Boo!!! Will Halloween Scare the Market into Respecting the Fundamentals?

Reggie Middleton's picture

I'll admit it to everyone, I am absolutely disgusted with my investment
performance over the past two quarters. I came into the second quarter up nearly 500% for the two years running thanks to top notch research across myriad sectors (see zipResearch_Samples 11/17/2008 for examples) and
loss about half of that profit fighting the bull rally that I easily
saw coming but severely underestimated the length, depth and breadth
of. Having switched over to market neutral in the third quarter (see Recent strategy analysis sample available to the public)
caused me to simply hover with a few percentage point gains here and
there, since by then most of the drastic moves were over, but I was
biding my time in mostly cash waiting for the fundamentals to kick back
in. You see I am a fundamental investor, and I kill it when 2+2=4, and
I do even better when it equals something else. The caveat is when it
does equal something else, I have to wait until it starts moving back
towards that number 4 for me to realize my meal. This severe boom/bust
market is basically custom tailored to my investment style (see "The Great Global Macro Experiment, Revisited", and realize why I call it BoomBustBlog!) just to an aggravated extreme! 

Hey, y'all! It appears as if we may be approaching that time where 2+2 may again equal 4.

By now I'm sure we have soaked in the head-fake that was the "better
than expected" GDP number. Well, the gross number was only marginally
better than expected, and if one bothers to taken even the most cursory
glance beneath the surface.... Whoa! Stimulus was quoted as the reason
the economy expanded, but this is just not true. Stimulus is something
that stimulates. That just didn't happen in this case. The main drivers
reported for the GDP pop came from automobiles (the cash for clunkers
so-called stimulus plan) and residential investment (the government tax
break, more so-called stimulus). This is how I see it. Automobile sales
are already down
since the clunker plan ended, so there is no speculation as to whether
or not this government effort stimulated anything, It didn't. All the
government did was to literally "purchase" a few GDP basis points. 
There was no multiplier effect. There wasn't even a material economic
impact that lasted a month after teh plan ended. Basically, the
government put $XX billion into car sales to get a $XX billion less
slippage and administrative costs purchase of a few GDP points for the
months in question. Basically, a waste of money that should have went
into guaranteeing ABS for small business loans to take over the hole
that CIT is making in entrepreneurial lending - with more realistic
underwriting, of course.

How about the housing boost? Well, home sales and home prices have
trended downward from what I can see, as soon as the deadline for the
first time homebuyer credit approached. Damn near in real time. Again,
now real multiplier and no lasting effect. I mean it didn't even last a
month into expiration. Again, a waste of money in an attempt to reflate
a bursting bubble.

So, what is it that I do see for the economy. Well, from my perch in NYC...

The condo glut will literally devastate rental and
owner-occupied buildings in the major metro areas. We have not come
close to seeing the worst of the housing price declines. This no
exaggeration! Up until this point, most of the attention has been drawn
to residential foreclosures due to retail buyers getting themselves in
trouble via too much debt, too much building, too little employment and
deflating asset values/wealth (the wealth effect is something to
behold, see Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke
for my take on social mobility, downwards style). Well now, it is the wholesale buyer/builder's turn. In "Who are ya gonna believe, the pundits or your lying eyes?" (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video),
I illustrated a trip from Chelsea Piers in Manhattan to Prospect Park
in Brooklyn, capturing the rampant supply of residential, office and
commercial space that is STILL being put up despite the extreme glut
currently in this rapidly declining market. As you look through all of
this visual material, remember banks have supplied the capital for
building all of these empty edifices, at no less than 10x leverage. And
to think that there are some that are actually bullish on the banking

Before I delve into those past posts, let's take a look at a recent article from Crain's NY:

