Finance and Real Estate Alert
January 2009
Contacts:
London
Andrew V. Petersen
+44.(0)20.7360.8291
andrew.petersen@klgates.com
New York
Anthony R.G. Nolan
212.536.4843
anthony.nolan@klgates.com
Boston
Gordon F. Peery
202.778.9066
gordon.peery@klgates.com
Charlotte
David H. Jones
704.331.7481
david.jones@klgates.com
Seattle
Shannon J. Skinner
206.370.7657
shannon.skinner@klgates.com
Dallas
Eugene F. Segrest
214.939.4991
gene.segrest@klgates.com
Washington, D.C.
Phillip J. Kardis II
202.778.9401
phillip.kardis@klgates.com
Berlin
Felix Greuner
+49.(0)30.220.029.100
felix.greuner@klgates.com
Hong Kong
Jasmine Chi Ping Ng
+1.85222303566
jasmine.ng@klgates.com
K&L Gates comprises approximately
1,700 lawyers in 28 offices located
in North America, Europe and Asia,
and represents capital markets
participants, entrepreneurs, growth
and middle market companies,
leading FORTUNE 100 and FTSE
100 global corporations and public
sector entities. For more information,
visit www.klgates.com.
www.klgates.com
Today’s International Real Estate Finance
and Investment Markets
Extracts from Liz Peace’s Seminar Introduction
Panel Chair, Liz Peace, Chief Executive, British Property Federation, introduced the
seminar and discussed the challenges facing the real estate finance markets.
I have been asked to just say a few words by way of introduction, I think because
I have written the introduction to the book, which I have to say, was the easy bit
when you actually look at the weight and the worth of the rest of the chapters in the
book. I have not read every one of them intimately yet, but it may take up a bit of
the Christmas holidays! But, as I say, I think I got the easy bit, but it was also a very
nice duty to perform, because I do think this book serves a very, very useful purpose
and will be very valuable in the times we have ahead. I will come back to that in a
moment.
I was going to just offer a few fairly general comments on the market and where we
are in general, and a few specific areas that I’m particularly interested in from the
perspective of the British Property Federation. I think we do have a crisis: we have seen
values fall, we have seen activity come to a virtual stop, and lending is at substantially
lower volumes than we have known before. However, the property industry is a fickle
industry; it always has been and it always will be. There is investment money out there,
there is equity out there. This will all come back. The only issue is: when will it get
better? People have been talking about 2011. I’d like to think it will be before then.
Our government certainly seems to think it’s going to be a sort of mere dip, and then
off we go again. I think they are possibly a little too optimistic, but I am an optimist
and it will come back. I don’t think it will be doom and gloom until 2011, and I hope
Trevor [Williams of Lloyds TSB] is going to be reasonably positive later on.
However, while we’ve got all that going on, there are some other things that we also
need to pay attention to. I think that all this is having an impact on the relationship
between the property industry and the property industry’s traditional clients. By that,
I mean their tenants. They maybe never used to call them clients, but they probably do
now, and they certainly should. I think the stresses in the market are leading to some
interesting changes in balance between the property owners and their clients (led by
the retailers of course, by certain well-known names that you have been reading about).
I think we are going to see a rebalancing in that relationship in these times of stress,
and I think it is actually a useful opportunity to wash out some of the problems that
have been causing us difficulties over the last few years. So, I think we are starting
to see significant change: in how our landlords and their clients actually handle the
issue of paying rent, how they handle the issue of service charges, how they handle the
issue of insurance. I think, at the end of this process, the relationship will actually be a
better one. The fact that it has been forced by the economy is perhaps a pity, but I think
Finance and Real Estate Alert
the outcome will be a better balanced relationship
and one in which we will have cemented what has
been a growing concentration on customer service
in the property industry, and I think that is hugely
important.
The second thing that’s going on while all this
economic chaos surrounds us is of course the whole
issue and debate on the issue of climate change and
sustainability. Now, lots of my members have said
to me, “Oh you haven’t got time to do this while
we’ve got this economic problem and this will go
away and the government is not really interested in
it anymore.” The answer is, the government is very,
very interested and actually most thinking people
are very interested in it, because none of us can
afford not to be. So, while we may be temporarily
diverted by interest rates, by business failures, by the
global crisis, the whole issue of climate change and
creating our product to respond to the demands of
climate change is absolutely not going to go away,
and we would do well to keep a note of that. In the
long-term, we have got to ensure that we, as a real
estate industry, actually do something with the new
buildings we build, and with the buildings we have
already got, and that we make our contribution to
making them as resource-efficient as possible, not
just energy, but total resource consumption. There
are great things being done throughout the industry,
not just in this country but abroad, in Australia and
Europe and in the United States. We are also going
to see an increase in drive from those people who
invest in our industry.
