The Great Global Macro Experiment, BoomBust Cycles, and the Refusal to See the Truth: Bubble Economics in the Mainstream Media

Back in September of 2007 when I was preparing to launch a hedge
fund, I came up with this interesting name for a blog. It was
BoomBustBlog. What made it interesting is that I can literally blog ad
infinitum on the synthetically crafted booms and busts of the global
economy, for the method of shepherding the economy in this day and age
is actually predicated on the existence and/or creation of Booms and
Busts. Of course, from my common sense perspective, one would think that
the job of a central banker would be to ameliorate the effects of, and
in time eliminate booms and busts… Apparently, that doesn’t appear to be
the flavor du jour. As a matter of fact, it appears as if central
bankers are doing the exact opposite. Of course, attempting to cure a
bust with a boom, or worse yet attempting to prevent a boom from busting
with another boom is a recipe for disaster, and worse yet the
probability of success is close to nil, yet central bankers try anyway.
This leads to overt and explicit policy errors, which leads to outsized
profit opportunities to those who pay attention. Enter “The Great Global Macro Experiment, Revisited“,
from which I will excerpt below. Please keep in mind that this article
was written in October of 2008, and turned out to be quite prescient, I
will annotate in bold parentheticals the portions of particularly
prescient relevance. The original macro experiment piece was posted on
my blog in September of 2007… For those that are interested, I plan on
discussing this topic live on Bloomberg TV today: “Street Smart” with Matt Miller & Carol Massar at 3:30 pm.

As the US real estate market (residential, and soon commercial) is tanking (see BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming), the opaque derivative structures that allowed banks to write loans bigger than their balance sheets follow (see Is this the Breaking of the Bear? among many others).
This will ripple throughout the world as speculative real estate and
exotic financing vehicles follow the same paths in Europe (see the Pan-European Sovereign Debt Crisis series), Africa (reference Dubai’s solvency issues), Asia (see Chubble
(The Unmistakeable, Yet Thoroughly Argued Chinese Bubble),
Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other
News and What Are the Odds That China Will Follow 1920’s US and 1980’s Japan?),
and South America. Spain’s residential real estate market is currently
on fire and 92% of the mortgages issued are ARMs, most of which are
concentrated to the lower income buyers (see “The Spanish Inquisition is About to Begin…“ and Spain Reports 20%+ Unemployment, a Structural Problem That May Persist For Some Time). Sound familiar? Similar scenes in Brazil. UK residential prices have soared (see Osborne Seems to Have Read the BoomBustBlog UK Finances Analysis, His U.K. Deficit Cuts May Rattle Coalition as well as the near collapse of several large UK banks), Australia up nearly 3 times (relative) (see Australia: The Land Down Under(water in mortgage debt),
China homebuilders and contractors or roaring, condos in Dubai
everywhere… Add in the US exported structured products… Practically all
of the popularized risky assets are destined to follow suit, not just
real estate – expect pressure in the emerging market debt markets as a
follow-through…

Understanding my proprietary investment style

My own, personal and discretionary
investment style leverages long and short positions in any traditional
or alternative asset class, in any instrument, in any market around the
world with the goal of profiting from macroeconomic trends. Put most
simply, I attempt to employ the tried and true adage: buy low and sell
high – I simply aim to do it during all phases of the market cycle. The
often used, but seldomly recognized as meaningless, investment style
classifications of value investing, growth company investing, etc. are
silly, to say the least. Everybody is a value investor. We all buy
something with the understanding that we will be able to sell it for
more, thus the implication that it is undervalued at the time of
purchase. The reason why we feel we can sell it for more is the impetus
behind these nonsensical monikers of value, growth, Amy, Cindy and
Karen! At the end of the day, we all want to buy low and sell high. The
key is, how do we successfully go about doing it.

Now, in reading the now historical missive above which references
debacle after debacle that policy makers retort “were impossible to see
coming” (yeah, uh huh!), it could conceivably be argued that a) I had a
crystal ball, b) I’m just smart as hell, or c) I simply pay attention
and adhere to basic math, i.e., 2 + 2 = 4, all day, everyday – you know,
realism. I’ll let you decide which answer is most appropriate. I go
through this exercise because while reading through Bloomberg at 2 am in
the morning (yeah, I know I should have better things to do,  but how
else will this blog get written), I came across a statement from some
professionals that reinforced my thesis that some investors literally
cannot possibly fathom that we are still in a bubble despite 40% drops
in commercial real estate prices. Take a look at the chart above, the
cycle goes up and down, and has been doing so for centuries. Despite the
fact that nothing has really changed for over a 1,000 years, it is
amazing that so very few have learned their lesson. Or to put it another
way, just because something is cheap doesn’t mean it can’t get a whole
lot cheaper. Wait a minute, I’ve got another one… I fall out of a 10
story window, and drop 60 feet in a matter of seconds…. Does this really
mean that my fall is over just because I fell 60 feet so fast, or do I
really have another 100 feet to go, then a very hard impact before all
is said and done???

