The Lehman Brothers bankruptcy in September 2008 was the culmination of a chain of events that brought markets worldwide to their knees, prompting governments and central banks to institute unprecedented measures (TARP, Massive Stimulus, Quantitative Easing, Regulation and then Deregulation). The commercial real estate market was devastated: credit froze, property values plunged, tenants failed or renegotiated leases, vacancy spiked, transactions of all types virtually stopped (buying/selling, leasing, refinancing). As many of us recall, the only financing available for years was government (Fannie, Freddie, SBA). But underwriting was very conservative and spreads were wide, private lenders (hard money at big rates for conservative transactions). The main culprit of the crash was excesses in the residential financing market: ridiculously loose underwriting standards allowing unqualified buyers to chase hyper inflated home prices and their mortgages to be packaged, insured and sold as investment grade securities. Commercial lending had its own issues with excess as the typical 2006-2008 CMBS loan structure was 80% LTV (or more), 10 years interest only, sub 100 spreads, and income included some pro-forma aspects (future lease up). Markets slowly responded: 2010 saw the first post-crash CMBS activity (with much more stringent underwriting), regular bank lending came back in 2011, construction lending picked up in 2012-2013.
As of today, all sectors of the Capital Markets are extremely active and liquid. Unregulated debt funds (also known as hedge funds, private equity) are very active in the commercial real estate lending markets. CMBS is back and thankfully underwriting has been restrained compared to pre-crash levels. New regulations involving risk retention and originator reps have winnowed down the number of originators to well capitalized banks and funds. Residential lending standards have tightened, but the general housing market is approaching bubble levels (mostly due to supply/demand imbalances, not pre-crash style over building). The hope is that when the next downturn in prices comes, the increased equity required for borrowers will not lead to a contagion in foreclosures. The “Too Big to Fail” Banks are now bigger and more regulated (but the political appetite for bailouts is gone, so they better not fail). The worldwide central banks (Federal Reserve, ECB, Bank of Japan, Bank of Britain) are trying to bring the world back to the “old normal” after years of stimulus. Massive liquidity has not led to inflation yet. The questions are: where will the next crisis come from and will the financial system be able to survive it without a 2008 style collapse?
“Turmoil on Wall Street and in the credit markets as Lehman Brothers declares bankruptcy, Merrill Lynch has been sold, AIG has been propped up by the US Government”. To read the full FINfacts “Market Update” from September 17, 2008 click here. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners