America's Route to Recovery

Continuing to look for solutions to the Great Recession, the report on America's Road to Recovery was released by Reuters today and it provides great insight into the way out of this economic morass as well as the life of the future which all of us, even us gray-beards, need to recognize for our own survival. The Reuters report is fairly long but worth reading.

On this occasion, may the new decade be good to you and your family!


SPECIAL REPORT-America's route to recovery
Tue 29 Dec, 2009
Reuters

(For the Reuters multimedia project Route to Recovery, a team of journalists toured America to examine the impact of the recession and posted their reports online. The following story is the last installment in the series that can be found at www.reuters.com/routetorecovery)

(To hear Nick Carey discuss the project on Reuters Insider TV please click on http://link.reuters.com/nec88g)

Successive bubbles masked underlying economic woes
Chasing smokestacks no longer the key to prosperity
Renewed focus on small business and education
By Nick Carey

YOUNGSTOWN, Ohio (Reuters) – When Bob Hagan was a boy people hereabouts equated the coke dust they swept off their doorsteps each day with opportunity, for it came from the steel mills that built this city.

After graduating from high school more than 40 years ago, Hagan worked briefly at one of the local steel mills that dominated the local economy. In 1971, he became a locomotive engineer at railroad company CSX Corp, switching rail cars in every mill and yard in the area over the years.
The job afforded him a ground-level view of the slow-moving disaster that would tear out Youngstown’s heart over the next decade and a half — as it did many other towns in America’s Rust Belt.

“In my rides through this valley on the train, I used to watch the fires of prosperity burn,” said Hagan, 60, an Ohio state representative since 1986 who still works for the railroad when not in session. “And then, years later, I watched the lights go out.”

On September 19, 1977 — remembered locally as Black Monday — Sheet & Tube Company laid off more than 4,000 workers in a single day. In the following years, the steel industry all but died here.

In hindsight, the big mistake was trying to save it.

“We have spent the past 20 to 25 years looking in the rearview mirror,” said Jay Williams, the city’s 38-year-old, independent mayor. “Letting go of the past has been difficult for many people because the past was so good.”

Today, the city immortalized by Bruce Springsteen’s 1995 Rust-Belt anthem “Youngstown” is moving on. Among other things, it has created an incubator to attract the types of small businesses that are expected to drive future growth. Despite the thousands of vacant homes that serve as reminders of a traumatic past and turbulent present, some business and civic leaders think this heartland city has a chance to lead the U.S. into its next era of prosperity.

Getting to there from here, however, won’t be easy — for Youngstown, for Ohio, for the nation.

BURST BUBBLES

Youngstown is an extreme but by no means unique case in America. On a basic level, it represents some of the challenges facing the country today in the wake of the longest and deepest downturn since the 1930s.

After two economic expansions based not on sustainable growth but on asset bubbles — the dotcom boom of the 1990s then the far more damaging housing mania this decade — longstanding problems have been brought into sharper focus.

Even during the recent good times, the U.S. manufacturing sector, the muscle behind U.S. post-war economic might, was buffeted as corporations shipped low-cost production overseas.

“The easy, blue-collar shot to the middle class is gone,” said Mike Rollins, president of the Austin Chamber of Commerce. “It’s going to take a lot more work to get there now.”

In short, the world’s largest economy is at a crossroads.

With a smaller manufacturing sector and a consumer base less able to keep leveraging future earnings, where will sustainable, long-term prosperity come from? And more immediately, where will jobs come from?

This is a debate that is taking place at the local level around the country, from Youngstown to El Centro, California, and many places in between. But it is also a discussion that few see taking place at the national political level.

“Washington just doesn’t get it,” said Shane Savage, a real estate agent in Pensacola, Florida, smoking a cigarette outside the home of a client who needs to sell fast in a down market. “It’s going to take a long time to fix the mess that we’re in and our politicians don’t have a clue how bad it really is out here.”

REINVENTING A NATION

Local politicians and businesses acknowledge that the answers to America’s primary problems have been long known.

The country has to get smarter and send more people to college, making it more able to compete in the global high-tech “knowledge economy” of the future. And America needs to keep attracting the world’s best and brightest to help it prosper.

Manufacturers must also continue moving up the value chain, switching to niche production that cannot be easily transferred to China or Mexico. In the future, the sector will involve fewer but more-educated workers.

Now civic and business leaders are looking closely at another part of the economic equation. After seeing the impact that the departure of large corporations can have, there is a renewed focus on fostering small businesses instead.

The reasons are simple: They create more jobs and can be more easily replaced if they leave.

According to the U.S. Small Business Administration, companies with fewer than 500 employees accounted for 64 percent of new jobs from 1993 to the third quarter of 2008.
Small firms also tend to be more involved in their local communities than major corporations.

“We have forgotten in this country that there is so much more to capitalism than just the exchange of goods and services,” said Amy Kedron, who runs Buffalo First, which sells books of coupons promoting businesses in this city at the far northern end of New York State. “It’s also about community.”

“And local businesses are the best at building communities,” she added, “because their owners are in it to make a living, not a killing.”

The other, not unrelated new focus is the “green” economy. Wind farms, solar panels and geothermal power plants will require someone to manufacture them, plus a trained workforce to run and maintain them. And if the private sector and government agree on anything, it’s that this industry must and will become increasingly relevant.

So at a time when critics have been quick to dismiss the U.S. economy as a has-been, some see the makings of an eventual if not immediate resurgence.

“America’s greatest ability has always been its capacity to reinvent itself,” said Diane Swonk, chief economist at Chicago-based financial services firm Mesirow Financial. “We may be able to emerge stronger and better, to the possible anger and envy of some parts of the world.”

But getting there will take a lot of time, effort and money in a nation not renowned for patience and long-term planning.

“Neither our political system nor our capital markets are used to anything but a short-term view, and fixing K through 12 is a long-term proposition,” Swonk said. “Not addressing the issue is an option we don’t have. There is a difficult decade ahead of us.”

The first step toward inventing the future, as Youngstown has found, is acknowledging that the past is gone.

“The thing we’re starting to understand is that the prosperity of the steel mills was the past,” Hagan said. “So let’s accept it and let’s move on into something that makes it even better.”

CASTLES BUILT ON SAND

What sets America’s current downturn apart from most past recessions is that the Great Recession has been national in scope. “Other recent recessions have been regional in nature,” says Swonk. “But this time, there is nowhere to hide.”

Data from the U.S. National Association of Realtors shows the median home price rose every year from 1989 to 2006 before the slide began in 2007. According to real estate website Zillow.com, as of the third quarter of this year 21 percent of all American homeowners owed more than their homes are worth. That equates to 12.4 million single-family homes with mortgages in negative equity, Zillow.com said.

Real estate gains have been a major source of wealth creation and class mobility, so the hangover from the recent binge is likely to prove more painful than usual.

“I keep telling people this is not a housing downturn,” said Al Muller, a partner at Pensacola, Florida-based Metro Market Trends Inc, which tracks real estate markets in Florida and Alabama. “We are in the middle of the bursting of the biggest real estate bubble in the history of this country.”

The wealth destruction in Florida, which along with California has been among the hardest hit by the property tailspin, has been staggering.

“In the years of easy credit we all thought that we had more money,” Muller said after flicking through a wad of papers that included the names and addresses of the 3,018 foreclosures for the first 10 months of 2009 in Escambia and Santa Rosa counties where Pensacola is located.

“The people in foreclosure could be your neighbors, your friends or you could go to church with them or work with them,” Muller said pointing to the papers with evident sadness.

“We all thought (in the boom) that we could live in a bigger house. But we never realized that we were not getting any wealthier… Now there’s simply less money everywhere.”

From its peak in 2005 to the second quarter of 2009, U.S. home equity fell 37 percent, or $4.7 trillion, according to the Federal Reserve. To put that into context, China’s economic output in 2008 totaled around $4.3 trillion.

By the second quarter of 2009, Americans’ total net worth had shrunk 17 percent or $10.7 trillion from its peak in 2007.

FEWER JOBS EVERYWHERE

As well as their money, many have lost jobs. Unemployment stood at 10 percent in November after hitting a recession high of 10.2 percent in October. More than 7 million Americans have become unemployed since the recession began in December 2007.

For areas like Wilmington, Ohio, the job losses involved a single major employer.

This town of 14,000 was home for two decades to express delivery company Airborne Express. In 2003, Airborne was bought by DHL, a unit of German post office operator Deutsche Post, which was looking to take on America’s homegrown package giants FedEx (FDX.N: Quote, Profile, Research) and UPS (UPS.N: Quote, Profile, Research) on their home turf.

After spending billions of dollars, DHL gave up and shut down its U.S. domestic operations in January of this year, with a cost of 9,500 jobs.

DHL was the biggest employer not just in Wilmington, but in the five surrounding counties. The shock waves are being felt in communities filled with people who were able to make a good living with relatively little education.

“I hate to say it, but you have to wonder whether in the long run it was a good thing having DHL and Airborne Express here,” said Katy Farber, president of the Chamber of Commerce in nearby Highland County.

Some 2,800 people out of a population of 42,000 in Highland County lost their jobs when DHL left. The county had Ohio’s highest unemployment rate in October — 15.9 percent. Unemployment in the area before DHL began ratcheting down operations in May 2008 had long been around 3 percent.

“For decades our children were able to make $50,000 to $60,000 a year throwing boxes without even a high school diploma,” Farber said. “We have to retrain our workforce because those jobs are gone.”

It’s a challenge to which Michigan, home of the automobile, has become accustomed.

“The hardest thing for many auto workers who’ve been doing the same job for 25 years or so to accept is that instantly, permanently, their standard of living has been ratcheted down 80 percent,” said Douglas Stites, chief executive of Capital Area Michigan Works, a career center in Lansing, Michigan. “You may have been making $25 an hour making widgets for years, but now your skill set means you’re worth $8 an hour.”

The center is a hive of activity, with people filing in to make job applications and sign up for retraining courses.

Stites recalls a group of Hmong men who turned up after being laid off at an auto supplier. Although they moved from Southeast Asia to America decades ago, their low-skilled jobs meant they never had to bother learning English.

“What do you tell people like that?” he said. “There is no way they’re ever going to be able to sustain the lifestyle they’ve become accustomed to.”

