Crisis looms in commercial real estate

The wall street journal reported the delinquency rate on $700 billion in securitized loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8% this month. It lower compared with the home-mortgage delinquency rate, but it is the highest rate in the last downturn early this decade.

Although some experts said the problems wouldn’t be as bad as the downturn, the article seemed more worried about financial market. It showed “a complete choking up, foreclosure disaster and increased stress on the banking system.” As the American consumer confidence dropped to 16 years low, we have the reason to believe the situation would be the same or even worse. And we can divide the effects of crisis into 4 parts. Size, refinancing, credit default and risk, I will explain followed by.

Size
Commercial real estate in U.S. is valued at $6.5 trillion and financed by about $3.1 trillion in debt, so it is potentially more dangerous to financial system than debt classes such as credit cards and student loans. And commercial real estate is unlike normal loans, once default, it will affect the supply of real economy.

Refinancing
Performing loans could face troubles because of a fall value of properties, making it hard for the owner to refinance when the loans come due. Of $154.5 billion of securitized commercial mortgages coming due from through 2012, about 2/3 likely won’t qualify for refinancing, and the commercial-property values of 35% to 45% from the peak in 2007. Even the famous business Donald Trump faced bankrupt in January, as the problem of refinancing. So I think when in the recession, government should do something to protect good companies, such as extend the term of loans.

Credit default
The bank estimates the default rates on the $700billion of commercial-mortgage-backed securities could hit at least 30% and loss rate, and the lender would loss over 10%. Foresight Analytics estimates the U.S. banking sector could suffer as much as $250 billion in commercial real estate losses in this downturn. In 1990s, more than 1000 banks bankrupt, hope this time will not be like that.

Risk
More than 2900 banks and saving institutions had more than 300% of their risk-based capital in commercial real-estate loans, including both commercial mortgages and construction loans. Since 2007, 49 banks and saving institutions have failed, and it is forcasted that 700 banks would fail as a result of their exposure to commercial real estate.

Printing money, keep the market flooded of money

It was reported by Yahoo finance that the Federal Reserve announced plans Wednesday to buy up to 300 billion dollars in long-term US Treasury bonds over the next six months "to help improve conditions in private credit markets." I was so surprise to see the negative way it reported the news. Cause in China, ” ” can express an opposite opinion, and also can be an irony. It was obvious that Yahoo doubted the benefit U.S. would get compared with the troubles other countries may face. I will analyze it later.

However, the other Chinese media XINHUA reported it differently, it seemed that XINHUA was more care about U.S.’s economy, such as CPI and stock market. That may because XINHUA is a bog communication institution, It’s necessary for it to report the news neutral. The same comes to BLOOMBERG, It reported the influence home and abroad market neutrally.

While in Wall Street Journey, it indicated that It’s hard not to see the $300 billion payment by the Federal Reserve. Which means it fully support Fed decision, so it’s positive attitude.

Increase the money supply
The 300 billion spent in long-term T-bill will create the market liquidity immediately. That equals to printing the money without any back up, except for the government tax revenue as the mortgage for interest rate. What’s more, the central bank also said it was boosting its purchases of mortgage securities by 750 billion dollars, bringing its total to 1.25 trillion dollars this year as part of a wide-ranging effort to revive the sagging US economy.

Lower the long-run interest
Treasury 10-year note yields fell the most since 1962 as the Federal Reserve surprised investors with plans to purchase as much as $300 billion in government debt to drive consumer borrowing costs lower and lift the economy from recession.

The other advantage is lower the cost of borrowing the money from abroad. As we know, many trade surplus countries buy U.S, long-term bonds in order to pursue high return. And once the interest low down, it means the cost of borrowing decreases, considering the depreciate of U.S. Dollar, these countries may lose value!

