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The Road to Economic Recovery: Capitalism is Dead, Long Live Capitalism

April 18, 2009

History teaches us that we don’t learn from history. Knowing what we did of history, many forecasters predicted that the deregulation of our financial system would ultimately be unsustainable and lead to collapse. In fact, there were many empirical warnings that the system was failing including admonitions from Fannie Mae and Freddie Mac.

On March 24th & 25th I attended a conference with the Global Interdependence Center at the Bank of France in Paris with distinguished central bankers and monetary professionals from France, the US and Zambia, where discussions focused on the financial crisis and expectations for the economic recovery.

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In Seattle, what should we expect from the economic recovery and how does that affect our local real estate industry?

Global Economic Recovery

On a global scale, the potential for growth is slowing and downsizing is happening everywhere. Developing countries and Eastern Europe are particularly vulnerable to the downturn. China’s economy, the biggest contributor to global growth, has slowed for the past five quarters. China however, has a $2 trillion dollars surplus in Foreign Exchange reserves that it has committed to sustaining growth through 2010.
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The debt of many countries including the US will limit the investment required for growth in technology, social welfare and the environment. Without capital and access to credit, even the much-hyped Green Economy will be slow to materialize.

The days of easy liquidity in the marketplace are over. There are structural changes coming in monetary policy that are predicted to keep our economic recovery flat for sometime. This runs converse to the anticipation that our recovery will be cyclical and return to the market of 2 or 3 years ago.

Investors and sellers should be aware that a cyclical recovery is not likely to happen. Credit in the market has already shrunk and become more restrictive. Consequently, the numbers of homebuyers is shrinking and financial services are being downsized.

The manufacturing decline is also expected to continue in the US. Bailouts to failed companies such as General Motors will not help the US compete with countries such as China, who have a surplus of low-wage labor and have outlined a plan for growth that includes leading the world in the production of electric cars. s-zap-electric-car-large

The deflationary spiral in the global economy is expected to deteriorate further this year. The banking system will worsen and we will see more bank failures and home foreclosures, after which a long recovery in which spending will be flat, will put an emphasis on savings over consumption. This will weaken the retail industries, which will further weaken the commercial sector.

Local Bank Failures up in WA State

Local Bank Failures up in WA State

Local Real Estate

The big story this year in real estate is the crash of the commercial market. Over $400 billion dollars is set to be up for refinance in June. Combined with a weak retail sector we will undoubtedly see rent prices falling and more commercial lease space vacant and for sale.

A weak commercial sector will put more pressure on financial institutions and markets that are already under strain. According to Atlanta Fed CEO Dennis Lockhart, this could complicate the ability of credit markets and the banking system to stabilize. Construction loans could end up on the books of banks if properties can not achieve the cash flow to service debt.

In the residential market, a slow economic recovery does not bode well for homeowners or builders looking to maximize value for their homes. The Case Shiller index shows an 11.2% decline in Seattle in 2008, with a national average down 16.6% in 2008 and 21% since home prices peaked in July 2006. Further declines are being speculated for 2009, ranging 5-15%.

Microsoft Word - Housing Paper Jan09 v2.doc

Lending

Underwriting guidelines are almost returning to sane levels and banks are lending, however the new guidelines limit those that are lent to, eliminating more than 50% of the possible buyers which existed 3 years ago.

Jumbo loans have been more difficult to obtain as borrows must now qualify on documentable income, put more money down, have more reserves, and have great credit scores to avoid paying 2-3 points to bring down rates.

This shows up in longer wait times on market and declining house values. Overstock is also an issue in stabilizing home prices. Until the overstock is sold, prices will continue to decline. In this buyer’s market, sellers will have to lower their expectations on the value for their homes, and face tougher appraisals.

Conforming loan rates for Seattle are at $506,000 and are not expected to adjust upward, although it may be feasible in some locations. The Fed and banks do not want to see higher loan rates because they are trying to stabilize prices.

Bank of America now offers Jumbo rates in the high 5% which is down from the average of 6.5% in March 2009 and 7.9% in October 2008. This should help borrowers. Other banks such as Chase and Wells Fargo are expected to also lower rates in order to compete for business.

Much of the overheating in the economy came from a lack of understanding of macroeconomics by many corporate entities that pursued “selling” over prudence.

The difficulty in fixing the financial problems today is that they are being misdiagnosed and therefore the solutions are misguided. The Obama administration is like a ship in the middle of a category 5 hurricane, trying to stabilize and instill confidence in the passengers that the boat is not going to sink. When the storm passes perhaps the administration will set new sails. Confidence will continue to be the fundamental issue for sometime.

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At Infiniti Real Estate and Development we provide real estate analysis, expertise and services for the local real estate market. If we can provide any advise to you on local economic conditions or the green real estate market, please contact info@infinitiRED.com.

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