SAM ZELL EXPOUNDS ON THE ECONOMY, WARNS OF RECESSION

SAM ZELL EXPOUNDS ON THE ECONOMY, WARNS OF RECESSION

Sam Zell was recently interviewed on Bloomberg’s “GO” TV.  The beginning of the post are some selected quotes from the interview.  I also provide a link to the full transcript.

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By Mike “Mish” Shedlock

Wednesday morning, Sam Zell, billionaire chairman at Equity Group Investments, spoke with Stephanie Ruhle and David Westin on Bloomberg’s “GO” TV.

Zell discussed a wide variety of topics from the Federal Reserve rate hike, the risk of a near-term recession, real estate, energy, and various foreign investment ideas. The interview was before the Fed announcement.

I put a spotlight on some interesting Zell ideas. Everything below is a selected quote except for two comments by me in braces[].

Twenty-Two Ideas

  1. Economy: High probability that we’re looking at a recession in the next 12 months.
  2. Rate Hike: Interest rate hike is probably 6 or 8 months too late. I think that the economy is closer to falling over than it is to going up.
  3. US Dollar: Devalued currencies make it very difficult for the US to compete internationally.
  4. World Trade:  World trade is slowing. Currencies continue to be manipulated. You’re looking at the beginnings of layoffs in multinational companies. Weakness is going to be pervasive.
  5. Global Deflation: You can’t put aside China. You can’t put aside Europe. If China’s numbers turn out not to be as accurate as we think, China could go into a recession. That’s about as deflationary a scenario as you could possibly come up with. And one that would for sure impact growth and affect Janet Yellen’s decision.
  6. Fed Tools: “Uh” …  [as in the Fed has none]
  7. Asset Prices: Assets will get cheaper.
  8. Cash: With zero interest rates the penalty for holding cash is not very significant.
  9. Stock Market: Nothing cheap. A number of falling knives that have been obfuscated by Amazon and Facebook et cetera. If you take out those stocks, the stock market isn’t doing real well.
  10. Mexico:  Mexico is terrific. I think there’s extraordinary opportunity there.
  11. China: I don’t think China is growing as fast as it reports to be. And I think that the world has a significant deflationary risk coming from a slowdown in China which I think would impact the cost of goods all over the world.
  12. Brazil: Brazil is obviously suffering significantly. On the other hand, as an investor I’m always looking at where nobody else is willing to go. We’re there already and under the right set of circumstances wouldn’t have any problem investing in Brazil today. I just think you can’t lose sight of the fact that this is a country with 180 million people. It’s still growing. It’s self-sufficient in water, oil, food. It’s an extraordinarily badly managed you know entity. But the extraordinary part hasn’t changed. I’m somewhat of an optimist and I think this whole process will be a cleansing process.
  13. Oil: It’s not so much prices as it is specific opportunities. What makes the opportunity is the distress of the situation.
  14. Natural Gas: I’m probably more focused on gas than oil. And it’s, you know, it’s a little bit like real estate. I mean we made a fortune because we bought real estate at a discount to replacement cost. Well we’re buying gas in the ground, gas that’s been drilled. People have spent $10 million a well, we’re buying wells at dramatically less than that. So it’s the same kind of creating a competitive advantage by virtue of your entry price.
  15. Real Estate: It’s very hard not to be a seller. And so we’re in effect fulfilling in some respects our longer term strategy in AQR where we’re liquidating the remaining garden apartments we have.  I’m not a big fan of buying at these cap rates.
  16. Blackstone: Blackstone is just buying brick and mortar. And they’ve been able to raise staggering amounts of money. And they’ve got to put that money to work. That’s something we’ve never wanted to be in a position of having so much capital that it affects our decision-making on an ongoing basis.
  17. Currencies: I’m very concerned about what’s happening in currencies. I think that you know Bretton Woods in 1948 was the allies coming together and saying we can’t recover in the world without growing free trade. We can’t create growing free trade without stable currencies. So let’s make sure we have stable currencies. That worked for a long time. Now we have very unstable currencies. World trade is slowing.
  18. Dodd-Frank: I’ve never known of a single situation in my life where reduction in liquidity was a plus. And effectively Dodd-Frank has dramatically reduced liquidity and that’s a big negative. And that’s something we haven’t dealt with yet.
  19. Politics: The American people are extraordinarily angry. The American people are extraordinarily depressed. The last time we had anything like this in my opinion was 1979. [To a statement regarding Trump’s popularity Zell responded]:  It’s because you guys are sitting here in New York City and you’re not in Des Moines. And you’re not in Boulder and you’re not all over the country. And you’re not seeing the enormous disparity that has existed between you know the coasts and the rest of the country. We have a lot of very unhappy people and I think this election is reflecting it. And I think it will be very dangerous.
  20. Flat Tax: I think if I were given a straight choice I would be in favor of a simple flat tax.
  21. Government Bonds: I’m not a big lender of money to governments period.
  22. Climate Change: The level of certainty of exactly what is happening has a lack of humility and arrogance to it that scares me. As far as I’m concerned, conventional wisdom is my greatest enemy. And this strikes me as an awful lot of conventional wisdom.

