Finance
A Year to Remember, and a Year to Forget
By Mark Levine
Thank you to everyone who responded to last issue’s story containing tips on how to shop for a commercial mortgage during these turbulent times. The landscape has not improved and we were correct to assume that additional lenders have stopped participating in the real estate finance arena. Well, many have actually stopped participating altogether because they have either gone out of business or have been acquired. It hasn’t become any easier to find a reliable source of debt. So in order to find someone who will actually close a loan, you should continue to seek a lender who practices communication, honesty, and a desire to openly work together towards accomplishing your financing goals.
Looking back on 2008, many things come to mind. Most of them should not be printed in a G-rated publication such as this. Suffice it to say that it was a difficult year which produced much anxiety and heartache. More than anything though, it produced dizziness. The events unfolded so quickly, and they came from all different directions. So it was nearly impossible to grasp the details of one bank failure before the collapse of some credit market made us spin our heads around in shock.
It will take a while for us to truly absorb what happened in 2008, as it relates to commercial real estate finance. Do you remember Countrywide Financial Corporation? Back on January 11th, Bank of America announced that it would purchase Countrywide which had essentially collapsed under the weight of its huge residential loan portfolio. At the time, that seemed like a monumental event, and one that would stand alone as a symbol of the slowdown in our industry. Looking back, the Countrywide collapse almost seems minor compared to the mayhem which followed it throughout the year.
So, what really did happen? If you have listened to a politician over the past few months, you might believe that Wall Street got too greedy. If you listen to Wall Street, you’ll find that the politicians became too involved with the financial markets. And if you listen to “Joe Six-Pack” on Main Street, you’ll learn that he was completely innocent in this whole mess. In reality, they’re all right; and they’re all wrong.
First of all, Wall Street and greed. Is this breaking news to someone? We’re not insulting anyone when we state that Wall Street is driven by greed, if greed means making money. Financial institutions are just like any other profit-driven business in that their primary purpose is to make their owners wealthy. Wall Street firms do this on a much greater scale than most other companies, because they are dealing with huge sums of imaginary money, and because they constantly invent new ways to earn this money. As long as the money continues to flow, it is nearly impossible to stop the momentum which is driven by this greed.
In hindsight though, it clearly should have slowed down. During the past decade, financial firms became overleveraged and they didn’t stop to consider the true risks. One financial instrument was packaged into another, and that instrument was insured by yet another. It created extremely efficient markets because it artificially reduced risk, and it therefore led to very low borrowing costs which created more borrower demand. But ultimately when the music stopped, someone was left without a chair. Unfortunately in that game, all of the other chairs were leaning on each other, and when one fell, the foundation of the entire system came crashing down. The intertwined nature of the markets, and the lack of reserves supporting the leverage, ultimately led to Wall Street’s troubles.
Some people on Wall Street respond to this by stating that certain politicians forced them to make bad loans. Yes, it is true that many officials in Washington, D.C. used various tactics to encourage certain financial firms to make and purchase riskier loans. At the forefront of these accusations are Fannie Mae and Freddie Mac, who were required to help provide specific amounts of debt to lower income borrowers and neighborhoods. This should not come as a surprise, considering that one of the mandates of these Government Sponsored Enterprises was to enhance the availability of credit to the housing industry. It should also not be surprising that when the housing market ended its uphill run, these riskier loans were the first to go.
The timing could not have been worse though. To have a financial meltdown during an election year is a recipe for a lot of finger-pointing and a lot of politicking. The markets tend to work out their problems over time, and fortunately most politicians do not try to get involved on a day-to-day basis. Obviously this crisis is much different given the magnitude of the liquidity problems and bank failures, and it absolutely required government intervention. But it certainly would be nice to be able to focus on the issues, without hearing about whose policies caused them and whose candidacies will benefit from the fixes. It was just one more aspect of the crisis which seemed to cause more fear and more accusations than was necessary.
Lastly, there’s Main Street, where Joe Six-Pack has his hands in the air and is wondering what happened. How did all these fancy securitization programs and Credit Default Swaps actually impact his daily life? For better or for worse, because of the widespread coverage of the events, he probably knows the answer to these questions now. Unbeknownst to him, the mortgage that he’s trying to refinance was packaged with thousands of other loans, and he has no idea who holds it now. The same goes for his car loan, his credit card debt, his student loans, and his business line of credit. The bank that used to be the face of all these loans can’t refinance any of them now, and none of it is Joe’s fault.
That’s only partially true. With all of those loans, Main Street was sitting on a ticking time bomb, and in hindsight, it should have known it. Spending was out of control, mostly fueled by soaring home prices throughout the country. This meant that there was not actual money behind the spending, but rather paper profits based on assumed real estate inflation. The real estate didn’t even have cash behind it, since mortgages covered nearly the entire value. It’s called leverage. Leverage, on steroids, in fact. It sounds strangely similar to the problems on Wall Street, and not coincidentally, it was indeed the same predicament in many ways.
We look back on this year not because we want to dwell on the crisis that changed our financial industry. Instead we look back in order to learn how we will move forward in the near future. Normally, when there are issues in our business or economy, we say that we will not repeat them, however knowing that we probably will. This one is different though.
2008 is a year that we will remember for a long time, and it’s probably one that we will be recounting to future generations. Because of that, we can bet that it will be a long time before we again see excessive leverage and extreme amounts of capital chasing convoluted financial instruments. I like to call this progress.
Questions?? Just Ask.
