Speaker 1: Hello, and welcome to another episode of The Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe Wiesn't so Joe. One
Speaker 1: of the themes that I think has been popping up
Speaker 1: quite a bit on recent episodes is this idea of
Speaker 1: this sounds really trite, but opportunity in crisis, or this
Speaker 1: idea that we're facing big, big economic devastation, but maybe
Speaker 1: there's some sort of hidden opportunity or even very obvious
Speaker 1: opportunity to remake the economic system or improve the financial
Speaker 1: system at the same time. Yeah, I think that's right.
Speaker 1: I mean, yeah, I think that that has been a theme,
Speaker 1: and this idea that there are a lot of policies,
Speaker 1: and we've sort of talked a lot about fiscal policies
Speaker 1: or monetary policy, but there's all kinds of trends that
Speaker 1: have been going in one direction and and people are
Speaker 1: questioning have they reached their endpoint as a society, as
Speaker 1: an economy, do we need to make some sort of
Speaker 1: like meaningful turn in a different direction? Right? And times
Speaker 1: of crises tend to be when we also see new
Speaker 1: innovations in the market specifically, and I'm thinking about one
Speaker 1: in particular back in the ninety nineties, immediately after the
Speaker 1: savings and loan crisis, there is a shortage of capital
Speaker 1: going into commercial real estate. Fast forward a few years
Speaker 1: and someone invented commercial mortgage backed securities to kind of
Speaker 1: take care of that problem. Now today, we've been discussing
Speaker 1: already the intense pain facing the commercial real estate sector
Speaker 1: at the moment. The question is is this going to
Speaker 1: lead to some sort of innovation or is it going
Speaker 1: to present some sort of opportunity to revisit the system
Speaker 1: as a whole. There are different types and different degrees
Speaker 1: of changes that could come about because of what we're
Speaker 1: seeing happen right now. Wait, you want to hear an
Speaker 1: interesting commercial real estate data point? Ye, go on. You're
Speaker 1: back in New York, aren't you. I'm in the office.
Speaker 1: I'm not only I'm not only back in New York.
Speaker 1: You're gonna be brimming, brimming with commercial real estate anecdotes now,
Speaker 1: aren't you. So I'm literally in commercial real estate as
Speaker 1: we speak, after several months of recording the podcast from
Speaker 1: a bedroom. So maybe it was all Maybe it's all
Speaker 1: over height, Maybe everything is going back to normal, But no,
Speaker 1: I don't know, it's not. It's definitely not normal by
Speaker 1: any stretch here in New York. It's definitely not normal
Speaker 1: by any stretch here in the office, and it's really
Speaker 1: unclear whether whether there will be a return to normal
Speaker 1: at all. Yeah, Okay, Well, on this episode, we're going
Speaker 1: to be digging more into the state of the commercial
Speaker 1: real estate industry. We we touched upon it a little
Speaker 1: bit when we were talking about reets the other day,
Speaker 1: but now we're going to go in depth with a really,
Speaker 1: really special guest. I'm thrilled to say that on today's
Speaker 1: episode we have Ethan Penner, who is widely credited as
Speaker 1: being the father of CMBs or the guy that created it.
Speaker 1: As I mentioned back in the ES, he's currently the
Speaker 1: founder and managing partner of Mosaic Real Estate Partners. So Ethan,
Speaker 1: thank you so much for coming on. Thank you. It's
Speaker 1: a pleasure. So Ethan, I'm really curious, could you could
Speaker 1: you maybe start out by describing the problems as you
Speaker 1: saw it in commercial real estate in the early when
Speaker 1: when you were first thinking about the CNBS structure, the
Speaker 1: CMBs product. What was the issue that you were trying
Speaker 1: to solve and how much of that do you see
Speaker 1: paralleled in the current situation today, Well, it's not really
Speaker 1: parallel at all at this point. Say, the situation that
Speaker 1: existed in the early nineties that moved me to kind
Speaker 1: of bring about the CNBS industry or CNBS solution was
Speaker 1: a very unique situation where kind of all the lenders
Speaker 1: who had serviced the real estate industry abandoned the industry
Speaker 1: all at once. And so the industry, which is you
Speaker 1: probably know this, but the real estate is the most
Speaker 1: pendant upon debt financing of all industries, and so here
Speaker 1: you had an industry that had its line cut off essentially.
Speaker 1: And it's an industry that is financed not only acquisitions,
Speaker 1: of course, with heavy debt, but the debt itself is
Speaker 1: structured so that there was very little amorgization, and loans
Speaker 1: mature on a regular basis and need to be refinanced.
