TARP, TALF, FSP, The Stimulus Plan and How They Will Affect the Investment Property Sales Market

Commercial News » Commercial Real Estate Edition | By Robert Knakal | February 19, 2009 10:13 AM ET

(NEW YORK, NY) -- The alphabet soup of government intervention is enough to make your head spin. The magnitudes of the programs are enormous. What I will do today is look at each of these initiatives and try to determine how they might collectively affect our New York City investment property sales market. We will examine three areas which have a significant impact on our real estate market: 1) Employment, 2) Credit Availability, and 3) Interest Rates. First, let's review these programs:

The Troubled Asset Relief Fund (TARP) (aka Bailout #1) was originally a $700 billion program handed to Congress by the Federal Reserve in September of 2008 with the intention of unfreezing the credit markets. This was to be done in the form of removing toxic mortgage-backed securities from the balance sheets of banks. Within one month, the plan for buying these toxic assets was abandoned because determining the value and, hence, the fair price of these securities was nearly impossible due to the continual decline in housing prices. If the collateral for the securities keeps falling and the expectation is that the reduction in value will continue, it is not possible to value the assets. The result was that the Fed deployed about half of the TARP funds in the form of cash injections into banks hoping that this injection would stimulate lending. Because there were almost no strings attached or guidelines with respect to the use of these funds, most of the TARP money was hoarded by the banks or, in a few cases, the funds were used to purchase other banks. The result was that credit availability was not enhanced.

Enter the Term Asset-Backed Securities Loan Facility (TALF) (aka Bailout #2). This program will not be financed with taxpayer dollars (directly) but rather by the printing of more money. This consumer bailout was anticipated to have a positive effect on credit availability as it would stimulate the secondary markets. The asset backed securities supported by this program initially were to include auto loans, credit card debt and student loans. The program was to allocate $200 billion by the Fed to security holders of consumer backed debt. Essentially, doing this would have insured the debt if a borrower defaulted. Additionally, backing the backers, the Treasury department was to provide $20 billion from the TARP funds to safeguard losses that the Fed might incur.

As the scale of the crisis became more apparent, the Stimulus Plan that had been discussed for months included a provision to increase the scope of the TALF in conjunction with the deployment of the balance of the TARP money. This initiative, which was laid out by Treasury Secretary Timothy Geithner, is dubbed the Financial Stabilization Plan (FSP) (aka Bailout #3)  This program's primary objective also revolves around unfreezing credit. In order to unfreeze credit banks need to be supported and this plan addresses two of the three main issues facing banks; "troubled" assets and undercapitalization. Importantly, the plan also addresses securitized lending and mortgage modifications. The plan expands the TALF from $200 billion to $1 trillion in capacity and would allow AAA CMBS as collateral, in addition to AAA consumer related ABS.  The CMBS program will likely differ from the consumer focused facility but should follow the same general guidelines. Since refinanced CMBS appear to be eligible under this program, it could address a large portion of existing issuance as it is refinanced. There is also an initiative to form a Public Private Investment Fund on a scale of about $500 billion to purchase mortgage backed securities from banks. Securitization volumes have evaporated in recent months; therefore, a revived securitization market would be an important supplement to bank credit. Additionally, the FDIC has suggested that it may extend its bank debt guarantee program to 10 years and allow guarantees of secured debt, which could also address this issue. It is estimated that between $170 billion and $400 billion of commercial mortgages will mature in 2009 which will need to be refinanced.

The unprecedented $787 billion Stimulus Plan was signed by the President yesterday. While anything that will help our economy would appear to be worthwhile, we must consider the long term costs associated with this stimulus. Unfortunately, what started as an economic initiative became a political spending program with allocations for many things that make you scratch your head about the resultant long term stimulus. 38% of the funds are in the form of tax cuts, the majority of which is in the form of $400 credits for most taxpayers and exemptions from the alternative minimum tax. 24% is in the form of spending including infrastructure construction and modernization and 38% is in the form of aid. That is an enormous stimulus plan. But is this really "stimulus" at all? Yes, there is a lot of spending but the Wall Street Journal estimates that only 12% of the funds will be spent on initiatives which could be considered growth stimulus. These are dollars spent which will produce a multiplier effect and the projection of only 12%, is disheartening to say the least.

So let's look at how all of this intervention will affect employment. In January, US companies slashed nearly 600,000 jobs. We currently have an unemployment rate of 7.6% and it is projected, by most economists, to approach 9% at its peak. If we hit this threshold, another 3.6 million jobs will be lost. Initially, the projection for job growth from the stimulus plan was 4 million jobs. This estimate has been revised down to 3.5 million by the government while many economists believe the number will be significantly lower. Regardless of your assumptions, the unemployment rate will continue to rise; the only question is by how much. This will have a negative impact on real estate fundamentals and will have a negative effect on value.

The credit markets have started to loosen, albeit at a slow rate. The securitization enhancement aspects of the TALF and FSP should provide relief to the commercial mortgage market. The sheer volume of necessary refinancing is not possible without access to public capital and the new programs should make this possible.  The TARP, TALF and FSP have had effects on the credit markets, in general. The US Treasury securities market has rallied based upon disappointments with the results of bank bailouts as funds sought comfort in low risk government securities. Two-year swap spreads, a major gauge of credit risks, have widened. Negative sentiment due to the lack of detail on the FSP has boosted interest in recent Treasury auctions. The bid-to-cover ratio, a major gauge of demand, has been as high as 2.67, well above the 2.4 average over the last 10 auctions. Notwithstanding these facts, the programs should have a positive effect on commercial mortgage availability which will have a positive impact on property values.

Interest rates are a major concern. With all of these government programs the need to raise cash is enormous. This means that the government will be flooding the market with Treasuries, greatly increasing the supply. When the supply goes up, the price goes down and as the price goes down, the yields go up. This is not a good thing for real estate, particularly because existing floating rate debt is often tied to treasuries and the cost of new borrowing will increase. China and Japan have been significant buyers of our debt and we should not expect Treasuries to appeal to foreigners as near record low yields are limiting future capital gains from price appreciation. The low or negative carry of treasuries over sovereign debt elsewhere plus the long term downward trend of the dollar erodes the relative appeal and total return of treasuries to foreign holders. Notwithstanding this fact, treasury yields have been growing since November of 2008 based upon the fear of excess supply. The yield curve is steepening and there are concerns that congress has already raised the ceiling on the national debt to $12 trillion. This could bring our government debt to GDP ratio to about 85% in late 2009 / early 2010. The oversupply of treasuries is concerning given the downside risks to growth, further bank losses, yet another stimulus package and additional funds for bank recapitalization. We expect upward pressure on interest rates due to these factors which will have a negative effect on real estate values.

While all of this information can be disquieting, we should keep in mind the following fact: History has shown us that coming out of a deflationary period with low interest rates; we are likely to see above trend inflation and increased interest rates. In that type of environment, investors want to own hard assets and real estate is a great hard asset to own.

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