Teetering and Tottering

Doug Marshall
Market Assessment
Published December 18, 2008

While brokers watch commercial lending sources dry up and investors and consumers sweat over their IRA’s and 401(k)’s, concern over one’s personal welfare can sometimes cause us to lose perspective on the depth of the credit and liquidity crisis affecting the nation.

It’s amazing to consider just how big this one-time credit crunch, now a near-depression, has affected things – things like the American banking community.

The 24th and 25th banks to fail in 2008 recently gave up the ghost. Haven Trust Bank of Duluth, Georgia, and Sanderson State Bank, in Texas, both got bought out by local rivals according to the FDIC.

The opportunity presented for the strong financial institutions to buy out the weak ones seems to be irresistible – from big powerhouse institutions to small boutique investment firms, banks sit and drool over weakened rivals that can bolster their portfolios and positions.

In considering that 25 banks have failed during the year, compared to just 3 bank failures in 2007, it’s plain that the entire financial and banking institution is reeling, tottering around and trying to maintain its own balance, like a woman with most of the glue gone from one high heel.

And when the FDIC itself doubles the premiums paid into the system by banks and considers tapping Treasury for short-term cash to ease its own cash flow – it says that we all had better hang on by our fingernails.

The FDIC, insurer’s insurer, was created by Congress in 1933 expressly for this purpose, to reestablish confidence in the banking industry. Since then, it has covered the failures of 2200 depository institutions and brags that “no depositor has lost even a penny of insured funds.”

The FDIC even felt called upon to issue a statement to that effect; basically a “you can count on us” speech that seeks to assure investors and depositors that it will be there no matter how many banks hit the floor.

But those of us living in the world of financing and lender/investor relations have to wonder where we’ll be in a year’s time. For most of us, our goal for 2009 should be to just get through it as best we can and not necessarily to get on top of it.

Sources:
Financial Week/Reuters, Dec 13, 2008 – Two More Banks Bite The Dust
Financial Week/Reuters, Aug 27, 2008 – FDIC May Hit Up Treasury For A Little Pin Money
Bloomberg News, Oct 8, 2008 – FDIC Will Double Premiums To Boost Insurance Fund
FDIC Press Release, Dec 10, 2008 – FDIC Reiterates the Guarantee of Federal Deposit Insurance
Tim Catts for Financial Week, Dec 15, 2008 – Big Battle Shaping Up For Smaller I-Banks

Say Good-Bye To LandAmerica

The nation’s third-largest title insurance company, LandAmerica Financial Group, has been forced to file for Chapter 11 reorganization, with the sale of its underwriting subsidiaries to Fidelity National Financial.

The announcement, made Wednesday of last week, marked yet another tremendous loss to the mortgage crisis, on a national level.

Having already lost its subsidiary LandAmerica 1031 Exchange Services, Inc, to bankruptcy earlier this week, the Richmond-based corporation decided to sell its two largest and most profitable subsidiaries, Lawyers Title Corp and Commonwealth Land Title Insurance Co.

LandAmerica had a merger deal on the table with Fidelity National as recently as November 7. Fidelity National, however, backed out of that deal within two weeks of its announcement, apparently after assessing LandAmerica’s financial condition.

LandAmerica recorded $2.8 billion in debt September 30.

Instead of assuming such debt, Fidelity National retreated and then returned to pick up the ailing insurance giant’s underwriting subsidiaries which constitute 90% of LandAmerica’s profitability.

There wasn’t much choice for LandAmerica. Trading for the company stock on the New York Stock Exchange had been suspended, since it had sunk to $.20 per share.

LandAmerica’s worth, as recently as last summer, was $1.6 billion. However, as many other companies in this industry and economic climate are discovering, the mortgage squeeze is sapping credit and savings as few other downturns have.

For those with large investitures in real estate-minded affairs, it’s going to be difficult to retrench far enough to save their limbs.


Sources:
Joseph A Giannone, Reuters, “LandAmerica Files For Bankruptcy, Sells Businesses”, Nov 26, 2008
Paul Jackson, NuWire Investor, “LandAmerica Declares Bankruptcy”, Nov 26, 2008
Richmond Times-Dispatch, “LandAmerica Files For Bankruptcy”, Nov 26, 2008

Deflation: Friend or Foe?

Doug Marshall
Market Assessment
December 5, 2008

It’s hard to keep up with the news in this market. Not more than a couple of months ago, we were all worried about runaway inflation with oil prices leading the way. What a difference a few months make.

Now, the worry is deflation. Deflation is a period of falling overall prices. Prices can drop in order to reflect an adjustment in the market. It’s perfectly natural at times, and wonderful. However, if prices drop for extended periods of time, it hurts the economy rather than helps.

Here’s an example: you are in the market to buy a new home, but do you want to be the person who takes out a mortgage on a home that may likely be worth less in six months? Assume for moment that you want to put 10% down and finance the balance. If the price of the house you purchased continues to fall what happens to your equity? It eventually goes to zero and at some point the loan balance may exceed the value of your home.

So instead of buying a home, you wait. Consumers and investors delay buying since they expect further price drops.