Accepting that many of the easy, high-paid jobs of the past are gone is the first step in a process that some communities have taken toward reinvention. Youngstown, for instance, spent many years looking for a way to revive the steel industry.

“We have had to embrace the fact that we are going to be different and there is no going back to where we were,” said Mayor Williams. “But being smaller can also be better.”

Part of Youngstown’s Plan 2010 strategy involves trying to revitalize neighborhoods that can be saved and — in a city with 4,500 vacant homes — letting go those that cannot.

“We are aiming to focus on the neighborhoods that can be saved,” said Phil Kidd, a community organizer at the nonprofit group Mahoning Valley Organizing Collaborative. “But we have to accept the fact that we are going to have to wind down some neighborhoods gracefully.”

From a peak of 28.3 percent in 1953, manufacturing’s share of U.S. Gross Domestic Product fell to 11.5 percent in 2008.

Much of that decline in the recent past has been due to production moving overseas to developing nations like China or across the U.S. southern border into Mexico.

This is a source of frustration and anger for workers like the 1,100 former employees at the Whirlpool (WHR.N: Quote, Profile, Research) refrigerator plant in Evansville, Indiana, which has said it will shut in 2010 as the company shifts production to Mexico.

“It was like a punch in the gut,” said Natalie Ford, 42, of the announcement in August. Ford worked at the plant for nearly 19 years, while her husband Jim, 47, counts 18 years there.

“After all we have done for Whirlpool, I feel like we’ve been betrayed,” she added, her eyes misting over.

A NEW REVOLUTION

Leslie Taito is executive director of Rhode Island Manufacturing Extension Services (RIMES), a nonprofit that provides consultation for small and medium-sized manufacturers in Rhode Island, a state of 1 million people.

Rhode Island was the home of America’s first mechanized cotton mill, but since Taito arrived 16 years ago, the number of manufacturers here has fallen to 1,945 from 2,800. Still, she believes that all of those that are left can be helped to survive and thrive — and the best way is to get smart and not try to compete with low-cost Chinese producers.

“Manufacturers have to specialize and find a niche where they develop high-end goods that are not sold just based on cost,” Taito said. “Sure, China can make it cheaper than we can,” she said, while weaving in and out of traffic en route through the heart of Providence. “But what they don’t have is the design or engineering capabilities that we do.”

One of the companies that RIMES has worked with in the past is Pawtucket-based Blow Molded Specialties, which makes products from hot plastic that is blown into molds where it sets. Its clients are predominantly in the healthcare sector.

President and majority owner Tom Boyd describes how the company’s largest customer switched production of a basic product to Mexico because it could be made there for 2 cents apiece instead of 8 cents in the United States.

That company had accounted for some 35 percent of business. “That was nearly the end of us,” Boyd said with a wry smile.

So instead of trying to compete on low-cost products, Boyd’s company specializes in high-end, complicated and intricate products, and even develops products for customers.

In the company’s meeting room, he shows off some of the firm’s products including one which looks almost like a plastic accordion and is about the same size, with evident pride.

This, he explains is a plastic bellows his firm developed for a healthcare company, whose name he says he cannot divulge. It has a special function. Conventional practice in organ transplants has been to ship organs on ice. But Boyd says it has been found that a better way to ship organs is to keep them functioning, and the bellows he holds in his hands is part of a device to keep a set of lungs pumping while in transit.

Asked how much Blow Molded charges for a pump like this, Boyd shrugs his slight shoulders. “Maybe a few dollars each. And we only sold a few of them.”

But then he leans forward with right eyebrow and right forefinger raised. “Ah, but you see, the money’s not in the product,” he said, his grin widening. “The money’s in the engineering. We bill our customers for the development work we do.”

Communities around the country say they want to attract small firms like Blow Molded rather than focus on major corporations, for the simple reason that when a giant plant shuts down, it is almost impossible to replace the jobs lost.

The classic example is Wilmington, Ohio, where empty store fronts on Main Street are grim testimony to what happened when DHL axed nearly 10,000 jobs.

“When a big company like that goes, it leaves a very large hole to fill,” said Mayor David Raizk (pronounced “risk.”)

“I’d rather see 200 small companies with 50 employees each than one big one,” he said. “You can lose one, two or even 10 of those and find a way to replace them. Big companies are great when they’re in town, but when they leave they devastate communities.”

One such small firm is Computer Technology Solutions Inc, the largest privately-held software firm in Alabama, which has added some 40 jobs this year and now employs 150 people. “If that’s what we can do in a recession, imagine how we can do when the economy improves,” said president Sanjay Singh.

CTS got its start in a business incubator run by the University of Alabama in Birmingham. Singh said that unlike big corporations — which tend to be bureaucratic, slow-moving and inclined to withhold responsibility from young employees — CTS gives its 20-something employees multimillion-dollar projects to run on their own.

“If you give young people responsibility, they deliver,” he said. “We don’t hang over our employees’ shoulders waiting for them to get things done, we just let them do it.”

GREEN ECONOMY A LONG HAUL

There are great expectations that alternative energy or the “green economy” will help move America forward.

According to Lisa Frantzis, managing director for energy at Navigant Consulting Inc, in 2009, 7,000 megawatts of wind power was installed in America with the creation of 70,000 jobs — 50,000 direct and indirect jobs, plus 20,000 service-related jobs. Solar power saw 300 megawatts installed with the creation of 60,000 jobs.

Jay Paidipati, a Navigant managing consultant who works with Frantzis, said because of the industry’s breadth and relative youth, it is hard to make forecasts. “I would feel comfortable saying that the number of green jobs will be in the millions,” he said. “Just how many millions, I don’t know.”

It will be years, however, before that potential is realized. One of the main problems is the mass of rules and regulations that make building plants a lengthy process.

Imperial County in southern California has hit on a novel way to get around red tape, using a provision of state law that allows local authorities to streamline the approval process for building a plant, as long as it is under 50 megawatts.

This loophole enables officials to handle the approval process in as little as a year, compared to several years at the state level.

“Getting anything done in California is hard,” said Imperial Valley Economic Development Corporation CEO Tim Kelley, at his office in El Centro some 100 miles (160 km) east of San Diego. “But it is less hard to get it done here.”

This area has 360 days of sun a year and has suitable geological conditions for geothermal power — there are 10 such plants already. Thirty others for solar, geothermal and wind facilities, are in the process of acquiring permits.

Red tape is not the only challenge.

Paul Rich is Chief Development Officer at Deepwater Wind LLC, which aims to develop America’s first offshore wind farm, in Rhode Island. The farm, which would eventually provide 15 percent of Rhode Island’s electricity, should come in two phases. The first test phase with six to eight turbines could be installed off the coast by 2012. By around 2015 the wind farm would contain around 100 wind turbines.

Rich described the coast between Maine and Maryland as the “Saudi Arabia of wind,” predicting an “enormous, exponential leap in jobs, manufacturing and infrastructure.”

Part of the reason for the long lead time is the need for extensive tests of local wind conditions, he said.

“It won’t happen overnight,” Rich said. “We are trying to create a truly new industry here and it has to be done right.”

“A far bigger concern for us is finding a qualified workforce to run and maintain the wind farm when it becomes operational.”

In blighted states like Michigan, many former manufacturing workers are already training for green jobs, even though relatively few have been created.

Matthew Derra, 41, lost his job at struggling auto supplier American Axle & Manufacturing Holdings Inc (AXL.N: Quote, Profile, Research) in July 2008. Now he is taking an associate degree in renewable energy and wants to find a job maintaining wind turbines.

“There’s nothing out there in my old field of work,” he said. “And there will be thousands of people out there chasing every green job, but I have to try.”

“I can’t just sit home and watch television.”

Even in California, which has America’s most aggressive climate change regulations, just 159,000 of the state’s 18 million jobs are considered “green” as of the start of 2008, according to public policy group Next 10.

Still, there are encouraging signs that money is flowing into renewable energy even in a sluggish economy.

Bill Gibson, is a business broker and principal of Gibson & Associates Inc in Pensacola, Florida. Gibson finds buyers for companies that want to sell.

He noted that companies selling luxury items are having trouble finding buyers because gun-shy banks won’t lend for that kind of investment, but he has noticed a lot more interest in renewable or alternative energy firms.

“There are definitely going to be haves and have-nots,” Gibson said. “Green energy is part of the future.”

The green energy industry is also seen as an opportunity for manufacturing firms to retool.
“What concerns me is when I hear people talking about manufacturing in the past tense,” said Virg Bernero, mayor of Lansing. “If we want wind turbines, someone here should manufacture them.”

GEEKS AT THE TABLE

Laurie White, president of the Greater Providence Chamber of Commerce, keeps a board covered in bad news — headlines from The New York Times, The Washington Post, The Boston Globe and The Economist about how badly the economy of the state has been faring. Rhode Island’s unemployment rate was 12.7 percent in November, the second highest in the country after Michigan.

“Our problems have made not just national but international headlines,” White said. “That motivates me to find a new way forward.”

Rhode Island is pinning its hopes on a strategy dubbed “Strengthening Providence’s Knowledge Economy.” It has involved bringing together local and state government, the Chamber of Commerce, the Rhode Island Economic Development Corporation (RIEDC) and hundreds of small hi-tech software companies.

“The geeks have finally been offered a seat at the table,” said business consultant Jack Templin.
White said there was an easy explanation: “The geeks are just about the only ones creating jobs right now.”

Companies like Working Planet, which handles algorithmic online market research for its clients, are now at the table.

“Up until a few years ago the chamber was focused on major companies and its existing membership base,” said Working Planet Marketing Group Inc president and co-founder Soren Ryherd. “Over the past three years the chamber has done an about face and is now also about the smaller companies that are creating jobs.”

“We have also become more organized because we need to reach the local universities so we can find and retain top talent,” he added.

Mike Saul is the interim executive director of the RIEDC and has spent much of his career as a “turnaround guy” taking poorly performing companies and making them thrive. He wants to do the same here, in part because three of his four children, like many of the state’s offspring, live outside Rhode Island because there was no work here for them.

“In any turnaround that is going to work you have to ask where is the enterprise value that I can push forward,” he said. According to Saul, the state’s education system and its wind potential create much of its enterprise value.

