Market Turmoil

Wednesday, September 17, 2008 - By Gate Arty

The recent turmoil in the financial markets has been nothing but staggering.  Storied institutions such as Bear Stearns and Lehman Brothers are essentially gone. Merrill Lynch was scooped up by Bank of America for a song. The US government has come into rescue Fannie Mae and Freddie Mac, but it figured at some point there is a risk of doing too much bailout.

What does all this mean for the real estate industry?

Get ready for more wild rides.  Now that equity markets have proven an unsafe and risky investment, more and more real estate investors will be coming out to play.  And now that financial institutions are filing for bankruptcy, this will setup even greater liquidation among those real estate assets.  

Which means that more wealth will be created for some individuals now than ever before, and frankly this type of wealth creating wasn't even possible when things were considered "good."  Sure things are plain awful out there for some investors, but for others this is the opportunity that comes around only once a decade, or perhaps a century.  The only thing that resembles this is the S&L crisis in the 1980s, where 747 savings and loan associations failed.  

Will there be more government subsidized bailouts? Many are asking why Lehman Brothers was not rescued. Well, enter the economic concept of moral hazard.  

Let me ask you a question.  Have you ever bought rental car insurance?  You know, after you pay for it you feel a little free when your driving someone else's car, right?  I know with rental cars I love to take the corners sharper, gun the engine, and basically get “my monies worth,” knowing full well that if I bang up the car, I've got nothing to lose (other than my health if I bang it up too much!).  Now please don't forward this e-mail to Avis and get me on their blacklist!

Same concept for the government.  They bailed out Bear Stearns.  They bailed out Fannie Mae and Freddie Mac.  But if they were to bail out yet another financial institution, particularly one that we can all live without, there would be a sense of carelessness that would encourage future speculators.

So what's the story here?  In this case, the government wants them not to intentionally cut off their toes, but rather if they see gangrene they go to the hospital rather than awaiting their financial windfall.  Lehman Brothers financial woes, due in large part to bad bets on real estate and its related securities, means that the economy is frankly in worse shape than many think.  There will be more collateral damage.  Lehman's unwinding will cause damage to other financial institutions as inevitably the interest rate swaps (which the Wall Street Journal reported may run into the millions) and other financial instruments affect other institutions, too.

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