So what's going to happen to all those partially built buildings around the city and the boroughs? I am afraid the prognosis is not good unless the developer has deep pockets....and who has deep pockets these days? Even those who do are up to their pockets in alligators right now. But let's go through an example of what happens to a real estate project when it fails to achieve its original highest and best use.....I'm warning those of you with weak stomachs that it ain't pretty. According to the International Herald tribune article cited below, there are over 100 of these sites around New York City.

This piece was first published on Urban Digs on 2/6/2009.

After touching off quite a lively debate with my last piece on the NYC housing bubble, I wanted to do a follow up piece that answered some questions and explored the issue of appreciation based on number of bedrooms. I also wanted to go as far back in time as the data permitted and look at price appreciation versus inflation to get a feel for how much "excess" return was generated in the New York City market as the result of animal spirits above and beyond inflation.

If you disagree that there was a bubble in New York City residential real estate, even this article is unlikely to convince you, so you may as well click along on your merry way. But if you're in the mode of accepting reality, you may be curious to get an idea of "Just How Big was The Big Apple Bubble?" in residential real estate.

A buddy of mine recently shared with me that one of his mentors used to say that residential home prices should track inflation over the long-term and that when it ran above for some period of time, it would eventually revert to the mean and in the process of so doing, prices would likely deflate to below the trend line for some period of time. I have used similar comparisons to look at past bubbles in many other asset classes, so of course this argument seemed reasonable to me. With this in mind I figured I would share some data with you on the subject of New York City's residential housing bubble

I have been talking ad nauseam about the imminent threats to the New York City land market, commercial real estate market and ultimately the residential real estate market as a result of the tentacles of the credit debacle going back quite a stretch. We opined over and over that job losses on Wall Street were on the way, the commercial market was going to get smacked despite being a "demand driven market" and that the residential market would go the same way. We have even gone so far as to assert that the near-sacrosanct multi-family rental market will get hurt due to over-use of leverage and, believe it or not, rent declines.

Unfortunately we were right and the world of "...New York is the capital of the universe, we never got overbuilt, they ain't making any more land on the island..." is now colliding with REALITY!

My assumption is that successful merger arbitrages will be hard to come by in 2009, quite simply because banks are unwilling to finance deals, companies are less willing to use their own cash and takeover prices will be reassessed, and most obviously, there is too much uncertainty.

Take a look at Puget Energy (PSD) and the 10% spread remaining. The risk of the deal failing is minuscule. Odds of 9-1 in my favor, yet the market is scared of something.

As those who read my piece "Running Off The Cliff" know, the changes made to the 421a tax abatement program resulted in a perverse rush by developers to begin construction on new condo projects in New York City in the face of a declining Wall Street economy. It's an amazing testament to the distortion of behavior that subsidy programs can have. The chart from that piece was so striking I am reprinting it here (but slightly gussied up).

lt's pretty sad when the list of the 20 best performing stocks in the S&P 500 year to date aren't all up on the year.  But that is the case so far in 2008.  Currently, just 18 stocks in the index are in the black this year, while 183 stocks (37%) are down more than 50%. 

As shown below, Family Dollar (FDO) has been the best performing stock in the S&P 500 year to date -- up 30.27%.  FDO is followed by Rohm & Haas (ROH), Big Lots (BIG), Celgene (CELG), and Amgen (AMGN).  Surprisingly, there are three Financials in the top 20.  Hudson City Bancorp (HCBK), BB&T Corp (BBT), and Wells Fargo (WFC) are all in the black year to date.

Bullish Calls:

CME posted the smallest decline, down only 1.47%, while GGP was down the most at 71.73% after cutting its dividend.  With many expecting the market to snap back very quickly, some of these stocks could emerge as market leaders, while others may recoup losses.

