The Stimulus from a Realestatarian’s Perspective

Your perspective on the relative success or failure thus far of the American Recovery and Reinvestment Act of 2009 aka “The Stimulus Plan”, probably depends, in part, on your political persuasion. Republicans have called it a failure and Democrats remain hopeful that the benefits will start to tangibly kick in. I would like to look at the $787 billion  (which equates to about 5.5% of GDP while the New Deal was only about 2% of GDP) the government has appropriated from the perspective of neither a Republican nor a Democrat, but rather from the perspective of a real estate guy or what I will call a Realestatarian.

In February, we were told that the Stimulus plan had to be approved by Congress “to avoid economic armageddon” because “we are approaching a financial catastrophe unlike anything this country has seen since the depression.” The President told us that, “A new wave of innovation, activity and construction will be unleashed all across America” and that it would, “create up to 4 million new jobs” (“create or save” was the modification months later when it was clear that the projection was a fantasy). The Vice-President said that the spending plan would “drop kick” the economy out of the recession. The National Economic Director said, “You’ll see the effects begin almost immediately”.

These statements sounded very positive. The Realestatarian in me told me that it sounded too good to be true. When has the government, under any party, efficiently implemented a program like this? And by the way, How were we going to pay for this spending plan?

Another major concern has been the unprecedented shift in economic power from the private sector to Washington D.C.  Moreover, notwithstanding the party affiliation of the resident in the White House, programs like this have typically been riddled with waste, fraud, abuse, inefficiency, incompetency and corruption. With a unified government the potential for these outcomes is unavoidable.

From the Realestatarian’s perspective, what matters most? JOBS, that’s what. Employment is the single most important indicator affecting the fundamentals of our real estate markets. If people are out of work they are not spending money and if people are not spending, our retail tenants are not leasing new stores, let alone paying the rent on their present locations ( 70% of GDP is the result of consumer spending ). If people are not working they are not likely to be moving to a bigger apartment, or moving from a rental unit into a newly purchased home. If companies are reducing the size of their workforce, they don’t need to lease more office space and may even be disposing of excess space caused by contraction. We need jobs to stimulate growth and the Stimulus Plan has not produced new ones. Whether jobs have been saved is difficult to prove, hence a wonderful political thesis.

Today, the Bureau of Labor Statistics tells us that the unemployment rate is 9.5%. This is, however, just the tip of the iceberg. This is based upon a June number of 467,000 jobs lost. These numbers are typically revised and the revisions rarely are downward. 7.2 million people have lost jobs since the start of the recession wiping out the total net gains of the prior nine years making this the only recession since the Depression during which all of the job growth from the previous expansion has evaporated.

Additionally, the unemployment rate does not take into consideration all of the people who have given up looking for a job or workers taking part time jobs who would would like to work full time or workers who have been asked to take unpaid leave. If these groups were included, the unemployment rate reaches 16.5% leaving about 25 million people involuntarily idle. Projections from most economists now indicate that unemployment will peak between 10% and 11% and rates over 9% are likely to be with us throughout 2010. To say this is not good for real estate is an understatement.

The Stimulus Plan was supposed to yield $1.50 of economic activity for every dollar spent. Thus far, less than 20% of the money has actually been spent and the benefits have been difficult to see. Unfortunately, the Stimulus Plan is loaded with pork and too much of the money has gone towards tranfer payments such as Medicaid and unemployment benefits, neither of which do anything to create jobs or stimulate economic growth. Jobs would be created by spending on  infrastructure but only about 10% of the $787 billion is slated for this purpose.

Benefits to small businesses would stimulate job growth and are needed. Small business entrepreneurs have led America out of the last seven post-World War II recessions. They also create about 2 of every 3 new jobs during a recovery. Rather than providing tax savings to these businesses (which can be implemented quickly and efficiently), all indications are that small businesses will face rapidly increasing taxes whether it is because of a need to pay for a government run healthcare system, a need to plug budget gaps created by all of the spending the government has initiated or simply because inevitable inflation (caused by a doubling of the money supply in just 9 months) will increase the cost of borrowing. This is a major concern as the money supply has grown by more in the last 9 months than in the last 50 years in aggregate.

