This past week has been a little crazy for me since I’ve recently started a new job. I’ve relocated from Texas to New York (big change) but have managed to stay within my industry, commercial real estate appraisal (not a big change). The only problem is how things work here. And the slumped market.
Surprisingly, the subject came up in my office about why commercial real estate is taking a fall. They thought that they were sheltered from the sub-prime mortgage mess since they “only do commercial real estate,” not residential. Now, since there is less work coming in, people are asking “Why is commercial real estate being pulled down along with residential real estate?.” Answer is pretty simple: Banks don’t have the money that they used to.
A lot of banks are licking their wounds from the sub-prime mortgage mess. So, to hold on to the money they have, they are cutting back on creating loans. Also, since Fall 2007 banks have been reporting to the Federal Reserve that they are tightening their loan standards; they’re making it harder for people to get loans. Gone are the days of no credit checks, no confirmation of income, or no down payment loans. And if you do find a bank who is still willing to give you one of those risky loans (since I know there are still some out there), do yourself a favor and find another broker.
Fast forward to mid-2008 and banks are still repairing their balance sheets. Who would’ve guessed? Now, money is tighter than ever and banks and investment banks alike are failing - regardless of size. Freddie and Fannie Mac are suffering a slow death. Commercial mortgages are also drying up. Why?
Liquidity (the flow of money within the market) is not flowing as freely as it used to. Along with sub-prime mortgages, all of the exotic mortgages are blowing up. Packaged mortgages used to be one of the bread winners in the banking industry. Now, the “mortgage backed securities” or MBS’s that we all hear so much about, are rarely trading or are being sold at a heavy discount. So banks are in a quiet panic. They’re hiding their write-offs until the last possible moment. People are losing their jobs. And the government has put a few band-aids on the dike. Woo hoo. What’s next?
It’s kind of like waiting for the next thrilling sequel of a bad movie: It’s only a matter of time before something else goes wrong. But in the meantime, banks have are trying to make up the difference by jacking up mortgage rates.
And this is an interesting point, because (generally speaking) the interest rates are supposed to follow the trend that the federal funds rate goes. So naturally, people question how it is possible that while the Federal Reserve reduced interest rates to 2.00%, that the interest rates on loans have increased to nearly 7.00%?
Part of the is because mortgages are perceived as a riskier asset than they were two years ago. The mortgage rate gap represents the premium that banks are putting on loans because of their perceived risk. When in reality, creating a loan is no riskier than two years ago. It’s actually less risky since they’ve tightened loan standards and all of the “fringe” buyers have been eliminated.
When money flows freely, the times are good. People were able to get no money down loans, crazy teaser rates, and interest only loans. But, when that money doesn’t flow, it’s the end of the world for banks since that is their livelihood. They shrivel up like a prune. And he lack of liquidity comes full circle. It taps into other kinds of loans, including jumbo loans and commercial loans.
But I doubt even Ben Bernanke saw that one coming. Just like Greenspan did not foresee the long term interest rates going down, even as the Fed was increasing the federal funds rate. So now people are upside down in the mortgages that they have, or they’re simply losing their homes. And the rest of us all suffer by paying higher interest rates on our student loans and credit cards.
Who knew.
~K
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