Speaker 1: And so borrowers were finding themselves in the early nineties
Speaker 1: with loans scheduled to mature and their existing lenders telling them,
Speaker 1: regardless of how well the loans were performing or the
Speaker 1: underlying properties, that they didn't have an interest in refinancing
Speaker 1: those loans, and they might give some short extension, but
Speaker 1: there needed to find a way to repay them, and
Speaker 1: so the industry was facing a tremendous crisis and existential
Speaker 1: crisis for many borrowers. And I saw that, and I
Speaker 1: realized that the securities markets, the bond buyer who had
Speaker 1: come to finance other asset types, primarily single family mortgages,
Speaker 1: but but other serbasses through the securization process that had
Speaker 1: kind of grown significantly through the eighties and then I
Speaker 1: had been a part of, was a very well suited
Speaker 1: place to turn to to fill this massive need. Uh
Speaker 1: And from that c NBS was born. I mean, there
Speaker 1: was a lot of a lot of work, a lot
Speaker 1: of mostly convincing. Actually, you know, when you create something new,
Speaker 1: even though it's needed, there's a certain constituent that feel
Speaker 1: threatened by anything new, and so getting kind of the
Speaker 1: necessary buying is really the challenge when you introduced new concepts.
Speaker 1: And it was a great experience for me, not without
Speaker 1: its pains and scars, but it was certainly well worth it.
Speaker 1: Can you just explain real quickly what it was about
Speaker 1: the conditions that caused the traditional real estate lenders to
Speaker 1: pull back from the market. Sure, well, real estate prior
Speaker 1: to this period, this early nineties period wasn't even though
Speaker 1: it's a very large financial asset, it was actial asset
Speaker 1: that was pretty much untethered to the rest of the
Speaker 1: financial or capital markets. It was a business that kind
Speaker 1: of happened entirely in the private sector, so there was
Speaker 1: no public market partition. In real estate, there were really
Speaker 1: no weeds to speak of, and there was no capital
Speaker 1: market printicipation in the equity or the debt financing. It
Speaker 1: was largely financed on the debt side by banks and
Speaker 1: insurance companies and in a very i would say backwards
Speaker 1: way to tell you the truth, without being tethered to
Speaker 1: the public markets. It was also being done without wellsta
Speaker 1: traditional financial burdens, so relative value didn't play a part
Speaker 1: in things, and pricing was oftentimes bizarre. Credit decisions were
Speaker 1: also kind of wacky. In fact, you know, there was
Speaker 1: a time when for a lot of the kind of
Speaker 1: wealthiest old American real estate families gained their wealth through
Speaker 1: the benefit of getting or more alone to costs, so
Speaker 1: they were able to borrow the totality of the cost
Speaker 1: of building a project, if not more and uh and
Speaker 1: have all the upside for putting up no money themselves.
Speaker 1: That formula tests are great great wealth and it did
Speaker 1: for many of the legendary names in real estate. The
Speaker 1: big problem that led to the crisis was that all
Speaker 1: the lenders were regulated lenders, right insurance companies and banks
Speaker 1: from this part, and regulators tend to react in a
Speaker 1: herd like fashion to especially marketaces. And so the the
Speaker 1: late eighties early nineties was a period that was really
Speaker 1: a very deep economic recession, and it centered around real
Speaker 1: estate because in the prior years real benefited from an
Speaker 1: immense amount of bubble, amount of capital that drove prices
Speaker 1: to ridiculous levels. And as the bubble started to burst
Speaker 1: and people started to kind of withdraw or try to sell,
Speaker 1: the unwinding was quite dramatic. You know, losses tend to
Speaker 1: communicate to regulators. Risk rights are equal to risk, and
Speaker 1: regulators react a risk by telling their constituents to stop
Speaker 1: doing whatever they feel is risking, realizing that doing so
Speaker 1: actually enhances the losses and the risk. It's kind of
Speaker 1: a perverse system. In fact, regulated lending. We could talk
Speaker 1: about that separately, because it's one of the one of
Speaker 1: the biggest problems I think in all the finance. Regulatory
Speaker 1: driven lending and regularly lending created its own set of
Speaker 1: cyclical problems, the likes of which we've seen and I