It was a fascinating 2-hour interview. I stripped off the intro, the rest appears below. It’s well worth a read.

For the full transcript go here.

 

Quiet U.S. Ports Spark Slowdown Fears – WSJ

America’s busiest ports reported a decline in imports during the key peak shipping season for the first time in at least a decade, sparking fears of a broader economic slowdown in the U.S.

The question is, what does a slowdown in economic activity mean to the economy in general, and real estate in particular?

 

Source: Quiet U.S. Ports Spark Slowdown Fears – WSJ

Household Incomes now equal to 1989 Levels – Rising Rents Bring Back Feudalism Society

The Fed surprised markets on Wednesday with their taper head fake.  Was it because the economy is booming?  No.  Was it because household incomes were growing?  Not exactly.  Was it because inflation is non-existent?  Not if we look at rents or medical care.  In fact, going through the Fed’s statement it is largely holding back on the taper because of fear of budget negotiations in Congress.  That is, we are hitting our debt ceiling yet again and the Fed wants some leverage here.  Yet the larger signs all pointed to a taper if we consider that rents are rising at nearly twice the rate of the overall CPI.  Also, the Census figures for 2012 were released and household income adjusting for inflation is now back to levels last seen in 1989.  Lost decade?  Try a lost generation.  Also, recent data highlighted that the wealthiest in our country are capturing most of the income gains and given this trend and the Fed’s taper-less September, the feudalism trade is fully on.

Household income

The Fed is the housing market.  Investors are dominating the market and this is their number one client.  It is no surprise that a moderate rise in rates has essentially clobbered the “normal” home buyers out in the market.  Regular buyers need every piece of help buying a home because household incomes have done this:

MedianHouseholdIncome

The above chart shows a full lost decade (24 years of weak income growth).  Even in real terms, household income has plunged since the recovery started in 2009:

2007: $55,627

2008: $53,644

2009: $53,285

2010: $51,892

2011: $51,100

2012: $51,017

The Fed is largely playing the market and ironically, these moves are likely to continue the wealth disparity in the US further as investors once again plow into the real estate market to chase yields.  For regular households, more income is going to go to housing on the rental front:

Rent vs CPI

Keep in mind that rising rents with falling incomes is not exactly a good combination.  Rents are rising at nearly twice the pace of the overall inflation rate.  This divergence has accelerated since 2012.  The Fed has made a one way bet here.  The Fed is operating under a QE forever scenario.  Take a look at the Fed balance sheet and tell me if you think a taper is in serious consideration:

fed balance sheet

The Fed is largely playing one big confidence game.  The too big to fail are even larger today.  Real estate investors are virtually half the market in 2013.  Even in expensive California nearly one-third of all home sales are going to investors (in Las Vegas it is closer to 60 percent).

