Which state had the most bank failures during 2008-10?

No, it’s not centers of sub-prime madness like Arizona or Nevada.  Nor is it big states like California or Florida.  It’s Georgia.  And Illinois is second.  Check out the graph in this link:

There is a good reason why most bank failures in 2009 did not occur in the sub-prime states; sub-prime loans were not the main problem.  Indeed mortgages of all types were not the main problem.  What was?  According to McNewspaper USA Today it was construction loans, often for commercial real estate: 

The biggest bank killer around isn’t some exotic derivative investment concocted by Wall Street’s financial alchemists. It’s the plain old construction loan, Main Street banks’ bread and butter for decades.

Deutsche Bank has called them “without doubt, the riskiest commercial real estate loan product.” The Congressional Oversight Panel, a financial watchdog, has warned that construction loans have deteriorated faster and inflicted bigger losses on banks than any other real estate loans.

That’s right, everything we were told about the financial crisis in 2009 (and which I also believed for a while) is wrong.  It’s a commercial RE crisis, not a mortgage crisis.   You might argue that it was housing loans that triggered the liquidity crisis of late 2008.  Yes, but the crash of late 2008 was caused by the Fed’s failure to do level targeting once rates hit zero.  The main public policy issue with bank failures is the cost to taxpayers, not the impact on the business cycle. 

In earlier posts I argued that the commercial real estate market does not appear to have been a bubble.  It held up very well in late 2006 and 2007, even as residential housing was falling almost continuously.  Only when NGDP growth slowed in 2008, did commercial real estate begin a significant decline.  No big surprise there, commercial real estate is extremely sensitive to falls in NGDP produced by excessively tight money.  The same problem hit commercial RE in the 1930s, when NGDP fell in half.  There are stories of the Empire State Building being mostly empty after it opened in 1931.

Why were all those bad commercial real estate loans made?  After all, shouldn’t banks take into account the risk of recession?  Well nobody could have expected NGDP to suddenly fall 8% below trend.  But even so, there clearly is a problem here.  Indeed it appears that our current banking crisis, which was initially thought to be very different from the 1980s S&L fiasco, was almost an exact replay of that earlier crash.  Initially we were told that the big banks were the problem this time–it was all about “Too-Big-to-Fail.”   But they have been quietly repaying their TARP loans.  Even the worst banking fiasco in nearly 80 years will not result in taxpayer money being permanently transferred to big banks.  Even if you include the AIG bailout as an implicit bailout of the big banks, the small banks are still the main problem.  Our government insurance company let’s smaller banks run wild, just as in the 1980s (i.e. before the so-called “regulatory reforms” that were supposed to fix the S&L problem.)  The cost to FDIC of all these smaller bank failures in places like Georgia will be many times larger than the net cost of AIG plus the banking part of the TARP bailout.  And let’s not even talk about the cost of bailing out the GSEs.

It’s not about big banks and it’s not about derivatives:

It did not end well. Construction loans started blowing up when the real estate market collapsed and the economy tumbled into recession. The 10 biggest banks, facing problems of their own with subprime mortgages, were largely immune to the deterioration in construction loans, which accounted for just 2% of their assets in 2007, according to the Federal Reserve. By contrast, construction loans accounted for more than 10% of assets at banks that didn’t rank in the top 1,000. “What’s causing the problem is Main Street America, the construction loan made by the bank down the street,” says Bill Bartmann, who owns a debt advisory firm. “They built, and nobody came.”

Making matters worse: Community banks never sold the construction loans to investors the way banks unload auto loans and residential mortgages. “Most construction loans are so unique, so different, so non-homogenous, that you can’t securitize them,” Bartmann says. “They were kept on the books of the banks that originated them.” And there, many of them started to turn rotten.

Here’s an example of what banks did in Georgia:

Rollo Ingram witnessed one spectacular flameout up close. He was chief financial officer at Atlanta’s RockBridge Commercial Bank, which opened in 2006, backed by other members of the city’s business elite.

RockBridge told banking regulators it planned to specialize in business lending. It didn’t, plunging instead into real estate and construction loans. The bank told regulators in 2006 that construction loans would account for 5% of its portfolio. By the end of 2007, they accounted for 42%. Business loans, which were supposed to make up 50% of RockBridge’s lending, came to just 28%, according to an after-the-fact autopsy by Federal Deposit Insurance Corp.’s inspector general.

Nor did RockBridge recruit veteran loan officers with enough experience to safely assemble its risky portfolio, the inspector general concluded. “They hired younger, less-experienced ones, and didn’t hire enough of them,” Ingram says. He says he was forced out in 2008 when he complained about the risky direction the bank was taking.

Those on the left complained the banking crisis resulted from “laissez-faire,” forgetting that the federal government effectively nationalized most of the liabilities of the banking system in 1934.  That’s right; when you deposit $100 in your bank account you are actually lending the money to Uncle Sam, who re-lends it at the same rate to the bank.  FDIC is effectively a government institution, and the fees on banks are effectively taxes, which of course are passed onto the public.  The government didn’t seem to care that wildcat banks in Georgia colluded with property speculators and ran wild with government loans made at risk free rates.