Speaker 1: think we're likely to see again. So this kind of lemming,
Speaker 1: like the action to regulation created this entire industry to
Speaker 1: be abandoned and uh, and it created is this need
Speaker 1: that I was able to help build. So today we
Speaker 1: have a big chunk of the commercial real estate industry
Speaker 1: financed through the private market, through investors who are buying CNBS,
Speaker 1: And we still have lots of bank loans, but there
Speaker 1: is a chunk of it in private investor hands. How
Speaker 1: has that changed the dynamics, if at all, or how
Speaker 1: does it impact the dynamics when we see a commercial
Speaker 1: real estate crisis such as the one we're in now. Well,
Speaker 1: CNBS was born to deliver capital to a capital starved,
Speaker 1: desperate industry. It was not born perfect, okay, And so
Speaker 1: it's imperfections or its flaws, like all systems are revealed
Speaker 1: most dramatically when things are tough. When times are tough
Speaker 1: and there's challenges like downturns like the O eight oh
Speaker 1: nine financial crisis, and I think like today, but it's
Speaker 1: true of all loans, by the way, like when when
Speaker 1: limes are good, they're never problems like borrowers pay their
Speaker 1: lenders on time, and then when loans come to borrowers
Speaker 1: pay their lenders off and uh, and the lenders are
Speaker 1: very happy and everyone's happy. It's only when that doesn't
Speaker 1: work out, when times are tough and borrowers can't make
Speaker 1: their loan payments on time, well, can't make their loan
Speaker 1: repayments on time maturity, you have stresses in the lending business,
Speaker 1: and so not surprisingly c MBS, it's probably always crop
Speaker 1: up uh, and it's in the shortcomes become obvious in
Speaker 1: these challenged times and fundamental kind of unique ethics that
Speaker 1: I think maybe you're alluding to that's worth mentioning with
Speaker 1: regards to c MBS is kind of what I'll call
Speaker 1: endemic laws. The ones that are that are I think
Speaker 1: germane today most have to do with I would say
Speaker 1: two realities. One is the typical of bond market financing,
Speaker 1: so it's not unique to see MBS. I would say
Speaker 1: it's true for any bond market financing. Let's pretend that
Speaker 1: you have two different lending constructs. One where you're a
Speaker 1: borrower and you borrow from me and I loaned you money,
Speaker 1: and you put up something as collapsed whatever that something
Speaker 1: is okay, And now you're calling me and telling me
Speaker 1: that you can't make your payment on time or you
Speaker 1: can't repay your loan. I'm your lender and I have
Speaker 1: your loan, and I could have a conversation with you
Speaker 1: and determine what's what's the right way go forward. You know,
Speaker 1: is this a temporary downturn? Are you valuable to the
Speaker 1: collateral like keeping you involved collateral? Is that a good
Speaker 1: thing for the collateral's value or not? We can make
Speaker 1: rational decisions together. And I have staying because I have
Speaker 1: your loan, and you don't have staying power because you
Speaker 1: owe me now, and we could I could trade staying
Speaker 1: power for moments with you. I could do things that
Speaker 1: are whatever needs to be done. I could take over
Speaker 1: the collateral and kick you out if I needed to,
Speaker 1: and contract would allow me to do that, And if
Speaker 1: that was the best thing to protect my investors, well
Speaker 1: then I should be prepared to do that. Bond market
Speaker 1: financing doesn't actually allow for that because, as you probably know,
Speaker 1: whether it's corporate bonds construct or a commercial mortgage backed
Speaker 1: securities construct, bond market lending really involves fragmented ownerships of
Speaker 1: that loan, right, it's taking that loan that was originated
Speaker 1: by one party, let's say it was me, and then
Speaker 1: taking it up into many little pieces and selling it
Speaker 1: to people all over the world. And none of those
Speaker 1: people have enough control of the loan to actually have
Speaker 1: a conversation with you, the borrower, when you need to
Speaker 1: have a conversation. So the problem number one is you
Speaker 1: don't have anyone who owns the loan to have a
Speaker 1: reasonable conversation and even make an appeal to that maybe
Speaker 1: the loan needs to be restructured. That's in the best
Speaker 1: interests of the lender and the borrower and the collateral.
