In Real Estate and Finance, How do you know what you don’t know?
How do you know what you don’t know?
And why is everyone so willing to pretend that you do?
I am fascinated by the ability of the rating agencies such as Moody’s, Standard and Poors and Fitch to sell the idea that they understood and could rate the risks of the various tranches of debt that were sold to investors and the willingness of those investors to accept unquestioningly their pronouncements.
The slicing and dicing of the debt obligations performed with mathematical precision of a professor and a surgeon’s skill, seemed good on paper. The theory that we can put all the stuff together, let the cream rise to the top and separate the various risk elements sounds good. The dairy analogy is akin to churning butter and producing not only butter, but buttermilk and skim milk along the way. But the genius did not stop at one iteration; for the theory said, we could then reprocess both the butter and the buttermilk and again produce even more of the best stuff. And here the theory moves deeply into uncharted territory as there was never experience to determine what really happens in these iterations or tests to stress the models and see how they perform under a variety of situations; do you really get more butter or just a bunch of rehashed stuff that you pretend to pass off as butter?
The fact that inventive Wall Street salesmen came up with the idea is no shock. That is what they are paid handsomely to do. Their management’s abrogation of their duties is the subject for another day. The fact that rating agencies and investors willingly bought into the idea without adequate understanding of that which they blessed or purchased respectively is a gross abrogation of their responsibility. Those that so grossly violated their fiduciary responsibilities must be held accountable for the damage they created.
The emperor had no clothes- Shame on those that undressed him, more shame still on those accomplices who paraded him around.
And why is everyone so willing to pretend that you do?
I am fascinated by the ability of the rating agencies such as Moody’s, Standard and Poors and Fitch to sell the idea that they understood and could rate the risks of the various tranches of debt that were sold to investors and the willingness of those investors to accept unquestioningly their pronouncements.
The slicing and dicing of the debt obligations performed with mathematical precision of a professor and a surgeon’s skill, seemed good on paper. The theory that we can put all the stuff together, let the cream rise to the top and separate the various risk elements sounds good. The dairy analogy is akin to churning butter and producing not only butter, but buttermilk and skim milk along the way. But the genius did not stop at one iteration; for the theory said, we could then reprocess both the butter and the buttermilk and again produce even more of the best stuff. And here the theory moves deeply into uncharted territory as there was never experience to determine what really happens in these iterations or tests to stress the models and see how they perform under a variety of situations; do you really get more butter or just a bunch of rehashed stuff that you pretend to pass off as butter?
The fact that inventive Wall Street salesmen came up with the idea is no shock. That is what they are paid handsomely to do. Their management’s abrogation of their duties is the subject for another day. The fact that rating agencies and investors willingly bought into the idea without adequate understanding of that which they blessed or purchased respectively is a gross abrogation of their responsibility. Those that so grossly violated their fiduciary responsibilities must be held accountable for the damage they created.
The emperor had no clothes- Shame on those that undressed him, more shame still on those accomplices who paraded him around.
David Levin
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A Million Lawyers a Lawyering
In today’s real estate market the song The Twelve Days of Christmas would need to expand to include A Million Lawyers A Lawyering.
The lawyers have their work cut out for them. As people look to get out of contracts and agreements, they need the advice and help of trained professionals to parse the documents and find grounds that the original agreement is not what everyone thought it to be and therefore invalid. It will be a messy situation as these disputes are resolved. Some might be renegotiated amicably but many will find themselves in a court where judges and juries will have the ultimate say.
Some of these disagreements are legitimate; many will look toward technicalities to get a party relieved of some commitment. When things turn against your position, it is natural to seek ways to get out of harms way. Or to use an analogy: When the light at the end of the tunnel is an oncoming train, you want to get off the tracks before it hits you. And if the train has already wrecked, you need to determine who is responsible for cleaning up the mess. This is where the lawyers come in.
The mess that exists in many parts of the real estate market is big and getting bigger. Having legal representation of your position in the midst of something that is put together with legal documents is expected. Whoever ultimate prevails, the lawyers will have racked up the billable hours that will be charged to both sides.
But the question remains: Then What?
The lawyers have their work cut out for them. As people look to get out of contracts and agreements, they need the advice and help of trained professionals to parse the documents and find grounds that the original agreement is not what everyone thought it to be and therefore invalid. It will be a messy situation as these disputes are resolved. Some might be renegotiated amicably but many will find themselves in a court where judges and juries will have the ultimate say.
Some of these disagreements are legitimate; many will look toward technicalities to get a party relieved of some commitment. When things turn against your position, it is natural to seek ways to get out of harms way. Or to use an analogy: When the light at the end of the tunnel is an oncoming train, you want to get off the tracks before it hits you. And if the train has already wrecked, you need to determine who is responsible for cleaning up the mess. This is where the lawyers come in.
The mess that exists in many parts of the real estate market is big and getting bigger. Having legal representation of your position in the midst of something that is put together with legal documents is expected. Whoever ultimate prevails, the lawyers will have racked up the billable hours that will be charged to both sides.
But the question remains: Then What?
Real Estate Predictions for 2008
I was recently asked in an interview for my 2008 predictions. I quipped that the best to be said of 2008 will be that 2009 will follow.
