Interesting Times

Will 2010 be the year that distressed assets get sprung from limbo, or will lenders still be kicking the can down the road?

BY JERRY ASCIERTO and Les Shaver, Apartment Finance Today

(Photo: Richard Clark)

There was blood in the streets last year. More than 130 banks failed in 2009. Fundamentals, from effective rents to occupancy levels, declined to record lows. There were fewer sources of debt all around. A number of large multifamily owners—including Fairfi eld Residential, Babcock and Brown, and Bethany Holding Group—went under. And a wave of loan defaults had vulture funds salivating as they hunted for easy prey at wholesale discounts.

Yet, while a new opportunity fund seemed to close every week in ’09, the pace of distressed acquisitions was slow, to say the least. Distressed sales only accounted for about 15 percent to 20 percent of the overall multifamily sales volume through December 2009, according to New Yorkbased market research firm Real Capital Analytics (RCA). This is despite the fact that the volume of distressed apartments reached $30.8 billion in December, according to RCA.

Although the pace of distressed acquisitions is expected to pick up in the coming years, “it won’t be the bloodbath that a lot of people expect,” says Linwood Thompson, managing director of Encino, Calif.-based broker Marcus & Millichap. “The amount of money being raised for distressed asset purchases is going to be a lot harder to place than most people think.”

Take Alliance Residential. From the start of 2008 to November 2009, the Phoenix-based company had underwritten more than $4 billion of potential distressed transactions—but only closed on $100 million. “The level of distress is certainly as much if not greater than we ever thought it would be,” says Jay Hiemenz, CFO of Alliance. “But the level of dispositions are not.”

That’s a common refrain. Most of the opportunity funds were expecting returns of around 25 percent. But as more buyers enter the market chasing the same few opportunities, those return expectations are falling fast.

As the industry enters 2010, the question is: When will all of those distressed assets emerge from limbo? Better yet, when will the peak of opportunity (or the pit of despair, depending on your point of view) reach its zenith?

“You can’t time an absolute bottom, and people who try are going to miss the opportunities,” says Dan Fasulo, managing director of RCA. “We’re still in the early innings of the distress cycle—a lot of opportunity-focused investors will be disappointed.”

For the past year, several factors have kept the floodgates of distress closed. The availability of agency capital has helped to prop up values. The London Interbank Offered Rate, the benchmark upon which most construction loans are based, was low throughout 2009, which has also been a boon. But the willingness of lenders to modify loans is the biggest factor staving off distress.

HOW BAD IS IT?

Through the fourth quarter of 2009, the volume of distressed multifamily properties was more than three times greater than reported at the end of 2008.

“The issue right now is one of valuation. There are a lot of properties that continue to cash flow, but if you value it today, there would be a substantial discount,” says Craig Butchenhart, president of Minneapolisbased Northmarq Capital. “As long as a property continues to cash flow, the lenders will extend a year or two and hope that things get better.”

But how long can lenders continue to amend and extend? Several investors believe that the peak of opportunity is right around the corner. It’s just a question of simple math, they say. Five-year, aggressively-underwritten CMBS loans done at the height of the market—from 2005 to 2007—should come due starting in 2010. “The next three years are going to be great,” says Eric Silverman, managing director of Boston-based investor Eastham Capital, which is raising a $50 million opportunity fund. “Many loans coming due in 2010 and 2011 will have difficulty refinancing and will have to re-trade.”

A Different Floodgate

Where will all of these maturing CMBS deals find refinancing capital? Fannie Mae and Freddie Mac obviously continue to be active lenders in the space, but they’re generally only doing 70 percent loan-to-value (LTV) loans on higher-quality deals. And regional banks aren’t big on nonrecourse long-term loans. “Ultimately, there isn’t enough regional bank capacity to bail those guys out,” says Mike Kelly, president and co-founder of Greenwood Village, Colo.- based Caldera Asset Management. “If you look at the maturity schedules, there’s only so much time that people can delay the inevitable.”

Indeed, these are boom times for special servicers. For instance, CWCapital Asset Management has been inundated with business—its portfolio of assets grew from $3 billion a year ago to $11 billion now. The division nearly doubled its staff in the first half of 2009, mostly for the distressed debt and REO groups. “I haven’t seen any kind of financing source enter the market on a broad basis to finance a lot of these properties,” says Brian Hanson, managing director of Washington, D.C.-based CWCapital Asset Management.

But just as lenders are extending loans based on sunny projections, many special servicers are now opting to asset-manage their way through the downturn, trying to stabilize or increase the NOI of an REO and wait a couple of years before selling.

“I don’t think the wave is coming. I don’t believe that the maturity defaults are nearly as scary as we thought six months ago,” says David Rifk ind, principal and managing director of Los Angeles-based George Smith Partners. “If the fundamentals and underwriting are there, extensions are granted fairly easily. The headlines we saw six months ago about the maturity tsunami—that’s all bullshit.”

Rifk ind’s firm offers a lender services group, which advises lenders on maximizing the value of their distressed assets. And based on what he’s seen, the majority of lender sales are going to be driven by measured strategic decisions, not the panic dumping that investors assumed would occur. The quality assets will generate serious bids at a pretty high level, he says.

Sandy Pockets

Not all markets are created equal, though. Caldera’s Kelly points to the large number of units that recently came online in some markets as further proof that a wave of distress is coming. Consider Phoenix, where builders delivered about 5,000 units in 2009, adding 2 percent to the existing stock. That doesn’t bode well for a market that ended 2009 with a vacancy rate above 12 percent, according to Marcus & Millichap.

“From a global view, the supply-anddemand balance of the apartment market looks good,” Kelly says. “But it’s all about submarkets: You start going down from 30,000 feet, and it’s a different story.”

In hard-hit states such as Florida, there’s no denying that more distress deals will take place in 2010. More than half of the deals that NAI Tampa Bay has processed since the beginning of 2009 have been distressed—a trend they see increasing this year.

“We’re seeing a dramatic slowdown in the pace of transactions,” says T. Sean Lance, president of the Troubled Asset Optimization Team of NAI Tampa Bay. “But the banks are starting to get comfortable with where some of the values lie, and they’ll start disposing. The drip might turn into a faster drip, but it’s not going to be the tidal wave everyone is talking about.”

Big Fish in a Small Pool

The size of deals currently at play has also changed. The vast majority of the distressed acquisitions closed in 2009 were smaller (less than $20 million), but larger deals emerged in the fourth quarter. For instance, Chicago-based Apartment Realty Advisors (ARA) marketed an ING portfolio of 10 assets located mostly in Texas and received more than 200 offers. The assets were mostly Class B- and C-quality.

“We are seeing people coming off the sidelines who were quiet six months ago; there’s been a real change in the number of offers we get on transactions now,” says Debbie Corson, who heads ARA’s Distressed Asset Solution Group. “These larger guys with equity are really coming out of the woodwork.”

Opportunity funds that hoarded cash for much of 2009 are starting to realize that the discounts won’t be as jaw dropping as they once believed and are starting to engage the market. Addison, Texas-based Behringer Harvard has been the most active buyer, closing deals in the $80 million to $90 million range. Chicago-based Equity Residential has also been active, recently paying $100 million for a 326-unit property in Arlington, Va. These acquisitions signal that it’s not just older assets that are hitting the distress auction block—larger deals constructed in the past 10 years are also at play, many of which have solid occupancy rates.

NAI Tampa Bay marketed a Class A REO asset of less than 100 units recently and received several full-price offers. “Six months ago, it wouldn’t have been the case, but now people are starting to realize they’re missing the boat,” Lance says. “They’re willing to pay a little premium now as opposed to having to compete for deals when prices go up.”

The 12-property Bethany portfolio deal in Phoenix attracted 50-plus offers, though deals of that size were few and far between at the end of 2009.

“There are only a handful of deals out there that the entire buying community is looking at, so it’s sort of an artificial feeding frenzy,” Kelly says. “There’s not a giant, deep bench of qualified buyers. You’ve got a couple of REITs and a handful of highnet- worth guys who can close deals.”

The distressed assets Caldera sees generally fit into two categories. The majority are Class C assets, but on the flip side is a growing number of construction loans going south. “We know the quality assets are there; it just takes time for them to come through the snake,” Kelly says. “It’s like what happened in ’07 and ’08 when it took so long for single-family homes to roll through the foreclosure process.”

RTC Redux?

When the Great Recession began, many expected a second coming of the Resolution Trust Corp., the government program of the 1990s that sold off troubled properties after the Savings & Loan scandal. Back then, the pace of dispositions was swift and orderly. But this cycle won’t behave like the last one. Why? For one, the assets of 20 years ago were facing severely-overbuilt markets. Throughout the 1980s, developers delivered about 4 percent of the existing apartment stock annually. But from 2000 to 2009, only 1 percent of existing stock came online annually, according to Marcus & Millichap.

Today’s culprit is unemployment. “This is not caused by overbuilding; it’s not a problem with the industry,” says Thompson of Marcus & Millichap. “As the economy strengthens, then the problems will go away rather quickly.”

Another major difference is the owners themselves: In the late ’80s, the industry was highly fragmented. Today, a larger percentage of units are owned by well-capitalized firms.

Additionally, the type of loans backing these properties is different today as well: Twenty years ago, unwinding a balance-sheet loan was easy. But CMBSbacked loans pose a much more difficult knot to untangle. “It’s like taking a building down floor by floor,” Thompson says. “You’ve got a mezz lender, a CMBS loan with four stacks in it, some [of which] has been syndicated across 15 different investors. It’s more time consuming because nobody wants to get out of the way.”

Kicking the Can to 2012

By 2012, the multifamily sector should be in full-recovery mode, but getting there is the hard part.

Most economists don’t see a return to significant job growth until the end of 2010. The 10-year Treasury rate is expected to rise in 2010, pushing up prices on fixedrate debt. And rising concessions and vacancies will produce more negative NOI growth in most of 2010.

“It’s going to be a slow, tough climb out of the recession,” Thompson says. “We’re still going to be bouncing around the bottom for another 12 to 18 months. But attitudes have already started to shift; people are less concerned about it getting substantially worse.”

Several factors complicate this forecast. Congress plans to debate the future of Fannie Mae and Freddie Mac in the spring, and any disruption in the flow of GSE funds could have serious ripple effects on the level of distress.

“It’s a false sense of security that there’s an efficient market for multifamily,” says Rifk ind of George Smith Partners. “How the GSEs operate could upset the fragile efficiency of multifamily finance, which is holding the market together.”

The Competition

As more distressed assets shake loose, transaction velocity will accelerate. “I think the competition will be intense once things start hitting the street,” says Robert E. Hart , CEO and president of KW Multifamily Management Group , a Beverly Hills, Calif.- based apartment owner with 10,000 units in the U.S. “There will be a few players to take it down. There’s a huge desire on the sidelines to get stuff.”

In fact, if you have been selling apartment properties during the past five years, you may not recognize the people bidding on assets today. On distressed deals, Bill Shippen, principal of the Atlanta office of ARA, says only about 50 percent of the current bidders were active in the last real estate cycle. The other half either hasn’t been bidding for deals in awhile or has stuck with retail and office investments.

“It’s a lot of new people. A lot of those people were players back in the early ’90s,” Shippen says. “They’re coming back in. They bought in 1992 to 1995, hung out, sold in 2001 and 2004, and have been sitting on the sidelines. Now they’re ready to do it again.”

The other new faces that Shippen sees come from the remaining commercial real estate sectors. They actually see more potential in multifamily distress than the battered retail and hospitality markets. And not only are they new to the multifamily sector, these groups also share a common thread—they’re private.

“There are a lot of private funds out there; it seems that everybody has got a joint venture these days,” says Eric Bolton , CEO of Mid- America Apartment Communities , a Memphis, Tenn.-based REIT with 42,252 units.

WHAT’S DUE?

The amount of multifamily loan maturities across all investor types will nearly double in five years’ time.

The reason for the private interest is easier to understand. High-net-worth individuals don’t have to get an investment board to sign off on their deals. They can take chances pursuing risky distressed deals. “Private capital and high-net-worth individuals are the most active,” says Joe Leon , a partner at Hendricks & Partners , a broker based in Phoenix. “Family trusts and high-net-worth buyers are nimble and can be more aggressive. That’s a big issue with a bank or a seller that’s motivated to get a transaction closed.”

