In continuing the discussion of trade setups and related strategies started with As Requested By Our Constituency: Trade Setups Based on BoomBustBlog Research, and continued in …

• More On Trading with BoomBustBlog Research;

• A Conversation Between a CDS Trader and an Equity Strategist,

I bring you the next installation in the discussion of trading the Pan-European Sovereign Debt Crisis. The annotated email chain is actually quite long so it will be continuously broken up. I will also include the comments of the European equity trader in later posts. Any accomplished tradeer who wishes to join the crowdsourced debate is more than welcome to throw their hat into the ring.

Eurocalypse, the European CDS trader

At this stage i have a remark/question in your « the inevitability of a banking crisis »(dated when ?) you were waaay too optimistic (!!) seeing 172bn of losses related to PIIGS. We may be over that only on Greece exposure!

Reggie Middleton, the American Realist

For those that don't read me regularly, Eurocalypse is referring to my work below...

Is Another Banking Crisis Inevitable?

Attention subscribers: A new subscription document is ready for download The Inevitability of Another Bank Crisis

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

Impact of bank’s banking books on haircuts

EU banking book sovereign exposures are about five times larger than trading book. The table below gives sovereign exposure of major European countries for both trading and banking book. The EU trading book has €335bn of exposure while banking book has €1.7t exposure towards sovereign defaults. EU stress test estimated total write-down’s of €26bn as it only considered banks trading portfolio. This equated to implied haircut of 7.9% on trading portfolio with losses equating to 2.4% of Tier 1 capital. However, if the same haircuts (7.9% weighted average haircut) are applied to banking book then the loss would amount to €153bn equating to 13.8% of Tier 1 capital.

We have also presented an alternative scenario since we believe that EU stress test had failed not only to include banks HTM books but also the loss estimates were highly optimistic, as has much of the economic and financial forecasting that has come from the EU. It is highly recommended that readers review Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for a detailed view of a long pattern of unrealistically optimistic forecasting. Here's and example...

image031.png

Revisions-R-US!

image044.pngimage044.pngimage044.png

In an alternative scenario, we have assumed weighted average haircut of 10% (exposure, haircut assumptions and writedowns for individual countries are presented in detail in the tables below) and have applied writedowns on both banking and trading books with the results available in the subscription document The Inevitability of Another Bank Crisis? Individual and more explicit haircut calculations are available for the following nations for professional and institutional subscribers:

• Greek Default Restructuring Scenario Analysis
• Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
• The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers
• Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts

Eurocalypse, the European CDS trader

Certainly, if we compare the fiscal trajectory of the Eurozone as a whole with the US, the US is not really on a better path. Austerity has started in Europe. US seems still in full spending spree.

Reggie Middleton, the American Realist

I disagree, in a way. The US situation is truly FUBAR, indeed, but it is a slightly differently  FUBAR'd than the EU. The US still:

1. is the world's reserve currency,
2. has the world's pre-eminent military and technological forces (which go hand-in-hand with number 1, hence is essentially the same thing if history is any indicator),
3. has a much more contiguos economy than the EU,
4. although is prone to lie about its book keeping situation, is definitely not as detached from reality as the EU states. Reference:
5. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!,

6. Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Believe Any Others

7. LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

Then there is the commercial real estate issue looming in the EU. The two strongest economies in the EU are being looked to pull the rest of the EU out of the fire through bailouts, but the ugly truth is that they are tied to the proflicate (and not so profligate, but still hampered) states by the waist. Outside of the (borderline recessionary) EU being their major trading partner(s), they have pretty much bankrolled CRE lending throughout the entire trading block. Those loans are due to be rolled over, and they are due to be rolled over on property that has materially declined in value - leaving a significant equity gap. We're talking close to 70% to 80% of CRE loans coming due in the next year and a half on properties that have significant oversupply, weakening rents, recesionary economies, sovereign debt issues and staunch austerity plans, and generally devalued properties leaving many a loan underwater. Haircuts, anyone? Inflation Misconceptions Hide A Downright U-G-L-Y Real Estate Landscape! - Part 1

You see, there is a highly reflexive relationship between overvalued sovereign debt held on a higly leveraged basis on EU bank balance sheets and CRE loans coming due on devalued and underwater real estate. The sovereign debt crisis is straining lending capacity at the same time that excess lending capacity is needed to fund underwater property loans that need to be rolled over. No one is discussing the real estate portion of the EU banking crisis to be, but it is very real!

I have delved deeply into this topic during my lectures in Amsterdam. Reference my featured article in Property EU, one of Europes leading real estate publicatios

Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.

Now, the US is in a similar situation, but we have managed to fudge the books to such an extent that some of our CRE investors have actually risen in price. See The Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression", Why Are REIT Shares Still So High and Which Ones to Short?

With the dearth of synthetic profit streams to support accounting earnings (as banks did in their supposed recover of 2009/10), Weakening Revenue Streams in US Banks Will Make Them More Susceptible To Contingent Risks. I believe, due to major policy errors in dealing with our crash, that we will see our own lost decade(s) in the US...