As 2007 closes and 2008 begins remember that the real estate cycles are affected by seasonality but not by the date January 1. In a nutshell, I believe we will see a continuation of those things already in process during 2007: Housing prices will continue to fall, credit will remain tight, a second wave of readjustments in Adjustable Rate Mortgages will hit the system, foreclosure activity will continue, inventory will continue to build further pressuring prices and Government help won’t. However, lenders may become more flexible with troubled borrowers.
Housing prices will continue to fall because of everything noted above plus the issue of affordability. Housing costs need to reflect the ability of the local wage earners to carry them. So Principal, Interest, Taxes and Insurance needs to be aligned with local income levels. Since incomes did not keep pace with the housing prices while insurance and taxes increased, prices will be pushed lower to realign with income levels.
The second tidal wave of Adjustable Rate Mortgage adjustments is scheduled to sweep through this year. This will do more of the same type of damage we saw in 2007, as many will not be able to meet their new payments. Many will have to talk to their lenders to renegotiate. Lenders confronting the same market as other sellers will probably consider a variety of alternatives to foreclosure including forbearance, short sales and other creative approaches. ONE CAVEAT will be the proliferation of scoundrels and charlatans waiting to prey on the unsuspecting. BE VERY CAREFUL when accepting help with a problem situation.
The excesses built up in the boom times will continue to take their toll. Unfortunately things do not immediately realign and then business continues on as before. It is a long arduous and expensive process. It will take at least through the coming year to work through much of it.
As 2007 closes and 2008 begins remember that the real estate cycles are affected by seasonality but not by the date January 1. In a nutshell, I believe we will see a continuation of those things already in process during 2007: Housing prices will continue to fall, credit will remain tight, a second wave of readjustments in Adjustable Rate Mortgages will hit the system, foreclosure activity will continue, inventory will continue to build further pressuring prices and Government help won’t. However, lenders may become more flexible with troubled borrowers.
Housing prices will continue to fall because of everything noted above plus the issue of affordability. Housing costs need to reflect the ability of the local wage earners to carry them. So Principal, Interest, Taxes and Insurance needs to be aligned with local income levels. Since incomes did not keep pace with the housing prices while insurance and taxes increased, prices will be pushed lower to realign with income levels.
The second tidal wave of Adjustable Rate Mortgage adjustments is scheduled to sweep through this year. This will do more of the same type of damage we saw in 2007, as many will not be able to meet their new payments. Many will have to talk to their lenders to renegotiate. Lenders confronting the same market as other sellers will probably consider a variety of alternatives to foreclosure including forbearance, short sales and other creative approaches. ONE CAVEAT will be the proliferation of scoundrels and charlatans waiting to prey on the unsuspecting. BE VERY CAREFUL when accepting help with a problem situation.
The excesses built up in the boom times will continue to take their toll. Unfortunately things do not immediately realign and then business continues on as before. It is a long arduous and expensive process. It will take at least through the coming year to work through much of it.
Happy New Year
As 2007 draws to a close, I would like to wish everyone a Happy Healthy New Year.
For many of us the markets the coming year will continue to be challenging. But as we work through it, take a moment to remember the blessings we have. Health, family, and friends count for a lot. And when we have those, the work stuff becomes much easier to do.
Thank you to everyone that has helped to make our 2007 a very good year. I sincerely hope that the website/ blog and the radio program have been insightful, interesting and even useful. I will do my best to make these even better as we move into 2008.
Happy New Year!
David
In Real Estate Cash is King, but Knowledge is the power behind the throne
When the going gets tough, the smart have cash.
As credit markets continue to be tight, financing real estate will remain particularly troublesome for leveraged deals. And as real estate markets deteriorate, desperate property owners will require infusions of Equity to carry projects or to bail out of deals gone awry. Cash is king.
Investors with access to cash equity will be in a unique position to capitalize on those situations. And those with a longer term view of the market will be poised to invest in interesting and potentially lucrative opportunities.
Remember that this is a high stakes game. Knowledge is key. Knowing which opportunities are the ones to invest in is based on a thorough understanding of the market. Now is the time to be learning all you can about the markets and the potential for each product type. For some areas, single family houses will be better opportunities than multifamily properties, offices may be better than retail. You need to learn all you can about the market, its risks and rewards and where you fit into the equation.
Lastly, spend time developing relationships with lenders. You need to understand what they are seeking and what product types they find desirable so when the opportunity does arise, you are prepared to move forward with equity and debt.
Many have described luck as preparation meeting opportunity. In other words it is not about luck at all. It is about knowledge and work.
As credit markets continue to be tight, financing real estate will remain particularly troublesome for leveraged deals. And as real estate markets deteriorate, desperate property owners will require infusions of Equity to carry projects or to bail out of deals gone awry. Cash is king.
Investors with access to cash equity will be in a unique position to capitalize on those situations. And those with a longer term view of the market will be poised to invest in interesting and potentially lucrative opportunities.
Remember that this is a high stakes game. Knowledge is key. Knowing which opportunities are the ones to invest in is based on a thorough understanding of the market. Now is the time to be learning all you can about the markets and the potential for each product type. For some areas, single family houses will be better opportunities than multifamily properties, offices may be better than retail. You need to learn all you can about the market, its risks and rewards and where you fit into the equation.
Lastly, spend time developing relationships with lenders. You need to understand what they are seeking and what product types they find desirable so when the opportunity does arise, you are prepared to move forward with equity and debt.
Many have described luck as preparation meeting opportunity. In other words it is not about luck at all. It is about knowledge and work.
