Podcast Summary
Mortgage Market Chaos: Landlords vs Tenants, Margin Calls on Mortgage Bonds: Amidst mortgage market chaos, real estate managers like Principal Asset Management seek opportunities. CEO Tom Barrack discusses fair value and margin calls during extreme illiquidity, but investing involves risk.
The mortgage market is experiencing widespread chaos and illiquidity during the ongoing coronavirus crisis. This is causing tension between landlords and tenants, as well as margin calls on mortgage bonds. Principal Asset Management, a real estate manager with a 360 degree perspective, is actively identifying investing opportunities amidst these challenges. Tom Barrack, CEO of Colony Capital, one of the biggest real estate investors, is also addressing these issues in a post on Medium. The mortgage market's current state brings up difficult questions regarding fair value and appropriate margin calls during periods of extreme illiquidity. It's important to note that investing in the mortgage market involves risk, including possible loss of principal.
The 2023 Financial Crisis: A New Structure: The 2023 financial crisis differs from 2008, with a nonbank system and illiquid real estate assets, requiring more credit enhancement for stability.
The current financial crisis is vastly different from the one in 2008, and the structure of the banking system has changed significantly. During the 2008 crisis, an oversupply of financial instruments and exogenous structural defects led to a collapse. Today, we have a banking system with a nonbank system, and real estate was previously an individual investment with limited participation. The public side of the capital markets, which benefited from liquidity, transparency, broad participation, and higher yield, is now facing challenges due to the illiquid nature of real estate. Commercial mortgage loans, totaling around $5 trillion in the US, are held by various institutions, and nonbank banks, such as commercial mortgage REITs and BDCs, have emerged due to regulatory changes. These nonbank banks pool and securitize commercial mortgages, as banks face stricter regulations. The need is for more credit enhancement in the securitization market to ensure stability.
Growth of shadow banking during financial crisis for commercial real estate lending: The financial crisis led to the growth of shadow banking, facilitating lending to SMEs through securitizations. REITs and nonbank banks originate and sell these loans as tradable securitizations, but private loans remain non-tradable, limiting liquidity.
During the 2008 financial crisis, the need for vinegar (credit enhancements) in commercial real estate lending increased dramatically due to the increased complexity and regulation of the banking industry. This led to the growth of the shadow banking industry, which facilitated lending to small and medium-sized enterprises through securitizations. Commercial mortgage REITs and nonbank banks originate and bundle these loans, sell them as securitizations, and use repurchase agreements to maintain liquidity. The good news is that these securitizations are tradable, allowing for daily market adjustments. However, the bad news is that on the private side, loans are not tradable, limiting liquidity. The public market, consisting of REITs and securitizations, and the private market, consisting of individually owned properties with loans from life companies, have different levels of liquidity.
Leading real estate manager's role in Main Street and Wall Street markets: Colony Capital, as a leading real estate manager, bridges the gap between Main Street and Wall Street markets, providing income, debt, and equity to small businesses and solutions to large digital companies, while navigating market challenges such as lack of liquidity and mark to market pricing.
Principal Asset Management, as a leading real estate manager, leverages a 360-degree perspective, combining local insights and global expertise to deliver compelling investment opportunities in real estate across public and private equity and debt markets. Colony Capital, led by its CEO, Tom Barrack, is a significant player in this ecosystem as an owner of legacy assets and a digital solutions provider. The real estate sector, which represents about 60% of America's GDP, functions in two markets: Main Street and Wall Street. Colony Capital aims to keep this ecosystem thriving as a provider of income, debt, and equity to small and middle-sized businesses and a solution provider to large digital companies. However, the current market conditions, such as the lack of a repo funding market for commercial mortgage-backed securities, can negatively impact the real estate sector. Mark to market pricing in this market is causing concerns, as there is no market for pricing these securities accurately. This lack of liquidity could significantly impact small and middle-sized businesses that lack the necessary liquidity to survive market downturns. Colony Capital, with its $4-$5 billion in liquidity, will survive, but the concern lies with those who cannot.
Market disruptions cause unnecessary wipeouts for banks and borrowers: During market turmoil, temporary markdowns can lead to cash shortages for banks and borrowers, causing a vicious cycle and further impacting small and middle-sized borrowers. Regulatory time-outs and artificial markets are being explored to alleviate the disruption.