The third thing I think we ought to just bear in mind,
and it’s something I suppose we have sort of got to
put up with and probably cannot do a huge amount
about is, and this is very much a UK issue, though
our friends across the pond may have some sort of
help and guidance to give us, we are in probably
the last 18 months of the current government. The
last couple of years of a government that may well
not be in power after the next election is always
quite challenging, potentially quite dangerous.
Governments in that situation, and I lived through
the last years, I was in government at the time of the
Tory regime, and I think the parallels between the
last “major” years and where we are now are quite
significant. We are now witnessing a government
driven into hyperactivity but not necessarily in any
particular direction. There almost seems to be a great
urge to rush around and do something, anything to
get the votes, to make sure people vote for us, and
this leads to a huge amount of ill-coordinated action.
It also leads to what I would view as a “smash and
grab” approach to finance, finding ways of raising
money.
The particular issue that you will have noticed that
we have been somewhat vocal on is the subject of
the removal of empty property rate relief, which I
think was a bad idea when it was first announced
by Gordon Brown and became a much, much worse
idea over the intervening years when it was actually
implemented in April 2008. I think it is one we
should still fight against. A little bit of it was restored
at the pre-budget report, £185 million out of about
£900 million, so they gave back about 20%, but
very much directed to the small property owner or
property occupier, those with a rateable value of
£15,000, which by my reckoning is probably about
the value of a cigarette kiosk down on the corner of
the street. So, I think we should keep fighting this
sort of iniquitous tax imposition, because that is
what it is. Also, Andrew [Petersen of K&L Gates]
said I was allowed to mention our petition on the
No. 10 Downing Street website, which if you have
not already clicked on it, please do so. We are up to
5,000; we would like to get to 10,000 by Christmas,
which would put us in the top five petitions on the
website, so just a little thing you could all go out and
do, and tell all your friends to do, as well.
So, that is the sort of climate in which I am currently
operating, and one thing it means is there is a lot
for the British Property Federation to do in terms
of campaigning and lobbying. But, looking at this
more broadly, and looking at tonight’s event of
course, which is about a global credit crisis in real
estate. I am driven back to that hackneyed old quote
January 2009
Finance and Real Estate Alert
about “no man is an island.” In this particular case,
no industry is an island, and no national industry
is an island. We are all in this together, this is a
global issue, and what we certainly need is global
understanding of where we are going. We all,
both individually and collectively, globally need
to avoid knee-jerk reaction, but on the other hand,
I think we have to look at where collective action
is valuable and necessary. I also think we have to
be very careful about what we say, where we say it
and picking our fights. There is no point whinging
everywhere. You know governments get pretty
sick of an industry that just carries on whinging in
every place and in every jurisdiction, so we have to
pick our fights, and this is where I think the book,
which you have all seen, has actually turned out to
be a very timely and apt moment for a publication
like this, which of course is truly global. It is sort
of pulling together the threads of real estate across
the globe. It is there to inform and hopefully inform
sensible, collective views and collective action, and
I would very much like to congratulate K&L Gates
for initiating this project, and I hope it is extremely
successful.
Now, on to the seminar. We are going to hear from
three people across the pond. First of all, Peter
Kretzmer, a Senior Economist at Bank of America,
is going to begin the seminar by discussing the
underlying dynamics of the ongoing credit crisis
and its effects on the U.S. economy. He is also
going to consider the new U.S. administration
stimulus and fiscal agenda. Then, we are going to
move on to Richard Shea; he is President and COO
of Anthracite Capital, and a Managing Director
of BlackRock Inc., and he is going to discuss the
commercial environment facing the global real estate
structured finance industry, and he is also going to
look at investment strategy and the dislocation of
the bid/offer price. Then, we are going to come
back to London and Trevor Williams, the Chief
Economist from Lloyds TSB Corporate. He is
going to discuss the impact of globalization and the
underlying dynamics of the ongoing credit crisis
and how it affects the UK, as well as considering
the economic environment facing the UK real estate
structured finance and investment market in the
future. Then finally, back out to America, Daniel
Crowley (who is one of the home team), partner of
K&L Gates in Washington, D.C. He is going to give
us some predictions on the U.S. global regulatory
environment going forward and how the Obama
transition team are going to deal with this. I think it
will be interesting to get a whole analytical view of
just how well somebody thinks the President-elect
is going to handle all this.