Speaker 1: But there's no one to really talk to. Okay, that's
Speaker 1: problem number one in body. Problem number two is that
Speaker 1: because the loan ownership is so fragmented, there is no
Speaker 1: lender per se to actually act in a lender's best interest,
Speaker 1: which is oftentimes in times that are trying to actually
Speaker 1: protect the lenders downside and take over the collateral and
Speaker 1: and control it and and operated to the best of
Speaker 1: the lender's ability. But because there is no one lender
Speaker 1: in control, there's no one really to do that. C MBS,
Speaker 1: there was a strug. There is a something called a
Speaker 1: special services right, and the special servicers theoretically the bond
Speaker 1: holders representative in this process, the one who is supposed
Speaker 1: to speak on behalf of all the bond holders and
Speaker 1: make decisions with regards to workouts and restructurings and foreclosures
Speaker 1: on behalf of all the bond holders. But there are
Speaker 1: a couple of problems. Number One, the special servicer is
Speaker 1: typically special service or for um hundreds if not lisens
Speaker 1: of loans, and during good times, very few of those
Speaker 1: loans are in trouble, and so they don't really need
Speaker 1: to run a big staff two handle the fee loans
Speaker 1: that are in trouble, And they don't because they don't
Speaker 1: actually get to charge servicing fees to the bond holders
Speaker 1: to the trust that the bond holders are invested in
Speaker 1: until and unless loans going to problems status, so they're
Speaker 1: not paid to maintain a regular staff to handle big
Speaker 1: volume of problems as happens in times that are tough
Speaker 1: like today or in the Great Financial Crisis. So so
Speaker 1: they're just not staffing for it, first of all. Second
Speaker 1: of all, and then they have to play catch up
Speaker 1: because they have to quickly bring on staff. But how
Speaker 1: do you find amount of talented people who can quickly
Speaker 1: address the needs of a barber base that's in desperate
Speaker 1: strengths and needs so much who can make decisions quickly,
Speaker 1: It's not really possible. The second problem is that the
Speaker 1: special servicer is also typically paid a feasttream when alone
Speaker 1: becomes problematic and for as long as remains unresolved. So
Speaker 1: so they actually have a financial incentive to not resolve
Speaker 1: problems quickly, which is banistic of course to the senior
Speaker 1: bondholders who accepted a very low rate of return for
Speaker 1: their low risk position, and now they're kind of hanging
Speaker 1: out longer than they want to hang out and longer
Speaker 1: than they probably should be hanging out. The special servicer
Speaker 1: is almost always the owner of the junior most interests
Speaker 1: of the c MBS bond structure, and so for them,
Speaker 1: a quick resolution that locks in losses is is literally
Speaker 1: money out of their pockets, and so so they have
Speaker 1: the further incentive to drag resolutions on for as long
Speaker 1: as possible in the hope that markets recover they can
Speaker 1: avoid locking in aucets. So there's all kinds of intricate
Speaker 1: conflicts of interest built into the the whole cruture and
Speaker 1: it's imperfect. Let's put that right in its current form,
Speaker 1: it's unfair to throw CMBs under the bus because so
Speaker 1: much of what I just said that was problematic about
Speaker 1: CMBN is also problematic in the corporate bond world, where
Speaker 1: ownership of loans in bond form is fragmented, and you know,
Speaker 1: one can make a reasonable case that buying debt in
Speaker 1: bond form is a bad deal. When you're a debt investor,
Speaker 1: you don't have any share of the upside. All you
Speaker 1: have is a best case to get your money back
Speaker 1: and your coupon interests and uh and if things don't
Speaker 1: happen as planned, it gets worse from there. Right, So,
Speaker 1: only that loan in fragmented form called bond form, you've
Speaker 1: given up your ability to actually enforce your lend to
Speaker 1: protect yourself when you need protection. Which is why in
Speaker 1: my firm, you know, the construct of Mosaic, we were
Speaker 1: able to own bonds and we're able to own loans
Speaker 1: in this kind of debt fund that we run. I
Speaker 1: never would buy a bond unless it was extremely cheap
Speaker 1: than being distressed prices. And it's sad that they are
Speaker 1: because distressed that the whole concept of distress that and
Speaker 1: the opportunities rise from distress that are the kind of
Speaker 1: flip side of the same coin of the flawed structure
Speaker 1: that creates the opportunity for distress. That right where people
Speaker 1: just throw their hands up that own these fragmented ownership
Speaker 1: of loans in bond form, and so I can't enforce
Speaker 1: my my lean, I just want to add to this thing,
Speaker 1: and then the I just want out of this thing
Speaker 1: translates into too deep of a discount relative to the
Speaker 1: credit and it creates the huge opportunities for opportunists. So
Speaker 1: I think the bond format kind of creates distress that opportunities.
