A practical view: what is driving an emerging new real estate model? Behind the scenes "Sub-prime", housing and real estate - another distribution evolution based on the internet

Written by : Tim Vasko | Published on April 29, 2008
Category: Real Estate

[NOTE: The market trends we are basing the model on is a new distribution model - beyond just "pretty pictures" ... this blog stream of thought is the beginning of a series on the current real estate market ... ]

First, please excuse the "academic" nature of this article - I realize I am going back to my old "Professor Vasko" days. However, I felt an overwhelming urge to run through a discourse on what's really going on in the financial and real estate markets. Mostly because, right now is a great opportunity for "smart money" looking to buy real estate from around the world and for our RealEstock model - so here I go ...

Mortgage Banking and Real Estate Distribution 401:

In the last month or so, Bear Stearns, the fifth largest investment bank in the world needed to be rescued, by the US Federal Reserve and JP Morgan. What does a $30billion dollar infusion (a support figure that pales in comparison to the controversial federal bailout of Chrysler in 1979-1980 under the reign of Lee Iacocca) indicate about the US economy, real estate and the world financial systems?

What "inspired" the Federal Reserve and US Government to bail out Bear Stearns? What does it indicate for the future of the real estate and related mortgage industry?

Bear Stearns, a firm notorious as a dispassionate "hardliner" has made a fortune in mortgage-backed securities but faced a possible collapse after those investments soured. Guaranteed, Bear Sterns never has, nor would have, bailed out anyone - they were one of the hardest nosed dealers on Wall Street - but that's another story.

So was this, (a) "compassion", (b) "rational" or (c) "irrational" action from the Fed (characterize as you would like)?

Answer - we'll not "(a)" above - it wasn't compassion !

Bear Stearns had (or has) over $13 Trillion dollars of obligations and contracts linked to the derivative markets. Derivatives are contracts - contracts to buy and sell financial assets that hedge certain financial obligations. And, in simple terms, if these contracts defaulted, the entire foundation of modern finance could begin to shake globally - but this isn't the first time this has happened, circa 1997 Merton Miller (Nobel Prize Winner in 1985 on Finance), the guru of Derivatives had a similar experience, but much less publicized - just as concerning to the world banking institutions however .

To put todays dollars involved in perspective and scope, the 1989 the US Feds created of the Resolution Trust Corporation involved 747 Savings and Loan institutions and around $394 billion in assets (about 3% of the current exposure of Bear Stearns alone). Another story is how the Fed's actually created this problem with a failed taxation policy ... but, again, that's another long story. Combined with the new merger of JP Morgan and Bear Stearns, the exposure in the world on the finance side reaches a staggering $77 Trillion dollars (that's $77,000,000,000,000) - which is roughly equivalent to the entire world GDP (estimated at $54,311,608,000,000 - I think, I lose track of all those zeros!) So now JP / Bear manage asset portfolios like the entire economic structure of all of the worlds countries gross domestic product (what would happened to the world economy if the US's largest trading partner, Canada disappeared - now multiply that across all of the worlds economic output?) Well you get the picture. The US wasn't just saving Bear Stearns, they were saving the economic equivalent of the entire US GDP economy. Inside US Borders (looks like a lot better bet than the War in Iraq.)

So, what has caused this so called "sub-prime" financial crisis? We'll first understand, it's not just "sub-prime". It is more about the fabric of the entire infrastructure of mortgage banking finance, which is the foundation upon which all modern real estate buying and selling sits upon - considering the fact that "Real estate is the world's biggest single asset class. Typically, property accounts for two-thirds of the tangible capital stock in almost every nation's economy." The picture of why this is such a big deal overall gets obvious pretty quickly - and it's why Governments are more than willing to jump in to support and fix the problem globally. All of this mortgage backed paper that started to crash, these so called "sub-prime" instruments, caused a general tightening and devaluation of this "mortgage paper" on trading desks globally. A phenomenon that drove UBS - the largest Swiss Bank, and one of the world's largest banks, to write off $36 Billion from their financial assets (more than the bail out of Bear Stearns by the US Feds)! And, to be specific, UBS didn't even take on any of the actual purchase of mortgages, they were "paper" traders - UBS was simply stuck holding contracts they couldn't unload at their trading desk as the market fell out " nobody was buying. They couldn't trade their contracts, so the losses just stacked up. That's a big factor that also Bear Stearns and others. So what really has happened, I mean reading between the lines of the media "sub-prime" blitz, and beyond all the analysts notions of "high finance"? The way it really has come down?