I am hugely flattered to have had the opportunity
to talk to you. I was also very pleased to have the
opportunity to support the book, and I wish that
well, and I wish you a very interesting debate this
evening.
Thank you very much.
Extracts from Peter E. Kretzmer’s
Presentation: The Impact of the Credit
Crisis on the U.S. Economy
Peter E. Kretzmer, Senior Economist, Bank of
America, New York, discussed the impact of the
credit crisis on the U.S. economy, including a
preview of the stimulus and fiscal agenda of the
incoming Obama administration.
The focus today is on determining the severity of the
current recession. Declining profits combined with
consumer spending are making way for a substantial
ongoing decline in business investment spending.
Unfortunately, this decline will get much worse
over the next couple of quarters as we’ll see doubledigit decline in the next quarters in equipment and
software spending. The current credit problems
appear to be quite persistent, but various public
policy programs are succeeding. We have begun to
turn the corner.
As far as gross domestic product and other key
indicators, for the year that is concluding, when we
look at 2008, we see GDP has been growing on net
until this quarter [4Q2008]. The first quarter showed
January 2009
Finance and Real Estate Alert
a small increase, the second a better increase and the
third a small dip. The housing market is not a pretty
picture. This is the most extreme bubble we’ve seen
in terms of the heights of the housing market. We
see great declines now that are close to previous
bottoms. We’ll probably overshoot before we find a
bottom. Energy costs also have risen, and they play
a big part in this crisis.
The LIBOR spread is a sign of how bad the
dysfunction in the credit markets became in the last
month or two in 2008, in that we have seen historical
highs in LIBOR spreads. There is evidence that the
direct injection of liquidity by the U.S. Treasury
seems to be having some effect that will likely
spread over time. Asset-backed bond yields remain
at highs relative to treasuries. Unemployment in the
United States may rise to about 8 percent or more
by the middle of next year. Consumer spending in
the States declined by 4 percent last quarter, and
an equally bad decline is expected for 4Q2008.
Consumer spending will continue to decline through
early 2009.
As far as the housing situation in the United States,
the trend in homeownership for the last 25 years
was reasonably stable but then spiked as a result
of public policy initiatives, credit availability and
general economic conditions. The housing bubble
was generated by public policy as well as the Federal
Reserve. To some degree, the homeownership
rate needs to adjust in a negative direction before
deleveraging will be over. We had a big increase
in mortgage debt as a fraction of GDP in the early
part of the decade. We need to stabilize that. The
credit recovery is incomplete without home prices
stabilizing no matter how well those stimulus
programs do. As long as home prices decline, the
raw material for the crisis continues to be generated
in the housing market.
­­­­­­­­­­­­
Extracts from Richard Shea’s Presentation:
The Commercial Environment Facing the
Global Real Estate Structured Finance and
Investment Markets
Richard Shea, President & COO, Anthracite Capital
and Managing Director, BlackRock, New York
spoke about the commercial environment facing the
global real estate structured finance and investment
markets, including a discussion on future investment
strategy.
Hello everybody. I want to thank K&L Gates for
this opportunity to bring people together in this
very difficult environment and economy for all of
us. I know we are all engaged in some aspect of
the capital markets and the broader economy. I
think it’s a very positive development that we bring
people together to talk about the solution. Rather
than continuing to focus on what happened in the
past, to look to the future and make sure that things
going forward are done properly and that we can
recover from this quickly and efficiently.
What I want to talk about is, from a broad-brush
viewpoint, what’s going on from the perspective of
someone who is running a specialty finance company
that is in the commercial real estate markets. Many
of you I’ve met before; some of you will know what
Anthracite Capital does. We are a finance company
in the commercial real estate space. We were a
prolific issuer of CDOs. We do take commercial
real estate credit risks, so we essentially are, to put
it bluntly, at the eye of this storm. It is something
that has affected us for about 18 months now. I just
want to share with you, from my perspective, what
I’ve seen on the inside, and hopefully foster some
additional discussion, throw out a couple of ideas,
and let us all think about it. Also, have these ideas
percolate, so that as we continue to work together in
the private sector, as well as much more within the
public sector. We all have some good coherent and
good straightforward ideas to help bring a healing to
this market and make sure we can all be a part of the
solution. As I said, I don’t want to continue to worry
about what happened in the past. The only thing that
I want to touch on briefly about the past is that we
January 2009
Finance and Real Estate Alert
are clearly in a credit panic that continues to go on
and on and on. One of the things that I have noticed,
that I think is a very important part of why we want
to be here today to share this idea, is that it appears
that, from my perspective having been running
Anthracite Capital for more than 10 years now and
been in the finance industry for more than 20, one
of the most significant and contagious diseases
known to mankind seems to be credit panic. What
is the underlying cause of credit panic? That seems
from my perspective to be a lack of information.
