Archive for November, 2009

Will the U.S. Housing Market Double Dip?

I am often asked why I, a commercial building sales broker, pay attention to the residential housing market. It is because we landed in this recession due to stresses in the housing market and the roads leading out of the recession will run through the housing market as well. During the summer, that road seemed to be heading toward recovery.

Over the past few months, there have been some signs that the U.S. housing market had begun to stabilize. Some economists have even said that the market bottomed as early as the spring of this year. Let’s look at the reasons for the optimism.

Industry experts were cheering October’s new-home sales figures, which easily beat estimates by climbing 6.2%. Prices, which had been in free fall, dropped by the smallest margin in nearly a year. (The S & P Case-Schiller Index, which only tracks 20 markets suggests prices have been increasing for 5 months running). The National Association of Realtors reported last monday that sales of previously occupied homes in October jumped 10.1% from September to a seasonally adjusted annual rate of 6.1 million, the highest level since February 2007. The number of home listed for sale nationally was 3.57 million at the end of October, down 3.7% from a month earlier. Much of the sales activity was driven by buyers who rushed to claim the first-time home buyer’s tax credit before it was to expire on November 30th of this year. The number of homes for sale in September was 3.63 million, down 15% from a year earlier.

Mortgage rates have been at historically low levels. Mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae rose to their highest level of the year last week buoyed by strong investor demand. Risk premiums on the bonds, which measure their yield (moving inversely to the price), fell as low as 1.24 perceentage points above the yields of comparable Treasuries last Wednesday. The previous narrowest level was 1.29 in May. These dynamics have created an average rate on 30-year fixed rate mortgages at only 4.78%, which matches a record low from April. That rate was down from 4.83 the previous week and 5.97% a year ago.

If we look at the housing market dynamics more closely, however, it appears there is a good chance that government intervention may be creating a bubble of its own, artificially and unsustainably propping the market up.

Consider this: The average single family home price in the United States is $178,000. Most mortgages made today are guaranteed by the Federal Housing Administration which requires only a 3.5% downpayment (less in several circumstances) which is $6,230. With the $8,000 first-time home buyer’s tax credit, the government (the taxpayer) is paying people to buy houses (It has been estimated that 80% of the purchases that occurred using the credit would have occurred anyway so the “real cost” of the economic incentive to create a sale is $40,000, not $8,000). Buyers are utilizing artificially low interest rates as the Fed is buying a significant percentage of offered Treasuries to keep rates down. Without this quantitative easing, mortgage rates would be much higher. The Fed is also buying much of the residential mortgage-backed securities that are being sold. Between Fannie, Freddie and the FHA, the government( the taxpayer) presently guarantees 92% of all home mortgages in the country. To top it off, the government (the taxpayer) is also purchasing a substantial amount of these very mortgages that we, um – I mean the government, guarantees.  Does this sound vaguely familiar to you? Isn’t this type of shell game that got us into this mess in the first place?

We must not forget that the catalyst for most of the stress in the housing market was government policy aimed at increasing the homeownership rate through lowering mortgage lending standards. These policies began in 1977 with the Community Reinvestment Act (CRA) which targeted banks and encouraged them to increase lending in low- and moderate-income communities. From 1977 to 1991, $9 billion in CRA lending committments had been announced.

In 1992, congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, also known as the GSE Act (ironically, the name sounds so benign). The objective here was to force Fannie and Freddie to purchase loans that had been made by banks; loans that were made as part of the CRA. The GSEs had to do this to comply with the law’s “affordable housing” requirements. Since then, Fannie and Freddie have purchased over $6 trillion of these mortgages. The goal of community groups, of forcing Fannie and Freddie to loosen their underwriting standards in order to facilitate the purchase of loans made under the CRA, was achieved. Congress inserted language into the law encouraging the GSEs to accept downpayments as low as 5% or less, ignore impaired credit if the blotch was more than a year old, and otherwise loosen their lending guidelines.

The result of these loosened credit standards, and a mandate to make “affordable-housing” loans, created a massive pool of high risk lending that ultimately drowned the GSEs, overwhelmed the housing finance system, and caused an expected $1 trillion in mortgage loan losses by the GSEs, banks, and other investors and guarantors. Most tragically, there is an expectation that, at the end of this cycle, the U.S. will have seen 10 million or more home  foreclosures.

