Doom Transcripts: Index & Guide

… It’s now [down] 40 percent as of the reports of the Moody’s index today. A peak to so-far for commercial property. And National Mortgage News had a nice article on this which they said this induces a strategy which might be described, they said, as "extend and pretend," but can also be described as "delay and pray." [no laughter]

Have a look at this preview of Alex’s slide #3 and you’ll see why Lingling at the WSJ has been spending so much time on CMBS stories lately.

Housing Doom is pleased to present a first selection from our under-construction transcript of the American Enterprise Institute’s October 22, 2009 event "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis".1 The event site has a number of resources, including an audio and video of the proceedings. There is as yet no official transcript.

This is the brief introductory presentation by moderator Alex Pollock.

Alex Pollock: [0:00:00] Good afternoon ladies and gentlemen. [slide 12]

When in the course of financial events we have a huge bubble and the inevitable succeeding huge bust, a decent respect for the the opinions of mankind requires that we try to learn something useful from the painful experience. That’s the point of these deflating bubble series of AEI conferences, which you all have so kindly supported with your participation. So welcome to Deflating Bubble Roman numeral VI, "The Lessons of the Bubble and Crisis."

This conference, like its predecessors, is co-sponsored by AEI and by the Professional Risk Managers International Association, represented by Chris Whalen, who is here on the panel with us; and Chris, thank-you for your great partnership.

We have for you today our usual excellent and insightful panel, whom I will introduce in just a moment. But first, I’d like to try a brief setting of the stage for the current act of the intense financial drama which the bubble created.

First of all, a picture of the bubble. [slide 2] This is the Case-Shiller National House Price Index going back to the origin of the series in 1987 with the 90 percent increase in house prices. I’ve added a trend-line to this chart, which is the trend through the beginning of the series through 2000. It’s about a 3.3 percent nominal average increase, which is pretty plausible for house prices.

So the point of this chart is not that corrections necessarily stop when they get to the trend, but when they get to the trend it means we’ve had a really large adjustment. And as you all know we did a little stabilization — that doesn’t mean that we can’t go on down further, but we have made it back to the trend line.

A second point, and Desmond’s … I think you’ll see in Desmond’s presentation I know you’ll see this chart again, but my point here is that the … well we all talk about the housing bubble, as we’re all now aware, we really had a double bubble: a housing price bubble and a commercial real estate price bubble; so this is the same Case-Shiller National Home Price Index, along side the Moody’s National Commercial Property Price Index. [slide 3]

When I had this chart made I was astonished at the practically identical shape of these property price bubbles, the commercial bubble lagging about … for a long time about 6 quarters, the peak about 6 quarters, and now the fall … And if you look over to the far right hand end, the commercial price index has now dropped further. So we had a peak-to-trough — at least trough so far — in the house price index of about 32 percent fall. It’s now 40 percent as of the reports of the Moody’s index today. A peak to so-far for commercial property. And National Mortgage News had a nice article on this which they said this induces a strategy which might be described, they said, as "extend and pretend," but can also be described as "delay and pray." [no laughter]

Lest you think that the highly regulated commercial banking sector was not part of the bubble, I want you to just look at this chart. [slide 4] This is the percent of aggregate commercial bank loans of all banks which are real estate loans. Note that from the last time real estate really hurt the banks in the early 1990s this was flat for several years, and then follows a run-up. Now this is not the amount of loans, this is the percent of all loans which are real estate loans, both residential and commercial, of the entire commercial banking system. So of course the total loans is expanding, and the proportion which are real estate loans dramatically expanded, as you can see here, and on the commercial part, as Sheila Bair remarked recently, that bank exposure to commercial real estate loans stands at an historic high.

Well how about the little banks? There are, of the 7,000 American commercial banks, about 6,500 we think of as the smaller banks. That’s banks with assets of less than $1 billion. This is the proportion of the total loans [0:05:00] of all of these smaller banks which are real estate loans. [slide 5] And as you see, on a 16 year look, the line has headed straight north-east from over half to a really quite remarkable 3/4s of all loans of these banks.

And within the banking system it’s not only loans, it’s also in the securities portfolios. So if we look at the percentage of the securities owned by the aggregate commercial banking system, and in this chart [slide 6] I have added together mortgage-backed securities and the debt of Fannie Mae and Freddie Mac. So it’s got Fannie and Freddie debentures, which are real estate investments, in fact, and MBS. And here you see, indexed to 2000 equals 100, the really quite remarkable rise.

So not only in the loan portfolio, but also in the securities portfolios of the banking system we had this amazing concentration of real estate risk.

So finally, what I do here [slide 7] is to take, coming back to the real estate loans, index them to 2000 equals 100, and set them up against the double bubble in residential and then commercial property prices and get this really amazing relationship with the prices of the underlying assets dropping as aforementioned. And you see the tracking of the flow of bank credit, of course facilitated by a government intervention called "deposit insurance." The flow of bank credit into real estate risk and contributing to the bubble.

And this is in the intensely regulated commercial banks, so in addition to bringing us at least to part of the current phase of the deflating bubble, it suggests one proposed lesson, which is that if you think that regulation will save you, it won’t. [0:07:04]

Notes and References

[1]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis", AEI event homepage, October 22, 2009.

[2]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis" (PDF slide deck), by Alex Pollock, AEI, October 22, 2009.

  1. Title
  2. The Housing Buuble: Case-Shiller National Home Price Index Values — 1987-2009
  3. The Real Estate Double Bubble: Commercial and Residential Property Price Indices
  4. Real Estate Loans as a % of Total Loans — All Commercial Banks
  5. Real Estate Loans as a % of Total Loans — Commercial Banks with Assets Less Than $1 Billion
  6. Mortgage-Backed Securities Holdings Index — All Commercial Banks
  7. Bank Credit and the Double Bubble
  8. Title (end)