During market disruptions, the mark-to-market process can cause unnecessary wipeouts for banks and borrowers. When markets seize up and there are no bids for securities, the temporary markdowns can lead to cash shortages for both the banks and the originators. This can result in a vicious cycle where everyone is trying to catch a falling knife, leading to severe indigestion at the banks. The small and middle-sized borrowers, who are already struggling, are further impacted. To address this issue, a regulatory time-out, such as forbearance, has been implemented on the residential side. However, on the commercial side, it's more complicated, and the Treasury, with the help of the Fed, is exploring options like the TALF program to create an artificial market and alleviate the clog in the system. In essence, the pipeline is still functioning, but there's a significant disruption in the market that needs to be addressed.
Addressing the Unique Financial Crisis Caused by COVID-19: The COVID-19 crisis has caused a unique financial crisis due to the complete cessation of revenue for many businesses and individuals, with potential catastrophic consequences if not addressed. The interconnected nature of the US real estate market and financial securities necessitates action to prevent a ripple effect.
The current economic crisis, caused by the COVID-19 pandemic and resulting government interventions, is unique due to the complete cessation of revenue for many businesses and individuals. This crisis is unlike anything we've seen before, and the consequences could be catastrophic if we don't address the liquidity issue in the financial system. The US real estate market, worth trillions of dollars, is interconnected with various securitizations and derivatives, meaning that a problem for one entity could ripple through the entire system. The cynical view might be that we've been here before, during the 2008 financial crisis, and that calling for suspension of mark-to-market accounting is just an excuse. However, the situation is different this time around. The government's call for a stop to commerce, while necessary for public health, creates unintended consequences, including a potential financial crisis. It makes no sense to have a financial system that continues to function based on the consequences of government actions, while the rest of the economy is at a standstill. The Fed and the government have taken steps to address this issue, but it's important to remember that this is just the beginning, and more stimulus bills are on the way. Therefore, if we're going to pay for the consequences of the government's actions, it makes sense to address the financial system's liquidity issues as well.
Regulatory complexities delay distribution of Fed benefits to borrowers: The financial crisis's intricate regulatory framework makes it difficult for banks to distribute Fed benefits to smaller borrowers, necessitating coordination among multiple regulatory bodies.
The current financial crisis involves a complex web of regulatory requirements among various agencies, making it challenging for banks to distribute the benefits they receive from the Federal Reserve to smaller borrowers. The banks themselves have all the liquidity they need due to the Fed's unlimited term borrowing, but the regulatory framework is so intricate that it takes time for all parties to agree on a solution. The lack of a central regulatory body further complicates the process. The speaker suggests that history shows that providing assurance to borrowers, such as allowing them to defer payments, can help keep the economy moving during uncertain times. However, the speaker acknowledges that implementing such a solution requires the coordination of numerous regulatory bodies, which can be a slow and daunting process.
Fed should buy a wide range of securities to bolster economy: Speaker advocates for bold Fed action to prevent long-term economic damage, but raises concerns about potential crony capitalism and unequal distribution of aid, while emphasizing the importance of keeping the economy moving and avoiding unintended consequences.
The current economic crisis caused by the COVID-19 pandemic is complex and requires swift action to prevent long-term damage. The speaker believes that the Federal Reserve should take a bold step and buy a wide variety of securities to bolster the economy, particularly for smaller companies that are struggling. However, there are concerns about the potential for perceived crony capitalism and unequal distribution of aid. The speaker also highlights the impending issue of missed payments and potential social consequences if people cannot function. In essence, the focus should be on keeping the economy moving and avoiding unintended consequences. The conversation underscores the urgency and complexity of the situation and the need for a comprehensive solution.
Mortgage Market Complexity: Navigating the Intricacies: The mortgage market's complexity makes a systemic pause on rent payments impractical. Servicing industry may face challenges with loan workouts and bankruptcy processes. COVID-19 adds complexity for landlords, especially those without legal resources.
The current state of the mortgage market is complex and messy. The idea of a systemic pause on rent payments may not be feasible due to the intricate web of regulations and entities involved. Instead, keeping things moving in the interim might be the most practical solution. The mortgage servicing industry could become overwhelmed with loan workouts and bankruptcy processes, making life harder for many individuals and small businesses. The ongoing COVID-19 crisis has added another layer of complexity, making it difficult for landlords, especially those without significant legal resources, to navigate eviction processes. As we delve deeper into the mortgage market, it's essential to understand the micro themes and intricacies that make this issue so complex. Stay tuned for more discussions on these topics. I'm Tracy Alloway, follow me on Twitter @TracyAlloway. And I'm Joe Weisenthal, follow me on Twitter @TheStalwart. Don't forget to follow our guest, Tom Barrack, @TomBarrackJr, and our producer, Laura Carlson, @LauraMCarlson. Tune in for more insights on the Bloomberg podcasts, @podcasts. Thanks for listening. Take your business further with American Express Business Gold Card.
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