And the smaller, private buyers also often have significant local market knowledge. “Every city has buyers who will buy more challenged deals with all cash,” says Caldera’s Kelly. “They know they can manage this rough clientele for x per door. That will be a local guy who has local management [expertise] and is not afraid of the submarket and economic risk.”

Waiting on the REITs

While the private buyers are often the first to bid on distress assets, many people predict they won’t be alone for much longer. “Generally, the private buyers are the first to buy and sell,” says Lili F. Dunn, senior vice president of investments at AvalonBay Communities, a REIT based in Alexandria, Va. “They also represent the majority of the buyers. They usually have more of a tolerance for risk. Until recently, most of the buyers have been small, private buyers or regional companies.”

Pat Barber, president and CEO of Encore Enterprises, a Dallas-based commercial real estate firm with 436 units, knows the institutions will eventually be players in the distressed (or, at least, discounted) space. That’s why he’s trying to make his move now.

“In the early stages, there’s always a lot of private money,” Barber says. “Then the institutional capital will come in when there’s a lot of money transacted on the private side.”

What’s more, the REITs seem to be focused on bigger moves than just buying one-off deals. “We could see the acquisition of entire companies,” says Nicholas Michael Ingle , director of capital markets for Hendricks & Partners. “Developers get bought. There’s an opportunity for deal making, but people haven’t gotten their head around it yet. That’s where I would see the institutions get an upper hand on the private guys.”

But Ingle doesn’t expect all institutions to become suitors for distressed apartments or their notes. Right now, both life companies and pension funds are more focused on selling.

“They’re pretty scared and burnt from losing so much money over the past five years,” Ingle says.

One thing is certain: People are anxious on both sides of the coin—hungry investors on offense and struggling owners playing defense—to just get it over with, to find a resolution. And nobody really disputes whether things will get worse before they get better. The falling knife is a foregone conclusion. The question on everybody’s mind is, how deep will it cut?

Interesting Times is brought to you by Bremner Real Estate (BRE), which specializes in Apartments and Single Tenant NNN Investments.  To learn more about BRE, and to see our listings, click here. 

In a speech on the Federal Reserve exit strategy to the House of Representatives Committee on Financial Services, chairman Ben Bernanke noted that the government-led credit provision, the Term Asset-Backed Securities Loan Facility (TALF) is reaching its end this month.

The exception to this deadline, however is newly issued commercial mortgage-backed securities (CMBS), and loans backed by newly issued CMBS. These will get an extra three months.

In a footnote accompanying the published transcript of the speech, the chairman’s comments are given justification:

The TALF extends three- and five-year loans, which will remain outstanding after the facility closes for new loans. The later scheduled closing of the CMBS portion of the facility reflects the Board’s assessment that conditions in that sector remain highly stressed, as well as the fact that CMBS securitizations are more complex and take longer to arrange than other types

According to Robert O’Brien, US Real Estate Leader at consultancy firm Deloitte, this approach mirrors the current “pretend and extend” strategy surrounding the larger commercial real estate industry.

There appears to be no better option for the moment, O’Brien adds, as “many commercial real estate (CRE) owners will likely continue to struggle with debt maturity in 2010 and beyond.”

In an environment of low interest rates, it makes sense to extend a loan for three or four more years in order to give enough time for the capital markets and investor appetite to return, along with a more robust job market, he adds.

In the case of CMBS, the assets remain off-books for issuers, who remain cautious about bringing such real estate back into the mix considering many of the properties aren’t making rental money and require servicing attention.

O’Brien, in his 2010 Industry Outlook, states that the Federal Deposit Insurance Corp. (FDIC) received guidance from the government on how to work with borrowers to avoid commercial foreclosures.

Nonetheless, foreclosures in CRE will see an uptick in 2010, the report adds, as investors continue to wait on the sidelines until a bottom to the market is definitively reached.

By Sibley Fleming, National Real Estate Investor, 3-24-2010

As President Obama signed health care reform into law Tuesday, the medical industry gained something greater than the prospect of adding 32 million Americans to the ranks of the insured — it gained a sense of certainty.

“Hospitals and doctors now know how many more people will be insured, and will be able to calculate how much and what kind of new space they will need to meet the historic surge in demand,” says Jeffrey Cooper, executive managing director of Savills US, who works in the London-based company's New York office.

A real estate formula for calculating medical space holds that a health care system requires about 1.9 sq. ft. of medical office space per patient, according to Cooper. With reform, 32 million people are being added to the ranks of the insured, which equates to the potential demand for 64 million sq. ft. of additional medical space.

Demand for space, however, will be constrained by the supply of health care providers, according to Robert Bach, chief economist for Santa Ana, Calif.-based Grubb & Ellis. “Do we have enough doctors, nurses and other professionals to accommodate the rising demand? Over time, we will see greater demand for health care facilities, but the rate of increase will be constrained by how quickly schools can ramp up the supply of health care professionals.”

Another, perhaps negative, bit of certainty that has emerged with reform is that hospitals and doctors will receive lower reimbursements for their services over time.

“Long-term I think the weaker hospitals and hospital systems are going to suffer because reimbursements are going to come down, and my guess is you’ll see some consolidation,” Cooper says. Consolidation would mean that some hospital campuses would likely close and others would experience increased demand for space.

Most hospital systems today provide 60% of their treatments on an inpatient basis and 40% as ambulatory care, or outpatient treatments. But that ratio is changing. “Hospitals believe that over the next five years, those percentages are going to be reversed,” he says.

Over the past five years, the Savills medical real estate team has advised on almost $2.5 billion in medical real estate transactions for developers, public and private real estate investment trusts, pension funds and private equity investors affiliated with 30 top health care systems.

The firm is now expanding its medical office team to add expertise in helping hospitals monetize their existing facilities through sale-leasebacks and other joint ventures.

Without health care reform, however, demographic trends were already supporting the medical office sector, notes Alan Pontius, managing director of the healthcare real estate group at Marcus & Millichap Real Estate Investment Services, in the firm’s San Francisco office. He contends that reform only makes a good thing even better.

While reform may have bolstered demand for space, investment principles for the health care sector won’t change. “I don’t think spec development in medical office is the right thing to do,” Pontius maintains. “We’ve seen a lot of this spec development fail in the past 24 months. And the impact of this health care reform isn’t going to show up overnight anyway.”

But with all of the new-found certainty, there’s still a lot of uncertainty over how health care reform will shift the overall economy, which drives demand for all types of commercial real estate.

If some employers choose to curtail hiring because of increased costs associated with the new mandates, that could reduce demand for commercial real estate space.

“Companies that already provide health insurance, especially small companies, may be able to get better rates through the pools that are going to be set up. So theoretically, they would hire more employees if their insurance costs go down,” says Bach. “I’m not sure how these two effects balance out.”

Why political futures markets got the health care bill so wrong.

By Daniel Gross, Slate, March 22, 2010

Central Valley Business Times, 3-25-2010

For underwater homeowners, the Titanic could be above water before their home values, suggests a new study by First American CoreLogic released Thursday.

It estimates that the typical U.S. homeowner who is in a negative equity position – where home values are less than the mortgage on the home -- will not experience positive equity until late 2015 to early 2016.

In some depressed markets, the typical borrower in negative equity may not experience positive equity until 2020 or later.

For the foreseeable future, decline in negative equity is driven slightly more by amortization than by home price appreciation trends, the report says.

First American CoreLogic looked at ten major markets, none in the Central Valley, the epicenter of the mortgage meltdown, but the results might be indicative of the Valley’s prospects.

More than 11.3 million, or 24 percent, of all residential properties with mortgages in the nation had negative equity at the end of the fourth quarter of 2009.

“Given that the largest home price declines have already occurred and negative equity is not expected to continue to increase significantly, the question going forward is: ‘how long will these borrowers will remain underwater?’ To answer that question, future home values and unpaid principal balances were projected for a selected set of Core Based Statistical Areas (CBSAs) to gauge how long it will take for the average underwater borrower to return to positive equity,” the report says.

For the typical underwater borrower in the U.S. it will take until late 2015 or early 2016 for negative equity to disappear. In certain markets, it will take another five to 10 years or even longer to return to positive equity, the report says.

“For example, Detroit is not projected to recover even by 2020, because of its depressed economy,” the report says.

In markets with low shares of negative equity, the recovery time will still be long because the few borrowers that are upside down are deeply in negative equity and these are typically not high appreciation markets, it says.

Although house price appreciation will, over time, offset negative equity, amortization (the paying down of loan balances) will in most cases be a more significant remedy to negative equity, says First American. Over the next 10 years, the average loan balance will decrease by an annual rate of 3.3 percent while home price are expected to increase at a 3 percent annual rate over the next decade.

Of the ten markets studied, the Washington-Arlington-Alexandria CBSA is expected to reach positive equity by 2015; Atlanta-Sandy Springs-Marietta, Dallas-Plano-Irving and Riverside-San Bernardino-Ontario are projected for 2016; Boston-Quincy by 2017; and Cape Coral-Fort Myers, Pittsburgh, Las Vegas-Paradise and Lancaster, Pa., by 2020.

It is estimated that Detroit will not reach positive equity until after 2020.

Alternative scenarios – using higher and lower long-term price appreciations and alternative speeds for the recovery in home prices to the long-term average – were also considered. Assuming a 5 percent nominal price appreciation nationally (which would be much higher than historical appreciation, given today's low inflation environment), the early markets will approach positive equity by 2013 and the majority will be positive equity by 2017. Assuming 1.5 percent nominal price appreciation, which would be fairly low relative to history, the earliest markets will not reach positive equity until 2017.

When alternative scenarios of how long it takes home prices to revert to the long-term average were tested, they had a moderate impact, but not as large as the absolute level of home price appreciation or amortization assumptions, the report says.

Analysis and Methodology

“A geographically diverse group of metropolitan CBSAs was selected and a forecast of home prices using the First American CoreLogic repeat sales home price index (HPI) was produced. The short-term forecasted home prices are driven by supply/demand factors such as interest rate-induced affordability, the unemployment rate, price-to-rent ratios, month's supply and foreclosure activity.

“The long-term home price forecast utilizes a mean reversion-based approach on over 30 years of data for the national market which is then is adjusted for each market based on the long-term relationship between the CBSA and national price trends.

“In the analysis, a 3 percent nominal annual national long-term price projection was used given that home prices in the selected CBSAs exceeded inflation by 1 percent over the last 30 years and the consensus inflation forecast is about 2.0 percent.

“In addition, historical trends in the largest state-level house price busts were utilized to determine how quickly previous home price recoveries ensued and reverted back to the long-term trend. We then applied the forecast for each market to the average value for all negative equity properties to produce a forecast of future values. The same analysis was applied to a typical underwater borrower nationally.

“To forecast future unpaid principal balances, an amortization schedule for a typical five-year-old loan with a fixed-rate mortgage of 6 percent was used. This is the typical loan in the First American CoreLogic LoanPerformance database of over 40 million active loans nationwide. Many of the markets that are most upside down in Nevada, Arizona, California and Florida heavily used alternative adjustable mortgage structures, but given the wide variety of the structures and payment options, it is difficult to determine what their amortization schedules are. However, the majority of payment option ARMs' (among the most popular "affordability" products) interest-only period ended within five years of origination and many of these loans have already, or soon will, become fully amortizing at a faster pace than a typical 30-year fixed-rate mortgage because the principal must be paid over the remaining period of the original 30-year term.”

By Michael S. Derby, Wall Street Journal, 3-24-2010

In a speech that said there’s no urgency to tighten monetary policy any time soon, a key central bank official also asserted her reputation as an inflation fighter.

Dan Francisco Fed President Janet Yellen (Reuters)

“I don’t believe this is yet the time to be tightening monetary policy,” Federal Reserve Bank of San Francisco President Janet Yellen said Tuesday. The current policy of essentially zero-percent interest rates is “accommodative” and “is currently appropriate… because the economy is operating well below its potential and inflation is subdued.”

