Subprime Crisis Reaches Main Street, Wall Street

“The housing market is at the epicenter of the global credit crunch and almost every imaginable business and industry is affected by it,” said Ed Ryder, ’92, managing director, Transwestern Investment Company, LLC and head of acquisitions, Transwestern Multifamily Partners, LLC.

Ryder moderated a panel of GSB alums on capital markets during Chicago GSB Real Estate Conference, sponsored by the Real Estate Alumni Group, November 5 at Gleacher Center.

The subprime lending crisis draws much media attention. “Main Street and Wall Street are both being affected simultaneously,” Ryder said.

Reactions to the credit crunch crisis vary from a frightened Wall Street to interested companies looking to how they can capitalize on better deals, said panelist Bruce Cohen, ’89, of Wrightwood Capital.

“If you talk to anyone on Wall Street today, they’ve never seen things this bad, and it just keeps getting worse,” Cohen said. “To them the whole capital markets are just absolutely scary.”

On the other hand, life companies find the situation interesting because they have capital to invest and plenty of choices, Cohen said.

But while there are “extraordinary” amounts of liquidity and plentiful capital, “deals aren’t trading because nobody knows how to price a piece of real estate today,” Cohen said. The difficulty of pricing assets arises from not knowing the percentage of financing that will be available, he said.

Confusion over asset pricing came about when complicated securities backed by subprime mortgages got into trouble when those mortgages began to default, panelists said. As a result many financial companies are taking billions in write-downs. 

So many securitized products are on the books - leveraged buyouts, commercial mortgage backed securities, and subprime collateralized debt obligations – that panelist Kieran Quinn, ’73, compared it to “a big elephant that’s going through the snake this season.” 

Wall Street needs to price the products and move them off its books, said Quinn, chairman and CEO, of Column Financial, a mortgage lending subsidiary of Credit Suisse. Quinn also is a managing director of Credit Suisse and chairman of the Mortgage Bankers Association.

The subprime lending business has exploded in the past decade, said Yasemin Tarakci, ’04, senior vice president of Countrywide.

Subprime loans carry lower FICO, have a higher loan-to-value ratio, or a higher debt-to-income ratio, or a combination of those factors, she said. As such, they are riskier than standard loans.

In 1994, subprime loans amounted to around $30 billion to $35 billion, and comprised a small percentage of total mortgage origination, Tarakci said. Ten years later, at the peak of mortgage origination, subprime loans accounted for about $620 billion, she said, amounting to an increase of “twenty times in a decade.”

Some subprime mortgages were being allowed to go through with a lack of documentation, low FICO, or with a loan-to-value ratio of up to 125, where “we paid people so we could refinance them,” she said. Further complications arose from new third-party mortgage originators. 

“Some of them had almost no experience in mortgage origination,” Tarakci said.

Still, Quinn said, 95 percent of all mortgages are paying and 85 percent of all subprime mortgages are paying.

As an investment banker in commercial real estate, Quinn said, “Our mantra is always: Go make a good loan.”

He noted a difference between commercial real estate and residential real estate.

“There is froth and there is fraud. We are definitely in the froth business,” Quinn said. “We’ve all been a little crazy in the last few years. I think subprime residential stepped out of froth and more into fraud over the last few years, just how they characterized some of their loans.”

Cohen said problems arose with the introduction of leveraged buyers of aggregated loans. Previously, the residential and commercial mortgage industries pooled loans and sold bonds against them. “That was great, because the primary buyers of these bonds were banks and life companies,” all cash buyers, Cohen said. But then hedge funds and other finance companies discovered they could package bunches of triple B-rated bonds, “almost junk bonds,” backed by subprime loans, and seek triple A ratings and leverage for them.  

“What we became was an extraordinarily leveraged economic system,” Cohen said, with releverages of leverages. When the subprime mortgages backing these securities began to default, the underlying value of the bonds came into question.

The solution, panelists said: De-leveraging.

From the lenders’ point of view, difficult situations are ensuing, said John Nikolich, ’92, managing director at Flint Creek Partners.

“You have people who are, two hours before closing, demanding escrow, retrading, not really looking at the commitments, because there is so much backlog right now in the CMBS market, so that has become a bit of an issue,” Nikolich said. “Really, everybody does want to know, what are the rates? What is the stabilized state that we’re going to end up in, so that we can get back to the business of deploying capital?”

At the individual property level, Nikolich said, the crisis has had two effects: “You have sellers looking at it, and saying, I only wish it could be 90 days ago. And then you have buyers saying, I only wish it were 90 days from now so the sellers would stop saying it was only 90 days ago.”

Quinn noted, “I think sellers need to own up to the fact that they just missed the greatest bull market in the history of mankind. I don’t think it’s coming back.”

– Mary Sue Penn