Reconcile all the facts coming out this month:

-Household incomes adjusting for inflation are back to levels last seen in 1989 (24 years ago – a lost generation)

-50 percent of income generated in 2012 is going to the top 10 percent of earners (highest ever since the early 1900s)

-Rents are rising much faster than overall CPI

-Investors are gobbling up an incredibly large share of all real estate purchases

There has been a serious disconnect going on since the recovery hit and these kind of divergent data points suggest we are in a mania like mode.  Investors are largely chasing yield even on many deals that simply do make sense (i.e., cap rates are simply not panning out in many markets).  The Fed taper is merely a magician’s trick.  The Fed can’t taper to any large degree.  It is an end-game in the mortgage market.  The Fed is the housing market.  The Fed is largely focused on helping member banks so it is no surprise that banks are doing exceptionally well and many financial institutions are the largest real estate buyers in the current market.  For now, the investor trade will continue to play out even if people with common sense realize this is simply one giant shell game and the Fed is on its way to a $4 trillion balance sheet.  Doesn’t seen so farfetched that we are entering a modern age of feudalism.

Dr. Housing Bubble
http://www.doctorhousingbubble.com/federal-reserve-taper-household-income-lost-generation/?

The Dollar Losing Ground As The World’s Reserve Currency

Australia and China have announced that they will trade with each other without using the U.S. Dollar.  China and Russia will chip away at the Dollar’s reserve currency status by establishing direct payment in their own currencies with one trading partner after another.  When the world no longer considers the Dollar a necessary reserve currency, we will be in big trouble.  We will no longer be able to endlessly print money and kick the can further down the road.  That will be the end game for the fiat currency system that has been in place since Bretton Woods.

In a previous article by David Stockton on this blog, he makes the following statement about Richard Nixon, which I completely agree with:

“When Richard M. Nixon essentially defaulted on the nation’s debt obligations by finally ending the convertibility of gold to the dollar. That one act — arguably a sin graver than Watergate — meant the end of national financial discipline and the start of a four-decade spree during which we have lived high on the hog, running a cumulative $8 trillion current-account deficit.”

The following is an article that appeared in zerohedge.com that demonstrates how the world is changing and how the U.S. Dollar is unlikely to remain the worlds reserve currency.

Continue reading “The Dollar Losing Ground As The World’s Reserve Currency”

Sundown in America – David Stockman

There have been a lot of doom and gloom articles appearing lately.  Should we be concerned?  (GA)

By DAVID A. STOCKMAN
New York Times
Published: March 30, 2013

The Dow Jones and Standard & Poor’s 500 indexes reached record highs on Thursday, having completely erased the losses since the stock market’s last peak, in 2007. But instead of cheering, we should be very afraid.

Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later — within a few years, I predict — this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too.

Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.

So the Main Street economy is failing while Washington is piling a soaring debt burden on our descendants, unable to rein in either the warfare state or the welfare state or raise the taxes needed to pay the nation’s bills. By default, the Fed has resorted to a radical, uncharted spree of money printing. But the flood of liquidity, instead of spurring banks to lend and corporations to spend, has stayed trapped in the canyons of Wall Street, where it is inflating yet another unsustainable bubble.

When it bursts, there will be no new round of bailouts like the ones the banks got in 2008. Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.

THIS dyspeptic prospect results from the fact that we are now state-wrecked. With only brief interruptions, we’ve had eight decades of increasingly frenetic fiscal and monetary policy activism intended to counter the cyclical bumps and grinds of the free market and its purported tendency to underproduce jobs and economic output. The toll has been heavy.

Continue reading “Sundown in America – David Stockman”

Moderate growth in Apartment sector will continue

By Natalie Dolce,  GlobeSt.com

ENCINO, CA- On a recent apartment webcast, 57% of participants predict that renter demand will get stronger in 2012, while 2% says it will be weaker, with 40% saying it will stay the same. The 2012 Apartment Market Outlook Video Webcast was put on by Marcus & Millichap Real Estate Investment Services, and was generally optimistic in the sector’s “continuation of modest growth in 2012.”