“Rhode Island’s attempts at economic development have been episodic in the past, but this time everyone is on the same page,” Saul said. “A crisis makes things happen. It helps individuals reinvent themselves and will help this country reinvent itself.”

‘CHASING SMOKESTACKS’

The idea of the “knowledge economy” is a common thread in different parts of America.
Commercializing research and leveraging highly-qualified university students, plus helping create small businesses via incubators has become a major focus in many communities.

The University of Alabama at Birmingham, for instance, has an incubator called the Innovation Depot, which provides low-cost space and resources for small startup firms. The incubator is currently home to around 70 small companies.

UAB’s annual research budget of around $400 million is 80 percent focused on biomedical research, followed by engineering and the physical sciences.

Birmingham, like Youngstown, was once a steel town. The city’s population has dropped more than 30 percent to 230,000 from 340,000 in 1960 and it has focused too frequently on trying to lure back big industry, according to Richard Marchese, vice president of research at UAB.

“The city has done its fair share of chasing smokestacks,” he said. “Birmingham has undergone an important adjustment by realizing that it needs to transform itself from an industrial based economy into an economy driven by innovation.”

Youngstown, like Birmingham, is betting part of its future on an incubator, the Youngstown Business Incubator, which has 28 business-to-business software firms in its portfolio with some 300 employees. The incubator occupies three renovated buildings in downtown Youngstown — which was mostly dead a few years ago — and will move into a fourth in 2010.

“We didn’t want to have a broad range of industries that we couldn’t serve properly,” said James Cossler, the incubator’s CEO. “We wanted to pick one sector and be a world class incubator… We picked software because it is in almost everything we use.”

One condition for startups to receive benefits and resources, including deferred and reduced rent and paid utilities for furnished offices, is they must share their expertise and resources with other member companies, even after they “graduate” and move out.

Craig Zamary owns Green Energy TV, which he describes as the “YouTube of the green movement.” It takes videos from around the world on innovations in alternative energy.
Zamary said that not long after Green Energy TV moved into the incubator in early 2008 he told a fellow business owner he was having trouble with code for his website. The next day the fellow business owner turned up with the code he needed.

“I was wondering what he was going to bill me for it, but he said ’That’s not how we do things around here,’” Zamary recounted. “Some day if he needs something from me I’ll be able to repay the favor.”

Cossler said office space in Youngstown’s incubator costs $8 per square foot compared to $200 in Silicon Valley, while “programming talent” costs about 60 percent more in California. There are also several universities within an hour’s drive, including Youngstown State University a few blocks away.

Cossler said criticism of the incubator — that it will not return Youngstown to its former size — has been misguided.

“We’re not going back to where we were,” he said. “Nothing can take us back and we have had to embrace the fact that we are going to be a smaller city.”

“But it’s absolutely realistic to expect that within a few years we could have 2,000 to 3,000 people employed here,” at the incubator or around it, he added. “This could be very powerful and very transformational for Youngstown.”

Youngstown’s Plan 2010 was developed by Youngstown State University in conjunction with the city and reflects a common thread between this city and other parts of the country like Rhode Island, Birmingham, or Austin, Texas, in that all of them have developed a strategy requiring cooperation between the authorities, local businesses and a local university.

MIND FACTORY

Unlike Youngstown, Birmingham or Rhode Island, Austin has had a business development strategy in place since the 1980s.

“We made a very clear and conscious decision that above all we were going to kowtow to the creative classes,” said Lee Cooke, a former mayor.

From food to music and entrepreneurial opportunities, Austin has focused on attracting creative people.

“It’s very simple. Creativity begets creativity,” said local state senator Kirk Watson.

Austin’s strategy has paid off. The city’s population has tripled to around 750,000 in 2009 from 250,000 in 1970. According to the U.S Bureau of Labor Statistics, the city of Austin had the highest level of job creation in America from 2003 to 2008. Private sector jobs overtook public sector ones — it is the Texas state capital — in the mid-1990s.

Austin has become known as a city of entrepreneurs — Michael Dell founded computer maker Dell Inc (DELL.O: Quote, Profile, Research) while studying at the University of Texas in 1984 — and has grown as people have flocked here looking for jobs.

While the inflow has slowed during the recession, the city is still a magnet for people like Norbert Wangnick. An entrepreneur who sold his niche recruitment firm in Germany at the peak of the market in 2007, Wangnick, 45, moved to Austin late in 2008. After a year off, he is looking to either invest in a company or start a new one.

“Austin has so much energy,” he said. “It’s a great place to be if you want to start a business.”

The city, which hosts the annual SXSW live music festival and considers itself a cultural oasis in Texas, is a strongly Democratic city in a Republican state. Former mayor Cooke, a Republican, said Austin’s political leanings are not in line with his own or the more conservative business establishment. But he added that this fact is irrelevant.

“The choices we have made concerning the economic future of this city transcend politics,” he said. “This is about everyone pulling together.”

Cooperating for the good of the community is something Cooke said is lacking at the national level in America.

“I’d like to get rid of all 535 politicians in Washington and get rid of all the politics of the last 75 years,” he said. “Washington is all about the politics of self-perpetuation, not doing what is right for the country.”

The cornerstone of Austin’s strategy is coordination among the city, businesses and its biggest asset — the University of Texas at Austin. With 50,000 students, it is one of the country’s largest universities and a research powerhouse — biomedical science, engineering, math, physical sciences. UT vice president for research Juan Sanchez estimates some 10 companies graduate from the university’s incubator every year.

Senator Watson said Austin’s fortunes have been a mixture of luck and the sense to capitalize on its “enterprise value.”

“We were lucky in that we weren’t like Detroit, we didn’t have an old industrial factory to protect,” he said. “In places like Detroit it’s understandable spending a lot of energy trying to save the old factory because it means jobs for local people. What we have here is UT.”
“UT is our mind factory.”

Watson describes that “mind factory” in largely industrial terms, even referring to students as “natural resources.”

Watson and Gary Farmer, chairman of Opportunity Austin — a regional economic development strategy — recall visiting Samsung Electronics Co Ltd <005930.ks> in South Korea in 2005 with UT’s Sanchez to persuade the world’s top maker of memory chips to choose Austin for a new semiconductor plant.

Watson and Farmer say a critical moment came when Sanchez informed Samsung executives that there were hundreds of Korean students at UT. In April 2006 Samsung said it would invest $3.5 billion in a plant here creating nearly 1,000 jobs.

“The authorities in Austin, the business community and the university have marched in step for a long time,” Sanchez said. “Much of this has been based on the recognition of UT’s potential.”
Sanchez said such recognition is growing in America.

“There is a growing understanding that intellectual capital is going to be at least as important as manufacturing and natural resources,” he said.

FIXING ‘K THROUGH 12’

Conversations with civic and business leaders around the country support that statement.

In Evansville, Indiana, while Mayor Jonathan Weinzapfel laments Whirlpool’s decision to move production abroad, the company’s decision to keep its research and development facility here is something he says the city can build on.

In cooperation with colleges like the University of Southern Indiana, Weinzapfel argues Evansville may be able to attract other R&D operations. “You have to find what your strengths are,” he said. “And you have play to those strengths.”

Locals around Bentonville, Arkansas — home to America’s biggest private employer Wal-Mart Stores Inc (WMT.N: Quote, Profile, Research) — say it is no coincidence that while Arkansas has one of America’s worst education systems, this local area’s school system is among the better performers.

“Walmart has provided a lot of support for the local school system,” said Jonathan Watson, pastor at the Bella Vista Assembly of God in nearby Bella Vista. “This is no accident, as Walmart uses the schools as a feeder system for providing well-educated future employees for its headquarters.”

According to Andreas Schleicher, the Paris-based head of the indicators and analysis division of the Organization for Economic Cooperation and Development (OECD) — a group of 30 mostly high-income, democratic nations — the problem with primary and secondary education in the United States, known as K through 12, is that it has been in suspended animation.

“For decades America has mostly been treading water while the rest of the world has been working hard to get ahead,” he said.

In 2007, some 78 percent of U.S. high school students graduated, slightly below the OECD average of 82 percent.

OECD data from the 1960s shows that 80 percent of American children graduated from high school then, compared to just 37 percent in South Korea. Now some 97 percent of South Korean children complete high school.

“America has been falling behind,” Schleicher said. “By the age of 15 a quarter of American students have problems with math and science, which foreshadows the problem many have completing high school.”

He added that although America spends more on education than many countries, its school systems are far more uneven in quality, particularly in inner cities. The graduation rate in some inner cities in America in 2008 was 50 percent or below.

“We’ve known about problems with America’s education system for the past four decades, but we haven’t had to deal with them,” said Mesirow Financial’s Swonk. “We were able to just stick under-educated people in factories and not worry about dealing with the problem. That is no longer an option.”

Sheldon Steinbach, a senior counsel in the postsecondary education practice at Washington-based law firm Dow Lohnes, said the United States has plenty of top-quality colleges and universities, but the problem does not lie there.

“As the old saying goes, if you put garbage in you get garbage out,” he said. “America’s K through 12 system has been broken for a long time and I am not sure if can be fixed because there are too many different authorities, federal, state and above all local, involved.”

UT’s Sanchez said if more young people make it to higher education, the pieces are in place for long-term growth.

As he notes, according to the OECD America still leads the way in research and development (R&D) spending. In 2007, the latest year for which data are available, America accounted for around 41 percent of R&D spending in the OECD. Japan was next with 26 percent. China’s R&D spending was equivalent to around 11 percent of the OECD total.

“It was not so long ago that China spent nothing on R&D,” Sanchez said. “Now they are a major power.”

“America is still clearly the global leader by a long way,” he added. “But we can’t afford to rest on our laurels.”

Two of the problems with the U.S. college system, however, are that it is expensive and too little is done to prepare school children to apply. State colleges and universities charge on average close to $20,000 a year, while some private institutions charge $30,000 to $50,000, Steinbach said.

David Kyvig, a distinguished research professor in the history department at Northern Illinois University, whose specialties include the Great Depression, notes that President Franklin D. Roosevelt’s New Deal in the 1930s helped but did not solve the country’s economic ills. World War Two lifted the economy thanks to massive government spending, funded by higher taxes. The U.S. government deficit stood at $10 billion in 1939 but hit $100 billion in 1944.

