[Planting A Garden] DJIA Surge = Better Mood = More Home Sales

March 23, 2009 | 11:32 pm | |

Who says the Dow Jones Industrial Average has anything to do with the outlook for the housing market?

I am certainly skeptical, and get downright annoyed every time someone would refer to the DJIA result that day as a litmus test for some sort of national mood.

Yet people seem to be feeling a little better about things (the economy/housing) today than a few weeks ago. Here’s a chronology of cause and effect (DJIA rises and home sales rise) conveniently edited to make my point:

First of all, this has been one heck of a busy news cycle and the path from DJIA to rising home sales is obvious.

Secondly, I need to splash some cold water on my face and get back to work.

Aside: we don’t need bipartisanship.

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[Risk as a Bonus] US Treasury Makes Another Attempt To Fix Economy, Housing

March 23, 2009 | 11:21 am | |

Last week, Dan Gross at Newsweek wrote a fun piece on Slate/Newsweek called “Jump” (not a a correlation with the old Van Halen song). Basically he says that nothing the government can do will fix the economy unless we participate.

In the grips of a bubble mentality, we—as investors, consumers, and businesses—blithely assumed risk and convinced our­selves it was perfectly safe to do so. We bought houses with no money down, took on huge amounts of debt, and let the booming stock and housing markets perform the heavy lifting of saving.

I remember the ridicule the former president took for his previous economic fix after 9/11 – “Shop!” else we enter the “paradox of thrift.

If everyone saves during a slack period, economic activity will decrease, thus making everyone poor­er. We also need to start investing again—not necessarily in the stocks of Citigroup or in condos in Miami. But rather to build skills, to create the new companies that are so vital to growth, and to fund the discov­ery and development of new technologies.

I am not suggesting that shopping is solution, but it is certainly part of the problem right now. When consumers and investors hunker down and do nothing, a failure spiral results.

Today Secretary Geitner announces the plan we have been waiting for, which is heavily reliant on the private sector. US Treasury secrectary Geitner unvailed his second attempt at getting the economy moving again and this time there is probably no room for a do-over. Did he really call it “My Plan”?

We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession. The rule of law gives responsible entrepreneurs and investors the confidence to invest and create jobs in our nation. Our nation’s commitment to pursue economic policies that promote confidence and stability dates back to the very first secretary of the Treasury, Alexander Hamilton, who first made it clear that when our government gives its word we mean it.

Of course Hamilton was shot dead in a duel. Let’s hope this strategy has a quicker draw and better aim.

Here’s the official press release and fact sheet posted this morning.

Here’s the problem with the AIG bonus outrage that fueled this modification of plans – it’s not about being scared of keeping AIG and other Wall Street firms afloat and it’s not about the obscene lack of morality – it’s about the danger of scaring off the private sector from participating in the solution. It’s called “Free Market.”

Council of Economic Advisers Chief Christina Romer said:

“We’ve got banks with a lot of toxic assets, what ‘toxic’ means is they are highly uncertain … so that is certainly the big picture, and that is going to be the main reason for doing this … We simply — we simply need them. We need them — you know, we’ve got a limited amount of money that the government has to go in here, so we need to partner, not just with private firms, but with the FDIC, with the Fed, to leverage the money that we have,” she said.

$165M AIG bonuses (actually it’s $218M) and it’s symbolism of greed have been a distraction and we have to be very careful of taking our eye off the ball. Cut out the “Main Street versus Wall Street” homilies and let’s fix this.

Congress underestimated consumer outrage and the House quickly passed retribution legislation to get even via a 90% tax. Because the political playing field is incentivized by one-upsmanship, Congress is much more comfortable with this sort of grandstanding/finger pointing and that’s what this debate has regressed to. Dodd is in hot water.

It began with the previous legislation of caps on Wall Street compensation (when Congress didn’t catch it), while a feel good measure, is also a short sighted position much more apparent now because there will always be work-arounds.

I love how many simply lump all Wall Streeters into one evil pile and feel it’s right to treat everyone the same. It’s professional prejudice on steroids. A market for the “toxic” assets needs to be fostered. Do we want to get out this mess or not? No room for populist shortsightedness.

More on the plan later. In the meantime I need to download that song from iTunes – it’s systemic so we might as well jump.


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Facing The Nation, Washington Doesn’t Really Get It (Hint: It’s Not Housing)

February 3, 2009 | 2:47 pm | |

I really enjoy Bob Schieffer’s Face the Nation program and listen to the podcast on a regular basis. I was particularly interested in the discussion this past week with senators Mitch McConnell and Chuck Schumer, as well as New York Times reporter columnist David Brooks because they discussed the stimulus plan passed by the House of Representatives and now making its way through the Senate.

I was a bit taken aback by the “non-stimulus” earmarks thrown in for good measure but both Senators seem to be interested in the rapid passage of the bill after modifications are made.

However, the main theme in all this and frankly in most political discussions on the economy seems to point to housing as the root of all our problems and therefore lower mortgage rates and tax credits are the answer.

Download the transcript to see what I mean. Housing is not understood.

Perhaps this is semantics, but the housing crisis was not the cause of the problem, it was the straw that broke the camel’s back (that phrase really looks weird in actual text). Home buyers and home owners looking to refinance, won’t be helped much by these solutions.

Because it is all about underwriting.

Look at the Fed’s Senior Loan Officer Survey above – underwriting restrictions are up significantly in the past two years.

