One of the beauties of the internet is the ability to find brilliant observations and critiques on today’s issues. Here are three stories I am reading that are helping me start to understand where we are, how we got here, where we’re going, and how the (local) real estate market is going to be affected. Rather than prognosticate about what tomorrow or the next day or the next month is going to look like, I’m still trying to digest what exactly is going on.
There is one major problem on Wall Street, that until solved, will result in meltown after meltdown in future years. I can’t say if the meltdown monkey will hit every 2,3, 5 or 10 years. But I can say with certainty that it will happen again. Why ?
Because Risk and Reward have been decoupled for CEOs on Wall Street.
If you are the CEO of a major public company, once you qualify for your golden parachute there is absolutely no reason not to throw the Hail Mary pass, and do high risk deals every chance you get.
What is the down side ? Lets just say for example, you run Fannie May or Freddie Mac. You basically f*** (edited) up the entire housing economy. Your punishment? You walk away with 9mm and 14mm dollars as severance. Would you take either of those jobs?
Lets say you run Country Wide Insurance. You get the housing market plumped up, during which you sell $414mm dollars worth of stock, and then watch as it spirals out of control because you lent money to anyone with a pulse, and probably to some without. Your punishment ? A $110mm payday. Oh wait, he had to give some back. Sucks to be him doesn’t it.
Which is exactly why we need to re-establish a link between risk and reward in public companies. The first step should be the following law:
If the government must step in and provide any sort of financing or guarantees for any part of a public company’s business, then all officers and directors lose all rights to severance pay and all outstanding vested or unvested options or warrants immediately become canceled. In the event the CEO of such corporation is not fired, but instead chooses to step down voluntarily, then the last 12 months of earnings is considered to be an interest free loan which the CEO must pay back over no more than a 10 year period.
So, anywayâ€¦again: what does â€˜Black Monday’ mean to the real estate and housing market? Probably very little. The corollary seems to be that these entities heavy investment in high-risk sub-prime mortgage loans led to their unwinding and/or demise.
Unless you live in California, Las Vegas, South Florida, or the Rust Beltâ€¦which either experienced high levels of mortgage fraud, illogical appreciation, or economic tough times due to indigenous â€˜industrial age’ industryâ€¦your local housing market is no worse off than it was before Wall Street’s most recent â€˜Black Monday’.
The good news is the U.S. is finally taking the necessary steps towards eventually resolving the crisis.
First, whether you agree or disagree with the FHFA and Treasury Secretary Paulson placing Fannie and Freddie in conservatorship, it has been obvious for some time that the U.S. Government had to explicitly guarantee the debt of Fannie and Freddie, or face a complete shutdown of the housing and mortgage markets. At least this guarantee was accomplished with the shareholders (both common and preferred) taking losses before the U.S. taxpayers. Since I have viewed a guarantee as inevitable, I consider this a necessary step toward the eventual resolution of the credit crisis.
Third, one of the reasons the credit crisis has lingered (in addition to house prices still being too high) is that a number of financial institutions have been unwilling to adequately mark down their assets. The reason for this reluctance is obvious as Lehman just discovered; too many write downs can lead to bankruptcy.
No one knows for sure how far prices will fall, but based on fundamentals, we can be pretty sure there is still a ways to go. (For a discussion of Price-to-rent, price-to-income, and real prices see: Housing: It’s about prices … ). Until the institutions get realistic on their house price forecasts, the write downs – and the credit crisis – will continue.