The refundable tax credit, available even if a family has no taxable income, will enable many more purchasers to buy a home, even if they are not qualified. But it could also bankrupt the FHA and, by doing so, would damage an already weak housing market.

This credit was initially available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). In 2009, about 40% of all first time buyers used the credit, so extending it was strongly supported by residential real estate brokers, home builders and their congressional allies. The recently passed extension (until April of 2010) makes the credit available, not only to first time buyers but, also to those who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000.

The first-time home buyers tax credit is expected to cost the Treasury about $15 billion in 2009, more than twice the projected cost when Congress approved the stimulus package (is it really hard to believe that the government could underestimate the cost of the programs it implements? – watch out healtcare reform!).

The problem here is that, as we discussed above, the FHA insures mortgages with such low downpayments that it can be funded completely by the refundable tax credit. Owners who don’t invest their own money into a house are much more likely to default on the mortgage. The FHA is already looking at a number of serious problems. Two weeks ago, the agency reported that its cash reserves, which are federally mandated to be no lower than 2% (down from 3% last fall) of its portfolio, had dropped to 0.53%.

The deteriorating quality of the FHA’s mortgage portfolio is a critical challenge to the housing market and the federal budget. A recent government audit concluded that the FHA would run out of money in 2011 and need a federal bailout if a recovery is not swift.

Presently, the percentage of U.S. homeowners who owe more on their mortgages than their properties are worth swelled to about 25% according to a report in the Wall Street Journal. Moody’s.com pegs this percentage at nearly 33%. Either way, this dynamic threatens prospects for a sustained housing recovery. These so-called underwater mortgages present a roadblock to a housing recovery as these properties are more likely to fall into foreclosure and get placed on the market, adding to an already bloated supply.

Over 40% of borrowers who took out a mortgage in 2006, when home prices peaked, are under water. In some parts of the country, home prices have dropped so much that borrowers who purchased homes five years ago now have negative equity. Even recent bargain hunters have been hit as 11% of borrowers who took out mortgages in 2009 already owe more than their homes are worth. Borrowers with negative equity are more likely to default and, today, about 7.5 million households are 30 days or more behind on their mortgage payments or are in foreclosure.

This level of negative equity has some economists projecting that housing won’t really bottom out until 2011. There are additional factors that lead to their conclusions.

The home sale statistics that are presented by the NAR and Commerce Department exaggerate activity as they double count some sales. If a foreclosure occurs and the bank sells the property to an investor at an auction who subsequently resells the house to someone who intends to live there, that counts as two sales. Additionally, “seasonally adjusted” numbers also will exaggerate the real level of activity.

Moreover, most of the sales activity is taking place in the areas which have been hit the hardest such as California, Southern Florida, Arizona and Las Vegas where we see the highest level of distress and very cheap condos, co-ops and single family residences.

Home prices are measured in three different ways: 1) median income to median sales price, 2) the cost of owning versus the cost of renting, and 3) the total housing stock value as a percentage of GDP. If we consider these three different methods of measuring home prices and affordability, it is possible to conclude that home prices have another 10% – 15% to adjust before the market actually hits its natural bottom.

All of the government intervention has prevented the market from hitting its natural bottom. No one wants to see people displaced but artificially propping the market up only makes things take longer to correct and simply delays the inevitable. The American consumer has had a long-held taboo against walking away from their home, but this crisis seems to be eroding that.

The Fannie and Freddie bailouts have already cost us $112 billion (and counting). How much will the FHA bailout cost? If housing values don’t recover, or the FHA cannot outrun its problems, the government audit suggests that FHA could ask for $1.6 billion by 2012. judging from history, that is probably a low-ball estimate.

Congress probably doesnt mind, however, because these liabilities are technically off budget, until they aren’t. i certainly hope the housing market recovers quickly but there appear to be many hurdles to overcome before this can happen.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

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A Potential Catalyst to Stimulate 2010 Property Sales Activity

This recession has hit the U.S. very hard causing an unprecedented level of government intervention. Trillions of dollars have been committed in spending, bailouts, tax credits and guarantees.  Eventually we must  pay for these financial commitments and we pay for them in the form of higher long-term interest rates, increased taxes or, most likely, a combination of both.