Bloomberg writes: Real Estate Premium to U.S. Bonds Signal Time to Buy Property

Sept. 1 (Bloomberg) — U.S.
commercial real estate yields are near the highest level relative to
Treasury bonds on record, a signal to some investors it’s time to buy
property. Capitalization rates, a measure of real estate yields,
averaged 7.22 percent in the second quarter, based on an index
calculated by the National Council of Real Estate Investment
Fiduciaries. That was 429 basis points, or 4.29 percentage points,
higher than the yield
on 10-year government bonds as of June 30, according to data compiled
by Bloomberg. It’s about 475 basis points higher than Treasury yields as
of yesterday.

That spread is near the record 539
basis points in the first quarter of 2009, when the U.S. was mired in
the worst of the financial crisis and property prices sank. Risk-averse
investors are seeking the highest-quality office towers, hotels and
apartments as the gap widens, according to Nori Gerardo Lietz, partner and chief strategist for private real estate at Partners Group AG in San Francisco.

“The data indicate that real estate
is poised for a rebound,” said Gerardo Lietz, who advises pension funds
on property investments.

Well, I have several problems with the statement above. For one, it
is very difficult to “time” real estate markets due to their illiquid
nature and a lack of a crystal ball, but if one were a market timer the
strategy above makes sense right? Actually, no it doesn’t. For one, we
are not in any better an economic or fundamental position now than we
were in 2009, its just that the government and the fed have spent so
many trillions of dollars to create the illusion that we are under the
umbrella of attempting to reinflate the bubbles of 2000 to 2007. With
that being said, of course spreads are similar, the situations are
similar save the government has less ammunition to fight the battle this
time around.

Chart sourced from CREconsole.com

The strategy above appears to be borne from the long only asset
management mantra of always buying an asset. Sometimes its best just to
say “No!”. For instance, the story clearly states that spreads are
almost as wide as they were in the first quarter of 2009, the height of
the financial malaise. So, if one were to use the logic inherent and
bought at those even wider blowout spreads (the argument for the thesis
was stronger back then), take a look at what would  have happened to
your hard earned (or your client’s hard earned) money…

The
Moodys/REAL commercial property index (CPPI) is a periodic
same-property round-trip investment price change index of the U.S.
commercial investment property market based on data from MIT Center for
Real Estate industry partner Real Capital Analytics, Inc (RCA). The
index has been developed with the objective of supporting the trading of
commercial property price derivatives. The index is designed to track
same-property realized round-trip price changes based purely on the
documented prices in completed, contemporary property transactions. The
index uses no appraisal valuations. The set of indices developed so far
includes a national all-property index at the monthly frequency,
national quarterly indices for each of the four major property type
sectors (office, apartment, industrial, retail), selected
annual-frequency indices for specific property sectors in specific
metropolitan areas, and primary markets quarterly indices for the top 10
metropolitan areas in the major property types.

The biggest hole (and there are a few) in this “spread” thesis is the
gross reliance of the spread to Treasuries without recognition and
appreciation that Treasuries themselves are most likely in a bubble.
This is why it is best to take a truly fundamental look at your
investments. Back to the story…

Some buyers already are acquiring
buildings at lower cap rates, which move inversely to price. In June, a
group of South Korean pension fund investors bought the 33-story Wells
Fargo Building in San Francisco for $333 million from Principal Financial Group Inc.
in one of the largest transactions in the second quarter, according to
Real Capital Analytics Inc., a property research firm. The office tower
sold at a cap rate of about 7 percent, said Goodwin Gaw, the developer who helped broker on the deal.

My question is, why not just wait until there is a discernible trend
in the stability of CRE? Why must everyone rush in to be first? Do
rental rates look to be going much higher in the near to medium term due
to materially firmer business fundamentals or lessened supply? Do
interest rates look to be dropping considerably in the near to medium
term? Are the fundamentals of the renters firm and strong? How does
supply vs demand look after rampant, bubblicious overbuilding (which is
still going on, may I add)? How does the financing and credit landscape
look? How about the credit metrics of existing buildings? Do we have low
LTVs or are these things thoroughly underwater (see the Macerich excerpt below). Let’s take a few pages out of my CRE 2010 Outlook report for subscribers (click here to subscribe). Be aware that this 47 page report was written nearly 10 months ago…

Are US Treasuries In A Bubble?

