Andre J. Peschong

The new regime is now taking over and what a job Obama has in store for him.  In fact, this is probably one of the most volatile handovers of power we have seen in our recent history.  Having said that, what happens in Obama’s first 100 days of office will set the tone for the next four years.  The new president and his advisors are going to have an extremely tough time of it, mainly in restoring confidence and liquidity back into the capital markets.  You will hear me say “confidence and liquidity” a number of times in many upcoming posts. Why? Because those are two of the most important factors in trying to resuscitate the flagging economy.  Everyone thinks that the worst of the storm has passed and now we need to inject the liquidity back into the market to help stimulate job growth again.  WRONG! (This is just my opinion but I will now try to lay out why I think this is the case.)

What we saw in the fourth quarter of 2008 was really just a knee jerk reaction, almost an involuntary reaction to the liquidity drying up, coupled with the massive write downs of the CMO (Collateralized Mortgage Obligation) pools.  This led to people/institutions needing liquidity or in essence running scared because of the severity of these write downs.  It caused a vacuum of capital which was the first domino to fall and the cascade effect continued. 

People are generally optimists, yes that is a generalization, but if you talk to Joe Q. Public, he mostly wants to know when it is time to buy, not when to short.  There is something about the spirit of capitalism that causes that effect.  However, this optimism can lead to justification, which can also lead to outright blindness.  What do I mean? There are some very large issues on the horizon that could cause a massive aftershock to the financial system.  The home mortgage market and all of these CMO’s have been decimated, losing, in some cases, almost 80% of their value.  Home values are still plummeting and banks and institutions are writing these off as fast as they can.  With all of this attention on the residential marketplace and its decline people are taking their eye off the ball.  We haven’t seen anything really happening to commercial real estate, including derivative products, and loans behind them. 

I believe this is the next shoe to drop.  In doing some covert, non technical due diligence, I believe the commercial real estate market is poised to get hammered. The banks are going to start writing off loans at a rate equal to or greater than the residential market.  Non performing centers or office buildings still have a massive debt load that they are carrying and if businesses are unable to pay the rents the debt service still exists.  This usually means the buildings are in some form of workout or rent abatement situation. Basically if the tenants leave there is no other form of cash flow, thus potentially leading to a default.  The commercial market always lags behind the residential market, as it did in the recession after the S&L crisis. 

Commercial properties and development took another 12 months to start showing declines.  By my estimate we probably have another quarter, maybe, before the banking institutions have to start taking these massive write-down’s.  When this happens, it could literally be a death blow to consumer confidence, which then means everything gets tightened up again causing additional constriction in liquidity.

I know I am full of happy news but as I see it, if we can be informed about a potential crisis or a deepening of the current crisis then we can take appropriate measures.  When selling a stock there is an old saying on Wall Street which is “I would rather be a month early selling a stock rather than a day late”.  I welcome your feedback on this post as I am sure many people have a strong opinion about what is currently happening in our capital markets.

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