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Article Excerpt
Commentary
Going into the summer of 2008, we were concerned about the ripple effect of the stagnating economy on the heels of the housing market collapse and the emerging credit crunch. Much has changed in a short period of time. Indeed, we have entered new territory, with the financial crisis sending waves crashing across the economy in a manner that paralleled Hurricane Ike in terms of breadth and depth of impact.
Although hurricane season has wound down, the country has enjoyed no respite from the financial turbulence, with the rapidly deteriorating financial markets and broader economy taking center stage and dominating the news and election rhetoric. The speed and magnitude of the losses that began in the credit markets continue to emanate outward from the vortex. The credit crisis has touched so many sectors of the economy and rippled so far across the globe that it is difficult to see an end to the carnage.
Many were caught off guard, and many households and investors are underwater. Indeed, the impact has left few unscathed, regardless of the role they may have played. And like the captain and crew of the Andrea Gail caught in the infamous "Perfect Storm" of 1991, many are finding it impossible to ride out the storm regardless of their training and resolve. Individual businesses, consumers, and households have lost confidence in their ability to navigate through these troubled waters.
Even more troubling is the fact the broader market has come to the hard realization that a significant portion of the value of the underlying assets, which many looked to for safety that would collateralize their positions, has been eroded.
To help avoid a deep recession that could be triggered by a collapse of the financial sector, Congress and other governmental agencies have announced a number of interventions. While far from divine, the early reading is that these programs may be able to help keep the economic ship afloat. However, even if they work the ride will be rocky, and we will need to bail out a lot of water before we return to smooth sailing.
Assuming the interventions help avert an economic collapse, they will come at tremendous expense and are likely to trigger collateral damages and unanticipated consequences for generations to come. This is especially true since a number of fronts have required immediate attention. Of particular concern is the fact that the interventions are being implemented without the benefit of strategic planning and preemptive thinking. Rather, they are occurring in a reactive, crisis mode. Further complicating the solution is the fact that the proposals are being vetted in the political arena, where it is difficult to arrive at the optimal programs and policies.
There has been significant disagreement as to what--if anything--should be done, to smooth out the credit crisis and bail out the financial industry. However, the problem is so endemic that the voices of hardliners, who might be expected to argue the government should step back and let the crisis play out by letting those who benefitted pay the price, have been muted.
In spite of the prospects for additional interventions in the form of monetary and fiscal policy, the good-faith efforts of the federal government and Federal Reserve--coupled with those of their global counterparts--are likely to fall far short. This pessimism stems from the fact that the initial policies and programs are dealing with visible symptoms, symptoms that point to the tip of the proverbial iceberg. At this point, the focus on the most immediate pressure points has prevented policy makers from taking a more comprehensive look at the broader implications of the easy credit and risk management by transfer practices that created this crisis. Furthermore, the lack of oversight and government regulation of some of the complex financial instruments and products, coupled with the absence of a clear accounting of the scale of such activities, suggests there are many more unrecognized challenges that will need to be addressed. However, it is doubtful that there will be anything left in the till to address these new challenges, or that elected officials have the resolve to de-lever the short-term debt of the credit market by placing long-term debt on the backs of taxpayers. Thus, the near-term outlook includes much more downside risk than upside potential. Businesses and consumers are expected to be hunkered down for some time, suggesting the economy is in for some hard times that will carry well into next year and beyond.
In this difficult and unprecedented situation, prognostication is much more complicated than in more normal times. The complex network of interdependencies woven among the financial markets and the economy, both domestic and global, renders even the most sophisticated econometric models unreliable. In this environment, economic axioms built on rational thinking that underpin most econometric models give way to a set of behavioral factors that rule the day. As such, it is difficult to predict what the broader market will do. The recent events have unfolded so quickly, decisively, and significantly that many players are simply shell-shocked and scratching their heads, pondering the question of what to do next. A further complication in calling the market is the fact that new challenges and proposed solutions are breaking on a daily basis. This is likely to continue for the near term.
Despite the challenges and uncertainty ahead, the objective of this column is to provide a prospective look at where we are headed and give some insight into what it all means to the real estate market. Before delving into the current state and near-term prospects for the economy, capital markets, and real estate fundamentals, it is useful to review the events that led up to the current situation. Since the rules of engagement by which the market operates are also changing, it is important to explore the interventions that have been taken and proposed. Thus, we will first review how Congress and a number of federal agencies--including the Federal Reserve, the U.S. Treasury, the FDIC, and the newly created Federal Housing Finance Agency--are approaching the crisis. Since the crisis has rippled across the globe, responses from individual countries trying to salvage their financial institutions, and the call to action for coordinated global responses, should also be recognized. Readers are cautioned to stay tuned to the issues as policy makers introduce new programs, and the leadership in Washington and many states is turned over to new regimes.
Review of Events
The first real signals of impending doom emerged in the residential market, which went into a deep tailspin in 2006. The initial debates about the problem focused on subprime mortgages that were blamed for the rise in delinquency and foreclosure rates. However, it quickly became obvious that the problem was not contained to a small segment of unqualified and marginal borrowers with exotic deals. Rather, the market began to realize the housing market was facing a maelstrom of epic proportions as a result of the cumulative effects of easy credit, reliance on financial engineering, lack of transparency, absence of regulation, and limited accountability that had driven the bull housing run. After the housing market went into freefall, the role of Fannie Mac and Freddie Mac came into question as policy makers struggled with the issue of what to do to turn things around.
Once attention was drawn on festering problems in the residential market, some began to worry about whether this was an isolated problem, or whether it was a symptom of a broader problem. Those who explored how widespread the credit practices were in other sectors realized that the market was a house of cards. In the broader economy the credit crisis quickly turned into a crisis of confidence. At first, some of the players who experienced problems blamed the press for creating a sense of paranoia that could become a self-fulfilling prophesy. Unfortunately, it soon became clear that the problems were both real and widespread, going...
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