If people understood what [EQL 100 2005 class
C J] actually was and had a very good handle on
what the underlying collateral was in that context,
it wouldn’t be so much of a who knows what and
a who doesn’t want to move forward and continue
doing transactions in this market, because people,
first of all, are concerned about getting the proper
information. I know this has been an issue to all
developing markets that have been developing over
the last 7 years, a standardization of information for
a CMBS or ABS package, I think, continues to be
crucial and has never been more so than it is today.
I think markets on the European side, as well as the
U.S. side, can always be much better at being able
to provide information.
The second aspect, of being able to provide
information, is making sure that, if you are an
investor in these sectors, you have the ability and
the expertise to evaluate that information effectively.
I think that has happened to a large degree. People
have actually gone out there, bought some of these
things with the fancy letters and the acronyms on
them with underlying collateral that they just didn’t
quite understand, and relied on other acronyms,
AAA, AA and A, etc., to really give them guidance
as to what the credit quality of the cash was on this.
I think what we need to learn from this, and to make
part of the solution going forward, is making sure
that people understand how to do and who is doing
the underlying fundamental credit research, so that
people will understand what is happening, so that
they get the information and they make professional
judgements about it and understand that markets go
up and markets go down. They always have, but
being able to make informed decisions and working
with people who can help you make those informed
decisions, I think, is going to continue to be the key
on all sides of the capital markets.
I think seeing things like opportunities in the CMBS
market, especially in the last several weeks, has
gotten to a point where it’s downright irrational. I
think that people’s understanding of the valuations,
or their lack of understanding of the valuations, of
any kind of asset-backed package, especially in the
commercial real estate world, has really been led a
little bit too emphatically by what happened in the
sub-prime market. Clearly, that’s an example of
bad credit underwriting or no credit underwriting
whatsoever, and people just assume that if that
happened in this segment of the market it’s going
to happen in the entire housing market, and it’s
going to happen therefore in commercial real estate
and that it’s therefore going to happen with credit
cards and therefore banks etc., etc., all the way
to the point where we’ve come in the last several
months, whereby money market funds cannot
function. The short end of the curve, which is the
lifeblood of our industry, cannot function properly,
and you need people to understand what kind of
risks they’re taking and not worrying about whether
or not this particular “XYZ 2005 - whatever” is a
concern [to them] but to Citibank or any financial
institution. What do they have as underlying assets,
and what kind of risks are they taking, and who is
going to be able to help them understand the risks
they are taking? You’ve got to make sure that that
information is there, and the ability to understand
what that information is all about has to be returned
to the market.
So, the two points that I want to continue
emphasizing are that the trustees and the asset
managers and the collateral managers of these
deals need to understand how crucial it is to get
information from your hands out into the world. So
that investors and their advisors can understand and
help them understand exactly what they have, what
risks they’re taking and be able to make intelligent
January 2009
Finance and Real Estate Alert
decisions about what’s being done going forward.
They may perform very well, or they may perform
very poorly, but at least people understand what
risks they’re taking, therefore, how to hedge, how
to communicate the risk they’re taking. If everyone
understands, you have much more of a dampened
volatility sense, and you don’t have the wild swings
that we have been subjected to going forward.
Specifically, in terms of running a finance company
like Anthracite or BlackRock, I think what you need
to do is make sure that you have the right operating
platform, and anybody who invests in that particular
operating platform has the opportunity to ask the
questions and evaluate that operating platform. For
a long time we saw companies thrown together
saying, “OK, this is great I can buy BBBs at 300
over, and I can securitize on the CDO Market at 100
over, that’s great.” That was about all the analysis
they had, they would put these together and then
would go out and get these things done. What you
really need to have in an investment platform is a
very robust operating platform. As an investor, for
those of you that are on the buyer side who may not
have a particular commercial real estate operating
platform that is as robust as an entity that has the
ability to operate in this market, as Anthracite has
for more than 10 years. But, you have to be able to
make assessments as to what kind of investments
you do want to make, so you want to make sure that
if you are taking a significant amount of credit risk,
that may work perfectly in a very broad portfolio,
that has a little bit of everything in it. But, you
want to make sure you are working with people
that understand how important and how crucial
information is and that they have a robust operating
platform that’s not just a simple fund that’s been put
together to manage in that interest margin. What you
are doing here is managing credit risk, and what we
have done, and a lot of our competitors have done,
is taken on some credit risk that obviously has not
performed very well on a pricing basis. But, on an
operating basis, on a pure credit-performing basis,
it has not done nearly as poorly as say the sub-prime
residential market. So, what you want to do is make
sure that you understand that and that then feeds
into a reasonable conclusion that there are highly
significant opportunities in certain niches of the
marketplace.