Well, if they are, not only does that debunk the “spread only” thesis
to CRE investing but it will devastate those who employed said thesis
when the bubble pops. As treasury yields spike, the cap rates on said
buildings will have to spike to maintain said spread or the spread will
have to lessen making the CRE that much more expensive relative to the
safer treasuries. Either way, the CRE investor would have wished they
waited! Let’s take a look at the NYSE US 10 yr index…

Whoa!!! Looks pretty bubblicious to me! Herein lies the problem. I
don’t think that many investors truly understand the predicament that
the US, much Europe and those big boys in Asia are in. Pray thee tell
me, how is the US going to pay back its massive debt? Taking this from
the beginning, many of us were told that the Federal Reserve’s mandate
was to management inflation and unemployment rates. I lost a lot of
profit and messed up a 7 year record of investing in the 2nd quarter of
2009 when the federal reserve performed a stealth mandate change, which
in essence was to reinflate and maintain the credit and risky asset
bubbles of the new millenium. This bubble blowing has been funded by the
tax payer through the US Treasury. I challenge anybody to prove that
the Fed’s objective has been anything but. The government and the CB has
literally pulled out all stops to prevent the “Bust” portion of the
Boom/Bust cycle. They have bought trillions in MBS, toxic assets
directly off of private companies balance sheets, insured and
indemnified private transaction, nationalized failed private financial
institutions, purchased treasuries and MBS directly in a bid to
artificially lower market interest rates -this is a move which is in and
of itself by definition, unsustainable and guarantees a rate spike.

To make a long story short, nearly all of the biggest private sector
problems have effectively been nationalized and made public sector
problems without forcing the private sector to right its wrongs. Since
nothing has really changed in the private sector and we are not marking
bad assets to market but rather letting whatever we couldn’t goose the
government into buying and converting into treasuries remain as they
were while cash generating from the faux recovery was paid out as
bonuses – the banks still have a shit load of trash on their balance
sheets amid a worsening macro environment, the most indebted government
of our lifetime and crumbling fundamentals. I pray thee tell me, exactly
how are rates not going to spike? US Treasures are the new CDOs,
wherein back in 2007 private banks scooped the trash they couldn’t
convince suckers clients into buying directly, said trash was aggregated and repackaged with a AAA moniker and then sold to suckers clients.
So, what is the difference between what Lehman, Goldman, Merrill and
Bear Steans did and what out Central Bank is doing – that is picking up
the garbage that nobody wants, recycling it into treasuries with a AAA
moniker and then reselling them? The biggest difference is that one of
the biggest suckers clients
buying these repackaged toxic assets cum treasuries is the Federal
Reserve, itself. Talk about a Ponzi scheme that is unsustainable. Again,
how is it that treasuries are not in a bubble? How will rates stay low
enough to justify buying CRE based upon the spread over treasuries at
historic lows that are virtually guaranteed to go higher before the
fundamentals of CRE improve significantly? I haven’t even touched upon
the situation of our friends over there in Europe  – see .Pan-European Sovereign Debt Crisis series,
where several nations are skirting default or restructuring (de facto
default, you don’t get your money as promised) which will most likely
cause some serious interest rate volatility, of which some banks are not
prepared to withstand – See The Next Step in the Bank Implosion Cycle???). Since banks lend to CRE investors…. Oh well, back to the article…

Comparing Yields

Investors compare property yields
with Treasuries to determine how much potential profit real estate
offers relative to an investment that’s considered low-risk. The spread
shrank to less than 80 basis points, the narrowest in 16 years, when
commercial real estate prices peaked in 2007. Property values have dropped more than 40 percent since the October 2007 top of the market, according to Moody’s Investors Service.

The gap’s widening follows a plunge
in bond yields after the global financial crisis spurred a flight to
safety and the Federal Reserve slashed interest rates
to a record low. Treasury bonds yesterday completed the biggest monthly
rally since the end of 2008 amid signs economic growth is faltering,
with the benchmark 10-year note yielding 2.47 percent.

“Property is attractively priced versus the fixed-income market,” said Ritson Ferguson, chief investment officer of ING Clarion Real Estate Securities in Radnor, Pennsylvania, which manages about $12 billion.

Yes, he’s right. Then again, 2 day old oysters smell attractive
versus 3 day old oysters as well. Does that mean that 2 day old oysters
smell good? The primary mantra of investing should be return of capital
over return on capital!