It's based on a decade of prosperity in lending money against inflating values in real estate that really didn't exist " excuse my poor grammar - that is to say, the real estate existed, the "value" on the upside that was being lent against, sub-prime and otherwise, didn't really exist in an economically tangible view.

The value of real estate markets was driven upward, on a false economy of transaction costs and trading. This was true particularly in the US, however, the same factors has recently put Spain's real estate market underwater as well (I've not really identified all of the depressed markets globally - but if anyone else would like to comment on this phenomenon in the world, either on the up-tick or down side, feel free to let me know).

What drove this false foundation of economics was not all that unlike the underpinnings of the .Com boom and bust 1999 - 2001. Then too, the market was driven by rampant enthusiasm, trading and no real financial economics to support the market of the web - of course, those survivors from that era who found an economic base and business revenue model have thrived since then (like my company CMAEON - RealEstock) and much better known companies, like Google,, eBay, etc. to name a few.

(HINT - find fundamentals in a real estate market today - and you've got a base to build upon. BUY! Hint #2: Where do wealthy baby boomers want a second/retirement lifestyle home?)

This real estate market we've just experienced has been driven by an increased volume of real estate buy and sell transactions, an expensive and inefficient way to handle all of this volume that has made the "traditional" transaction makers (brokers, agents, lenders, finance companies, traders, lawyers, title and escrow insurance companies and agent's buckets of money) - all of which occurred just as a result of an ineffective system of distribution which added no real tangible economic value added to the properties - in other words, the laws of supply and demand were outstripped by the pure volume of transactions and the values increased simply (ok - mostly) because of transaction costs (Hint: Look at what Wal Mart and Cosco have done in retailing with a better distribution model, smaller retailers can't compete - new and improved distribution of information and selling will emerge in real estate, except it will be online). In the stock market high volume trading in the same stocks in a portfolio is called "churn" [Bear Churns]. In the housing market it's recently been called "..flipping" - call it what you will, the last guy standing and holding the paper or the property takes the hit.

Transactions give rise to the 'paper trading' and the home selling and buying market - for a decade this high volume of activity has carved off percentage points, or fractions of percentages making the transaction makers money, in these trillions of dollars of real estate deals. For the firms, and individuals involved in the web of finance and distribution surrounding the buying, selling and financing of real estate it was a boondoggle. And most banking firms and financial institutions, hedge funds, that formed the backbone of the finance industry, were involved, in some way - as were real estate brokerage companies and agents. Which is why Bear Stearns ranks was joined by Citi Bank, Merril Lynch, Country Wide Mortgage / Bank of America, HSBC and hundreds of others in the distribution channel of finance - and now, why the model of buying and selling of real estate will transform forever.

Later this week, I'll provide the calculations on how a home in Southern California or Florida, valued at $400,000 in 2001, easily became a $700,000 or $800,000 home, just based on flipping and transaction fees. Rule #1 in today's market - Do the research and get ready to buy the real estate of your dream second or vacation condo, resort or estate home -the time is now. Real estate is still about location, location, but throw out the last "location" (referring to the old statement about the three factors in buying real estate, "location, location, location."), and replace that verb with 'lifestyle'.

With we've replaced the model with our own version "location, location, lifestyle" Globally, there are still a lot of buyers out there - they are called Baby- Boomers . We are more critical and discerning about our location, lifestyle and how we will invest our money in the properties we want, where we want to live and build the last half of our lives. The market's not over, it has just corrected for good reason - it's actually good news for us Boomers. So start looking now for your next investment, dream second or retirement vacation home, luxury residence. That market will drive back strong and fast driven by a number of positive economic factors that we Baby-Boomers have going for us .. more to come - stay tuned and visit

Tim Vasko

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