Steel Tips for Paulson's Quiver

Perhaps, wooden arrows are a metaphor for the $700 billion TARP or something can be added which is specifically designed for the purpose at hand.   In the end, most Americans are still trying to understand the magnitude of the problem and the steps to move forward.   Beyond the causes of subprime, Freddie, Fannie and the cash crunch, what else is happening that has put us in such dire straits? The answer might be explained with a quote borrowed from a friend.

“When expectation exceeds reality there may be unhappiness.” As history repeats itself, so do the ravages of exuberance in commercial real estate. At each cross road, the government is left to step up; purchase undervalued assets; and sell it back to the market over time to stabilize prices. This result occurs from the lack of a short term liquid market for trading into long term asset return.

With our current unhappiness, the extension of credit was not used to overdevelop the market (as in the S&L crisis); instead it was used to pay higher prices on existing property. The higher prices were based on sustained rent growth from a robust economy in full swing. As the economy stalled, these lofty expectations began to sour and unhappiness is the market reality.

The immediate question comes to mind, could this have been prevented or could we have seen this in advance? Modern fundamentals may have helped.

On June 9^th Seeking Alpha ran my article, “Pollination of Commercial Real Estate” describing the possibility of these events. On August 4^th, "The Fed Hedge” described the precarious situation of Merrill (MER), Lehman (LEH) and Goldman (GS) and the urgency of hedging commercial real estate.

Below are charts (click to enlarge all images) presented at Bloomberg on March 26^th 2008 to illustrate forecasts for trading real estate options and forwards on the Rexx Index. With modern fundamentals, the impact of increasing Vacancy, rising CPI, and declining Fed Funds projected the potential impact these conditions might have on the future return for commercial real estate.

For efficient pricing of commercial real estate, options and forwards, transparent pricing, limited counter party risk, exchange trading, price improvement and liquidity are paramount. Rexx Index has been fortunate to have the support of key firms CBRE/TWR, Cushman & Wakefield and Newmark Knight Frank to initiate licensing of the Index to the ISE Alternative Market Exchange. The ISE Alternative Market is based on the Longitude “auction” platform which can trade Rexx Rent and Rexx Total Return which are key proxies to the underlying commercial office property market.

Prior Rexx Index results released August 15^th 2008 for the commercial office market 2008 - Q2, showed rent across the nation was flat/negative, and the view of reality was coming with significant unhappiness.

With the tremendous effort from Congress to bring TARP together, it seems Secretary Paulson should have at his disposal all the means to get us back on track. Commercial real estate is the largest asset class lacking the liquidity and transparency associated with other asset classes. With the Rexx Index, the changes in return of commercial real estate are based on macro and micro economic factors which eliminate building specific risk and appraisal bias. Add the steel tips of the ISE Alternative Market to provide transparency; access to global liquidity and central clearing; and reality may exceed expectation with the successful development of a short term liquid market for long term asset return.