Commercial developers joining the bailout crowd

Due to an inability to refinance loans for commercial property developments (which generally run for well less than 10 years and must be rolled over) and reduced income from higher vacancy rates and lower retail sales, developers are asking to be included as part of a federal rescue plan. From a Wall Street Journal story:.

With a record amount of commercial real-estate debt coming due, some of the country's biggest property developers have become the latest to go hat-in-hand to the government for assistance.

They're warning policymakers that thousands of office complexes, hotels, shopping centers and other commercial buildings are headed into defaults, foreclosures and bankruptcies. The reason: according to research firm Foresight Analytics LCC, $530 billion of commercial mortgages will be coming due for refinancing in the next three years -- with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off.

Unlike home loans, which borrowers repay after a set period of time, commercial mortgages usually are underwritten for five, seven or 10 years with big payments due at the end. At that point, they typically need to be refinanced. A borrower's inability to refinance could force it to give up the property to the lender.

Click here for full story.

California tries to avoid another RTC-style hit

When the federal government created the RTC to mop up the mess created by the S&L failures, California's Inland Empire took a huge hit to property values since so many properties (both homes and land) were dumped on the market at the same time at greatly discounted prices. This time, however, California officials are trying to avoid a similar fate. From a Wall Street Journal story:

Officials in San Bernardino and Riverside counties are determined to avoid a repeat of what happened 20 years ago, when the savings-and-loan crisis led to a massive selloff of distressed real estate in the area by the federal government's Resolution Trust Corp. Many of those properties, including foreclosed homes, were sold at fire-sale prices to investors who unloaded them quickly. In some cases, entire neighborhoods of what had once been homeowners turned into largely rental communities, further depressing property values and delaying an economic rebound...

Government representatives in the area are now scrambling to muster support for a federal bill that would allow local businesses and governments to buy up some of the real estate to make sure it doesn't fall into the hands of speculators who have no stake in the community. The bill, introduced Sept. 27 by Rep. Gary Miller, a Republican who represents some of the areas in Southern California hurting from the mortgage meltdown, promotes the formation of regional public-private partnerships that could buy homes in their geographic area from the Treasury. This approach, they argue, would help stabilize neighborhoods and maximize financial returns to taxpayers...

The concern in parts of Southern California illustrates the risks that could lie ahead for other communities as the Treasury begins a massive churn of assets. Depressed real-estate values in areas across the country could slide further if homes are sold to large financial investors who then flip them to others who want to make a quick profit.

Mr. Miller said he tried unsuccessfully to get his bill incorporated into last week's federal rescue package. He said he has spoken to other members of Congress who support the bill and that there is still time to debate the measure when Congress reconvenes in January...

Counties such as Riverside and San Bernardino are already trying to gear up for what is expected to be a massive real-estate sale once the Treasury program gains steam. Last week, they passed resolutions supporting the formation of the "Regional Asset Value Recovery Corporation," an Inland Empire partnership to "preserve and restore neighborhoods and communities."...

Mr. Miller's hastily written bill, H.R. 7189, is vague about how the proposed public-private partnerships would work. It would allow the Treasury to retain a stake in any of the properties that the partnerships acquire. Mr. Miller argues that the local partnerships would have better odds of ensuring that the assets rise in value, thus allowing the Treasury to retain a stake and "greatly improve the likelihood that the federal government makes a profit."

One of the biggest challenges, however, will be the unbundling of assets intertwined with various kinds of complex securities. In order to attract regional buyers, the Treasury would first have to group different assets by geography.

Bankruptcies, not bailouts

Remember those nearly 200 economists who signed a treatise against the bailout? One of them, Jeffrey Miron from Harvard, speaks out on the reasons why in a CNN editorial:

This bailout was a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle...

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen...

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

So what might happen without a bailout?

So let's say that Congress can never agree on a bailout package, and free market forces are allowed to correct the excesses the deleverage the economy on its own. What might that look like? From an LA Times story:

If the House vote against the $700-billion financial rescue proposal stands, Americans may be in for a test of free-market economics the likes of which the country hasn't seen since the early 1930s.

With the Treasury Department hobbled by the rejection of its plan, the Federal Reserve and Federal Deposit Insurance Corp. are the chief government institutions standing between the nation and the brutally Darwinian process that could unfold if the panicky financial markets are left to sort their problems out alone...

That's something the United States last experienced in the early 1930s, when Herbert Hoover was in the White House. Some conservatives believe that's still the best long-term solution to the problem, though none has gone so far as Hoover's Treasury secretary, Andrew Mellon, who said: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. . . . It will purge the rottenness out of the system."...