The wide spread carries a warning signal to some investors because the economy remains weak, hurting commercial rents and occupancy. To contact the reporter on this story: Hui-yong Yu in Seattle at [e-mail]

Those would be the more prudent investors they are referring to, at least in my oh so humble opinion.

The Amount of Underwater Properties is Nothing to Sneeze At

In December of 2009, I posted an article and accompanying research titled, “A Granular Look Into a $6 Billion REIT: Is This the Next GGP?” The following are excerpts from it:

The results of these activities have
been congealed in our analysis of Macerich’s entire portfolio of
properties (118+ properties), including wholly owned, joint ventures,
new developments, unconsolidated and off balance sheet properties.
Below is an excerpt of the full analysis that I am including in the updated Macerich forensic analysis. This sampling illustrates the damage done to equity upon the bursting of an credit binging bubble. Click any chart to enlarge (you may need to click the graphic again with your mouse to enlarge further).

Notice the loan to value ratios of the properties acquired between
2002 and 2007. What you see is the result of the CMBS bubble, with
LTVs as high as 158%. At least 17 of the properties listed above with
LTV’s above 100% should (and probably will, in due time) be totally
written off, for they have significant negative equity. We are
talking about wiping out properties with an acquisition cost of nearly $3 BILLION,
and we are just getting started for this ia very small sampling of
the property analysis. There are dozens of additional properties with
LTVs considerably above the high watermark for feasible refinancing,
thus implying significant equity infusions needed to rollover debt
and/or highly punitive refinancing rates. Now, if you recall my
congratulatory post on Goldman Sachs (please see Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off),
the WSJ reported that the market will now willingingly refinance
mall portfolio properties 50% LTV, considerably down from the 70% LTV
level that was seen in the heyday of this Asset Securitization Crisis.
Even if we were to assume that we are still in the midst of the
credit bubble and REITs can still refi at 70LTV (both assumptions
patently wrong), rents, net operating income and cap rates have moved
so far to the adverse direction that MAC STILL would not be able to
rollover the debt in roughly 37 properties (31% of the portfolio)
whose LTVs are above the 70% mark – and that’s assuming the credit bubble returns and banks go all out on risk and CMBS trading. Rather wishful thinking, I believe we can all agree.

For those of you who didn’t catch it in the table above, I’ll blow it up for you…

Notice anything familiar??? There is a very strong chance that every
single property on the list detailed in the forensic reports will be
taken over by the lenders, that’s a lot of properties. Subscribers
should reference MAC Report Consolidated 051209 Retail 2009-12-07 03:46:49 580.11 Kb , MAC Report Consolidated 051209 Professional 2009-12-07 03:48:11 1.03 Mb, Click here to subscribe!

So, why has Macerich and the entire REIT
sector defied gravity despite the fact they are getting foreclosed
upon faster than a no-doc, subprime, NINJA loan candidate who just
lost his minimum wage job amongst all of these “Green Shoots”??? Well,
I took the time to answer that in explicit detail… I urge all to read The
Conundrum of Commercial Real Estate Stocks: In a CRE “Near
Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

Now since the posting of the article above, Macerich as forced to
disgorge several of those properties due to solvency issues. The math
doesn’t lie! Chances are there will be several more! Anyone who has an
interest in the CRE space should download my 47 page outlook for the
sector in 2010 (available to all paying subscribers of any level):  see Reggie Middleton’s CRE 2010 Overview 2009-12-15 02:39:04 2.72 Mb (42 pages). Now, I’m aware that viewpoints and statements may not win me many popularity contests in man professional circles (ie Even With Clawbacks, the House Always Wins in Private Equity Funds), but I aim to call it as I see it.

More on commercial real estate:

• Even With Clawbacks, the House Always Wins in Private Equity Funds
• Commercial
  Real Estate Continues to Dropped into Foreclosure as the Landlords of
  Said Properties Enjoy Skyrocketing Share Prices? Yep, Makes Plenty of
  Sense
• The
  Conundrum of Commercial Real Estate Stocks: In a CRE “Near
  Depression”, Why Are REIT Shares Still So High and Which Ones to Short?
• The Shortlist of the Shortlisted “Stocks to Short for 2010″: What We See as the Most Profitable Bear Postions for 2010
• Developing Implications on Loan Accounting Law: Mark to Market, Mark to Model, or Mark to Market Crash?