But some on the right were arguably even worse, not paying enough attention to this problem and constantly harping on the need for “deregulation,” aka the doctrine of “business should be free of regulations that inhibit their ability to loot the Treasury.”

I’m amazed that after the S&L fiasco of the 1980s our government wasn’t able to figure out the problem.  Or maybe they do understand the problem, but are in the pocket of property developers. 

And of course now if someone proposed a crackdown, there’d be complaints about how it would “starve the economy of capital, and slow the recovery.”  Just one more side-effect that results when hawks at the Fed prevent an adequate recovery in NGDP.

Update:  I just saw an example of the “blame it all on laissez-faire” meme discussed in Arnold Kling’s blog.  And Barry Eichengreen isn’t even very left wing.


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39 Responses to “Which state had the most bank failures during 2008-10?”

  1. Gravatar of marcus nunes marcus nunes
    3. September 2010 at 10:02

    D. Beckworth today again insisted on the Feds responsibility for the crisis (the story of rates too low for too long). But then, data comes out showing that the problem was elsewhere (or did “low” rates entice CRE loans?).
    The fall in NGDP is more consistent with the “facts”. That´s why every economist should read the Sherlock Holmes collection.

  2. Gravatar of scott sumner scott sumner
    3. September 2010 at 10:18

    Marcus. I’d say the Fed was 5% responsible for the housing bubble (slightly too fast NGDP growth), bad regulation was mostly responsible, with some bad decisions by private actors thrown in.

    Of course it was falling NGDP that caused the severe recession that began in 2008:3. At worst, slightly elevated NGDP in 2005-06 might have caused a slightly slowdown in RGDP growth in 2008.

  3. Gravatar of Greg Ransom Greg Ransom
    3. September 2010 at 10:21

    So what here doesn’t fit right in with the Hayekian artificial boom / inevitable bust causal mechanism?

  4. Gravatar of Greg Ransom Greg Ransom
    3. September 2010 at 10:23

    Note well. This did NOT include the Hayekians, who wrote extensively about these problems across the decade.

    Scott wrote.

    “But some on the right were arguably even worse, not paying enough attention to this problem and constantly harping on the need for “deregulation.”

  5. Gravatar of q q
    3. September 2010 at 10:24

    i’m not sure you have this right. most of the subprime loans which ended up on bank books at all (ie not having been securitized and sold to other kinds of institutions) were on the books of the big banks. small banks were pushed out of residential mortgage markets when the big banks moved in. the financial crisis (as distinct from the long lackluster recovery) was never about the failure of many systemically unimportant institutions over a protracted period of time. the financial crisis was about the possibility of large interlinked internationally important institutions falling like dominoes.

    that the losses are substantively different from the how they would have been perceived is not a surprise.

    the fact that reality has played out differently from perception (often the case, no?) doesn’t mean that the crisis that happened in 2008/2009 is suddenly about something different from what it was about when it was happening.

  6. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 10:28

    Scott, the developers the article is talking about were developing residential stuff – that why there are ghost neighborhoods / and empty towering condos in SoCal, Vegas, Pheonix, Miami. These guys were all feasting on the mortgage market.

    Without the mortgage market – outright fraud + low rates, there would have been no argument for all these commercial developers over-building.

    And from what I’ve heard while commercial real estate is suffering, but is it under-going a more orderly liquidation because no one is screaming about how sad it is they can’t keep owning their underwater office building.

    “There is a good reason why most bank failures in 2009 did not occur in the sub-prime states; sub-prime loans were not the main problem. Indeed mortgages of all types were not the main problem.”

    Dude, the good reason is because there are 800-3000 banks that are insolvent – as in they CANNOT make loans, they are only surviving because of your QE stuff, IOR, extend and pretend.

    But todays Friday, so I’m sure there will be a couple more executions.

    ONE MORE NOTE: I think it’s a pretty well established fact that the banks that do have better balance sheets – they are keeping their powder dry, precisely so they can be the lucky ones to get the assets from the failing banks unwound by FDIC.

    The FDIC does really favorable loss sharing transactions with the acquiring banks.

    This is why I keep calling for all failed banks assets to go at REO auction – to private investors only.

    Either way you are nuts to say the BIG problem is commercial lending.

  7. Gravatar of OneEyedMan OneEyedMan
    3. September 2010 at 10:29

    It makes sense that commercial real estate loans would do more damage than a similar dollar value of residential real estate. There is little stigma in commercial defaults and much in residential ones, and therefore more strategic behavior.

    I don’t see how we know enough to establish that “Even the worst banking fiasco in nearly 80 years will not result in taxpayer money being permanently transferred to big banks. ”
    If many of the large banks would have failed without tarp money that could not have been raised elsewhere then this kept wealth in the big banks that would at least in part gone to the next generation of large banks that grew from the survivors.

