CRA and you don’t get securitized sub-prime. The CRA started in 1977. Securitized sub-prime loans, counted to wards banks’ CRA allocation, in 1995. Fannie started securitizing the CRA loans, to make room for more of them, in 1999.
When did the real estate bubble start, Robert?
October 4, 2008 — 1:30 pm
Joe Strummer says:
If the Treasury buys at 65 cents, it’s got SOME built in downside protection if it must foreclose; not all of the loans will be 100% LTV.
If Treasury buys at 65 cents, then it’s not injecting liquidity into the market. The whole point of a bailout is that Treasury is giving money for nothing, or at least money for less than full value.
All the Treasury is doing is taking money from some people and giving it to other people, and it’s giving to people who have not produced value for it.
If treasury pays 65 cents on the dollar but, according to you, wants to sit on it for a number of years until it gets $1 on the $1 two things happen. First, if Treasury taxes to get that $1, taxpayers lose the dollar and if treasury prints more money to get the $1, the value of the dollar drops in order to fund the $700 billion. Money isn’t wealth. Money is – or ought to be – a mechanism to get wealth. Wealth is things people want.
If Americans have decided they want to live in government-owned housing, they should just admit it. But it’s not wealth creation to be handed a home by the gov’t. Or to be told by the government that you don’t need to pay for the home you supposedly purchased with a mortgage. It’s simply redistribution. There can be no quick real estate recovery in that system.
October 4, 2008 — 4:13 pm
Brian Brady says:
Joe,
I’m no big fan of the bailout. Having disclosed that, I’ll still disagree with you on a few things:
“If Treasury buys at 65 cents, then it’s not injecting liquidity into the market. The whole point of a bailout is that Treasury is giving money for nothing, or at least money for less than full value.”
That’s not entirely true. You see, the mark-to-market accounting rule (recently suspended by the SEC) requires banks to value those securities at a value the market might pay. Because if the illiquid nature of this market, the valuations are horrendous. This requires banks to have more “net capital” and less available for lending.
The Treasury Plan to buy those loans will get the loans off the books and “free up” capital that otherwise might have had to be held by the banks.
“If treasury pays 65 cents on the dollar but, according to you, wants to sit on it for a number of years until it gets $1 on the $1 two things happen.”
Not according to me, according to Hank Paulson
“It’s simply redistribution.”
Well…yeah. Isn’t the whole darned real estate industry based upon socialist principles ,though?
“There can be no quick real estate recovery in that system ”
Amen. I’ll restate that I’m no real fan of the bailout
October 4, 2008 — 5:24 pm
Greg Swann says:
> Isn’t the whole darned real estate industry based upon socialist principles, though?
Emphatically not. Private ownership of real estate is the essence of liberty, the sign and symbol of political freedom. The distinguishing characteristic of free societies, throughout history, is the right freely to acquire, use, enjoy and dispose of real estate. Tyranny, by contrast, is always marked by some form of hoarding of the land — by a monarch, an aristocracy or a collective. The western countries that proved to be most susceptible to Communism were those where much of the land was held in vast tracts by a very small minority of the population. I could write a book abut the relationship between real estate and freedom. It suffices to say that the freedoms we are more apt to celebrate — speech, religion, the right to bear arms — all issue from the free ownership of the land. Without a redoubt of one’s own to return to and defend to the death, none of us is free.
The real estate business in the United States has been toying with collectivist ideas since 1932 — and to a lesser extent since North America was settled by Europeans. But even in the present disaster, the real estate market in America is still very free as compared to other countries around the world and across the ages. These betrayals of liberty by the federal government are disgusting and potentially very dangerous, but they don’t even come close to being a usurpation of the right to buy and sell real estate. I’m not excusing what’s been done — and I’m sure that the frustration of the middle-class dreams of poorer Americans was exactly what ACORN intended — but, even now, real estate is the engine of freedom. Don’t sell it short.
October 4, 2008 — 6:09 pm
Joe Strummer says:
Look, mark-to-market has its problems, but the alternative – pegging valuation to some chimerical future number – isn’t any better, and many times is worse since it allows financial institutions – see Enron – to claim that its assets are worth many times more than they are.
The problem with the current system isn’t mark-to-market. It’s the fact that financial institutions were investing in instruments that, it turns out, were backed by promises to pay by people who had no business getting mortgages in the first place. At the end of the day, these financial instruments represented promises by millions of people to pay on their mortgages. And many of them can’t.
It wasn’t the “illiquid nature” of the credit market that made mark-to-market fail. It was the fact that these assets were bought at a time when people were making payments, but once 1) the teaser rates started going away and 2) the Fed’s tighter money supply policies started taking hold in 2006-7, those assets turned out to be worth far far less.
Secondarily, as those assets were shown to be worth far less than they were bought for, creditors started hording liquidity this past summer, because they could not be sure that those asking for credit could pay back the loan AT ANY INTEREST RATE.