Yellen’s comments came from the text of a speech prepared for delivery before an event by Town Hall Los Angeles.

In her speech, Yellen sought to counter the worries she is not as strong an inflation fighter as some would like her to be. “I have personally supported an increase in our target for the federal funds rate on 20 different occasions,” Yellen said.

Yellen said in her speech there’s little reason to fear inflation from high government deficits as long as the Federal Reserve remains an independent central bank.

“I’m not alarmed by the current enormous deficits” because they are “transitory and recession-related.” Looking further out, even with the bleak picture facing the government, the price pressure picture need not be dark.

“In advanced countries with independent central banks, government deficits do not cause inflation, either in the short run or in the long run,” Yellen said. “As long as monetary authorities have the freedom to fight inflation without interference, then deficits won’t pull them off course.”

Yellen said that she is expecting at best a gradual recovery and a slow ebb in high levels of unemployment, all of which argues for supportive monetary policy. But she warned that “as recovery takes firm root and economic output moves toward its potential, a time will come when it is appropriate to boost short-term interest rates.”

While Yellen doesn’t currently occupy a voting role on the interest rate setting Federal Open Market Committee, her views on the economy and monetary policy have come under increased scrutiny given that the White House has expressed interest in elevating her to the vice chairman position at the Federal Reserve Board.

The central bank’s current number two, Donald Kohn, is due to step down from the Fed in late June. Kohn has played an instrumental role in the central bank’s unprecedented response to the financial crisis. Economists generally applaud the idea of Yellen as Fed vice chairman, although some have noted that the official, who has been one of the most vociferous advocates for keeping rates very low for an extended period of time, is a decidedly dovish choice for a top central bank leadership position.

The policy maker spoke in the wake of last week’s Fed decision that once again pledged to keep the central bank’s de facto 0% interest rate policy in place for some time to come. Central bankers noted then they see signs of more economic improvement, but with unemployment high and inflation low, they are content to wind down emergency lending efforts now and defer a tightening of monetary policy to some later date. Many economists believe won’t be until late this year, if not next year, before the Fed raises interest rates.

The policy maker’s outlook on the economy jibbed squarely with consensus outlook on the Fed. “My forecast is that moderate growth will continue, inflation will remain subdued, and unemployment will inch down,” Yellen said.

The economy should “gradually” speed up, with growth in the current quarter ranging between 2.5% to 3%, Yellen said. The official expects a rise of around 3.5% for the current year and 4.5% in 2011.

But inflation is unlikely to be a problem, both because of the hard hit the economy has already taken, and how much current and future growth will be under the economy’s potential growth rate.

Yellen said, “I don’t expect the output gap to completely disappear until sometime in 2013,” and, because of this “tremendous” amount of economic slack, “underlying inflation pressures are already very low and trending downward.” Yellen added “if the economy continues to operate below its potential, then core inflation could move lower this year and next.”

Essential to the longer run inflation picture is the state of the job market. “I’m happy to see evidence that the job market is turning around” but “given my moderate growth forecast, I fear that unemployment will stay high for years,” Yellen said. Now at 9.7%, Yellen sees the jobless level edging down to 9.25% by year’s end, before hitting 8% by the close of 2011. The official deemed this “a very disappointing prospect.”

While Yellen believes it will be some time before the Fed starts to unwind it current policies, she did offer some hints about how she’d like to proceed.

She noted that the end of Fed mortgage purchases this month, the main driver in the huge expansion of the Fed balance sheet, are not likely to trouble the economy. “I believe that our program worked” and made mortgages more affordable, and “I am hopeful that mortgages will remain highly affordable even after our purchases cease.”

When it comes to shrinking the Fed balance sheet, Yellen said the Fed faces a “manageable” process in getting its balance sheet smaller. She indicated the first move of a tightening would rest on increases in interest rates.

While Yellen would like the balance sheet to move eventually back to an all Treasurys portfolio, she believes “the FOMC will reduce the size of our balance sheet only gradually over time.” Assets sales are likely to happen only late in the unwinding process, Yellen said.

By James Altucher, Wall Street Journal, 3-16-10

These strategists have missed the opportunity of a lifetime and it gnaws at them that they missed the party.

Here are some of their arguments and why I think those arguments are dead wrong and will only cost money for the people who listen to them.

Bearish arguments and my responses:

Many homes are still in foreclosure or under water:

• Although forececlosures last month were still 6% higher than the year ago period, they were 2% less than last month. The 6% is the lowest year-to-year increase since January 2006. The rate of foreclosures are decreasing and the fact that we had a month-to-month decrease in foreclosures suggests that the 50-month stretch of year-to-year increases could be coming to a close.
• The Case-Shiller Housing index has been up for the past six months, suggesting prices are stabilizing
• When a foreclosure happens, people have more money to spend (they are no longer spending on mortgage.
• The housing declines began in 2006. The market top didn’t happen until November, 2007 and the collapse didn’t happen until Lehman collapsed in September, 2008. The market collapse was more a function of the financial collapse and then the “Great Liquidation” (see below) than the housing collapse.

The 5.9% GDP growth last quarter is “just” an inventory rebuild story and not an exhibit of real organic growth in the economy.

• This is true, but if you look at change in private inventories, this recession had the sharpest year-to-year change in inventories since the Great Depression. ALl businesses assumed that the world was ending and fired all of their employees and didn’t rebuild any inventories. This Great Recession is more aptly called “The Great Liquidation” since the sharp decline in GDP and the sharp increase in unemployment was directly related to inventory liqudiation. So now they are rebuilding these inventories. This is a good thing. It will start with basic materials companies (steel, aluminum, etc) and those companies and employees will prosper, leading to more prosperity, etc.

Unemployment is at 10%

• Yes, but that is unsustainable with the inventory restocking that is happening. What we are seeing in the latest employment numbers is: 1.) Hourly pay is up. Employers are paying for overtime before they rehire fulltime. 2.) Temp workers are at their highest point since 2004. Temp workers are hired before they rehire full time.  3.) Payrolls are up relative to where they were a year ago. In fact, the increase (or less decrease) in payrolls looks like a sharp V. 4.) This will not be a jobless recovery.

The Obama stimulus didn’t work.

• I’m in the camp that believes we never needed stimulus. The economy was going to come back on its own. But, that said, only 30% of the stimulus was spent, with the bulk to be spent on infrastructure projects happening this year. I’m afraid the economy might overheat when the other 500 billion is spent.

P/E ratios are still way too high for an economic recovery.

• Market timers often point to the lows in the ’70s or early ’80s when P/E ratios hit as low as seven and the market burst forth from there. Unfortunately for them, there is no hard and fast rule about what P/E ratios should be. If you flip over the P/E ratio so you get E/P you get the earnings yield of a company. The key is to compare earnings yields with the interest rates on products with comparable risk (corporate bonds, for instance). Interest rates were in double digits in the early ’80s, so P/E ratios had to be much lower to compete. Interest rates now are at all-time highs, so P/E ratios could be much higher and you still get better comparisons now than you did in the ’80s.
• Most people are looking at last year’s P/E when we were in the middle of a recession. The forward P/E ratio of the S&P 500 is right now approximately 13.5 and that number may be even lower considering how many companies have been exceeding analysts’ earnings estimates. A P/E of 13.5 or lower puts it much lower than the 100 year average of 16.
• Many stocks are still dirt cheap. Apple, despite 40% growth projections, trades at a forward P/E of 15 when you back out its cash. CSCO a forward P/E of 15. XOM a forward P/E of just 9. WMT, just 12. GOOG, just 17. MSFT, just 13. Large cap America is cheap at the moment from a bottoms-up perspective.

The Fed is printing up so much money we could be entering into a hyperflationary period where the dollar is rendered valueless.

• Ron Paul likes to point out that the dollar has lost 97% of its value since 1913. My question is: Wouldn’t you have wanted to be in stocks over that time frame? You’d be up about 1,000,000%
• About 40% of S&P 500 revenues come from abroad. An inflationary environment would be better for the stock market than at any time before now.
• Unfortunately with 10% unemployment, and we are about 11mm jobs away from full employment, we’re more likely in a deflationary environment.
• The weakness of other possibilities (the euro, the yen) keeps driving strength in the dollar.

Municipality finances are a wreck and this is the next shoe to drop.

• Municipalities rarely go bankrupt and even when they do they tend to pay their bondholders at 100 cents on the dollar. The worst municipality bankruptcy ever, Orange County, Calif., in the early ’90s, paid back its bondholders in full.
• Municipal bonds are being issued and bought right now at record low interest rates. People are comparing municipal bonds to subprime mortgages. But on the one hand (subprime) you had fraudulent lending and abuse backed by houses that were quickly under water and on the other hand you are backed by governments that have authorization to pay bondholders back with increased tax revenues. Most municipalities are required, by constitution, to pay back debt before paying workers.
• Assured Guaranty (AGO), which could earn as much as $6 a share this year and trades for just $20, is the best way to play the fear on municipal finances.

Commercial real estate is the next show to drop and could the “next subprime.”

• Commercial real estate is a fraction of the size of residential real estate and banks seem to be having no problem providing refinancing for most CRE projects.

Perhaps I’ve been looking at things with rose-colored glasses, but I’ve been dead-on with most of my picks here (including my short picks) and I do expect the market to keep improving as the economy roars back.

While total investment sales activity in the retail real estate sector remains slow, single-tenant net lease deals are picking up steam, according to industry insiders.

The lower price tags associated with single-tenant properties have translated into greater demand from investors. Meanwhile, the easier risk assessments inherent in deals involving single tenants with long-term leases make net lease acquisitions seem like a safer bet to lenders. As a result, in the first quarter of this year, there was an appreciable uptick in transaction volume compared to the first quarter of 2009, and on some of the highest quality assets, cap rates declined.

“These deals aren’t trading on pure real estate; they are trading on the credit of the tenant [as well.] That adds value in a tough market,” says Kris Cooper, managing director with the retail capital markets at Jones Lang LaSalle, a Chicago-based real estate services firm. “And a lot of those deals are done long term, with 10-year, 15-year, 20-year leases, so you have a lot of stability, a lot of security.”

Because of net lease deals’ perceived stability, the sales volume in the sector hasn't dropped as far during the down cycle as it has for overall retail investment sales. While total sales declined about 80 percent from mid-2007 through mid-2009, sales of net lease properties decreased by only about 40 percent, according to Bernard J. Haddigan, senior vice president and managing director of the national retail group with Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based firm.

Even during the deep freeze of 2009, single tenant assets occupied by the likes of McDonald’s and AutoZone continued trading, says Jon Adamo, vice president of dispositions with National Retail Properties Inc., an Orlando, Fla.-based REIT specializing in single-tenant net lease investments. And now that financing has become easier to obtain and tenants are once again talking about expansion, investors are starting to target larger properties in major metro markets. Among these are well-performing drugstores including CVS and Walgreens; dollar stores and bank branches for large national banks like Chase and Bank of America, according to Adamo.

Brokers say Walgreens drugstores are among the most coveted single-tenant properties on the market.

Brokers note that though there has been less interest from 1031 exchange buyers (simply because in today’s market those buyers have fewer gains to protect), high net worth individuals and newly formed funds continue to have an appetite for single-tenant net lease deals. While last year many of the deals that closed were in the $1 million to $2 million range, in the first quarter of 2010 there were more transactions with $5 million and $6 million price tags, says Randy Blankstein, president with Northbrook, Ill.-based net lease brokerage firm The Boulder Group.

In part that’s a function of financing availability—loans for transactions larger than $8 million are still difficult to get, he notes. But on smaller deals involving a good credit tenant it’s possible to secure conservative financing with a 70 percent LTV ratio and an interest rate of approximately 6.25 percent, with a five-year term and a 25-year amortization schedule. (That’s not far off the historical norms of 80 percent LTVs, 10-year terms and 30-year amortization schedules.)

In addition, Blankstein notes that approximately 30 percent of net lease transactions today are done on an all-cash basis.