Not only is the federal government running massive and record-setting deficits but most states are in the same position.  While the fed is presently committed to keeping interest rates low (we know they will have no choice but to tighten monetary policy at some point), the tax picture is another story. There is no doubt that taxes are going to increase and increase across the board.  Federal, State and local taxes are going to increase and everyone, even those who were promised no tax increases constantly in pre-election speech after speech after speech.

The Bush administration’s tax cuts sunset at the end of 2010 which will push the federal capital gains rate up from 15% to 20%. It is expected that the present administration will raise this rate also by only three to five percent. They can get away with what looks like a small increase because they are not responsible for the 5% increase already built into the system. So we could be looking at a 23% to 25% capital gains rate beginning in 2011. But wait, there is more….

The healthcare proposals that are going to be debated in congress have politicians scrambling to find ways to pay for the (at least) $1 trillion program. In order to achieve their objective of making this program appear deficit neutral, we are seeing some of the most creative accounting techniques used, most of which increase taxes and on, just about, everyone. Some of these techniques would even make Bernard Madoff blush. (For instance, under the healthcare proposal, we are theoretically deficit neutral because we count revenue over 10 years but spending over only 6. Revenue comes in beginning in 2010 but payments are not made until 2014. I wish we could account for profits this way in the private sector. ) But let’s get back to taxes.

For the first time in over 30 years, we may see the return of income tax bracket creep. Buried deep in the 2,000 page healthcare bill is a provision which will partially repeal tax indexing for inflation. What this provision means is that, as earnings rise over a lifetime, Americans can look forward to paying higher income tax rates even if their income gains are not “real”. Two main features of the current version of the plan are not indexed. The first is the $500,000 threshold for the 5.4% income tax surcharge (does the word “surcharge” really sound more benign than “tax”?). The second is the payroll level at which small businesses must pay a new 8% tax penalty for not offering employees health insurance.

Let’s take a look at the true impact of the surcharge. This tax is set to begin in 2011 on all income above $500,000 for single filers and above $1 million for those filing jointly. Assuming a 4% inflation rate over the next decade (not an aggressive assumption given our fiscal picture), the $500,000 threshold for an individual filer would impact families with the 5.4% surcharge at an inflation-adjusted equivalent of about $335,000. After 20 years without indexing, the surcharge threshold falls to about $250,000.  As the real inflation rate rises, these thresholds drop further.

This mechanism is a covert way for politicians to dig deeper into more worker’s pockets each year without having to legislate tax increases. The negatives of failing to index compound over time, producing a windfall for the government as the years go by hitting unsuspecting taxpayers.

This trick is nothing new and its impact is tangible. For example, in 1960, just 3% of tax filers paid a 30% or higher marginal tax rate. By 1980, the inflation of the 1970’s resulted in that share increasing to 33% of filers! These stealth tax increases, which forced more Americans to pay higher tax rates on phantom gains in income, were widely thought to be unfair. In response, in 1981, as part of the Reagan tax cuts, indexing the tax brackets for inflation was adopted by a bipartisan coalition.

Another example of the impact of this stealth, inflation-ruse, technique can be seen in the performance of the Alternative Minimum Tax. In 1969, when this tax was first passed, it was intended to only hit 1% of all Americans. In 1993, the Clinton administration increased the AMT tax rate. At neither of these times was the tax indexed for inflation. As a result, the number of families hit by this tax more than tripled over the next decade. Today, unless congress passes an annual “patch”, families with incomes as low as $75,000 can be affected.

Importantly for our real estate industry, the 5.4% surcharge has been creatively written to be applicable to modified adjusted gross income. This means it applies to capital gains taxes. Piled on top of the increase caused by the sunsetting of the Bush cuts, our 2011 federal capital gains tax rate would balloon to 25.4%, even without any additional increases imposed by the present administration. If congress acts as expected, the new rate could top 30%.

With such a dramatic increase in the capital gains rate, sellers, who are considering the sale of commercial real estate in the short-term, must seriously consider the implications of this increased cost. Logic would dictate that this dynamic should catalyze an increase in sales activity in 2010 as seller’s rush to take advantage of the low 15% rate.  This increase in sales volume would be welcomed as 2009 will be, by a wide margin, the year with the lowest turnover (in terms of number of buildings sold) of investment property sales since at least 1984 (we do not have records prior to 1984).

