November 14, 2007

Expanding Real Estate Crisis

So far the mortgage crisis has been in the residential sector. Yet as Nouriel Roubini says, the shoddy lending practices infiltrated the commercial real estate market as well and it too is now showing signs of stress.

Many of the same excesses that were observed in subprime – poor underwriting standards, loose and excessive lending to marginal projects – are also observed in CRE. For example, as reported by Fitch, since 2005 there has been a very sharp increase in interest rate only mortgages and mortgages with high loan to value ratios. Loans increased to 118 per cent of the value of commercial properties in the last quarter, as reported by Moody’s, suggesting widespread use of reckless negative ammortization mortgages. And while real investment in commercial real estate has been strong in recent months (growing at a SAAR rate above 10% while residential was collapsing at a negative 20% rate) there is now evidence that commercial real estate is also at a tipping point. Actually the bubble in CRE construction – like the bubble in residential construction – will soon turn into a painful bust.

The reasons for this coming bust are clear. Commercial real estate – or more generally non-residential investment in structures - includes two main elements: office buildings, shopping centers/malls; and construction of structures for the manufacturing sectors (i.e. new factories). Both components are now under stress. The reason why we will observe a sharp slowdown in construction of new offices and shopping centers is that, with a lag, commercial real estate follows residential real estate. Indeed, as the SF president Janet Yellen put it last year there are plenty of new residential ghost towns in the West in places like Nevada, California, Arizona, etc. So why would anyone want to build new shopping strips/malls, hotels and offices in such ghost towns. If the towns are empty the stores and malls and offices will be empty too?

Meanwhile as Atrios pointed out, the Bush administration is trying to game the system once more by forcing the Fed to lower interest rates so they can keep the economy limping along until the election is over.

So the government is in the process of twisting the arms of Federal Reserve Board members to lower interest rates by as much as 2 percentage points over the next year, including potentially a whopping half-point cut next week. That will allow banks to go back to one of their favorite recession-delaying ploys: encouraging debt-strapped consumers to refinance their loans at lower rates.

If that doesn't work, the government has been making noises about creating something like a Marshall Plan for home foreclosures -- a giant bailout fund similar to one used during previous housing crises. Just for good measure, analyst Bove notes, the administration is engaged in other types of powerful job-creating fiscal stimuli as well, such as ramping up spending on defense, infrastructure and transportation construction. "The administration in power is not going to go into an election year in a recession," he insists.

How much money will they have to print to push that strategy? And what's left for the next President to cleanup after this juvenile gang gets through?

Posted by Mary at November 14, 2007 07:54 AM | Economy | Technorati links |
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