According to William Hughes, managing director of Marcus & Millichap Capital Corp., from a lenders standpoint, the improving apartment fundamentals have supported their level of confidence in the marketplace. “It has been easy to finance core assets all the way down to C assets across the board,” he said. “It becomes a little choppy as you move into tertiary and smaller assets, but even those are being financed by local and regional banks.”   Continue reading “Moderate growth in Apartment sector will continue”

The Worst Housing Crash Since the Great Depression

This is reposted from an article at DoctorHousingBubble.com.

The worst housing crash since the Great Depression just got worse. What happens when home values pop in other bubble metro areas? New home sales fall 82 percent from peak versus 80 percent during the Great Depression

This is likely to be the first ever global economic disaster caused by real estate sponsored by big banks.  During the Great Depression real estate values collapsed as the economy contracted and millions lost their jobs.  That is the typical pattern of real estate bubbles bursting.  Something in the economy creates a vision of a new paradigm and money starts flowing into real estate as a consequence of this euphoria.  This happened inJapan as their economy and stock market frothed over with mania.  There is no time in history that the entire world from the U.S. to Canada to Australia to Spain to China suddenly went into a massive trance and believed that real estate suddenly would carry the weight of every single economy forward.  Of course what we are seeing is the unraveling of this system.  The bubble has burst.  Yet the banking system that relied on real estate as their game of choice in the casino cannot come to terms with reality because it would render them insolvent (which they are by the way).  So instead, the charade continues yet the public is catching on to this mass deception.  What happens when the worst housing crash since the Great Depression gets worse?

Deepest fall in new home sales ever

new home sales

There is little demand for new home sales because the public with weak incomes and an economy that is still struggling has little appetite for overpriced homes.  Even if the appetite were there, the incomes are certainly not.  The juice that kept the game going was debt.  As we have seen with the debt ceiling bread and circus we might be reaching a limit in regards to what we can take on without adding on subsequent real growth.  I know when the contraction started occurring some could not envision the correction lasting longer than a year or two.  People have been conditioned to quick changes and have a hard time realizing that the housing market of the 2000s was a historical mania.  That is it.  It is done for a generation just like Tulip mania or any other mass delusion.  The fact that home prices are now inching closer to early 2000 price levels simply does not jive with the religion many believe.  During the Great Depression, new home sales fell 80 percent from peak to trough.  In this crisis we have fallen 82 percent.

The chart above is rather startling but makes sense given that we have 6 million homes lingering in theshadow inventory.  The way banks are leaking out inventory we are bound to have a lost decade (or two) in our books.  Unless something radically changes the policy is to bleed the productive economy for the ill-gotten gains of the big bankers running this country.  This is why after trillions of dollars funneled to the banking sector little has been done in terms of boosting incomes or home prices.  Where do you think the money went?  It certainly didn’t go to adding jobs:

civilian population employment ratio

This is a troubling chart.  The civilian employment-population ratio is a better measure of employment success in our economy.  We are now back to early 1980s levels.  What is more troubling is the jump from the early 1950s on had to two with the rise of two income households.  The two main driving forces for this reversal are a poor economy and demographics.  How can people look at these trends and think things will reverse?  Even if things do change the demographic change is built into the system.  Some point to wealthy immigrants as the catalyst for rising home prices but we are unable at the moment to provide quality jobs to the masses of the unemployed.  Unless we find an age reversing pill this trend is sticking around for years.  There are limits in life even though Hollywood and Wall Street would like to convince people otherwise.

Bubble still going on in many U.S. areas

The general collapse in home values has left many believing that the housing market has reached a trough simply by default.  That may be the case in many states where home values never really had excessive bubbles yet many highly populated metro areas are still in significant bubbles.  When these bubbles burst financial losses will be large yet again and you can expect the financial system to dig deep into the pockets of struggling Americans.  What happens when these places pop as they will?  Let us look at some of those overpriced regions:

most overpriced metro cities in united states

Source:  Fiserv

This data is current and you can see even after major price corrections these areas are overvalued.  On both coasts, these bubbles still rage but California is still the leader in bubble metro areas.  Folks are delusional thinking this is sustainable.  These bubbles will pop.  It can happen quickly or drag out for years.  The above ratios are flat out unsustainable.  Just take a look at the median home price to median income ratio.  This will pop.  In addition, many of these areas have high unemployment rates.  Take a look at San Diego that nearly has a double-digit unemployment rate for the county.