Speaker 1: It's an interesting phenomenon. It needn't be that way, but
Speaker 1: it is that way because the way it bonds were
Speaker 1: so given that it takes a lot of time to
Speaker 1: renegotiate leases, and given the annics and different incentives that
Speaker 1: you just described, such as the idea that special services
Speaker 1: might be overwhelmed with the number of troubled loans that
Speaker 1: are having to take care of at the moment, what
Speaker 1: does that mean for valuations, Like how long will valuation
Speaker 1: resets actually take in commercial real estate now versus previous
Speaker 1: real estate crisis. We're in uncharted territories in much of
Speaker 1: the commercial real estate market today, and there is no
Speaker 1: real basis for for insets for even taking wild guesses
Speaker 1: on valuation. Evaluation really comes from at the very beginning,
Speaker 1: the question of viability. And to me, the word viability,
Speaker 1: when I apply it to real is very simply the
Speaker 1: human beings want to be there, okay, wherever there is, Like,
Speaker 1: you know, you have a nice office building goes in
Speaker 1: right now, and the question is will you and things
Speaker 1: wanted to actually go to the office in that location. Well,
Speaker 1: it was the answer before March seemed to be unquestionably yes,
Speaker 1: But even for a wonderful building like the one Joe
Speaker 1: sitting in right now, it's certainly less certain than an
Speaker 1: absolutely yes and so out knowing kind of viability, it's
Speaker 1: really it's really impossible to to kind of arrive at
Speaker 1: value today. I think much of commercial will stay today.
Speaker 1: I would say it's nearly impossible to establish values for
Speaker 1: a lot of commercial real stay today, and we just
Speaker 1: have to see how the world plays out a little
Speaker 1: bit more. Both the other the other part of valuation
Speaker 1: also timing, So you can say, well, maybe that building
Speaker 1: is going to be viable, but maybe it's going to
Speaker 1: take two years before it returns to its prior normal
Speaker 1: operating level. Well, then you have to discount cash flows
Speaker 1: that are suboptimal for two years and ducts kind of
Speaker 1: whatever shortfall there is from the evaluation. So timing and
Speaker 1: absolute viability are so uncertain toy that it would be
Speaker 1: it would just be more gambling than investing to try
Speaker 1: kind of decide a value. So I loved your sort
Speaker 1: of description about the tensions and conflicts of interest that
Speaker 1: emerge from the bond or the CNBS structure and the
Speaker 1: difficulty that arises so practically speaking, right now in New York,
Speaker 1: obviously all kinds of issues. There's questions about office buildings,
Speaker 1: there's questions about areas that are retail and very tourists dominated,
Speaker 1: and as you say, we really just we're just guessing
Speaker 1: at this point because we really don't know what the
Speaker 1: future looks like. We don't know when there will be
Speaker 1: a vaccine and so forth. How does the tension that
Speaker 1: you described, how is it playing out right now as
Speaker 1: retailers try to negotiate with landlords and landlords tried to
Speaker 1: renegotiate with lenders what is the discussion and the tension,
Speaker 1: what's happening right now in those rooms. Well, I've not
Speaker 1: been privy to those rooms myself, so again i'd be
Speaker 1: just reporting second hand to you from what I see
Speaker 1: and how things out and how I knowing some of
Speaker 1: the players, how I would imagine they're handling it. But
Speaker 1: it's not fun for anybody. You're talking about retail real estate,
Speaker 1: which is the most uncertain of all. You know, you've
Speaker 1: got retailer, You've got office hotels. To a certain extent,
Speaker 1: are the three areas where you've got the greatest uncertainty
Speaker 1: In that order, I would imagine and and and As
Speaker 1: it pertains to retail real there's existential issues that retailers
Speaker 1: themselves are facing. So you know, I think, uh, it'll
Speaker 1: will be some lawyers who do very well in this process,
Speaker 1: because I think that you're gonna see heightened litigation. You'll
Speaker 1: see bankruptcy lawyers doing very well, and I think a
Speaker 1: lot of it will be centered around with retail. The
Speaker 1: counterbalance so far is that contorically easy monetary policy, and
Speaker 1: that's playing out not just with historically low interest rates,
Speaker 1: but also directs straight from the Fed to the banking
Speaker 1: community to be kind to borrowers and uh and not
Speaker 1: press them. You know. The old need might have not
Speaker 1: been too happy about that, because I'm a fairly strong
Speaker 1: market advocate, but I actually think it's it's the prudent
Speaker 1: thing to do. You know, the system itself is so
Speaker 1: fra today had say historically fragile that it's the wise
Speaker 1: thing to do and is creating whatever audicum of stability
Speaker 1: that allows us to kind of breathe as easy as
Speaker 1: we can breathing today, considering how grave the crisis. There
Speaker 1: was some talk earlier this year, um sort of in
Speaker 1: the depths of the crisis, of potentially seeing a CMBs
Speaker 1: or cr E bailout of some sort What do you
Speaker 1: think about that idea? Does Does the idea of being
Speaker 1: um nice to borrowers extend all the way to bail out?
