Friday, December 26, 2008

Houses in Richistan

The market for houses financed by jumbo mortgages is about to enter a death spiral. There are four reasons:
1. Jumbo financing has died up. The government efforts to get mortgage lending moving again are focused on conforming loans. The interest rate relief that has driven down the price of a conforming mortgage has opened up historically unprecedented spreads between conventional and jumbo financing.
2. Houses north of, say $500,000, are move up houses. The whole idea of moving up has been one of the prime casualties of the current housing crisis. Extracting one's equity from a middle class residence to apply towards the down payment on a larger home is harder than it's ever been.
3. The more affluent families that are the principal purchasers of these houses tend to have more financial assets than the general public. They have, therefore, felt more severely the impact of the collapse of the financial markets. They have less in the retirement plans, less in their brokerage accounts and, even if still employed in high paying jobs, are far poorer than they were a year ago.
4. The decision to buy a house has also been an odd decision--one part an investment decision, one part of matter of personal consumption. The more expensive the house, the bigger the investment component. The idea that rich people are different, and are indifferent to losses on their real estate, is ridiculous, and piously repeating it as part of the wealth worship liturgy, doesn't make it any less ridiculous. In any event, to the extent that buying a house is an big investment decision, the willingness to go long an expensive house in a declining real estate market, is markedly diminished.

And that's the mumbo jumbo.

Tuesday, December 23, 2008


A spectacular crime.

A rich tapestry.

I like the thread woven by those who, believing Madoff to be a crook, nonetheless entrusted him with their money because they thought he was stealing for them, not stealing from them (i.e., front running, not running a Ponzi scheme).

I like the three-person accounting firm's ability to evade peer review by certifying every year for 30 years that it was conducting no audits. The cool thing about the certification is that, at least as far as the books, records and financial statements of the Madoff organization are concerned, it was true.

I love the masters of Hedgistan (fund of fund variety) whining that this was a failure of governmental regulation, losing sight the the fundamental point that hedges funds are definitionally lightly regulated investment pools, and that half the justification for the fees of the fund of funds managers was their careful scrutiny and sophisticated monitoring of the managers into which they fed their investors capital.

Will the Madoff Affair have consequences? Quite possibly. He fleeced enough of the right people. In tandem with Mr. Dreier they are extremely attractive poster children for the proposition that the whole game was a crooked business, and needs to be shut down.

So shut it down. Start with the bonus culture. Turn the banks into public utilities every bit as exciting as Con Ed. Tax the investment pools out of existence. Then move onto exemplary justice. Executions at midfield in the Yale Bowl aren't part of the American Tradition. Not yet.

Monday, December 22, 2008

A commercial real estate bust . . .

is a short term non-event, as far as the level of general economic activity, once you absorb the cost of a slow down in construction and development activity.

Last time I checked, the wind down in construction started late in 2007, and has continued progressively through 2008. Because it only makes sense in extreme circumstances to leave a building under construction unfinished, there is a bit of a lag between the recognition of a problem and the winding down of activity. But existing projects are finished and new ones are cancelled, and, voila, the slow down is underway.

I think that's already happened, for the most part. I'd be willing to venture that larger projects with longer lead times are still under way, but those, too, will wind to a conclusion--frequently in hands of whoever financed their initial stages. And all of the smaller stuff has ground already ground to a halt.

The event, in terms of the economy and the policy response, is the constuction slow down, not the real estate bust. And all the talk about 'shovel ready' infrastructure spending is a pretty good sign that the road map to a resolution of that slowdown is well accepted.

But a real estate bust itself, in the sense of declining property values, decline rents, rising vacancies, foreclosures and involuntary ownership shifts, and workouts and restructurings of existing financing packages is not, in itself, of much concern to nayone except the developers, investors and their professionals. Remember, commercial mortgages don't have to be marked to market (though CMBS are another matter entirely). A real estate loan that is performing, or has gone non-accrual, or is impaired, held in a financial institution's portfolio is subject to an entirely different set of accounting rules (which is not to say that real estate chargeoffs can't swamp the boat and cause the institution to fail--remember the S&L crisis?).

In that dynamic, the question becomes, just how lax and bad loan underwriting became in the insurance companies, pension funds and other institutional lenders to commercial property developers. If the news out of Calpers and the behavior of a couple of major insurance company stocks recently are any indication, underwritings standards did deteriorate. They almost had to, given the availability of alternative source of credit from those originating and packaging CMBS.

If that's the case, it could get interesting. There is something about real estate, its documentation and its culture that seems to lead to more fraud than is typical of the securities markets. That's right, more not less, fraud. We could all speculate on why.

Sunday, December 21, 2008

Retail Travails

Expect the retail sector to enter the chute.

The American consumer (remember him/her?) is tapped out. A big chunk of the decline in consumer spending can be traced to collapsing auto sales. Another big chunk can be traced to a falling consumer durables--not being purchased because people are buying appliances for the new houses they aren't buying. Throw in a shortened, weather-impaired holiday season undermined by declining consumer confidence, and there's a recipe for retail catastrophe.

This is probably a good holiday season to spend those gift cards as soon as you get them, and not save them for a big purchase down the road.