Commercial Real-Estate Crisis Squabble

For the past few weeks, financial news has been mixed on commercial real estate.  On the one side, fear mongers like Randall Zisler expect crisis in the next few years.  The meat of their argument is that high default rates and high unemployment will keep the market depressed.  On the other side, high profile investors like Sam Zell  say that the crisis is a myth. 

I’m leaning toward Zell here, and agree with Sheryl Nance-Nash.  She referenced a report that found commercial real estate markets are likely to bottom in 2010.  Notice the verb there- bottom, not crash.  The report calls 2010 through 2012 a “cyclical low” period in the market.  In other words, there will be great opportunities for prudent investors in the next few years.  As the rest of the economy picks back up, capital will flow into commercial real estate and bring prices back up to normal, or at least 70 percent of recent highs.  The report is worth taking a look at.

The federal propensity for bail out clouds the issue.  The FDIC announced last week that it would allow banks to report underperforming loans as performing.  Many properties are worth less than the debt owed on them, and this legislation gives banks leeway for renegotiation.  There is little evidence on how much refinancing is actually taking place.  Instead of selling properties off, banks are keeping them on the books.  As long as seller is kept from buyer, the market is on freeze.  In the short-term this policy prevents a crisis by avoiding a panicked sell-off.  However, the regulation prevents the market from functioning, perhaps even prolonging recovery in the long-term.

Fed Policy

Don Bauder at the San Diego Reader links, correctly, the troubled commercial real estate market in California with its budget problem.  He then argues that recent stock gains are not based on ‘reality’ but a low federal funds rate: 

“The Journal’s lead sub-headline Tuesday morning was “Cheap Money Sends Shares to 2009 High” — a stark warning that liquidity is buoying various markets, not reality. The Federal Reserve promises to keep interest rates around zero for the indefinite future. This emboldens investors to gamble…. — watch out.”

Under Greenspan, this was a fair argument.   However, today we are at the ‘zero-lower bound’ of interest rate policy. Any increase in the funds rate is seen as devastating for recovery. It’s important to recognize that the source of growth today may not be interst rate policy- since monetary policy has become ineffective.  Also, liquidity is welcomed by the Fed during recessionary periods.

Thomas J. Powell

 

 

 

Recession and Recovery- Mixed Signals

Today’s news from the Fed has been optimistic. Bernanke says the recession might be over, but what does that mean for us? In technical terms, a recession is two consecutive quarters of zero growth. It looks like we are beating that trend. So what? Cheer the administration, forget about the troubled financial industry and move on right? Wrong. Krugman points out that, although the recession is technically ending, we’re not out of the woods yet. Unemployment, as expected, will remain high for years to come. Compared to where we were two years ago, the US faces an enormous output gap, something around a trillion dollars a year. According to Condgon from the IMF, the broader monetary base has been shrinking. The Fed’s insistence on boosting capital ratio’s may be back firing here: if banks are required to increase capital ratio’s there is less to lend, and subsequently a decreased capacity to grow. Despite decent news from Bernanke, a shrinking money supply points to deflation. Instead of recovery, we may be looking at a double-dip recession. That’s when we start to recover, only to fall flat again.
How do we avoid another, possibly deeper recession? Krugman argues for more stimulus. Condgon expects monetary easing. I must reiterate my core values here. The recovery will come when smaller firms have adequate access to capital. Private capital will pull us out, not more stimulus. Quantitative easing has brought us to near-zero interest rates with no affect on output. How exactly is monetary policy going to work if money continues to contract? As for fiscal stimulus, wouldn’t that bring us back to where we are now, a slow recovery with continued high unemployment?
Let’s get away from big government bail-out schemes and let capitalism do its job. In today’s WSJ, Cochrane and Zingales argue against the too-big-to-fail doctrine. If banks don’t fail, bankers have no incentive to react to risk. It’s called moral hazard- tails I win, heads you loose. The too-big-to fail doctrine flies in the face of a hundred years of economic theory. One of capitalism’s grand fathers, Joseph Schumpeter, argued for “creative destruction,” a process that enables the most efficient distribution of capital. If banks cannot fail, the industry cannot correct itself. The system has forgotten Schumpeter. It no longer rewards the most productive enterprises. Instead, the government has transferred trillions of dollars to failed enterprises. The result isn’t capitalism, but some corrupt form of corporate banditry.

All my best,

Thomas J Powell