So, I think, as things evolve, you are not going to
see a reduction of what’s going on in the commercial
finance markets, I think you’re going to see an
increase, but I think that the way you are going to
see it is much smarter. People are going to be looking
for the platforms that do have a robust operating
capability to be able to get in there and evaluate,
assess risk, take the risks that they think are the
most prudent ones, utilizing a highly experienced
group of professionals that have been gathered on
that particular platform, and to be able to underwrite
assets very effectively. Once again, I keep saying
it, communicating and over-communicating very
effectively, as well. So, I think that that is going to
be a very important aspect of it, because real estate
finance, let’s face it, is just not going to go away. It is
a very crucial part of what is going on in the capital
markets and once people get comfortable once again
with fundamental underlying credit risk as to how
to do it, who to go to and who to work with to be
able to do that, you’ll see things slowly start to move
back to whatever “normal” is going to be over the
next several years.
I want to say the same thing about capital structure.
Companies like Anthracite Capital live or die based
on capital structure. The point that I made a minute
ago, that the assets in many commercial real estate
below investment grade investment platforms have
actually performed reasonably well. The length of
the recession will, of course, affect how long real
estate credit performance will be affected, but a
very key aspect of how these companies operate is
capital structure. I want to make sure that everybody
understands that aspect of it, too, because what is
exacerbating this particular problem is that many
entities in this space had shorter liabilities and
longer dated assets. It’s a classic problem. We have
seen that be a problem in so many different cycles
from the ‘80s to the ‘90s. I remember 1998, when
we first went public with Anthracite, we witnessed
what happened with the Russian default and longJanuary 2009
Finance and Real Estate Alert
term capital, and the liability structure just wasn’t
advanced enough yet for these types of entities to
maintain themselves through these difficult markets.
However, even back then, credit performance on
the underlying assets was very good. We did not
see massive delinquencies like we saw back in the
early 1990s. To the contrary, we saw reasonably well
underwritten collateral that people just didn’t quite
understand and were not able to finance properly.
When you are looking at investments to be made,
you of course, want to look at the asset side, but
also the liability side, because that is a crucial part
of being able to withstand up-and-down markets
like we have here. Certainly the development of the
CDO technology was very important in developing
what was happening in the asset-backed space, not
just commercial real estate. From my perspective,
while I think that was a very effective tool, you
do not see these investors stepping up any longer
because those investors were not the sort of robust
type that were able to do the underlying analysis and
relied entirely too much on the rating agencies.
I want to say also, a very important point is that I
don’t think the securitized market, or even the CDO
market, if I can be so bold as to say the CDO market,
is technically dead. I think it is a good product. I
think it is a very effective tool for spreading risk
around. I think it is just something that people need
to be able to evaluate effectively. Don’t just rely on
the fact that it says AAA. Don’t simply rely on the
fact that this AAA has 30% subordination under
it. That is not enough information; what you need
to do is understand the underlying collateral. You
need to understand as a macro aspect of what that
underlying capital is affected by, and of course first
and foremost, you need to understand what that
issuer does and how they do it. Because, even if
you have 30% subordination, you can be affected
to some extent by credit issues, and certainly if you
are at the bottom of the stack, where we tend to be
very active, that is also clearly going to be a very
important aspect of what you do.
So, while I will not come out and say that you will
see CDOs like we used to see, they are going to
be retooled. They are simply secured vehicles that
provide secured interest in an underlying group
of assets. Now you may not see credit-tranching
of CDOs in the future; you may see participations
where a couple of opportunistic hedge funds that do
understand the risks and get underneath the aspects
of what these things do, will continue to step up
and look at this as opportunities, because you are
seeing pricing to a point where as the assets become
very attractive the liability structure becomes very
attractive too. So, as a company, if we can invest in
something on a risk-adjusted basis or a loss-adjusted
basis that yields say 25-30% and we can issue some
type of secured CDO type product or an SPE that is
secured by these underlying instruments, you could
issue that at 20-25%. Once you focus on the spread
between the liability cost and the asset and what it is
earning on a loss-adjusted basis, there could be some
very compelling transactions out there.