The more favorable market conditions have caused cap rates on assets occupied by the most desirable tenants to compress by about 20 basis points to 25 basis points, to the mid-7 percent range, according to several brokers. Today, a deal on a Walgreens, which is considered a benchmark for the net lease market, would close at approximately 7.75 percent, says Gill M. Warner, senior director of investment sales with Stan Johnson Co., a Tulsa, Okla.-based commercial real estate investment firm. Warner estimates that in the first quarter of 2010 Stan Johnson, which specializes in single-tenant net lease assets, experienced a 50 percent increase in transaction volume from the first quarter of 2009.

Even assets occupied by riskier tenants are trading hands, though at higher than average cap rates. Last month, for example, National Retail Properties closed on a sale of a Starbucks site in Harlingen, Texas at an 8.62 percent cap rate. Starbucks has eight years remaining on its lease.

Barring any unforeseen circumstances, the net lease market will likely continue to improve through the rest of the year, according to Cooper. “I think we are at the bottom, we’ve seen stabilization occur. At some point, we’ll see prices increase,” he says.

—Elaine Misonzhnik, Retail Traffic, 3/23/2010

On March 16 the Tea Party crowd showed up for yet another demonstration on Capitol Hill in Washington. Curious about the factual knowledge these people have regarding the issues they are protesting, my friend David Frum enlisted some interns to interview as many Tea Partyers as possible on a couple of basic questions. They got 57 responses--a pretty good-sized sample from a crowd that numbered between 300 and 500 people. (Survey results are here.)

The first question that was asked concerned the size of government. Tea Partyers were asked how much the federal government gets in taxes as a percentage of the gross domestic product. According to Congressional Budget Office data, acceptable answers would be 6.4%, which is the percentage for federal income taxes; 12.7%, which would be for both income taxes and Social Security payroll taxes; or 14.8%, which would represent all federal taxes as a share of GDP in 2009.

Not everyone follows these numbers closely, and Tea Partyers may have been thinking of figures from a few years ago, before the recession when taxes were higher. According to the CBO, the highest figure for all federal taxes since 1970 came in the year 2000, when they reached 20.6% of GDP. As we know, after that George W. Bush and Republicans in Congress cut federal taxes; they fell to 18.5% of GDP in 2007, before the recession hit, and 17.5% in 2008.

Tuesday's Tea Party crowd, however, thought that federal taxes were almost three times as high as they actually are. The average response was 42% of GDP and the median 40%. The highest figure recorded in all of American history was half those figures: 20.9% at the peak of World War II in 1944.

To follow up, Tea Partyers were asked how much they think a typical family making $50,000 per year pays in federal income taxes. The average response was $12,710, the median $10,000. In percentage terms this means a tax burden of between 20% and 25% of income.

Of course, it's hard to know what any particular individual or family pays in taxes, but according to IRS tax tables, a single person with $50,000 in taxable income last year would owe $8,694 in federal income taxes, and a married couple filing jointly would owe $6,669.

But these numbers are high because to have a taxable income of $50,000, one's gross income would be higher by at least the personal exemption, which is $3,650, and the standard deduction, which is $5,700 for single people and $11,400 for married couples. Owning a home or having children would reduce one's tax burden further.

According to calculations by the Joint Committee on Taxation, a congressional committee, tax filers with adjusted gross incomes between $40,000 and $50,000 have an average federal income tax burden of just 1.7%. Those with adjusted gross incomes between $50,000 and $75,000 have an average burden of 4.2%.

Even though the Tea Partyers were specifically asked about federal income taxes, it's possible that they were thinking about other federal taxes as well, such as payroll and excise taxes. According to the JCT, when all federal taxes are included, those earning between $40,000 and $50,000 have an average tax rate of 12.3%, and those earning between $50,000 and $75,000 pay a rate of 14.5%.

In short, no matter how one slices the data, the Tea Party crowd appears to believe that federal taxes are very considerably higher than they actually are, whether referring to total taxes as a share of GDP or in terms of the taxes paid by a typical family.

Tea Partyers also seem to have a very distorted view of the direction of federal taxes. They were asked whether they are higher, lower or the same as when Barack Obama was inaugurated last year. More than two-thirds thought that taxes are higher today, and only 4% thought they were lower; the rest said they are the same.

As noted earlier, federal taxes are very considerably lower by every measure since Obama became president. And given the economic circumstances, it's hard to imagine that a tax increase would have been enacted last year. In fact, 40% of Obama's stimulus package involved tax cuts. These include the Making Work Pay Credit, which reduces federal taxes for all taxpayers with incomes below $75,000 by between $400 and $800.

According to the JCT, last year's $787 billion stimulus bill, enacted with no Republican support, reduced federal taxes by almost $100 billion in 2009 and another $222 billion this year. The Tax Policy Center, a private research group, estimates that close to 90% of all taxpayers got a tax cut last year and almost 100% of those in the $50,000 income range. For those making between $40,000 and $50,000, the average tax cut was $472; for those making between $50,000 and $75,000, the tax cut averaged $522. No taxpayer anywhere in the country had his or her taxes increased as a consequence of Obama's policies.

It's hard to explain this divergence between perception and reality. Perhaps these people haven't calculated their tax returns for 2009 yet and simply don't know what they owe. Or perhaps they just assume that because a Democrat is president that taxes must have gone up, because that's what Republicans say that Democrats always do. In fact, there hasn't been a federal tax increase of any significance in this country since 1993.

One other possibility is that taxpayers are operating on the basis of a sophisticated economic theory called "Ricardian Equivalence." According to this theory, budget deficits have no stimulative effect on the economy because taxpayers implicitly discount the future tax increase that will be necessary to pay off the additional debt. People increase their savings now, the theory posits, in order to prepare for this future tax increase, thus offsetting all of the stimulative effect of the deficits with an equal and contractionary increase in saving.

While Ricardian Equivalence is a legitimate economic theory that economists continue to debate, one often hears a variation of it on talk radio shows and such, where it is said that deficits are a tax on the economy. The problem is that many people conclude from this arguably true statement that raising taxes to reduce the deficit would in effect constitute a double tax. We're being taxed once by the deficit, people think, so why should they have their taxes raised to reduce it?

Of course, this is a non sequitur. People can't be taxed twice by the expectation of a tax and again by the actual tax itself. But more important, the underlying assumption of Ricardian Equivalence--that taxes will eventually rise to pay off the debt--is now seriously in doubt. Perhaps once it was true when people genuinely cared about a balanced budget. But today's Republicans and Tea Party members oppose all tax increases for any reason, no matter how big the deficit is. I really believe that many would rather default on the debt than raise taxes by a single penny. If this is true, then Ricardian Equivalence is a dead letter--to the extent that it ever existed at all.

Probably the simplest motivation the Tea Partyers have is the one that Howard Beale (actor Peter Finch) gave in the 1976 movie Network. "I'm mad as hell, and I'm not gonna take it any more!" he said to cheering crowds. In other words, tea parties just represent unfocused anger at current economic conditions. Those who feel this way have latched on to the Tea Party movement not because they really believe that their taxes are too high, that taxes are rising or that taxes are at the root of our economic problem. Rather, they have joined because it's the only game in town; the only organized force with at least the potential of bringing about change that might make things better.

In this sense, the tea parties are simply the latest manifestation of populism, which has arisen periodically throughout American history. In the 19th century populist anger was based in rural America and directed at the banks and railroads as well as government. Populists thought that free coinage of silver, an inflationary policy that would have raised prices for farm commodities, was the solution to their problems in the same way that today's Tea Party crowd thinks that the Federal Reserve, bailouts to big businesses and a looming government takeover of the health industry are at the root of our economic malaise. Tax cuts are like free silver--a one-size-fits-all policy response.

Unfortunately for the Tea Party populists, there is no evidence in American history that populism has ever had a meaningful effect on policy. Even when the movement had a charismatic and articulate leader in William Jennings Bryan, the populists only elected a handful of members to Congress and never achieved the presidency. One reason is that the major parties co-opted populist issues and leaders, which bought time until the populist impulse burned itself out like a brush fire.

Whatever the future of the Tea Party movement in American politics, it's a bad idea for so many participants to operate on the basis of false notions about the burden of federal taxation. It only takes a little bit of time to look at one's tax return to see what one is actually paying the Treasury, calculate the percentage of one's income that goes to taxes, and compare it with what was paid last year and the year before. People may then discover that their anger is misplaced and channel it into areas where it is more likely to bring about positive change.

Mar 17th 2010 | From The Economist online

RECENT renewed American calls for China to revalue its currency have so far fallen on deaf ears. China has rejected accusations that America's huge trade deficit with it is caused largely by an artificially weak yuan, which has been pegged to the dollar since July 2008.

Economists point out that an appreciation of the yen did little to help reduce America's trade deficit with Japan in the 1980s. But the yuan is unquestionably undervalued.

Our Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should equalise the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar.

AP

by Mark Vitner, Wells Fargo Securities, March 16, 2010

The summer of 2009 marked my 25th year of analyzing the economy on a professional basis. Through this period I have had a front row seat to the Reagan Revolution and economic boom that followed it, the 1987 stock market crash, the collapse of the savings and loan industry, the fall of the Soviet Union, a couple of huge real estate cycles and credit crunches, a stunning stock market boom and spectacular crash, the rise, fall and re-emergence of newly industrialized economies, a handful of oil shocks, the 9/11 attacks, a couple of wars and the rewriting of the rules governing the financial markets. ...

The three broad philosophies have been invaluable to me over the past 25 years. The period has seen an incredible amount of change but much of what was true long ago still holds true today. I have compiled a list of my favorite 25 rules for analyzing the economy. There are probably many more than this and many that have yet to be discovered, but this list has served me well over the past quarter century and hopefully will be of use to others.

Twenty-five fundamental rules for analyzing the economy

“Economics is just common sense made difficult.” Too often economists make things more difficult than they need to be. The most important concept to grasp when analyzing the economy is what motivates individuals and businesses to buy goods and services and what motivates them to produce and provide them. Forecasting the economy then simply devolves into determining if new policies or events would cause individuals to buy more goods and services, invest in more plant and equipment, hire more workers, or work more.

“It is important to distinguish between what you think the Fed will do and what you think they should do.” As economists, we tend to follow the Federal Reserve very closely and while we may have a good understanding of how monetary policy works, our views on what the Federal Reserve should do are irrelevant. It is far more important to have an understanding of what you believe the Federal Reserve, under its current leadership, will actually do.

“Recessions are caused by the build-up of imbalances and some sort of event or policy change that causes investors, consumers, businesses and regulators to become more risk averse.” Once you understand where recessions come from, you can begin to assess the risk of falling into one. The significant event leading up to the most recent recession was the housing boom, which resulted in an enormous oversupply of housing and a sharp run-up in housing prices. The event that put us on a path to recession was the unprecedented drop in home prices that began back in 2006. Falling home prices led to growing financial problems and bankruptcies at mortgage lenders and government sponsored enterprises that eventually brought down huge investment banks and financial institutions.

“Imbalances can build up far longer than seems logical.” During a boom, all sorts of justifications for the elevated level of economic activity will seem logical. We saw this at the height of the tech bubble and height of the housing bubble, which is one reason we ended up with such a tremendous oversupply of fiber optic cable and single-family homes.

“Persistent inflation is always a monetary phenomenon.” Measured price increases can sometimes pop up because of supply disruptions, spikes in key commodity prices, or bad weather. A persistent rise in inflation, however, will only take hold if the money supply has increased dramatically for a sustained period of time.

“Rising food and energy prices by themselves are deflationary if they are not accommodated by a loose monetary policy.” If consumers are spending more of their income for necessities, they have less to spend on everything else.

“Conditions do not have to be perfect in order for the economy to grow,” and that is a good thing because conditions seldom are perfect. The economy almost always faces a seemingly endless string of challenges: the budget deficit is too big, taxes are too high, regulation is too burdensome, and consumers have too much debt. Yet, while this was true for most of the prior 25 years, the economy grew solidly throughout most of this period.

“There is a tendency for forecasters to focus more attention on what is wrong with the economy than what is right.” Bad news almost always gets more attention than good news, and this is no different with economics. A danger, however, is that focusing too much attention on the negatives might cause you to miss out on valuable opportunities.