Survey shows 601 troubled condos in the city, Downtown Brooklyn worst off

There are 601 condo buildings in just six neighborhoods across New York
City that have either a substantial amount of vacant units or stalled
construction activity, according to survey data from the New York
chapter of the grassroots community organization Right to the City.
This number is well above the 454 buildings originally reported by the
Department of Buildings for the entire city. The survey, which will be
released next Tuesday at a rally in Downtown Brooklyn, found the
highest concentration of troubled developments in Downtown Brooklyn,
where 126 buildings are currently maintaining very high vacancies. It
was not immediately clear how the organization defined a substantial
amount of vacant units. The 246-unit Be@Schermerhorn condo building, at
189 Schermerhorn Street, has a 93 percent vacancy rate, and the
108-unit Forté condo, at 230 Ashland Place, has a vacancy rate of more
than 60 percent, according to the survey.
The report will also include
data on troubled developments in the South Bronx, Bushwick, Harlem, the
Lower East Side and the West Village. “We want to show the city how big
the problem is,” David Dodge, a member of Right to the City's New York
chapter, said. “The problem is larger than people knew and the city
took count of.”  [Crain's]

Now those of you who are not familiar with lower Manhattan or
Downtown Brooklyn may not realize the extent of the highly leveraged
monies wasted here. That is why created the pictorials linked above.
Let's pull some content from them, shall we?

This is the Forte' Condos from various angles, many of which can be
seen through empty lots (buildings that were razed to make room for
more condos and higher density office space, funded by banks at 10 to
60 times leverage):

For those who don't know NYC, this is not grasslands. This space in the
5 or so pics above abutts the 2nd largest transportation hub in all of
NYC (Flatbush and Atlantic Avenues- with access to LIRR, and at least a
dozen subway lines, the largest hub is Grand Central Station in Midtown
Manhattan) and is walking distance from Manhattan.


More gigantic, empty condo towers, empty lots that are paid for with
bank money and will try to be condos, and more condos. Here's an
interesting view of the Forte' Condos, as seen through a space that was
a building that has since been torn down to maximize the air rights to
make an even bigger office/retail/residential space. I gues they ran
out of money... To the right is vacant retail and office space, and you
can guess what's to the left.


  And off that very same corner, the historically significant
Williamsburg Bank and Clock Tower, bought by some smart speculators to
convert into... I'll let you fill in the blanks. If you do, you'll be
more successful than they are in filling all of those expensively built
(with bank money) blank condo units. There are a lot, this is a BIG
building (the tallest in the borough of Brooklyn), surrounded by many
other BIG condo units, interspersed between many condo towers under BIG
construction. By now, I would assume that you're recognizing a pattern





 The Forte' Condo is literally right around the corner from what you
see here. If they are only 47% occupied after years of trying to sell,
how do you think these guys are going to fair in a 10% unemployment
environment? The 246 unit Schemerhorn building that is over 90% vacant
is walking distance from this bunch. Check out the next block over
toward Manhattan...

Massive construction of what was supposed to be condos, now rentals,
next store to apartments for rent, next store to a lot slated for
apartment building construction! By the way, these are directly across
the street from newly built condos that are already in disrepair. Not
to worry, because about 30 seconds down Flatbush Ave and over the
Manhattan bridge are 4 more super condo towers, freshly built that are
not in disrepair yet.


 I strongly suggest you go through my pictorial links if you haven't
already, then see the video so you can get a true feel of the amount of
pain the banks will feel from these endeavors. Remember, banks fund the
construction loans, mezzanine, permanent, and the retail mortgages of
the end buyers. This ugliness is just getting started. Here ya' go
again: "Who are ya gonna believe, the pundits or your lying eyes?" (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video),
I will be expanding my coverage of the commercial side next week as I
start to unveil the first of several REITs that will not have the cash
to rollover their debts (at least as of now they don't) to subscribers.
We are also still waiting for that plus four number from some existing
guys, February REIT Actionable Intelligence Note Update -check out the video here.

This is the most recent CS condo pricing index report:


 As you can see, it does not appear that the index believes NYC prices
are going anywhere significant. The macro scene of unsustainable and
government suppressed mortgage rate levels, rampant unemployment
expected to increase for at least another year, and the potential end
to government housing subsidies really don't seem to bode well for
prices either. Oh well, what the hell do I know?



Of course, what good is a solid investment thesis without a juicy government conspiracy thrown in...

Check out this breaking story from the Journal...

Federal bank regulators issued guidelines allowing banks to keep
loans on their books as "performing" even if the value of the
underlying properties have fallen below the loan amount.

The volume of troubled commercial real-estate loans is skyrocketing.
Regulators said that the rules were designed to encourage banks to
restructure problem commercial mortgages with borrowers rather than
foreclose on them. But the move has prompted criticism that regulators
are simply prolonging the financial crisis by not forcing borrowers and
lenders to confront, rather than delay, inevitable problems.