We do see a lot of sophisticated hedge funds raising
a lot of money right now, because they are looking
at AAA CMBS, which have 30% subordination
levels underneath them, and a very diverse pool of
U.S. collateral underneath them. They are trading at
1600 over swaps, which to me is insane, so unless
you think those are properly priced, which if that’s
the case, what you should probably be buying is
canned food and portable water, you have got to
think that there is an opportunity here. Where there
is an opportunity, there’s an innovation, and where
there’s an innovation, there is usually a lot of smart
people getting together, like here today, and being
able to exchange ideas and looking for where the
opportunities are, and making sure that we have the
ability to be able to evaluate and understand exactly
what is going on, and I think that is what is going to
help us navigate through a very difficult market.
In Washington, the regulatory bodies are going to
continue to try and make it all look good, so that
they can all get re-elected in the next 2, 4 or 6 years,
whatever they happen to be looking at, but we have
to live with this day-in-and-day-out, and we have to
understand that the underlying fundamental problem
is making sure people understand all aspects of
January 2009
Finance and Real Estate Alert
what’s going on here. If you don’t have that in your
own particular shop, but you are still looking to
take exposure in something like commercial real
estate, you should be taking that exposure with a
partner that you can work with that has experience
and understands not only how to evaluate but how
to communicate what they are evaluating.
I think that all issues are going to have to come
together whether it be regulatory issues or through
trade groups like the CMSA or informal gatherings
like the one we are doing here today. I think that
that is what we are going to focus on. I would ask
each and every one of you to get out there and share
those ideas, and make sure that people understand
that the underlying problem here appears to be a
lack of information. A lack of information creates
insecurity, and insecurity leads to panic on both
sides of the balance sheet. You just have to be able
to understand how to get that information, and make
sure you can evaluate that information. If you are
going to be taking that risk, work with people who
can understand how to take that risk and who can
work with you to continue forward with that. That,
I think, is what is going to get us out of the current
malaise that we are in. I’m not an economist, so I’m
not here to tell you how long this is going to take,
but I think if we continue to work together like this,
through seminars like this, it will be shorter rather
than longer.
So, as a conclusion, I will just leave you with
those thoughts and ask all of you to keep the line
of communication open. You can reach my cell,
and I’m sure K&L Gates is available to all of you,
and let’s continue working together. We are not
looking to create a trade industry here, but I do
think that talking to each other is going to be the
solution to this kind of problem, so I want to thank
everybody for their attention and their time today,
and especially thank K&L Gates for putting this
together and then turn it over, to, I guess it goes
back to London.
Extracts from Trevor Williams’ Presentation:
The Impact of Globalization on the UK
Economy and the Effects of the Credit Crisis
on the UK Finance Markets
Trevor Williams, Chief Economist, Lloyds TSB
Corporate Markets, discussed the impact of
globalization on the UK economy and interim and
long-term effects of the credit crisis on the UK
markets.
This is a classic crisis caused by borrowing shortterm in liquid markets and lending long-term in
illiquid markets. Anyone who did that and is in
long-term illiquid assets and now wants access to
short-term markets which are no longer liquid, then
they are in trouble, and that explains so much of
why so many firms have gone under. This crisis
has not been one year in the making, it has been
about 15 years in the making and a lot of it is to
do with three key things: (1) the changing nature
of the global economy; (2) the way that that global
economy interacted with the big surpluses that were
being built up and how that was being intermediated
through the world economy; (3) and then ultimately
the policy response.
Government balance sheets are basically expanding
to take on the risk that private sector balance
sheets can no longer handle…the resolution to this
unfortunately means…it has to be done, because
this will, otherwise, be a long-lasting and potential
deep recession. This is a different environment
[to the 1930s], partly because we do have open
markets, and we have so many countries involved
in international trade and so many have benefited
from it that no one is going to draw back from it.
We are certainly on the verge of a big change in the
way that financial markets operate, particularly in
the West, because we have seen a shift of power
away from those financial institutions to those in
the emerging markets, particularly those that are
creating sovereign wealth funds to hold some of the
wealth that they were creating.