  8. Gravatar of TonyD TonyD
    3. September 2010 at 11:11

    I remember reading an article that described the boom in derivatives as being a direct result of the 80′s S&L mess. If true, then the current financial crisis a delayed response to the earlier problems.

  9. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 12:29

    I’m wondering if IOR pales in comparison to this:

    http://www.fdic.gov/bank/individual/failed/lossshare/

    Watch that video and tell me how my plan isn’t QE.

  10. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    3. September 2010 at 13:35

    Some form of deposit insurance is pretty much necessary, federally or privately run, but it is quite disturbing that FDIC FAQ is filled with recommendations how to abuse the system to get many times more insurance than officially guaranteed.

    Is there any excuse why instead of insurance limit per person, it is per person per bank per ownership category? It probably simplifies accounting somewhat, but it seems to severely increase moral hazard with little benefit in terms of banking system stability.

  11. Gravatar of Wonks Anonymous Wonks Anonymous
    3. September 2010 at 14:00

    I think Alan Blinder set up a business dedicated to helping people game deposit insurance.

  12. Gravatar of marcus nunes marcus nunes
    3. September 2010 at 14:22

    Scott
    Please enlighten Thoma (that it´s all about expected future MP)!
    http://economistsview.typepad.com/economistsview/2010/09/will-a-payroll-tax-cut-stimulate-the-economy.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View+%28typepad%2FKupd%29%29

  13. Gravatar of Benjamin Cole Benjamin Cole
    3. September 2010 at 14:28

    There is an outfit named Trepp that track CMBS (commercial mortgage backed securities). market. If memory serves, there are about $1.4 trillion in commercial loans underwater now, coming due before 2014 or 2013.

    I have to closely follow the commercial real estate markets of SoCal for professional reasons. Loans flowed like water over Niagara into commercial r/e before the bust. Many borrowers knew they overpaid, but had plans to rehab —”reposition” was the fave word– and raise rents.

    Now, if should be noted that on many commercial loans there is “mezzanine debt.” That is a layer in the capital stack above the commercial bank loan, but below equity. My guess is that mezzanine lenders will get pulverized (along with equity).

    I still say we have to reflate property ASAP. Loans are made in nominal dollars. These are non-recourse loans.

    Now is no time for pettifogging about the dollar and gold. And Jeez Louise, inflation has been mild for 30 years.

    Growth Hawks need to enter into the public policy debate arena. The timid Japan Wing of the Federal Reserve Board needs to know they are dithering, and feeble, and hurting the business people of America.

  14. Gravatar of marcus nunes marcus nunes
    3. September 2010 at 14:37

    A better rendition of the “Thoma theme”:
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/09/re-thinking-the-new-keynesian-is-curve.html

  15. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 14:40

    MY GOD, Benjamin you do not have your facts straight:

    http://money.cnn.com/2010/07/13/news/economy/CMBS_accidental_recovery.fortune/index.htm

    Please read the WHOLE article so you can see what has happened when the government isn’t involved.

    Seriously, how can you come to the table with such distorted on the ground data?

  16. Gravatar of marcus nunes marcus nunes
    3. September 2010 at 14:42

    “Where have all the flowers gone…”
    http://www.frbatlanta.org/news/speeches/lockhart_090310.cfm

  17. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 14:52

    And one more to help you Benji:

    http://www.housingwire.com/2010/09/01/debtx-july-cre-loan-value-up-to-79-4

  18. Gravatar of David Pearson David Pearson
    3. September 2010 at 15:20

    Scott,

    The problem with community, or regional, banks was obvious to many observers prior to 2007. Their CRE loan concentration was extreme: many of these banks had multiples of core capital tied up in these types of loans. At that level of concentration, any hiccup in the CRE market would result in losses, sales of collateral, falling collateral prices, and more losses, more sales, etc. In fact this is what occurred, and why I was able to short several of these names down to failure/low single digit stock prices.

    The problems in CRE began under a rather mild recession or fall in NGDP, not the 8% crash. Zions, a major Southwest region CRE lender, saw its stock price fall from a peak of $85 in 2007 to $40 by the START of 2008. Many of the other regional banks’ stock prices show the same trend. Moreover, the underlying solvency concern at Lehman was over its large, illiquid CRE portfolio. This concern obviously pre-dated the crash in NGDP expectations–it was a focus of investors from the time Bear Stearns failed.

    The accumulation of leverage and excessive risk concentration leads to financial system fragility and its eventual failure. I sometimes wonder why this appears to be a controversial concept among economists.

  19. Gravatar of scott sumner scott sumner
    3. September 2010 at 17:02

    Greg, You asked;

    “So what here doesn’t fit right in with the Hayekian artificial boom / inevitable bust causal mechanism?’