“The natural tendency for the U.S. economy is to grow.” Each year the United States adds close to three million new residents, which means we add the equivalent of France to our population every 20 years. In addition, trend productivity growth is somewhere around 2 percent. When you add in Americans’ strong desire to live better than each preceding generation, there is an enormous natural tendency for the U.S. economy to grow.

“The greatest forecasting mistake economists have made is to underestimate economic growth.” Paying too much attention to all the negatives in the economy tends to make economic forecast too pessimistic. Forecasters tended to overestimate the drag from federal budgets deficits during the late 1980s, the banking crisis in the early 1990s, and most of the subsequent crises that we faced during the past two decades. Many forecasters were also slow in recognizing that the potential growth rate of the economy had increased in the late 1990s with the advent of new information technologies.

“A trend will continue until is stops.” This famous line attributed to Herb Stein [1998] really cuts through the clutter on a number of fronts. Anything that grows faster than the underlying fundamentals can support will ultimately stop. If homebuilders build houses at a faster rate than the growth in the number of households that can afford to buy them, then ultimately building activity will stop. Likewise, if the federal government spending rises faster than the Treasury’s ability to raise taxes or borrow money then spending growth will eventually stop.

“You can learn an awful lot by simply observing.” Some of the best economic indicators I have seen in recent years have been things that I have observed with my own eyes and then verified with the data. If the airports seem more crowded take a hard look at the airline revenue passenger miles, whose growth tends to coincide with real GDP growth. A pickup or deceleration in airline revenue passenger miles may tip you off to a shift in the economy’s underlying momentum. While it may seem trivial, the same holds true with retail sales and business at your favorite restaurant.

“Never be overly eager to change your forecast.” Obviously you have to change it when the facts change but always remember that economic data are revised frequently and often by substantial margins. Some of the worst mistakes I have made have been to give up on a forecast too soon.

“Do not be afraid of making mistakes.” You will make them. It is part of the job. I learned when I was a goalkeeper on our high school soccer team not to get so upset about the other team scoring a goal that you second guess every move. You can do the same thing in economics. The critical questions you need to ask are: is your forecast well thought out? Have you researched and tested you conclusions? What are the holes in your argument and what are the risks associated with them? Are you making conservative or aggressive assumptions? If you have done all your homework, stated your position clearly and identified the risks, then you are likely to be wrong far less than you are right. Most important of all, have you informed your clients and prepared them for contingencies?

“Rapid growth nearly always sows the seeds of its own destruction.” Booms generally lead to busts because they lead to overproduction or overinvestment in the sector that is booming.

“Booms generally lead to unforeseen problems.” When activity is booming sloppy credit underwriting, inefficient operations, and outright fraud are hard to see. This is the basis behind one of Warren Buffet’s [2002] favorite sayings “You never know who is swimming naked until the tide goes out.” Just think of the Bernie Madoff scandal, which did not become evident until the fall 2008 financial market collapse.

“Capital will always flow to the highest available risk-adjusted rate of return.” Every investment and business endeavor involves evaluating the risks involved in investing in that business and the return on that investment. The greater the risks, the higher the return has to be in order to attract any given amount of capital. Anything that heightens risks in the economy tends to restrain investment and business activity in general.

“The economy does not simply grow and contract, it is constantly evolving.” This is a concept made famous by Joseph Schumpeter [1975] and has become known as creative destruction. The basic concept is that there are always new industries and growth sectors evolving in the economy and there are always industries and sectors that are declining. Unfortunately, the declining sectors are typically easier to see than those that are growing.

“Soft landings are extremely hard to pull off.” The relatively long business cycles of the past few decades have witnessed several attempts by the Federal Reserve to bring the economy in for a soft landing. The Federal Reserve’s objective is to slow the economy just enough to head off inflationary pressures without causing the unemployment rate to increase. The Federal Reserve’s record is spotty to say the least. The problem with soft landings is that slower economic growth leaves the economy vulnerable to external shocks. The Federal Reserve nearly engineered a soft landing back in 1990 but then Saddam Hussein invaded Kuwait and oil prices skyrocketed, sending the economy into recession later that month. We were also headed for a soft landing back in 2001 but 9/11 put an end to that.

“Changes in political leadership matter” because the forces behind these changes have an immense amount of resources invested in their efforts.

“View the economy through the eyes of a business owner, consumer, and policymaker.” Think about how each would view the current environment and what each would view as risks and opportunities.

“Always look for consistencies and inconsistencies” in the economic data and your forecast. Inconsistencies demand considerable attention and may provide a hint about possible mistakes and vulnerabilities in your forecast.

“Write your reports and give presentations as if you were explaining economic concepts to your mother.” This will help ensure you respect your audience and do not talk over their heads.

“Listen to those who have opposing views.” At a minimum they will provide a good stress test to your own view and they might be right. I have found that I learn much more from reading reports and books written by folks that I disagree with than those I agree with.

“Do not outrun your headlights.” Know you limitations. The economy is like a giant puzzle that you will never finish piecing together. Do not try to do everything. Accept help when it is offered and concentrate on the things you know and do best.

by Alex Tabarrok on March 18, 2010

In 2000 Zimbabwe began to forcibly redistribute land from private but predominantly white-owned commercial farms to much poorer black farmers who toiled on communal lands.  Stunning pictures from Google Earth collected by Craig Richardson show the result.   

Take a look at the Before picture.  The communal land on the left is dry, dusty and unproductive compared to the private farmland on the right which is green and dotted with blue ponds and lakes.  Why?  There were two theories to explain this difference. 

• The Tragedy of the Commons – the farmers on the communal lands did not have the incentives to invest in the land and thus the land eroded and turned to desert.

• The land on the right (which was owned mostly by whites) was better quality land.

Both theories could be true.  Regarding the latter explanation, however, notice that the dry communal lands on the left are sharply delineated from the green private farms on the right--so sharply that soil quality and rainfall alone are unlikely to explain the difference.

So what happened after the land was redistributed beginning in 2000 and all of it made communal?

Click on the arrow to progress between before and after photos

After reform the land quality worsened everywhere. In particular, note that the blue lakes and ponds on the right became dry and empty as farmers no longer had an incentive to invest in maintaining these resources. The tragedy of the commons.

This excellent visual look at the tragedy of the commons was produced by Todd Moss at The Center for Global Development based on pictures and ideas from Craig Richardson.  Of course Zimbabwe had many problems before and after this forcible land redistribution.  You can find more pictures, background information and a lengthier discussion of this episode here.

Posted by Alex Tabarrok on March 18, 2010

Short sales are a hot topic right now—especially with a much-ballyhooed government program focused on short sales, the Home Affordable Foreclosure Alternatives program, about to come online. But in the end, the real key to resolving the problems that yet remain in housing is likely to come back to an old standby: REO property sales.

Yes, really. But to understand why, you’ve got to first really understand the scope of the mortgage default problem we’ve now got.

According to data from Lender Processing Services (LPS: 40.41 +0.47%), a whopping 7.4m loans are now non-current, compared to just 4.1m on average between January and June of 2008. A recent JP Morgan Chase (JPM: 42.98 -0.21%) investor presentation presents the problem more visually, per the data below: (You can literally almost see the pig in the python.)

What the above chart should call attention to is the aging of loans in the default pipeline. Again using LPS data, for all loans more than 90 days in arrears, the average days delinquent is now at 272 days—up from 204 days in early 2008. For loans in foreclosure, the aging numbers are even more staggering: loans in this bucket average 410 days delinquent, up from 260 days delinquent in early 2008.

Ponder those numbers for just a second. On average, severely delinquent borrowers have gone more than 9 months without making a mortgage payment—and yet foreclosure has not yet started for them. For those borrowers who are in the foreclosure process, it’s been an average of 13.6 months—more than one full year—since they last made any payment on their mortgage.

So, can short sales ride in to save the day for these 7.4m troubled borrowers? What about for the many millions more who are current on their loans, but are underwater on property value and unable to sell? For some, short sales will be an important solution—but don’t kid yourself: the hype currently surrounding short sales and the HAFA program will prove to be short-lived, and REO expertise will be prove to be the key to recovery, as it has been in prior cycles.

Let’s explore two primary reasons for this.

Second liens. Laurie Goodman at Amherst Securities, one my favorite mortgage analysts of all time, recently published some analysis showing that $1.053trn in second mortgages remain outstanding—and $963bn of that is on the balance sheets of commercial banks, thrifts and credit unions (the rest is largely within securitized pools). In plain terms, extinguishing second liens will have material impact on the reported capital positions of some of our largest commercial banks, a Very Bad Thing™.

Goodman’s team estimates that roughly 51% of first mortgages outstanding have a second lien associated with them in some form; for prime and Alt-A mortgage holders, those numbers reach closer to 60%.

Second lien holders, when they exist, effectively determine whether a short sale can proceed—and there is zero incentive, whether through the Treasury’s HAFA program or otherwise, for a second lien holder to voluntarily vaporize their note.

Unless, apparently, money can be passed under the table. As seen in a story first broken by Diana Olick at CNBC, we’re already hearing reports of short sale fraud involving second lien holders attempting to extort dollars from seller’s agents directly, outside of the HUD settlement statement. Government’s implicit endorsement of short sales via the HAFA program seems only more likely to increase this sort of pressure. Regulators now face a very unique conflict of interest, and it will be interesting to see how this is resolved: on one hand, violating RESPA helps grease the wheels of a short sale, something the administration wants to see happen; on the other hand, violating RESPA is a federal offense.

All of which means that second liens aren’t just a little stumbling block to short sales; they’re a boulder the size of Texas.

Meet HAFA, child of HAMP. The HAFA program, going into effect on April 5, is getting plenty of attention—and the program’s heart is in the right place. But most are forgetting that it’s an extension of HAMP, the government’s loan modification program that has seen tepid success at best thus far. A loan must first be HAMP-eligible in order for anyone (borrower, servicer, or investor) to qualify for the program’s various incentive payments for short sale or deed-in-lieu.

Which means any of the guidelines applicable to the HAMP program—loan in default or default imminent, within UPB guidelines, owner-occupied, and originated prior to 2009—still apply.

Out of the gate, this simple fact rules out HAFA incentives for the many millions of borrowers that are underwater on their mortgage, but still performing. Read that again, because I’m seeing plenty of overzealous real estate experts suggest that the HAFA program will drive real estate sales for underwater homeowners (so sign up for their paid course to learn how to make millions using short sales!).

As for the 7.4m already troubled borrowers? 1.3m troubled homeowners have received offers for modifications under HAMP to date, according to the latest report card, with 1.1m agreeing to a trial – and of that, 168,000 have moved to permanent status since the program’s start in the middle of last year. (We don’t know how many have since re-defaulted, however.)

One of the largest problems within the HAMP program, even among eligible borrowers, is obtaining the paperwork required from the borrower to process a loan modification. JPM, for example, recently reported that out of every 100 HAMP trials offered, 25 borrowers do not pay as agreed and another 29 do not submit required documents, omitting Social Security Numbers, signatures and the like on documents that are submitted.

Keep in mind these omissions and failed document submissions remain despite 15,000 staff members at JPM alone dedicated to nothing but loss mitigation. These omissions are coming despite an outreach strategy for each borrower that includes 36 calls, 15 letters, and 2 door-knocks prior to JPM kicking any individual borrower out of the HAMP program.

If that’s what we’re seeing in terms of an effort to keep people in their homes, I’m not sure we should expect better performance when it comes to short sales (which would have people leave their home).

Further, HAMP is itself a limited program, which means HAFA will face the same limitations. And HAMP’s handlers in the government understand the limitations of the program; the most recent report card from the Treasury notes that out of an estimated 6m borrowers at 60+ days delinquent, HAMP eligibility currently extends to 1.8m.

While officials repeatedly state that they expect more borrowers to become eligible over time, even if the program hits its goal—3-4m trial offers extended by 2012—it’s still only part of a solution, not the solution. (After all, as the LPS data clearly shows, we’ve already got more than double the 3-4m 2012 HAMP target in troubled borrowers right now, to say nothing of who else will enter the pipeline between now and then.)