What is important to also note is that these prices have already fallen by 10, 20, and even 30 percent in many cases from their peak.  They are still inflated.  The shadow inventory in these markets is dramatic.  At a certain point reality will need to be faced and when that day comes, you will see prices moving lower.  That is the only way out or we can grow household incomes and double it in the next few years but do you see that happening?  I would love to see evidence that our financial system would reward productive behavior instead of putting all the money into the hands of the banking system that largely operates like a vampire on the productive side of the economy.  We do need banks, but investment banks should be spun off and allowed to make their own non-systemic destabilizing bets.  At the moment the financial system is simply looking for ways to pilfer funds from the majority of Americans.  If they could find a method to profit from slamming Americans lower they would do it.  Many a hedge fund made billions by gambling and speculating on the failure of American homeowners.

So what happens next?  It is an interesting side note that during the typically hot summer selling season with mortgage rates at all-time lows that home sales are weak.  Why?  At a certain point it boils down to income.  Many that have their brains cleansed by the 1984 media machine think that just because many people have luxury cars or dress a certain way they are wealthy.  They are not. The data does not back up this phony studio set and many are starting to realize that the financial Wizard of Oz is more smoke and mirrors than anything real or tangible.  Certainly there is tremendous wealth in the country but not enough to support entire metro areas with inflated prices.  Just because the mainstream press isn’t reporting this next bubble bursting doesn’t mean it won’t happen.  Heck, they didn’t start talking about the most obvious housing bubble in generations until it blew up in their face.

Severity of Commercial Real Estate Impairment of Banks Is Decreasing

While commercial real estate continues to burden the nation’s 7,584 insured banks and thrifts, the severity of the CRE-related impairment is gradually decreasing. Most of the recuperation is stemming from write-downs and attrition in construction and development loans, the dearth of new lending and from improvement in the multifamily sector.
Busted Bank
As deteriorating conditions lessen, the amount of capital that banks have available to loan should increase. Banks are already setting aside fewer dollars to deal with the losses, according to the FDIC. New provisions for loan losses fell to $20.7 billion in the first quarter from $51.6 billion a year earlier. This marks the sixth quarter in a row that loss provisions have had a year-over-year decline. It is the smallest quarterly loss provision for the industry since third quarter 2007.

“Certainly this has been aided significantly through the continued low interest rates engineered by the Federal Reserve,” noted CoStar Group Senior Real Estate Strategist Christopher N. Macke. “If the termination of QE II or some other factor leads to rising interest rates, banks will have to rely on strengthening property fundamentals to offset the rising rates – commercial real estate’s version of “The Amazing Race.”

The total amount of CRE loans outstanding fell by $32.3 billion (2%) during the first quarter. At the end of March, insured institutions reported holding $1.58 trillion in CRE-related loans, down from $1.61 trillion at the end of 2010.

The total amount of construction and development loans on bank books fell by $25.9 billion (8%) to $295.6 billion.

The total amount of nonresidential loans (including owner-occupied buildings) on bank books fell by $6 billion (less than 1%) to $1.07 trillion.

However, the total amount of multifamily loans on bank books was flat falling by just $300 million to $214.5 billion.

The total amount of distressed CRE assets (delinquent loans, foreclosed assets and restructured loans) at banks stood at $170.9 billion, just 1.3% of all outstanding bank assets.

Total delinquent CRE loan balances (loans 30 days or more past due or in nonaccrual status) fell by $3.5 billion (2.8%) during the first quarter. At the end of March, banks and thrifts reported $121.6 billion in delinquent CRE-related loans, down from $125.1 billion at the end of 2010.

Delinquent construction and development loans fell by $4 billion (6.9%) to $53.8 billion.