    Answer: Falling NGDP, according to the older and wiser Hayek of the early 1970s.

    q, The financial crisis of late 2008 wasn’t caused by small or large banks, it was caused by tight money. I am trying to account for the public policy problems created by bank failures, and that is bailouts. And that is mostly small banks, just like in the S&L crisis.

    Morgan, If you have some data showing I am wrong, then I’d like to see it. I don’t see any evidence in the article you sent me that construction loans for condo towers are handled differently than construction loans for shopping centers or office buildings.

    Regarding public policy, I am criticizing FDIC-insured deposits being used for these sorts of highly speculative real estate ventures. Do you disagree with my critique?

    OneEyedman, You said;

    “I don’t see how we know enough to establish that “Even the worst banking fiasco in nearly 80 years will not result in taxpayer money being permanently transferred to big banks. ”
    If many of the large banks would have failed without tarp money that could not have been raised elsewhere then this kept wealth in the big banks that would at least in part gone to the next generation of large banks that grew from the survivors.”

    I agree we did the big banks a huge favor, but that doesn’t conflict with my point. I wasn’t trying to defend the TARP bailout, I don’t favor bailouts. I was trying to identify where the biggest losses to the taxpayers will end up being. Ironically, despite all the talk about too big to fail, the biggest losses occur bailing out the small fry, and F&F.

    TonyD, Yes, good point. Except it now appears the derivatives weren’t the main problem. But I agree, we are always like the general fighting the last war. We don’t attack the root cause of the problem—FDIC.

    Tomasz, You raise a very good point. Deposit insurance is not about protecting individuals. It is about protecting banks from scrutiny by depositors so they can make lots of gambles without worrying about bank runs. That’s why bankers today are far more reckless than in the 1920s.

    Canada had no deposit insurance until about 1967, so I don’t see it as essential.

    Wonks Anonymous, Interesting.

    Marcus, Yes, I’ve attacked that argument before. Gauti Eggertsson’s model is massively refuted by the behavior of wages and output during the 1920s and 1930s. And of course you have the same people making that argument (which only works if the central bank is powerless), who are also demanding that the Fed do more to boost inflation. One of them even won a Nobel prize. (In fairness, Thoma is a monetary effectiveness sceptic. So he’s fairly consistent.)

    Benjamin, Agreed.

    Marcus, I’ve been sparring with Nick in the comment section over there.

    Marcus, The Atlanta Prez predicts inflation won’t fall in 2010, it does fall, then he says we are getting a normal recovery anyway so no more stimulus is needed. Normal!! Has he seen the job loss graph compared to other post-war recessions? (DeLong had it recently.) It looks like a disaster by comparison.

    David, You were doing a public service in shorting those %$#&*@$ wildcat banks. I’m glad you made lots of money. It really angers me that these people are taking the taxpayers for a ride, and it angers me even more that our leaders let them do it, and will continue to let them do it.

    The fall in CRE prices only began in 2008, with the slowdown in NGDP growth, and the sharp fall in NGDP prices occurred in late 2008, when it became clear NGDP was falling.

    Stocks may have fallen sooner in areas exposed to the sub-prime mortgage downturn, which hit the SW before the country as a whole.

  20. Gravatar of Benjamin Cole Benjamin Cole
    3. September 2010 at 18:24

    CMBS Loan Defaults Hit 9.5%
    08/02/2010 |
    NEW YORK CITY-The current tally is in line with year-end expectations of an 11% default rate for commercial mortgage securities.

    One in nine commercial real estate securities defaulted…..

  21. Gravatar of Benjamin Cole Benjamin Cole
    3. September 2010 at 18:44

    Morgan W—really, the commercial r/e markets are troubles in many places….lenders taking back lots of properties, a lot of stuff selling half-off….tell Moody’s they are wrong….”one in five loans in special servicing”

    Moody’s Sees CMBS Delinquency Poised to Rise 9%-11% in 12 Monthsby JASON PHILYAW

    Commercial Real Estate CDOs Set for More Downgrades, Special Serviced Loans Rise
    Subprime-Mortgage Defaults to Surge: Report
    S&P Warns on $351.7 Billion of Alt-A RMBS
    Option ARMs Surpass Subprime Mortgages in Loss Severity
    Short Sales Mitigate First-Lien Severities, BarCap Says
    Friday, August 13th, 2010, 11:36 am
    Moody’s Investors Service expects the share of commercial mortgage-backed securities loans that are delinquent or in special servicing to continue to rise over the next year.

    Analysts expect delinquencies to increase by 9% to 11% during the next 12 months with loans in special servicing climbing to about 20%, which would be up from the current 11.3% and 5% a year ago.

    Analysts said $3.2bn of commercial loan debt was liquidated between Jan. 1 and June 15, including $731m in March and another $743m in April — which represents the highest-monthly total ever, according to Moody’s. For the entire same period a year ago, a mere $600m of loans were liquidated.

    Senior analyst Keith Banhazl said he wouldn’t be surprised if the agency’s next quarterly report shows a monthly amount of liquidated loans that’s even higher than April.