The creative accounting in Washington could have another silver lining for our industry. Similar to the way the “modified adjusted gross income” includes capital gains, it also includes dividends. Adding the 5.4% surcharge to the increase caused by the Bush cuts sunsetting, the tax rate on dividends will explode from 15% to 45% ( 5.4% plus the pre-Bush rate of 39.6%). This dramatic increase would shift massive amounts of capital away from equities into other forms of investments, including commercial real estate.

I always try to figure out how our industry is affected by what goes on in Washington. While there may be some positives for commercial real estate, the present shenanigans are troubling. The return of the days without inflation indexing is nothing more than stealth taxation. It would repeal a 30 year bipartisan consensus that it is unfair to tax unreal gains in income. The result will be that millions of middle-class Americans will be hit with new taxes over time with taxes advertised as only hitting “the rich”.

Mr. Knakal is the Chairman of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

Why Sellers Should Sell and Buyers Should Buy

Whose kidding whom? Sellers will only sell if they want or need to and buyers will only buy if they believe they see a good opportunity. Brokers can’t “sell” a client into acting but I wanted to discuss some reasons why sellers might want to sell today and buyers might want to buy today.

Clearly, there is tremendous uncertainty in today’s investment sales market. Values are far below their peak and are expected to continue dropping. The volume of sales is also far below its record peaks as activity has ground to a halt. As a broker who sells buildings, the level of sales activity is far more important than the direction of prices. The activity just has not been there in 2009.

I am asked several times each day by clients who would like to purchase properties if the time is right to buy. They think prices will continue to drop so the inevitable question is, “Why not wait until prices hit bottom?”. Potential sellers constantly ask when the optimal time to sell is ( I rarely suggest that sometime in 2006 or 2007 would have been optimal). “If I wait a few months will prices be better?” and “How long do I have to wait until my value will be higher?” are the most frequently asked questions from them. As uncertainty rules the day, how do I answer these difficult questions without sounding self-serving? 

Let’s take a look at current market conditions to set the stage for the discussion of perspectives relayed to buyers and sellers. I will discuss conditions in the New York City market as that is the only market I know. I assume most markets around the country are experiencing similar dynamics, to differing degrees perhaps, but still heading in the same direction.  

Using the Manhattan marketplace, for example, in the first three-quarters of 2009, there were 209 investment property sales having an aggregate sales value of $3.2 billion. The $3.2 billion in sales represents a 92% reduction from the activity in the peak three-quarters of 2007 in which there were $40 billion in sales. The 209 properties sold represents a reduction of 74% from the peak number of properties sold in the first three-quarters of 2007 which totaled 803.

The Manhattan market has a total of 27,649 investment properties (south of 96th Street on the eastside and south of 110th Street on the westside). Over the past 25 years, the average turnover of this stock has been 2.6% or approximately 719 sales. The lowest turnover we have ever seen was 1.6% in 1992 and 2003, both years were at the end of recessionary periods and both years experienced cyclical peaks in unemployment.

If we annualized the activity in the first three-quarters of 2009, turnover was running at 1.0%. (It is actually trending up as, in the first quarter, the volume was running at 0.7%, in the first half it was 0.9% and 1.0% for the first three-quarters). We believe turnover will finish the year at 1.1% to 1.2%, establishing a new low since we began tracking this data in 1984. 

In the Manhattan market, the average sales price in the first three-quarters of 2009 dropped an average of 32% from the peak prices achieved. In order to understand this reduction more clearly, we need to look at how different property types are performing. 

Multifamily properties have performed best with walk-up properties having lost only 16% from the peak with elevatored properties dropping 20%. Given the fact that consumer spending has been greatly reduced, retailers have had a difficult time which has resulted in large reductions in retail rents. It is, therefore, not surprising that mixed-use properties (those having at least 20% of their square footage occupied by retail tenants with apartments above) have lost 46% of value while retail properties have lost 49% of value from their cyclical peak.

Office buildings have lost 62% of their value from the peak. However, if we look at office properties which are well-leased on a long-term basis without market exposure, average values have dropped only 25%. Those with significant vacancy, or a large percentage of leases rolling in the short-term, have seen values fall by 70%.

