What Happens if Debt Ceiling is Not Raised?

You may be thinking I'm going to weigh in on the debt ceiling debate.  This reminds me of the old saying, "Fools rush in where angels fear to tread."  I'm not going there.  Not a chance.  I've heard everything from the world is going to end to nothing is going to happen and everything in between.  And likely you have too.  

What I am going to discuss is a bizarre side effect of this fiasco: contrary to everything I've ever read on this subject interest rates on U.S. treasuries are plummeting.  What's going on here???   

Regardless of what happens on the debt ceiling debate the U.S. is likely to lose its triple A bond rating.  The rating agencies have been threatening a down grade of our nation's credit rating not unless $4 trillion is reduced from our spiraling out of control federal deficit.  None of the proposals currently being considered are close to this amount of deficit reduction.  So the likely effect will be a downgrading of our bond rating.  If this happens then logic dictates that interest rates on everything will go up, from credit cards, to auto and home loans to loans on commercial real estate.  But no one really knows for sure the consequences of a down grading of our bonds.  No one.    

So how is it that on Friday last week the 10 year treasury rate plummeted 17 basis points and is now at 2.78% as of this writing?  This is the biggest one-day drop since December 2010.  A drop in interest rates seems so counterintuitive to me.  This is just the opposite of what I would think would happen.  The "experts" believe that investors view the stock market as being more adversely impacted by the debt ceiling debate than the bond market.  As a result investors are selling stocks (notice the Dow Industrials declined 537 points last week, the worst week this year) and are buying bonds.  Go figure!  There is a "flight to quality" - the selling of riskier assets, in this case equities, and the buying of the most secure investment available today - treasuries.

Other so-called safe havens will also benefit from this uncertainty caused by the debt ceiling crisis.  But gold, top-rated corporate debt or the bonds of other countries with triple A ratings are miniscual markets in comparison to the almost $10 trillion U.S. treasury market.  Investors are also confident that the U.S. Treasury will continue to pay the principal and interest owed on existing bonds, even in the case of a prolonged deadlock.      

In addition it is in China's best interest, as the largest holder of U.S. debt, to come to our rescue if things got out of hand with a gridlocked Congress in order to prevent serious harm to their huge existing holdings of U.S. treasuries.  

So for these reasons we are seeing treasury rates declining.  At least for now.  This is a great time to be locking in long term fixed rate financing.  If you are on the sidelines wondering when I should refinance, what are you waiting for?   

Sources: Debt Ceiling Deadlock Could Lower Interest Rates, CNNMoney.com, July 28, 2011; and Treasury Yields Fall By the Most This Year, Market Watch, July 29, 2011. 

First Half 2011 Transaction Activity

The first half of 2011 has come and gone!  From a sales standpoint how well did we do compared to previous years?  Shown below is the criteria we used to tabulate the results:

• Sales information from the CoStar database
• Transactions closed between January 1st and June 30th
• Investment properties only (no owner user)
• Property types - apartments, office, flex, industrial, retail, mixed use & specialty use
• Transactions with sales prices of $1 million or larger
• Arms length transactions only
• Transactions located between Kelso, WA and Eugene, OR including Bend

Based on these criteria the chart below compares the sales activity for the first half of 2011 for each of the last five years:

As you can see, the sales activity for the first half of 2011 increased significantly over the same time period for the last two years: up 17% over 2009 and a whopping 54% over 2010.  We are still well below the transaction activity that we achieved in previous years but the trend is going in the right direction.  Hey that's encouraging!

We then analyzed the 91 transactions for 2011, starting by property type:

Multifamily and retail sales comprise 72 percent of all the sales transactions which is similar to what we've seen in the past couple of years.

Of the 91 sales transactions, 75 of them identified the broker representation and 77 of them identified the lending source that was used.  The remaining transactions did not identify broker representation or lending source.  Shown below is a summary of broker representation fo these 75 transactions:

Assuming that the trend for the 75 sales held true for all 91 sales transactions, then there were about 73 paydays for all of the real estate brokers in our area in the first half of this year (91 x 53% x 2 + 91 x 15% + 91 x 12%).  So if you want to know your personal market share of all the broker paydays divide your number of paydays by 73.