There are those who believe US CRE is on a bullish trend, but I believe they have been mislead by accounting and regulatory shenanigans. Commercial real estate rarely thrives in high unemployment, increasing interest rates, stagflationary, sluggish economic times. Then again, maybe I'm wrong... Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate

 

The US CRE situation is overshadowed (and possibly rightfully so) by the popular realization that Reggie was accurate in his 2007 assertions that we are in a residential real estate depression, further complicating any truly organica economic recovery - at least until true price discovery is allowed by the financial markets central planning cartel of government and central bankers. Reference:

1. Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!!

2. The "American Realist" Says: Past as Prologue - Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!!

3. The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression! The MSM is Just Catching Up

4. There's Stinky Gas Inside Of This Mini-Housing Bubble, You Don't Want To Be Around When It Pops!

5. Bubble, Bubble, Real Estate Toil and Trouble: Macro Climate for Real Estate Still Sucks, Despite New Bubbles

As this discussion/debate is getting rather lengthy, it will be continued in a later post. In the meantime, interested readers can follow me on twitter or subscribe to BoomBustBlog directly.

On 5/24/11 I recorded a podcast interview with the Sound of Money, an interesting financial show that airs on NYC's WNYE radio. You can listen to 46 and a half minutes of my viewpoints and opinions via this link, Sound-money-interview-of-reggie-middleton-05-24-11. Be sure to peruse the blog of the show as well.

Summary: I called it the coming RE Depression in 2007! I put MY money where my mouth was and sold off all of my investment real estate. I put YOUR money where my mouth was and shorted all that had to do with real estate (REITs, banks, builders, insurers). I called almost every major bank collapse months in advance. I warned the .gov bubble blowing does not = organic economic recovery. Now I'm saying we need to, and will, continue what's left of the crash of 2009, with ample global company. There will be no RE recovery this year, and there will be a crash. OK, you heard it here!

First, let's go through the headlines for the day then proceed to breadcrumb trail that clearly led us to where we are now and where we will ultimately end (oh yeah, In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse Wednesday, February 23rd, 2011)

...

Commercial Real Estate

US Commercial Real Estate Prices Decline to Post-Crash Low ...‎ - Bloomberg

U.S. commercial property prices fell to a post-recession low in March as sales of financially distressed assets weighed on the market, according to Moody’s Investors Service.

The Moody’s/REAL Commercial Property Price Index dropped 4.2 percent from February and is now 47 percent below the peak of October 2007, Moody’s said in a statement today.

The national index has fallen for four straight months as sales of distressed properties hurt real estate values. Investor demand is strongest for well-leased buildings in such major markets as New York and Washington as vacancy rates decline and the economy grows.

The index “continues to bounce along the bottom as a large share of distressed transactions preclude a meaningful recovery of overall market prices,” Tad Philipp, Moody’s director of commercial real estate research, said in the statement. “Indeed, the post-peak low in price has been reached in the same period as a post-peak high in distressed transactions has been recorded.”

So-called trophy properties in New York, Washington, Boston, Chicago, Los Angeles and San Francisco are helping those markets avoid the drag caused by distressed asset sales nationwide, Moody’s reported. Prices of properties of $10 million or more have risen 23 percent since their July 2009 low, according to a separate report issued today.

No Recovery Signals

The overall index shows “no sign of recovery,” Moody’s said.

Almost a third of all March transactions measured by Moody’s were considered distressed, meaning the properties’ owners faced foreclosure, had difficulty covering their mortgage payments or experienced other financial problems. It was the largest proportion of distressed property sales in the history of the index, Moody’s said.

For all of those wondering how CRE can be doing so bad while REITs are doing so well, well I explained it in explicit detail several times in the past. Once we eliminate rampant fraud and bring back mark to market, all will be good again...

1. The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

Note: This is a very long post, and would have been longer if I didn't decide to break it up into pieces. I am presenting plenty of background material in it that regular readers have probably seen before because the subject matter is so pertinent to asset values both today, and tomorrow. I suggest those with interest in the real estate and/or banking arena read it in its entirety. The latter portion of the post is all new material that leads into valuations of real CRE properties that are currently on the market and ties in seemingly unrelated issues such Portugal's bailout and Greece's inevitable restructuring.

Last night, I spent an interesting time with the esteemed  and world reknown macro economist, entrepreneur, NYU professor and strategist,  Dr. Nouriel Roubini. Nouriel is a very, very bright guy. He has to be, he agrees with many of my viewpoints :-). Dr. Roubini had a client reception at his downtown loft in NYC. It was a delightful affair, plenty of heavy thinkers, a bevy of beautiful women, engaging debate of things geopolitical, macro-economic and financial... and of course at least one trouble maker. That would be that tall handsome fella in the middle who had the nerve, after Roubini literally deadened the room with his proclamations of what could come in the case of China crash, European default or US hard landing, to actually burst out and say the esteemed economist was actually being TOO OPTIMISTIC!

Hmmm, and they have the nerve to call Roubini Dr. Doom. Don't they know Dr. Doom wears a mask, a suit of armor, and is truly no joke?.