In addition, you get runs. Runs on banks, and runs on the real estate market. For instance, the real estate market in Phoenix is particularly hard hit because of all these people who realized in 2007, early 2008 that the market was softening and started putting their homes on the market in order to escape from big mortgages before interest rates adjusted upwards.
My point about the treasury department is that there’s nothing magical about what it’s doing. A bailout is a bailout because it is the government giving free money to people who didn’t earn it. The treasury department isn’t purchasing these mortgage backed assets at a FMV. If they did that, that wouldn’t be a bailout. People will buy these mortgage backed assets at FMV. But FMV isn’t what the banks want. The banks want far more than FMV – i.e., the value they were speculating the would get. The problem is that FMV of these assets is far below what the banks paid for them, and conseuquently, that’s why they’re failing.
http://www.buymyshitpile.com basically explains what you need to know about the accounting and FMV principles involved. Just because you think the Barry Manilow CD you own from 1988 is a collector’s item and just because someone convinced you to spend $10,000 on it with the promise that it would be worth $15,000 this year, doesn’t make it so. A thing is only worth what someone is willing to pay for it. And when you say to Treasury, buy my Barry Manilow CD, they could come back and offer you FMV, say $5.00. If you say you want $10,000 for it, you’re getting a bailout. The treasuring department can hold that thing for 100 years, and maybe at that point someone will spend $10,000 for it. But don’t mistake the market-distorting effects of the Treasury’s actions for anything other than what they are.
The Treasury Department is buying these assets at well above FMV because they are “bailing out” banks, by definition.
And, then, once they take that stock, it will kill the relevant real estate markets for a decade or more.
October 4, 2008 — 7:01 pm
Joe Strummer says:
The Treasury Plan to buy those loans will get the loans off the books and “free up” capital that otherwise might have had to be held by the banks.
I don’t mean to be rude, but this is nonsense. If the government gives me $700 billion today, then I guess I have capital in the sense that I’m $700 billion richer. But the gov’t has not created capital in society. It has taken $700 billion from other people in society through taxation and given it to me. Assuming no leakage, at best it’s just a redistribution, with no net increase in capital. Capital is idle wealth that can be invested for some particular end. $700 billion more greenbacks is not capital.
The other way that gov’t could get that $700 billion is to inflate the currency, which is how it’s probably going to do this bailout. And that’s just taxation by another name: ruining the saved capital of 300 million people to benefit me by decreasing the value of each dollar they hold.
What’s more $700 billion is a drop in the bucket. If I’m a bank that receives part of the bailout, why would a creditor necessarily lend to me. It doesn’t know the extent to which these debts still infect my balance sheets, especially because even after the Bear bailout banks were warned by the Gov’t to fess up, and they did not. That’s because they knew that if push came to shove, another bailout would be around the corner. So they hoped to ride out the summer.
All government is doing through this bailout is taking money from some people and giving it to other people – namely people who made some awful financial bets. The people who are getting the money – and who have been demanding it – are smarter and better connected than your average American, and so they talk about credit markets seizing, and a looming depression.
Well, there should be a credit seizure. There’s a LOT of bad debt out there that needs to be cleaned out. And there should be a recession, at the least, because Americans have been living beyond their means. That’s not a bad thing.
What’s a bad thing is making this depression drag out for 10-15 years, rather than the 2-3 years it would take if we didn’t try to socialize the losses.
The UK was hit by depression in 1929, but it had recovered by about 1934, in large part because it didn’t inflate its currency. It was a deep drop, and then recovery. The U.S. did the opposite, trying to soften the blow through expansionary monetary policy and high spending so that the U.S. economy suffered throughout the 30s.
We can do this the quick way, but we’ve decided to do this the hard way.
October 4, 2008 — 7:17 pm
Robert Kerr says:
When did the real estate bubble start, Robert?
2002/2003. Fueled by Greenspan, not the CRA. IMO.
And with Alt-As going sour for the past 8-10 mos, how can you continue to point to the CRA?
October 4, 2008 — 7:37 pm
Brian Brady says:
Joe,
Milton Friedman would have argued that the length of the Great Depression was because NOT ENOUGH was done to insure a fluid banking system.
There is a multiplier effect that comes from loans. For example, proceeds from a particular mortgage loan made (from freed funds) could result in a remodeling. Those proceeds could purchase drywall, paint, etc. Moreover, that same mortgage loan proceeds could start a business, that serves the fuel needs of China. thereby increasing money into our domestic money supply.
The zero-sum philosophy you highlight here:
“All government is doing through this bailout is taking money from some people and giving it to other people”
fails to recognize what you pointed out earlier:
“Money isn’t wealth. Money is – or ought to be – a mechanism to get wealth. Wealth is things people want.”
Exactly. If we import more money from the money we lend domestically, we have a net gain to the money supply.
Again, I don’t like this bill but I don’t hate it. Properly administered, it could result in a positive result
October 4, 2008 — 7:37 pm
Joe Strummer says:
Exactly. If we import more money from the money we lend domestically, we have a net gain to the money supply.