Shown below are the first half lending sources for the 77 sales transactions that a lender was identified:

Thirty out of the 77 transactions (39%) were either all cash buyers, assumed the existing debt or were seller financed.  Only 47 transactions (61%) used conventional financing.  Both regional and national banks made up the majority of these loans.  Insurance companies only made 2 acquisition loans in the first half of this year.

Thank goodness owners have to refinance their properties from time to time.  Refinancing properties is not included in the figures above.  If we had to live solely off acquistion financing many of us on the lending side would be out of business.

Let's hope for all of our sakes that the upward trend in commercial real estate activity continues to improve so there are more paydays for all of us in the industry. 

Fed Scorecard: Where QE Worked and Where It Failed

Quantitative Easing, which ended last Thursday, has had its successes and failures.  But before we look at the outcomes of QE let's quickly review what it is.

The term Quantitative Easing (QE) describes a form of monetary policy used by The Federal Reserve to increase the supply of money in an economy where interest rates are at or close to zero.  The Fed does this by first crediting its own account with money it has created ex nihilo ("out of nothing") or some would say, by "printing money."  It then purchases financial assets, including government bonds, from banks and other financial institutions.  The purchases give banks the excess reserves required for them to create new money.  The increase in the money supply thus stimulates the economy.  That's the theory at least.  Let's see how well it worked.

Where it Worked

1. The stock market benefitted.  Since last August when Fed Chairman Ben Bernanke announced QE2 the major stock indexes have increased between 20 to 29 percent.
2. Commodity prices climbed.  When a currency is debased, it takes more dollars to buy the same product.  Commodities such as oil, precious metals, farm products, etc have benefitted.
3. U.S. exports rose.  Cheap dollars when compared to other world currencies makes our exports that much cheaper, increasing the demand for our exports.
4. It reduced our chances for deflation.  By pumping enough liquidity into the markets we have for the time being avoided the harmful effects of deflation (far worse than inflation). 
5. It created a "Wealth Effect" for some.  If you invested in the stock market, or commodities during this time chances are you did quite well.

Where It Failed

1. Housing is broken.  Bernanke assumed that lower mortgage rates would have a positive influence on the housing market.  That has not happened.
2. Jobs market is broken too.  QE2 was supposed to spur spending, which would increase demand resulting in more jobs.  This hasn't happened.
3. Inflation may not be temporary.  Bernanke called food and energy prices "transitory" and will likely reverse.  This doesn't appear to be happening.  Inflation is currently 3.6% and trending upward.
4. Dollar's potential destruction.  There is a fine line, which may have been crossed, between stimulating the economy with cheaper dollars and ruining the currency.  This is my greatest concern.
5. Interest rates will eventually go higher.  They have to.  Rates are unnaturally low.  If the U.S. continues to borrow debt at the current pace, who will buy it once The Fed is no longer purchasing it?  In order to get sell our debt, rates will have to rise, maybe dramatically in order to attract a new buyer.  

In hindsight, it's easy to see that Quantitative Easing did not accomplish the two most important things it was supposed to do: 1) correct our housing crisis; and 2) get our economy moving in any substantial fashion.  

So where do we go from here?  What other means will be employed to get our economy going again?  Is there anything that can be done?  From my perspective, neither political party has had the political will to outline a realistic plan to get our economy moving in the right direction.  Leadership is the key but no one has yet to act like a statesmen instead of just another politician pointing fingers.  No one has yet shown a willingness to yield a little on one of their pet positions in order to achieve a benefit for the greater good.  Until that happens we will have more of the same. 

Sources: Yahoo.com, CNBC, Fed Scorecard: Five Ways QE2 Worked-And Where It Failed, June 30, 2011; Quantitative Easing by Wikipedia.