Lack of Liquidation

It’s four years after the crash in the housing market and the economy is still in a funk. Sure the stock market has recovered, but unemployment remains high, housing prices continue to go nowhere, and plenty of unemployed 50 years olds worry they will never work again. Just how long are we to wait for a recovery and why is it taking so long?

The continued government stimulus of zero interest rates, bailouts, and fiscal stimulus have kept the asset bubble in real estate from correcting, at the same time it has pumped up the stock and bond markets.

But while there are more than a few pundits calling a bottom in the housing market, any slight bounce in activity we’ve seen is merely the resulting malinvestment brought about by zero interest rates, and the legal quagmire stopping home foreclosures. The market has not been allowed the clear. Until it is, the market will continue to meander near the bottom.

Ironically, it is Alan Greenspan who sheds some light on this in an interview with Bloomberg Businessweek. Greenspan points to a key difference between the RTC liquidation process after the S & L crash, and today’s lack of liquidation. When asked about the current administration’s policies, Greenspan said,

Well, it’s not the present administration, it’s the current view of most policy-oriented economists. And here, regrettably, I am in the minority. The notion that if there is an economic problem, the government is obligated to address it, necessarily creates uncertainty about the future. And there’s hard research that shows such activism is responsible in part for the very heavy discounting of earnings on longer-lived business investments, and by households that had dramatically shifted from owner occupancy to short-lived rentals in the face of the uncertainty of the direction of home prices. We need to replace such activism with a policy that allows the markets to correct their own imbalances. Remember the Resolution Trust Corporation in the early ’90s? I was on the oversight board of the RTC. It got stuck with the job of liquidating more than 700 failed savings and loans. Some of the stuff that the RTC wound up with was perfectly liquid and saleable. But a big chunk was uncompleted eight-hole golf courses, half-built office towers, and vacant malls. Nobody wanted it. We all sat around and said, “This stuff is deteriorating very rapidly, and if we don’t get rid of it, the taxpayers are going to take a huge hit.” I mean, the numbers were very, very large. Somebody suggested, “Let’s package it and sell it.” And we did. Needless to say, the bids were less than 50 percent of the original cost. Congress was outraged. We were giving away taxpayer-owned assets to greedy vulture funds.

A couple questions later,

Yes. Investors cleared out our illiquid inventory in a matter of months. The final cost to the taxpayers for the savings and loan crisis amounted to $87 billion, a fraction of the original estimate. Allowing the markets to liquidate worked.

What’s different with this crisis is that the FDIC remembers Congress being outraged. The deposit insurer does not want to be accused of “giving away taxpayer-owned assets to greedy vulture funds” again. So, it sits on almost $22 billion in failed bank assets and is partner in billions more.

For instance, NYSE-traded homebuilder Lennar Corp. purchased 40% stakes in bank loans from the FDIC in 2010, with the FDIC retaining the other 60% ownership along with providing seven-year, interest-free financing for Lennar’s share, beyond the $243 million the homebuilder contributed in equity. The three billion dollars in loans was purchased for $1.22 billion or 40 cents on the dollar according to Wall Street analysts.

Colony Capital was also a buyer of busted bank portfolios, again partnering with the FDIC. Commercial Mortgage Alert wrote about one of Colony’s purchases,

The stake was offered under the FDIC’s structured-sales program – one of the agency’s options for liquidating assets inherited from failed banks. Under the program, the FDIC sells stakes of 20-40% in portfolios to operating partners, which work out the assets. The agency retains an interest in order to share in any upside.

These partnerships are not the quick liquidations of the S&L/RTC days. The assets really haven’t left the government’s hands. The government holds majority shares in the partnerships and the minority partners are beholden to the FDIC for the interest-free financing. The seven -year term of the loan belies the idea that these assets will be quickly liquidated.

So as not to anger Congress, the deposit insurer is hoping the market will magically turn around and the punk loans and assets will be sold at higher prices.

The government braintrust embraces the view that the economy is cyclical and that no matter what the Fed or the government is doing, if they just wait long enough the market will turn around and a whole new real estate bubble will appear for them to sell into.

Unless the market is allowed to correct, these asset values are going nowhere. Meanwhile, the Federal Reserve’s monetary pumping will only create other asset bubbles that will ultimately crash.