For now, the Fed and FDIC are doing what they can.

Early Monday, the Fed pumped an extra $630 billion into banks around the world. Its goal: to keep money flowing through the financial plumbing that's hidden from view but is crucial to the global economy's operation....

For the Fed, the problem is that with business confidence so shaken, the banks on the receiving end of its latest flood of cash are parking the money in their vaults rather than lending it out to keep the economy functioning. Bankers worry that they might need the money if conditions keep getting worse....

Little cash is available for growth and job creation. But there's a more immediate danger: To an extent little appreciated by most Americans, businesses today no longer pay for their day-to-day operations with their own money but do so with borrowed funds.

Making next week's payroll or buying the supplies workers need to do their jobs tomorrow depend on loans. Without those loans, companies and the economy as a whole begin to grind to a halt.

The slowdown is feeding other problems that plague the nation: plunging home prices, the imploding value of mortgage securities and collapsing confidence. Among other things, that's all but certain to push more financial firms over the edge.

When that happens, the Fed and the FDIC have only one course of action: to pick and choose among collapsing firms, deciding which ones get a soft landing and which ones crash....

If Washington's rescue resources were to run out, the nation's investors, traders and lenders could discover that it was up to them alone to right the financial system.

That's a situation that has not occurred in more than three-quarters of a century, during the Great Depression.

"This is smacking more and more of the late 1920s and early 1930s," said New York University economic historian Richard Sylla.

In fact, in a less disastrous manner than during the Depression, something like Mellon's prescription of across-the-board liquidation is now underway.

And without a big, new program like the one rejected by the House on Monday, there is only so much the existing institutions can do.

Grassroots rage building over the federal bailout

It's one thing to see "no bailout" tags at the end of blog comments, but with a growing backlash against a federal bailout of the financial industry -- which is apparently trying to add everything but the kitchen sink in with failed mortgages -- it's easy to see why Congress can't seem to agree on a solution. Columnist Lou Barnes takes it on:

Any large-scale federal financial rescue was certain to face political chaos. However, within hours of rollout last Thursday this rescue collided with two linked and disastrous forces that may yet defeat immediate rescue...

Most grown-ups know that it's a mistake to ask a group to vote on an important proposal without prior discussion. You wouldn't spring something big on your PTA, your HOA or your book club and demand an immediate approval. You wouldn't ask a Cub Scout troop to vote on a field trip without some testing of the water.

Hank Paulson would. Hank has had 13 months to prepare a contingency plan in case market solutions to this crisis failed, and quietly to explore alternatives with Congress. Instead, he dumped on Congress a three-page sketch of a highly technical and questionable proposal. Tuesday's hearings in the first minutes revealed bipartisan, confused, angry and incredulous Senators, and an ill-prepared Paulson...

Over last weekend another force erupted all over the country: native, grassroots rage at a bailout that would leave all the big institutions in place -- officers, directors, stockholders, all -- and offer to taxpayers the absurd promise of payback from hundreds of billions of trash that the institutions couldn't unload on anyone else.

You tell me your precious markets will melt down without this? Why do I care? Your stock market can go to goddamn zero on Monday, and then you can come down here with me to find out how it feels not to be able pay the bills. More than half of Americans have no stake in these markets, no savings at all; and there is a political price to be paid for extreme inequality of income.

This bailout, incomprehensible to civilians and many experts and senators, should have taken ownership in the institutions involved. Proper vetting to Congress months ago would have gotten that done. Instead, the same ancient American forces that ignited the Palin phenomenon, Jefferson-Jackson-Bryan-LaFollette populism, have mobilized an anti-bank, anti-smarty-pants, street-level riot not seen in modern times.

Completing the scene: President Bush's nasty little speech on Wednesday, assigning blame and taking no responsibility; Senator McCain's grandstand play on economic issues he's said for decades he's not any good at; and Senator Obama's silent tip-toeing along.

Did Lehman's failure cause the global cash crunch?

Although the federal government defended its refusal to bail out Lehman Brothers, a story in the Wall Street Journal asserts that the consequences of that decision have been much more dire than predicted. That's the thing with predictions -- they're just GUESSES:

Two weeks ago, Wall Street titans and the government's most powerful economic stewards made a fateful choice: Rather than propping up another failing financial institution, they let 158-year-old Lehman Brothers Holdings Inc. collapse.

Now, the consequences of that decision look more dire than almost anyone imagined.