January 2009
Finance and Real Estate Alert
The way that this will be resolved is going to have
to involve a using of the market to find the price for
the troubled assets. So the assets which have caused
this crisis were at the start in the United States in its
real estate market, and I think the resolution for this
will come from those markets, as well and will come
certainly from the U.S.
Paulson’s plan to create the TARP program, to create
a market in these, was absolutely the right thing.
Abandoning it was a disaster, and I don’t think that
they can continue to do that. I think there needs
to be a market created through auctions possibly,
ultimately backed by government, but ultimately
must involve the private sector, to find a floor for
these prices and for these assets, and therefore for
trading to take place. Then, I think they will come
off balance sheets, and then we will start to see a
renewed lending in credit markets. That is going
to take maybe a year or so, possibly less. It will
depend on how quickly the administration being put
together in the United States starts to create a floor
for these assets. Once that floor is created, and prices
begin to be realized for them, then, I think, we will
begin to see the end of the credit crisis.
For the real economy, the end of the crisis will
involve lots of government money being spent in
backing markets for which there is no longer a desire
on the part of participants to be involved in. So, the
lessons from the credit crisis are long and will require
quite a while to be resolved. Rating institutions
failed, liquidity management arrangements failed,
understanding of risk failed. I am afraid that all that
could possibly go wrong in these new markets has
gone wrong, and it’s going to take a long time for
that to be sorted out. But, it doesn’t mean that we
won’t move on from it; we will move on from it
when the markets which are on the sidelines waiting
to buy these assets, when they feel the prices are low
enough become activated by government finding
a floor, by beginning to auction off these troubled
products.
I think that economic recovery actually will take
place over the next 18 months. A positive thought,
and I am told that those who have positive thoughts
tend to live longer and enjoy life more. The way to
think about this is that we are already beginning to
see governments spending huge amounts of public
money. We are already beginning to see exceptionally
low interest rates. Those always work.
I think that the analysis done by the IMF of 18 richcountry recessions over the last 100 years shows that
in two years, 13 of those recessions are over, and in
the third year, the other remaining five recessions
are over. So, I think the good news is that with the
timing of the U.S. recession starting in December
of last year, I am pretty sure that we should be out
of recession in the UK and the United States by the
second half of next year.
The other part of the good news, I think, is that
global growth will remain positive, that the axis of
that has shifted to the emerging markets, and I think
that that, too, is a big change that we are seeing in
global development. That won’t change because
we have got 1.3 billion people in China, 1.1 billion
people in India, and we have got an assortment of
other large populations being actively involved in
international trade. That means that the space being
created for financial flows is huge, and if you think
of the size of the growth in global asset markets, if
you think of the size of insurance markets that are
going to develop, there is absolutely no way but that
Western economies, particularly like the U.S., will
do anything but benefit from this.
I think that in the medium term, the trend for the
UK economy has got to be able to shift away from
debt growth, which has been the decade that we
have seen, particularly consumer led growth. A
decade ago household debt was about 100% of
annual disposable income; it is now 170% of annual
disposable income. You can’t continue to expand
through debt anymore. It’s got to be expansion led
by the corporate sector, led by investment spending.
The profile for that involves, I am afraid, challenges
for the UK in terms of the way that its economy
is structured. But the interesting point about the
flows into real estate, I think, is it depends on local
markets. All housing markets are local, and this one
is no different.
January 2009
Finance and Real Estate Alert
The unique feature of the UK real estate sector is
that, first of all, there has been no overbuilding
of property here. The lack of house building from
the local authorities sector ever since the Thatcher
revolution has gradually built up, and if you look
at the growth in household formation relative to
growth in housing supply in the UK, it has been
grossly inadequate supply, and that is what underpins
prices here. So, I think the UK property market
will recover and will recover quite strongly once it
occurs. And, as I said, I suspect that recovery will
likely take place toward the back end of next year
and into 2010, and then, I think, we will then see
aggressive increases in real estate prices.
The UK is also a global market for commercial
investments into property, and I suspect there,
too, that the UK will see quite a strong recovery
once it takes place. So, I am not at all worried
and pessimistic about the long-term prognosis for
investment flows globally, because as I said, markets
are likely to remain open. It needs two more things
to take place. One is an agreement on agriculture
globally and that will pave the way for agreement
on services, which will benefit the UK hugely. So,
I think that there are things to be optimistic about,
absolutely, medium term.
Extracts from Daniel F. C. Crowley’s
Presentation: Where TARP is Likely to Head
Under the New U.S. Government
Daniel Crowley, Public Policy Partner, K&L Gates
LLP, Washington, D.C., discussed where TARP is
likely to head under the new government in January,
including predictions on the U.S./global regulatory
environment and how the Obama transition team
will deal with future regulation.