Banks, borrowers, and businesses all stand to lose from such a situation, causing more economic turmoil for the average citizen as well as the capital markets. During the Great Depression, 10% deflation per year contributed to a huge lack of demand. Farmers found it impossible, also, to keep up with mortgage payments, due to the falling prices of agricultural products. (1)

How real is this worry? Here are some statistics from October alone that have economists’ brows furrowed (2):

> The consumer price index dropped an unexpectedly large 1%, including an 8.6% plunge in energy prices. The core index (excluding energy and food) fell 0.1%, the first drop in the index since 1982.
> The producer price index, measuring wholesale prices, reports that the index fell 2.8% in October, including 12.8% in energy prices. This is the largest decline in the PPI in the report’s 61-year history.

Another example of deflation of most concern to the real estate profession is the yields on treasuries. Yields have fallen on the 2-, 10-, and 30-year bonds to some of the lowest levels since the Federal Reserve began keeping records in 1962.

This is a sign of frozen credit (3), where lenders would rather invest in low yielding treasury bonds rather than lending to other lending institutions or borrowers where the risk of default is unknown.

All in all, a deflationary period of any sustained length of time would hurt everyone. Let’s just hope that the market proves more resilient than to follow this inevitable path to destruction.

1 John W. Schoen, “Falling Prices Raise Worries About Deflation” (MSNBC.com Eye On The Economy)
2 Ben Steverman, “Deflation: What Investors Need To Know” (BusinessWeek)
3 David Goldman, “Treasurys: The Pressure Eases A Little” (CNNMoney.com)

Light At The End Of The Tunnel

Doug Marshall
Market Assessment
Published November 11, 2008

The future may not be quite as grim as some make it out to be. In a recent study conducted by Jones Lang La Salle (JLL) they discovered that almost half of the CRE professionals they polled expected activity and investing to pick up in 2009, a big jump from earlier and heavier skepticism.

JLL is a financial and professional services firm specializing in real estate services and investment management worldwide. That’s the good news. Now for the bad news.

Jack Minter, JLL Managing Director for investment sales, explains that the reasoning for the increase in optimism is exactly because of the credit market crisis. More CRE professionals than in previous studies expect that values and corresponding prices of property will decline, across the board, and make investment at “distressed prices” a good idea rather than a bad one.

While the retail sector is viewed with the most concern, office, industrial, and multi-family space don’t fare much better. Fully 94 percent of those surveyed expect retail investments to decline by 0 to 50 percent!

Seventy-five percent of respondents expect office investments will also decline by about the same amount. The outlook for the multi-family and industrial markets fare only slightly better.

The “good news” is that a larger percentage of respondents to this poll, than the same poll a year earlier feel that sales activity will be better in the coming year, producing a “flurry” of investment sales.

Small comfort, one might say, but small gleams are still light.

Source:
Paul Rosta, Senior Associate Editor
www.CommercialPropertyNews.com

Emerging Trends' Crystal Ball

Doug Marshall
Market Assessment
Published October 30, 2008

Emerging Trends in Real Estate is a 30-year old annual publication, focusing on the real estate and land use industry. It is co-authored by ULI (the Urban Land Institute) and PricewaterhouseCoopers LLP. It surveys experts from all sectors of commercial real estate and comes back with a report on where they believe the industry stands and is heading.

Brace yourself. The future has (unfortunately) become clearer.

According to the 2009 report issued recently, experts don’t expect the US economy to hit bottom until 2009, and they feel it will “flounder” throughout 2010 as well. In general, interviewees believe that financial institutions will continue to be pressured into moving bad loans off balance sheets.

Investors will likely wait until sellers realize that the market has adversely changed requiring them to lower their asking prices or wait until the market slowly comes back. Once the adjustments have made, both by lenders and sellers, those investors with cash or can afford low leverage transactions will be “king.”

In a situation like this, when bad debt is rampant and investors are burdened with upside down properties, serious retrenching is taking place. Absolute avoidance of risk seems to have taken priority with both lenders and those they serve. Commercial real estate is seeing a tremendous shift to a “back-to-basics attitude toward property management, underwriting, and deal structure”.

However, if you own an 8-plex apartment house near a bus stop, you’re still probably going to make money. That’s one of the few shining lights left in commercial real estate, says the report.

While the situation is dire, to be sure, there is hope for the future in the creation of more stable real estate markets. However, Emerging Trends has indicated several things that have to happen before we can see that recovery:

1. Private real estate markets need to correct – lenders must force distressed owners to become motivated sellers.
2. Debt capital needs to flow – the CMBS market must recreate itself and lenders will need to learn to adjust to the new, more conservative regulatory environment.
3. Regulators need to restore confidence in the securities market – systemic overhaul of the capital markets will slowly increase debt flows.
4. The economy needs to improve – unfortunately a waiting game for most CRE players.

The report predicts that the property sectors most promising in the months ahead will be apartments, with distribution/warehouse coming in second. Downtown office space is expected to outperform suburban markets.

But retail development will likely be at the bottom end of the real estate investment spectrum, with vacancies expected to climb due to the economic downturn.

Source:
www.marketwatch.com, Commercial Real Estate Market to Hit Bottom in 2009…, October 21, 2008.

Update On The Fed Rate Cut

Doug Marshall
Market Assessment
Published October 14, 2008

Last week the U.S. central bank, in a coordinated monetary policy move along with other major central banks worldwide, lowered the federal funds rate by 0.5% to 1.5%.