The point here isn’t that short sales won’t matter—they will. But expecting HAFA to kick short sales into high gear all of a sudden is probably a very misguided expectation. As is expecting short sales to come to replace REO volumes in distressed real estate transactions.

Instead, the short sale process in general is likely to become more streamlined as a result of the HAFA program, and that will help servicers process more short sales than they may have in the past.

Nonetheless, in the end, we aren’t going to simply short sale our way out of 7m or so housing units’ worth of foreclosure overhang. What gets us out of this mess is tens of thousands of committed real estate professionals that really and truly understand REO.

I’m not alone in this conclusion, either. JPM’s got my back on this, and told investors a few weeks back that it sees REO volumes returning in the back half of this year, after dipping sharply in Q4 2009 and Q1 2010 under the influence of various government modification programs.

The company’s baseline projections (below) show REO volumes returning to Q2 2009 levels by the end of this year—with stressed scenarios putting REO volumes back at late 2008 levels by the fourth quarter of 2010.

Thanks to effective intervention from the government, we won’t see REO volumes soar to peak levels anytime soon—but we will see elevated inflows at least through the mid-2012, out of necessity. And those inflows should be seen as the road to recovery by anyone watching real estate. JPM forecasts, for example, that by Q4 2012, 22-28% of home sales in the Los Angeles region of California will still be REO; in Phoenix, that number is projected to be 39-50%.

These projections underscore a message I’ve shared privately with many industry colleagues recently: recovery in housing is spelled R-E-O. Anything else is wasting time until we get there.

By Denise Kalette, NREI, 3-16-10

As cap rates begin to stabilize, investors are showing more confidence in the commercial real estate market than at any point in the last two years, a new report from New York-based PricewaterhouseCoopers shows.

Although transactions are expected to be lower in 2010 than at the peak of the market, the report released today projects marked improvement over 2009, with the apartment sector leading the recovery effort.

Cap rates, which gauge expectations of property income and value, not only show signs of leveling off, they have even declined slightly in some markets for quality assets, according to the PricewaterhouseCoopers' Korpacz Real Estate Investor Survey.

As cap rates become more attractive to investors, that trend is expected to help stabilize commercial property values. Survey participants project that over the next six months, overall cap rates will hold steady in 19 of the 30 markets surveyed. Last quarter, the survey projected stabilization in only two markets.

“The worst seems to be over, according to survey participants, as investors suggest that the bottom is near, if not here, particularly for better-positioned markets and assets,” said Susan Smith, director of real estate advisory practice at PricewaterhouseCoopers, and editor-in-chief of the survey.

Commercial real estate fundamentals also are expected to moderate in the remainder of this year. Across property types, occupancy and rental rates have deteriorated significantly in the past 24 months, but the declines are not expected to be as severe in 2010 as they were last year, according to the survey.

“Following the onset of the recession and the credit crisis, underlying fundamentals were deteriorating and overall cap rates were expanding simultaneously and quickly, causing values to plummet,” said Smith.

Marketing pace quickens

In the apartment market, the low end of the range for overall cap rates decreased 75 basis points this quarter to 5%, as investors showed up to bid for quality assets in healthier markets. In another good sign, the average time it took to market the assets declined in two survey markets, indicating restored confidence among many investors, according to the report.

Investors forecast that the apartment sector will be the first to recover, noting that some multifamily assets already are showing slight value increases. The office and retail sectors, meanwhile, are more deeply mired in the economic doldrums, and affected by nationwide job losses.

Survey participants said that owners and lenders finally are coming to agreement on the value of properties, overcoming at least in part, the bid-ask stalemate over prices that has impeded many transactions for more than a year.

Because of the new willingness of buyers and sellers to reach agreement on price, the report says that sales are likely to increase markedly over 2009 levels.

The report showed optimism about the lending climate as well. Banks appear more willing to lend, although underwriting remains very conservative and more equity is needed to secure debt, the report says.

But there is plenty of pent-up demand, and some investors are flush with money for acquisitions. “There is a tremendous amount of capital seeking real estate opportunities, and now is still a great time to buy,” said Smith.

In a number of markets, good deals can be found, including distressed assets. “Many investors in our survey still anticipate incurable deleveraging issues on the part of both lenders and owners to provide opportunities to acquire quality assets at below-peak pricing, and there’s strong competition among buyers for such deals,” said Smith.

Looming debt maturities are expected to pose major problems for owners and lenders, pressuring owners to sell at distressed prices. Although lending institutions and special servicers of commercial mortgage-backed securities are likely to provide some of the forced sales, other sources will also fuel the transactions, said Smith.

“More distressed selling will likely come from borrowers, who are more comfortable with where the market is now and will accept a loss in order to move on,” she said.

By Morris Newman, Los Angeles Times, 3-7-10

It's a cold winter for apartment investors in Los Angeles County: Rents are down, prices have fallen and vacancies are way up.

Deal velocity -- broker slang for sales volume -- is a thin stream compared with the overflowing activity of 2005 and '06, the most recent boom years.

But to smaller investors like Johnny Caal, with cash in hand and a taste for risk, the weather is delightful.

This is the best market I've seen since 1994," during the previous recession, said the Van Nuys-based investor, who owns six small rental complexes in L.A. County. He is in escrow on a six-unit building in Van Nuys.

Falling apartment values bring out the so-called bottom feeders, or small investors in search of inexpensive property.

In 2009, the bottom feeders and other small investors ruled the investment market in multifamily housing.

Apartment complexes with five to 49 units captured a lopsided share of new investments in multifamily properties in Los Angeles County last year: There were 552 sales, according to figures compiled by Marcus & Millichap, a national real estate brokerage based in Palo Alto. By comparison, only 15 complexes with 50 to 100 units sold, and 16 with 100 units or more sold.

Many people think of small apartment complexes as those with fewer than 15 units. California law requires larger complexes to have an on-site manager, an added cost that some investors shun.

Overall, apartment-house prices have been falling for the last few years: They slipped to an estimated median of $128,500 a unit last year, down 4% from 2008, Marcus & Millichap data show. The median price is the point at which half sold for more and half for less.

The largest complexes are favored by institutional investors such as pension funds and insurance companies. Those big investors are sitting out the market for good reason.

Armed with professional advisors and expensive software, institutional investors want deals that conform to specific investment criteria. And owners of institutional-grade property don't want to sell in this dismal market. In other words, it's an investment stalemate.

But in the mom-and-pop market for smaller buildings, many people are eager to gain a foothold in the potentially profitable investment field. A small apartment building is often the first real estate purchase after an investor's residence.

Many small investors aren't as methodical as institutional buyers, and some are willing to accept a riskier or less profitable project so they can get into a coveted type of investment.

The current market seems almost the opposite of the boom years of 2005 and 2006.

Prices rose sharply in those years, attracting get-rich-quick investors who believed they could hold properties for short periods and sell them profitably -- regardless of the income generated by rents.

Currently, "there are more listings than buyers who are both motivated and financially qualified," says Roderick "Rick" Raymundo, a broker with the Los Angeles office of Marcus & Millichap.

Not all small rental complexes are underpriced, Raymundo says. For a small number of fully occupied, well-maintained properties in desirable locations, sellers may receive a dozen offers or more, with bids close to the asking price.

"In a market like this, there is a flight to quality, to investments that are less risky," he says.

Apartment vacancies in Los Angeles County rose to 6% in mid-2009, according to Marcus & Millichap figures. In a strong apartment market, vacancies can fall below 2%.

In a weak market, landlords cut prices to compete for tenants.

"People are lowering rents to fill up their buildings, and the decline in income probably hurts the moms and pops," says Bruce Bernard, an L.A.-based investor who owns a portfolio of buildings with 40 to 100 units each.

Discouraged by market conditions, apartment investors who bought property in the "up" market may choose not to sell, while those who are selling may stick stubbornly to unrealistically high asking prices, says Tracey Seslen, assistant professor of clinical finance at the USC Marshall School of Business.

"Some sellers are doing the ostrich thing," she says, "not really wanting to cut their losses and move on to the next phase into their investment strategy."

Rather than trying to bid down the price of expensive buildings, Caal says he is particularly interested in buying distressed properties, "because that's the best bang for your dollar."

In April, Caal bought a six-unit building that was nearly empty, with boarded-up windows. The seller was having difficulty getting rid of the property because no bank was willing to finance a sale for a building in such poor condition.

Caal says he persuaded the previous owner to carry the mortgage -- that is, to remain the official owner while Caal assumed responsibility for all expenses.

The investor repaired the property and found new tenants.

Nine months later, Caal was able to find a bank willing to make a loan on the refurbished building and complete the sale.

Caal remains interested in buying apartment complexes, and he doesn't plan to offer any of his own properties to other investors.

"I'm not selling," he says firmly. "It's a pretty crazy time to do that right now."

Despite poor commercial real estate fundamentals, retail and apartment real estate investment trusts (REITs) are enjoying a powerful resurgence. For the 12-month period ending February 28, a key equity REIT index soared 95.19%, outdoing both the Nasdaq and Standard & Poor’s 500 index of stocks, according to a new report.

For the month of February, U.S. REITs gained more than 5%, according to the report by the National Association of Real Estate Investment Trusts (NAREIT), a trade group based in Washington, D.C. The gains were driven by investment in the retail and apartment sectors, according to the report.

“This has been a period of tremendous growth for REIT shares,” says Ron Kuykendall, vice president at NAREIT. “What it means, I believe, is that investors are betting on a recovery.”

The performance represents a remarkable contrast to the period from the market peak in early 2007 to the trough in March 2009, the lowest point for REITs. Share prices fell a devastating 75% during that period, says Kuykendall.

If investors indeed are betting on recovery, that could provide a shot in the arm to the commercial real estate industry across the U.S. Although REITs comprise just 10% to 15% of the total U.S. commercial real estate marketplace, they represent many of the largest companies and property owners across all property types — retail, multifamily, office, industrial and hotel.

Dealmakers get busy

A developing trend that factors into the recent investment in shares is that acquisitions are once again beginning to take place after the nation’s deep recession and credit shortage, particularly in the retail and apartment sectors.

“We have seen apartment companies like Avalon Bay and Equity Residential doing some strategic acquisitions. It has also begun to happen in the retail sector, where you have of course the General Growth situation,” says Kuykendall. Several rival REITs have expressed interest in buying mall REIT General Growth as it attempts to emerge from Chapter 11 bankruptcy.

“Equity One has been talking to Liberty about acquiring some of their retail shopping centers,” as well, says Kuykendall.

Over the past year, many REITs strengthened their balance sheets as they recapitalized, raising fresh equity through secondary equity offerings and paying down debt, says Kuykendall. The steps made them more attractive to investors.

“There were about $22 billion in secondary equity offerings in the REIT marketplace last year,” says Kuykendall. “That represented more shares coming onto the market.” The offerings followed a trend developing over the past year of share growth rather than a reduction in the number of shares outstanding.

Regional malls recorded an 11.9% return on the FTSE NAREIT Equity REIT Index in February, while shopping centers registered 8.9%. During the month, apartments also showed strong gains of 8.4%, a dramatic improvement from a year earlier. In February 2009, shopping center index returns declined 25.8% while regional mall returns dropped 21.1%. In the same period, apartment returns declined 24.7%.

This year, REITs are generating more optimism. “Investors have been looking forward to the returns that REITs are going to be able to generate by acquiring high-quality property at good prices,” says NAREIT economist Brad Case. “What we’ve seen in the last month is that those opportunities have arrived.”

The investors are driving the prices of REIT stocks up in anticipation of better REIT performance going forward, says Case. He notes that in addition to the improved returns for retail and apartments, lodging REITs recorded a 6% gain in February.

Tough year for fundamentals

The gains have taken place against the backdrop of a brutal climate for commercial real estate fundamentals. The vacancy rate for community and neighborhood shopping centers is projected to rise to 11.5% this year, according to New York-based data research firm Reis. That would represent the highest vacancy rate for the centers since at least 1999.

The shopping center vacancy rate is projected to rise to 12.2% next year. For apartments, Reis projects a vacancy rate of 8.3% in 2010, shattering records for the last 11 years.