“The myth today is that Americans will never accept higher taxes,” Kyvig said. “But the deficit during the war was funded by higher taxes and Americans were willing to pay more because they knew it had to be done.”

He said that a large chunk of government spending went on the GI Bill — passed in 1944, it provided returning World War Two veterans with a college or vocational education.

“The GI Bill was the backbone of a quarter of a century of American prosperity and helped create America’s middle class,” Kyvig said. “It was not cheap, it cost an awful lot of money. But it paid off.”

Former Austin mayor Cooke, a Republican, agrees something like the GI Bill could help now.
“Americans will pay more in taxes if they know what they’re paying for,” he said.

In 2002 some 52 percent of high school graduates went on to tertiary education. That figure reached 62 percent in 2009 and is expected to hit 64 percent in 2010.

“We still have a long way to go,” said Opportunity Austin chairman Farmer, echoing state senator Watson’s analogy: “We need to develop a better pipeline for our mind factory.”

ATTRACTING THE BEST AND BRIGHTEST

The six-minute plus video that Mary Tribble prepared for the annual meeting of the Charlotte Chamber of Commerce is aimed at encouraging business to embrace another changing dynamic in the U.S. economy — immigration.

As technicians bustle about preparing for the meeting, Tribble plays the film, making a slightly nervous gesture that says “humor me, please.” A music video appears entitled ‘I see,’ featuring ordinary residents of Charlotte, many of them Asian, Hispanic or black.

“This is a major departure for the chamber,” said Tribble, owner of Tribble Creative Group, an event organizing firm. “The cast of this film does not reflect the composition of the audience that will see it.”

What she means is while those in the video are ethnically diverse, the audience will be almost entirely white.

“Charlotte has changed a lot over the past few decades and the people here need not just to be aware of that fact, they should embrace it,” she said. “If we embrace diversity, more people will come and keep our local economy growing.”

Charlotte saw its white, non-Hispanic population decline to 55.3 in 2008 percent from 70 percent in 1990. Its black population edged up to 28.7 percent from 26.3 percent during that period but its Asian population more than doubled to 3.9 percent and Hispanics soared to 10.2 percent from 1.3 percent.

It’s a similar story nationwide. In 1900 one in eight Americans was not white, by 2000 that number was one in four. Census Bureau projections put whites in the minority by 2050.

Immigration has become a hot button issue, especially when it comes to low-skilled Hispanic workers from south of the border. Critics complain these immigrants steal American jobs.

But many people warn against shutting the doors to newcomers, noting that a big part of America’s success has been its ability to attract the highly educated people who can contribute to future U.S. prosperity.

“The last generation of immigrants in has a tendency to want to close the door behind them,” said Swonk. “But if we descend further into populism we risk losing that ability.”

Since the al Qaeda attacks of Sept. 11, 2001, the visa process for foreign students has become tougher, and the system also makes it hard for many to stay after they graduate.

CTS’ Singh in Alabama describes himself as the “poster child” for what America has represented to the world.

Revealing a history he says he has preferred not to divulge over the years, Singh said he came to America in the mid-1980s as a college dropout from India. While flipping burgers for a living, a chance meeting with an academic who interrogated him about the courses he had taken in India led to an invitation to enroll in an MBA course at Georgia College & State University in Milledgeville, Georgia. After his MBA , he did consulting work for some large southern corporations.

“Here I was advising the CEOs of big companies two years after flipping burgers,” Singh said.

“The point being that with an education anything is possible in America.”

He said on recent visits to India he has talked to young, well-educated Indians who feel less inclined to come to America because of visa difficulties, plus growing employment opportunities closer to home as the Indian economy grows.

“America’s two biggest strengths have been its ability to reinvent itself and its ability to attract the best and brightest from around the world,” Singh said. “The moment that stops being the case, it’s over.”

DETERMINATION

There is no doubt the world’s largest economy faces a multitude of challenges. But many are convinced they can be overcome. The feeling among many Americans is that the United States must embrace what needs to be done and move forward.

In Youngstown, U.S. Congressman Tim Ryan believes that thanks to its software incubator and other local businesses, “this area could lead the recovery.”

State representative Bob Hagan — who watched this city stagger and fade as the steel mills left — is also convinced that Youngstown, and America, will emerge stronger.

“We can make a better future for our children,” he said. “But it won’t be quick, it won’t be easy and at times it will be painful.”

“We will get there. But we’re not there yet.”(Editing by Jim Impoco and Claudia Parsons)

Holiday message 2009

Dear friends, clients and colleagues,

As the first decade of the 21st Century draws to an end, America is in the midst of an economic recession destined to change our economy, fighting two wars and trying to manage at least two rogue nations (Iran and North Korea) seeking to produce nuclear weapons, while coming to grips with universal health care, global warming and a whole host of other adversities. Our social, political and economic fabric is changing radically.

We, as a nation, are facing many challenges – with a large number of Americans facing the challenge of providing for their family – a circumstance we all thought was part of the past – not the present. And, yet, our country was born in adversity….lest we forget:

A week before Christmas '77 Washington's army took up winter quarters at Valley Forge on the west side of the Schuylkill. Although the General's choice of location was sharply criticized, the site he had selected was central and easily defended. Then came a cruel race with time to get huts erected before the soldiers, barefoot and half naked, froze to death. Hundreds of horses did in fact starve to death, and for the army starvation was a mortal danger. "No meat, no meat!" was the constant wail. Improvements came about after Nathanael Greene assumed the duties of Quartermaster General on March 23rd.

Yet, despite the ever-present fear of mutiny, no real disaffection occurred. As Hessian Major Baurmeister conceded, the army was kept from disintegrating by the "spirit of liberty." Men and officers accepted their tragic plight with a sense of humor and extraordinary forbearance, but it was an ordeal that no army could be expected to undergo for long. Nathanael Greene wrote to General Washington, "God grant we may never be brought to such a wretched condition again." - The Spirit of 'Seventy Six*

From the Revolutionary War and the travails of Valley Forge, a new nation was formed as a contract among men which grew to become a leading nation among the nations of the world. And out of the Great Depression where 25% of Americans were unemployed and another 25% were “underemployed” came the Empire State Building, the Hoover Dam, the Chrysler Building, the Golden Gate Bridge, Rockefeller Center, the SEC, FDIC, Ginny Mae, Fannie Mae, Freddie Mac, the 30-year mortgage and Social Security among other significant and revolutionary institutions.

Do not lose heart for we have seen from our past experience that we can, and will, survive this ordeal and we have the opportunity to grow from the experience into better people. It is a tough environment, one which those of us younger than eighty have not experienced first-hand, but we have a collective memory and a strength of spirit to survive – and soon to prosper once again – is unfailing. The question soon will be: What have we created and built as a result of the Great Recession? Will it be Green buildings, less volatile financial markets, alternative energies, universal healthcare, a global spiritual consciousness or all of the above?

My prayer this holiday season is for you and yours to enjoy good health, love, peace and hope – hope for a future without fear for as President Roosevelt said in his first inaugural address: “…the only thing we have to fear is fear itself.”

May God be with you during these times and may you remember that “Happiness lies not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort. The joy and moral stimulation of work no longer must be forgotten in the mad chase of evanescent profits. These dark days will be worth all they cost us if they teach us that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.” **

As always,

Paul L. Jones, 12/7/09


* Excerpt from: http://americanrevwar.homestead.com/files/VALLEY.HTM** Excerpt from the Inaugural Address of Franklin D. Roosevelt, January 1933

Banks Report CRE Exposure Risky but Manageable

A new eblast service I receive is from CoStar: It is a WatchList which is a weekly column focusing on distressed market conditions, commercial real estate properties, mortgages and Corporations Published by CoStar News. I highly recommend it...

The following article which was published today shows the disparity in the views of bankers who think their problems are manageable and those of real estate practitioners who believe that they are living with their head in the sand with the depth of the problems for CRE loans. A key part of this article is that banks are reducing their exposure to CRE which means that they are not making any loans to new borrowers anytime soon.....which is contrary to the goals of the bailout our Federal government initiated and explains why things are not getting any better....money is currency and needs to flow for it to grow....but there is always next year, right?

Banks Report CRE Exposure Risky but Manageable
Multifamily Lending Showing Signs of Turning a Corner
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By Mark Heschmeyer
December 2, 2009
For the U.S. banking sector overall, commercial real estate exposure remains a significant risk. But it appears the risk level is becoming generally more manageable -- more so among the largest financial institutions than regional mid-size and smaller banking institutions, according to the Federal Deposit Insurance Corp.

As of Sept. 30, FDIC-insured commercial banks and savings institutions held $1.1 trillion of nonresidential commercial real estate loans and another $216.5 billion in multifamily loans. Of that exposure, approximately $149.3 billion of that had been charged off, was delinquent or the collateral backing the loan turned over to the banks, according to the FDIC.

Overall, the amount of commercial real estate and multifamily loans becoming delinquent has stopped increasing. While they are still much higher than June 2008, nonresidential income-producing property loans becoming delinquent have seemed to hit a plateau.

Noteworthy, too is that multifamily delinquencies have started to decline. Equally encouraging is that banks have also begun disposing of foreclosed-upon multifamily properties. The total volume of such assets has dropped from $1.58 billion three months ago to $1.44 billion. Banks also again increased their lending on multifamily properties in the last three months, marking the second quarter the amount has risen. The total outstanding loan volume on multifamily properties has increased from $210.6 billion at the end of March to $216.5 billion at the end of September - a nearly 3% increase.

However, banks have not shown equal leniency on nonresidential income producing properties. The amount of such properties being foreclosed upon or taken over by banks continues to escalate rapidly - more than doubling in the past year to $5.84 billion.

According to the Federal Reserve's October Senior Loan Officer Opinion Survey on Bank Lending Practices, conditions in the nonresidential construction sector generally remained quite poor. Nonresidential construction and employment continued to decline. Also, bank lending standards and terms tightened on commercial real estate loans because of widespread paydowns and charge-offs. At the same time, demand for new commercial construction as developers are reluctant to begin new projects or purchase existing projects under current poor economic conditions, which include a surplus of office space as firms downsize and vacancies rise.