Think of a bank making the decision to lend right now – applicants have rising jeopardy for job loss and housing markets are declining – future losses loom for lenders as well. Not a comfortable environment for making a loan without very difficult terms. That is what is choking off the housing demand. It’s not because buyers need a bigger tax deduction or need a lower mortgage rate to qualify. They need to qualify for mortgages within reason.

Housing is a lagging indicator not a leading indicator.

Focus on credit and the financial system. And I think we need to let some of the financial institutions fail – as painful as it can be.

The problem is, with house prices still in free fall and unemployment rising, tight lending standards, as evidenced by the latest survey of Senior Loan Officers, make sense.

The bigger conundrum for Washington, however, is that, just as the banking sector appears to have suddenly found religion, consumers are also unhelpfully doing the same. Almost half of loan officers surveyed reported weaker demand for consumer loans. Demand for mortgages, while having improved from December’s nadir, remains weak. Meanwhile, demand for commercial and industrial loans has plummeted.

Unfortunately, this is largely unavoidable. Plunging stock markets and property prices blew a $5.6 trillion hole in households’ net worth in the first nine months of 2008. That surely worsened in the fourth quarter.

Consumers simply don’t have all the money in the world, even if retailers are offering 70% discounts.



[Straight From MacCrate] Ellwood – A Beautiful Mathematical Formula But Often Misused

February 3, 2009 | 1:18 am | |

Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

…Jonathan Miller

By James R. MacCrate MAI, CRE, ASA

I have had the opportunity to review many real estate appraisal reports over the last two years and I am amazed by the number of real estate appraisers who only use

to develop overall capitalization rates. Commonly known as the Ellwood formula. No wonder why folks question real estate appraisals on commercial properties. This formula does not reflect the actions of informed real estate investors. In fact, in 1971, Max Ramsland, MAI pointed this out succinctly in his article “Ellwood: A Practitioner’s Observations” in The Appraisal Journal. In English, this formula basically states that an indication of the overall capitalization rate can be developed by taking the following steps:

The Ellwood formula was designed as an analytical tool for real estate appraisers, investors and other real estate professionals. Its misuse was clearly evident during the real estate collapse of the 1970’s and 1980’s. The model above is for a level income stream over a specific number of years. Who buys real estate expecting the income to be level over the projection period? If income and value are expected to change over time, the Ellwood J or K factor must be applied and incorporated into the formula. It appears that it is being misused again by real estate appraisers. Mr. Ramsland points out several weaknesses that are worth revisiting at this juncture.

First, it is extremely difficult to verify the equity yield rate required to attract investors to real estate investments. Many real estate investors will not disclose their “hurdle rates” to invest in real estate. Abstraction of the required information to properly apply this methodology is difficult. During the last several years many transactions that occurred were the result of a 1031 or tax-deferred exchange which created aberrations in the observed overall rates, sometimes below 4.00%. These transactions were driven by after tax returns and appraisers generally do not have access to the information required to develop a proper analysis. Many of the transactions were not economically justifiable and this is becoming evident now. If this information is abstracted from historical transactions it can be very misleading without proper consideration of the market conditions as of the date of sale. Mr. Ramsland points out that investors have various reasons for making an investment decision: some of which are well thought out and others who dream about the future and hope, but are incorrect.

Appraisers often assume that investors will hold the property for ten years and that the property will appreciate in value. The market indicates that values do not always go up and, in fact, can decline for long periods of time and/or stay stabilized. Finally, what investors use this analysis to make an investment decision? I have been in this business for more than 25 years and the last time investors used this model the real estate market collapsed.

Mr. Ramsland further points out that “the allowance for depreciation can have a measured affect on the final value estimate if not realistically applied. A more serious problem could exist, however, if the appraiser projects an equity-yield and depreciation factor inconsistent with safe investment practices.”

Terry Grissom, PhD, at the University of Ulster, Ireland points out that the issue of stable income and the assumptions behind an accumulated sinking fund growth factor is an accrual valuation measure that is inconsistent with discounted cash flow analysis and the cyclical nature of real estate investments. Valuation needs to explicitly cope with changes over time to return to equilibrium or growth assumptions during down phase. Don’t misunderstand me, the Ellwood formula is an excellent tool in the arsenal that appraisers have to utilize to develop overall rates if applied correctly; but with computers available today, appraisers should apply the methods employed by investors who acquire real estate. In addition, more than one method should be used to support a capitalization rate. The appraiser can consider the following methods to develop an appropriate overall rate:

  • Interview market participants
  • Review published surveys
  • Abstraction from comparable sales
  • Abstraction from multipliers developed from comparable sales
  • Developed by the band of investment method
  • Estimated by the debt service coverage ratio method
  • Abstraction from expected property yield rates.

All techniques to develop a capitalization rate should produce similar results if properly constructed with the correct assumptions.

Note – Thanks to Max Ramsland, MAI, Duluth Minnesota and Terry Grissom, PhD, University of Ulster.


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The 6th Highest Wall Street Bonus Payout In History, Girlfriend

February 1, 2009 | 12:07 am | |

Last week the New York State Comptroller announced that Wall Street bonuses fell 44% to $18.4B and the securities industry losses may exceed $35B

Troubled Asset Relief Program (TARP), which infused billions of dollars into the financial system, helped prevent more institutions from failing. TARP placed restrictions on bonuses for top executives and many have voluntarily forgone bonuses, but it did not impose limitations for lower-level employees.