Yesterday, I bluntly called out the European state of economic affairs as I saw them in "Liar, Liar, European Pants on Fire!" Today, I present the article published by Property EU, one of the leading real estate publications in Europe which illustrates much of my thoughts on the topic of how and why Europe is nowhere near out of its economic malaise, and more importantly how this may pull the value of real estate down. The vast majority of European banks lend against real estate and when the value of said collateral goes down in conjunction with the value of what many are carrying on their books at par as risk free and hold to maturity assets at 30+x leverage... Well, you can use your imagination for the Lehman like results... 
This week I will go through several property devaluation scenarios as applied to what looks like very promising cash flow scenarios using real life examples of NYC commercial real estate starting tomorrow, and culminating with a more in depth analysis for subscribers next week. The most interesting part of the analysis will be the application of our real asset protection program to hedge against the risk of property value decline. Stay tuned, it should be exciting, and if you are not a finance nerd like me - at the very least interesting...

Yesterday, I revisited the US employment vs  inflation situation, which itself was an extension of my warnings on Employment and Real Estate Recovery. In the second post, I included the story from a BoomBustBlogger who was an investor of a large multi-family properties. As a BoomBustBlogger, he uses math to make decisions and the math simply doesn't pan out. Of course, due to .gov bubble blowing, unintended consequences often occur and this time around it is a bubble within a bubble burst in multi-family housing. The dilemma is, do you pull the trigger m/f investments that have increasing net effective rents even though we are almost certain to have higher interest rates (see Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate), more of a depression in housing (In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse), stagflation (Inflation + Deflation = Stagflation ~ Lower Real Estate Values!) and most importantly... obvious activity that is indicative of rampant speculation that goes against the fundamentals...

I will try to use math to address this conundrum in my next post as I'm running out, but realize that the recessionary (depressionary) pressures of s/f housing is not going anywhere soon. Let's look at the data taken from the February 11. 2011 HUD FHA Portfolio Analysis report:

A reader wrote me complaining about the nonsensical bubble blowing in multi-family properties before the last bubble was even finished bursting. I feel his pain. Let's run through a quick pictorial of how I see the macro climate for real estate as of right now...

Of the major economic powers, China is the only economy that is facing true inflation as I see it and China is primed for a hard landing - at best. The US, EU, and UK face stagflation. After the AP excerpt below is a clip from my recent keynote presentation at the ING Real Estate Valuation seminar in Amsterdam on this very timely topic.

LONDON (AP) — Rising inflation around the world weighed on stock markets Friday as investors wondered how fast central banks will raise borrowing costs to counter the threat of rising prices, while the euro was undermined by ongoing worries that Greece will have to restructure its massive debts.

Figures Friday reinforced market expectations that both the European Central Bank and the People's Bank of China will soon be raising interest rates again to counter rising inflation.

In China, figures showed consumer prices rose 5.4 percent in the year to March, up from February's 4.9 percent. The increase was largely driven by surging food costs and represents a setback for the government, which has boosted interest rates four times since October to cool prices.

Analysts expect the People's Bank to enact further measures in the days to come in response to those figures.

[youtube o0CD2fsc-gQ]

Here is a collection of my archived posts on the topic:

For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

Euro banks remain weak as compared to their US counterparts

Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.

I really do mean substantial!

Here's a quiz for you. An ages old correlation that has pretty much remained rock solid is now upon us. Real estate has been highly correlated to inflation and has acted as an inflation hedge for a very long time. This makes sense, since hard assets that both throw off income and have an actual demand for physical use (in other words, they have have intrinsic value) that hold when fiat currencies assimilate toilet paper in both value and use as input prices skyrocket. The question du jour is, "What happens when you have a glut of unused real estate supply abound in a tight credit environment, a guaranteed increase in rates AND higher input prices?". Of course the smart people out there (in other words nearly everyone with the impetus to read BoomBustBlog) are then forced to challenge the thesis, "So is this time different? After all Reggie, you have been bearish on real estate."

The short answer is, no this time is not different. It rarely ever - if ever - different this time. The key is the terminology. You see, many in the media are throwing around the word "inflation", and understandably so as they see prices (particularly staples, commodity and input prices) and money injected into the system go up appreciably. The problem is that the core real assets are not only in a deflationary cycle, but in a downright depression - reference In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse. How can you have inflationary input prices and deflationary real asset prices amid stagnant employment? The answer is STAGLFATION! I have been calling for stagflation since 2008, and it definitely seems as if I called it correctly. Keep in mind that this will be one of the corner stone topics discussed in the ING Real Estate Valuation seminar in Amsterdam on April 8th, which has now sold out its capacity of 250 seats -see www.seminar.ingref.com. Amsterdam is a very interesting city to have such a discussion, for the pundits there are calling for a 25% office vacancy rate at a time of increasing inflationary pressures. On top of that, they have actually called in the world's leading real estate bear as the keynote speaker! It should be fun. I actually have an implementable solution to this mess. I wouldn't necessarily call it light at the end of the tunnel, but it is a way of pricing, valuing and transacting in these depreciating, illiquid assets correctly. Something that is currently lacking. Let's dig in, shall we...