Delinquent multifamily loans fell by $400 million (3.8%) to $10 billion.

However, delinquent nonresidential loans grew by $900 million (a 1.6% increase) to $57.8 billion.

The balances of foreclosed assets continued to grow at the nation’s banks from $30.9 billion at the end of the year to $31.2 billion as of March 31. All of that increase was in nonresidential properties, which grew by $500 million to $10.7 billion.

The amount of foreclosed construction and development projects fell about $100 million to $18 billion; and foreclosed multifamily properties also fell by about $100 million to $2.5 billion.

The total amount of restructured CRE loans at the end of the first quarter stood at $34.9 billion, (the amounts are not available for previous quarters). Of those restructured loans, $16.7 billion (48%) were again delinquent or in nonaccrual status.

The number of insured commercial banks and savings institutions reporting financial results in the first quarter declined from 7,658 to 7,574 in the first quarter. One new reporting institution was added during the quarter, while 56 institutions were absorbed through mergers and 26 institutions failed.

From the big picture of gradual recuperation in CRE bank assets, we’ve pulled together some of the highlights from the individual bank numbers.

  • The number of institutions on the FDIC’s “Problem List” increased from 884 to 888 during the quarter. Assets of “problem” institutions increased from $390 billion to $397 billion.
  • Of the 7,584 insured banks in the country as of March 31, distressed CRE assets made up 1% or less of total assets at 4,298 banks.
  • 566 banks out of the total of 7,584 (7.4%) hold more than 80% of the distressed commercial real estate on bank books. The 10 largest banks in the country hold $49.4 billion in delinquent, foreclosed or restructured assets (29%).
  • Wells Fargo Bank holds $2.24 billion of commercial real estate properties on which it has foreclosed, including $1.14 billion in construction and development properties and $868 million in nonresidential properties. Citibank holds the largest amount of foreclosed multifamily properties at $710 million. While high in dollar amounts, the total amount of CRE distress at these two banks is 1% or less of their total assets.
  • Distressed CRE assets make up more than one-third of total assets at five banks: Builders Bank, Chicago, IL; First Choice Community Bank, Dallas, GA; High Trust Bank, Stockbridge, GA; Security Exchange Bank, Marietta, GA; and Cortez Community Bank, Brooksville, FL.

A Housing Apocalypse is Coming

A Housing Apocapyse is Coming

Source:  Dr. Housing Bubble

There will be no sustainable housing recovery until the shadow inventory is cleared out.  As of April with the latest data close to 6.4 million loans are delinquent or in foreclosure.  This is a massive number of homes.  What is downright disturbing of the 2.2 million homes in foreclosure you have 675,000 homes (31 percent of the pool) that have not made a payment in over two years.  That is right, two full years.  Apparently one-third of the bank’s strategy in dealing with foreclosures is simply to ignore missed payments.  Glad it took them giant bailouts and four years to figure that one out.  The housing crisis strategy is really a banking-centric one and that is why nothing has really been resolved since the crisis started.  Banks are dictating the movement going forward so the idea of keeping prices inflated is simply one to protect banking interests.  Since the market has very little desire for inflated real estate, banks just slip it under the rug for another day.  Keep in mind that many Americans are seeing lower wages so lower home prices are actually good for their bottom line since it eats away less of their hard earned income.  Plus, one-third own their home outright and another 30 percent rent.  So this idea of keeping home prices high just for the sake of keeping them high is a ploy that comes out of the suspension of mark-to-market logic.  Do people finally get that home prices have to fall to reflect local area incomes?

The state of distress in U.S. housing

First, it is probably useful to get a sense of the entire potential shadow inventory out in the market:

us home foreclosures

Source:  Calculated Risk

According to CR we have the following:

-2.24 million loans less than 90 days delinquent.
-1.96 million loans 90+ days delinquent.
-2.18 million loans in foreclosure process.

-For a total of 6.39 million loans delinquent or in foreclosure in April.