State Comptroller Thomas P. DiNapoli seems to be inferring that high level executives held back and the more pedestrian lower paid employees took the money? I don’t think so. Sure, CEOs at Citi and others witheld bonus compensation, but that wasn’t in the majority. In fact 79% of all Wall Street employees got paid a bonus this year.

In fact, although the bonus pool was down 44%, it was the sixth highest payout in history.

Here’s what I wrote about bonuses last year at this time. Much has changed, other than the concepts applied to compensation (hint: they’re not correlated with performance.)

That certainly important for the New York real estate economy, but given the credit crunch, it may not prove to be much help. Each January, the bonus compensation starts the real estate market engine.

Maureen Dowd in her Op-ed piece Disgorge, Wall Street Fat Cats suggests:

The president needs to think like Andrew Cuomo. “ ‘Performance bonus’ for many of the C.E.O.’s is an oxymoron,” he said. “I would tell them, a) you don’t deserve a bonus, b) where are you going to go? and c) if you want to go, go.”

Firstly, I think we all need a refresher course on what a bonus is:

bo⋅nus   [boh-nuhs] noun, plural -nus⋅es
1. something given or paid over and above what is due.
2. a sum of money granted or given to an employee, a returned soldier, etc., in addition to regular pay, usually in appreciation for work done, length of service, accumulated favors, etc.
3. something free, as an extra dividend, given by a corporation to a purchaser of its securities.
4. a premium paid for a loan, contract, etc.
5. something extra or additional given freely: Every purchaser of a pound of coffee received a box of cookies as a bonus.

I always saw bonus as a mislabeled compensation method – most see it as base pay plus commission. After all, the average compensation on Wall Street has averaged 40% to 50% of total compensation and bonus payouts have been at or near record levels over the past 6 years – based on nothing really. It morphed into a way to offload compensation risk to the employees. We’ll pay you half of your salary at the end of the year if we can, which morphed into no matter what.

Felix Salmon at Portfolio opines further on this point – that there is a minimum bonus payment level that must be made (seemingly contrary to Andrew Cuomo’s statement above).

Now there are good reasons for having a bonus system: it incentivizes profitable work, and it makes it easy for banks to pay less money in lean years. But as Bookstaber writes, there’s definitely an implicit minimum bonus at investment banks — a sticky level below which it’s hard to cut bonuses any further.

There are reasons to have a minimum bonus, rather than baking that money into base pay: it’s not included in pay-rise calculations, for starters. But when banks start getting multi-billion-dollar government bailouts, it looks really bad if they then just turn around and spend a similar amount of money on bonuses.

But resentment is growing and the campaign weary “Main Street vs. Wall Street” has found new life. Wall Street has lost billions, been bailed out for billions and been paid billions in bonuses. The mortgage securitization juggernaut will end up costing taxpayers trillions and the industry is whining about compensation.

Washington is angry, and perhaps embarrassed for not building this into the TARP.

But seriously, did Congress really expect Wall Street to stop paying out bonuses voluntarily? Its part of the culture, always has been. It’s like asking Congress voluntarily not to run attack ads and not be overly partisan – it’s simply built into their DNA.

No moral judgement being made here – people outside this world don’t seem to understand what makes Wall Street tick. If its not mandated, then status quo will prevail.

Even worse, the lower compensation is having an adverse effect on the social lives of Wall Street bankers, ’cause its the economy, Girlfriend.

UPDATE: Signs Wall Street may already be re-inventing itself.


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[Sounding Bored] Interview With Jim MacCrate: proposed Interagency Appraisal and Evaluation Guidelines

January 10, 2009 | 4:14 pm | | Columns |

Sounding Bored is my semi-regular column on the state of the appraisal profession. There have been more changes made to the profession in the past several years than in the entire history of the profession, and most of the changes have not resulted in a more credible service. Still, I’d like to hope that the latest financial services sector turmoil will bring a clean slate approach to better regulatory oversight (devoid of insanity).


On November 19, 2008, to little fan fare, a joint agency request for comments on proposed Interagency Appraisal and Evaluation Guidelines was made. Comments are due by January 20, 2009.

I called on Jim MacCrate to get his thoughts on this initial foray by the federal government to fix what is broken in the appraisal industry. Jim is a highly respected appraiser and teacher in the valuation community and who holds the MAI, CRE and ASA designations. He also contributes to this blog in his widely read “Straight from MacCrate” column.

Like many things in my life, I was delayed in posting his commentary to Soapbox.

I asked Jim to run down the document as presented and I throw in a few observations of my own:

Jim

First, the government has acted in haste with outlining the causes of the collapse in the credit markets. I believe, based on my experience, it was poor underwriting standards and lack of enforcement by the FEDS, state governing agencies, accounting firms and others who were responsible for sound underwriting practices. This was a repeat of the 1970’s but it will be far worse.

The OCC regulations and the regulations from the other duplicate agencies had similar guidelines after the bust of the seventies and eighties. Why were they ever changed?

Licensing weakened the quality of reports nationwide. It established minimum qualifications, not experience and expertise.

Jonathan I agree. Appraisal quality diminished with licensing because it was used as a placebo for competence.

Jim

Professional organizations, whether it be appraisers or lawyers or accountants, can not self regulate. That was a joke of the nineties and in to the 2000 error.

Jonathan I remember in 2005 when the Mortgage Bankers Association said there was no real issue with appraisal pressure and the solution was to have appraisers simply do a better job at self-regulation. Of course now 60% of mortgage brokers are gone.