The purpose of this decision was to help calm the credit markets by taking another step towards stabilizing the global financial system.

The federal funds rate is the interest rate that banks charge each other for overnight loans. This decision will have an almost immediate impact on credit card rates, automobile loans, and business loans.

The rate cut is meant to give the economy a slight lift during a tough time, by reducing interest rates and making it less expensive for consumers and businesses to spend money.

But what effect will the rate cut have on commercial real estate loans? The day before the rate cut the 10 year treasury rate was trading around 3.50%. Today it is trading at 4.01%, an increase of 51 basis points.

Why would lowering the federal funds rate by 50 basis points increase the 10 year treasury rate by about the same amount?

The reason is that the 10 year treasury rate is not set by the Fed but rather by the market. And who owns most of our treasury bills? Foreign investors do.

The cut in the fed funds rates has left many foreign investors worried about the Fed’s ability to contain inflation, which has led them to begin pulling their investments out of US dollar- denominated assets.

So, as foreigners reduce their investment in US treasuries it reduces the demand for US treasuries. The law of supply and demand dictates that if the supply is staying essentially the same and demand is weakening then the price is going to come down, pushing up the yield rate.

So in effect the rate cut by the Fed is actually having the opposite effect that many hoped it would. It’s actually causing long term interest rates, which are more important to the economy and particularly the real estate industry, to rise.

Go figure!

Sources:
Matt Heaton, Active Rain Real Estate Network, Update on the FED rate cut
Reuters.com, October 8, 2008 Fed funds rate at 1.5 percent, matching target rate

The Four G's of Investment in a Hard Asset Economy

Doug Marshall
Market Assessment/Review
Published October 1, 2008

Last Friday I had the opportunity to attend the 3rd Annual CCIM/CID Conference in Bend, Oregon. The guest speaker was Dr. John Baen, professor of Real Estate at the University of North Texas. For three intense hours, Dr. Baen had the audience on the edge of their seats as he explained in layman’s terms what was happening in the capital markets.

His explanation of the current crisis was fascinating, but instead of simply focusing on the problem he also talked about the solution. In every economy, he said, there are opportunities for the savvy investor.

The crux of his talk could be summarized this way: we are at the beginning of a new hard asset cycle, where cash is king and where investing in securities, such as money market accounts, stocks, and bonds will be the big losers.

He talked of “the four G’s” – the type of investments that will prosper in a hard asset economy:

· Gold – precious metals will be a hedge against inflationary pressures.
· Ground – not just land but real estate as an asset class. Bare land is an excellent hedge against inflation but produces a smaller return on your investment than income-producing properties.
· Gas – investing in gas and oil is an excellent investment, but only for those with an understanding of this type of investment.
· Grub – meaning food, i.e., commodities and basic staples such as corn, wheat, etc. These will do well in the years ahead.

Dr. Baen then focused most of his time on how we can identify good real estate investments. Here are some of his thoughts:

Interest rates will have to go up substantially in the years ahead. He cited Alan Greenspan’s book, The Age of Turbulence, as a reference. Those who lock in long-term interest rates today will be among the winners.

Not all real estate will prosper equally. In a “down” economy, apartments and rental housing should do well. As the economy continues to soften, office and retail properties will be likely losers.

In the months ahead, lenders will be willing to make deals on properties in default in order to get them off their books. Those investors who are willing to propose very one-sided offers may be pleasantly surprised by lenders eager to make deals.

Bob Nelson, principal of Pacwest Real Estate Investments, also attended the seminar and did a much more thorough job of taking notes than I did. Click here for Bob’s 6 page summary of Dr. Baen’s talk.

Source:
Dr. John Baen, Professor of Real Estate, University of North Texas

Is WaMu The Next To Fail?

Doug Marshall
Market Assessment
Published September 18, 2008

The Oregonian, citing anonymous sources, revealed in today’s paper that Washington Mutual now seems prepared to “throw in the towel.”

The ailing Seattle thrift has hired Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) to begin an auction, several media reports including The New York Times are saying. The obstacle, however, is that no one knows what they are worth because the amount of bad loan debt is not fully known.

We can only hope that another financial institution will acquire the largest savings and loan in the country. As disruptive as that would be, the bankruptcy of WaMu would be far worse for the Pacific Northwest’s economy and specifically the commercial real estate community.

Ironically, the crisis that WaMu is currently facing has nothing to do with their commercial real estate lending programs. Their problems arose from WaMu’s origination of billions in subprime loans, home equity lines of credit and so-called Option ARM loans to people who could not afford them.

Shares of Washington Mutual stock have plummeted in recent weeks amid the concern of mounting losses. As of this writing, WaMu stock is trading at $2.35 per share, down about 94% from its 52 week high.

On a different note, regional lender Umpqua Bank may be the next to falter. Stay tuned.

______________________________________________

Sources:

Troubles hit Northwest as Washinton Mutual, with regulators’ help shops for buyer by Jeff Manning, The Oregonian, September 18, 2008

Washington Mutual Worries Remain; Associated Press, September 17, 2008

On the Brink - Washington Mutual Preps for Sale by Laurie Kulikowski, September 18, 2008.

