After the House of Representatives surprisingly voted down the bailout bill early last week, nearly 20 commercial real estate groups jumped into action and began lobbying aggressively to get Congress to pass Treasury Secretary Henry Paulson's contentious Emergency Economic Stabilization Act (EESA). In the end, the bill—after it was loaded with new provisions by the Senate—passed both houses of Congress and was signed into law by President Bush Friday. The question, however is whether the industry might regret not heeding that famous advice, “Be careful what you wish for … you just might get it.”
For the commercial real estate industry, two provisions in the EESA could have potentially big effects. EESA allocates $700 billion for the Treasury Department to purchase distressed mortgage-related assets—including commercial-mortgage backed securities (CMBS). The bill also gives the Securities and Exchange Commission the authority to temporarily suspend mark-to-market accounting rules. Such rules require banks to value loans, securities and other financial positions at what they would fetch if sold into the market rather than the value at inception or an estimation of the assets' final payouts.
The Real Estate Roundtable (RER), ICSC and the Mortgage Bankers Association (MBA), were among the associations and organizations that rallied behind the bill. ICSC’s Senior Vice President of global public policy Betsy Laird, for example, urged ICSC members to contact their congressional representatives, contending that the industry "has been held hostage to a lack of liquidity in the commercial real estate markets for several months, but recently, the ability to obtain loans, capital guarantees and access to financial markets has become untenable."
Similarly, RER President and CEO Jeffrey DeBoer issued a statement that said: "What happened to values in the residential market could very well happen on the commercial side – something which we can take steps to prevent. The credit markets are now blocked by fear.… The Treasury rescue plan is the best solution to restore credit availability. Now is the time to take resolute action." DeBoer added that the Treasury’s plan "goes right to the heart of the problem." By helping to remove many of the illiquid assets weighing down financial institutions, it should help restore confidence in these assets, he noted. DeBoer also wrote an OpEd piece that appeared in the Wall Street Journal.
After Congress voted, the trade groups issued statements lauding the bill.
RER, statement read, "This bill should go far to restore confidence and stability to our credit markets. The bill establishes a mechanism to remove many of the illiquid assets that are weighing down financial institutions. This will help break the impasse occurring in credit and mortgage markets and help restore confidence in these assets, thus providing necessary liquidity to financial institutions."
MBA's Chief Operating Officer John A. Courson also issued a statement: "This will enable financial institutions to offer credit so individuals can purchase homes and other items and businesses can continue to operate and grow."
ICSC and RER would not comment beyond their statements.
But, not every real estate trade organization supported the bill. The Urban Land Institute ran a commentary from senior resident fellow John McIlwain questioning the effectiveness of some of its provisions. He pointed out that most of the assets the federal government will be buying are not whole mortgages but parts of various tranches of residential and commercial mortgage-backed securities, along with collateralized debt obligations (CDOs), and structured investment vehicles (SIVs) made up of all the above.
"No one knows what is in most of these pools, and heaven knows where the documents are," McIlwain noted. "In time, with enough effort, most of the documents will be found, but not for some time and not all of them – witness the cases where special servicers have been trying to foreclose on a mortgage without original documents, usually unsuccessfully."
Despite the happy talk, however, the immediate aftermath of the bill has shown that it, in itself, has not offered any immediate relief to the credit markets. Part of the argument by bailout backers was that the government needed to act quickly and did not have time to discuss alternative options. Moreover, the argument was that mere passage of a bailout would send a positive signal and help calm markets.
In fact, lending metrics indicate short-term credit has actually seized further since the bill’s passage. The TED spread is an indicator of perceived credit risk in the general economy. The spread, the difference between the interest rates for three-month U.S. Treasuries contracts and the three month Eurodollars contract, hit 4.03 percent Wednesday morning—higher than before the passage of the bailout and much higher than the normal situation when the TED spread is typically less than 0.50 percent.
Moreover, since the bill’s passage the Federal Reserve Bank has gone on to adopt a handful of further measures in its continued attempts to re-start short-term lending. It has doubled the size of the Term Auction Facility, began to pay interest on deposits at the Federal Reserve and, on Tuesday, announced plans that it would begin to buy short-term debt in an attempt to unfreeze the $1.6-trillion commercial paper market. Also Wednesday morning, the Federal Reserve cut the target for the federal funds rate by 50 basis points to 2.00 percent in an extraordinary coordinated action with other central banks across the world.
So if the bill provided no immediate relief, what about the long-term provisions? Soon, the government will begin to purchase bad debt under the Troubled Asset Relief Program. Will that prove beneficial? Commercial real estate pros are unsure of the answer.
"The liquidity infusion is definite and quantifiable, but the restoration of marketplace confidence is much more difficult to control and predict," says Steve Himmelfarb, president of Himmelfarb Commercial, a Washington, D.C.-based retail development and brokerage firm. As a result, "We will know very soon if the government infusion is too little, too late, or a welcome kick start."
Most commercial property professionals are hoping the bailout will have the effects the industry trade groups have laid out. The premise is that the government's ability to buy commercial mortgages will eventually free up lenders' balance sheets for new loans.
Industry observers point to the fact that the bailout plan will at least create a floor on values. Right now, nobody knows how low securitized debt should trade. As a result people are afraid to do deals because it could trigger a round of write-offs as banks go through the “mark-to-market process.” Once the government establishes a bottom, however, the hope is that other buyers will emerge and start buying assets as well—especially if the pools stay relatively healthy in terms of defaults and delinquencies.
"The bailout creates a buyer” for loans the banks can’t sell, says Adam Weissburg, a partner in the Los Angeles office of the law firm Cox Castle & Nicholson, who specializes in commercial real estate securitization and finance. He predicts that lenders will not only be able to off load their troubled loans, but a new market will be created as other buyers jump into the market to take advantage of opportunistic transactions.
Moreover, some of the conditions in the bill may also incentivize lenders to turn to the market rather than the government. For example, if an institution sells more than $100 million of assets to the government it must grant warrants—rights to buy a company’s stock in the future at a price agreed to today—to the FDIC. To avoid having to sell stock to the government, Weissburg says that some lenders may choose to sell to other buyers that are offering more favorable terms.
"Despite cries that we've created a pseudo socialist solution, I believe a market will be created," he says. "Hopefully, by creating the market, sellers of paper will receive new capital infusions and those banks that choose to hold on to their paper will have a better measure for the worth of non-performing loans that will free up their balance sheets."
The question remains, however, how big the CMBS market will be if and when it comes back? After all, will lenders turn around and expose themselves to the same sorts of assets they currently can’t sell?
--Jennifer Popovec