Reading an article in the Wall Street Journal this morning I was hit twice by the number 52. (For those that are looking for signs it can be noted that you can reverse today’s date and get 52 as well!)
The first sighting, Robert Taubman, chief executive of Taubman Centers, Inc. decided earlier this year to stop covering interest payments on it $135 million mortgage on the Pier Shops at Caesars in Atlantic City, N. J. “Taubman, which estimates the mall is now worth only $52 million, gave it back to its mortgage holder. (See http://professional.wsj.com/article/SB10001424052748703447004575449803607666216.html?mod=wsjproe_hps_TopMiddleNews.)
The second sighting: “Of the $1.4 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is attached to properties that are underwater, according to debt-analysis company Trepp LLC.”
The question raised in this article: is it a smart economic decision for commercial real estate firms to just stop making mortgage payments on properties whose values have fallen FAR BELOW the mortgage amounts?
This discussion parallels the discussions that took place many months ago about whether or not it was a smart economic decision for homeowners to just walk away from mortgages on properties whose values have fallen FAR BELOW the mortgage amounts.
The burning issue is between morality and economic incentives. And, what does the economist say about this? Well, everyone has a price. One of the rules I frequently hear is “Don’t say that you wouldn’t sell out for a particular price until you have actually been faced with the decision in real life and actually decided that you wouldn’t sell out for that price.” It’s easy NOT to walk away from a property if you have never been faced with the temptation!
This situation raises concerns relating to two major interpretations of the current economic situation.
First, debates are raging about whether or not we are in a deflationary period. For the last nine months the Consumer Price Index has shown a positive year-over-year rate of increase reaching about 3.0% during this time. For July the year-over-year growth rate was 1.3%.
Yet, the value of real properties seems to be going down and down.
But, isn’t this the same problem that existed in the early 2000s only on the other side of the coin? Then the Consumer Price Index was showing very little inflation, yet the value of real properties was increasing in the 10% to 15% range.
The problem was that the Consumer Price Index measured the price of “flow” goods and services and not the value of the “stock”, the value of the asset. Rent is what is measured in the Consumer Price Index and this is an “imputed” figure. Much concern was raised at the time about the validity of the estimates for rental prices used in the index. Perhaps the same issue should be raised now.
Second, this brings up the issue about whether or not we are in a period of debt deflation. This is the other side of the problem of the early 2000s when we had a credit inflation. In a period of credit inflation the problem is that there is too much credit chasing too few goods and services around. The credit keeps “the music playing” and as long as the music is playing, according to Chuck Prince, Chairman and CEO of Citigroup at the time, you have to keep dancing. A credit inflation is cumulative.
The problem with a debt deflation is that there is too much debt around. When there is too much debt around people have to de-leverage. And, de-leveraging takes a long time and is very, very painful.
One remedy to a debt deflation is for the government to re-flate the economy. This is what many economists, politicians, and pundits would like to see happen. If the government can cause prices to rise again the real value of the debt will go down and guess what? The music starts playing again.
The problem with this solution is that there are historical periods when the amount of debt outstanding becomes unsustainable. People have to accept the fact that “credit bubble” they lived in for so long, no longer exists. And, when this happens, people have to get their balance sheets back in order and live more practically within their means. In times like these, governments and others find it more and more difficult to push them back into profligate habits of spend, spend, spend.
The realization of this hit Europe earlier this year and the pain is evident.
Yet the fundamentalist ministers of “inflationary finance” like Paul Krugman, like many fundamentalist ministers when they are not being listened to, cry out that those who do not respond to their teachings are just members of a cult. These people that oppose them have been misled to a false teaching and are heretics.
The United States (and Europe and some other areas in the world) has a debt problem. And, a great deal of this debt is connected with real estate. And, a great deal of this debt rests on the balance sheets of depository institutions. (See my “Where is Banking Headed? Not up! http://seekingalpha.com/article/222005-where-is-banking-headed-not-up.)
What does a financial institution do when it is holding a mortgage for $135 million and the underlying property is given to them and the value of this underlying property is only $52 million? What does the banking system do knowing that 52% of the $1.4 trillion in commercial real estate debt coming due by the end of 2014 is underwater, and, by all we know, a lot of it is substantially underwater? What does the Federal Reserve and the FDIC and the Treasury Department do when they know that a very large number of the depository institutions in the United States have assets on their balance sheets that are substantially underwater?
This is what happens in a debt deflation. The economy, in a sense, implodes. But, it takes time for everything to happen because it is cumulative. First, there is the panic phase which we have gone through. Now, we are in the un-winding phase because a large number of people know what is happening, they are not surprised anymore, and are trying to work out the problems as smoothly as they can.
The best evidence I can give to support the idea that this implosion is happening is what I presented in the post cited above: on December 31, 2002 there were more than 7,888 commercial banks in the United States. As of March 31, 2010 there were only 6,772 commercial banks. In the next three to five years, many analysts expect this number to drop to 4,000 or so. Note that if the number of banks fell to 4,102 banks, this would be 52% of the number of banks that existed at the end of 2002.