Jim

My understanding is that the employees of the regulatory agencies have very little experience in valuation. For example, there is only one MAI at the Federal Reserve. Economists do not understand what we do. See article from the FED on the value of an acre of land in NYC in 2006.

Real estate lending was always a credit decision first. You look to the collateral when the credit fails.

Jonathan Exactly.

Jim

Personal guarantees are meaningless. AVMs are part of the problem. Economists and statisticians believe in them. The databases are screwed up. They are reportedly using BPOs and that further weakens the reliability. Brokers have a conflict of interest. See Wall Street for Support. Of course no conflicts of interest between Goldman, AIG and others.

Independence

Jim

You know ethics, honesty, etc. are more important than independence. It is this generation that has done anything for a buck and failed to consider the consequences.

Jonathan Absolutely, but if the appraisal industry can not work without being pressured to “make the number” as has been past practice, then honesty and ethics fade away as those individuals are driven out of business. How can I compete with someone who is fast, cheap and always comes in with the exact number needed to make the deal?

Selection of Persons Who May Perform Appraisals and Evaluations

Jim

There is no comment on years of experience. That is caused by the licensing. Back in the seventies (and there were problems too) appraisers were selected because they had the MAI or SRA. Those standards were way above today’s. States do not have the money, knowledge or resources to enforce compliance [with state licensing]. Folks who order appraisers should be knowledgeable and qualified to do the appraisal; otherwise how do they know who to hire?

Jonathan I agree with you – Take Appraisal Management Companies: We are often dealing with kids just out of high school who have no real estate valuation experience, let alone understand the problems with valuation. And revenue collected from state licensing boards for oversight is often diverted to other areas of the government. The problem with “pure” enforcement is that it becomes an argument of semantics because valuation is an opinion. Fraud aside, how legally viable is it for a state agency to reprimand an appraiser who estimated the value of a property as $500,000 when the state employees think its $475,000, especially when there is limited market data? It’s tough to say anything a certain percentage below or above the state value is unethical. And what if the state is wrong? It’s not a realistic solution.

Minimum Appraisal Standards

Jim

The Appraisal Foundation weakened its standards with the latest version and previous version. Economic principles drive valuations. Three approaches to value are the support to a supportable, defensible estimate of value. You knock off one leg of a three legged stool and what happens. The stool falls over.

The comment on AVMs should be stronger.

The Scope of Work is correct. It is up to the agencies and the financial institutions to determine the scope of work; not an appraiser. Risks are determined by the financial institutions who then should determine the scope of work required to protect the financial institution if the credit fails. The collateral is the default to protect from losses.

Tract Developments with Unsold Units

The appraiser should include and analyze the developer’s projections. The appraiser can not work in a vacuum. They need the information to properly analyze these types of projects. See what was written in the 1990’s by Prittenger and others for the OTS. Why are we reinventing the wheel? We spent tax payers dollars on this issue in the 1990’s and late 1980’s.

What happened to a market analysis? That led to failures in the 1970’s, 1980’s and now with REITs. I guess supply and demand are not important criteria that determine pricing.

market analysis should be performed by state-certified or licensed appraisers in accordance with requirements set forth in the appraisal regulation..

experience is the key. A license does not make you qualified.

Transactions That Require Evaluations

All transaction should be evaluated to prevent fraud.

the reputation and qualifications of the person(s) who perform evaluations are the key.

Reviewing Appraisals and Evaluations

Who is doing the review for the financial institution? A check is needed. They cut costs and relied on unqualified appraisers to the work. Knowledgeable folks in the appraisal process must do the review. I know it’s a pain but it is a safeguard that the system had and it was eliminated by many financial institutions. A loan officer has a conflict of interest because how they may be paid or compensated.

USPAP sets minimum standards. The financial institution must set the standards that exceed USPAP and they must be enforced at all levels, including the CEOs who tell lending officers oh, it is not necessary this time around..

Referrals

Jim

They will not do it. That is a joke. It is up to the regulatory agencies to sample the loan documentaion and if they see a problem, they should make a referral.

I think the first part indicates that the authors do not have experience or knowledge of the past or what has been written by the OCC, OTS, FDIC, etc. in their regulations. The real culprit was greed by CEOS and Wall Street who had no interest in the future but only current earnings now. The MBS market allowed lenders to off load loans without recourse by the investors in the final packages put together by the likes of Goldman Sachs, etc. who indirectly got bailed out by lending and supporting AIG.

This document does not address what has caused the problem and that is to hold those at the top, lending officers, accountants, etc. accountable financially and responsible over the life of a loan.

The Addenda

Jim

Item 2 Page 41- In today’s day and age with bankruptcies increasing appraisals are needed. Abundance of caution you need all the tools to be used to protect against defaults. In the current environment there is no certainty of repayment. Personal guarantees, etc do not exist once an individual or company falls on hard times. During audits at old PW the staff was directed not to consider personal guarantees at all.

Item 5 Page 43 same comments. Taxpayer funds are at risk. Fraud occurs at all levels. Appraisals should be required even on loans $500,000.

Item 8 Page 47 “These transactions should have been originated according to secondary market standards and have a history of performance.” Standards were not enforced so that’s a dumb statement. How does one know in the current environment without proper due diligence which would include a thorough review of all appraisals.