Nearly all of the nation's 22 largest banks reported to the U.S. Treasury that they were actively reducing their exposure to commercial real estate loans, because they expected delinquencies to persist. The outstanding balance of commercial real estate loans among the 22 banks decreased 1% in September. However, they continued to show a willingness to renew loans to existing customers. Total renewals of commercial real estate accounts increased 18% from August to September.

Fitch Ratings completed a review of commercial real estate exposures across its universe of rated U.S. banks in November. In that review, Fitch estimated that simply taking into account assumed vintages by origination year and average changes in actual and expected values of commercial real estate, this total balance is exposed to a potential impairment of 10%. This level of impairment reflects the amount current loan balances may need to be written down in the future to support an assumed loan-to-value ratio of 75%.

Notably, Fitch said that does not mean it expects banks to report charge-offs in their commercial real estate portfolios of 10%. Rather, the 10% is Fitch's attempt to quantify the problem, which in this case represents the difference in value between current loan balances and the level such loans would need to be adjusted to achieve an underwriting standard of a loan to value of 75%.

A 10% reported loss rate would be a high water mark for this asset class and would exceed the levels of losses reported by the industry in the commercial real estate crisis of the late 1980s and early 1990s. Fitch said it does not believe the magnitude of the problem in today's commercial real estate portfolios exceeds the levels of past crisis levels in aggregate.

Fitch's analysis shows that a relatively small 20% of this impairment, or 2% of total outstanding, is represented by loan balances in excess of assumed collateral values (i.e. loan to value greater than 100%). The remainder of this impairment, which is the majority of the balance, represents loan balances that are protected by collateral values, but at levels that Fitch would view as at risk until meaningful improvements in commercial real estate values become evident.

Importantly, these amounts exclude the roughly $500 billion of construction loans, including residential construction loans, that are subject to even greater risk.

While a 10% impairment would appear manageable even after accounting for the greater risk exposures represented by the construction portfolio, the size, geographic concentrations, and product mix of individual bank portfolios differ materially and need to be evaluated on a case-specific basis, Fitch noted, for example, that none of the four largest U.S.-based banks (assets in excess of $1 trillion) have commercial real estate in excess of 10% of total loans.

Overall, commercial banks and savings institutions insured by the Federal Deposit Insurance Corp. (FDIC) reported aggregate net income of $2.8 billion in the third quarter of 2009, but loan balances declined by the largest percentage since quarterly reporting began in 1984. Quarterly earnings were more than three times the $879 million the industry earned a year earlier and represented an improvement over the industry's $4.3 billion net loss in the second quarter of 2009. More than 26% of all insured institutions reported a net loss in the latest quarter, up slightly from nearly 25% a year earlier.

The number of institutions on the FDIC's unpublished "problem list" rose to its highest level in 16 years. At the end of September, there were 552 insured institutions on the "problem list," up from 416 on June 30. This is the largest number of "problem" institutions since Dec. 31, 1993, when there were 575 institutions on the list. Total assets of "problem" institutions increased during the quarter from $299.8 billion to $345.9 billion, the highest level since the end of 1993, when they totaled $346.2 billion. Fifty institutions failed during the third quarter, bringing the total number of failures in the first nine months of 2009 to 95.

The U.S. thrift industry broke even for the second consecutive quarter in the third quarter of 2009, the Office of Thrift Supervision (OTS) reported. The industry's profit of $1.3 billion for the third quarter was a significant improvement from the losses of 2008 and early 2009. However, $1.1 billion of the third quarter profit resulted from a non-operating gain at one thrift. Without that gain, the industry's net income would have been $200 million - essentially breaking even.

The number of problem thrifts was 43, up from 40 in the previous quarter and 23 one year ago.

Download this story and all of the stories in the Watch List Newsletter here. The Adobe pdf version also includes all of this week’s leads of distressed properties and loans of concern, lease cancellations applied for in bankruptcy proceedings, local and national facility closures & layoffs, banks with distressed real estate portfolios and lists of loans approaching their maturity date. Plus the pdf version contains bonus news items not found in these columns or the CoStar Group web news pages.

Receive notice when a new Watch List Newsletter column is published by receiving The Watch List E-Mail Alert. It's the quickest way to link directly to the news and leads you want. Just e-mail me your name, title, company, company business, city, state, and e-mail address. You can reach me by clicking on the byline above or e-mailing me at Mark Heschmeyer

Fed Reserve's TALF Program Backs First New Issue CMBS

The creation of CMBS 2.0 has not even begun but evidence that demand for the bonds exists was demonstrated this week as Developers Diversified and Goldman Sachs issued the first CMBS deal in over a year - of course it is backed by the TALF program which will have time limits. So, while this transaction brings hope, it is not a evidence that we have developed a panacea for the long-term....much like taking an aspirin to cure a head ache caused by a brain tumor....Below is a description of the transaction as provided by Co-Star on its Watch List eblast.

Developers Diversified, Goldman Sachs Put CMBS Deals Back in Action

By Mark Heschmeyer
November 18, 2009

Town Center Plaza in Leawood, KS, benefited from the first new CMBS deal in more than a yearThe first new-issue commercial mortgage backed securities (CMBS) supported by brick-and-mortar properties in nearly two years successfully sold this week.

DDR Depositor LLC Trust 2009 Commercial Mortgage Pass Through Certificates, series 2009-DDR1 represents the beneficial interests in a trust fund established by affiliates of Developers Diversified Realty Corp. The trust fund will consist primarily of a single promissory note secured by cross-collateralized and cross-defaulted first lien mortgages on 28 of Developers Diversified Realty's properties. Goldman Sachs Commercial Mortgage Capital originated the $400 million loan.

The deal sold at its asking price and saw strong investor demand. The word on the street was that the deal was up to five-times oversubscribed. The capital markets had been looking to this deal as a measure of investors' appetite for risk involving commercial real estate assets and, in some ways, as a sign of the potential strength of the recovery.

As sold, DDR's five-year loan would bear an interest rate of less than 6% after factoring in all fees and expenses. As a result, the strong demand for this deal could prompt other potential borrowers to pursue CMBS financing, according to Opin Partners LLC, an investment house in New York. In fact, DDR is said to have another upcoming securitization, and other REITs are also expected to come to the table including, Fortress Investment Group, which may have as much as $650 million in commercial mortgages to package into a new-issue CMBS eligible for TALF funding.

The Federal Reserve's TALF (Term Asset-Backed Securities Loan Facility) was key to the deal. The Federal Reserve created TALF to help market participants meet the credit needs of households and businesses by supporting the issuance of asset-backed securities collateralized by commercial mortgage loans, auto loans, student loans, credit card loans, equipment loans, floorplan loans, insurance premium finance loans, loans guaranteed by the Small Business Administration, or residential mortgage servicing advances.

Eligible borrowers on the DDR deal can borrow Fed funds for the five-year fixed period at a rate of 3.5427%. TALF funds can only be used for the purchase of AAA-rated class of securities. Of the $400 million DDR deal, Fitch Ratings rated $323.5 million as AAA ($41.5 million was rated AA and $35 million A). The DDR deal is expected to close officially next week at which time, the loans will also be funded.

Some of key ratings drivers cited by Fitch Ratings included:

Loan-to-Value Ratio (62.4%): The Fitch stressed value is $641 million, based on a Fitch weighted average cap rate of 8.7%.

Debt Service Coverage (1.44x): The Fitch-adjusted cash flow for the 28 properties was $55.6 million, approximately 16.% less than the trailing 12 months net operating income.

Strong Tenancy and Mix: A majority of the portfolio is anchored by national or large regional tenants, with Wal-Mart representing the largest tenant exposure at 10.3% of the total square footage and 5.4% of base rent. The top five tenant concentrations, which represent 23.2% of total square footage (and 15.2% of base rent) are all investment-grade rated. Other top tenant concentrations include TJX Cos., Lowes, Home Depot, and Bed Bath & Beyond.

The 10 largest properties backing the deal and their allocated loan amount are listed as follows:

Town Center Plaza, Leawood, KS; 649,696 square feet; $54.3 million; Hamilton Marketplace, Hamilton, NJ; 956,920 sf; $44.4 million; Plaza at Sunset Hills, Sunset Hills, MO; 450,938 sf; $30 million; Brook Highland Plaza, Birmingham, AL; 551,277 sf; $26.4 million; Crossroads Center, Gulfport, MS; 545,820 sf; $26.4 million; Mooresville Consumer Square, Mooresville, NC; 472,182 sf; $19.5 million; Deer Valley Towne Center, Phoenix, AZ; 453,815 sf; $18.9 million; Downtown Short Pump, Richmond, VA; 239,873 sf; $13.4 million; Abernathy Square, Atlanta, GA; 129,771 sf; $13 million; and Wando Crossing, Mt. Pleasant, SC; 325,907 sf; $12.8 million.

Regulating Financial Companies: The House Committee Draft

This week the US House of Representatives issued its draft legislation on regulating financial companies...which has significant implications for the future of banks, mortgage REITs and CMBS issuers....from Dewey & Le Beouf:

The Discussion Draft (the “Draft”) on financial stability released by the House Financial Services Committee combines many of the proposals originally made by the Obama administration but frequently changes their force or emphasis. In the course of this bill-drafting process, Congress appears to be gradually creating a more general system of financial regulation, changing in potentially fundamental ways the basic orientation of regulation in the United States from one focused on a specific industry or product to one concerned with the effects and importance of financial activities and products in general, regardless of their history or specific characterization. In the Draft, this change manifests itself in the near omnipresence of the defined term “financial company” and its variants and in the generality of the proposed remedies. In certain portions of the Draft, the word “company” alone (without the modifier “financial” and without appearing in the defined form of “financial company”) plays a significant role, at least in circumstances in which the entity being subjected to regulation engages in significant financial activity. To accommodate institutions whose activities might be dramatically affected by an abrupt implementation of more general financial regulation, the Draft also creates an unusual transitional or grandfathering mechanism.

For more, click on the following link:

http://www.deweyleboeuf.com/~/media/Files/clientalerts/2009/20091110_RegulatingFinancialCompanies-TheHouseCommitteeDraft.ashx

FDIC Adopts Guidance on Prudent Commercial Real Estate Loan Workouts

The much anticipated FDIC guidelines for loan workouts was published today. The key word in their title is "prudent" which is the standard which banks will be held to when doing a workout.