Increase the price of resources
Gold rebounded from the biggest decline in two months after the Federal Reserve said it will buy Treasury securities and mortgage and agency debt to end the recession, renewing concern that inflation will accelerate. And consider devalue of U.S. Dollar, investors prefer hold hard currency, which made the gold price rise $50 Dollars during last week. As we know, U.S. hold 8500 Ton of gold reserve, the increase of price is really a good news for him.
Oil price also increased $5 per barrel last week.

Dollar crush
The dollar was predictably crushed in the reaction to the Federal Reserve’s historic undertaken of quantitative easing.

Save domestic stock market, slump others
The Dow Jones rose 1.23 percent. The Standard & Poor's 500 index rallied 2.09 percent, and the Nasdaq gained 1. 99 percent. However, European stocks declined for a second day, led by raw- material producers, as crude oil and metals slipped and U.K. unemployment rose at the fastest pace since at least 1971.

Unfair to developing countries
U.S.’s stimulate plan has already driven the commodity price, which may make the living condition in developing countries even worse. The foreign reserve can be the trade surplus of the country for years, but will lose more than 20% just because of the financial crisis. The hard work will exchange for loss.

American strategy
Don’t think U.S.’s strength will be weakened. Actually when seeing the history, every time America suffered deep recession, its hegemony would be consolidated. When the currency devalued, the export would increase. 1929 recession was like this. In 1985, Plaza Accord made Japan( the biggest creditor of U.S.) dead. So now, do you think the history repeats itself? Is the next aim China?

Uncertainty of China’s appetite for U.S. debt

It was reported by The wall street journey that before G20 Meeting, China unusually pointing and raising the possibility that China’s appetite for U.S. debt could wane. Then Obama administration rejected China’s concerns that vast holding of U.S. assets might be unsafe.

The attitude of the WSJ compared with the officer in White House seems so negative. WSJ wrote, the presidential spokesman Robert Gibbs said”There’s no safer investment in the world than in the Unite State”. That view was reiterated by the president's chief economic adviser, Lawrence Summers, who defended record U.S. deficit spending as a salve to the nation's economic woes.” This is obviously laughing at government spare no effort selling the national debt. In 2009, U.S needs to borrow 2 trillion Dollars for the fiscal deficit, if the market loses confidence for U.S. bonds, the bond market would crash as the stock money, the consequence would be incredible, the country cannot live on debt any more, which means the country may face a revolution completely, may be as Soviet Union. The reason is in such a bearish market, it’s so hard to raise money.

I also find the similar report in Chinese website, I found the way the media described Obama’s speech just like obviously insincere talk and cheating, especially in “China and all the investors in the world should have absolutely confident in American investment.”The bias may because subprime crisis started from U.S., China suffered enough loss against credit default and the value of the foreign reserve.

I’ll analyze why China fears purchasing U.S. bonds.

T-bill, low return
With the financial crisis, in order to stimulate the domestic economy, U.S Federal cut the interest to 0.5%, which made the 10-year yield of T-bill only 2.6%. Though U.S is the one of the highest rating countries, this kind of return is a little bit low, let alone the depreciate of US Dollar.

Facing devalue
In China, money supply depends on GDP growth and government is not permitted printing the money or borrowing the money from central bank directly. While in America, the country seems has got used to live on debt. The Federal kept printing money, government borrowed money, people got loan and overdraft their future purchasing power, which made the Chinese currency has natural appreciating characteristic against US Dollar. In 2008, US Dollar depreciated 6.88% against Chinese currency. Considering the $1.946 trillion foreign reserve, this is really a bog loss.

Commercial bonds, risky
In order to pursue a higher return, China changed its strategy to be a little risky. They started purchasing commercial bonds junior bonds and even junk bonds. However, at last China felt bruised by the investment thought were safe, including holding in mortgage giant Fannie Mae and Freddie Mac, Morgan Stanley and the collapse Reserve Primary Fund. For me, Chinese investment really disappointed me. First came the Black Stone, then was the Morgan Stanley, it seems China still cannot adapt to the international investment. So we need to be more careful about the risk.