Showing posts with label walk-away. Show all posts
Showing posts with label walk-away. Show all posts
Wednesday, August 25, 2010
Friday, January 8, 2010
Something is Wrong!
A headline in the New York Times, “Walk Away From Your Mortgage!”
Why not?
The best remedy for the current economic malaise?
Since there is too much debt, let’s all just walk away from our debt.
And, if the New York Times is printing such material, then it must be OK! Right?
As we “recover” from the Great Recession we see pockets of problems all over the place. Things just don’t fit together the way they used to. And, what we are doing to combat these problems doesn’t seem to be relieving the suffering. The whole world seems to be dislocated.
There is too much debt outstanding. No one disagrees with that, but how do you get people and businesses and governments to start spending again when they are desperate to reduce their outstanding debt?
Other headlines this morning point to the problems in commercial real estate. In “Delinquency Rate Rises for Mortgages” we read that “More than 6% of commercial-mortgage borrowers in the U. S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year.” (See http://online.wsj.com/article/SB20001424052748704130904574644042950937878.html#mod=todays_us_money_and_investing.) Also, “Further Slide Seen in N. Y. Commercial Real Estate” points to the fact that 180 buildings totaling $12.5 billion in value, are in trouble in Manhattan. (See http://www.nytimes.com/2010/01/08/nyregion/08commercial.html?hp.)
But, the problems don’t seem to be just in commercial real estate. The New York Times article cited above states that at least one quarter of all residential mortgages in the United States are underwater and that 10% of the mortgages outstanding are delinquent. Another round of foreclosures and bankruptcies seem to be on the way.
Which brings us to the banking system: here the difficulties bifurcate depending upon size. If you are really big you seem to be doing very, very well these days. In fact, it seems as if the “good ole daze” have returned for these bankers. Risk-taking and speculation in the carry trade abound. Simon Johnson, an economist at MIT issued a warning on CNBC yesterday morning that the next phase of the financial crisis could be just beginning and this gets back to the risk-taking of the six major banks in the US whose combined balance sheets exceed 60% of United States GDP.
If you are smaller, however, your problems are immense. The smaller banks are carrying the burden of the commercial real estate problems and consumer debt and mortgages still present these banks with problems because these loans represented “Main Street” and were not all packaged and sold to investors in Finland. Remember there are 552 banks, all small- and medium-sized banks that are on the FDICs list of problem banks and this is expected to grow this year before declining, generally do to actual failures.
There are more dislocations throughout the economy that point to persisting problems. For example, in manufacturing, since the 1960s the unused capacity of United States industry has continually declined from peak usage to peak usage of that capacity The latest peak utilization of capacity still saw that about 20% of the industrial capacity of the United States remained unused. Unused capacity for the past thirty years seems to average around 23% to 24%.
We see unused capacity in the labor force as well. Since the 1970s under-employment of labor has grown quite consistently. Attention is focused upon the unemployment rate, but this measure does not include those individuals that have left the labor force because they are discouraged and those that are only working part time but would like to work more. We have seen estimates that 17% to 20% of the employable people in the United States are under-employed. Another dislocation that is not comforting.
Then we hear about the problems in state and local governments. Reports indicate that there are more than 30 states that are currently experiencing fiscal difficulties. We hear most about California and New York, but there are many other states particularly in the west and southwest that are having real problems. One estimate is that the states will have a combined budget shortfall of at least $350 billion in the fiscal years of 2010 and 2011. And, this doesn’t even get to the difficulties that are being faced by local governmental bodies.
And, there are the dislocations being created by the federal government. Budget deficits for the next ten years have been placed in the range of $15 trillion. The United States is fighting in three wars throughout the world. The government is passing health care legislation that has been justified fiscally by postponing start dates of programs from three to five years. There is climate control efforts being considered along with regulations, like anti-pollution controls, that will just exacerbate the economic and fiscal problems of the country. Then there are other changes in the rules and regulations that apply to industry that will further change the playing field and create greater uncertainty about what management’s should do.
There is the problem of unemployment, the number one issue among the American voter. (And, you thought the number one issue was health care or pollution or terrorism or the war in Afghanistan.) But, there is a dislocation problem relating to federal government stimulus programs.
For fifty years or so, the federal government has attempted to stimulate the economy to put people back to work in the same jobs that they were released from. The government has sought to put unemployed people back to work in the steel industry, in the auto industry, and in other jobs that are the backbone of American industry (according to the labor unions and others). As a consequence, the steel industry lost competitiveness, the auto industry lost competitiveness, and so do many other industries.
This effort to stimulate the economy and put people back into the jobs that they had lost has contributed greatly to the increase in the unused industrial capacity and to the increase in the under-employed in this country. The effort to constantly maintain a low unemployment rate by putting people back into the jobs they have lost has resulted in a massive slide in the competitive position of the United States.
The point of this discussion is my concern with the huge dislocations that now exist within the country. Things are out-of-whack and it is going to take us quite a while for us to get things back together again. Yes, we can try and “force” the economy back into a position of higher employment and greater capacity utilization, of lower debt burdens and greater solvency. But, this would just postpone, once again, the need to realign the country to deal with the pressures of the 21st century.