Item 10 Page 49 Freddie and Fannie made mistakes. Why should these transactions be exempt? Do not exempt them and it becomes a check of the system and does not cost the taxpayers a dime. There was fraud in the appraisal and lending process that Freddie and Fannie did not catch. Now it can passed on to others?

Item 13- Page 50 Same as above. Why? It is a check on the system. Fraud has occurred in the same organization transacting business with subsidiaries.

Page 52- AVM’s – The databases are not perfect. Statistics are not always correct – look at what the FEDS have done relying on statistic modeling. You know what is wrong with AVMs.

Now, good I see a definition of market value again and some other terms.

Jim

There ya go sorry I can’t spend more time right because no one is bailing me out and our retirement accounts. I guess I am small and can fail at no cost to society.

Jonathan Thanks Jim!


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[Below 1%] Turning Japanese, I Really Think So

December 5, 2008 | 1:53 am | | Radio |

Not much wiggle room left for the Fed, but always time for New Wave “turning Japanese” nostalgia.

I keep thinking about the 0% discount rate set by the Bank of Japan since the mid-1990s and how that hasn’t worked. The Bank of England’s rate was dropped to 2%, the lowest since 1951.

Referring to Great Britain, but the same concept applies to the US economy:

Like Japan, the recession has shown government spending to be way out of kilter with the size of the post-bubble economy, and our budget deficits are set to easily reach those of Japan at its peak.

In Barrons:

Are U.S. Markets Turning Japanese?
It would seem so as yields plunge well below 3%. Think of it as the 1970s in reverse.

BABY BOOMERS, MORE THAN ANY OTHER GENERATION, seem stuck in their youths. Think of how the tastes of so many of their numbers remain ossified in the 1960s and 1970s, from Classic Rock on the radio to recreations of the autos of their youth, such as the VW Beetle, the Mustang and the Mini.

So, too, have their expectations about the economy. Prices only go one way — up — whether for the stuff they buy every day (except for computers and the other electronic accoutrements), their assets such as stocks or houses, or the pay for their services. They can no more conceive another kind of world than one without cell phones. And any departure must be an aberration, surely short-lived and certain to revert to the norm they’d known.

In other words, finance, as we know it, is undergoing massive change and the products we end up with are not going to be the same as we had a few years ago when the market was always going up.

Mortgage rates are fallng and mortgage applications (not necessarily successful applications) have just tripled and the US Treasury is talking about pushing rates as low as 4.5%. Although it doesn’t address jumbo mortgages, it is a first sign of progress, but by no means does it solve a whole lot.

Some say that with the nearly 8 trillion in exposure we taxpayers have through guaranties and investment, rates will rise with the flood of paper issued to pay for all this. I’m not sure. If the economy is lackluster at best for the next 2-3 years, I have a hard time seeing rates rising with the lack of demand in the near term.



Aside: Donald Trump is complaining his new Chicago condominium project is too expensive.

Yet another aside: This is your child’s brain on a Sony HD 52 inch Flat Screen with surround sound.

Big 3 + UAW aside: Combined common stock worth $3B, so lets give them $34B To date they have: fought emissions restrictions, fuel economy, safety features, make poor quality cars, and paid 12,000 people to not work. I went to school in Michigan and, despite obvious sympathy for hard working people in this situation, I have a hard time seeing how things are going to change in any way whatsoever. I’ll bet they don’t go on the same extravagant trips that AIG took if this goes through now that they have driven their own hybrids.


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[The Navigator] Strategic Planning Can Get Appraisers Under The TARP

October 20, 2008 | 10:13 am | |

Joseph P. Egan is a Massachusetts Certified General Real Estate Appraiser with over 25 years of professional valuation experience. The assignments performed by his firm, Joseph P. Egan & Associates, cover a broad range of commercial real estate properties as well as family and closely-held businesses in Cape Cod, Nantucket and Southeastern Massachusetts. This experience intersects with all major industries such as the automotive, food service, healthcare, lodging, marine, professional services, recreational, and retail sectors. Joe is a thoughtful and thorough writer who draws on this experience when delivering unique insight on issues that impact appraisers in today’s market. I am deeply grateful to have Joe’s to help us “navigate” this challenging environment for appraisers.
– Jonathan Miller



Earlier this month the Troubled Assets Relief Program (TARP) became a done deal and the U.S. Treasury has since been diligently crafting a global strategy to implement the greatest government bailout or rescue since the 1930’s.

Despite the many unknowns of the $700 billion program, one underlying theme being increasingly acknowledged is that TARP related assets will stimulate demand for experienced workout related professionals. Given what we know, it appears the increase will largely concern asset collateralized by commercial real estate and new construction assets.

One piece of evidence of the growing demand are the widely published reports of the FDIC’s efforts to employ more workout professionals beginning with retirees possessing prior on the job experience gained in the prior S&L bailout. In the private sector, Anthony LoPinto of SelectLeaders a leading commercial real estate recruiter stated in a recent blog post that due to “a meltdown of the financial system” and the need to “contend with the large pools and billions of dollars of commercial real estate loans that will be maturing over the next 12 to 36 months”, demand for experienced workout and restructuring professionals is expected to increase. An anecdotal review of available job postings, hiring news, and general industry dialogue all seem to corroborate Mr. LoPinto’s front line perspective.

The positive news is advisory and valuation companies of all types will likely have opportunities to meet the growing need for workout services. Professionals and organizations with prior workout exposure may have a leg up and perhaps be most inclined to seize opportunities. Less experienced professionals seeking to diversify into the arena can still adopt strategic and focused measures to explore opportunities.