The guidelines, released on Friday by agencies including the Federal
Deposit Insurance Corp., the Federal Reserve and the Office of the
Comptroller of the Currency, provide guidance for bank examiners and
financial institutions working with commercial property owners who are
"experiencing diminished operating cash flows, depreciated collateral
values, or prolonged delays in selling or renting commercial
properties." Restructurings are often in the best interest of both
lenders and borrowers, the guidelines point out.

The new rules don't reverse existing rules. Rather they are more
explicit than regulators have been in the past about how banks should
deal with restructuring issues. Banks in recent months have been
peppering agencies with questions about this as the number of problem
loans has soared.


About $770 billion of the $1.4 trillion commercial mortgages that
will mature in the next five years are currently underwater, according
to Foresight Analytics. As of last week, 106 banks had failed this
year, the most since 1992—the peak of the savings-and-loan crisis.
Regional and community banks especially have been paying dearly for
their aggressive push into commercial real-estate lending during the
boom years.

The new guidelines are targeted primarily at the hundreds of
billions of dollars worth of loans that are coming due that can't be
refinanced largely because the value of the properties have fallen
below the loan amount. In many of these situations, the properties are
still generating enough income to pay debt service.

Banks have generally been keeping a lid on commercial real-estate
losses by extending these mortgages upon maturity. However, that
practice, billed by many industry observers as "extending and
pretending," has come under criticism by some analysts and investors as
it promises to put off the pains into the future.
to the point, the longer you wait to foreclose, the less the collateral
will be worth. Those silly, dilly, nillies who are waiting for property
values and rents to go back to where they came from better have a few
Snickers bars available, for it ain't going back to the credit bubble
highs until, well,,, we have another credit bubble! Once the banks
realize this, those that can take the immediate losses without being
rendered immediately insolvent, not many of them but there are a few
out there, will actually race to the bottom of the valuation ladder
since it is bascially first come first serve for distressed properties
in a rapidly deflating market. I better get mine before you get yours
since there is less and less for either of us to get the longer we
wait. And when you do wait... Well that is how Japan was able to fit 19
years of deflation into what many who can't count call the lost

Now federal regulators are essentially sanctioning the practice as
long as banks restructure loans prudently. The federal guidelines note
that banks that conduct "prudent" loan workouts after looking at the
borrower's financial condition "will not be subject to criticism (by
regulators) for engaging in these efforts." In addition, loans to
creditworthy borrowers that have been restructured and are current
won't be reclassified as "high risk" by regulators solely because the
collateral backing them has declined to an amount less than the loan
balance, the new guidelines state.

Critics say the new rules are yet another example of a
head-in-the-sand approach by regulators, pointing to the relaxed
accounting standards last year that enabled banks to avoid marking the
value of the loans down. This is doing long-term damage to the economy,
they say, because it ties up bank capital, preventing them from
resuming lending.

Critics say a wiser approach would be for regulators and banks to
deal with problems quickly like the Resolution Trust Corp. did in the
early 1990s during the last commercial real-estate crash. Back then,
the RTC helped purge the financial system of toxic mortgages.

The new guidance "gives people a long time to figure out they're not
going to pay it back," said Douglas Durst, a leading New York City
developer. "We are in a period where nothing is happening," he said,
adding that banks are "not making any new loans because they have this
bad debt on their books and not writing it down and getting rid of it.

Let's not forget the intertwined relationship between these buildings
and individual residential mortages. Those who are in sparsely
populated condo buildings tend to default at a higher than average
rate, due to a varierty of factors, maintenance being one of them (see
lyin' eyes part 2 for the math on this topic) - US Home Vacancies Rise to 18.8 Million on Defaults

So, taking this WSJ article into perspective, who among the big and
small banks are lying about thier commercial loan portfolio? Take a
gander at the numbers in question from just one bank. Click to enlarge.


I strongly urge professional subscribers to go through the balance sheet sections of the extended reports available from the downloads section
to see what your favorite bank is holding. If you have any questions,
you can post them in the public comments and if they are germaine to
specific subscription content, I will have my analysts address them in
the professional subscribers' discussion forums.

