The Fed Was Not Looking Where It Needed To

I have been reading the Bernanke book which is a moment by moment description of events leading up to the crash on October 2008. It made me recall a lunch I had on May 9, 2007 with four other senior capital markets executives at a ULI conference. At that lunch we all were in a position to be intimately familiar with what was really happening on the ground in CMBS and the markets in general. The group unanimously agreed that the end was near, the collapse of the CMBS and other markets would begin in late July, 2007 and that the crash would be the worst we had ever known. All of those predictions were on the money. It was not that we were so smart, nor that we had some special knowledge. It was simply that we had all been around for over 25-30 years and we knew from experience that what we were witnessing with the deteriorating underwriting, covenant lite, and the way pools were being constructed and financed could not have any outcome but total collapse. What struck me in the Bernanke book is how clueless the Fed and Treasury were as to what was really happening before and as it was unfolding. The Fed was focused on housing and subprime mortgages and seemingly never even paid much attention to CMBS. In summer of 2007, they noted the housing market was deteriorating rapidly and they knew that would have negative affects on the economy, but they completely ignored what many of us knew was the complete deterioration of CMBS quality and the predicable outcome that would lead to.

What is now clear is that the Fed regional banks and the NY Fed were talking to the wrong people in the market and were getting spin. They talked to the CEO's and CFO's and other top managers at the banks and market makers. None of those people was about to tell the Fed or Treasury that what we were all doing with CMBS and CDO's and how pools were being assembled made no sense. Nobody who runs a bank or Wall St firm is about to tell regulators that what they are doing is going to lead to a crash. Yet at various conferences over the period from 2006-2007, various brave souls who had been around for a long time, stated clearly that what was going on made no sense and the markets were headed to disaster. Nobody listened to them, and nobody listened to the five of us at that lunch. Most importantly, it is clear from the book that nobody at the Fed or Treasury even seemed listen or even know what was happening. Even as late as spring of 2008, as the capital markets were collapsing, the FOMC did not seem to fully grasp the enormity of what was occurring. Bernanke seems to have eventually sensed what might happen, but even he was reluctant to do all that could have been done to possibly mitigate the collapse.

So here is my suggestion. The regional Fed banks and the NY fed need to talk to a much wider population of capital markets participants and not just the top managers who will never say –look, what we are doing is nuts. It needs to be people who have been in the markets 25or more years, who are independent thinkers and who are willing to be honest. That is not a lot of people, but they need to be part of the regular discussions Fed leaders have with the markets. I am not even sure how to identify such people, as they are few and far between and most people have their own agenda to protect. The vast majority of participants don't want to think of the negatives and only of the next deal closing and let the good times roll. A prime example of this is the Hotel Investment Conference in January 2008. All of the leading data pundits were on stage saying this is the greatest time, hotels will do even better going forward, and we have a long runway ahead of good times. One leading appraiser at the June 2008 NYU Hotel Conference even publicly stated it was time to be a buyer that the rough period was over. Clueless. When I stated publicly at the January conference that the end was fast approaching and that the hotel industry was about to crash in late 2008, I was literally yelled at and called stupid and Dr Doom. I just was looking at the capital markets collapsing underway, and it was clear then to anyone who was really paying attention that the economy was about to crash. My point is, few people are willing to take a reality look at what is going on in the real world, and to get off the party train before it goes over the cliff. In Washington there are far too many political pressures at play for there to be the hard, objective, cold analysis required.

While I know we are not going to have a 2008 style crash, or anything of that magnitude, I do believe the world has more black swans circling now than ever. The new Chairman of the Joint Chiefs stated such in his confirmation hearing. The geopolitical disaster created by the Obama Clinton foreign policies of the past seven years has left us in a world situation which is spinning out of control since the US is not there to lead. Whether it is the collapse of political and economic functions of Brazil and Venezuela, the election in Turkey which will be contentious, the horror in Syria and Iraq, the deterioration of Afghanistan with the US troop reductions, China in the South China Sea, Putin seizing leadership in the Mid east, the Israeli Palestinian ongoing battles, the Iran nuke deal which is the worst and most dangerous agreement and event since World War II, the collapse of oil and commodity prices which is driving many countries to recession, or the currency wars, or the failure of Europe to control the refugee crisis, they all are tinderboxes which have the possibility to boil over at any moment. The slowdown in jobs in the US, flat wages, over regulation and the anti cop rhetoric which has already led to big spikes in crime, all suggest we have real issues that are going in the wrong direction just as the rest of the world is a tinderbox. And with all of this, it is unclear if the Fed, and definitely not the administration sees the risks clearly. In my view we learned little form the crash about how to anticipate potential crises.

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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.