Publish criticize at home
Suffering from the loss value of foreign reserve and failure investment overseas, China has more and more pressure publish criticize at home. They doubt why the government kept doing such a losing business.

Better substitute
Now China seems have better substitute of using the foreign reserve. Such as the deal with Brazil and Russia loan for oil, supporting domestic companies merger overseas, the most excellent one must be Chinalco and Rio Tinto, which was the biggest multinational merger deal.

A tool for negotiate
Though China pointed out the appetite for U.S. debt could wane, I don’t think China will really do so. In November 2008, China sold $9 Billion US long run bonds and purchased $38.2 billion short run bonds, which I think that it’s barging chip for negotiate. Such as ask America stopping forcing Chinese currency appreciate the problem of Taiwan, Tibat and so on.

Imaging if China announces it will sell U.S. bonds, the price of bonds will slump, interest rate will go up rapidly, more credit default will occur, the recession will be deeper. At then, everybody will criticize Chinese behavior, even worse, some countries may have trade barriers with China, just like oil embargo in 1973. And even China will suffer a huge loss, cause then US Dollar would be nothing but a colorful paper.

My suggestion:
We need to make our investment profitable in the long run, I come out 2 ways. One it adding resource reserves, especially gold and oil. If possible, China can ask for US have gold back up for the T-bills. Greenspan said gold was the last medium of payment, John Maynard Keynesian said gold was the final guide and reserve that nothing can take the place of it. In the age of gold standard, gold means everything.

The second way is buying the transferable bonds rather than normal one. Though the yield would be lower, you can transfer into share, and you can share the profit of the company, and you can even control the company as long as you get enough percentage of shares. That’s the reason why I’m so supporting Chinalco buying transferable bonds of Rio Tinto.

Chinese economic policies disappointed investors?

The wall street journal reported the economic policies speech made by Chinese Premier Wen Jiabao in Chinese National People’s Congress disappointed both domestic critics and trading partners. In his speech, Wen said the current policies would maintain expanded social programs and jobs as well as $585 billion government-investment plan and aid for major industries. However, the critic argued Chinese government should focus on encouraging consumption by spending more on health care, education and social welfare. Economist said that would cushion the immediate effect of job losses and wage cut.

The criticism was full of the report. It’s obvious the opinion of the media is negative. It called for Chinese government spending more money stimulate the economy, such as buying bad asset from the bank, just as US and UK did at present. The reason causes this bias maybe it is American newspaper. US has got used to rescue plan once they come across economic problems.

For me, I’m supported what China is doing now. The reasons are followed.

Infrastructure is the best way to stimulate the economy
According to Chinese basic condition, using the money into real economy is definitely a right choice. As you know China has lots of labor force, investing the infrastructure can not only stimulate public sector but also down-stream enterprise. And the $585 billion will be used to reduce structural tax burden on companies and householders as well. Though China didn’t stimulate the consumption directly, but all that did it for employment, so that future consumption must be better.

Health care, education and social welfare is not that urgent in China
Many Euro countries call for China improving health care, education and social welfare, which China is doing it all the time. The problem is what’s the degree we need to achieve? Do we need to build the medical market as perfect as Europe? I’m afraid not. European such as UK has already known how heavy the burden is. The perfect social security made government expenditure deficit every year, lots of people prefer talking society allowance rather than work themselves. Considered Chinese population, we can’t take this risk. So the reform is not urgent, we need to find the most suitable way of China.

Bank rescues are not so necessary
China is still a deposit dominate country, compared with US, the mortgage default in China is much lower. China has strict repayment ability examine the people who want to get loan. So maybe the best way for central bank is expanding the loan limit, so that the companies which run well but have problem of capital turnover can get the money.

In sum, according to my analysis, I agree Chinese current economic policy. And I believe Adam Smith's invisable hand, the market will clear itself sooner or later. But if global economy still goes further down, which badly affect Chinese export and investment, I’m afraid China has to turn its main aim to domestic consumption.