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Bailout kills Real Estate Development
Over the past week, I have watched, read, and listened to as many so called experts as I can bear explain the financial crisis we are in – including the presidential candidates.
Nearly all of them say the same thing,
“Nobody wants to bailout the banks, but the problem is so bad that we have to do it.”
It is impressive how much detail these experts are able to go into explaining exactly why the crisis happened and who is to blame. But what’s really amazing, is how little detail these experts are able to provide on how the $700 billion dollars will solve the problem and why $700 billion is the right amount to do the job.
“Just trust us (with your money).” is the common answer we are provided.
(And for the few that do attempt to explain the solution, they all leave out the real danger this solution creates – which I will explain in a moment)
So how will the bailout impact real estate developers and the property development industry as a whole?
Well to start you need to understand the problem. I am not going to rehash it here but I will give you a snippet from a particular doomsday email I received from John Mauldin’s Thoughts of the Frontlines service. (John Mauldin is a best selling author and financial expert. His weekly economic e-letter goes out to over 1 million subscribers. You can subscribe here, http://www.frontlinethoughts.com/learnmore )
“Banks can lend to consumers and investors about 12 times their capital base. If they have to write off 20% of their capital because of losses, that means they either have to sell more equity or reduce their loan portfolios. … Because banks and investors and institutions are having to deleverage, that means they need to sell assets at whatever prices they can get in order to create capital to keep their loan-to-capital ratios within the regulatory limits.”
In other words, because of regulations, banks are forced to sell their loans at a time when nobody is buying which is fueling the economic downward spiral for these banks. And until the banks get to the bottom of the spiral, they can’t make any new loans. Its new loans (i.e. the supply of capital) that fuels the growth of the economy.
So, if the government can buy all these loans from the banks, the banks can get back to doing what they need to be doing – supply the cash for the country to grow.
Or at least that is what we are told. And to sweeten the deal, most of the pundits finish off by saying “…the government will most likely make a profit on these loans because they get to buy so cheap now and they can sell them for higher prices later on.”
So as a real estate developer, the bailout sounds great right?
I mean you need financing to get your project developed and the bailout will increase the availability of that financing.
Uhmm, no.
Or at least under the current plan, that is extremely unlikely to happen.
One of the best explanations of why this is the case was presented by Ken Courtis, former vice chairman of Goldman Sachs, Asia and George Magnus, senior economic adviser at UBS during an interview on the BBC Worldservice. This interview is by far the best discussion on the problems and potential solutions I have heard to date. (I recommend you listen to the entire interview here - http://www.bbc.co.uk/worldservice/specials/1512_debates/page24.shtml )
In the interview, Ken Courtis and George Magnus explain that under the bailout plans that are proposed the government will be buying the bank’s loans, but not actually increasing the amount of capital reserves with which to make new loans. And in fact, the new banking rules implemented as a part of the bailout will actually make it more difficult for banks to lend money.
The bailout will actually reduce the availability of financing for real estate developers making the depression worse.
This is one of the biggest reasons the bailout is bad for real estate developers – but not the only one.
There is another reason – a reason that is actually more important and the ramifications are far more serious than what all the experts are talking about at the moment.
You see everyone is focused on problems with supply – but no one seems concerned about the problems with demand.
The banks ability to loan capital to businesses is the SUPPLY. The DEMAND is business’s need for loan capital to meet the publics growing demand for their products.
Unfortunately, taxing the public to the tune of $700 billion dollars (actually it is closer to $2 trillion) will create a massive drop in DEMAND - sending us into a deeper and longer recession. Ken Courtis attempted to point this out in the BBC interview and was cutoff because nobody wants to hear it.
Nobody wants to face the fact that whether the drop in DEMAND happens immediately or is put off by financing the bailout with overseas loans – the drop in DEMAND is going to happen. And it will most likely be severe. Gross National Product will go down and could stay down for a long time.
The structure of the bailout;
• solely focusing on buying loans,
• no attempt to increase bank’s capital reserves while further restricting their ability to make loans,
• and no serious concern for the devastating impact the financial burden of the bailout will have on DEMAND and GNP –
creates a high probability that we are facing a decade long recession similar to the one Japan is only now coming out of.
When faced with the real result of the bailout, one has to wonder why any real estate developer would be in favor of it. Yes the lumps we are taking now are not easy to swallow. But I would rather take one bad beating and get it over with than face a long drawn out tortuous series of beatings in the future.
September 29th, 2008 at 9:03 pm
Thanks Bart.
After hearing all of the political spin, I appreciate hearing the numbers.
On Cspan I was outraged to hear FANIE AND FREDIE were actually in trouble a year ago!
Yes, I too have been assessing this situation through BBC reports.
Why is our USA media in treating politicians like rock stars, rather than giving us the facts on real issues?
You can find our how we have been hoodwinked by reading Andrew J. Bacevich’s new book, THE LIMITS OF POWER: THE END OF AMERICAN EXCEPTIONALISM.
It is the shame faced truth.
Now for property development:
Before we had the Feds and Wall Street in the game, there were a number of “do-it-yourself” means of financing development.
Check out the history of the City of Anaheim, CA. Bone up on Savings and Home Cooperatives, some times called “home building societies”.
My brother told me that the German banks sell construction bonds to local investors for local commercial construction projects.
Go to the horse’s mouth. That is pension funds and insurance companies and land owners. Do not be shy about asking non-profits [who can get grants] to become partners.
Your ideas here.
A Linda prediction:
Now comes the age of creative financing.
PS: Wall Street got its name from that part of town being walled off to keep the neighborhood pigs out. Oops! Looks like they found their way in anyway.
September 30th, 2008 at 12:27 pm
Great Post Linda,
I think you are right about how creative the financing is going to get.
I have been around developers long enough to know how great they are getting past obstacles. They can be imaginative and resourceful as hell when foreced. Even if some of them didn’t quite do it legally ;]
September 30th, 2008 at 7:35 pm
Hello there:
We are private commerical lenders who help real estate developers in need of commerical financing.
We have private short term commercial loans starting at at $2 million dollars and up.
If we can help with your financing needs, please feel free to contact me.
November 4th, 2008 at 5:24 pm
[…] CM wrote an interesting post today onbailout kills real estate developmentHere’s a quick excerptwhen faced with the real result of the bailout, one has to wonder why any real estate developer would be in favor of it. yes the lumps we are taking now are not easy to swallow. but i would rather take one bad beating and get it over … […]