  22. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 18:57

    From your article:

    “And the worst may be yet to come. Banks, adopting a desperation strategy known as “extend and pretend” or “delay and pray,” have been reluctant to admit defeat, repossess half-completed housing developments and strip malls — and dump them on a depressed market at a big loss. “There probably are many loans out there that are in worse shape than reflected on lenders’ books,” says Chicago construction lawyer Joshua Glazov.”

    “The regulators have probably held back in places,” lawyer Glazov says.

    Troubled construction projects are a nightmare for banks. “If a bank forecloses on a house, it’s a house. Everybody knows what to do with it,” Bartmann says. “But if you’re dealing with a half-constructed hotel or a half-constructed strip mall, not only does no one want it, you now have to maintain it” — trim the hedges, pay the property taxes, write checks to the power company. So, many bankers have chosen to wait it out, extending the terms of loans to troubled developers to keep from having to foreclose and take possession of a half-built headache. Which leaves bad loans and troubled property in limbo.

    “The loans aren’t coming to market,” says Sam Chandan, president of Real Estate Econometrics in New York. “The distress is sitting on bank balance sheets.”

    Message loud and clear: these loans are not being liquidated.

    Meanwhile, mine says:

    “CMBS’s were in a complete freeze in 2008 and early 2009. They weren’t saved solely by government programs or a concerted “save CMBS” movement. Instead, a game of financial hot potato accomplished the necessary work of turning up the right buyers at the right times. Again, the prices weren’t always right — at one point, the “super-senior,” highest-rated tranches were trading at a paltry 50 cents on the dollar — but they reflected what people were willing to pay and represented a market nonetheless. That’s better than RMBS, CDS and CDOs could ask for at the height of the financial crisis.”

    You article does not say:
    1. Mortgage Loans were not the problem in our economy – they were.
    2. Construction Loans were the biggest problem in our economy – they weren’t.
    3. The crisis was really a Commercial RE thing, not a mortgage thing – it was a Mortgage thing, and construction was a small piece of commercial.

    You article does say: Construction Loans (a small segment of commercial) are a friggin mess, because they are still fighting off liquidity. i.e. the worst is yet to come.

    My article says: CMBS, hey it’s not pretty, but is in’t a friggin mess like it would be – if they didn’t do liquidation. i.e. the worst is behind us.

    So:

    1. Liquidation is a positive. CMBS used to be predicted as worse than Mortgages – didn’t happen.
    2. Construction loans (a smaller piece of commercial) are still held by zombie banks fighting liquidation.
    3. Huge numbers of Residential Mortgages (easy money and fraud) bundled as MBS and sold off to Wall Street (and now the Fed) drove construction loans held by the zombie banks.

    You disagree the evidence leads this way? Why?

  23. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2010 at 19:06

    @Benji, you say “default” like it is a bad thing.

    The point of the article is that the expected default load is tracking – and an ugly but orderly process happened in the magical free market – WHEREBY: CMBS pricing is no longer falling.

    They have gone open kimono on the assets, they have priced in the deflation FAST – ripped off the band-aid, shared the pain, and investors are actively buying – sometimes to get close to the underlying assets and acquire it.

    Default means nothing. What you are concerned about is a deflationary spiral – and if we rip off the band-aid, it won’t happen.

    Do not be afraid Benji, the losses are already there, just open the door and greet them. Get it over with.

  24. Gravatar of WhiskeyJim WhiskeyJim
    3. September 2010 at 19:47

    Scott, how does the fact that the commercial market is many times larger than the residential market, and cannot be generally securitized where the risk is spread all over the place affect your argument? We knew in 2007 that the commercial market was going to come home to roost about 1-2 years after the residential market. Now it is happening.

    I believe the main issue remains that banks are in general over-leveraged. They multiply their risk. Having governments run at the very margin of their Ponzi income tax revenue only compounds the issue when re-alignments of the economy take place.

    We are watching a huge re-pricing of a lot of assets. They WILL reach their new levels, killing a lot of banks and jobs and generally rippling through the economy. No stimulus can stop that. In fact, it delays it, making it worse.

    It would have been much better to force bankruptcy on Wall St. and the GSE’s. A great many of houses would have gone on the market at very low prices, and a lot of people would have had to move. But the market cannot heal until a real market is established.

    In the meantime, leaving all that toxic crap on Balance Sheets will make the commercial re-alignment even worse because we are delaying the bottom and extending the pain. The market HAS to clear. The economy will not recover until it does. It will eventually clear. We are just at incredible cost preventing that clearing and re-alignment from happening.

  25. Gravatar of Joe Joe
    3. September 2010 at 22:19

    Professor Sumner,

    You state, “the federal government effectively nationalized most of the liabilities of the banking system in 1934″

    But we had plenty of financial crises long before the 30s. Now, of course, a well studied individual would note that these crises were the result of bad monetary policy and bad federal financial regulation. However, we did after all have 50 years of financial bliss after we regulated in the 30s.

