Commercial property owners choosing to default

Much like homeowners strategically defaulting on underwater properties, large commercial real estate owners are choosing to walk also.

http://www.sott.net/articles/show/214217-Commercial-Property-Owners-Choose-to-Default

Rant

I've been immersed in these games the government and banks play, so I incorrectly assumed everyone believes what I believe about Wall Street, our government, central banks, fiscal and sovereign debt problems, Iceland, Dubai, Greece, etc.

The problem is this: most people don't have a clue about basic economics and financial models, even people much smarter than me, including the experts. Have they been that influenced by the media and teachings? Why do they cling to a Keynesian school of thought which clearly has failed? Why do they believe the only way to fix a huge debt problem is to add more debt, induced by a few privileged men? Why do they continue to believe the economic equivalent of a flat earth?

I've managed to piss off Ivy Leaguers, industry experts, financial insiders--you name it--for being the messenger. I've talked to economists, historians, and academicians from top schools and they believe the system is sound--that outlying events spoiled it for all of us, they reckon. They don't see the systemic breakdown in our fiat, fractional reserve financial systems--or how leverage has created huge pools of toxic derivatives, vulnerable to manipulation. Our financial system is a gigantic, rigged casino. Our profligacy has turned unfunded entitlements like pension funds, social security and healthcare programs into giant Ponzi schemes.

My friends in the real estate and equities markets have shunned me. What are they running away from--me? I'm one data point, unable to move my old dishwasher, much less markets. I haven't been a popular member of the cocktail circuit or at family dinners. And I thought to myself: why are these very bright people so unaware of what has been so coherent to me? I've ranted endlessly the basic economic laws of supply and demand for a certain asset class. Why are educated, bright, authoritative, and influential people missing out on something so luminous? I leave these questions to ponder, unsure of the correct answers. And I exit hoping I am completely wrong in my conclusions.

Commercial real estate train wreck

Andy Miller's take on the pending implosion of commercial real estate:

http://www.caseyresearch.com/editorial/3212?ppref=CRX175ED0210C

FDIC is broke

The Federal Deposit Insurance Corporation (FDIC) insures bank deposits up to $250,000, and this is why it is broke:

http://www.fdic.gov/bank/individual/failed/banklist.html

This list of failed banks will grow longer as residential foreclosures continue, and commercial real estate loan defaults accelerate.

Gold vs. the USDollar

The price of gold isn't increasing in real terms--it has retained its value for 6000 years. The reason why gold prices have increased in nominal terms is due to weakness in the USDollar. This gold vs. USDollar chart gives a clear illustration of what's happening to the tenuous status of the world's reserve currency.

FDIC (insolvency)

The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation's financial system by:

* insuring deposits,
* examining and supervising financial institutions for safety and soundness and consumer protection, and
* managing receiverships.

According to Kevin McElroy:

Right now the FDIC insures around $4.5 trillion of banking reserves. That’s the money you and I count as “safe” when we deposit it in almost any American bank account.

The actual truth is they insure this $4.5 trillion with just $10.4 billion. That $10.4 billion came directly from the FDIC-insured banks themselves – meaning that it’s an indirect tax on deposits paid by depositors.

Doing some quick math, we can see that $10.4 billion goes into $4.5 trillion 432 times. So essentially, the FDIC insures every $432 of deposits with one lonely dollar. That’s two-tenths of 1% worth of insurance! It’s not hard to imagine a circumstance where that paper-thin cushion gets wiped out.

The FDIC currently insures 8,153 banks. So far this year, 81 have failed – or 1% (in 2007, just three failed). And there are another 416 banks on a watch list. What happens if another 1% fails – or if even two-tenths of 1% fail?

Well, the FDIC has a reinsurer of its own, sort of. It’s called the U.S. taxpayer, backed by the full faith and credit of the Fed’s printing presses. If they can’t tax us enough, they’ll backstop the FDIC with newly created dollars – the very definition of inflation.

Rising defaults among residential subprime mortgage borrowers caused the implosion of major money centers over the last 3 years, catalyzing a string of bank bailouts. Prime borrowers are also defaulting in record numbers due to resetting of Option ARM loans. Commercial real estate loan interest rates will also reset starting next year, instigating a bust in that sector as well.

Regional banks will fail because they lend to the commercial real estate markets, but they won't receive bailouts, as they aren't "too big to fail." And fail they will, further dwindling FDIC reserves. The FDIC itself is insolvent, and will require the US Treasury to bail them out.

And round and round we go. More printing of dollars will be needed to shore up our banking system. The back stop to the banking back stop will be the US tax payer. To make matters worse, not only will taxes increase, but inflation will further decrease consumer purchasing power due to US Dollar debasement.

Hello gold and silver.

Commercial real estate in real trouble

Not news to us, as the predicted bankruptcy of the General Growth Properties REIT was as inevitable as GM's and Chrysler's. But Deutsche Bank's analysis could be even grimmer than mine, if that's possible.

http://moneynews.newsmax.com/economy/commercial_real_estate/2009/06/23/228099.html

Peter Schiff's prediction--in 2006!

See how accurate he was--in the face of a consensus of detractors who insisted he was part of the lunatic fringe.

"The United States' (economy) is like the Titanic and I am here with the lifeboat trying to get people to leave the ship," said Schiff, president of Darien-based Euro Pacific Capital, a brokerage firm that specializes in trading foreign equities.

"I see a real financial crisis coming for the United States,"Schiff said. "I am helping my clients protect themselves."