That is a large number of homes.  Now keep in mind many foreclosures are now starting to make their way onto the MLS since banks are actually taking full possession of the homes (although the reality that 675,000 people have not made a single payment in two years tells you where things stand).  Think about the above data; you have roughly 600,000 to 800,000 as current REOs (all the way through the foreclosure process) but you also have 675,000+ people in foreclosure who haven’t made a payment in two years:

loans in foreclosure

I’ve seen some pundits argue that many of these loans will cure.  We know for a hardcore fact that if you are behind on your payments for two years it is likely that your home is going to move from the shadow inventory into the REO pipeline.  This also doesn’t examine the fact that we have close to 2.2 million homes in foreclosure.  How many have made no payment in one year?  Keep in mind we are only looking at the foreclosure category so far.  So the entire U.S. banking system is being overwhelmed with 600,000 to 800,000 active REOs yet we have that many in foreclosure without two years of payments.  Here is a good estimate of REO data in the U.S.

LawlerSelectedREO

Source:  Tom Lawler via Calcualted Risk

The above doesn’t cover the entire universe of REOs but does a good job.  I went ahead and took a quick look at active foreclosures in the state of California and found the following:

calif foreclosures

calif foreclosures2

Depending on what data source you look at California has roughly 80,000 to 89,000 homes that are REOs and ready for sale.  That still leaves another 600,000 to 700,000 REOs across the country that need to be sold.  You also have to wonder of the 675,000 foreclosures with two years of missed payments how many are in massively overpriced bubble states like California or New York?  Well I can tell you that California currently has 157,000 homes in the foreclosure process that have yet to go REO.  The bottom line is you have a massive pipeline of distressed properties waiting to make their entrance on the MLS stage.

And the foreclosures will work through the system like a rabbit filtering through a python.  We have another 4.2 million homes delinquent where the foreclosure process hasn’t even started (1.96 million of the loans 90+ days late).  Don’t fool yourself because many of these will end up as REOs at some point (could be years down the road given the absurd timeline we are experiencing).  It can’t be stated enough that keeping the process slow and providing banks with trillions of dollars of bailout money is simply a method of clogging the financial pipes so the FIRE economy can figure out what other sector to gut and inflate into a bubble.  In the end it is the taxpayer that will foot the bill unless something radical changes.

I wanted to draw the current distress universe to show how little of the shadow inventory is being shown to the public:

foreclosures q2 2011

The bars are drawn to scale to show actual magnitude relative to other buckets.  The only homes the public is viewing are those in the purple box above.  But look at what we have coming down the pipeline.  Things don’t seem to be changing so it is looking more and more likely that we will witness a Japan like real estate market with zombie banks walking the Earth in search of easy capital brains.

It is extremely troubling that we have so much money being lobbed at the banks with such horrible results.  But what do you expect?  Someone was going to pay for this decade long orgy in real estate.  As it turns out it is the prudent public and middle class.  The people living rent free are simply the other side of the coin to the morally bankrupt financial sector.  We have to go back to watching archived films to remember a time when banking and finance actually carried a positive connotation.

I’m curious to know how many people are living in million dollar homes rent free.  We’ve seen homes in foreclosure in Beverly Hills so it is certainly happening and readers have sent over confirmation of this in their own neighborhoods.  Talk about a giant mess.  The New York Times had an interesting graph showing how long it would take to move 872,000 foreclosures:

timeline to clear foreclosures

Source:  New York Times

It would take roughly 40 months to clear the current foreclosure inventory (aka the tiny blue rectangle in our earlier chart).  And more will be coming into the pipeline but banks are trying to make their speculative gains in other bubbles to soften the blow here.  After all, they wouldn’t want to spoil the trillions in loot they have stolen from Americans.

The Recovery Will Be Bifurcated

Big Lenders and Big Borrowers Will Be the First in Line as Credit Returns to the Economy
By Mark Heschmeyer

These are the best of times for cash-rich borrowers and lenders, but they continue to be tough times for less well-funded borrowers and lenders. Just as the investment markets are bifurcated with top-notch properties in top-tier cities commanding escalating prices and lower tier properties and cities still fighting uphill climbs, so too does it appear that the capital markets are split between the haves and have-nots.