    It was only when we had lot’s of innovation in financial markets and deregulation did we have BOOM! junk bonds collapse, S & L, 1987, LTCM, tech bubble collapse, and 2008 crash.

    I believe you once said that the 50 years of quietness was not the result of good regulation but something about “inflation propping up asset prices.”

    But still….

  26. Gravatar of Luis H Arroyo Luis H Arroyo
    4. September 2010 at 01:14

    Scott, i´ve just read your last contribution in “The Economist”, I enjoyed it very much. I think is a good explanation to what happen in the second quarter, with $ up and euro down. Germany is an big exporter, its exports account for a high percentage of GDP. On the other hand, the high $ has had a relation with the slowdown in manufactures & employment.
    I like the end off the article:
    “Many economists overestimate the importance of real shocks in the business cycle of large diversified economies, and underestimate the importance of monetary shocks. That’s not to say that real shocks are unimportant. If the Greek crisis ends up costing German taxpayers a great deal of money, then it may be a net negative for German welfare, even with the short term boost to growth. But if we are focusing purely on the business cycle, then shocks to the supply and demand for money (including expectations of future changes) are the primary determinant of the pace of recovery”.
    i agree disequilibria in money market are fully understated as potential amplifiers of real shocks. Perhasp a barter economy had not so ample fluctuation, but, evidently, it couldn´t be so affluent.
    Many economists overestimate the importance of real shock because they understimate the monetary problems. And in 2008 we have had “the mother of all the monetary problems”.

  27. Gravatar of scott sumner scott sumner
    4. September 2010 at 06:00

    Morgan, I am talking about the bailout costs to the public, which is what I care about. You are talking about whether the market has found some sort of equilibrium price. Of course it has, and I don’t find that very interesting.

    Unlike you, I think housing is also in equilibrium.

    WiskeyJim, You said;

    “We knew in 2007 that the commercial market was going to come home to roost about 1-2 years after the residential market. Now it is happening.”

    Who is we? I didn’t know that. The people paying record high prices in 2007 for commercial RE didn’t know that. Anyone who did should have shorted them and got rich. Apparently one of my other commenters did—good for him. But it wasn’t widely known.

    CE prices only fell when we went into the recession, which tells me the recession caused the price drop, as recessions usually do.

    You said;

    “We are watching a huge re-pricing of a lot of assets. They WILL reach their new levels, killing a lot of banks and jobs and generally rippling through the economy. No stimulus can stop that. In fact, it delays it, making it worse.”

    This is exactly the “liquidationist” attitude that led to the Great Depression. Do we want to repeat that mistake?

    Joe, Canada had no deposit insurance, and a banking system that was much less regulated than the US, and had no bank failures during the Great Depression, Indeed they didn’t even institute deposit insurance until 1967. I’m not defending the pre-1934 US banking system, I am defending the pre- and post-1934 Canadian system, which I have repeatedly plugged on this blog.

    The US banking system was in terrible shape in 1980, even before any deregulation took place. Indeed the deregulation (under Carter) occurred precisely because banks were in such bad shape. They were collecting 5% on long term mortgages, and paying depositors 10% to attract money. Is that a good business model? But that occurred during the so-called regulatory “golden age.”

  28. Gravatar of Morgan Warstler Morgan Warstler
    4. September 2010 at 07:40

    Well yes Scott housing is in equilibrium if you pretend there are not 7.1M houses that need to be liquidated on the market.

    What’s interesting is this: Find me a real estate investor who thinks housing prices aren’t headed down for this reason. The only guys I know buying are doing it on the court house steps at DEEP discounts to your equilibrium.

    Bail-out costs to the public?

    Jesus Scott, do you not understand the “the longer you wait, the more damage you do” The problem is that nothing can get back to normal until those houses get liquidated.

    Day in and day out, I have to poke your balloon because you claim there is deflation – but falling rents is the only reason we have sub 2% inflation.

    And now, you want to say housing is in equilibrium?

  29. Gravatar of WhiskeyJim WhiskeyJim
    4. September 2010 at 10:09

    Scott, let me clarify. As soon as the residential market began to implode, most people realized the commercial market was next. It was simple; there is no reason to believe that builders and bankers did not over-build in that market also. This understanding was wide spread, at least in the construction industry. I saw people like Schiff on TV saying the same thing.

    Throughout 2008 the commercial market continued to work through its almost 1 year order book. Large engineering and construction firms were still busy although some projects were halted half finished. There is the 1-2 year lag.

    And yes, all those assets must find their new price before the economy can turn around. The supply and demand must find a new market. If that means liquidation, then so be it. That is where Keynes is horribly wrong. He viewed the economy, as many economists do, as a static system that can be prodded and pulled. It is not. It is a complex system that adapts to market signals. No public employee directed stimulus, much less any stimulus, can stop what the market must do before it can be active again; find new prices based on current value.