Speaker 1: I don't think so. You know, I actually wrote a
Speaker 1: piece that was picked up by some of your folks
Speaker 1: in Bloomberg in the government can't help everybody out. I
Speaker 1: think it should not. I think that it needs. You know,
Speaker 1: in times like this, we need to make sure that
Speaker 1: the people who are most fragile, most vulnerable, and his
Speaker 1: basic needs they're not able to attend to that they
Speaker 1: that their needs can be attended to. So that's where
Speaker 1: I think the bandwidth of government large s must be
Speaker 1: must be spent. I don't think um having that lost
Speaker 1: run through the hands of corporate entities or wealthy individuals
Speaker 1: makes any sense at all. It's just so we have
Speaker 1: a fine legal system in this country that allows for
Speaker 1: banksies to resolve issues, and that allows for loan foreclosures
Speaker 1: to resolve issues and new owners can come in. I
Speaker 1: don't I don't think that's That's not the way the
Speaker 1: world should work. I'm pretty out of it, actually, I
Speaker 1: just want to go back to a question you need
Speaker 1: talking about this extraordinary moment of uncertain to the evaluation
Speaker 1: of this real estate. Is there a market for it?
Speaker 1: Is there even a bid ask spread right now? If
Speaker 1: someone wanted to come in and make a bid for
Speaker 1: a big, you know, commercial real estate location. Does that
Speaker 1: market exist or is it just basically no one's selling
Speaker 1: because no one has any idea. I think that there's
Speaker 1: there is a market. There's a fairly big gap between
Speaker 1: where sellers would like to sell and where buyers would
Speaker 1: like to buy. I think that they're I don't necessarily
Speaker 1: think there should be a market though, as I said before,
Speaker 1: for many assets, because I think uncertainty is very high,
Speaker 1: and I think that there is money burning a hole
Speaker 1: through people's pockets, and it's not their money, it's money
Speaker 1: they charge fees on. So that's part of the part
Speaker 1: of the interesting phenomenon of how money is managed and
Speaker 1: is invested in this world, not just in real estate,
Speaker 1: but it's typically invested. It's money is kind of cooled
Speaker 1: as it is in pools that I manage and invested
Speaker 1: by people like my mouth who get paid to manage
Speaker 1: the money. So the money also sometimes comes with final
Speaker 1: maturity dates where if it's not invested by a certain time,
Speaker 1: it needs to be checked to its original owner. So
Speaker 1: that creates an impetus to invest okay so as to
Speaker 1: lock in the associate with managing that money rather than
Speaker 1: return it to the investor hund invested. So there is
Speaker 1: a lot of money organized today that is sitting and
Speaker 1: waiting and wants to invest, and managers who want to
Speaker 1: invest it, and I think that there's the tug of
Speaker 1: war between being imprudent and investing. I think sellers would
Speaker 1: like to get near March prices, and I think buyer's
Speaker 1: kind of would feel very bad if they didn't get
Speaker 1: at least for real estate today and the retail sector
Speaker 1: or the office sector at least, and hotels or more
Speaker 1: down to March pricing, and I would argue they deserve
Speaker 1: more because uncertainty is so high. So I think that
Speaker 1: there is a market. There's been very little that's transacted
Speaker 1: again because on the seller side, there's been kind of
Speaker 1: an advance of pressure from the lending community really directly
Speaker 1: resulted from the FEDS policies, and I think you've seen
Speaker 1: very little selling. There was a big office building in
Speaker 1: downtown l A that's sold at one what I think
Speaker 1: one would characterize maybe below what it might have been
Speaker 1: worth six months ago. That was about it. There has
Speaker 1: been very little and there's very little activity for the
Speaker 1: reasons I mentioned so far. You mentioned the role of
Speaker 1: the FED just soon, and of course we know that
Speaker 1: the Central Bank is acting as a backstop for a
Speaker 1: whole bunch of different assets. At the moment, I'm wondering,
Speaker 1: given the FED is there and the FED is the backstop,
Speaker 1: in what situation would we ever see, Siri, credit spreads
Speaker 1: blowing out again. When you say CRI spreads so there's
Speaker 1: there's CMBs, which has almost I would say a very
Speaker 1: bifurcated world in the sense that there's the senior most bonds,
Speaker 1: which are triple A rated, which I think are reasonable
Speaker 1: credits that have held up over cycles before, and those
Speaker 1: tend to blow out at the very beginning with everything