Regardless of your level of workout experience, before dipping into this inviting yet clouded pool, it may be best to develop a reasonable short list of what we currently perceive to be in store under TARP and highlight a few differences between the last time workout services was a growth industry. Armed with this perspective (which is being further refined at this moment) a range of possible workout opportunities likely to be offered in the marketplace can be brought into closer focus.

Fully recognizing that the range of differences is an evolving topic, as TARP unfolds the short list of current differences include:

  • The financial and systemic magnitude of the TARP program and the solution it hopes to provide are much larger and more global than the S&L bailout. From a structural perspective, the range and diversity of market participants, stake holders and service providers will be broader as well.
  • Using the establishment of FIRREA in 1989 as the starting point, the S&L bailout lasted into the mid 1990’s. The timeframe for the TARP program is unknown due to dependent variables such as the type of assets to be acquired, price levels achieved, the degree to which assets are performing, holding periods (some assets may be held to maturity), and the manner in which Treasury adjusts their terms over time. Continued bank mergers and failures along with the dysfunctional state of the commercial credit pipeline, thus triggering the degree to which banks will need to participate in the TARP program, all remain significant variables as well.
  • In the S&L bailout, the bulk of assets acquired by the RTC and resold comprised whole asset sales acquired from a neat profile of U.S. banks. A significantly higher percentage of the troubled assets to be acquired under TARP, however, are expected to comprise internationally held whole mortgages and other financial instruments of many blends, rather than primarily hard assets such as real property. In addition, the troubled assets will be divided among the yet to be named asset managers in two groups handling either whole loans or securities backed by a multitude of mortgages.
  • Based on available information, gaining adequate control of securitized assets, aptly assessing risk, and developing reliable pricing and buy/sell mechanisms, particularly for securitized assets, will be the major challenges.
  • Through the consistent introduction of “innovative debt” structures and greater reliance on private rather than institutional capital, a broader pallet of international stakeholders now exists. The consistent formation of new private venture funds keen on opportunities to acquire distressed assets at favorable terms is just one example of how this realm is already expanding. Another stakeholder may comprise tax payers like you and me under a plan being considered where Treasury financing would be provided in selected joint venture transactions. The equity partnerships are aimed at promoting assets sales while providing the opportunity for tax payers to be a stakeholder.
  • Qualifying banks deciding whether to retain or acquire collateralized assets not sold to Treasury will represent another type of potential workout client. Certainly, the relaxing of market to market requirements, changes on the treatment of distressed assets in whole mergers, along with restrictions on executive pay, equity participation, and recoupment could provide incentives for banks to strongly consider holding or acquiring assets, except for the most seriously impaired. As part of this decision making process, banks will require workout related guidance on assets collateralized by real property.
  • The range of sophisticated analytical tools and the level of readily accessible public and proprietary market data, software applications and information technology have significantly increased since the 1990’s. Consequently, on the regional or local level appraisers providing the most sought after workout services will be required to demonstrate the high value capabilities and specialized technical expertise not readily decipherable from third party data sources or based on remotely developed software models.
  • Participating appraisers must fully understand the needs and structure of this evolving process which over time will ultimately become a sophisticated and highly channeled niche market. Consequently, a new long-term commitment to being properly positioned on the right regional and national radar screens will be paramount. Getting there first, establishing your targeted expertise, and being “top of mind” is even better.
  • Due to the magnitude of the current rescue plan as we know it, efficiency and credible assignments results will even rank higher. Project management skills, accountability, the ability follow defined scope of work requirements, and the willingness to provide high touch follow up service will no doubt reign supreme.
  • Given the volume of assets to be managed and Treasury’s emphasis on the “paramount need for expeditious implementation”, asset managers and other workout clients will seek out service providers with the capacity to reliably complete multi-property or portfolio assignments in the most optimum manner possible.

With these observations in mind, in addition to appraisals, some ideas on the types of targeted workout related services to be requested will include:

  • Liquidation Value The ability to estimate reasonable and adequately supported liquidation values will be needed area of expertise. Assisting banks in the development of “fair value” estimates on ORE properties could perhaps be another related service to be requested. (See FDIC, FIL 62-2008, Guidance on Other Real Estate, issued July, 2008)
  • Development Consulting Professionals and organizations with a firm local and regional grasp on absorption rates, development costs, unit pricing, sales concessions, bulk sale analyses, etc. or the more encompassing market and feasibility studies, will be sought out. Depending on your geographic region, through properly developed scope of work scenarios this niche service sector can offer good opportunities for developing a solid niche and attracting ongoing and repeat assignments.
  • Market Analysis Providing market data and specialized analysis to a range of clients are examples of the type of work out related assignments likely to be requested. Possible scenarios include requests for supplemental market data and analysis to be considered by a client in connection with an existing appraisal they are currently reviewing. Individuals and organizations performing advisory or valuation services in a market area where you have superior expertise or better resources may comprise another client group. The need for up to date and reliable market data and trend analyses to be utilized in connection with a client’s internal portfolio review processes is another area where market analysis services will have a good fit in the workout arena. Since the ability to assess a borrower’s capacity to continue to pay on a performing loan will be front and center, one offshoot in this area could possibly involve assignments supporting the underwriting and risk assessment processes with greater precision. Recognizing that the original mortgage was created at both a different time and underwriting scenario, such clients may require more on the ground intelligence addressing critical topics such as the state of the immediate market area and the competitive environment.
  • Property or Subject Specialization Professional advisory and firms with specialized areas of expertise will be sought out to provide reliable solutions concerning unique properties and problems. And based on what we already know about lax underwriting and loose credit standards, there will be many unique properties and problems. In a workout environment, prudent asset managers realize they cannot know every market or every property type and are inclined to turn to specialists for answers. The byproduct — timely and sound decision making is what they need most. One obvious example of specialized subjects involves the broad category of distressed properties with the possibility of further segmentation. Additional examples may include specialization by property type (e.g., gas stations, net leased restaurants, lodging properties, recreational properties, food processing plants, interval ownership resorts, etc.), by region or perhaps based on very specialized knowledge within a closely aligned field (e.g., geology, agriculture, environmental engineering, etc.).