Mark Levine is a Vice President with PNC ARCS in their San
Francisco office. He can be reached at 415-981-9700 or via email at Mark_Levine@arcscommercial.com
Finance
A Year to Remember, and a Year to Forget
Thank you to everyone who responded to last issue’s story containing tips on how to shop for a commercial mortgage during these turbulent times. The landscape has not improved and we were correct to assume that additional lenders have stopped participating in the real estate finance arena. Well, many have actually stopped participating altogether because they have either gone out of business or have been acquired. It hasn’t become any easier to find a reliable source of debt. So in order to find someone who will actually close a loan, you should continue to seek a lender who practices communication, honesty, and a desire to openly work together towards accomplishing your financing goals.
Looking back on 2008, many things come to mind. Most of them should not be printed in a G-rated publication such as this. Suffice it to say that it was a difficult year which produced much anxiety and heartache. More than anything though, it produced dizziness. The events unfolded so quickly, and they came from all different directions. So it was nearly impossible to grasp the details of one bank failure before the collapse of some credit market made us spin our heads around in shock.
It will take a while for us to truly absorb what happened in 2008, as it relates to commercial real estate finance. Do you remember Countrywide Financial Corporation? Back on January 11th, Bank of America announced that it would purchase Countrywide which had essentially collapsed under the weight of its huge residential loan portfolio. At the time, that seemed like a monumental event, and one that would stand alone as a symbol of the slowdown in our industry. Looking back, the Countrywide collapse almost seems minor compared to the mayhem which followed it throughout the year.
So, what really did happen? If you have listened to a politician over the past few months, you might believe that Wall Street got too greedy. If you listen to Wall Street, you’ll find that the politicians became too involved with the financial markets. And if you listen to “Joe Six-Pack” on Main Street, you’ll learn that he was completely innocent in this whole mess. In reality, they’re all right; and they’re all wrong.
First of all, Wall Street and greed. Is this breaking news to someone? We’re not insulting anyone when we state that Wall Street is driven by greed, if greed means making money. Financial institutions are just like any other profit-driven business in that their primary purpose is to make their owners wealthy. Wall Street firms do this on a much greater scale than most other companies, because they are dealing with huge sums of imaginary money, and because they constantly invent new ways to earn this money. As long as the money continues to flow, it is nearly impossible to stop the momentum which is driven by this greed.
In hindsight though, it clearly should have slowed down. During the past decade, financial firms became overleveraged and they didn’t stop to consider the true risks. One financial instrument was packaged into another, and that instrument was insured by yet another. It created extremely efficient markets because it artificially reduced risk, and it therefore led to very low borrowing costs which created more borrower demand. But ultimately when the music stopped, someone was left without a chair. Unfortunately in that game, all of the other chairs were leaning on each other, and when one fell, the foundation of the entire system came crashing down. The intertwined nature of the markets, and the lack of reserves supporting the leverage, ultimately led to Wall Street’s troubles.
Some people on Wall Street respond to this by stating that certain politicians forced them to make bad loans. Yes, it is true that many officials in Washington, D.C. used various tactics to encourage certain financial firms to make and purchase riskier loans. At the forefront of these accusations are Fannie Mae and Freddie Mac, who were required to help provide specific amounts of debt to lower income borrowers and neighborhoods. This should not come as a surprise, considering that one of the mandates of these Government Sponsored Enterprises was to enhance the availability of credit to the housing industry. It should also not be surprising that when the housing market ended its uphill run, these riskier loans were the first to go.
The timing could not have been worse though. To have a financial meltdown during an election year is a recipe for a lot of finger-pointing and a lot of politicking. The markets tend to work out their problems over time, and fortunately most politicians do not try to get involved on a day-to-day basis. Obviously this crisis is much different given the magnitude of the liquidity problems and bank failures, and it absolutely required government intervention. But it certainly would be nice to be able to focus on the issues, without hearing about whose policies caused them and whose candidacies will benefit from the fixes. It was just one more aspect of the crisis which seemed to cause more fear and more accusations than was necessary.
Lastly, there’s Main Street, where Joe Six-Pack has his hands in the air and is wondering what happened. How did all these fancy securitization programs and Credit Default Swaps actually impact his daily life? For better or for worse, because of the widespread coverage of the events, he probably knows the answer to these questions now. Unbeknownst to him, the mortgage that he’s trying to refinance was packaged with thousands of other loans, and he has no idea who holds it now. The same goes for his car loan, his credit card debt, his student loans, and his business line of credit. The bank that used to be the face of all these loans can’t refinance any of them now, and none of it is Joe’s fault.
That’s only partially true. With all of those loans, Main Street was sitting on a ticking time bomb, and in hindsight, it should have known it. Spending was out of control, mostly fueled by soaring home prices throughout the country. This meant that there was not actual money behind the spending, but rather paper profits based on assumed real estate inflation. The real estate didn’t even have cash behind it, since mortgages covered nearly the entire value. It’s called leverage. Leverage, on steroids, in fact. It sounds strangely similar to the problems on Wall Street, and not coincidentally, it was indeed the same predicament in many ways.
We look back on this year not because we want to dwell on the crisis that changed our financial industry. Instead we look back in order to learn how we will move forward in the near future. Normally, when there are issues in our business or economy, we say that we will not repeat them, however knowing that we probably will. This one is different though.
2008 is a year that we will remember for a long time, and it’s probably one that we will be recounting to future generations. Because of that, we can bet that it will be a long time before we again see excessive leverage and extreme amounts of capital chasing convoluted financial instruments. I like to call this progress.
Questions?? Just Ask.
Mark Levine is a Vice President with PNC ARCS in their San
Francisco office. He can be reached at 415-981-9700 or via email at Mark_Levine@arcscommercial.com