More on residential real estate:

• I
  Told You Housing Was Going to Take a Downturn for the Worse. I’ll
  Tell You Something Else, We Are in a Housing Depression! It’ll Get
  Worse Until Market Forces Rule Over Government Bubble Blowing!
• Anecdotal Evidence That Banks Are Hiding Depressed High End Real Estate
• As I Made Very Clear In March, US Housing Has a Way to Fall
• Australia: The Land Down Under(water in mortgage debt)
• Australia: The Land Down Under(water in mortgage debt), pt. Deux: Which Banks to Short?
• Aussi Bubble Video to Go With You Aussie Bubble Speculation?
• Recent Mortgage Loss and Credit Performance Commentary

Comments

[tom]

You've got an interesting project and I wish you the best with it. In my experience, the macro fund is a tough sell. Conservatives want their managers to hedge out rather than predict cyclical turns, and cowboys like to re-allocate bullishly vs bearishly depending on their personal outlook, wrong as it usually is. Timing is the hardest thing to credibly claim to have better than others. Besides, these days, it's all armchair-quarterbacking the policy moves. You need to know the minds of the FOMC.

[RoRoTrader]

Reggie,

Zero Hedge had a Michael Pento article/interview out earlier and Pento argues that the FED is about to become the defacto market for stocks and CRE (massive debts  maturing in 2011/2012).

The FED waved its magic wand and created $2T out of thin air and then swapped the cash out to the banks and took the banks's toxic assets onto the FED balance sheet in exchange.

The banks then deposited the $2T back at the FED for which the FED pays the banks interest.

The point being, and a point made by others besides Pento is that the FED has its arsenal for QE2 already in place in the form of the $2T which is put back out to the banks can be multipied using fractional bank practices to create a number 10X or more than the $2T, and the multipied number of $10T can be pushed into the purchase of stocks and CRE.

The problem with the scale and frequency of interventions is that price/s has/have become distorted, and if the the FED follows through with a scheme of this scale then the elimination of price risk for this phase of intervention dwarfs the elimination of price risk seen in the 2009 markets.

The FED has become the risk to natural price discovery.

[Gloomy]

Great data and commentary at Consumer Metrics. Their stuff should be regularly posted on ZH.

"There probably hasn't been two separate recessions in three years, simply one that has evolved in significant ways. But if this really is a "double dip" recession, then our data indicates that the "Great Recession" of 2008 was merely the precursor, and not the main event. It is this current dip that we should be really concerned about; the current contraction in consumer demand is about structural changes in consumer behavior, whereas the "first dip" was about short term loss of consumer confidence"

http://www.consumerindexes.com/index.html

[RockyRacoon]

Thanks, Reggie.  Lots of info to follow up on.  I'm always reminded of the old axiom, "If it looks too good to be true..."

Making things look "good" seems to be the only goal of TPTB.

[redrob25]

Understand the fundamentals first, then if they look good, do your technicals analysis.

If the fundamentals look really bad, ignore technical data. It's a trap. Always see big picture first.

[DaveyJones]

"Pray thee tell me, how is the US going to pay back its massive debt?"

they're not, hence the prayer

[proLiberty]

There is only one way out: treat it like a restructuring.   We must sell whatever assets we can.  We must cut spending.  We must structure taxes and SEC regulations to do all we can to unleash people who have sound business ideas so they can raise venture capital and hire employees.  If we do not stop borrowing and start growing, we are doomed.

An exmple of assets we must liquidate:

The US government owns 30% of land, including > 50% of the land west of the Mississippi.  Some of it like the Grand Staircase-Escalante National Monument in Utah overlay some of the world's most valuable coal deposits.  We can no longer afford the luxury of having endless pristine vistas, as much as it pains me to state this hard fact.

[MrSteve]

My first response was to just junk such stupid logic as proposed here by proLiberty, except I think a better response is to label it as Libertarian outhouse effluent. Certainly the measure of value in protecting unique experiences and incredibly valuable long term energy holdings in western lands is the best plan for long term investors in America's families' holdings. The grasping, short-termism clowns who would sell off everything of long term value (like all Federally-held coal deposits) are nothing short of stupid value whores who know the price of everything and the value of nothing, except their next cheap fix. I do apologize in advance to all cheap whores who are demeaned by proLiberty's usurpation of their status.

[Sudden Debt]

Why do you think banks ask at least a 25% upfront payment if you want to buy a house?

Because banks still expect a 25% drop.

[MrSteve]

Anecdotally, a personal banker here in metro Chicago told me her firm was very concerned with bank regulators looking over their shoulder on every loan and noting the lack of cash or savings on the borrower's part. The paucity of savings on the consumer's part is holding back banks from making loans, at the same time the banks need to increase reserves for loan losses "pending", or more accurately, already baked into the books.

It will take years for the excesses to be worked off, if ever! Who will stand the loss when the FDIC has a current -.38% coverage? Mr & Mrs 1040 payer!