The preceding review of the major aspects of the TARP program and brief list of likely workout services serve as only a brief back drop to the anticipated growing need for professional workout services. Certainly, many other key observations are worth noting and no doubt these waters will become clearer in coming weeks. Nevertheless, the preliminary list serves its purpose of being a vehicle to inspire interested professionals to begin to strategically consider the key questions surrounding the future for workout assignments, essentially the who, what, where, when, how, and why of it all. Naturally, for those among us already experiencing a steady increase in workout related assignments sharing your valued observations would be a true reflection of professionalism as we join together and prepare to meet the serious challenges before us in the coming financial and economic environment.


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[Think] Fear (and Anger) Beats Out Greed For The Hearts And Minds Of Americans

September 30, 2008 | 12:03 am | |

I had MSNBC and CNBC on as white noise for much of the day and was somewhat surprised that the markets saw such a sharp drop on the news that the bailout was rejected by the House. I suspected it would be close, but it really wasn’t. In fact, the stock market fell below levels seen at the start of the first term of our president. Television pundits were interpreting the sharp decline as the market’s way of telling us that the bailout, if to be passed, had to be re-jiggered.

Did you notice how any discussion of the housing market problems has been shouted out by congressional bickering?

In reality, the Constitution worked well today and thats why we have elected officials, no matter how much we complain about them. Conventional wisdom says we will have a revised deal within a week, or even less. And perhaps even a better deal. A different proposal is what 56% of taxpayers want.

This just in: $700B is not a lot of money. $1.2T was lost in the stock market today. Memo to self: I need to think really, really big.

It’s interesting because Wall Street has got a bad rap because I suspect many Americans lump everyone in the industry in one big pile. Here’s an example: Dot-Com Billionaires are Good, Wall Street Billionaires are Bad. Even CNBC used the term “fatcat” more times today than I could count. The people I know who lost their jobs over the past week were not “fatcats.”

Speaking of “fatcats,” perhaps there is distortion in news accounts that are dramatizing the “anger” that main street is feeling right now against a “bailout.” It’s all how you phrase the question.

And here’s a commentary written before the vote by Edward Leamer, Professor of Economics and Management at the UCLA Anderson School, who sent me this link to his article: Please Think This Over. The article takes issue with the broad powers to be yielded to the US Treasury. In fact, the wording reminded me of the intimidating legal language commonly used in my flirtation with Wall Street last year. My way or the highway.

The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgagerelated assets from any financial institution having its headquarters in the United States. Decisions by the Secretary pursuant to the authority of this Act are nonreviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Wow. It’ll be interesting to see whether Congress is able to rework this. I am getting anxious to talk about housing again, but for now, it’s all about credit and changing that light bulb in my entry foyer. Its also about remembering that this was the day I was born, as many years ago as the contiguous states and yet I don’t feel red or blue.

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[Banking On Recovery] Did The Glass-Steagall Repeal Cause Our Insecuritization?

September 29, 2008 | 12:15 am | |

There has been a lot of debate on whether the repeal of Glass-Steagall on November 13, 1999 via the Gramm-Leach-Bliley Financial Services Modernization Act was the beginning of the end of the separation of financial church and state. The Glass-Steagall Act, also known as the Banking Act of 1933 was created to prevent commercial banks from entering the investment bank business.

If you’ve been abducted by aliens for the past three weeks, here’s a great way to catch up on the bailout.

And when you are caught up (assuming the alien thing was accurate), here’s a once in a while requirement from Matrix. A required reading assignment: What’s Free About Free Enterprise?

The first is the risk of moral hazard within the bailout itself. That is, if government is going to make good so many losses throughout the system, why would anyone set limits on future risk-taking? The situation could turn into a free-for-all that makes the recent disregard of risk look like child’s play.

The second problem is more philosophical, involving what the bailout plan reveals about the functioning of the free enterprise system. This raises disturbing questions. Although I agree with President Bush’s observation that “the risk of not acting would be far higher,” we should be aware of the secondary effects of what we are getting into.

Analysis of an IMF study on bank failures shows that the average recovery rate in a banking crisis averaged just 18 percent of the gross costs. Barrons seems to think the taxpayer will come out ahead.

Not everyone thinks the bailout is a great idea.

I should add, though, that I don’t think the people spearheading the bailout have a clear idea about what they’re doing either. They remind me of the old saying: “Something must be done. This is something. Therefore this must be done.” I’m a former student of Chairman Ben Bernanke and his behavior during this mess has been a big disappointment.

