Should Dodd-Frank Be Repealed?

The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama in 2010 is considered the most sweeping change in U.S. financial regulations since the Great Depression.

Many of those regulatory changes will become effective beginning January 1, 2012. If you’ve listened for any length of time to the Republican presidential debates one of the re-occurring themes that is bandied about by several of the candidates is that Dodd-Frank should be repealed. They consider this legislation a quintessential example of government red tape that is crippling our economy. Hmm… Is that really true?

I freely admit I’m no expert on the subject of the Dodd-Frank bill which totaled over 2,300 pages in length and most likely neither are you. So let’s begin by doing a quick overview of what was in the bill and how it impacts commercial real estate.

1. Banks are required to have 5% “skin in the game” for every loan that they approve. No longer can they approve a risky loan and then sell it to some unsuspecting investor by passing it off as a quality investment. This means that lenders are now scrutinizing and documenting real estate loans more carefully. Anyone in the mortgage lending business will tell you that it takes much longer and requires much more paperwork today than it did three years ago. You can thank this 5% rule for the reason why loan processing has become so much more cumbersome.

2. Banks are required to carry more capital reserves. They now have to prove they have the correct amount of reserves, and based on recent default rates and delinquencies, they have had to increase capital reserves significantly over what they were required only a few years ago. This has resulted in decreasing the overall amount of lending capacity in the market in addition to decreasing significantly the number of lenders lending. Pre-2008 lenders were tripping all over themselves competing for loans.

3. Rating agencies now bear more risk and liability under Dodd-Frank. Gone are the days when credit agencies were fearful of losing lucrative business if they came down too conservatively on risky loan pools. As a result CMBS issues today are much more conservative, with lower LTVs and higher debt coverage ratios. It is no surprise that the CMBS market is a shadow of its former self. In 2007 there was $228 billion in the CMBS market compared to a measly $12 billion in 2010. There are several reasons for this downturn but the rating agency reform in the Dodd-Frank bill is certainly one of them.

I would be the first to admit that the Dodd-Frank bill is having a huge adverse impact on the banking system in the short term. But would you prefer to go back to where the banking regulations were prior to the sub-prime loan debacle? I don’t think so. Yes it’s painful and it certainly makes a good sound bite on the campaign trail to rail against the Dodd Frank bill. But all three of these changes are just plain common sense. They are needed in order to slowly repair a battered banking system that has lost all the respect that it once had. If you disagree, I welcome your comments.

Source: Regulatory Reform: What Impact Will It Have On Commercial Real Estate?, CoStar Group Real Estate Information, Randyl Drummer, July 28, 2010.

IREM Forecast Breakfast - Optimism Abounds

The 24th Annual IREM Forecast Breakfast was awash in cautious optimism as the commercial real estate industry is slowly rebounding from the most difficult recession in our lifetimes. For 2012, each of the presenters, whether it be for office, retail, industrial or apartments, forecasted modest but steady improvements in both occupancy and rental rates for the Portland real estate market for the coming year.

But I would prefer to focus my commentary today on the presentation given by Nawad Othman, Chief Executive Officer for Otak, Inc. Mr. Othman, a self-described “optimist” gave a compelling presentation about current world affairs that he described as a time of uncertainty and an age of complexity. It would be easy to focus on all the real and ever pressing issues that confront us, and they are legion! Or we can, as Mr. Othman did, focus on the many things that truly make us the envy of the world. I would like to take the liberty to expand on Mr. Othman’s list.

• We live in a country of laws that protect our civil liberties. We should never take this for granted. Franklin Roosevelt described them as our four fundamental freedoms: freedom of speech and expression; freedom of worship; freedom from want; and freedom from fear. These freedoms are the bedrock upon which our government was founded.

• Our business environment fosters, promotes, and encourages innovation like no other country in the world. It isn’t by accident that Microsoft, Google, Facebook, Amazon.com, to name just a few, are American corporations. China may be able to make things cheaper but they have no ability in creating the next new idea. They, and the rest of the world, look to us to do that.

• Our kindergarten through high school educational system may not be stellar but our universities are the best in the world. Students from all over the world flock to our universities.

• We have a strong commitment to fostering and maintaining a viable middle class. Unlike many countries of the world, we believe in public education. We believe in the American dream where someone who works hard and takes risks can rise to the very top of our society.

• Unlike many countries of the world (Japan, China, Europe) we have a growing population base. People from all over the world want to come to live in our country. Population growth is absolutely vital in order to have a healthy economy. And if you believe in Social Security, Medicare and other social welfare programs that help the most disadvantaged among us, a growing population is absolutely necessary to fund these programs.

Yes, we can focus on all of our problems or we can pause for a moment and see how blessed we are as a nation. So are we willing to view the proverbial cup of water half empty or half full? Even those of us who have gone through tough times (as most of us have during this recession) deep down realize there is no better place to live then where we live right now at this time in history.

Have a Merry Christmas or Happy Hanukkah and a prosperous new year! If this closing offends you, get a life! :)

Source: IREMOregon.com; 2011 Forecast Breakfast Transcript, December 8, 2011. 

What exactiy did The Fed do?

Last week the Dow Jones Industrial Average soared almost 500 points (4.2%) on the news that The Federal Reserve in a coordinated effort with five other central banks of the world came to the rescue of European banks. Specifically, The Fed’s action effectively gives these central banks access to a massive pool of new U.S. dollars that they can borrow at a very low rate of 0.5% to fund their banking sectors. Why should this action be viewed with euphoria by the world's stock markets?

To better understand what is going on you need to know why The Fed took this action. For European banks to lend money they have traditionally borrowed dollars from other banks, money market funds and institutional investors. As the European debt crisis has deepened, these lending sources have slowly pulled back because Europe’s banks are holding ever larger amounts of sovereign debt that is becoming increasingly more likely it will not get paid back.

Since May, U.S. money market funds have reduced their loans to European banks by 42 percent reports the Fitch rating agency. If we could know what the other lending sources for European banks were doing we would likely see the same response. Prudent lending sources seeing the increasing risk of sovereign debt are unwilling to risk their own money by lending it to the European banks. This is just plain common sense. You would do the exact same thing. Therefore the reason The Fed acted as it did last week is because the European banks were starting to experience a liquidity crunch.

It is the equivalent to what happened to Washington Mutual a few years ago. Recall what brought down WaMu was bank customers losing confidence in the long term viability of the bank quietly, but ever so quickly withdrawing their deposits. There was a run on the bank. In the period of a few weeks, WaMu went from being healthy to insolvent. The exact same thing is happening right now to European banks. The only difference is that it is happening across all the major banks in Europe, not just one particular lender like Washington Mutual. So I ask you? Is this something to be euphoric about? Does this justify a 500 point increase in the Dow? Only if you think bad news is good news.

We should be very concerned with what just happened and here’s why:

1. This did nothing to solve the European debt crisis. All it did was to delay the outcome.

2. The Federal Reserve has now become the lender of last resort. In other words when a European bank defaults, which will happen, we the American public will be picking up the tab.

How does that make you feel?  Euphoric?


Sources: What exactly did the Fed do?, by Robert J. Samuelson, The Oregonian, December 2, 2011; Fed Action in Europe Underscores Dollar Primacy, STRATFOR, November 30, 2011.