We believe that value will continue to fall into 2010 as unemployment continues to rise. As unemployment rises, real estate fundamentals become stressed and as fundamentals become stressed, value falls. Economists expect unemployment to peak in the first half of 2010. It is at this point that fundamentals will be at their weakest and value will, presumably, be at its lowest.

Why should sellers sell today?

With values well below their peak and expected to fall a little more, why should a seller sell today? As counterintuitive as it may be, there are several reasons why a seller could benefit from selling today. This, of course, assumes that an owner is compelled to sell or has some external pressure motivating them to sell within the next year or two.

The first thing to consider is that the extremely low volume of sales has been caused by supply constraint not a lack of demand. The fact is that demand is significant. We have received dozens of offers on each of the income producing properties we are selling and have received over 50 offers on each of the notes we have sold this year.

Additionally, there is a massive amount of capital sitting on the sidelines waiting for an opportunity. We can refer to this patient capital as “shadow demand”. Much of this is from institutional distressed asset funds which are currently being pressured by their investors to show some activity. The lack of supply has created frustration for these funds and their appetite is currently very large.

Another reason to put a property on the market today is that the supply of properties available for sale is extraordinarily low. The massive demand that is chasing few assets is actually driving property prices above the level that fundamentals would dictate (notwithstanding the price reductions we have already seen). It is anticipated that distressed assets will be coming onto the market in significant numbers over the next couple of years which will provide more choice for investors, placing downward pressure on prices.

Potential sellers should also consider that prices have not yet hit bottom and they may be able to get out prior to the market hitting its bottom. Value will be lower in the future before it increases.

Financing, particularly for smaller multifamily properties, is plentiful from portfolio lenders for cash flowing properties. Community banks and small regional banks have remained very active and continue to look for additional opportunities.

Additionally, mortgage rates are very low by historical standards providing buyers with the ability to pay a relatively aggressive price. Given how much the Fed has increased the money supply and has increased spending, there is nowhere for rates to go but up. We will have to pay for these policies in the form of higher long-term interest rates , higher taxes or, most likely, a combination of both. As mortgage rates increase, values will face additional downward pressure.

Today’s market also provides an opportunity for portfolio reallocation. Several clients are looking to sell “maxed out” properties or smaller, non-core assets in order to take advantage of the more reasonable pricing of core assets.

Why should buyers buy today?

So, with value expected to drop further, why should buyers look to purchase now. The first reason is that it is nearly impossible to time the exact bottom of the market. Value has fallen so much already that it is expected to bottom out in the short-term, only falling another 10% or so. If this is the case, and a buyer has a long-term investment strategy, buying today may not be such a bad move.

The supply of available properties in New York is always very low. If you consider that the average turnover rate during a 25 year period has been 2.6% of the total stock, this means the average holding period is 40 years. Yes, some properties like the GM building have traded several times within the past 15 years but properties like that are offset by properties which have been owned for over 100 years by the same family. For these reasons, when an asset becomes available, if an investor wants to own that asset, they should move on it because is will likely not be for sale when the buyer decides the market has hit bottom. (We will only really know we have hit bottom after we have emerged from it.)

If a buyer believes that the government’s reaction to the recession will lead to inflation, hard assets are great things to own in an inflationary environment. Commercial investment properties are excellent hard assets. Investors would want to ride the upswing in inflation but with inflation comes Fed tightening and higher interest rates. However, if properties are purchased now, locking in today’s low rates on a long-term, fixed-rate basis, they will be sitting pretty when inflation hits.

After the market hits bottom, we expect value to just bounce along the bottom for 2 or 3 years as the market goes through deleveraging. Whether, and to what extent, properties appreciate will be dependent upon a fight between upward pricing pressure created by excessive buying demand and downward pressure created by the massive deleveraging that will be necessary as 2006 and 2007 vintage loans mature in 2011 and 2012.

Regardless of the incentives created by the dynamics mentioned above, we still believe the volume of sales in New York City will be lower than the 1.6% level in 2010. We hope that we are wrong but the congestion in the distressed pipeline is not expected to loosen up until the later half of the year.