The U.S. federal government’s policy response to
the credit crisis can generally be boiled down to
three basic components. First, the government is
attempting to address private sector deleveraging
and attempting to ameliorate the impact of that
deleveraging, primarily through the use of public
debt. Second, there is an attempt to address
systemic risk; over the next 18 months or so, the
U.S. Congress may consider legislation in this
regard. Third, there is a strong desire to increase
transparency in the financial system, particularly
where it does not currently exist.
The government’s response to the credit crisis
has included a host of key federal initiatives. The
U.S. Congress’ most significant response to the
credit crisis was to enact the Emergency Economic
Stabilization Act of 2008 (EESA), which created the
$700 billion Troubled Asset Relief Program (TARP).
Treasury has committed the first $350 billion tranche
of the TARP funds. Initially, TARP funds were used
to purchase preferred stock in banking institutions,
including as part of the massive Citigroup bailout.
As the program has matured, Treasury and the
Federal Reserve have become increasingly inventive
in addressing the continuing credit market crisis.
For example, Treasury recently allocated $20
billion in TARP funds to back a $200 billion Term
Asset-Backed Securities Loan Facility established
by the Federal Reserve to increase liquidity in the
consumer credit market. The remaining $350 billion
is subject to Congressional disapproval by joint
resolution enacted within 15 calendar days after
Treasury certifies its intention to use those funds.
Outgoing Treasury Secretary Paulson has seemingly
been reluctant to utilize this second tranche because
of considerable Legislative Branch push back.
There are two basic things that Congress does;
frankly, there are only two things that Congress
does. They engage in oversight, and they pass
legislation. In terms of oversight, Congress has held
an extraordinary number of hearings on the credit
crisis; I stopped counting at 24. In addition, Secretary
Paulson’s initial three-page proposal to Congress
seemed almost calculated to provoke exactly the
kind of response it got. In enacting EESA, Congress
added four additional layers of oversight, including
the Congressional Oversight Panel, a new executive
branch agency, a new inspector general, and the
Government Accountability Office. These hearings
are also setting the stage for comprehensive reform
legislation like we’ve never seen before. Most of
the financial services laws in the United States date
January 2009
Finance and Real Estate Alert
back between 1933 and 1940; Congress is likely to
revisit all of them in the next 16 to 18 months.
The regulatory reform agenda is unprecedented.
There has been much discussion of the need for a
“systemic risk regulator” to more effectively regulate
“dark pools” of capital, such as hedge funds, private
equity funds and other investment vehicles that
have the potential to impact the markets. As an
added layer of complexity, regulatory reforms are
increasingly taking on an international dimension.
In November, the G-20 ministers agreed to begin
work on a coordinated response to the financial
crisis.
A number of other areas are ripe for reform efforts.
With respect to over-the-counter trading, there
are already proposals to centralize clearing of
credit default swaps and other instruments. This
is presumably an effort to pre-empt what would
otherwise be inevitable legislation to compel more
centralized standardization trading of derivatives.
Although credit rating agencies have largely escaped
vilification up to this point, Congress will likely
revisit the pay-for-rating system. The movement
from defined benefit plans to defined contribution
plans has transferred the risk of market volatility
from employers to pension holders and is likely to
provoke a backlash from Congress. There has also
been movement toward an optional federal charter
for insurance companies; however, the specifics,
such as which federal agency will be responsible
for the program, will be developed in the coming
months. Credit card issuers are also likely to be
targeted for raising consumer and retailer rates.
Finally, Congress will be forced to grapple with
federal tax issues, as the Bush tax cuts are set to
expire at the end of 2010.
The environment has dramatically changed in
Washington, D.C. Even before the election, the
pendulum was shifting back toward re-regulation.
The election has resulted in a unified activist
government with an agenda and what is believed to
be a mandate to create fundamental change. And,
they will.
K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the U.S., in Berlin, in Beijing (K&L Gates LLP Beijing Representative Office), and in Shanghai (K&L Gates LLP
Shanghai Representative Office); a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining our London
and Paris offices; a Taiwan general partnership (K&L Gates) which practices from our Taipei office; and a Hong Kong general partnership (K&L
Gates, Solicitors) which practices from our Hong Kong office. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices
are located. A list of the partners in each entity is available for inspection at any K&L Gates office.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used
or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
©2009 K&L Gates LLP. All Rights Reserved.
January 2009