______________________________________________

View our interest rates page on our website. Please call us if we can be of assistance on your next transaction.

Fannie/Freddie Taken Over By Treasury Department

Doug Marshall
Market Assessment
Published September 8, 2008

The other foot has finally dropped. What many experts were expecting to happen has happened quietly over the weekend. The two lending giants, Fannie Mae & Freddie Mac, are being taken over by the Treasury Department, at least temporarily.

This move by Treasury represents the most significant intervention by the government in the financial industry since the housing bust touched off turmoil in the credit markets a little more than a year ago.

As many have said in recent months, Fannie & Freddie are too large and too important to the credit markets to let them go down in flames. Intervention was the only real option unless of course you wanted to risk the very real potential of an economic meltdown.

The move by Treasury was precipitated by the steady rise in U.S. home mortgages that were either overdue or in foreclosure.

The latest survey by the Mortgage Bankers Association indicated that over 9% of all home mortgages in the country were at least a month overdue. That is up from 6.5% a year earlier and is the highest since the MBA began such a survey 39 years ago.

Fannie and Freddie guarantee more than $5 trillion in mortgages and have incurred combined losses of about $14 billion over the past four quarters. As loans continue to default, Fannie and Freddie losses continue to mount requiring more capital infusions to stay solvent.

The question that affects those of us in the commercial real estate industry is whether Fannie and Freddie will continue to lend on apartments. Although the default rate on commercial real estate is quite modest, estimated at less than 0.2%, no one knows for sure whether they will continue apartment lending.

A quick search on the internet did not uncover any clues on what Treasury will do with the comparatively highly successful apartment lending programs.

In related news, Kerry Killinger the chief executive officer of Washington Mutual was ousted today. WaMu’s stock price, already at a precipitously low price, plummeted another 12% as the news was announced of Killinger’s firing.

We aren’t through the crisis yet. Stay tuned.

Sources:
Frank Confirms Treasury Intervention To Shore Up Fannie Mae, Freddie Mac
by Deborah Solomon and Damian Paletta, The Wall Street Journal

Foreclosures, Overdue Mortgages Increase Again by James Hagerty, The Wall Street Journal

Go, Greenback!

Doug Marshall
Market Assessment
Published August 19, 2008

re·val·u·ate / riˈvælyuˌeɪt / ree-val-yoo-eyt:
to increase the legal exchange value of (a nation's currency) relative to other currencies

In hard times, it’s always encouraging to hear good news.

This week, that good news concerns the almighty dollar, which has taken a beating in recent months, since the sub-prime collapse and the upheaval in markets that many thought were going to result in one of the worst recessions in recent memory.

However, investment bank Goldman Sachs has noted that the dollar appears to be strengthening so well that they have begun re-thinking their 10-year bearish stance on the American currency.

Due to the increasingly poor relative performance of other currencies outside the U.S. and continued stable and stabilizing growth within, the investment bank says that they feel positive about continued long-term growth of the dollar.

The “powerful improvements in the real trade balance suggest the dollar has bottomed” and the investment firm, the largest in the U.S., expects that capital inflows are going to improve and thereby reintroduce confidence in the economy.

While this evaluation sounds very encouraging, the dollar still faces challenges. Volatility in oil prices, the condition of its position in the market, and decreased consumer spending are three factors that could continue to adversely affect it.

But there are many economists and market-watchers now that fully expect that with the continued improvement of the dollar against currencies like the yen and the euro (especially the yen), revaluation of the beloved greenback is likely.

There is always a chance that things will reverse again and we’ll see more losses after this rally. However, the upward trend of the dollar has continued for a little while and, with continued improvement, it is hopeful that this strengthening may be seen as permanent.

This is the good news for the week, then: a stronger dollar means that investors around the world will sleep better after sending money this way.

Sources:
Financial Week.com, August 14

Liquidity Crisis: Are We At Bottom?

Doug Marshall
Market Assessment
July 31, 2008

It’s the question of the moment… where are we in the financing freefall? Are we still going down or are we ready to rise?

In a recent presentation, Eric H Better, a Vice President with George Smith Partners, listed both the positive and negative aspects of the current commercial real estate market:

The positives:

• Default rates on CMBS loans are 0.33% which is historically very good.
• Basic real estate fundamentals and underwriting are sound.
• The Fed is taking a very proactive role in assisting investment banks in their recovery, and

The negatives:

• Spreads are still wide, about 150 to 200 basis points wider than they were 12 months ago.
• CMBS lenders still cannot calculate their true cost of capital.
• Many CMBS lenders have permanently left the market; others are waiting for the market to come back.

As a sector of the capital market, conduits could be financing as little as 10% of the volume they did in 2007, from $240 billion in 2007 to $25 billion this year.

Until a reasonable yield curve can be determined on the bond side, the conduits are not the best lending alternative.

Concerning life companies, the news isn’t much better. While the life companies have the potential to provide about $50 billion of capital to the industry, experts like Mr. Better see them investing as little as $20 billion in 2008.

Instead of lending, many life companies have decided to purchase CMBS bonds. The wider spreads make them an attractive alternative to lending.

This year commercial banks have been the most aggressive of the three major capital market sectors. Select local, regional and national lenders are competing effectively against Fannie Mae and Freddie Mac for multi-family loans.