This policy statement stresses that performing loans, including those that have been renewed or restructured on reasonable modified terms, made to creditworthy borrowers will not be subject to adverse classification solely because the value of the underlying collateral declined.

It provides guidance to examiners, and financial institutions that are working with CRE borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. It also recognizes that during these difficult economic circumstances, continued credit availability to businesses, especially small businesses, is challenging, even where borrower performance has been acceptable. This policy statement reflects the appropriate balance of prudent credit practices and meeting legitimate credit needs.

Believe it or not, the Feds recognize that prudent loan workouts are often in the best interest of both financial institutions and borrowers, particularly during difficult economic conditions. This policy statement details risk-management practices for loan workouts that support prudent and pragmatic credit and business decisionmaking within the framework of financial accuracy, transparency, and timely loss recognition. Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.

The policy statement includes examples of CRE loan workouts. The examples, provided for illustrative purposes only, reflect examiners' analytical processes for credit classifications and assessments of institutions' accounting and reporting treatments for restructured loans. The policy statement reiterates existing guidance that examiners are expected to take a balanced approach in assessing institutions' risk-management practices for loan workout activities.

To download a copy of these guidelines, go to: http://www.fdic.gov/news/news/financial/2009/fil09061a1.pdf

Let the mayhem begin

Open Letter to the CMBS Industry

We are all looking for solutions: Solutions to the economic situation, solutions to the investment equation, solutions to our personal financial condition, solutions to problems we never knew we had.

The loss of jobs together with household wealth and income that has occurred over the past two years has only one precedent in our country’s history: The Great Depression.

The government reaction with regard to the commercial mortgage market has been underwhelming. With over $290 billion of commercial mortgages maturing in 2009 and 2010, the credit crunch is real and is forcing banks, special servicers and insurance companies to extend and amend….pretending that capital will return to the marketplace by the time these loans come due again – as well as the deluge of loan maturities already scheduled to occur over the next three years – which will not happen without the revitalization of the CMBS market.

It is clear that the banks and insurance companies cannot replace the capital lost when the CMBS market collapsed. Everyone in commercial real estate has a vested interest in the creation of a new and improved structure for mortgage-backed securities which uses the tremendous infrastructure that has been developed and provides appropriate safeguards in order to make CMBS attractive to investors, profitable for the participants and practical for the borrower.

Many of our industry organizations like the CMSA, the MBA, the Real Estate Roundtable and others are weighing in on these matters but the bondholders, the B-piece buyers, the servicers (primary, master and special), the rating agencies, the SEC, the IRS and the FASB are all working in a crisis mode – and buried under legacy asset issues….such that it is difficult for them to look into the future without a jaundiced eye.

We all recognize that the mechanisms put in place to prevent a meltdown did not work so we have to start with a clean slate. The following issues all need to be addressed:

Ø Creation of Generally Accepted Rating Principles including standardized underwriting standards and an industry oversight mechanism which could be modeled after the accounting profession;;
Ø A bond structure whereby loan originators and investment banks retain an interest in the bond pool to prevent aggressive and sloppy underwriting and execution;
Ø Imprudent loan structures that do not provide for future cash needs, like leasing reserves, or aggressive underwriting or sizing should result in the need for increased subordination levels over deals that do not provide these protections;
Ø REMIC rules and Pooling and Servicing Agreements need to be written to enable timely portfolio and asset management when loans become troubled.
Ø Bond pools and loan structures need to be simpler whereby conflicts of interest are eliminated;
If we are to resurrect the CMBS market, these issues and many more must be addressed. We need to start a dialogue to bring out the best and brightest ideas to establish a workable structure to revitalize the Commercial Mortgage Backed Securities market. With hundreds of billions of loans maturing in the next five years, this is one of the most critical projects we can execute to provide an exit for the legacy assets on the books today.

I implore our industry organizations and government regulators to start an open dialogue with all industry professionals – through blogs, conferences, meetings and any other way for us to get the great CMBS financial engine running again.

Please let me know your thoughts

Bad boys parts I, 2 and 3....

The "Bad Boy" carveouts hang over the heads of real estate investors who sunk their life savings into buying properties and using a conduit loan to finance it...If the ownership enity files BK, then the loan becomes recourse to the guarantor which is typically the principal in the investment. So, you either turn over the keys and walk away, or risk the family farm if you try to save your investment through the courts and fail....that is the choice...Well, GGP proves that you cannot tell a book by its cover and each circumstance needs to be evaluated on the facts and circumstances of the specific transaction....Investors have significant equity investments in properties that are suffering cyclical stress....all you have to look at is the increase in value realized from 1991 to 1996 and beyond to know that the current values are just that - current - which means that they are not reflective of tomorrow's value....We know that without liquidity, property values are going to continue to decline - and where that liquidity comes from is yet to be seen - but we all just know that we have to be close to the bottom, we just have to be....The following article raises the issue of the "bad boy" carveouts.... do they work or don't they, it depends....

Mon 12 Oct, 2009, Commercial real estate's bad boys: Agnes T. Crane, a Reuters columnist. The views expressed are her own -

NEW YORK (Reuters) – The bad boys are back, but whatcha gonna do when they come for you? That’s a song investors in commercial real estate shouldn’t have in their heads thanks to “bad boy” provisions built into loan agreements that aim to protect their interests.

Yet, at least two high-profile cases have quashed the idea that investors in commercial real estate debt can rest easy that the collateral backing non-recourse loans won’t get tied up in messy legal proceedings. When financing finally returns to the beaten-down sector, lenders should demand more concrete concessions from borrowers — like more equity and higher interest rates — rather than rely on personal pledges by borrowers to stay out of court.
Like many assumptions cherished during the credit boom — home prices never fall, credit default swaps can cushion the financial system against shocks and securitization helps minimize risk — personal guarantees in the commercial real estate market could turn out to be just as flimsy.

“Bad boy” provisions are intended to protect lenders from the antics of an irresponsible borrower by making someone — usually a principal — personally responsible for the loan. Most loans funded by bond investors and insurance companies are non-recourse, meaning the borrower can walk away without putting his other assets at risk. The guarantees helped lenders sleep better at night since they’re handing over millions, if not billions, of dollars to fund a project, purchase or development.

The types of behavior deemed bad are many, including failing to properly maintain the property, fraud and environmental liability, and of course, bankruptcy.

Lenders hate bankruptcy. They would rather an underwater borrower turn over the keys and foreclose on a property then force creditors into a protracted battle in court. After the savings and loan crisis, lenders started to demand a no-bankruptcy pledge from borrowers in exchange for the non-recourse loan that often carried with it cheaper financing.

The bankruptcy provision, however, doesn’t look so iron-clad anymore.

Take David Lichtenstein and his attempt to dodge a $100 million personal liability he agreed to when buying Extended Stay. Lichtenstein filed for bankruptcy in June, just two years after he bought the hotel chain from Blackstone Group (BX.N: Quote, Profile, Research) for $2 billion. By striking a deal with some of his creditors, Lichtenstein hopes to wiggle out of his bad boy clause.

The bad boy provisions are just one piece of a larger issue of “bankruptcy remote” — that collateral backing the loans and by extension bonds can be sealed off from bankruptcy proceedings.

The bankruptcy of General Growth Properties, one of the nation’s largest REITs, though upended the whole concept of bankruptcy remote — namely that collateral backing commercial real estate loans would be safe from bankruptcy proceedings if it is tucked away in special purpose entity.

There are likely to be other cases as the commercial real estate sector, unlike other areas of the economy, is extremely weak. Not all borrowers will be successful in shirking their personal pledges, and lawyers note that courts have been sticklers in ruling in favor of lenders when it comes to other bad boy guarantees.

But, it could — and should — have a lasting impact on lending terms.

Real Estate Impact Huge Under Accounting Changes

I first heard about the proposed changes in accounting for leases last spring when the ICSC picked up on the issue from the on-going discussions between FASB who is sets the accounting standards and the International Accounting Standards Board to create a uniform accounting standard around the world. CB Richard Ellis has published a report on the potential impact of the change in accounting. Globe St. published a special report summarizing this study which is below. The full report can be accessed at: http://www.cbre.com/NR/rdonlyres/8D7AEFC0-1154-472A-8521-6323B02AE3A6/777874/FAStalkingCBRE082009.pdf

By Bob Howard GlobeSt.com EXCLUSIVE Last updated: October 1, 2009 10:05am
LOS ANGELES-New accounting standards requiring property to be marked to market and proposed changes in lease accounting rules could have an immense impact on the balance sheets, income statements and overall financial outlook of US corporations, many of whom are unprepared for the changes, according to a new report from CB Richard Ellis.

The white paper by CBRE, titled "FAS Talking--Unpacking Real Estate's Impact on Financial Statements," says that the estimated balance sheet impact of the proposed lease accounting changes alone could be well in excess of $1 trillion for US companies. The report says that the combined effects of mark-to-market and the lease accounting changes hold the potential to negatively impact earnings, capital requirements, debt covenant ratios, credit ratings and other measurements of corporate financial health.

Todd P. Anderson, CBRE senior managing director of global corporate services who co-authored the report along with CFO Michael M. Omiya of Boeing Realty Corp., explains to GlobeSt.com that the changes in accounting standards are "a continuation of the effort to have greater financial transparency, in particular in the financial statements for publicly traded corporations."


The white paper analyzes the potential impacts of both the mark-to-market requirement and the proposed lease accounting changes--which could go into effect as early as 2011 or 2012--and discusses courses that corporations can purse in order to mitigate the effects of the changes. The mark-to-market requirement, known as FAS 157, went into effect for financial assets as of Nov. 15, 2007 and for non-financial assets including real estate as of Nov. 15, 2008.

Anderson explains that one of the problems corporations face in marking down the real estate they own is that when a property is marked down, the write-down not only reduces the asset's value on the balance sheet, it generates a pre-tax loss on the income statement. The issue is further complicated by the difficulty of valuing real estate in a market in which few if any comparable sales are available because so few properties are trading. One of the steps that corporations can take to prepare for the impact of mark-to-market, Anderson says, is to review its properties before the end of the year to determine which ones have the potential to create write-downs.