Robert Shiller writes an opinion piece in the Washington Post this weekend telling everyone to calm down – government intervention is not unusual and not a bad thing. Everybody Calm Down. A Government Hand In the Economy Is as Old as the Republic. He makes the argument that capitalism evolves and is not etched in stone. He makes a compelling argument.

Megan McArdle in The Atlantic says its not about the Glass-Steagall repeal at all because securitization has been around for a while and Gramm Leach didn’t impact lending standards at commercial banks, among other items.

But Dan Gross at Slate and Newsweek says that the repeal is the end of an era and perhaps infers, that it caused the situation we are in today.

The policy response was to erect a wall between investment banking and commercial banking. It outlasted the Berlin Wall by a few decades. In the 1990s, as another bull market took hold, momentum built to overturn Glass-Steagall. Commercial banks were eager to get into high-margin businesses like underwriting hot tech stocks. Brokerage firms saw commercial banks, with their massive customer bases, as great distribution channels for stocks, mutual funds, and other financial products that they created. Generally speaking, the investment banks were the aggressors.

While I don’t blame the credit carnage all on the repeal of Glass-Steagall, it sure is a compelling milestone and played a role. Banks and investment banks had blurred lines of distinction and regulators were no match for the investment banks. Of course, JPMorgan Chase, who seems to be coming up roses with recent mopup efforts, was the merger of an investment bank and a commercial bank.

The mindset was free markets need to be free because market forces were self-regulating. Of course, that purist view may very well have caused one of the most constraining regulatory environments in the modern era going forward.


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[Straight From MacCrate] What Has Happened To Manhattan Apartment Property Values?

August 17, 2008 | 10:08 pm | |

Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

UPDATE: Mark your calendar, Jim has been invited by the Wisconsin Chapter of the Appraisal Institute to address distressed commercial real estate properties for professionals including real estate brokers, owners, and appraisers. The Appraisal Institute is inviting the FDIC to attend this critical and timely seminar on August 27th, 2008 in Milwaukee, Wisconsin.

Here’s how to sign up for the seminar.

…Jonathan Miller

Real estate appraisers have to be wondering what property values are doing in Manhattan and elsewhere. Clearly, the real estate market is being hit by numerous factors that are affecting property values. The following chart indicates how Manhattan apartment values have changed in comparison to changes in the nationwide apartment value index, CPI index and applying capitalization rates to the projected changes in income to develop indexes based on the average and median long term (20 plus years) capitalization rates. From 1998 through 2003, apartment value trends followed the CPI very closely.

The nationwide apartment value index followed a similar pattern to New York’s until 2003. If the long term average or median capitalization rate is applied to the projected net operating income, apartment values in Manhattan would not have kept pace with inflation in New York.

Impact of Financing

Other factors drove the increase in apartment values. The following chart indicates the path the apartment capitalization rates took for the last eight years or so. Optimism, lower interest rates, huge capital inflows (beginning in the latter part of 2003) and tax free exchanges drove apartment prices into a bubble that is waiting to collapse.

If it is true that over the long term real estate values keep pace with inflation and returns regress toward the mean, Manhattan apartment values are in for a rough ride. If rates of return do regress toward the mean as interest rates increase, a large drop in value is indicated or values will remain stable waiting for the CPI to catch up. During the 1970’s and early 1990’s, apartment values declined and, then, stabilized for several years.

But Wait.

Not only are interest rates and debt coverage ratios increasing, all operating costs are increasing quite rapidly in the New York area. The NYC RGB forecasted the following expected increases in operating expenses from April 2007 through April 2008 for all apartment projects as follows:

During the first six months of 2008, fuel costs have already reportedly increased 20% annually. Real estate taxes will have to be increased more than expected to cover the shortfall in city revenues from other sources. All other costs will probably follow the inflationary spiral that has begun. Increases in rental income generally lag expense increases.

What will hurt apartment values will be increasing capitalization rates, operating costs and switching from interest only loans to amortizing loans. It would not be surprising to see an increase in delinquencies within the next six months or so. Lenders will be forced to modify loans or foreclose.

In addition, the New York City Comptroller’s Office issued a report stating “the real estate sector accounted for nearly $200 billion of the New York metropolitan area’s gross product in 2005, showing a location quotient of 1.3, or 30 percent higher than the national average.” That sector is contracting along with the financial services sector which accounts for 13.6 percent of the regional economy. Job growth is slowing and unemployment is rising.

So, The Question Is Not If But When?

The following chart provides a summary of the estimated apartment capitalization rates over time.

With capitalization rates falling below 6.00% during the mid-2000, it is only a matter of time for the rates to regress back to the mean and let the air out of the balloon. The events unfolding were predictable and the general historical patterns are similar. Financial regulation and sound underwriting policies disappeared during this time period of “irrational exuberance.”


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[In The Media] Bloomberg TV – On The Economy Housing Starts And Fits

July 19, 2008 | 9:07 am | | Public |

Thursday I was on with Kathleen Hays at Bloomberg News, one of the best business anchors on television, to talk about housing starts. I was joined by Beth Pierce, of the California Association of Realtors (CAR) and owner of her own brokerage and mortgage companies. I thought she provided refreshing candor.

At one point I was asked a question about the change in NYC building codes and how it accounted for the surge in starts which helped skew the national numbers. I experienced a senior moment because my answer pertained to the recent expiration of a long time tax abatement program that had stimulated new development rather than talking about building codes. Sigh.

Here’s more info on the NYC building code change.

On the bright side, I got my first ever tv interview teaser earlier in the day. Gotta love Bloomberg News!


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