Seth Chalnick

Is There an End Game to the Recession?

Along with everyone else, I sure hope there is an end in sight to our current crisis, and the points you mentioned are good ones. I can’t speak so much to the asset side of the balance sheet, but I see an issue on the “interest rates” front, at least as it pertains to the real estate world. I would image the gist of my comment may apply to non-real estate markets in some way too, but even if it doesn’t, I believe the real estate spiral is enough to single-handedly curtail consumer spending… more so because the next wave of the spiral is coming to a theatre near you… where the higher priced homes of small business owners will be affected. If less spending by sub-prime folks can shake things up, less spending by the real economic stimulators won’t be pretty.

I am afraid the Fed can lower rates all they want, but ultimately supply equals demand. An investor who would otherwise look to lend out, say $50m in new mortgages right now sees 6% returns on conforming loan amounts. Why invest at 6%, when you can buy the underlying asset, trading at or below its intrinsic value, and get 5-10% net ROI by renting out the asset, while positioning for long term appreciation? On loans limits greater than conforming, say $700k-$2m (there are some agency jumbo programs that exceed $417k), an investor can get around 8%, but on the one hand, there is no demand for these loans when consumers have to pay it against inflated prices, and on the other hand the investors know… well… the prices are inflated. Nobody wants to touch a mortgage back security until debt-to-income ratios get back to <40%. We are nowhere near these levels in the upper middle class pricing tiers.

Regarding our liquidity crisis, even if everyone has their hearts set in the right place in our attempt to “bailout” the economy, lenders first need to cover their reserve requirements before they can lend money. If they lend out in a ratio of 12 :1, and then the asset of the 1 goes down to .9, then they need more money to preserve the ratio. By allocating more money to preserve the ratio, they are not lending, and this also contributes to downward pressure on the underlying asset value. Fact is, the time for action was when banks were leveraging profits by 30:1. Now we are experiencing the de-leveraging process... and it is just not as fun.