In Ben Bernancke's new book he goes into detail about how the fed was tracking the housing market and they considered that the key data point to track to determine the health of the capital markets, and it is now clear why the Fed, Treasury and others missed what was happening. While the housing market is a key component of economic growth or failure, tracking the RMBS market was not a major part of what caused the crash. It was very clear to many of us who were deeply involved in the CMBS market in 2006-2007, that things there had gotten to the ridiculous, and that a crash was inevitable. Underwriting had all but gone out the window, loans were being made based purely on projections and at .98 debt cover. Mezz levels had reached as high as 95% in some cases, and there was a complete lack of pricing the risk properly. The pressure was on to fill large pools and to pump them out to the uninformed buyers in Europe and China. Pump and dump was the order of the day. The rating agencies became too loose under pressure from issuers and by 2007 we even had virtual loans going into pools. That was when I was certain the crash was inevitable.
The Fed apparently was not tracking any of this because it was not in a data base like housing prices and home mortgages. They could track CMBS issuance and bonds, but what they did not see nor understand was the underlying collapse of underwriting and covenants. Those are not in data bases that the fed or Treasury were looking at. It is the opaque part of the whole process that is not easily discernible from the outside. While there were quite a few of us older guys who started to warn of the risks in 2006, nobody wanted to hear it. Times for bankers were never better and bonuses were never larger. Life was great and why stop the train.
On May 9, 2007, a group of five of us senior capital markets people had lunch at a ULI meeting. All of us had been around the capital markets for over 25 years and we all were in a position to know what was really happening. The group concluded that the crash was definitely coming, and it would be really bad. We even projected that the market would start to deteriorate by end of July 2007, which it did.
The point of all this is not to relive the past, but to make the point based on the Bernancke book, that the fed and Treasury need new ways to figure out what is really happening in the capital markets from sources who will be frank and will provide warnings before it is too late. That is very hard. Like most big waves, few will stand up and say this is nuts and going to end badly. Most people in any market that is doing well, only want to think it is going to continue, and do not want to be the predictor of doom. Few are willing to say, this is going to end badly. When I was at the Lodging Conference last week, most panelists and all the data providers sounded just like they did in January of 2008. They talked about this being the golden age for hotels, it is going to go one for two or more years, etc. I was sitting on two panels and raised the concerns of the world situation, the slowing world economy, and the excessive prices now being paid for hotels. Most others said they did not see risks and life would continue on being great. That is very typical. Nobody wants to think the good times are ending or may end.
The Fed regional banks are supposed to keep their ears to the ground and report conditions monthly. I suspect they talk to CEO's and CFO's and none of those people will tell the Fed things are getting out of control. I cannot imagine the CEO of any investment bank in 2007 telling the Fed that what their firm was doing in CMBS was nuts and dangerous. Never happen so the Fed had no source to learn what was really happening. I am recommending that there needs to be a different way for the fed and Treasury to get down into the trenches and see what is really happening. They need to be talking to people in the mix and not just top management who are never going to tell the Fed their business model is flawed.
We are maybe smarter after the crash, but more regulation as we have had from Dodd Frank, and other rules is not the answer. Better on the ground intelligence and more shifting of risk to the lenders for CMBS is helpful. We will see if what was done after the crash makes any real difference next cycle which is fast approaching.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