Commercial spreads, though wider than multi-family spreads, are typically better than what most life company quotes and many times without the reserve requirements and onerous prepayment penalties.

So are we at the bottom or will it take time and more time to correct the adjustment in this market economy? Right now it seems to be a “wait and see” world.

As Mr. Better points out, there are several things required before it can be said that we’re moving in the right direction: stability in CMBS pricing, bond investors returning to the market, and more stable and subtle swings in interest rates.

Your answer: hang on!


Source:
Eric Better, Vice President
George Smith Partners
July 2008 CRE Presentation: “Nationwide Commercial Lending”

The Woes Of The GSE's - Fannie Mae And Freddie Mac

Written by Tanya Gerritz
Published July 18, 2009

There’s so much going on right now I don’t really know where to start. Well first off, as you will see below, I added some other information to show you how the market has changed over the past year.

Now I could continue to focus on the current economic worries – oil prices, trade deficits, weak currencies, high unemployment, inflation, and so on but instead I’m going to discuss recent news out on the financial markets regarding Fannie Mae and Freddie Mac.

This update is basically going to educate those who don’t really understand Fannie Mae and Freddie Mac and how they affect our economy as a whole.

So what are Fannie Mae and Freddie Mac? They are the largest purchasers and insurers of residential mortgages in the country, holding or backing more than $5 trillion in mortgages, which is about half the outstanding mortgage debt in the United States.

They were created to provide low and middle income Americans the opportunity to purchase houses with a reasonable interest rate by adding to the available cash that banks can loan people. By buying mortgages from banks they replenish the banks’ accounts allowing them to make more loans.

Now a lot of people think that they are owned by the government but they are not, they are both publicly owned companies and their stock is traded on the open market. People also believe that they are backed by the government but the law that created them explicitly says the government does not guarantee the loans.

Now yes this is said in the law that created them but due to the fact that it would be devastating to the economy if they went under the Federal Reserve would step in with additional support if needed, like they are now!

What problems are they facing now? Well Fannie Mae and Freddie Mac don’t just buy home loans and repackage them into bonds that are traded on Wall Street; they also guarantee all of the loans they sell to investors! Therefore, if a homeowner defaults on a mortgage, Fannie and Freddie will step in and make good on the loan.

Well, as we all know, homeowners are defaulting and being foreclosed on at alarming rates, so Fannie and Freddie are being forced to make good on those guarantees to investors. Already they’ve posted combined losses of $11 billion, and investors are worried there’s much more to come!

Fannie Mae and Freddie Mac are required by their government regulator to have a financial cushion but due to their recent loses the cushion has been dwindling.

Investors who are worried that the two companies will not be able to raise new money during a time in which it has been expensive and difficult to do so started frantically selling off their shares causing the companies’ stock prices to fall to a two-decade low, dragging the rest of the market into bear territory.

What is being said about the situation? One former Fed official says the two companies are technically insolvent, while others disagree.

Some analysts were arguing that the sell-off was overdone and that neither company is in imminent danger of collapse, while others called for a federal takeover of the two.

What would happen to the housing market if these two mortgage institutions did indeed go under? It would be a catastrophic event that would totally disorient the private housing market. William Seidman, publisher of Bank Director magazine and former chairman of the Federal Deposit Insurance Corp. says, “It would be as close to a disaster as I can think of. If they could no loner package and guarantee mortgages, funding availability for housing in the U.S. would be drastically reduced.”

If they did fail, says Brad Neigel, a senior analyst at Aite Group, a financial services research firm, “it would be the collapse of the entire mortgage industry as we know it.”

What is currently being done to help the two mortgage giants? The Bush administration and the Federal Reserve announced an emergency rescue plan Sunday to help the two companies.

The plan would temporarily increase a long-standing Treasury line of credit that could be provided to either company. Treasury also said it would, if needed, buy stock in the companies to make sure they have enough money to operate.

The Fed also announced it would allow Fannie and Freddie to get loans directly from the Fed – a privilege previously granted only to commercial banks until this March, when the Fed extended the borrowing to investment banks to deal with the collapse of Bear Stearns.

Source:
The Oregonian, MSNBC.com, MSN Money, Wells Fargo

How Old Federal Reserve Laws Help Us In New Crises

An Old Law for a New Step at the Fed
by Sudeep Reddy
July 14, 2008 @ 12:24 am

The latest turn in the Federal Reserve’s efforts to prevent a deeper economic crisis came with its vote Sunday to authorize direct lending to Fannie Mae and Freddie Mac.

The central bank invoked powers established by Congress during the Great Depression to lend to individuals and companies, using a different piece of the law from March when the Fed started lending to investment banks.

The Fed’s existing authority effectively allowed it to stand behind the Treasury Department, whose much broader plan would require congressional approval, as a backstop for the two firms underpinning much of the U.S. housing market.

The Fed’s Board of Governors in Washington voted unanimously to allow the Federal Reserve Bank of New York to lend to Fannie Mae and Freddie Mac “should such lending prove necessary.”

The mortgage firms would borrow at the primary credit rate, which is now at 2.25%. That’s the same rate that commercial banks and securities firms pay for discount window access.