• Europe measures bring cheer. Leaders of the 15 Euro-zone nations emerged from unprecedented weekend meetings with an outline of sweeping steps member countries should take to address the financial crisis, including government-issued guarantees and insurance, buying stakes in faltering companies, and stabilizing long-term maturities (statement). The measures were cheered by Asian and European markets, which posted healthy gains Monday (see below), and by IMF managing director Dominique Strauss-Kahn: "We have now a comprehensive response to the crisis, and I think the markets will reflect it," he said. "I hope that in a few weeks the peak of the financial crisis will be behind us." Euro-zone countries will begin implementing the plan Monday, and expect over the coming days to finalize the exact amount of money each state will earmark for crisis control.
• Central banks go green. The Bank of England, European Central Bank and the Swiss National Bank will offer unlimited dollar funds to help create liquidity in frozen short-term money markets (Fed statement). The central banks will conduct auctions of dollar funds in 7-, 28- and 84-day maturities at fixed interest rates. To facilitate the massive injection, the U.S. Fed said it would increase the size of its swap lines with the BoE, ECB and SNB "to accommodate whatever quantity of U.S. dollar funding is demanded." Commercial banks will be able to borrow any amount they want against 'appropriate collateral.' The Bank of Japan is considering a similar move to aid access to dollars.
• U.K. takeover sinks RBS. The U.K. government is set to buy majority stakes in Royal Bank of Scotland (RBS), the nation's fourth-largest bank, and HBOS, its biggest mortgage lender. RBS will get £20B, with the government taking £5B in preference shares and underwriting £15B in capital. The aggressive move is aimed at shoring up the country's struggling financial system and flagging investor confidence, and falls in line with other governments across Europe which are taking radical steps to prevent systemic collapse. Shares of RBS are down 7.4% at 7:00 EDT. HSBC (HBC) is up 8.5%, and Barclays (BCS) is up 7%.
• German banks climb on €470B rescue package. Shares of German banks were sharply higher Monday after the government agreed to a €470B bailout package, including €70B in capital injections and €400B in guarantees for interbank lending. "Both the state guarantee and the possible capital injection should help bring back confidence in the sector," Landesbank Baden-Wuerttemberg analyst Olaf Kayser said. At 6:40 EDT, Deutsche Bank (DB) is up 12.9%, and Allianz (AZ) is +7.3%.
• A sweetened Morgan deal for MUFG. Morgan Stanley (MS) and Mitsubishi UFJ (MTU) continue to negotiate their $9B pact. Both sides want to keep the essence of the deal intact, while adding a few sweeteners for MUFG to compensate for the steep drop in Morgan's share price. Under the new terms, MUFG would receive only preferred shares instead of a mix of preferred and common shares, and the conversion price for convertible preferred shares would move down to the low $20s from $31. U.S. officials, in a potentially important precedent, urged a hesitant MUFG to proceed with the deal and promised its planned investment in Morgan would be protected.
• Santander in talks with Sovereign. Spain's Banco Santander (STD) is in advanced talks to buy the shares of Sovereign Bancorp (SOV) it doesn't already own after Sovereign approached the Spanish bank late last week. Santander is expected to pay around $3.81/share, Sovereign's closing price on Friday, in a deal that values the largest remaining U.S. savings and loan at about $2.53B. The Spanish bank has been considered a potential buyer ever since it got a 24.9% stake in Sovereign three years ago along with three seats on the board. The original agreement allowed Santander to bid for Sovereign after May 31 of this year but required the bank to bid at least $40/share. The restriction will likely be waived as Sovereign's shares are down 60% this year. A deal could be completed as early as today.
• Wachovia buyout hurried along. The Fed is fast-tracking Wells Fargo's (WFC) $15.1B acquisition of Wachovia (WB), which it says could be consummated within five days (statement). Wachovia said Sunday it will forego a shareholder vote on the issuance of preferred stock to Wells Fargo in favor of expediency. Shareholders still need to approve the proposed merger. Analysts say Wells Fargo is likely to sell or downsize Wachovia's investment-banking unit. I-banking is not Wells' strong suite.
• GM focused on growth? Sources say GM (GM) and Cerberus discussed a swap in which GM would acquire Cerberus' 80% stake in Chrysler in exchange for its 49% stake in auto-lender GMAC, of which Cerberus owns the other 51%. Negotiations are at a standstill, but inactive talks could be renewed if markets stabilize. Meanwhile, in July, before exploring a swap with Chrysler, GM proposed a join-up with Ford (F), which it ultimately rejected, breaking off talks in September. Analysts say almost-broke GM would need plenty of cash to swallow Chrysler. That anomaly, and the untimeliness of a deal, has them speculating there's more to the proposed combo than meets the eye.
• Private equity cuddling huge loan losses. Private-equity firms, including Apollo, Blackstone (BX) and TPG, which bought billions of dollars of senior debt 'on the cheap' from top-tier banks like Citigroup (C), Deutsche Bank (DB), and Royal Bank of Scotland (RBS), are sitting on major paper losses. The loans, bought for an average of $0.85 on the dollar, now trade for about $0.65. "The trouble is, things are still likely to get worse as the economy weakens. And private-equity firms acquired the leveraged loans with - yes - leverage. The selling banks financed the transactions, lending the buyers about 75% of the purchase price."
• Borrowing gets a smidgin cheaper. Borrowing costs fell modestly from Friday, with the three-month U.S. dollar Libor down to 4.75% from 4.82%, and three-month sterling Libor fixed at 6.27% vs. 6.285%. The TED spread - the difference between what banks and the U.S. government pay for three-month dollars - narrowed 7 BPs to 4.57%.

Earnings: Monday Before Open

• BE Aerospace (BEAV): Sees Q3 EPS of $0.58 vs. $0.54 consensus. Sees Q4 EPS of $0.50 vs. $0.57. Sees full-year EPS of $2.00 vs. $2.84 and revenue of $2.5B vs. $2.88B. "We expect to report excellent financial results for the third quarter of 2008, but the near-term outlook has significantly deteriorated." [PR]
• Philips Electronics (PHG): Ebitda of €128M vs. €168M consensus. Says it will slow down the completion of its share repurchase program. Shares -4.8% in Amsterdam. [PR]

Today's Markets

• Strong gains across the board in Asia. Hang Seng +10.24% to 16,312. Shanghai +3.65% to 2,073. BSE +7.64% to 11,332. Tokyo closed.
• In Europe at midday, the bank rescue was front and center. London +4.4%. Paris +5.4%. Frankfurt +6.6%.
• U.S. futures indicate a strong open. Dow +4.1% to 8,712. S&P +5.05% to 936. Nasdaq +4.6%. Crude +4.6% to $81.28. Gold -0.33% to $856.20.