So, should sellers sell and should buyers buy? The answers to these questions will be decided by participants in the market and the timing of these decisions will determine who the winners will be coming out of this downturn. One thing is clear, a significant transfer of wealth will occur over the next few years and the results for each individual (other than those who are forced out of positions by lenders or note buyers foreclosing on them) will be based upon how they answer those two questions and the timing of the decisions they make.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

10.2% Unemployment and the Impact on Commercial Real Estate

I know what you’re thinking: Why is Knakal addressing unemployment yet again? Simply, it is because last week’s announcement that the official rate has climbed to more than double digits further illustrates that the administration is incorrectly focused on things other than job growth.

As I have always stated, our commercial real estate markets need employment more than anything else to enhance our fundamentals and turn our outlook around. As unemployment increases, our fundamentals degrade and as our fundamentals degrade, our values drop. Until the trend in unemployment reverses, it will be nearly impossible to see tangible health return to any segment of commercial real estate. Our rising unemployment rate begs the question: How did job creation get put on the back burner?

In October 2008 in Toledo, Ohio, a major economic speech was delivered by then candidate Barack Obama. Let’s take a close look at what he said:

“Right now, we face an immediate economic emergency, and that requires urgent action. We can’t wait to help workers and families….who don’t know if their jobs……will be there tomorrow. … We need to pass an economic rescue plan for the middle-class, and we need to do it not five years from now, not next year, we need to do it right now. It’s a plan that begins with one word thats on everybody’s mind, and its easy to spell: J-O-B-S.”

That sounds pretty good and is pretty powerful. That sounds like focus. Mr. Obama gave the impression that job creation would be his top priority and that his action would be swift.

Gandhi once said that, “Action expresses priorities”. If this is true, job creation has, clearly, not been one of the president’s priorities. Recently, the administration has begun talking about job creation but this provides little comfort as this recession began two years ago.

The results of the off-year elections in Virginia and New Jersey have demonstrated that Americans are increasingly believing that the administration should not be prioritizing health-care, climate change, and financial regulation while hundreds of thousands of people continue to lose jobs each month. Nearly 90% of those voting in these gubernatorial races said they were worried about the direction of the economy and the majority of those who held that view voted for the Republican candidate. Are we looking at another 1994 (a year in which we saw a dynamic shift in political power) in 2010? If jobs do not become the priority, we just may be.

Could it be any more obvious that the objective on Pennsylvania Avenue is to push an entire agenda through before power is potentially lost in the midterm elections? This could be a tragic policy flaw which could lead to relinquished majorities in the fall of 2010.

This lack of focus on jobs has resulted in an official unemployment rate of 10.2% (the highest since 1983) and an underemployment rate of 17.5%. The latter takes into consideration those who are out of work and have stopped looking for work and those who are employed part-time who are seeking full-time employment.

Clearly, job creation has dropped from a top priority to just one of many, and President Obama has been remanded to pandering for patience and offering excuses. On one hand he argues that there is some good news in the awful numbers as things are indeed getting worse but at a slower pace. On the other, he constantly reminds us that he inherited this mess. How long can he continue to do this? Fair or not, finger-pointing is not effective policy.

The administration now claims that the stimulus has “created or saved” one million jobs. Does anyone really believe that?  (Maybe if Congress spends another $787 billion, it can get the jobless rate up to 12%). The data upon which this claim is based is of extraordinarily low quality and are not reliable indicators of job creation or the even vaguer notion of job retention. There are two major problems with the data. The first is a strong reporting bias. Those providing data are those who have received stimulus funds. If they are creating or saving jobs, they are likely to get more free money, hence, a strong incentive to inflate reality.

The second is that the government is using what is referred to as “gains-only” reporting.  When the government reports this figure, it wants us to believe that the new hires came from the pool of the unemployed and that they are net additions to the stock of employed workers. The data do not speak to the number of workers who left their current jobs to fill government sponsored jobs.  Because these data do not tell us where the workers come from and what happens to the positions they left, the numbers cannot answer the ultimate question: How many net jobs were created? The government is reporting the gross positive figures, not the relevant net figures.

On a monthly basis, the Department of Labor reports activity from the Job Openings and Labor Turnover Survey (Jolts). The Jolts data show that, in August of 2009, about 4 million workers were hired. Unlike the administration’s new jobs-created-or-saved data, the Jolts data also lets us know that about 4.3 million workers lost their jobs. How difficult is it to figure out what the relevant numbers are?