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Anonymous's picture

delacroix sez about who's propping up WFC:
0 sum game. their lifting each other up at their own expense. there is no one else.

You sir have cooked it down to the essence of pure truth, saying in that one sentence what has taken pundits volumes to say . ...Bravo. Thats the theory Ive subscribed to and when GS dove there are few pieces left in the puzzle that don't fit. My other theory that it was all money managers looking for a big pay day by years end ...well I think they are going to have to live with what they got by now because the owners of the smoke and mirrors circus are running out of smoke and the mirrors are becoming transparent.

Anonymous's picture

delacroix sez about who's propping up WFC:
0 sum game. their lifting each other up at their own expense. there is no one else.

You sir have cooked it down to the essence of pure truth, saying in that one sentence what has taken pundits volumes to say . ...Bravo. Thats the theory Ive subscribed to and when GS dove there are few pieces left in the puzzle that don't fit. My other theory that it was all money managers looking for a big pay day by years end ...well I think they are going to have to live with what they got by now because the owners of the smoke and mirrors circus are running out of smoke and the mirrors are becoming transparent.

huubs's picture

"Those silly, dilly, nillies who are waiting for property values and rents to go back to where they came from...., for it ain't going back to the credit bubble highs until, well,,, we have another credit bubble! "

Reggie, isn't this exactly what is going on right now? First an inflation in stocks (like during the dotcom bubble) and then an inflation in real estate value (like the housing and CRE bubble of 2002-2007).
Why should Bubblenanke stop at 2.1 T balance sheet? He doubled it once, he can double it twice, or three times, just as is needed for reflation. Japan and some EU countries have central bank reserve balance sheet much larger than the FED (as % of GDP)!

delacroix's picture

0 sum game. their lifting each other up at their own expense. there is no one else

deadhead's picture

Excellent Reggie. Thank you very much.

Mr. Efficient Market will return....with wrath.

by the way, who keeps supporting WFC?  I watch that one closely and there is always some force hitting the offer......

Anonymous's picture

that would be GS on orders and funny money from Timmy Tax Cheat.

delacroix's picture

thanks reggie, it makes it a little easier to accept my losses fighting this phantom bull, knowing a savvy guy like you was doin the same. now lets make it all back, and then some

Anonymous's picture

Reggie, First I read your article and watched your exciting home movies of Brooklyn. Both great. Then Apparently I lost my mind for a second and surfed to cnbc and found this story on the front page.

The tag line "why real estate may be better investment than stocks.

Laughed my ass off. Great work. I think I'll believe my lying eyes.

Anonymous's picture

Thank you.

cbxer55's picture

Here in the Oklahoma City area and its surrounds, there are bunches of new, empty buildings. And new ones being built, for whom I cannot even guess.

We have our money (what little we have left) in Bank Of Oklahoma. Its not on the troubled bank list yet, but I know you posted something the other day about them. Is now a good time to get that money out, before TSHTF?

Your articles are good. I am not an investor, would be if I could find a frikkin job. But I still enjoy? reading them.

Thanks for what you do.

Anonymous's picture

If a criticizing regulator is a banks only fear.........sheeeeeeeeeeeeeit my wife could be a regulator.

Anonymous's picture

hey brotherman?care NOT about your performance.

DaddyWarbucks's picture

First class Reggie. One of the benefits of ZH is that we outsiders get to see that there really are true financial professionals out there. Now if we could just get rid of the riffraff..

Arthur's picture

Excellent article and a bit scary.   Things here in Chicago look better on the ground.  Many of the failed condo projects are converting to rental.  There is a dearth of modest rental properties in Chicago.  It may be possible to slow the bleeding to a manageable rate but I have no idea if the conversions are financially viable alternatives.

To me the real question is whether Federal government can continue to support the charade and at what cost?   Japan kept it going for almost two decades.  How many of the so called zombie banks have been resurrected and now have legit, stand alone balance sheets? 

 Can the Feds tweak the system so the banks are required to make “reasonable” loans to credit worthy borrowers instead of playing in the financial markets with the governments “free” money? 

Clearly, absent accounting changes and Fed dollars many banks fail.  But with the Fed changing the rules what is the average investor supposed to do?  Given a long enough horizon the banks may become legitimately profitable.