    Kling’s explanation in “Labor is Capital” at American.com is a good one. I would add that assets themselves, hidden on bankrupt balance sheets despite all the money they were loaned, are still the problem. The market voted to extinguish most of Wall Street. Better that it would have been allowed to do its work. It’s main contribution to the 20th century was the ATM.

  30. Gravatar of Joseph Joseph
    4. September 2010 at 10:45

    Scott, I think your facts about CRE market are wrong. There has actually been enough people pointing to potential issues there long before 2008.
    google site:calculatedriskblog.com CRE bubble
    f.e. posted in Dec 2006
    http://www.calculatedriskblog.com/2006/12/real-estate-crash-lessons-have-been.html
    “Well I guess bank regulators are expressing some concern on CRE (see new guidance). I think it is more difficult to call CRE a “bubble”, as compared to the residential housing market, but the impact of a shakeout could be significant with the extensive leverage of buyers, and the loan concentration of mid-size institutions in CRE. ”
    or
    http://www.calculatedriskblog.com/2007/09/cre-index-declines.html
    “The Midwest led the biggest-ever drop in the national quarterly commercial real-estate index compiled by the Society of Industrial and Office Realtors.
    The national index dropped nearly 4.5 points, to 113.7, for the summer of 2007. That is the weakest score since SIOR began compiling the index nearly two years ago.”

    That is an index, not some estimate, back in 2007. Do you still believe there was no other reason for CRE to tank apart from “sharp drop in NGDP”?

  31. Gravatar of OGT OGT
    4. September 2010 at 12:18

    I have to mostly agree with Whisky. In the real estate industry it is well known that commercial real estate prices and investment tend to lag residential on both the way up and the way down. That has been the pattern in most recessions since WWI, the 2001 recession was actually an outlier in this regard.

    Also, as others have noted, the CRE concentration of local banks was also well known before the crisis, many commentators were worried about it. This was also a somewhat new phenomenon as local banks were priced out of residential lending by competition from the sub-prime brokers.

    Lastly, accounting for the public bailout one can’t let the big companies off the hook without accounting for the backdoor bailouts through AIG, credit guarantees to lower the cost of capital, through the GSE’s and currently through IOR.

  32. Gravatar of Immigration and Housing Prices Immigration and Housing Prices
    4. September 2010 at 16:01

    [...] prices in non-sub-prime areas to begin falling.  Ditto for commercial real estate.  We saw in an earlier post that it was commercial real estate, not subprime housing, which was the main cause of bank [...]

  33. Gravatar of WhiskeyJim WhiskeyJim
    4. September 2010 at 22:14

    To make it all worse, people on the ground are now saying the evidence is piling up that real estate is cheating by reporting the MLS price as the sell price instead of the actual price.

    It’s also not uncommon for the buyer to ask for a cash kickback direct from the seller, added onto the cost of the house. So what if the realtor gets a commission on that money? It’s tax deductible over 30 years on record low mortgage rates.

    The numbers are bad. If the Fed and the banks want to play games, everyone else will too.

    Which brings up the essential problem with bailouts to elites. Don’t ever discount the psychological effects of practices deemed unfair by the hard working stiffs on the street who depend on honest capitalism to make a living. If the golden rule or fairness is perceived to no longer apply, we’ll see corruption on a scale the government never dreamed of. And once it’s systemic, the system will never fully recover. Go visit Russia or Latin America or Mexico or …

  34. Gravatar of Rebecca Burlingame Rebecca Burlingame
    5. September 2010 at 06:43

    As a former entrepreneur I am certainly familiar with the fact that if you build it they don’t necessarily come, which is one reason I have closely watched the situation with commercial real estate and wondered what its impact really was. However, that commercial real estate overbuilding may have even been a greater problem than subprime really surprises me. I tend to think of those getting commercial loans having better oversight for their financials. And the fact that the loans weren’t securitized makes things worse? Is this like the 80′s because of government’s insistence on 30 year mortgage terms or are the commercial loans set up completely differently? Admittedly there may be a simple answer to this; too many people building commercial who are hoping the tenant will come, as opposed to the (direct) business getting the loan, hoping the customer will come. I tend to think in terms of the business doing the borrowing, perhaps a bit old fashioned.

  35. Gravatar of scott sumner scott sumner
    5. September 2010 at 08:01

    Morgan, You said;

    “What’s interesting is this: Find me a real estate investor who thinks housing prices aren’t headed down for this reason. The only guys I know buying are doing it on the court house steps at DEEP discounts to your equilibrium.”

    You don’t seem to understand the meaning of the term “equilibrium.” Those courthouse prices ARE equilibrium.

    And I don’t say there is deflation now, I said it occurred in late 2008.

    WhiskeyJim, You said;

    “Scott, let me clarify. As soon as the residential market began to implode, most people realized the commercial market was next.”

    I guess “most people” doesn’t include those buying CRE at higher and higher prices in 2007.

    I do agree with you about one thing, Keynes was wrong about a lot of things. I am no Keynesian.

