No it isn’t some conference of sex coaching, it was a group of bankers (including Fannie Mae) and real estate investors who gathered this week in Miami for the IMN Distressed Real Estate Conference, and frankly, it was a little depressing.
The debate seemed to revolve around lender’s decisions to ‘extend loans and pretend that the loans were still viable’ is a good practice or a bad practice that will cause America to suffer an extended recession the same way Japan’s ‘extend and pretend’ banking system has worked for the last 12+ years.
Much criticism has been heaped on Japan’s banks for ‘not owning up to their losses’, writing down/off bad loans, and taking their pain. The world has preached at Japan to ‘come clean’ and write off all those bad real estate loans that are under water.
But if statistics were true at this conference and from ULI, 40% of all US home owners will be under water on their home values (debt exceeds value) by mid-2010. The speakers at the IMN conference said that commercial real estate will be near this statistic by year’s end. That would mean that without ‘extend and pretending’, banks might need to write off, sell or modify 40% of every loan in their portfolio. What would this do to a fractional reserve banking system?
Consider that for every $100 lent out in on a mortgage, the bank only holds $10-30.00 in deposits, and $3-5 in ‘equity capital’. A write off of just 5% of a bank’s loans will wipe out all their capital, and cause a bank to be technically insolvent.
When a bank goes bankrupt, the FDIC insurance (government/taxpayers) must chip in money to make the depositors whole or the entire financial system collapses. In light of this reality, the idea of extending and pretending that 95% of the underwater or non-performing loans makes good sense?
Time is the friend to financial market participants. By giving more time to borrowers to ’stabilize’ their properties, banks keep from owning properties and the properties stay in the hands of people who may be able to make them work. It is cynical to say that the present owner is not the best owner, most of the homes under water are not because the home owner neglects the house - to the contrary - they may have spent too much at Home Depot improving the kitchen.
No, this is a macro-event that is sinking all ships in real estate. Every foreclosure sale ‘clears’ the market and takes a bad loan/REO off the banks books and replaces it with a TARP loan and deficiency judgment against a borrower. But these are not real assets. The foreclosure sale also further depresses value and encourages the neighbors to short sale their now-under-water homes as well.
No the answer, as ugly and Japanese as it may seem is time and pretending.
Along this same note, transparency may be working against the housing market. I like Zillow, but every month I get an update from Zillow.com that reads “Mr. Waun your home has fallen by $18,752 this month”. This transparency is sinking the market too. In an internet age when you can value rare baseball cards, exotic cars, Peruvian wine and homes in an instant, the falling tide of home values is further encouraged by Zillow’s honesty.
How many home owners have decided to send back their keys because they have become all too aware that they are hopelessly and forever negative equity at home? Or are they? What if inflation does kick in gear, and real estate rises with this tide?
Last statistic from the conference, from the Wharton economist on my panel: 450,000 home starts occurred in the last 12 months, this is a historically low figure. The US population is growing. There is pent up demand.
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