It is difficult to imagine a more complete repudiation of Keynesian stimulus than the recent evidence in our job market. Only 11% of the stimulus money is actually stimulative (spent on infrastructure) with significant percentages being spent on pork projects and non-stimulative transfer payments such as Medicaid and jobless benefits. The net effect is that net job creation has been negative. The much ballyhooed Keynesian multiplier that every dollar of government spending yields 1.5 times that in economic growth has, once again, been exposed as false. Few people remember that Keynes developed his theory when government spending only represented about 2% of GDP, a far cry from where it is today.

The policy lesson here is for both political parties (if you are  a frequent reader of StreetWise, you know that I try to critique both parties equally and, I believe, fairly). In 2008, President Bush caved-in and initiated the first “stimulus”, a $160 billion program that was ill-conceived and not very stimulative. Mr. Bush lost policy bearings during his last year and forgot that in order for a tax cut to be stimulating it must be immediate, permanent and at the margin of the next dollar. Instead, for the past two years, the U.S. and most of the rest of the world have been pouring trillions into a Keynesian black hole. Let’s not forget that this spending must be paid for at some point. Tax increases are inevitable and this expectation continues to stifle consumer spending.

If the administration is serious about wanting to create jobs (a by-product of which would be to help our commercial real estate markets) the best policy action would be to ask themselves and Congress, Why?…..

Why create so much investment uncertainty and additional barriers to businesses hiring new employees?

Why raise the costs of doing business by making it easier to unionize workers via “card check”?

Why raise energy costs for businesses with a cap-and-trade (“cap-and-tax”) bill?

Why add to an already inflated budget deficit and future tax burden with a 12% increase (proposed in the draft budget) in domestic spending in 2010?

Why force through Congress, on a partisan vote, a health-care bill that imposes a 5.4% income tax “surcharge” on anyone making more than $500,000? The Joint Tax Committee reports that about one-third of this $460.5 billion tax increase will be paid by small business job creators who file their taxes under the individual income tax code.

Perhaps someone should read Mr. Obama a transcript of his Toledo speech. Then maybe he will be reminded that he cannot wait for next year, he needs to act now and, very simply, it’s all about J-O-B-S.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

How Green are the Economy’s Green Shoots?

This past Thursday, the government announced that our Gross Domestic Product – a broad measure of the economy that sums up all the goods and services produced in the U.S. – increased at a rate of 3.5% during the third quarter of 2009. The Dow Jones Industrial Average has been hovering around 10,000 and housing market indexes have been positive for months. These statistics might lead you to think that our economy was starting to briskly emerge from the recession, however,  let’s take a closer look at each of these green shoots.

During the third quarter of 2009, GDP did, indeed, expand after shrinking for four consecutive quarters, indicating an apparent end to the worst recession since World War II. The expansion was 3.5%, however, a majority of the increase was related to vehicle purchases and residential construction, both stimulated by government support. 2.2% of the increase was due to these two sectors and an additional 0.6% was attributed to government spending.

Additionally, inventories had been stripped to the bone and are now being rebuilt. In the third quarter, companies dumped inventory, though less aggressively than during the previous three months. By the math of GDP accounting, merely slowing down inventory liquidation will boost growth.

The most surprising result was the pace of consumer spending growth, although a significant portion of this appears to have been borrowed from the future. Consumers provided nearly two-thirds of the GDP growth with auto sales and parts alone adding 1% to the total. The cash-for-clunkers program stimulated significant increases in July and August sales but activity crashed in September after the program expired as demand was accelerated from future months.

The first time homebuyer’s credit has prompted residential investment to increase handsomely. Private residential investment, of which home building is a large component, surged 23.4%, the first increase in 14 quarters. This accounted for half a percentage point of GDP growth. We will look at this credit in more depth when we discuss the housing market.

Much of the growth relies on government spending or incentive programs which are either expired or expiring. Therefore, it is unclear if consumers and businesses have regained the strength to propel the economy on their own. Businesses remain cautious and American households are still burdened by mountains of debt, two factors that have economists predicting growth will slow considerably in the coming months.

The Dow Jones Industrial Average has closed near 10,000 for a couple of weeks as a healthy majority of firms have exceeded earnings expectations recently. Unfortunately, these earnings are the result of companies cutting jobs and working hours and squeezing costs mercilessly.

