Monday, March 17, 2008


The commercial real estate market is strong. This market is enjoying rising rents and decreasing vacancies; what is not to like? On the other hand, new construction has slowed. There are at least two reasons, one is to wait to see if there really is going to be a tough recession. The second is that with stock prices on sale, the pace of spending money on share buybacks has once again quickened. It is silly to build a new business if you can buy shares in your existing business at a "below the mean" price. Even so, high employment around the globe and the low dollar implies that US businesses should expand to meet high profit demand.

Share buy backs are strong and broker dealers and banks have just been granted expanded access to the Fed. To understand the situation, assume for a moment that the Fed chairman called you yesterday and said that he would give you cash at 3.25% in exchange for holding the deed to your house. Say your house is valued at $300,000 and you are aware of a foreclosure close down the street available at the deeply discounted price of $200,000. After using $200,000 of the cash to buy the home, you could then take the deed to the FOMC and get another $200,000 in cash. The aggressive person who had such a deal available would soon own a few dozen houses, 100% financed by the FOMC at 3.25%. A less aggressive person would buy one house at $200,000 and offer to resell it for a higher price at a higher interest rate. A lot of people might be attracted to a $300,000 house priced at $250,000 with 5% financing available. Again, once this less aggressive investor has "flipped" the first home, he would be in the market to submit the deed to raise the money to do another. This all sounds crazy but the FOMC has basically given banks and broker-dealers the power to buy a lot of $300,000 paper that is selling for only $200,000. Tomorrow, when the FOMC cuts the rate, say to 2.5%, the discounted paper will be even more attractive.

Those who are expecting a collapse in the housing market from here do not appreciate the power of the FOMC. The FOMC has been slow to act, it should have cut rates hard back in August or at least by last October. Instead, the FOMC played along with "taking out one of the big boys". Now the congress and the next president will have all the backing it needs for regulation reform of the banking and brokerage system. Between now and them, the market will clear. The FOMC has access to all the money needed to stop the forced selling of assets. As of yesterday, the FOMC made a huge chunk of money available to broker-dealers and banks. There are still a lot of hedge funds and others caught in the "sub-prime mess" but the banks and broker-dealers have the cash to buy out the weak ones.

The markets are still going to be volatile, but the situation is different today than it was on Friday. After the market crashed on October 19, 1987, the FOMC immediately flung open the discount window. Within a couple of weeks the market had not only stabilized but it had started its next big climb. The wall of worry has grown tall in this cycle. The market will climb this wall of worry, including the political and geo-political concerns. No one can call tops or bottoms, but many buy indicators are at levels seldom seen if ever.

My guess at GNP is about 1.5% this quarter and 4% by the third quarter. No recession. Tough markets. Fear. Confusion. World wide strength. Strong US exports. Strong commercial real estate. Temporary slow down.

Buy the Russel Small Cap Value Index. Small banks are once again enjoying a positive yield curve. The FOMC will probably cut short rates by at least 50 basis points tomorrow. Lending is once again a profitable business.