Speaker 1: because when liquidity tightened, when liquidity times up, it affects everything,
Speaker 1: and then the triple A spreads tend to snap back,
Speaker 1: and it turns out to have been a very good
Speaker 1: trade if you could, if you could put buy some
Speaker 1: and enough trades to make it a big trade for anybody,
Speaker 1: And it happened here. So like triple A spreads, which
Speaker 1: had been so certainly some one hundred spread widen out
Speaker 1: to three twenty, and it was, you know, it was
Speaker 1: a great and obvious trade. Not too many sellers at
Speaker 1: three twenty and therefore not too many buyers block. But
Speaker 1: it was obviously it was going to snap back, and
Speaker 1: it has snap back to saw under it again. The
Speaker 1: more junior classes, where there's concentrated credit risk, they're still
Speaker 1: pretty wide, and I think deservedly so. I wouldn't touch
Speaker 1: him with the tent football. You're taking a concentrated credit
Speaker 1: risk with tremendous exposure to retail and office and hotel
Speaker 1: properties around the tree and UH and no ability to
Speaker 1: really enforce your lean because of this fragmented ownership in form.
Speaker 1: So I think I'd be surprised if those tightened anytime soon.
Speaker 1: Over time, if things hell, they will tighten because there's
Speaker 1: money to invest and will push threads tighter. Money flows
Speaker 1: determined pricing more than anything else, more than credit worthiness.
Speaker 1: On the loan side, it's more an on off thing.
Speaker 1: I think that there's no real loan money to speak
Speaker 1: of available or office in retail today UH and hotel
Speaker 1: very little. So there's just not a lot getting done.
Speaker 1: So I don't know if spreads or wider. Just money
Speaker 1: is not very avaluable, spreads are a little wider as
Speaker 1: a result of what you have to get something done
Speaker 1: for sure, Spreads or wider, and the loan side by
Speaker 1: a good hundred basis points, maybe maybe even a little more.
Speaker 1: Looking forward, this is where I think, going back to
Speaker 1: something we talked about it earlier, which is the tie
Speaker 1: in of everything everything. So if you look at the
Speaker 1: gigantic debt government runs, and not just federal government, but
Speaker 1: state and local governments and the fiscal imbalances that exist
Speaker 1: in this kind. I often wonder how much of bank
Speaker 1: balance sheets will ultimately be co opted to buy that
Speaker 1: debt that happens, and I suspect it will. You know,
Speaker 1: there was a time in America when bank balance sheets
Speaker 1: were more than government debt in recent past, it in
Speaker 1: the single digits. So if I'm right, and bank balance
Speaker 1: sheets become the haven kind of to store low rate
Speaker 1: government debt because there's no real market did for that
Speaker 1: any near the yields that makes sense kind of fiscally,
Speaker 1: then that crowds the bank out before forcing a lot
Speaker 1: of the private sector, which pushes it into private funds financing.
Speaker 1: And the rate that private funds blant is going to
Speaker 1: be substantially higher than where benchmarks like government bonds trade,
Speaker 1: which is where benchmarks typically are. So spreads to governments
Speaker 1: for credit could widen dramatically over the next I would
Speaker 1: say decade. I would not be eyes if that was
Speaker 1: a trend that we saw for the next second, for
Speaker 1: the reason I mentioned, let's I'm curious about, you know,
Speaker 1: the sort of knock on effects, like let's say some
Speaker 1: of these assets really do they don't bounce back for
Speaker 1: years prime real estate and hotels and offices and big
Speaker 1: cities like New York and other, Chicago and elsewhere. What
Speaker 1: are the then following effects, like what is the who
Speaker 1: are the pools of owners of this dead and what
Speaker 1: does it do to them if they really have to
Speaker 1: take in the end sort of massive marks down mark
Speaker 1: downs on their holding. It's going to be very exciting
Speaker 1: to that play out because they're clearly, you know, one
Speaker 1: would suggest they're they're clearly going to be big losses
Speaker 1: that have to be born by someone, you know, some
Speaker 1: group of someone, and there's always been a tug of
Speaker 1: war as to the allocation of those losses between the
Speaker 1: equity owner of party and their lender. It's a it's
Speaker 1: a it's an old kind of tradition in real estate
Speaker 1: when when things go well, the property creates efficient cash
Speaker 1: flow to pay and repay the lender, you know, when
Speaker 1: the loan tourers. But when things don't go well, the
Speaker 1: borrower calls a lender and says, we've got a problem,
Speaker 1: you know, instead of utter problems, we've got a problem.