Schiff likes the Titanic metaphor. Everyone thought the ship could never sink, just like most people think the U.S. economy can't, he said. But people were wrong about the Titantic, and they are wrong about this country's economic stability, he said.

Schiff sees a mammoth iceberg ahead that's going to obliterate the U.S. dollar. The investors' lifeboat, he said, will be to put their money into non-dollar assets and foreign currency.

Besides being down on the dollar, Schiff said U.S. equities are substantially overvalued and bond prices are on the verge of collapse.

Here's his take on real estate:
"The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only and negative-amortization mortgages, a can't-lose attitude among speculators validated by ever rising 'comps,' the complete abandonment of lending standards, widespread corruption in the appraisal industry, rampant fraud among sub-prime lenders and the moral hazards associated with loan originators reselling loans to buyers of securitized products who perceive minimal risk and an implied government guarantee, has produced the mother of all bubbles."

Who is shorting gold?

Regarding the gold shorts, I've read JP Morgan, HSBC, and Goldman Sachs were shorting gold futures, artificially driving the price down, while at the same time hoarding the physical bullion on the spot market at a lower price. Ironically, JPMorgan Chase and Citigroup analysts are forecasting $2000/oz gold. Looks like manipulation, especially when you factor in a ten-fold increase in short positions. Someone on the inside knew what was going on with Fed easing and tightening.

I'm not sure if it was just big money centers--I think some of the commercial shorts were mining companies themselves. If they short it and the price plummets, they've locked in a profit as the short contracts increase in value when gold declines in price. That's why gold producers use it as a hedge in the case of falling gold prices. If they sell short the futures contracts, and prices rise against them, they are forced to cover at a higher price, but then their gold inventory also increases in value, negating the loss from short sale. In other words, they profit either way--as long as they have the gold in inventory. Without said inventory, they are "naked" and must realize the losses within 5 days--or until they deliver the physical product.

If indeed manipulation is going on, it is not only illegal, it will not be sustainable. Eventually, the Fed won't be able to save the shorts, as physical bullion becomes even scarcer, and buyers insist on delivery, instead of some "shadow" paper delivery against some vault. Gold experienced backwardation for the first time ever in December--the spot price was higher than the forward contracts. In other words, buyers wanted delivery NOW--and would not sell at ANY price, as fear has gripped the markets. Under normal conditions, a contango exists, where forward contracts command higher prices. I think this backwardation is very bullish for gold, and the fact that mints are out of inventory is indicative of that.

Also, I've read statistics where central banks, especially in Europe, are no longer selling their gold inventory. If the Chinese government steps up and purchases tons of gold like they have threatened (their ratios are much lower than the US's and Europe's), that will absorb inventory and drive prices higher also. And India is already the world's largest buyer of gold, up to 20%. With the Pakistan thing going on, I can't imagine them wanting more rupees, instead of gold, which has become the de facto currency.

Bottom line: MV = GDP, and as long as the Fed provides easy credit (interest rates can't get much lower than 0%), and as long as the Treasury prints trillions of dollars, the money supply M will be poised to catalyze inflation. But once the velocity V of capital flows thru the economy, it will provide the stimulus our economy needs, but potentially kicking off hyperinflation. In other words, once bank balance sheets have been restored, they will start lending again. We would have avoided another Great Depression, but God helps us when we get runaway inflation a la the 70's. Having an extra $8 trillion floating around in our economy will prove inflationary, and interest rates will soar. Treasury bondholders with longer maturities will get crushed, as the Fed can only influence short-term maturities (T bills). With higher interest rates, the government won't be able to pay off its huge debt obligations, and we'll have stagnant growth for years. We are experiencing a credit crisis because investment and commercial banks are insolvent. When the markets realize the US government is also insolvent, all hell will break loose. The government has compounded a multi-billion-dollar debt crisis into a multi-trillion debt crisis.

I hope I'm wrong in this logic chain, but this playbook has been repeated many times before when fiat currencies are under attack by central banks. I just don't see any other outcome when your debt is almost as large as the size of your economy.

The next shoe to drop...

We've seen the subprime mortgage crisis spill over to the whole residential mortgage industry, causing property values to plummet in many regions. Collateral debt obligations and credit default swaps turned sour have caused a further erosion of asset values and balance sheets across the globe. This has caused a run on several investment and commercial banks, most notably Lehman Brothers and Washington Mutual, respectively. This cascaded over to the stock market, leading to breath-taking declines across all sectors, including industries in hard assets, like oil, natural gas, gold, and the other minerals and commodities. While the Fed dropped its funds rate to 1.0%, and the Treasury turns on the money spigot, we anticipate future inflation. However, due to massive investor redemptions at hedge funds and now mutual funds in an effort to raise cash, individuals and institutions alike are scrambling to de-lever their precarious financial conditions. Deflation--not inflation, is the current concern. The R word (recession) is not a question of if, but how deep and for how long.

So the worst is over and the unknowns are out on the table, right? Wrong. Just as many teaser residential loans have been re-setting, causing a barrage of foreclosures, the commercial real estate market, which has held up relatively well up to this point, is now in real danger of falling off the precipice as well. As companies announce massive layoffs, and as consumers hunker down to save for a rainy day, companies have lowered earnings projections (hence, shares of equities have plummeted). These conditions will be disastrous for commercial real estate values, which are ultra-sensitive to economic conditions. Expect more bankruptcies, vacancies, and foreclosures in the commercial real estate space.