Because REITs have been able to raise fresh capital through equity offerings, unlike private companies, they have not been hamstrung by banks’ unwillingness to lend money for acquisitions, says Kuykendall. That has made a crucial difference in their ability to grow as the nation attempts to shake off the effects of the economic slowdown.

Another problem for private commercial real estate companies is that many are weighed down by maturing debts, while banks practice a policy of “extend and pretend” rather than foreclosing on assets.

That’s why the investment marketplace has looked more favorably on REITs, says Kuykendall. Debt maturities still hang over the private companies, while REITs are positioned for opportunistic buys. “These are going to be the winners as banks come to a point where they are no longer willing or able to do the pretend and extend.”

By Denise Kalette, National Real Estate Investor, 3-10-10 

The U.S. housing market is poised to withstand the removal of government and Federal Reserve stimulus programs and rebound later in the year, contributing to annual economic growth for the first time since 2006.

Increases in jobs, credit and affordable homes will help offset the end of the Fed’s purchases of mortgage-backed securities this month and the expiration of a federal homebuyer tax credit in April. Sales will rise about 6 percent this year, and housing will account for 0.25 percentage point of the 3.6 percent growth, according to forecasts by Dean Maki, chief U.S. economist for Barclays Capital in New York.

“I would bet even odds that we’re at a bottom and that we’re going to see improvement in the coming months,” said Karl Case, co-creator of the S&P/Case-Shiller Home Price Index and a professor of economics at Wellesley College in Wellesley, Massachusetts.

An improving market would allay concerns at the Fed that sales will relapse after the tax credit expires. It would also give Fed Chairman Ben S. Bernanke and his colleagues, who meet this week in Washington, a freer rein to ultimately raise the interest rate for overnight loans among banks from near zero.

“They’re going to be tightening credit sooner than people expect,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. He forecasts that the Fed’s first increase since 2006 may come as soon as June.

Reflecting Optimism

Homebuilders’ shares reflect the optimism. The 12-member Standard & Poor’s Supercomposite Homebuilding Index hit a five- month high March 9 on speculation the expanding economy will boost sales. The index has gained 14 percent this year, led by a 41 percent jump in Columbus, Ohio-based M/I Homes Inc., a 31 percent increase by Standard Pacific Corp. in Irvine, California, and a 28 percent rise in Miami-based Lennar Corp.

Recent housing data have been mixed. Sales of existing homes fell 7.2 percent in January, while housing starts rose 2.8 percent, according to statistics from the National Association of Realtors in Chicago and the Commerce Department in Washington.

Employment is key to the outlook, according to Patrick Newport, an economist with IHS Global Insight in Lexington, Massachusetts.

“When people get jobs, that’s when they move or decide to buy a bigger house,” he said.

The U.S. may add as many as 300,000 jobs in March, the most in four years, thanks to an improvement in the weather, government hiring of temporary workers for the census and a growing economy, said David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. Payrolls dropped by 36,000 in February, according to the Labor Department, depressed in part by East Coast snowstorms that closed many businesses.

‘Turning Positive’

“The underlying trend is turning positive,” said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York.

The Senate last week approved a $138 billion measure that would extend unemployment benefits and provide additional aid to states. President Barack Obama praised the bill’s passage, saying it will help put the U.S. back on a solid footing.

The economy is projected to grow 3 percent this year, according to the median forecast of 52 economists surveyed by Bloomberg News from March 1 to March 10. It expanded at a 5.9 percent annual pace in the fourth quarter, the most in more than six years, after a 2.2 percent increase in the third.

Credit conditions may also be improving. A net 13.2 percent of banks surveyed by the Fed in January reported that they tightened standards on prime mortgage loans in the fourth quarter, the smallest percentage since the central bank began tallying such data three years ago.

‘Important Step’

“This is an important step in the right direction,” Peter Hooper, chief economist at Deutsche Bank Securities in New York, and his colleagues wrote in a report to clients last month.

Mortgage originations for the purchase of a home will rise to $745 billion this year and $822 billion next year, the highest since 2008, from $740 billion in 2009, according to forecasts from the Washington-based Mortgage Bankers Association.

Falling home prices and low mortgage rates have made homes more affordable. The median price was $164,700 in January, matching the year-ago level, which was the lowest since May 2002, according to the Realtors’ association. The trade group will report February housing data next week. The average rate for a 30-year fixed mortgage was 4.95 percent last week, up from a record-low 4.71 percent in December, according to Freddie Mac, the McLean, Virginia-based mortgage buyer.

The average household had 177.8 percent of the income needed to purchase a property in January, the highest since a record 184 percent in April 2009, when mortgage rates tumbled to 4.78 percent, according to data from the Realtors’ association.

First Hurdle

The housing market’s first hurdle comes at the end of this month, when the Fed completes its program to purchase $1.25 trillion of mortgage-backed securities and about $175 billion of housing-agency debt.

The move probably won’t have much impact, said Mahesh Swaminathan, a mortgage strategist at Credit Suisse Holdings USA in New York. Private demand will replace the central bank, keeping down the spread at which mortgage-backed securities trade to 10-year Treasury notes, he said. The spread on Friday was about 60 basis points.

“We don’t anticipate a massive widening of spreads once the Fed stops buying,” he said. “It will be a few basis points here and there.”

As a result, he sees mortgage rates remaining “about where they are now.”

Mortgage-Backed Securities

Much of the private buying will come from money managers who are underweight mortgage-backed securities in their portfolios relative to their benchmarks, said Ajay Rajadhyaksha, managing director of Barclays Capital in New York, who sees spreads rising about 15 basis points in the second quarter.

Once the Fed completes its purchases, the next obstacle for the market is the expiration of the tax credit for first-time home buyers. The original credit helped boost existing-home sales by 4.9 percent to 5.16 million in 2009, the first increase since 2005, according to the Realtors’ association. The credit, which was slated to end on Nov. 30, was expanded and extended through April.

The Fed’s Beige Book business survey released March 3 found that some contacts in the housing industry are “apprehensive about future sales” of homes once the credit expires, even though the extension hasn’t helped as much as the initial incentive.

Potential Buyers

“A lot of people moved up their purchases to meet the original deadline and that used up a lot of the pool of potential buyers,” Newport of IHS Global said.

The credit of as much as $8,000 stimulated only 180,000 extra sales from December to April, said David Crowe, chief economist at the National Association of Home Builders in Washington.

It was “certainly positive, but it has not fueled a huge increase in sales,” Ara K. Hovnanian, chairman and chief executive officer of Red Bank, New Jersey-based Hovnanian Enterprises Inc., the nation’s seventh largest homebuilder by revenue, told analysts on March 3.

The final challenge for the housing market this year is the supply of available properties and the prospect that it may rise. Foreclosures may increase to 2.2 million this year from a record 1.7 million last year, according to a forecast by Mark Zandi, chief economist for Moody’s Economy.com in West Chester, Pennsylvania.

The number of vacant homes for sale rose to 2.09 million in the fourth quarter from 1.99 million in the prior period as banks seized property, the U.S. Census Bureau said Feb. 2.

Excess Supply

An improvement in the job market would spur household formation and help absorb the excess supply, said Thomas Lawler, a former economist with Washington-based mortgage company Fannie Mae who now is an independent housing consultant in Leesburg, Virginia.

There may be 1.25 million new households in 2010 if the economy continues to expand, he said. The number has stayed below 1 million for the last three years as adult children lived with their parents and Americans generally conserved cash, he said.

“If we get a rebound, you could see excess supply disappear very quickly,” Lawler said.

“The underlying trend in home sales is for gradual improvement,” Maki of Barclays Capital said. “While activity will remain at low levels for some time, the housing bust is essentially over.”

We live in interesting times, times that are no doubt going to get much more interesting in the years ahead and, unfortunately, probably more violent.

The recent demonstrations on California college campuses following the Tea Party protests of last summer bring up the intriguing possibility that we could actually see protesters against government spending and for government spending face off against each other in the streets.

Just the fact that people are protesting at all is probably a big step in the right direction as we've become a much too docile population over the last 20 years here in the U.S., but, multiple bursting asset bubbles and the realization by millions of parents all across the land that, for the first time in generations, the quality of life experienced by their children may pale in comparison to their own - all of this goes a long way in changing that.

The younger set seems to be pretty angry too.
Now, the little girl in the photo above probably doesn't understand the meaning of the sign she's holding but, in another fifteen years she likely will.

It's hard to say what motivates people to finally take action, but it looks like that's what they're doing now and that's probably a good thing.

The Tea Partiers

The Tea Partiers are a diverse group and, while I don't know this for fact, they are probably a lot less crazy than they are portrayed in much of the mainstream media. From what I've seen, they are mostly an older bunch who, understandably, don't like the way government has been spending money lately and think that we should all try to live within our means, something that hasn't exactly been typical of the U.S. government or its citizens in recent decades.

That appears to be changing.

We've come a long, long way over the last hundred years. Those who were adults during the Great Depression and who are still alive today are too old to get out and protest, however, it seems there are more than enough children of those who were scarred by the Great Depression and who can't figure out why the government has to spend so much money that they feel compelled to do something about it.

Anyone over the age of 50 surely knows hardship better than generations that followed, even if their worst pre-1980 experience was having to wait in gas lines, but, it's not clear whether the younger Tea Partiers really know what they're asking the government to do.

Dramatically reducing government spending on all sorts of things that millions of Americans have come to take for granted will cause untold hardship and, while we, as a nation, seem unprepared to embark on an "austerity program", there seem to be more than a few younger folks willing to give it a try.

We'd probably be better off in the end, but will people be able to endure it?

When you think about how unsustainable the current system is, it might be worth a try.

Budget reform doesn't come easily and, in the U.S. there is no better example of this than in California where the state seems hell bent on spending more than it takes in come what may.

Deep Denial

The fact is, there are millions of people in this country, many of them working in the public sector, who are in deep denial about what the government can and can't do.

The past 15 or 20 years have led many people to assume that things can continue as they've been going indefinitely, but, when you look at the prospects for credit-fueled economic growth over the next 15 or 20 years, you quickly realize that it's about run its course.

We've already entered a new era of slower growth and slower credit creation, both of which mean that the government has to spend less.

The notion that governments around the world (and particularly the U.S. government that is now in hock by many trillions of dollars with dozens of trillions more when you include unfunded liabilities) can continue to borrow and spend money at an ever increasing pace in perpetuity is, on its face, illogical and unacceptable to most people.

Sure, an argument can be made that governments will always have some level of debt that grows in a relatively stable relationship with the level of economic activity but, lately, we seem to be approaching escape velocity for that metric.

The result we see today is that people figure they can't spend more money than they make indefinitely and then they wonder why the government should think that it can.

Unless the folks in Washington and on Wall Street can figure out how to inflate another gigantic asset bubble that will make Americans think that they're getting wealthier again, we stand little chance of "growing our way out" of the current mess.

The Campus Protesters

But, the funny thing lately is that, in some parts of the country at the state and local level, the government is spending less and - surprise, surprise - people don't seem to like it. Those who benefit from government largess don't want the spending to stop.
You see these sort of protests in Greece and in other parts of Europe where the public has become conditioned to expect a certain level of benefits from the state and they don't really know or care where the money comes from.

I'll never forget that conversation a few years back with a retired schoolteacher who said that virtually all of the nation's problems can be easily solved by reducing classroom size by half. When queried as to how this would be paid for, the Pavlovian response was "raise taxes".

Just today, we received a note from the Census Department advising us that our 2010 Census form will be coming in the mail next week. Now, how much it costs to mail out this advance notice and whether it's effective in getting a better response next week is unknown, but, what is clear is that the text of the letter has some scary overtones (emphasis added).

Your response is important. Results from the 2010 Census will be used to help each community get its fair share of government funds for highways, schools, health facilities, and many other programs you and your neighbors need. Without a complete, accurate census, your community may not receive its fair share.

1 a : stern and cold in appearance or manner b : somber, grave
2 : morally strict : ascetic
3 : markedly simple or unadorned
4 : giving little or no scope for pleasure

"Austere" is definitely the wrong word here.