“There seems to be a dam that is keeping the flood of capital provided by the Federal Reserve from flowing to smaller real estate borrowers and properties,” said Chris Macke, senior real estate strategist for CoStar Group. “Expanding the recovery in commercial real estate hinges on breaking this dam.”

The split between cash-rich businesses and those in need of capital has set the stage for a bifurcated economy, with growing challenges for small- and medium-sized companies.

“Depending on where you stand, the debt maturity crunch ahead could either look like a crack in the pavement or the entrance to the Grand Canyon,” Deloitte LLP reported in a new paper this week entitled: A Tale of Two Capital Markets.

In it, lead researcher Dr. Ajit Kambil, research director, CFO Program, Deloitte United States, reported that cash is also unevenly distributed across industries, not just among companies within a particular sector. Unless the financial services industry lends or invests its cash in varied industries, companies outside of financial services could face potentially severe credit constraints.

Deloitte said the convergence of growing demand for debt with supply constraints has created a new normal in the capital markets. A more accurate descriptor would be two new normals – reflecting dramatic differences between cash-rich and cash-challenged companies. Competition for capital will most likely favor investment grade companies over non-investment grade companies as both seek to refinance debt obligations.

What is true across industries is also true within the commercial real estate industry, according to CoStar Group. Last September, CoStar’s Property & Portfolio Research (PPR) subsidiary “delved into how larger banks are much better positioned than smaller banks to “earn their way out” of the current cycle,” said Mark Fitzgerald, a CoStar debt strategist. “And as they recover, with life insurers in better shape as well, this contributes to the bifurcated market, as both of these sources of capital tend to lend on larger, coastal assets, whereas small banks are in worse shape, and this will hurt the recovery in secondary and tertiary markets.”

Since the downturn began, earnings for larger banks, while far from strong, have outperformed their smaller counterparts, CoStar reported. Perhaps the most important reason why this is so is the portfolio composition for larger institutions. The 20 largest banks hold 61% of all bank assets but are underexposed to commercial real estate loans. The bigger banks also have been more aggressive in taking write-downs.

CoStar’s Fitzgerald projected that large banks will “earn their way out” of the Recession in about two years, while regional and community banks could take two to four times as long.

As the economic recovery develops, CoStar Group projects that it will bring mixed blessings to CRE investors.

On the one hand, economic recovery enables banks to earn their way out faster, achieve better execution on poorly underwritten or nonperforming loans, and therefore sell distressed CRE assets at a faster pace.

On the other hand, such economic recovery minimizes the attractiveness of the distressed asset opportunity, as pricing is firmer and disposition of assets is likely to be at a controlled pace.

Furthermore, the modest pace at which banks return to health will minimize the amount of “fuel” (leverage) available to propel a robust rebound in asset values.

With limited leverage, borrower liquidity now also matters. And in that regard, big firms hold the edge. The 9,000 largest companies hold $9 trillion in cash reserves and that level of liquidity makes them more fundable.

An analysis of non-investment grade debt and changing credit spreads finds smaller companies are especially vulnerable to increasing spreads and volatility in credit markets. Differences in cost or difficulties in access to capital can be a key source of competitive disadvantage.

Deloitte research said that most non-investment grade debt is generally concentrated among small companies with market capitalization of less than $5 billion while larger companies’ debt is almost completely investment grade. For the most part, smaller companies tend to have lower credit ratings and company size is a key variable in credit ratings.

Deloitte research found that prior to the recession, companies in the aggregate were accumulating cash in excess of what they needed to grow. This was fortunate as many companies entered the recent recession with unprecedented amounts of cash on their balance sheets – allowing them the flexibility to navigate the worst of the credit crisis.

These cash reserves are unevenly distributed and mainly reside in the financial services industry, with about $2 trillion of cash outside financial services. Unless this cash is deployed to refinance companies, there is a potential deficit in refinancing non-financial service industry debt.