Back to the Future?

A recent Globe Street article about the condition and outlook for the real estate markets begins, “There’s a practical chorus of big investors and experts saying that commercial real estate, excepting maybe office, is getting closer to bottom if not there already.”

In a recent CNBC interview, Drew McKnight, Fortress Investment Group co-CEO & managing partner, was far more cautious: “I think it’s top of the first inning. If you look at the number of defaults to date, it’s very, very low.” Pointing out several reasons, he continued, “Real estate was the biggest beneficiary of low rates. And unless rates can reset and reset quickly, I just don’t see an easy solution.”

During the so-called Global Financial Crisis of 2008-2010, the number of problem banks (those deemed in danger of insolvency) would peak at almost 900, or 12% of all FDIC-insured institutions. There were ultimately 489 bank failures between 2008 and 2013. In today’s cycle to date, there have been five.

“The economy might be able to hold up okay even if we have this real estate reset. But for folks that own real estate levered, it could be very painful,” continued McKnight. “In the context of trying to pick a bottom, I think it’s really, really early. I think we have a lot of time. I think prices will go lower for real estate, almost across the board.”

Even as someone with over half a century of experience in banking with over eight years leading the FDIC during severe banking and thrift crises, I find the debate about where we are headed extremely difficult to understand. I fear that the central banks and governments around the world might well have given us a false economic outlook, as happened during the raging bull market of the 1920s, which led to the stock market crash in 1929 and the Great Depression of the 1930s, during which one-third of U.S. banks failed, immediately followed by World War II.

Look at the interest rates from 2010 to 2020 – close to zero, or even below zero in some countries (like Japan). How can real estate not be over-purchased with zero interest rates and little cost of carry? Of course, big investors are going to tell us the worst is behind us, because they desperately need for Congress to continue its massive deficit spending spree with the Fed accommodating it with nearly free money.

In my opinion, the “Global Financial Crisis” is a term coined by Wall Street to persuade global governments to dump vast amounts of money into economies rather than cleaning up massive financial problems. Four successive administrations (Bush, Obama, Trump, and Biden) and their Congresses threw out the incredibly difficult and painful decades of work by Paul Volcker, the Fed, the FDIC, Treasury, and Congress to undo the reckless and inflationary monetary and fiscal policies of the 1960s and 1970s.

When I was Chairman of the FDIC, we handled some 3,000 bank and thrift failures in the period from 1978 through 1992. Major failures included Continental Illinois, nine of the ten largest banks in Texas, and many other of the largest banks and thrifts across the country. Moreover, thousands of other banks were merged out of existence without government financial support, taking us from 13,000 banks in 1978 to a little over 4,000 today. Finally, the Treasury, Fed, and FDIC developed a backup plan to nationalize the major U.S. banks if/when they experienced defaults in their enormous portfolios of loans to lesser developed countries.

The cost of this massive cleanup of the banking and thrift problems during this period was borne entirely by the banking and thrift industries, except for the $150 billion cost appropriated by Congress to fund the Resolution Trust Corporation (RTC) – and even the cost of the RTC was ultimately covered by FDIC premiums paid by future charges against the banking industry.

Contrast that record to what was done during the “Crisis” of 2008-2010, which continues to haunt the world today. First, Congress appropriated $750 billion to fund the absurd Troubled Asset Relief Program (TARP), senselessly increasing deficit spending to bail out banks, Wall Street firms, insurance companies, and others (including our largest automobile companies, of all things). It has only grown worse since then, as the Federal Reserve and Congress have created and dumped into the economy massive amounts of debt at close to zero interest rates, allowing us to ignore the problems while they have mushroomed beyond control.

What are we going to do now? The bulls are telling us to go back to the future, lower interest rates, and buy more real estate. Why didn’t we think of that sooner?

William M. Isaac, former Chairman of the FDIC & Fifth Third Bancorp, is Chairman of Secura/Isaac Group, a global consulting firm to governments and financial institutions. The views expressed are his own and not those of any firm or organization with which he is or was affiliated.