Before the credit crisis started last August, the Fed had maintained the discount rate at a full percentage point above the benchmark federal funds rate, the rate for overnight lending between banks that now stands at 2%.

The Federal Reserve Act’s Section 13(13), created in 1933 and amended in the late 1960s, allows the Fed to lend to any individual, partnership or corporation with collateral backed by U.S. government securities or securities issued by federal agencies. Fannie Mae and Freddie Mac debt is generally included in that latter category of safe holdings, even though it’s not directly guaranteed by the U.S. government.

In March, the Fed used Section 13(3) of the act to extend its lending arm to investment banks during the Bear Stearns liquidity crisis (first with an initial Bear Stearns loan and two days later in creating the primary dealer credit facility).

That provision allowed the Fed to lend during “unusual and exigent circumstances” only if a firm can’t borrow elsewhere.

The latest Fed action Sunday requires neither finding. The collateral allowed for investment banks was much broader, while the Fannie and Freddie lending would be safer from the Fed’s perspective because their holdings are more liquid and don’t require the same safeguards.

Lending under the 13(13) provision has occurred at various times from the 1930s through at least the early 1970s. Regular lending to investment banks has been in the tens of billions of dollars in some recent months (though it dropped to zero in the latest reporting period).

The lending to Fannie and Freddie could end up being zero, unless there’s a severe crisis in the markets. The Fed structured the latest arrangement to serve as a backstop: The mortgage giants would have to request to the New York Fed that they need the loan, but only after tapping their Treasury credit lines, which now stand at $2.25 billion even without the increases to be sought by the Treasury Department.

The government’s move Sunday to stand behind the two firms could offer enough support to prevent the kind of short-term liquidity fears that have hit investment banks, even though capital — not liquidity — had been the concern at Fannie and Freddie into the weekend.

The Fed did not provide an explicit timeline for how long the lending would be available. But the central bank said in its statement Sunday that it was acting to support Fannie Mae and Freddie Mac “during a period of stress in financial markets.”

For investment banks, the Fed has already indicated that the “unusual and exigent circumstances” may last into next year.

Debate is already underway about whether the existing Fed authority is adequate. Testifying about financial regulation before a House committee last week, Fed Chairman Ben Bernanke was asked whether the authority it used during the Bear Stearns crisis — under Section 13(3) — needed to be clarified to allow the Fed to act in the future. Mr. Bernanke replied:

“That was set up by Congress with the intention of creating a very flexible instrument that could be used in a variety of situations, and it allowed us to address the situation, which we did not anticipate, which we’ve not seen before. And so in that respect, having that flexibility I think was very valuable.”

Mr. Bernanke added, however, that in the short term “it’d be entirely appropriate” to have discussions with congressional leadership — as he did over the Bear Stearns weekend — “about what the will of the Congress and how we should be approaching these types of situations.”

He reiterated the call that he and Treasury Secretary Henry Paulson have made to create “a more formal mechanism that created some hurdles for decision-making, that set a high bar in terms of when these kinds of powers would be invoked, and provided more than just lending tools.

"It’s really not well suited in some cases to address systemically important failures.”

Unlike most aspects of the Treasury Department’s plan, the Fed won’t necessarily need congressional approval to get started on its new tasks.

The direct-lending, if it were even necessary, would be done under its existing authority. Treasury’s Mr. Paulson included the Fed as one piece of his three-part proposal to address the crisis, giving the central bank “a consultative role” in setting capital requirements and other standards with the new regulator for the government-sponsored mortgage giants.

The Fed already consults with other agencies that monitor financial institutions; earlier this month it signed an agreement with the Securities and Exchange Commission to cooperate in oversight of investment banks.

The balance sheets for the mortgage firms is less complex than for investment banks. As a result, the Fed conceivably could work more closely with the current regulator over Fannie and Freddie — the Office of Federal Housing Enterprise Oversight — even before any changes move through Congress.

How the latest decisions are intended to work in practice could become clearer in the coming days.

The weekend’s actions come just before Mr. Bernanke makes his semiannual monetary policy reports to Congress. He’ll face questioning from Senate lawmakers on Tuesday, followed by House members on Wednesday.

Article re-printed from Real Time Economics: http://blogs.wsj.com/economics

Securitization Made Insecure

Doug Marshall
Market Assessment
Published July 9, 2008

In assessing America’s current credit crunch and the past year’s near-collapse of markets, an important observation has been made by San Francisco Federal Reserve Bank president, Janet Yellen.

It was the securitization and distribution of bundled mortgage-backed assets that was the “key driver” of our hyper-inflated real estate market, argues Yellen.

Loan originators, says Yellen, with no motivation to do otherwise, bundled and sold loans as mortgage-backed securities to the highest bidder without worrying over-much about their quality, the credit risk they carried, or their liquidity.

In the market that we had, where money was loaned almost without looking, there were several key culprits and factors that contributed to this over-securitization and caused a leveraging of our bank system that, Yellen declares, probably won’t stabilize for at least another year.

• The market’s rapid and insatiable need for mortgage-backed securities left loan originators with no reason or responsibility for properly vetting the bundles that they sold. They weren’t morally aligned or held responsible for the quality of those loans.
  
