On the use of the term “Liquidity Crisis”

[4plexowner]

thanks for posting the article Rustico – I like this line best: “Keynesian economics is at the heart of the reason for all levels of government being broke.”
~

Keynesian vs Austrian
http://www.financialsense.com/fsu/editorials/sutton/2007/0413.html

this is a brief comparison of the two schools of economic theory with a bias towards the Austrian school

~

Ron Paul is very much pro-Austrian economics – go Ron Paul

~

Dave – sorry for hijacking your thread – still hoping you will provide some more insight into the banking industry – is there outrage or rejoicing about the bailouts?

[TheBreeze]

Great posts Dave. Yeah, it’s amazing how literally no one in the MSM is talking about this. It’s like none of the Wall Street guys and none of the commentators on CNBC know how to value real estate. There is actually one commentator on CNBC — that women who reports on the California market quite a bit — who seems to have a clue. But other than that, nada.

I am really surprised by Cramer. I consider him to be a smart guy, but he really thinks that all that needs to happen is for the Fed to lower interest rates a bit more and everything will go back to being hunky dory.

The folks who get close to the root of the problem are those who mention that it is “difficult” to value the CDOs/MBSs. However, they never talk about why it is difficult to value them. One of the main reasons it’s difficult to value these things is because the home buyer at the bottom of the pyramid probably “stated” his or her income. To really get a handle on the value of these things, someone would need to investigate all the individual buyers and find out what their actual ability to repay is and how likely they are to repay. They would also need to estimate the value of each individual property based on rental rates in the area or what have you. Who the heck is going to do all that? Given the amount of work required to evaluate these things, you have to figure that at least a 10% reduction to market value (which no one really knows) will be needed to move these things.

[TheBreeze]

Great posts Dave. Yeah, it’s amazing how literally no one in the MSM is talking about this. It’s like none of the Wall Street guys and none of the commentators on CNBC know how to value real estate. There is actually one commentator on CNBC — that women who reports on the California market quite a bit — who seems to have a clue. But other than that, nada.

I am really surprised by Cramer. I consider him to be a smart guy, but he really thinks that all that needs to happen is for the Fed to lower interest rates a bit more and everything will go back to being hunky dory.

The folks who get close to the root of the problem are those who mention that it is “difficult” to value the CDOs/MBSs. However, they never talk about why it is difficult to value them. One of the main reasons it’s difficult to value these things is because the home buyer at the bottom of the pyramid probably “stated” his or her income. To really get a handle on the value of these things, someone would need to investigate all the individual buyers and find out what their actual ability to repay is and how likely they are to repay. They would also need to estimate the value of each individual property based on rental rates in the area or what have you. Who the heck is going to do all that? Given the amount of work required to evaluate these things, you have to figure that at least a 10% reduction to market value (which no one really knows) will be needed to move these things.

[TheBreeze]

Great posts Dave. Yeah, it’s amazing how literally no one in the MSM is talking about this. It’s like none of the Wall Street guys and none of the commentators on CNBC know how to value real estate. There is actually one commentator on CNBC — that women who reports on the California market quite a bit — who seems to have a clue. But other than that, nada.

I am really surprised by Cramer. I consider him to be a smart guy, but he really thinks that all that needs to happen is for the Fed to lower interest rates a bit more and everything will go back to being hunky dory.

The folks who get close to the root of the problem are those who mention that it is “difficult” to value the CDOs/MBSs. However, they never talk about why it is difficult to value them. One of the main reasons it’s difficult to value these things is because the home buyer at the bottom of the pyramid probably “stated” his or her income. To really get a handle on the value of these things, someone would need to investigate all the individual buyers and find out what their actual ability to repay is and how likely they are to repay. They would also need to estimate the value of each individual property based on rental rates in the area or what have you. Who the heck is going to do all that? Given the amount of work required to evaluate these things, you have to figure that at least a 10% reduction to market value (which no one really knows) will be needed to move these things.

[TheBreeze]

Great posts Dave. Yeah, it’s amazing how literally no one in the MSM is talking about this. It’s like none of the Wall Street guys and none of the commentators on CNBC know how to value real estate. There is actually one commentator on CNBC — that women who reports on the California market quite a bit — who seems to have a clue. But other than that, nada.

I am really surprised by Cramer. I consider him to be a smart guy, but he really thinks that all that needs to happen is for the Fed to lower interest rates a bit more and everything will go back to being hunky dory.

The folks who get close to the root of the problem are those who mention that it is “difficult” to value the CDOs/MBSs. However, they never talk about why it is difficult to value them. One of the main reasons it’s difficult to value these things is because the home buyer at the bottom of the pyramid probably “stated” his or her income. To really get a handle on the value of these things, someone would need to investigate all the individual buyers and find out what their actual ability to repay is and how likely they are to repay. They would also need to estimate the value of each individual property based on rental rates in the area or what have you. Who the heck is going to do all that? Given the amount of work required to evaluate these things, you have to figure that at least a 10% reduction to market value (which no one really knows) will be needed to move these things.

