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