    Joseph, You said;

    “Scott, I think your facts about CRE market are wrong. There has actually been enough people pointing to potential issues there long before 2008.”

    That in no way conflicts with what I said. In every single boom market in all of world history there have been numerous people sitting on the sidelines saying prices have reached excessive levels. They have said this in bull markets where they were correct, ex post, and bull markets where they were incorrect, ex post. So it doesn’t tell me anything about where prices are likely to go.

    I used the price index in Krugman’s post:

    http://krugman.blogs.nytimes.com/2010/01/07/cre-ative-destruction/

    It shows CRE prices rising throughout 2007. If you have evidence that this index is wrong, I’d love to see the evidence.

    OGT, See my answers above. Those buying CRE in 2007 clearly did not see a crash coming.

    You said;

    “Lastly, accounting for the public bailout one can’t let the big companies off the hook without accounting for the backdoor bailouts through AIG, credit guarantees to lower the cost of capital, through the GSE’s and currently through IOR.”

    I agree on AIG, and always add that in when I estimate the costs of bailing out the big banks. But its still very small compared to the small banks. Regarding F&F and IOR I strongly disagree. The net effect of Fed policy has badly hurt the big banks. So if you are talking about indirect effects that must be taken into account. And F&F is a policy I have strongly criticized over the years. I see it as an entirely separate issue from the big banks. Most of the criticism of the big banks, would be much more effectively directed at FDIC and F&F and their Congressional supporters. That’s where the big problems lie.

    WhiskeyJim, You said;

    “Which brings up the essential problem with bailouts to elites. Don’t ever discount the psychological effects of practices deemed unfair by the hard working stiffs on the street who depend on honest capitalism to make a living. If the golden rule or fairness is perceived to no longer apply, we’ll see corruption on a scale the government never dreamed of. And once it’s systemic, the system will never fully recover. Go visit Russia or Latin America or Mexico or …
    Joseph, I relied on the index in this Krugman post, which shows CRE prices rising throughout 2007.”

    Bingo! You are 100% right, and I entirely agree. That’s one reason I support NGDP targeting, so we will have fewer bailouts.

    Rebecca, The main problem was the recession.

  36. Gravatar of Joseph Joseph
    5. September 2010 at 08:50

    Scott,
    The link that I provided mentioned the index – SIOR CRE index. There does not seem to be a graph available to non-members but a quick search shows, f.e.
    http://www.realtor.org/press_room/news_releases/2009/08/decline_slowing
    “The SIOR index has declined for 10 consecutive quarters and stood at 36.0 in the second quarter, compared with a level of 100 that represents a balanced marketplace.”

    10 quarters by August 2009 – seems the decline started at most in the middle of 2007. And anyway, even MIT index shows there were significant dips in 2007 and if you take into account that preparing a CRE deal takes some time it is clear prices started falling before money became tight. As others mentioned, there is a lag between residential and CRE so if seems the decline was inevitable. Of course it is possible tight money made it worse.
    Actually, how does the presence of people buying in 2007 at the peak (I refer to your reply to WhiskeyJim) prove the prices should not have fell (without tight money)? Inevitably when there is something that later turns out to be a bubble somebody buys at peak price. Is that not so? Can we not have prices rising and then falling without tight money?

  37. Gravatar of OGT OGT
    5. September 2010 at 17:53

    That’s obviously true that people buying in 2007 didn’t see the crash coming, especially the deals I saw with a cap rate of 4%, well below the mortgage rate and no debt coverage to speak of. But, that’s one of the problems in bidding systems with heterogeneous beliefs, the most optimistic ones always win the bid. It’s also why slowing sales tend to be a worrying sign, it means that the market may be trying to adjust to a lower clearing price. This was happening in 2007.

  38. Gravatar of scott sumner scott sumner
    6. September 2010 at 09:47

    Joseph, I don’t see the “significant” declines you see in the MIT index during 2007. I see prices at a very high level and trending slightly upward, despite continual declines in housing prices.

    Sure it’s possible there was a CRE bubble, it doesn’t have to be tight money. But it still looks to me like it was mostly tight money, not a relapse from a bubble. You’d expect a NGDP slowdown in early 2008 and then decline in late 2008 to cause a CRE price fall in early 2008 and then crash in late 2008, and low and behold that’s exactly what happened. It isn’t proof, but it’s the most plausible explanation we have. Certainly the CRE price decline seems disconnected from the housing crash.

    OGT, You said;

    But, that’s one of the problems in bidding systems with heterogeneous beliefs, the most optimistic ones always win the bid.”

    That’s true of any auction, and its equally true of when prices are rising and falling.

  39. Gravatar of Director’s law? « Entitled to an Opinion Director’s law? « Entitled to an Opinion
    4. April 2011 at 17:53

    [...] in the southeast, although it was initially limited to much smaller amounts. Scott Sumner said here that the “too-big-to-fail” investment banks have been blamed when small ones are [...]

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