Unfortunately, the economic downturn has been used as an excuse to greatly expand the size of government. The Stimulus, and how the money has been allocated, clearly reveals that, presently, income redistribution is prized above all else, including job creation and economic growth. As Realestatarians, we can’t be feeling too good right now. We need to see a reversal in the direction of unemployment before a real estate recovery can occur.

The Poop on the PPIP

This past week, we read an announcement about the Treasury selecting nine fund managers to implement the PPIP program. Is this a positive thing? Should we celebrate? Let’s take a closer look:

In what has been called, “The greatest program that never happened”, the government’s Public-Private Investment Program, or PPIP (which is part of the TALF) has lost significant momentum and is a mere shadow of what is was initially intended to be.  Originally slated to help banks rid their balance sheets of $1 trillion of toxic assets, the program is now targeting $30 to $50 billion. These toxic assets were to include bad loans and distressed securities. One of the main goals of the PPIP was to help create liquidity in frozen markets. Our real estate market was hoping that the program would provide a shot in the arm to the CMBS market, a desperately needed component of the massive financing the market requires. As real estate brokers, we were hoping that pools of real estate loans would be purchased by institutions in bulk and funneled back into the market expeditiously creating opportunities for us.

At the time of its initial announcement on March 23rd by Treasury Secretary Geithner, markets rallied nearly 500 points or about 7%.  Subsequently, some of the larger banks were able to raise capital based upon the resulting confidence the announcement gave to investors. Federal officials now say that the slimmed down PPIP has been trimmed due the banks’ becoming healthier. But are they really healthier?

Since the start of 2008, seventy banks have failed. Most of these institutions have been smaller community banks and regional banks. Banking analysts are projecting hundreds of additional collapses during the next two years. These smaller banks often play key roles supporting their local economies and, taken together, are important to our financial system and our economic recovery.

During the S & L crisis in the early 1990’s, the RTC was instrumental in selling off bad loans and securities of banks that failed. In this cycle, efforts to rid banks of toxic assets have sputtered repeatedly. In the fall of 2007, federal officials tried to implement a plan to establish a fund to buy securities from banks, but this effort was aborted. In 2008, the Bush Administration established, through the TARP,  a $700 billion program to purchase banks’ soured assets. Mainly due to difficulties in determining the value of those assets, the US abandoned that plan opting instead to pump taxpayer money directly into banks. But the strings attached to the TARP funds left banks rushing to return the money rather than lending it.

Banks still have mountains of bad debt and devalued securities sitting on their balance sheets. As those loans and securities lose value, they are saddling the banks with losses and restricting their ability to lend.  Bankers had hoped the PPIP would help them unload bad assets (many of which were loans on commercial real estate) that were negatively impacting their positions. In June, the FDIC announced that it was indefinitely postponing its Legacy Loan program which was supposed to buy $500 billion of loans from banks. This month, the FDIC plans to use PPIP for a far narrower purpose which is to auction loans the agency has inherited from failed banks.

The new iteration of PPIP will focus not on bad loans but on purchasing toxic securities which are a problem for a relatively small percentage of the nation’s banks. This is terrible news for smaller banks burdened with growing piles of defaulted loans. These banks find it more challenging than their larger counterparts to access capital markets. They have been eager for the US to help them unload the loans in order to bolster their capital cushions.

Based upon these dynamics, it is hard to believe that “banks’ increased health” is the reason why the PPIP has been trimmed. There are several other challenges that the program has faced. One of these is the risks faced by program participants of being a business partner with the government. It is tough to play a game where the rules can be changed in the middle of play and the government has repeadedly demonstrated that they love changing the rules midstream. This is thought to be the main reason why PIMCO and Bridgewater Associates opted not to participate in the program. Hedge funds and private equity investors were unnerved by the restrictions placed on banks participating in TARP. Fund managers were also bothered by the President’s strong criticism of “all of the speculators on Wall Street” and, particularly,  hedge funds holding Chrysler debt who had refused the government’s buyout offer.

Questions remain. Will banks sell toxic assets into this program at significant discounts creating holes in capital? Will pension funds, endowments and municipalities gravatate to the program given they look like natural fits as  partners with the government? Will the need for banks to raise capital or to get their Tier 1 ratios up be so compelling that deals can be made?

The answers to these questions will become apparent over time. Many banking experts contend that the financial system won’t fully stabilize until banks get rid of their bad assets. This is precisely why my firm and others have been focused on helping banks sell their troubled loans collateralized by real estate.