Lehman's bankruptcy filing in the early hours of Monday, Sept. 15, sparked a chain reaction that sent credit markets into disarray. It accelerated the downward spiral of giant U.S. insurer American International Group Inc. and precipitated losses for everyone from Norwegian pensioners to investors in the Reserve Primary Fund, a U.S. money-market mutual fund that was supposed to be as safe as cash. Within days, the chaos enveloped even Wall Street pillars Goldman Sachs Group Inc. and Morgan Stanley. Alarmed U.S. officials rushed to unveil a more systemic solution to the crisis, leading to Sunday's agreement with congressional leaders on a $700 billion financial-markets bailout plan...

In hindsight, some critics say the systemic crisis that has emerged since the Lehman collapse could have been avoided if the government had stepped in. Before Lehman, federal officials had dealt with a series of financial brushfires in a way designed to keep troubled institutions such as Fannie Mae, Freddie Mac and Bear Stearns Cos. in business. Judging them as too big to fail, officials committed billions of taxpayer dollars to prop them up. Not so Lehman.

"I don't understand why they didn't understand that the markets would be completely spooked by this failure," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. Rather than showing the government's resolve, he says, letting Lehman fail only exacerbated the central problem that has afflicted markets since the financial crisis began more than a year ago: Nobody knows which financial firms will be able to make good on their debts...

The government's decision to let Lehman go marked a turning point in the way investors assess risk. When the Fed stepped in to engineer the takeover of Bear Stearns by J.P. Morgan Chase & Co. in March, Bear's shareholders lost most of their investments, but bondholders came out well. In the financial hierarchy of risk, this wasn't surprising, since bondholders have more contractual rights to get their money back than equity holders. But it created a false impression among investors that the government would step in to rescue bondholders when the next bank ran into trouble. By letting Lehman fail, the government had suddenly disabused the market of that notion.

The reaction was most evident in the massive credit-default-swap market, where the cost of insurance against bond defaults shot up Monday in its largest one-day rise ever. In the U.S., the average cost of five-year insurance on $10 million in debt rose to $194,000 from $152,000 Friday, according to the Markit CDX index.

When the cost of default insurance rises, that generates losses for sellers of insurance, such as banks, hedge funds and insurance companies. At the same time, those sellers must put up extra cash as collateral to guarantee they will be able to make good on their obligations. On Monday alone, sellers of insurance had to find some $140 billion to make such margin calls, estimates asset-management firm Bridgewater Associates. As investors scrambled to get the cash, they were forced to sell whatever they could -- a liquidation that hit financial markets around the world...

To make matters worse, actual trading in the CDS market declined to a trickle as players tried to assess how much of their money was tied up in Lehman. The bankruptcy meant that many hedge funds and banks that were on the profitable side of a trade with Lehman were now out of luck because they couldn't collect their money. Also, clients of Lehman's prime brokerage, which provides lending and trading services to hedge funds, would have to try to retrieve their money or their securities through the courts...

Spooked that other securities firms could fail, hedge funds rushed to buy default insurance on the firms with which they did business. But sellers were hesitant, prompting something akin to what happens if every homeowner in a neighborhood tries to buy homeowners insurance at exactly the same time. The moves dramatically drove up the cost of insurance on Morgan Stanley and Goldman Sachs debt in what became a dangerous spiral of fear about those firms.

At the same time, hedge funds began pulling their money out of the two firms. Over the next few days, for example, Morgan Stanley would lose about 10% of the assets in its prime-brokerage business...

To some, the government's decision to resort to a bailout represents a tacit admission: For all officials' desire to allow markets to punish the risk-taking that engendered the crisis, banks have the upper hand. "Lehman demonstrated that it's much harder than we thought to deal effectively with banks' misbehavior," says Charles Wyplosz, an economics professor at the Graduate Institute in Geneva. "You have to look the devil in the eyes and the eyes are pretty frightening."

200 economists sign petition against quick bailout plan

Lately most of the anti-bailout rhetoric I've seen has been from people commenting on blogs, with most economists quoted in the MSM in favor of it. So why haven't the 200 economists who have signed a petition against the existing bail-out plan been widely quoted? I guess that's a question for the media. From a member's website:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

Click here to see the list.

Bailout still not guaranteed to fix housing market

Whether the amount if $700 billion or $1.4 trillion, the bailout being proposed by the Bush Administration may fix Wall Street but not Main Street -- at least not the real estate sector. While that may be partly due to housing prices that are still unaffordable by historical measures, it's also due to the lack of credit which made the boom possible. From an AP story via MSNBC:

Despite the Bush administration's historic and head-spinning $700 billion rescue of the financial industry, it will do little to ease lending standards so more homebuyers can qualify for loans, nor has it had much affect on mortgage interest rates so far.