• Risk management in assessing credit and liquidity was left behind. Institutions and investors, even large ones, who were doing the buying of these bundles relied so heavily on flawed “rankings” of the products that they neglected to carry out their own independent assessments on what they were buying.
  
• Finally, the re-intermediation and deleveraging process, the attempt to come to rely less on debt and more on equity, is probably going to continue for a while until commercial banks, who are less heavily regulated able and therefore able to shoulder this burden, appear healthier.

While Yellen expects the deleveraging process and recovery to continue well into 2009, she can see things getting worse before they get better. Banks must continue to find, and use more wisely, new equity capital. And the balance of losses and growth must continue, especially in larger institutions, to stabilize.

It’s like choosing the treadmill over the buffet. It takes a while to return to your ideal weight, and it comes down to making choices every day that mean a healthier financial institution and venture, and continuing to maintain those wiser decisions as a matter of policy.

Source:
Janet Yellen On Risks And Prospects For The U.S. Economy, Econobrowser, July 7, 2008

Fed, Focus! Beef Up That Dollar!

Doug Marshall
Market Assessment
Published June 19, 2008

The Federal Reserve, in continuing to focus on preventing recession and a greater economic downturn through interest rate-cutting, is now doing the American economy a disservice, according to Zaya Younan of Facts Matter.

Mr Younan, while applauding the aggressiveness with which the Fed has restrained the shadow of recession, points to the same rate-cutting done in the early months of 2008 as a primary reason for the current weak dollar and, not coincidentally, the rise in prices of commodities and inflation.

The U.S. dollar has taken a hard hit, dropping sharply to $1.5535 with the Euro (as of June 18, 2008), and will continue to fall unless the Fed takes off the rate brake and starts to increase them in an attempt to boost the battered greenback.

Until treasury rates come up and the dollar strengthens, Mr Younan sees inflation going further and creating the same recession that the Federal Reserve has sought so hard to avoid: consumer spending drops; commodities and gas prices jump; major corporations post deficit earnings; and economic growth goes negative.

While the Fed has announced that it will not be lowering rates further, it is imperative, says Mr Younan, that the Fed continue to play with and increase interest rates in an attempt to achieve equilibrium between diverting recession and dampening inflation.

Although we in commercial real estate wince at the prospect of higher interest rates it’s probably understood by all that such a move in this market will become more and more necessary. And the alternative (a devaluing of the dollar in relation to other currencies), at least according to Mr Younan, must be seen as even more unattractive.

Source:
Facts Matter by Zaya Younan, for GlobeSt.com, June 9, 2008

Credit Crunch: On To Recovery?

Jennifer Sinclair
Summary of Market Information
June 12, 2008

While some economists alternately warn of, and plead for, rising interest rates and many bank lenders seem to be retrenching and retreating from financing, the chief investment officer of one of the largest fund managers in the world, BlackRock, thinks that the worst of the credit crunch has passed.

However, in saying that “we’ve seen the worst of it in terms of crisis”, BlackRock Vice-Chairman Bob Doll admits that recovery will be slow, taking another two to four years to correct.

“There is still more to come,” said Mr Doll in Singapore recently, confessing that recovery from the bank-stability standpoint will be slow and other crises in credit card loan markets and auto loan markets, may slow growth even further.

The Federal Reserve is the hero, according to Mr Doll, with the bailout and provision for failing banks like Bear Stearns, ailing Washington Mutual (down 9.3% ), and pressurized Lehman Brothers (down 13.6%). “The point is policy-makers make bold, creative moves when the pressure is on…”, said Mr Doll, emphasizing the need for such measure to maintain the U.S. bank system.

While Mr Doll feels that the U.S. faces simple slower-than-normal economic growth, he admits that should gas prices and commodities prices continue to rise as they have, a full-blown American recession is likely.

Whether due to the end of a period of expansion or the beginning of 1970s-style stagflation, these indicators seem to be the ones to watch in assessing the future of the American economy.

Sources:
Financial Week, June 9, 2008
MSN Money, June 11, 2008

Interest Rate Cuts By The Federal Reserve Undercuts Inflation Fight

Doug Marshall
Market Assessment
Published June 3, 2008

The Federal Reserve has responded to the slowing economy by cutting the Federal Funds rate over the last several months. Has this produced the desired effect of spurring on the economy?

Analysts are saying it is having the opposite effect. It’s made things worse because inflation, according to the Consumer Price Index, has been zooming upwards in recent months. Inflation is expected to rise to 5.2% over the next year, a rate that hasn’t been seen since the late Carter and early Reagan administrations.

The Fed’s monetary policy has created real negative interest rates, where short term interest rates are below current inflation rates. The Fed hopes weak growth will cool inflation, yet it remains to be seen how long the Fed can maintain its present monetary policy without occasioning a spike in long-term inflation.

The Fed is belatedly realizing that it has helped turn smoldering inflation into a five-alarm fire, burning out of control. Consequently, they have signaled that they’re ready to abandon their policy of rate cuts.

Though short-term rates have come down in reaction to those early rate cuts, even those rates are looking to increase soon. One analyst (Mike Larson, http://www.moneyandmarkets.com/) feels that we’re more likely to see the Fed raising rates in the near future.

So what does that mean for your clients who need financing on their commercial properties?

