Lender Groupthink

Here’s an excerpt from Michael Skapinker’s opinion piece in the Financial Times, “Diversity Fails to End Boardroom Groupthink”:

Disagreeing with the company’s direction is hard enough. Doing so when an entire industry is going in the same direction is harder still. It is not just boards that suffer from groupthink; entire sectors do. The banking industry did.

Any investment banking chief executive who had listened to a director’s warning that complex financial instruments spelt trouble would have been in trouble himself. As Peter Hahn, a fellow at Cass Business School, told the Treasury committee: “If one of those banks in 2005 decided to be more conservative and hold back in their activity, they more than likely would have had their CEO and board replaced in 2006 for failing to take advantage of the opportunities.”

The implication is that we should heed the advice of dissidents, but real life is not so simple. In the 1980’s a lender I worked for had losses in Las Vegas, and as a result of that experience and my general distrust of low constraint markets, I believed Las Vegas was a dangerous place to lend. Today, I’m right – lenders who made loans in Las Vegas after 2005 are going to take losses. But, I was wrong for 20 years. 12 month change in employment growth is a good proxy for the health of CRE in a market, and the chart below shows went went on in Vegas:

CRE loans in general went through an extended period of virtually no losses, and the lenders making speculative land development, condo, and aggressively underwritten loans enjoyed an extended run of success. In at least some cases more conservative lenders decided to join the party at the end, and are now paying the price.

I discuss how difficult it is for credit officers to go against the flow in the post below:

Fox Guarding the Henhouse: Bear Stearns Risk Manager Now at the Federal Reserve

Lender Conspiracy to Destroy Competition?

The developers of the Fontainebleau casino and hotel development in Las Vegas believe Deutsche Bank is out to get them. From Zero Hedge:

In a stunner of a development, Las Vegas casino operator Fontainebleau has amended its ongoing lawsuit against a set of banks, and has alleged that Deutsche Bank is now "seeking to destroy the Fontainebleau in order to minimize competition" with the Cosmopolitan Resort and Casino, which was acquired by Deutsche Bank in a foreclosure auction in September 2008 for $1 billion, after the casino had defaulted on a $760 million loan. Allegedly, DB is doing this by pulling Fontainebleau's revolver, making it impossible for the development-stage casino to survive…

As both the Fontainebleau and DB's Cosmopolitan developments are in their final stages of development, their "successful" opening would result in yet another flood of hotel rooms in the already oversupplied Las Vegas market. The Fontainebleau casino would provide 3,800 brand new rooms and condo units, while the Cosmopolitan would supply yet another 3,000 rooms and condos.

How plausible is this argument? This plan would require monumental stupidity at Deutsche Bank. Shutting down the Fontainebleau development would ultimately lead to a new owner who would acquire the development at a much lower basis than the current owner. This would allow the new owner to substantially undercut the Cosmopolitan, pulling that project down too. I’ve discussed this downward spiral effect in more detail in my post CRE Loans and the Death Spiral of Doom.

If you view an income property submarket as an ecosystem, the whole system does best when all the competing properties have similar cost structures. When a predator property with a much lower cost basis enters the system (as a result of a greatly discounted purchase out of a foreclosure or note purchase, for example) it can offer much lower rents, which in turn can destabilize other properties. Eventually a new equilibrium is established, but at a much lower level than before the system was destabilized.

If Deutsche Bank is really trying to shut down Fontainebleau to benefit Cosmopolitan, it’s shooting itself in the foot.

Which Markets Have Lost the Most Jobs?

Employment has suffered the most in Detroit (no big surprise there). However, there are some surprises in the other rankings, including which markets have held up the best.

A word on methodology. I looked at the highest employment level in each market since January, 2000, and compared it to the latest level. All data is from BLS Local Area Unemployment Statistics.