[TheBreeze]

Great posts Dave. Yeah, it’s amazing how literally no one in the MSM is talking about this. It’s like none of the Wall Street guys and none of the commentators on CNBC know how to value real estate. There is actually one commentator on CNBC — that women who reports on the California market quite a bit — who seems to have a clue. But other than that, nada.

I am really surprised by Cramer. I consider him to be a smart guy, but he really thinks that all that needs to happen is for the Fed to lower interest rates a bit more and everything will go back to being hunky dory.

The folks who get close to the root of the problem are those who mention that it is “difficult” to value the CDOs/MBSs. However, they never talk about why it is difficult to value them. One of the main reasons it’s difficult to value these things is because the home buyer at the bottom of the pyramid probably “stated” his or her income. To really get a handle on the value of these things, someone would need to investigate all the individual buyers and find out what their actual ability to repay is and how likely they are to repay. They would also need to estimate the value of each individual property based on rental rates in the area or what have you. Who the heck is going to do all that? Given the amount of work required to evaluate these things, you have to figure that at least a 10% reduction to market value (which no one really knows) will be needed to move these things.

[davelj]

OK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:

HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateral

Unfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.

An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.

4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.

TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.

[davelj]

OK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:

HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateral

Unfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.

An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.

4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.

TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.

[davelj]

OK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:

HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateral

Unfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.

An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.

4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.

TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.

[davelj]

OK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:

HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateral

Unfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.

An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.

4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.

TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.

[davelj]

OK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:

HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateral

Unfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.

An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.

4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.

TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.

[barnaby33]

I find it hard to believe, that any bank, let alone a small bank hasn’t loosened its standards to compete. After all the last few years, if you didn’t loosen standards your business dried up completely. Customers don’t normally care how solvent the bank is when the borrow money, only when they deposit.

The race for growth was the race to the bottom, but even those that were aware of what was happening had to have participated, those bank employees have to be paid somehow.

All of which brings me to my actual point. A sh*tty asset crisis my not affect all banks equally; Dave yours may be relatively prosperous. All RE based assets are going to take a hit in terms of valuations. The good as well as the bad. This means that all banks are going to want to lend less money, hence credit contraction. Ultimately that is what the FED is fighting against.

When banks start failing people are going to be a lot less willing to lend them money which only tightens the noose. The good banks and the bad banks get hit with the same macro-economic mackerel, or so it would seem.

Josh

[barnaby33]

I find it hard to believe, that any bank, let alone a small bank hasn’t loosened its standards to compete. After all the last few years, if you didn’t loosen standards your business dried up completely. Customers don’t normally care how solvent the bank is when the borrow money, only when they deposit.

The race for growth was the race to the bottom, but even those that were aware of what was happening had to have participated, those bank employees have to be paid somehow.

All of which brings me to my actual point. A sh*tty asset crisis my not affect all banks equally; Dave yours may be relatively prosperous. All RE based assets are going to take a hit in terms of valuations. The good as well as the bad. This means that all banks are going to want to lend less money, hence credit contraction. Ultimately that is what the FED is fighting against.

When banks start failing people are going to be a lot less willing to lend them money which only tightens the noose. The good banks and the bad banks get hit with the same macro-economic mackerel, or so it would seem.

Josh

[barnaby33]

I find it hard to believe, that any bank, let alone a small bank hasn’t loosened its standards to compete. After all the last few years, if you didn’t loosen standards your business dried up completely. Customers don’t normally care how solvent the bank is when the borrow money, only when they deposit.

The race for growth was the race to the bottom, but even those that were aware of what was happening had to have participated, those bank employees have to be paid somehow.

All of which brings me to my actual point. A sh*tty asset crisis my not affect all banks equally; Dave yours may be relatively prosperous. All RE based assets are going to take a hit in terms of valuations. The good as well as the bad. This means that all banks are going to want to lend less money, hence credit contraction. Ultimately that is what the FED is fighting against.

When banks start failing people are going to be a lot less willing to lend them money which only tightens the noose. The good banks and the bad banks get hit with the same macro-economic mackerel, or so it would seem.

Josh

[barnaby33]

I find it hard to believe, that any bank, let alone a small bank hasn’t loosened its standards to compete. After all the last few years, if you didn’t loosen standards your business dried up completely. Customers don’t normally care how solvent the bank is when the borrow money, only when they deposit.

The race for growth was the race to the bottom, but even those that were aware of what was happening had to have participated, those bank employees have to be paid somehow.

All of which brings me to my actual point. A sh*tty asset crisis my not affect all banks equally; Dave yours may be relatively prosperous. All RE based assets are going to take a hit in terms of valuations. The good as well as the bad. This means that all banks are going to want to lend less money, hence credit contraction. Ultimately that is what the FED is fighting against.

When banks start failing people are going to be a lot less willing to lend them money which only tightens the noose. The good banks and the bad banks get hit with the same macro-economic mackerel, or so it would seem.

Josh

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