"In the absence of comparable sales, you have to figure out how to establish a value for your property," Anderson says, and the time for a corporation to do that is before the end of the year when it is busy with so many tax and accounting duties that it will be hard-pressed to complete the tasks on time. "The corporate real estate department, if it understands what's going on in the mark-to-market arena, can come in early and start to take a look at its properties and basically create an argument for why it is valuing properties the way it is," he says.

The CBRE white paper points out that, "If a corporation has the financial wherewithal to carry the property until normalized market conditions return, the argument exists that the company should be able to avoid a distressed sale scenario in which the asset would be valued at a fire sale price."

Regarding the proposed changes in lease accounting, Anderson explains that the new rules would reclassify "operating" leases as "capital" leases, which in turn would require the operating leases to be reflected on corporate balance sheets instead of held off the balance sheet as they are now. Anderson comments on what a far-reaching change this could be: "Many companies can have as much liability for operating leases as they do for all of their other liabilities on their balance sheet, but operating leases today are not on the balance sheet," he says.

Under current practices, the only item that companies record on their income statements regarding operating leases is one year's worth of rent expense. "If you have a 10-year operating lease on a building, you will show nothing on your balance sheet and only one year of rent on your income statement," Anderson points out. He says that the argument in favor of reclassifying these as capital leases--which are reflected on balance sheets--is that operating leases are like bank loans, which are reflected on balance sheets. The argument is that an operating lease, like a loan, is an obligation of the corporation, not just for one year but for the entire duration of the lease. "The regulatory bodies are starting to say that such an obligation is too much of a financial component of a company to not be represented on the financial statements," Anderson observes.

Under the proposed accounting changes, corporations would compute the present value of all of their future lease payments and record them as both assets and liabilities on their balance sheets. "Just doing those two things alone could throw off debt covenants and various financial ratios that could have significant implications for a company's credit rating and other impacts," Anderson says.

The proposed changes would also affect how leases are treated on income statements, producing both depreciation and interest expenses, which would be greatest during the first half of the lease. The upshot is that corporations would take hits on their balance sheets in terms of performance ratios such as return on assets and debt covenant ratios, and they would also take hits on their income statements for the first half of the lease term.

The proposed changes in lease accounting have myriad implications for how companies structure and manage their real estate, Anderson points out. Not every company has the same proportion of owned versus leased properties, so the lease accounting changes would have very little effect on a company that owned the majority of its properties. A competitor that leased the majority of its properties, on the other hand, would suffer significant hits to its financial statements. One answer for such a company would be to execute shorter-term leases, which would show up as lesser obligations on the balance sheet, but the solution isn't always that simple: Not all real estate is suitable for short-term leases because the user may require long-term control of the property, Anderson points out. For properties that a corporation might need for 10 years or longer, it might be more practical to buy rather than lease because of the depreciation advantages of ownership.

Although the new lease accounting rules would not go into effect until 2011 or 2012, corporations should be looking at their real estate now to prepare for the potential impacts of the rules changes, Anderson advises. "Most companies are only beginning to understand these changes," he says.

Anderson notes that the accounting changes address only the user side of leases. "One of the big unknowns is what will this do to the landlord/investor side of the market," he says. Accounting standards boards have yet to tackle that question, so the answer "is truly an unknown right now," Anderson says.

Ratings Agencies May be Held Liable for Fraud for Misleading Ratings

From NYC attorneys Crowell Mornig comes the news of a precedent setting court decision involving the rating of a privately placed loan portfolio which failed.

The failure of the rating agencies to maintain prudent underwriting standards in support of their CMBS and RBS ratings has been a key contributor to the low-cost of funds resulting from those ratings and the shrinking subordination levels. For the bonds, the rated portions carry a much lower cost of capital than the unrated portions which results in an overall lower cost of capital much like the cheap mortgage and mezzanine financing which funded up to 95% of the purchase or value of commercial properties reduced the cost of capital to a purchaser and facilitated the low cap rate environment we experienced during the 2-3 years prior to the market meltdown. This law suit may (and should) result in a complete restructuring of the rating process as part of the revitalization of the CMBS market. Check it out:

"In a recent decision, the United States District Court for the Southern District of New York, in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc., et al1 denied a motion to dismiss fraud claims brought by certain noteholders against Moody's and Standard & Poors ("Rating Agencies"), in connection with the defendants' ratings of certain mortgage and asset backed securities. Departing from the general rule, the Court rejected the Ratings Agencies assertion that liability based upon their ratings is prohibited under the First Amendment right to free speech.

BackgroundIn Abu Dhabi Commercial, the Ratings Agencies were hired by Morgan Stanley, the arranger and placement agent for the notes (the "Placement Agent"), to rate notes in connection with the issuance of three categories of notes under a structured investment vehicle. These ratings were included with the knowledge and approval of the Ratings Agencies in information memoranda and other documents distributed to specific potential investors, but not disseminated to the general public.

The Ratings Agencies worked directly with Placement Agent to structure the notes in a manner to ensure that they received the highest ratings. As a part of that structure, the Ratings Agencies were responsible for ensuring certain minimum and maximum percentage requirements of rated assets backing the notes were met. These percentage requirements, however, were not met, resulting in riskier notes than the ratings suggested. In particular, the structured investment vehicle failed meet its guaranteed minimum percentages "AAA" and "AA" collateral assets and exceeded its maximum percentage of residential mortgage backed security investments.

Subsequently, the issuer, not being able to service its debt, filed for bankruptcy. As a result, the notes produced little to no recovery for the noteholders.

Court RulingThe Abu Dhabi Commercial Court denied the portion of the Ratings Agencies motion to dismiss the noteholders' fraud claims finding, among other things, that these ratings were not protected speech under the First Amendment. In reaching this result, the Court held:
the First Amendment protects rating agencies, subject to an 'actual malice' exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern. However, where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is not afforded the same protection.2

Here, the lack of wide spread dissemination of the ratings was pivotal in the Court's finding that the First Amendment protections were in applicable.

Conclusion: In short, this decision steps away from the traditional treatment of ratings as protected First Amendment speech and opens a new avenue for noteholders to seek redress for claims such as fraud. As many similar securities offerings are so targeted, this case may have wide reaching repercussions."

For a full copy of this "noteworthy" decision: Go to: http://www.crowell.com/PDF/Abu-Dhabi-Commercial-Bank_v_Morgan-Stanley.pdf

As the Fed sleeps

Every now and then a columnist has an opinion which is spot-on....this one hits the bulls eye. We need continued action to realize the fruits of our labor....caution does us no good now....there will be time to rest in the future...sooner if we can keep the recovery actions moving now....

By Christopher Swann
NEW YORK (Reuters) – It’s not even October and the Federal Reserve already appears to be going into policy hibernation.
Today’s statement appears intended to attract as little attention as possible. Even the more gradual tailing away of mortgage purchases by the Fed seems calculated to assist the Fed’s quiet retreat.
There will be no further efforts by the Fed to accelerate the pace of growth. Given the grim economic outlook this is a shame. Today’s Fed statement pointed to a pickup in growth, but the Fed’s own economic forecasts still scream out for stronger action.
Even through 2010 unemployment is expected to hover close to 10 percent. Core inflation meanwhile could go below 1 percent in 2011. This is the kind of outlook that would normally prompt the Fed to stamp on the accelerator.
Sadly, the Fed no longer has this option. Ben Bernanke is hemmed in on two fronts.
The first is a political constraint. The doubling of the Fed’s balance sheet during the crisis alarmed many in Congress. As the financial crisis has receded, there seemed less justification for such extraordinary action.
The Fed now badly needs to win back support in Congress. The stakes are high as lawmakers prepare to overhaul the regulatory framework. Not only does the central bank hope to win the new role as systemic regulator, they may need to fight hard to avoid encroachments on their independence by Congress.
They will be particularly keen to prevent oversight by the Government Accountability Office. Such political pressures explain why the Fed’s last significant public announcement was a populist initiative to curb financial sector bonuses.
The second limitation is of their own making. It results from a failure of nerve. The Fed was too quick to sound the retreat on credit easing. Soon after financial conditions started to normalize and fears of depression eased, the Fed indicated that the balance sheet would not expand any more than had already been planned.
This was premature. The Fed could have added another trillion dollars to its holdings without generating inflationary risks or unsettling the markets. By raising the potential ceiling on their asset purchases Fed officials would have given themselves much more room to pursue the goal of full employment.
Now, however, the Fed appears to be locked into its sleepy strategy. To reverse course and expand asset purchases would throw the market into turmoil and undermine Fed credibility. The damage to the Fed’s inflation-fighting credentials could actually push up interest rates — more than offsetting the impact of further credit easing.
Bernanke can claim a good deal of credit for hauling the United States from the brink of disaster. But he swung too swiftly from boldness to caution — putting the Fed on the sidelines. Barring an unexpected downswing, is now powerless to help accelerate recovery and bring down unemployment.

IRS Gives Servicers Flexibility to Modify CMBS Loans

Important update from Commercial Real Estate Direct Staff Report

The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.

Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.

The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.

Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity.
Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.

In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."

In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.

The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.

In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.

"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."

The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.

Comments? E-mail John Covaleski or call him at (215) 504-2860, Ext. 208.

Copyright ©2009 Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.

Stemming the Rising tide of foreclosures plaguing the Middle Class with the Guaranteed Mortgage Assistance Program (gMAP)

In an email blast regarding my blog, I introduced the following proposed solution to the continuing housing crisis which a friend and colleague, Jud Ireland, and two esteemed colleagues, Michael Intrillgator and Kyle Martin, created. The following article regarding this program was published today in the Huffington Post.....it is truly a solution we all need....please tell the President and your representatives in Congress...GET INVOLVED!