If tomorrow the government says, instead of $25 trillion, there are going to be $50 trillion issued, it has not increased wealth – i.e., the amount of stuff in the country. It has just increased the NUMBER OF DOLLARS it takes to buy that stuff.
That’s not capital creation or wealth creation. That’s inflation.
Also, the Fed was engaged in massive inflation throughout the 20s and 30s, and Friedman is just wrong, and we know he’s wrong because of Britain.
The bailout will have a positive result to those who receive the bailout. The rest of us are not going to be better off, we’re going to be taxed and inflated to pay for it.
You’re right that those net winners who receive the money will be able to remodel, or whatever, and that that will benefit those segments of the economy that focus on real estate, construction, remodeling, and so forth.
But that money comes from somewhere: the net losers are people who are taxed to pay for it. And those people will have $700 billion less of it to do all of the things they would’ve done with it. That will have a deadening effect on all of those people and their lives. But we won’t really hear about that as much because we’ll be hearing about how the the banks are enjoying their newfound $700 billion.
That’s kind of the nature of any government program: the people who receive the money get their concentrated benefits, and talk about how wonderful it was for them to receive that and its wonderful multiplying effects.
October 4, 2008 — 8:07 pm
Brian Brady says:
“That’s kind of the nature of any government program: the people who receive the money get their concentrated benefits, and talk about how wonderful it was for them to receive that and its wonderful multiplying effects.”
Agreed. I want to reiterate that I don’t necessarily like the bailout plan, Joe. I’m assuming that we’re discussing these points academically now. In that spirit, let me offer this theory for your consideration.
What if the $700B can be financed through a T-bond issue? Certainly, an issue of that size will be 100bp above the current 4.11. Can the Treasury buy assets, with higher coupons, and benefit from both the price advantage (after expected defaults) and arbitrage?
Again, I’m posing an academic question
October 4, 2008 — 8:22 pm
Brian Brady says:
“And with Alt-As going sour for the past 8-10 mos, how can you continue to point to the CRA?”
The CRA was genesis of all REGULATED non-prime lending.
“2002/2003. Fueled by Greenspan, not the CRA. IMO.”
Okay. Some folks believe the disconnect from the inflation-paced returns of real estate started in the mid 90s as a direct response to the securitized sub-prime boom. We had a pause when the Russian current crisis killed sub-prime for a year or two and a pause in late 2001.
Could Greenspan’s actions, designed to avert a deflationary response to 9/11, have been fuel, not the ignition of this bubble, Robert?
October 4, 2008 — 8:27 pm
Brian Brady says:
“Russian current crisis”
should read: Russian currency crisis
October 4, 2008 — 8:28 pm
Joe Strummer says:
What if the $700B can be financed through a T-bond issue? Certainly, an issue of that size will be 100bp above the current 4.11. Can the Treasury buy assets, with higher coupons, and benefit from both the price advantage (after expected defaults) and arbitrage?
When the government issues more T-bonds, it’s printing more money. That’s what inflation is.
October 5, 2008 — 7:10 am
Joe Strummer says:
Also, this isn’t academic at all. It’s how the economy works.
October 5, 2008 — 7:11 am
Greg Swann says:
> When the government issues more T-bonds, it’s printing more money. That’s what inflation is.
That’s an important point, because Americans have been very carefully taught to understand inflation as broad-based price increases. But those price increases are a secondary consequence of currency inflation. The bank of issue increases the quantity of currency relative to the quantity of goods. With more dollars chasing the same amount of goods, prices must rise.
FWIW, it’s interesting to me how well the American economy has kept pace during the current reign of raining cash. In industries where productivity is increasing relative to the surging money supply, prices have held steady or even declined. It will be interesting to watch how this plays out in the economics of abundance.
Brian: You should entreat Joe Strummer to make time to appear on your radio show tomorrow. I think that would be very enlightening.
October 5, 2008 — 7:41 am
Brian Brady says:
“Brian: You should entreat Joe Strummer to make time to appear on your radio show tomorrow. I think that would be very enlightening.”
Agreed, Greg. Joe, would you do us the honor at 4PM tomorrow? Figure 30-45 minutes?
October 5, 2008 — 12:34 pm
Joe Strummer says:
4 pm eastern? I’ll be in court.
October 5, 2008 — 12:37 pm
Brian Brady says:
4PM AZ time (Pacific). I don’t have a live call scheduled (with participants asking questions) so I can do it later if you’re available
October 5, 2008 — 1:16 pm
Joe Strummer says:
Thanks for the offer. I don’t think I would be able to do it this week. Too much on my plate.
October 6, 2008 — 10:14 am
Brian Brady says:
Say it ain’t so, Joe (I’ve been dying to use that line).
I appreciate the consideration. Please keep commenting here and I will try and take a raincheck.
October 6, 2008 — 2:30 pm