While 73% of firms beat earnings expectations, 58% had worse than expected revenue. High unemployment has created significant slack in the economy with tremendous excess capacity. Productivity has increased at a rate of 6.4% as employers are squeezing more work out of exisitng workers.  It is very typical to see productivity increases as an economy emerges from recession as firms wait until the last possible moment to begin rehiring.

These favorable earnings are, unfortunately,  not sustainable without revenue growth as there is only so much overhead that companies can eliminate.

With regard to the positive news coming out of the housing sector, most in the media point to the S & P Case Shiller Index. This index has seen strong gains for five months running. Unfortunately, many economists discount the accuracy of the index as it only tracks 20 markets, representing only approximately 38% of all homes in the U.S.  It is thought that this index overshoots reality both on the upside and the downside.

While the housing numbers appear positive, economists warn not to make too much of them because low prices and low mortgage rates, along with the tax credit, have spurred a home buying bonanza, at least in the low end of the market. Roughly one-third of home resales are foreclosures or short sales, where the mortgage exceeds the sales price.

The $8,000 first time homebuyer credit has catalyzed much of the activity in the sector and there is good reason for this. The average home price in the U.S. is $178,400. Given FHA’s 3.5% downpayment requirement (which amounts to $6,244 for the average home) the government is, essentially, paying people to buy a home.

This program has been ripe with fraud as is often the case with government run programs, particularly those with “refundable” credits that guarantee that claimants will get cash back even if they paid no taxes. A lack of documentation requirements make this program a layup for scammers ( You really couldn’t even make this stuff up!).

The Treasury tax-oversight office said at least 19,000 filers who hadn’t purchased homes claimed $139 million in tax credits and were reimbursed. Officials have found an additional 74,000 tax credit claims, valued at $500 million, where evidence of previous homeownership could make their claims invalid. More than 500 people under the age of 18, including a 4-year-old child, also had their names on applications for the credit which has no minimum age requirement. Most of the claims involving children were made by parents who purchased homes but would not qualify for the credit because their incomes were too high.

These problems show the dangers in creating refundable tax credits that give money to filers even if they don’t owe any taxes. The Internal Revenue Service and Justice Department are investigating more than 100 suspected criminal schemes involving the credit. The IRS is conducting more than 100,000 examinations that could require filers to give back the credit and pay civil penalties.

This program was set to expire at the end of November, so naturally given its record of abuse, Congress has extended and expanded the program. Not only is the program extended into 2010 but now existing homeowners, who have owned their present home for at least 5 years, can qualify for a $6,500 credit in the event of a new purchase.

So let’s recap the housing situation: 1) the government is providing tax credits to buyers through which buyers are “paid” to purchase a house; 2) there are no documentation requirements for the reciepients of the credit; 3) the government guarantees 92% of all single family mortages through Fannie, Freddie or FHA; 4) the government purchases most of those mortgages. Does everyone on Capitol Hill have amnesia?

While the credit seems to have boosted home sales, many of those sales would have happened anyway and have merely been stolen from the future. Meanwhile, the credit continues to distort the housing market and delays the process of home prices achieving a natural bottom which would serve as the basis for a fundamentally sound recovery.

There has only been modest growth in business investment which reveals how wary companies are about taking new risks or committing to expensive projects or new job creation in the current political and economic climate. The fiscal stimulus has pounded the federal balance sheet. With a deficit of $1.4 trillion in 2009, and $9 trillion more predicted over the next decade, every investor and business in America can see a gigantic tax bill coming right at them. The House health-care bill, which was released last week, takes another major wack at the job creators who own small businesses. The uncertainty of the Washington policy outlook is, no doubt, putting a significant crimp on future investment plans.

The simple truth is that without a recovery in the job market, consumers will not be able to carry the expansion for long and real growth is just an illusion. I guess it was heartening when, last week, after the recession has been with us for 22 months, Nancy Pelosi finally said the the focus has to be on job creation. Washington’s current policy makers are growing increasingly concerned about the jobless rate and the looming mid-term elections in 2010. They should, however, remember that the best way to nurture an expansion isn’t to feed it recklessly with easy money and more stimulus in order to meet an election timetable. Let the economy’s natural animal spirits revive at their own pace.

We are certainly in a better place than we were one year ago, but we still have a long way to go and should not be misled by data that inaccurately reflects reality.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.