A slogan on the White House website states "A Strong Middle-Class = A Strong America."
Vice President Joe Biden, recently gave a speech at the Brookings Institution on the status of the economic stimulus plan and shared several examples of how the American Reinvestment and Recovery Act is starting to benefit the economy, including middle-class Americans.
We applaud the positive points he addressed. However, the truth remains that millions of middle-class Americans are still on a collision course towards losing their homes. The objectives of this paper are three-fold: 1) to put this problem into perspective, 2) to address why the existing program is not working effectively and 3) to propose a bottom-up solution that could be readily implemented for the benefit of not only middle-class America but also the nation as a whole.
The Scope of the Problem:
Recently many articles have expressed optimism that the recession is ending. While we all want this, foreclosures are still an enormous problem with many adverse secondary repercussions. Unless proactive measures are taken quickly, this problem will escalate. The flood of foreclosure filings continues to rise according to the latest data from RealtyTrac. Les Christie of CNN Money recently reported that between June and July of this year, the number of foreclosure filings rose by 179,599 or 9% in one month alone. This foreclosure rate is up 93% above the rate recorded in July of 2006. Right now there are at least 15 million Americans who are out of work. This number is expected to rise and by the end of the year1.3 million Americans will lose their unemployment benefits and tens of thousands of these are destined to lose their homes unless a more effective program is implemented quickly. Twelve percent of mortgages are now delinquent. RealtyTrac's® July 2009 U.S. Foreclosure Market Report™, indicated that in July 360,149 U.S. properties were in default and received foreclosure filings, default notices, or were scheduled for auction and bank repossession.
This represents an increase of 32 percent from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July. "July marks the third time in the last five months where we've seen a new record set for foreclosure activity," noted James J. Saccacio, chief executive officer of RealtyTrac. The problem is acute and, as Biden's speech revealed, is not getting proper attention from the Obama administration. For example, the payroll tax cuts which Biden referenced do very little to prevent unemployed homeowners from losing their homes as they only benefit those who have jobs. The program we propose benefits unemployed homeowners who are striving to become positive contributors to the nation's GDP.Through June of this year, aggregate wages and salaries are down 4.7%. This problem is compounded because 25% of all homes in the U.S. are now worth less than the mortgages against them. Thus there is often little incentive for homeowners to keep their homes when they are struggling just to make their mortgage payments. Coupling this "upside down" status of homes with the employment situation, it is no wonder that over 844,000 homes were foreclosed on by May 2009. Even though the economy may be starting to show signs of a weak recovery the glut of upside-down properties will put a major drag on this recovery. In quantitative terms, the Conference Board Consumer Confidence Index has been rising: From a low of 23.5 in February 2009 to 47.4 in July and now 54.1 in August. So, although the trend looks like it is moving in the right direction, the reality is that it takes a reading of 90 to indicate that economy is on solid footing. A reading of 100 or more means that the economy is growing. This is prima facie evidence that the U.S. economy is not on solid footing and has a long way to go before returning too normal. So, if we are going to end the recession now, we need to do something different.
Deficiencies with the Existing Housing Recovery ActThe Housing Act does not directly address those who have lost their jobs. For example, a job loss may put the homeowner in even more jeopardy of not qualifying for assistance! The applicant must comply with several conditions. Even then, there is no guarantee the applicant will receive assistance since the program is voluntary and lenders are not required to participate in it. The program's scope is also too narrow. Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers who are in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. This number is by no means acceptable. In California alone, foreclosures scheduled for sale in July rose to 124,874, a 10.4 percent increase from June, and a 93.3 percent increase year-over-year from July 2008. Although the American taxpayers bailed out banks, these banks have not reciprocated in a commensurate manner and have been rejecting too many applications for loan modifications. For example there have been incidents where Aurora Loan Services has rejected requests for home loan modifications from clients who are in need of help due to losing their job, but, have tenaciously continued to make all their payments on time. With the proposal we introduce in this paper, such clients would be guaranteed assistance in making their mortgage payments.
Our Proposed Solution to Stemming the Rising Tide of ForeclosuresIn a Financial Times article, Paul Krugman, the most recent Nobel Prize laureate in economics, candidly stated "Damned if I know," in response to an inquiry per what the most promising short-term investments would be for promoting the recovery. We have an answer to this question, which addresses a major subset of the overall macroeconomic problems. Specifically, in this paper we present a solution to the problem of middle-class Americans losing their homes. The primary objectives of this program are to prevent homeowners from losing their primary residence while simultaneously enabling these homeowners to focus their energies on obtaining new jobs and being productive members of society. If not these homeowners will waste productive energy on the hardships of relocation associated with foreclosure. Further, this program will provide homeowners positive incentives and help shore up the balance sheets of the banks and other financial institutions that are holding the mortgages.
We term this program "The Guaranteed Mortgage Assistance Program" (GMAP). The basic concept for this initiative involves guaranteed loans for making mortgage payments in the form of mortgage vouchers. Here we: 1) articulate the framework for the rapid mass implementation of this initiative, 2) provide an example of how this program could benefit a typical middle-class homeowner, 3) estimate in aggregate how much this program would benefit America as a whole, and 4) propose the recommended next steps towards implementing this program. To date, most of the Federal government's initiatives have been of the "top down" variety, which resulted in billions of dollars being pumped into banks, and insurance companies with the hope there would be trickle-down benefits to the middle-class. But hope is not a strategy! These rather startling initiatives included the unprecedented funding of foreign banks, the relaxing of accounting rules and even the funding of private corporations. However, it was the Cash for Clunkers program which worked the best. In magnitude it was miniscule in comparison to the TARP bailout. Specifically, the $3 billion allocated to the Cash for Clunkers program is only 0.381% of the $787 billion TARP bailout. But Cash for Clunkers put approximately 17,000 people back to work on automotive assembly lines. This program worked because it was bottom-up; that is the investment was focused directly on those who were the beneficiaries. It had the triple-benefit of:
* Saving Americans up to $4,500 per vehicle purchased
* Putting thousands of Americans back to work
* Decreasing Greenhouse gas emissionsAmericans have witnessed that bottom-up programs are a much more effective use of capital than top-down programs. In a manner corollary to Cash for Clunkers, our proposed guaranteed mortgage loan voucher program is a triple-benefit "bottom up" approach which would get right to the core of solving the housing crisis while simultaneously helping the banks and stimulating the economy; but at no long-term cost to the government. We now discuss the program in detail.
The Mortgage Payment Voucher ProgramWe propose a fresh new and innovative solution that hasn't yet been tried. This initiative is aimed at benefiting middle-class taxpayers; who for the purpose of this initiative we define as individuals with personal or family incomes of no more than $250,000 with this number selected based on President Obama's definition of the middle-class during his campaign. These loans will be limited to a) primary residences and b) to a maximum of 10% of the mortgage amount of the home. The bottom-line objective of this program is to enable homeowners to be able to make their mortgage payments without losing their homes. This program would have the secondary benefit of enabling the homeowner to focus on finding another job without the stress and dilution of focus caused by the pending loss of one's home. This program would have the immediate benefit of putting a stop to the majority of primary residence foreclosures.
The basic structure of this program is that the government grants 10-year loans to homeowners to help pay their mortgages in the form of a Guaranteed Mortgage Assistance Program (GMAP). These GMAP loans will be fully repaid because they can be secured in the same fashion as a tax lien, so the program is deficit neutral, and hence at no cost to the government.
In terms of specifics, there are three primary time-staged phases to this program, which would work as follows: Phase 1: After successful completion of an application, the government provides a voucher to the homeowner who in turn transfers the voucher to the bank. The homeowner uses this voucher as an equivalent to dollars, which, together with their payment, makes up the total monthly mortgage payment .
Phase 2: The government reimburses the bank for the amount of the vouchers over an extended period of time.
Phase 3: The homeowner reimburses the government for the loan at the end of 10 years as a balloon payment that could be funded either by the homeowner's accrued savings or by taking out a second mortgage against the property or selling the home.For example, if 10 percent of the homeowners elect to participate In this program (roughly correlates with the unemployment rate) at the program limit of 10% of the outstanding mortgage balance, the program will have an upper limit of $100 billion. This number was computed based on the $10 trillion total outstanding residential mortgages. If the government elects to reimburse the banks at the 5% rate then the upper-limit cost to the government is $50 billion over the course of 10 years, which would be fully collateralized and fully repaid by the homeowners. We envision that this program would immediately begin to increase housing equity for the following reasons: When the government announces this program Americans will see that the end of the housing crisis is in sight. With government now backstopping the fall in prices, a large number of potential buyers on the sideline will jump in, driving up demand and leading to further rising prices.
Benefits of the GMAP ProgramThe banks benefit by converting non-performing loans into performing loans, thus shoring up their books. This will significantly contribute to a further thawing of the credit markets by enabling the banks holding GMAP loans to loan against them (like a Treasury asset) at a reasonable multiple of value, thereby further stimulating the economy with new loans. The banks redeem GMAP funds back to the government at a rate of 5 or 10 percent of the principal value per year. Under the 5 percent per year plan, the government would be required to pay the bank a balloon payment of 50% in the tenth year. This is at the same time the homeowner is paying the government the entire loan amount, at the end of the term. The 100% repayment by the homeowner may require taking out a second mortgage. However, after ten years the equity in the home is likely to increase. Thus we have proposed a solution to stem the rising tide of foreclosures at virtually no cost, which would also significantly contribute to stabilizing the banks.Other bottom-up programs should also be considered by the Obama administration. These include small business loans and an initiative for funding pre-school education. For example, University of Chicago Professor of Economics and 2000 Nobel Prize winner Dr. James Heckman states in his prescient paper The Productivity Argument for Investing in Young Children "Enriched pre-kindergarten programs available to disadvantaged children on a voluntary basis, coupled with home visitation programs, have a strong track record of promoting achievement for disadvantaged children, improving their labor market outcomes and reducing involvement with crime." [http://jenni.uchicago.edu/Invest/FILES/dugger_2004-12-02_dvm.pdf] The details associated with implementing these two other programs are beyond the scope of this paper. However, the authors intend to expand on the details of these programs in future papers. Conclusion:This continuing economic disaster can be dramatically mitigated with the GMAP program that serves as a triple catalyst for increased equity in housing, stronger bank balance sheets, and no increase in government debt. This program is based on providing a little short-term reprieve to struggling homeowners while counting on them to have full accountability by fully reimbursing the government. As we see it, it is now time to adopt the GMAP initiative and other such bottom-up economic solutions to address the recession so as to avoid an economic relapse or a prolonged recession like the "lost Decade" in Japan in the 1990's.
Michael D. Intriligator is Professor of Economics, Political Science, and Public Policy at UCLA; Jud Ireland an investor; and R. Kyle Martin Is an accredited investor and a consultant to institutional investors with a focus on companies in the technology sector.