You Can't Get There from Here

The simple fact remains that people know in their gut that there's something fundamentally wrong in the world today when it comes to what governments are doing with their money and, even if they work in the public sector, they probably know that it's just plain wrong to borrow and spend so much with so little hope of paying it back.

Of course, when it's your family's livelihood that's at stake, you're much more likely to protest alongside the college kids than the Tea Partiers - that's just human nature.

The sad thing about the entire situation is that, realistically, both sides would be well served to lower their expectations for the kind of change they are seeking.

Conventional wisdom has it that developed nations don't really start getting into trouble until their budget deficit is 10 percent of their GDP or their debt service accounts for 10 percent of their overall spending. Here in the U.S. we've eclipsed the first measure and, with any appreciable rise in interest rates back to less-freakishly-low levels, we'll quickly surpass the second one too, due in no small part to the trillions of dollars in debt the folks in Washington have added in just the last few years.

But, that doesn't mean that the D.C. crowd will act any differently than they do now.

The status quo and entrenched interests in a two-party system dictate that the sort of change that is now needed won't come voluntarily and, no matter which party is in power, when it comes to spending, they'll both keep doing what they've been doing until the system just stops working.

The two sides on the debate over spending - the Tea Partiers and the college kids - should probably get used to the idea that neither will get what they want. The first group faces a generation of incumbents who only seem to care about the next election and the second group doesn't yet realize that, in the world today, they are asking for the impossible.

Tim Iacono, The Mess That Greenspan Made, 3-10-10

States and companies have started investing very differently when it comes to the billions of dollars they are safeguarding for workers’ retirement.

Trent May, chief of Wyoming's pension fund, said states were “moving away from the perceived safety and liquidity of the investment-grade market.”

Companies are quietly and gradually moving their pension funds out of stocks. They want to reduce their investment risk and are buying more long-term bonds.

But states and other bodies of government are seeking higher returns for their pension funds, to make up for ground lost in the last couple of years and to pay all the benefits promised to present and future retirees. Higher returns come with more risk.

“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, which oversees public plans in that state. “Double up to catch up.”

Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now.

The Texas teachers’ pension fund recently paid Chicago to receive a stream of payments from the money going into the city’s parking meters in the coming years. The deal gave Chicago an upfront payment that it could use to help balance its budget. Alas, Chicago did not have enough money to contribute to its own pension fund, which has been stung by real estate deals that fizzled when the city lost out in the bidding for the 2016 Olympics.

A spokeswoman for the Texas teachers’ fund said plan administrators believed that such alternative investments were the likeliest way to earn 8 percent average annual returns over time.

Pension funds rarely trumpet their intentions, partly to keep other big investors from trading against them. But some big corporations are unloading the stocks that have dominated pension portfolios for decades. General Motors, Hewlett-Packard, J. C. Penney, Boeing, Federal Express and Ashland are among those that have been shifting significant amounts of pension money out of stocks.

Other companies say they plan to follow suit, though more slowly. A poll of pension funds conducted by Pyramis Global Advisors last November found that more than half of corporate funds were reducing the portion they invested in United States equities.

Laggards tend to be companies with big shortfalls in their pension funds. Those moving the fastest are often mature companies with large pension funds, and who fear a big bear market could decimate the funds and the companies’ own finances.

“The larger the pension plan, the lower-risk strategy you would like to employ,” said Andrew T. Ward, the chief investment officer of Boeing, which shifted a big block of pension money out of stocks in 2007. That helped cushion Boeing’s pension fund against the big losses of 2008.

Shedding stocks gave Boeing “material protection right when we needed it most,” Mr. Ward said. By the time the markets had bottomed out last March, Boeing’s pension fund had lost 14 percent of its value, while those of its equity-laden peers had lost 25 to 30 percent, he said.

“We estimated that the strategy saved our company in the short term right around $4 or $5 billion of funded status,” he said.

Boeing and other companies seeking to reduce their investment risk are moving into fixed-income instruments, like bonds — but not just any bonds. They are buying and holding bonds scheduled to pay many years in the future, when their retirees expect their money.

The value of the bonds may fall in the meantime, just like the value of stocks. But declining bond prices are not such a worry, because the companies plan to hold the bonds for the accompanying interest payments that will in turn go to retirees, not sell them in the interim.

Towers Watson, a big benefits consulting firm, surveyed senior financial executives last year and found that two-thirds planned to decrease the stock portion of their companies’ pension funds by the end of 2010. They typically said their stock allocations would shrink by 10 percentage points.

“That’s 10 times the shift we might see in any given year,” said Carl Hess, head of Towers Watson’s investment consulting business. Economists have speculated that a truly seismic shift in pension investing away from stocks could be a drag on the market, but they say it would not be long-lasting.

Corporate America’s change of heart is notable all on its own, after decades of resistance to anything other than returns like those of the stock markets. But it’s even more startling when compared with governments’ continued loyalty to stocks. When governments scale back on the domestic stocks in their pension portfolios these days, it is often just to make way for more foreign stocks or private equities, which are not publicly traded.

Government pension plans cannot beef up their bonds that mature many, many years from now without dashing their business models. They use long-range estimates that presume high investment returns will cover most of the cost of the benefits they must pay. And that, they say, allows them to make smaller contributions along the way.

Most have been assuming their investments will pay 8 percent a year on average, over the long term. This is based on an assumption that stocks will pay 9.5 percent on average, and bonds will pay about 5.75 percent, in roughly a 60-40 mix.

By MARY WILLIAMS WALSH, New York Times, 3-8-2010

Despite the havoc that the past year wreaked on office rents and occupancies, the combination of limited supply growth and expected stabilization in the labor markets foreshadows a relatively quick return to positive rent growth.

This forecast implies that although the sales market for office properties has remained slow, a pickup in transaction volume and prices may occur swiftly.

After the office market peaked in 2007, the bubble deflated slowly through 2008 before the downturn gathered steam after the fall of Lehman Brothers.

Office properties took the brunt of the recession last year, with rents falling at record rates. Effective rents cratered by 8.9% in 2009, the largest decline on record in almost 30 years of Reis history.

Hidden amidst the devastation were signs that office occupancies were faring better than other property sectors. While multifamily and retail vacancies were hitting highs unseen in two decades or more, the national office vacancy rate was 17% at the end of 2009, the highest level since 2004.

Underlying factors

While previous downturns were characterized by massive overbuilding, office inventory growth was relatively constrained from 2004 to 2008 for a variety of reasons.

Due to a spike in construction costs from 2004 to 2006 and tepid rent growth that really didn’t begin accelerating until 2005, developers were far more interested in building residential units amid a housing boom.

As a result, an average of approximately 50 million sq. ft. of office space came on line annually from 2004 to 2008, less than half of the annual completions from 1999 to 2003.

The second reason office occupancies are holding up is that leases have yet to roll over. The typical multifamily lease expires in 12 months, whereas the average lease term for office space spans anywhere from four to seven years.

Naysayers will argue that the rollover risk is still high. Five-year office leases up for renewal in 2010 are generating lower rents than a few years ago. However, there is growing evidence that as the economy recovers, rents may indeed post tepid but positive growth by 2011.

If this comes to pass, two years spent in negative territory in 2009 and 2010 pales by comparison to the negative rent growth that office buildings endured from 2001 to 2004.

Ecology of space

One data point that Reis tracks carefully is the percentage of properties able to post increases on a quarter-by-quarter basis, and which properties are compelled to lower rents instead. Consider the line graph below illustrating the percentage of properties in New York City that lowered asking rents in a given quarter.

After the dot-com meltdown and terrorist attacks on the World Trade Center in the early 2000s, the percentage of properties that lowered rents spiked from around 8% to over 50%.

By comparison the situation is much worse in today’s downturn, with financial services at the epicenter of the aftermath of Lehman’s collapse. The percentage of properties that lowered rents spiked from around 8% to 86% in the fourth quarter of 2009.

There still is room for rents to fall, so much so that Reis expects office rents in Washington, D.C. to be higher than rent levels in New York by the end of the year.

Signs of a turnaround

The big question is whether we will see a downward trend in this line graph in the next few quarters. Recent national labor market figures are heartening, with the unemployment rate holding steady at slightly under 10%.

Despite the ire that banks receive because of their bonus payouts, Wall Street has begun to hire again, and job loss figures for New York City were not as bad as expected.

Unexpected events can derail this recovery, and economic growth is expected to be fragile for the near term, but as more positive news emerges we may be on track to seeing rents grow as early as next year.

If this is the case, transaction volume and prices may pick up quickly to capitalize on the next upswing.

Victor Calanog, National Real Estate Investor, 3-9-10

EACH year some 30 million American men undergo testing for prostate-specific antigen, an enzyme made by the prostate. Approved by the Food and Drug Administration in 1994, the P.S.A. test is the most commonly used tool for detecting prostate cancer.

The test’s popularity has led to a hugely expensive public health disaster. It’s an issue I am painfully familiar with — I discovered P.S.A. in 1970. As Congress searches for ways to cut costs in our health care system, a significant savings could come from changing the way the antigen is used to screen for prostate cancer.

Americans spend an enormous amount testing for prostate cancer. The annual bill for P.S.A. screening is at least $3 billion, with much of it paid for by Medicare and the Veterans Administration.

Prostate cancer may get a lot of press, but consider the numbers: American men have a 16 percent lifetime chance of receiving a diagnosis of prostate cancer, but only a 3 percent chance of dying from it. That’s because the majority of prostate cancers grow slowly. In other words, men lucky enough to reach old age are much more likely to die with prostate cancer than to die of it.

Even then, the test is hardly more effective than a coin toss. As I’ve been trying to make clear for many years now, P.S.A. testing can’t detect prostate cancer and, more important, it can’t distinguish between the two types of prostate cancer — the one that will kill you and the one that won’t.

Instead, the test simply reveals how much of the prostate antigen a man has in his blood. Infections, over-the-counter drugs like ibuprofen, and benign swelling of the prostate can all elevate a man’s P.S.A. levels, but none of these factors signals cancer. Men with low readings might still harbor dangerous cancers, while those with high readings might be completely healthy.

In approving the procedure, the Food and Drug Administration relied heavily on a study that showed testing could detect 3.8 percent of prostate cancers, which was a better rate than the standard method, a digital rectal exam.

Still, 3.8 percent is a small number. Nevertheless, especially in the early days of screening, men with a reading over four nanograms per milliliter were sent for painful prostate biopsies. If the biopsy showed any signs of cancer, the patient was almost always pushed into surgery, intensive radiation or other damaging treatments.

The medical community is slowly turning against P.S.A. screening. Last year, The New England Journal of Medicine published results from the two largest studies of the screening procedure, one in Europe and one in the United States. The results from the American study show that over a period of 7 to 10 years, screening did not reduce the death rate in men 55 and over.

The European study showed a small decline in death rates, but also found that 48 men would need to be treated to save one life. That’s 47 men who, in all likelihood, can no longer function sexually or stay out of the bathroom for long.

Numerous early screening proponents, including Thomas Stamey, a well-known Stanford University urologist, have come out against routine testing; last month, the American Cancer Society urged more caution in using the test. The American College of Preventive Medicine also concluded that there was insufficient evidence to recommend routine screening.

So why is it still used? Because drug companies continue peddling the tests and advocacy groups push “prostate cancer awareness” by encouraging men to get screened. Shamefully, the American Urological Association still recommends screening, while the National Cancer Institute is vague on the issue, stating that the evidence is unclear.

The federal panel empowered to evaluate cancer screening tests, the Preventive Services Task Force, recently recommended against P.S.A. screening for men aged 75 or older. But the group has still not made a recommendation either way for younger men.

Prostate-specific antigen testing does have a place. After treatment for prostate cancer, for instance, a rapidly rising score indicates a return of the disease. And men with a family history of prostate cancer should probably get tested regularly. If their score starts skyrocketing, it could mean cancer.

But these uses are limited. Testing should absolutely not be deployed to screen the entire population of men over the age of 50, the outcome pushed by those who stand to profit.

I never dreamed that my discovery four decades ago would lead to such a profit-driven public health disaster. The medical community must confront reality and stop the inappropriate use of P.S.A. screening. Doing so would save billions of dollars and rescue millions of men from unnecessary, debilitating treatments.