1. The days of low interest rate loans are over. Ten years from now we will look back at 2006 and the first half of 2007 and realize just how good we had it.
2. You should be encouraging your clients to lock in rates as soon as possible, for as long a term as possible.

Sources:
Wells Fargo Commercial Mortgage Update, May 27, 2008
Mike Larson, www.moneyandmarkets.com, May 27, 2008

Bonds On The Ropes

Jennifer Sinclair
Summary of Market Information
May 9, 2008

In assessing how stocks, bonds, and treasuries are moving, the conclusion has been drawn that U.S. markets are headed down a tough road.

Bonds had, since June of last year, been trending upwards. Now, however, they seem to have peaked and, indeed, are moving frighteningly close to nasty falls and downward spirals.

Costs of mortgaging and other kinds of financing are in a position to get driven up, by spiking yields on Treasury notes. And, considering that the federal funds rate is yielding below inflation, real interest rates stand at negative values.

So, should inflation roar in, bond yields have the potential to soar, and even the conservative Federal Reserve is beginning to pay attention to that possibility. Kansas City Fed President Thomas Hoenig admitted that he is seeing “inflation psychology to an extent that he hasn’t seen since the 1970’s and early 1980’s.

So those looking to invest are advised to stay away from long-term bonds, a losing investment in an inflationary environment like this.

And for heaven’s sake lock the rates on any mortgage or borrowing instrument. Get financing for your project early and hang on to the interest rate, so that trying times don’t try your wallet.

Source:
Mike Larson, www.moneyandmarkets.com, May 9, 2008

Federal Reserve Credit Survey Results – Not Pretty

Doug Marshall
Market Assessment
Published May 21, 2008

In a survey taken quarterly by the Federal Reserve, some hard numbers get put to the trends seen in banks and their credit requirements for real estate funding.

A net tightening/loosening figure was placed on each sector and their lenders, reflecting an net tightening of credit by banks looking at loan requests, across markets.

The survey, titled “Senior Loan Officer Opinion Survey on Bank Lending Practices” for the second quarter of 2008, found that:

► A net 55.4% of lenders have tightened their standards on commercial and industrial loans to mid- and large-sized customers. At this time last year, banks were easing these requirements.
► On commercial real estate, a net 78.6% of lenders also tightened their standards. The first quarter of 2008 had the highest net increase in history; the second quarter, on which this number is based, comes in right behind.
► Residential mortgage numbers are even worse: 77.5% of lenders have tightened their standards in the sub-prime market. And even in the prime mortgage markets, 62.3% of lenders have tightened up. This is the highest increase, by a long shot, that the Fed has ever found in this sector.

The story told by these numbers is that lenders, who have been generous but not terribly discriminating in the past few years, are getting stingy with consumer, corporate, and commercial real estate funding. And in the consumer credit arena, even though demand has improved, supply just isn’t there.

Source:
Mike Larson, www.moneyandmarkets.com, May 9, 2008

Surging Credit Card Borrowing and Scary Implications

Jennifer Sinclair
Summary of Market Information
May 8, 2008

In a recent report on credit borrowing, it was found that consumer borrowing for auto loans, credit cards, and other non-real estate transactions has shot through the roof, by $15.3 billion.

The anticipated growth of credit borrowing by economists was $6 billion, so this comes as a surprise. This much borrowing, in a healthy economy, would signal a strong consumer increase in spending and more economic growth over time. But as we all know, this is not a health economy.

So what does this number mean? It means that consumers who are accustomed to taking out home equity loans and lines of credit, using them for vacations, boats, and other fun stuff, aren’t getting that money anymore. Banks aren’t willing to lend past equity and therefore have pulled the plug.

Instead, credit cards and other borrowings, for even day-to-day transactions have skyrocketed. Surging food and energy prices have forced consumers to rely on credit instead of ready cash. And this will weaken an already stumbling economy if allowed to persist.

Source:
Mike Larson, www.moneyandmarkets.com, May 8, 2008

Why Subprime Residential Lending Affects Commercial Real Estate Lending

Doug Marshall
Market Assessment
Published May 8, 2008

The question is persistently asked: why is commercial real estate financing suffering from the backlash caused by sub-prime residential lending?

CRE brokers and borrowers find little correlation between the two markets and therefore remain confused as to why the downturn in one is so affecting the other.

The reason pointed out by Dan Smith in the latest Commercial Mortgage Insight magazine is simple: the similarities in the two markets are driving them in the same direction more than their differences.

Basically, both markets syndicate and securitize their loans on Wall Street. The investor in securitized mortgage pools, for whatever reason, is not recognizing the major differences between the two lending markets: very lax underwriting in the subprime residential market compared to relatively tight-controlled underwriting for commercial lending.

More importantly, the delinquency rates for residential subprime loans are soaring compared to a very modest 0.3% for commercial loans. But it is the similarities between the markets now which is driving both toward the same depressed condition.

The market isn’t expected to stabilize for a couple of years, until new investor money comes into it, easing liquidity and injecting optimism.

But the impact has been minor for the second- and third tier lenders who seldom securitize their commercial real estate loans.

There is still plenty of money available for the smaller, “bread and butter” type of properties, albeit at more conservative rates and underwriting standards.

Source:
Commercial Mortgage Insight (May 2008)