Monday's Economic Calendar

• 8:15 Fed's Hoenig speaks on regulation in Washington

• Notable earnings before Monday's open: FAST
• Notable earnings after Monday's close: XL

Seeking Alpha editor Rachael Granby contributed to this post.

Barron's isn't sure about those as it expects more billion-dollar writedowns that will hurt Europe’s less-capitalized banks. Large banks with high credit ratings like Credit Suisse (CS) and HSBC Holdings (HBC) or those with acquisition experience like Santander, should benefit in the current consolidating environment. 

Bullish Calls:

Big Losses As House Defeats Plan – Wachovia Corp (WB)

Potash Inc. (POT) – With the financial bailout package unfolding before our eyes, the reality isonce again a realization that the degree to which financial toxins have become entwined in the global body is greater than anybody guessed. The simultaneous failure of European financial institutions serves to remind us that other central banks and treasury officials elsewhere have some of their own nursing to do especially in light of the revelation that the alternative (for the U.S. economy) is not likely to be a pretty sight. The rally in the dollar coupled with the prospect of weakening demand has helped bury commodity prices. Shares in this fertilizer manufacturer have slipped 7.4% to $136.52 and stand well-off a 52-week high at $240 and change. Around 13% of open interest is in action today with a notable trade occurring in the December contract at the 170 strike, where 4,800 lots appear to have been sold at a premium of 9.90 per contract. The calls have a 35 delta inferring a one-in-three chance of landing in the money within three months. Elsewhere the October 130 puts appear to have been bought in defense of further reckless share price declines, while there also appeared to be evidence of selling higher strike October calls as if a door was slamming firmly shut behind upside potential for this company’s share price.

As the shadow banking system implodes and core deposit-funded banks prepare to expand to fill the void that’s been created, inquiring minds want to know: where on earth were the regulators?

Answer: they were counting the twigs as the forest burned.

Much has been made of bank exposure to Fannie Mae (FNM) and/or Freddie Mac (FRE) securities exposure. This is to be expected given the current state of affairs.

The following examples of financial institutions and their exposure, as disclosed on or about July 20, 2008, should be noted and applied towards any financial security considered for investment.

Earnings: Monday After Close

• Pep Boys (PBY): Q2 EPS of $0.11 beats by $0.04. Revenue of $500M (-9.4%) vs. $515M. Shares +0.1% [PR]

Today's Markets

• Asia markets on Tuesday gave back some of Monday's strong gains. Nikkei -1.77% to 12,401. Hang Seng -1.46% to 20,491. Shanghai +0.11% to 2,146. BSE -0.3% to 14,901.
• In Europe, markets are broadly higher at midday. London +1.2%. Paris +0.6%. Frankfurt +0.8%.
• U.S. equity futures are up, lead by Nasdaq. Dow +0.2%. S&P +0.3%. Nasdaq +0.65%.
• Crude -1.07% to $105.20 (low: $104.23). Gold +0.49% to $806.50.

Tuesday's Economic Calendar

• 7:45 ICSC Retail Store Sales
  
• 8:55 Redbook Chain Store Sales
  
• 10:00 Pending Home Sales
  
• 10:00 Wholesale Inventories
  
• 2:30 PM OPEC Conference
  
• 5:00 PM ABC Consumer Confidence Index

Seeking Alpha editor Rachael Granby contributed to this post.

Last year investors were touting New York City multi-family rental properties as being as low risk as T-bills, but with upside. The upside was to be generated by "repositioning." In many cases, this was code for throwing out rent-controlled/stabilized tenants and capturing the arbitrage versus free market rents. Both of the suppositions embedded in this strategy have been called into question recently.

I would point out that a backlash was brewing in the city and in Albany, where several bills were introduced in the state Senate to tighten up regulations and prevent landlords (read: hedge funds and opportunity funds) from significantly increasing turnover in their properties. Secondarily, costly, over-levered and often ill-conceived condo projects which are topping off in a soft demand environment are all of a sudden being forced to go rental, causing a spike in supply (see Crain's article cited below). Couple the increased supply, albeit modest, with the soft economy and evidence of a slowing in rental rate increases and even declines are emerging.

According to my math, the government will essentially own about 80% of FNM and FRE after the bailout.   The current preferred equity will no long pay a dividend until at least 2010.  While the preferreds have traded 45% to 65% lower already, they will most likely be completely wiped out from here.  If the companies can recover, there might be some value to the common and preferred equity in five to ten years.  However, as the companies enter run-off, my guess is that the common and preferred equity will not regain much value.