Here are the results:

Employment as of November, 2008	Peak Since 1/2000	Current	Change from Peak	% Change from Peak
Detroit	2,217,186	1,899,782	(317,404)	-14.32%
San Jose	962,408	845,417	(116,991)	-12.16%
San Francisco-Oakland	2,250,832	2,138,050	(112,782)	-5.01%
Chicago	4,721,131	4,542,407	(178,724)	-3.79%
Los Angeles	6,307,149	6,098,378	(208,771)	-3.31%
Riverside-San Bernadino	1,711,443	1,658,533	(52,910)	-3.09%
Atlanta	2,650,838	2,569,010	(81,828)	-3.09%
Washington DC	2,967,601	2,882,203	(85,398)	-2.88%
Miami	2,739,126	2,668,358	(70,768)	-2.58%
Orlando	1,070,271	1,048,644	(21,627)	-2.02%
Denver	1,346,897	1,323,378	(23,519)	-1.75%
San Diego	1,485,911	1,468,666	(17,245)	-1.16%
Sacramento	1,003,441	994,697	(8,744)	-0.87%
Dallas	3,023,034	3,005,173	(17,861)	-0.59%
San Antonio	906,335	902,089	(4,246)	-0.47%
Austin	831,555	829,083	(2,472)	-0.30%
Houston	2,680,121	2,675,806	(4,315)	-0.16%
Las Vegas	936,369	934,956	(1,413)	-0.15%
Phoenix	2,022,781	2,022,725	(56)	0.00%

Detroit employment peaked in June, 2000, and has lost jobs ever since. Here is a chart showing year over year job loss for this market:

(Click on charts to open larger versions in new windows)

The market with the second worse performance is San Jose. It, along with San Francisco (to a much lesser extent), has never fully recovered job losses sustained in the dotcom bust. Here is the year over year chart for San Jose:

The best performing markets are also something of a surprise: Las Vegas and Phoenix. Both of these markets have severely distressed housing markets, and the conventional wisdom is housing difficulties drag down employment. Here are the charts for these two markets:

Finally, let’s discuss Riverside-San Bernardino for a minute. There is no question this market is hurting – I’ve discussed it previously here and here. But, a Bloomberg story with Calculated Risk commentary suggests a parallel between Detroit and this market because both have the same high (9.5%) unemployment rate. I think it’s wrong to suggest Detroit’s situation, which has had sustained job losses for eight years totaling 14.3% of it’s peak employment base, is similar to Riverside-San Bernardino, which has only lost jobs for a little more than a year and is down a little more than 3% from it’s peak. I’ve previously argued unemployment is not a good measure of market distress, because it’s possible to have very high unemployment rates and still have positive employment growth.

You can download a free report which provides similar employment charts on many other markets here.

What Markets Are in a Recession Now?

A couple of recent posts (Econbrowser "Is This a Recession?" and The Big Picture "A Perfect Recession Indicator" have observed a perfect correlation between year over year employment loss (i.e., fewer people are employed in April 2008 than in April 2007) and the subsequent identification of a recession for that time frame. No one publishes GDP figures for individual markets, but if we accept year over year employment loss as a proxy what markets are in a recession now?

Of the markets we track, the big loser is Detroit (probably no surprise there):
Detroit has been losing jobs every period since 2001. It's probably also not a surprise that Riverside-San Bernardino is losing jobs:

But, if you thought all markets with housing price woes are in recessions, you would be wrong. For example, not only is Las Vegas gaining jobs, it is doing so at an accelerating rate:

Here is the whole list:

Moderate to Strong Job Growth Trending Up: Austin, Chicago, Dallas, Denver, Houston, Las Vegas, San Antonio

Weak Job Growth and/or Trending Down: Atlanta, Orlando, Phoenix, San Francisco-Oakland, San Jose, Washington DC

Nominal Job Growth or Actual Decline: Detroit, Los Angeles, Miami, Riverside-San Bernardino, Sacramento, San Diego

The data is as of April 2008 (released by the BLS in June). The sources and methodology can be found in the free sample report which can be downloaded from our website here.