Matthew Miller

Housing: Where Is the Bottom?

John: I wrote a comment that became a post -- view it at: seekingalpha.com/artic...

The David Lereah Saga: Now Even More Pathetic

I had to chuckle a bit (OK, belly-laugh out loud) while reading the WSJ article. I believe that the most amazing part of Lereah's story is that someone with so little common sense and a bit of specific training could be thrust into a position to offer investment advice to - and write a book for - the masses.

From here forward, it should be required that if you are going to be paid >$100,000/yr. and talk to audiences larger than 5 people on behalf of a lobbying group, you must make it to the end of "Are You Smarter Than a Fifth Grader?" ...

I am neither an alarmist nor an extremist - but if "we the people" do not prepare and launch a bloodless revolution in the Country soon, I fear that there will be nothing left for which to fight.

Does anyone know the number for Rosetta Stone so that I can order the Chinese CDs? (www.rosettastone.com/p...)

Common Sense: My Solution to the Mortgage Crisis

MichaelNYC and jlounsbury59, et al-- I think that much of the focus related to the present financial services debacle has been misplaced at the "retail" level of the housing transaction(s) given the nature of the initial SA post. One of the primary motivations for Wall Street pushing ill-conceived residential mortgage products to end users from Miami to Sacramento was to generate enormous origination fees and out-sized returns for real estate developers and institutional equity investors in relatively short periods of time - with Wall Street scraping its share of the “ups” along the way. The “Tech-Wreck” coupled with the attack on our Nation on 9/11 left institutional equity investors with few options for capital investment at the time. As a result, institutional capital flowed like a tidal wave into residential and commercial real estate development and re-development projects. So much in fact, that deal structures, which once priced equity investments commensurately with the risk(s) that the capital was taking, now dramatically favored developers/sponsors as the competition to make deals supplanted many investors’ penchant to exercise common sense.

To supply the lenders and equity investors with new projects quickly, many successful real estate developers then “levered-up” by forming guaranty entities which allowed them to guarantee development loans at a ratio of 8:1 to 15:1 relative to the cash deposits on hand. To summarize, a developer with $5MM in a guarantee company could guarantee $40MM to $75MM worth of development loans with that $5MM in cash. This number was extrapolated further since many development loans have guarantee “burn off” provisions as certain hurdles are met - e.g. once 50% of construction is complete, then a portion of the developer’s liability under the loan guarantee is extinguished, freeing up those guarantee dollars to be applied to other projects. It is important to note that the success of the first project in this example is not guaranteed; since only 50% of the construction has been completed its ultimate success will not be measured for months or years to come. By now the question of underwriting standards should be cropping up again – but now the loans in question ranged in the tens/hundreds of millions of dollars.

The points made above are only important because one of the several “other shoe(s) to drop” will undoubtedly be commercial real estate loans. By their nature, development and re-development loans made to developers/sponsors are “performing” as long as they have not burned through the interest reserve line item that is reserved by the lender at the inception of the loan. As such, it is difficult to get an accurate indication from lenders regarding the health/status of these loans prior to maturity. One can surmise, however, that with staggering real inflation / record price levels for commodities and staples coupled with rising unemployment, the need for additional residential condominium towers and office buildings could be negligible for the foreseeable future. If you look at many markets in the south and southwest both product types dot the skylines liberally. The number of institutional quality projects is increased dramatically when high-end rental apartment units are factored into the equation. In many markets, the forecasted rental rates for a 1,000 square foot apartment with glossy granite counters and five-fixture bathrooms exceed the cost of ownership for a modest home of twice the size in the same submarket. Again, some time must pass before we can judge the overall success of such projects, but it suffices to say that there are several projects that are not meeting there pro forma rental rates. However, the development loans are still performing -- until the interest reserve is exhausted completely…

Lastly, many developers of residential lots were able to finance the infrastructure and ongoing services for these projects (utilities, roads and emergency services in some cases) with bonds that mimicked the characteristics of municipal bonds, without the implied backing of the municipality. These bonds were rated and sold into the market as fixed income securities with a future income stream to be derived from the levy placed on homeowners within the “district” that was created. In essence, homeowners were paying for the infrastructure in their neighborhood(s) through the future tax payments they will make to bondholders. Again, it is too early to tell in many cases, but one can surmise how this story will end for many of the taxing districts created. Two things are certain: (1) developers and bond underwriters were paid up front to build the infrastructure and issues bonds and (2) unsold homes and foreclosures were not part of the original business plan when forecasting when/how payment streams come online – the theme has been replayed too often during the time leading up to this debacle. This is just one small example of how the subprime/lax lending issue invades other “unrelated” areas such as fixed income investments.

My overarching theme to my comments is that there were a variety of parties/interests involved in the process of inflating the latest real estate bubble. From the mortgage broker/banker at the retail level working with the end users to the Wall Street firms packaging and re-packaging (or ReRemic) the securities; to developers and equity investors that acted as the “dealer” providing supply of product in an attempt to meet the insatiable demand of Wall Street players willing to push toxic sludge/asset backed securities into both local and global financial markets; to the banks and investors willing to believe that out-sized returns were possible and sustainable in this new world of financial alchemy.

It is difficult to parse and assign blame when so many were complicit.