Economic Crisis: A Look Ahead

0:00Well, it's hard to follow an uplifting outlook like that.

0:10Unfortunately, I'm going to carry on with the same theme. Unfortunately, I was there for part of this, but now I'm here and it feels much, much better. Denial, Anger, Bargaining, Depression, Acceptance

0:5512 months after being in the recession, the Bureau of Labor Statistics finally came clean and said, yeah, the economy isn't doing so hot. So we got through the denial stage, but I think we're smack dab in that anger. Whose fault was it? It was those guys on Wall Street, it was the mortgage brokers, it was the appraiser, whoever it might be. We're in that anger stage, and now with this, just exactly what Gary talked about, we're in that, you know, government's in that bargaining stage. Hey, let's put together a plan. Geithner's got a plan. Every week he has a plan.

1:41So, we're still in that bargaining stage, but eventually that's not going to work, and then we'll go through the depressions stage, we'll all be depressed, if we're not already, and then we'll have acceptance, and that's probably when the mal-adjustments will have been cleared, and the economy will be put back on an equal footing again. To take off a little bit from what Gary was talking about, because he was talking about the investment banks becoming commercial banks to qualify for government assistance and an effective nationalization of Fannie and Freddie and, by the way, there's probably no two entities that have had more ongoing regulation, they've had their own regulator since, what was it, 1992 or 1993, I think, are continually regulated and regulated right into being penny stocks for those who have owned those securities.

2:51And obviously, they continue to ask for more money over and over and over again, and there's really no end in sight. And of course, that's the continual mantra. We just haven't had enough regulation in the last few years, if we could only have been regulated more and believe me as someone who used to be regulated you could barely turn around and not bump into a regulator I mean they were they were constantly at your door and constantly telling you what to do and if you work at one of the big banks they honestly were on site all the time so but we have a huge concentration of assets with the largest banks in the of the country. So the idea of nationalizing the banks really isn't very hard. 114 banks constitute the banks that are greater than $10 billion each. That is 1.4% of the banks.

3:50They contain 78% of the assets. So when you offer tarp money or talp money or talcum powder or whatever they're going to call it to these banks to bail them out, you really just have to hit that top 112 and you've effectively nationalized these guys and of course we can see very rapidly what the government is very interested in when they start regulating. They want to know how much people are going to make and they better not make more than and the President does. And you better not be sponsoring any golf tournaments or anything else that might upset the other Fed Chairman Barney Frank.

4:43And that's what regulation is going to look like for the banks. Nationalization, that's what it's going to look like. and of course we know what going to government quote service providers is like, we've all got our license plate, driver's license, things like that and of course getting banking services will be very similar to that I think. But the banking industry is in a very bad way, you know, we hear some mixed results I got an alert a while ago on my Blackberry. Ken Lewis at B of A, if you don't know who he is, the head guy, he said that B of A is profitable and there's no need for nationalization.

5:35Now he honestly says this every other day, one of these guys. So I think Shakespeare comes to mind, me thinks you protest too much. much because I think these guys know what's going to happen but they're continuing to the guy at Citibank said yesterday that they are they sent a memo to their employees they're making money of course we've taken bailouts four different times but he didn't include that in the memo but supposedly they're doing better than they ever have but the overall banking system for 2008. Actually, other than a couple of accounting tricks, if you take the accounting tricks out, the entire industry lost money. And it's been a long time since that has happened.

6:31And when you lose money in a bank, that lowers the amount of capital you have. And you have You have to maintain a certain level of capital to stay in business. Now if you can't go sell capital in the financial markets, which nobody can sell private capital, and you can't get TART money because you don't have any friends at Goldman Sachs, then you have to shrink your balance sheet. And this goes again to something that Gary said a while ago, is that banks are going to have to shrink their balance sheets. So if you go to your, you guys that are in business and you have to go to your bank and you're looking to renew your line of credit and you've always revolved it and you've always performed, don't be surprised when they say, no thanks, can you pay us off? You're going to say, hey, I'm a good customer. I know you've got a bunch of deadbeat real estate guys that aren't paying you. Why don't you extend my credit? I can't

7:38I get the deadbeat real estate guy to pay me off, so I need you to pay me off so I can shrink my balance sheet to make the amount of capital I have worked. And that's going on throughout the banking system. And I think you're going to see more and more of that because as banks write down the level of their assets, they're going to lose capital and they're going to have to shrink the asset side of the balance sheet, and that means their loans. And the real estate market is not going to turn around right away. In fact, the only part of the real estate market that's really melted down has been the residential side. The commercial side is just starting to Roll Over, and for years and years and years, the cap rates that lenders used to underwrite commercial real estate loans got lower and lower and lower.

8:43What's that mean? That's the opposite of what a P-E ratio would be to a stock. So if you had a 10 cap on a real estate deal, that's like 10 times earnings of a P-E ratio. And that used to be kind of our default sort of cap rate in a commercial real estate map. It was a 10 percent cap. If you didn't know what the cap was, you'd kind of guess 10. It got to the point in the boom where banks would underwrite at 6 percent cap, 5 percent and Cap, and that means, to put it in PE terms, 20% price earnings ratio. So you can see, as commercial real estate reverts to where residential has, is that commercial projects will be cut in half just on probably cap rate alone, let alone the fact that their vacancies are going up, the rents are going down.

9:43I mean, if someone would have brought a construction loan for a retail center with Circuit City, Sharper Image, you know, there's a few others, Starbucks, you know, you would say, boy, that's a slam dunk. Well, guess what? Two or three are bankrupt and the other one is cutting locations all the time, and let alone the yoga shop and the karate studio and all the other users out there. So the commercial side of real estate lending is going to take the next hit because it was really an outgrowth of residential development.

10:34The more rooftops you put up, the commercial development sees the rooftops, the commercial developer says, gee, look at all those houses, I better make a retail center. Same way with office, office was heavily dependent on title companies, engineers, appraisers, also involved in the residential housing business. and let alone industrial buildings. Anybody that flew into Atlanta, took the 85, you saw acres and acres of empty industrial space that is currently being unused. So I think the commercial side of the real estate loan portfolios is the next shoe to drop.

11:23Meredith Whitney, who's done some great work on Wall Street, wrote a piece in the Wall Journal the other day that credit cards is the next squeeze so I think credit card lines of credit are going to be restricted and again this is banks trying to desperately hold on to cash and protect the capital that they have by shrinking their balance sheet and if you don't think real estate lending is is important to the banking industry as a whole. It's 60% of the aggregate loan portfolios of all banks is in real estate. Now that's a very, very high number and it's increased since roughly 51% since the fourth quarter of 1997. The number of banks has already decreased from 14,482 in 1991, we're at 8,305, and who knows how many we will end up with by the end of this, but suffice it to say that many will be under federal control of some sort by the end of this period.

12:41Thank you very much.