Something has changed, however. The United States is now facing a more competitive and hostile world economy. The government may not be able to “force” the economy back into its old mold.
Why not?
The best remedy for the current economic malaise?
Since there is too much debt, let’s all just walk away from our debt.
And, if the New York Times is printing such material, then it must be OK! Right?
As we “recover” from the Great Recession we see pockets of problems all over the place. Things just don’t fit together the way they used to. And, what we are doing to combat these problems doesn’t seem to be relieving the suffering. The whole world seems to be dislocated.
There is too much debt outstanding. No one disagrees with that, but how do you get people and businesses and governments to start spending again when they are desperate to reduce their outstanding debt?
Other headlines this morning point to the problems in commercial real estate. In “Delinquency Rate Rises for Mortgages” we read that “More than 6% of commercial-mortgage borrowers in the U. S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year.” (See http://online.wsj.com/article/SB20001424052748704130904574644042950937878.html#mod=todays_us_money_and_investing.) Also, “Further Slide Seen in N. Y. Commercial Real Estate” points to the fact that 180 buildings totaling $12.5 billion in value, are in trouble in Manhattan. (See http://www.nytimes.com/2010/01/08/nyregion/08commercial.html?hp.)
But, the problems don’t seem to be just in commercial real estate. The New York Times article cited above states that at least one quarter of all residential mortgages in the United States are underwater and that 10% of the mortgages outstanding are delinquent. Another round of foreclosures and bankruptcies seem to be on the way.
Which brings us to the banking system: here the difficulties bifurcate depending upon size. If you are really big you seem to be doing very, very well these days. In fact, it seems as if the “good ole daze” have returned for these bankers. Risk-taking and speculation in the carry trade abound. Simon Johnson, an economist at MIT issued a warning on CNBC yesterday morning that the next phase of the financial crisis could be just beginning and this gets back to the risk-taking of the six major banks in the US whose combined balance sheets exceed 60% of United States GDP.
If you are smaller, however, your problems are immense. The smaller banks are carrying the burden of the commercial real estate problems and consumer debt and mortgages still present these banks with problems because these loans represented “Main Street” and were not all packaged and sold to investors in Finland. Remember there are 552 banks, all small- and medium-sized banks that are on the FDICs list of problem banks and this is expected to grow this year before declining, generally do to actual failures.
There are more dislocations throughout the economy that point to persisting problems. For example, in manufacturing, since the 1960s the unused capacity of United States industry has continually declined from peak usage to peak usage of that capacity The latest peak utilization of capacity still saw that about 20% of the industrial capacity of the United States remained unused. Unused capacity for the past thirty years seems to average around 23% to 24%.
We see unused capacity in the labor force as well. Since the 1970s under-employment of labor has grown quite consistently. Attention is focused upon the unemployment rate, but this measure does not include those individuals that have left the labor force because they are discouraged and those that are only working part time but would like to work more. We have seen estimates that 17% to 20% of the employable people in the United States are under-employed. Another dislocation that is not comforting.
Then we hear about the problems in state and local governments. Reports indicate that there are more than 30 states that are currently experiencing fiscal difficulties. We hear most about California and New York, but there are many other states particularly in the west and southwest that are having real problems. One estimate is that the states will have a combined budget shortfall of at least $350 billion in the fiscal years of 2010 and 2011. And, this doesn’t even get to the difficulties that are being faced by local governmental bodies.
And, there are the dislocations being created by the federal government. Budget deficits for the next ten years have been placed in the range of $15 trillion. The United States is fighting in three wars throughout the world. The government is passing health care legislation that has been justified fiscally by postponing start dates of programs from three to five years. There is climate control efforts being considered along with regulations, like anti-pollution controls, that will just exacerbate the economic and fiscal problems of the country. Then there are other changes in the rules and regulations that apply to industry that will further change the playing field and create greater uncertainty about what management’s should do.
There is the problem of unemployment, the number one issue among the American voter. (And, you thought the number one issue was health care or pollution or terrorism or the war in Afghanistan.) But, there is a dislocation problem relating to federal government stimulus programs.
For fifty years or so, the federal government has attempted to stimulate the economy to put people back to work in the same jobs that they were released from. The government has sought to put unemployed people back to work in the steel industry, in the auto industry, and in other jobs that are the backbone of American industry (according to the labor unions and others). As a consequence, the steel industry lost competitiveness, the auto industry lost competitiveness, and so do many other industries.
This effort to stimulate the economy and put people back into the jobs that they had lost has contributed greatly to the increase in the unused industrial capacity and to the increase in the under-employed in this country. The effort to constantly maintain a low unemployment rate by putting people back into the jobs they have lost has resulted in a massive slide in the competitive position of the United States.
The point of this discussion is my concern with the huge dislocations that now exist within the country. Things are out-of-whack and it is going to take us quite a while for us to get things back together again. Yes, we can try and “force” the economy back into a position of higher employment and greater capacity utilization, of lower debt burdens and greater solvency. But, this would just postpone, once again, the need to realign the country to deal with the pressures of the 21st century.
Something has changed, however. The United States is now facing a more competitive and hostile world economy. The government may not be able to “force” the economy back into its old mold.
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