The Fed released its Beige Book today, which is a collection of mostly anecdotal information from across the country. Presented below are key sections of the report along with my reactions to them.
“Reports from the 12 Federal Reserve Districts indicated either stabilization or modest improvements in many sectors since the last report, albeit often from depressed levels. Leading the more positive sector reports among Districts were residential real estate and manufacturing, both of which continued a pattern of improvement that emerged over the summer.
“Reports on consumer spending and nonfinancial services were mixed. Commercial real estate was reported to be one of the weakest sectors, although reports of weakness or moderate decline were frequently noted in other sectors.”
This sounds better than the last Beige Book, which in turn was more optimistic than the one before it. What seems clear to me is that the economy is getting better, but it is starting from a pretty awful place.
Historically, commercial real estate (CRE) has lagged the overall economy, so it is not a huge surprise that is is not doing too well right now. It will pose a very serious problem for lots of banks, particularly the small-to-medium sized regional banks that are very heavilly exposed to it. In many areas, the value of CRE is off more than 40% from the peak.
CRE mortgages are generally structured for only five years and come with big balloon payments. Banks are not going to want to roll over a mortgage when it is for far more than the value of the building. This is going to cause lots of CRE owners to default.
Put it this way: the banks are not going to be hurting for office space, as they are going to own a ton of it as the owners turn over the keys. This is going to be an ugly situation for the REITs like Simon Property Group (SPG) and Vornado (VNO).
“The weakest sector was commercial real estate, with conditions described as either weak or deteriorating across all Districts. Banking also faltered in several Districts, with Kansas City and San Francisco noting continued erosion in credit quality (often with more expected in the future).
“One bright spot in the banking sector was lending to new homebuyers, in response to the first-time homebuyer tax credit. Finally, labor markets were typically characterized as weak or mixed, but with occasional pockets of improvement.”
Those toxic assets have not gone away, even if the banks are allowed to hide them on their balance sheets. The tax credit is pretty expensive and not all that well targeted. “Cash for Castles,” as I like to call it.
Unlike “Cash for Clunkers,” it does nothing to reduce the outstanding supply of housing units. It just shifts people from being renters to being owners, resulting in more vacant apartments and more pressure on rents, which pulls the price-to-rent ratio back out of whack (one of the key signals that we were in a housing bubble is when it soared), and will just result in more trouble in the apartment sector of CRE. Still, the Realtors have a very powerful lobby, so this turkey of a program will probably be extended (if not expanded).
“Districts generally reported little or no increase to either price or wage pressures, but references to downward pressures were occasionally noted.”
Inflation is not a problem, as was amply demonstrated by the recent CPI and PPI reports. A still very tentative recovery, extremely high levels of unemployment and very low levels of capacity utilization are the big problems. The Fed needs to stay easy for awhile to come now.
The report is more evidence that we are on the right track, but still moving slowly on it — and have a very long journey to get back to where we need to be.
Read the full analyst report on “SPG”
Read the full analyst report on “VNO”
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