By purchasing mortgages en masse from banks and other lenders, the U.S. Treasury will have more power to stop the cascade of foreclosures and help more Americans keep their homes, which will act as a brake on falling prices.

The question is, how fast can they act? More than 4 million homeowners were already at least one month behind on their loans at the end of June, and almost 500,000 homeowners had started the foreclosure process, according to the Mortgage Bankers Association...

...on Friday the average rate on a 30-year, fixed rate mortgage rose to 6.11 percent, up from 6.07 percent a day earlier, according to financial publisher HSH Associates. The average rate had fallen as low as 5.87 percent on Tuesday, but investors are clearly still jittery.

Congress refusing to roll over to approve Paulson Plan

Member of Congress, ever mindful of how livid voters are over the financial meltdown on Wall Street, are certainly not rubber-stamping the latest plan outlined by Paulson & Co. So what do they want? A story in the New York Times explains:

Treasury Secretary Henry M. Paulson Jr. received an angry and skeptical reception on Tuesday when he appeared before the Senate Banking Committee to ask Congress to promptly give him wide authority to rescue the nation’s financial system... But after hours of back-and-forth, the committee’s leaders said explicitly what had seemed clear all day: that they rejected the administration’s plan. “What they have sent us is not acceptable,” the committee chairman, Senator Christopher J. Dodd, Democrat of Connecticut, told The Associated Press.

The panel’s ranking Republican agreed. “We have to look at some alternatives,” Senator Richard C. Shelby of Alabama told The A.P.

One after another throughout the session, senators from both parties said that, while they were prepared to move fast, they were far from ready to give the administration everything it wanted in its proposed $700 billion plan to buy up and hopefully resell troubled mortgage-backed securities...

Senator Dodd called the Treasury proposal “stunning and unprecedented in its scope and lack of detail.”

Asserting that the plan would allow Mr. Paulson to act with “absolute impunity,” Senator Dodd said, “After reading this proposal, I can only conclude that it is not only our economy that is at risk, Mr. Secretary, but our Constitution, as well.”

Another expression of disgust came from Senator Jim Bunning, Republican of Kentucky, who said the plan would “take Wall Street’s pain and spread it to the taxpayers.”

“It’s financial socialism, and it’s un-American,” Mr. Bunning said...

Mr. Paulson said in response to questions that he shared the senators’ exasperation. “I’m not only concerned, I’m angry” over the events that led to the problem, Mr. Paulson said. He blamed an outdated regulatory system for the turmoil and, in an effort to counter any impression that the proposed rescue plan is for the benefit of fat-cat Wall Streeters, said: “This is all about the taxpayers. That is all we are about.”

Mr. Paulson said that “this troubled asset purchase program is the single most effective thing we can do to help homeowners, the American people, and stimulate our economy.”

He and Mr. Bernanke said that the problems in the housing industry were the core of the crisis but that the problems would continue to spread far outside the housing sector if the problems in the mortgage markets were not addressed, and soon...

None of the senators who listened to Mr. Paulson and Mr. Bernanke disputed the grim possibilities if Congress should do nothing, but it was clear that they were hearing from their angry constituents. Senator Elizabeth Dole of North Carolina, for instance, said residents of her state have been complaining about “costly and reckless” behavior on Wall Street, and the potential cost to people who are anything but wealthy. (Senator Dole is running for re-election.)

The senators on the banking panel were unanimous in calling for ways to protect taxpayers’ investments — which at $700 billion would amount to $2,300 for every American citizen, Senator Mike Enzi, Republican of Wyoming, noted...

The back-and-forth came as the Bush administration and Congressional leaders moved closer to some kind of agreement on the bailout, including tight oversight of the program and new efforts to help homeowners at risk of foreclosure.

But Congress and the administration remained at odds over the demands of some lawmakers, including limits on the pay of top executives and new authority to allow bankruptcy judges to reduce mortgage payments for borrowers facing foreclosure.

Congressional leaders and Treasury officials also said they were close to an agreement over a proposal by some Democrats in which taxpayers could receive an ownership stake, in the form of warrants to buy stock, from firms seeking to sell distressed debt.

Lawmakers want to require an equity stake, while the administration wants flexibility on that matter, a Treasury official said.

Mr. Bernanke’s testimony was exceptionally brief, considering the enormous stakes involved, a mere nine paragraphs, much of it devoted to a recapitulation of the growing crisis and how it took shape.

It seemed to reflect the way Mr. Paulson and the administration have presented the bailout legislation, in bare-bones fashion, but with a clear tone of urgency.