Speaker 1: How are we going to fix it? Of course, the
Speaker 1: way it's supposed to be is the boss is supposed
Speaker 1: to lose everything because the lender has taken this safer
Speaker 1: position in lieu of upside. But again, as I go
Speaker 1: back to, because most lenders, even whole own lenders like banks,
Speaker 1: are just not set up to own property. There's been
Speaker 1: a long edition in real estate where when things don't
Speaker 1: go well, the lender recreates value or economic value because
Speaker 1: they don't have the will of the capacity to enforce
Speaker 1: their own mean and take the barrow out. And so
Speaker 1: lenders do lose money when they not necessarily you wouldn't
Speaker 1: think they should because of the hierarchy of the capital structure.
Speaker 1: So how that all plays out will be very interesting
Speaker 1: to watch, but unquestionably there are losses in the system. UM,
Speaker 1: I have a sort of big picture question for you,
Speaker 1: and I know you like to to think about these,
Speaker 1: and I've seen some of your recent blog postings, But
Speaker 1: when you look at the economic crisis, of what role
Speaker 1: do you see there for the federal government? What should
Speaker 1: they be doing to to cush in the blow, if
Speaker 1: if anything. As I said earlier, I'm a big free
Speaker 1: market advocate, but I'm also a person who's living my
Speaker 1: eyes open and realizing the realities of the tuation we're facing.
Speaker 1: I think we're too far on to be have a
Speaker 1: libertarian last affair approach to things. You know, that worked,
Speaker 1: by the way, and you know the early nineties when
Speaker 1: CNBS was created, that was a time when the government
Speaker 1: largely had a last affair approach and and closed a
Speaker 1: lot of financial institutions and liquidated their assets when they
Speaker 1: didn't have enough regulatory capital. They actually took a harsh
Speaker 1: stance and and a non kind of savior stance to
Speaker 1: the world. The O A response changed everything. And I
Speaker 1: would say the O eight response was gravely mistaken, but
Speaker 1: it created and I knew it would, and I wrote
Speaker 1: at the time it created a dependence mentality upon the
Speaker 1: FED and upon the government to save us from pain suffering.
Speaker 1: And once that precedent was set, you know, a theyre
Speaker 1: is never going to be turning back. And so that's
Speaker 1: too late. We've we've been running around with this crutch
Speaker 1: of dependence for so long that our legs don't work
Speaker 1: any As a decided we can't run around without the crouch,
Speaker 1: and so bad behavior, running up massive debts and and
Speaker 1: and unsustainable cystal imbalances has been the natural byproduct of
Speaker 1: oh eight o nine and now as a society. Uh,
Speaker 1: and I say us, it's global, it's not just America.
Speaker 1: We're in an impossible position. And no, no, if you
Speaker 1: really predict exactly where things are going, I have my opinions,
Speaker 1: but but I don't think the government can walk away
Speaker 1: because government kind of exists to help us society avoid archy.
Speaker 1: And I think where at the we're as close to
Speaker 1: anarchy as we've ever been in modern times. I think
Speaker 1: we're in a depression. So I'll tell you this. I
Speaker 1: think that we're in a depression like the nineteen thirties.
Speaker 1: But the difference between the nineties and now is the
Speaker 1: federal government's response. Right. In the nineteen thirties, there was
Speaker 1: no response, so nobody got helped. The banks were allowed
Speaker 1: to fail, everything was allowed to kind of go go under,
Speaker 1: and where there were breadlines and there was massive homelessness.
Speaker 1: Today you have massive government response, right, And so the
Speaker 1: massive government response is masking over some of the natural
Speaker 1: symptoms of the depression. And you know what, it's hard
Speaker 1: for someone libertarian leaning to say this, it's the only
Speaker 1: right choice. There is no other choice, and we're just
Speaker 1: going to have to get used to it. Those of
Speaker 1: us who are grew up lovers of the free market,
Speaker 1: We're just gonna have to suck it up and just
Speaker 1: say this is this is the new world that we're
Speaker 1: living in, and it's not going to change and can't.
Speaker 1: I'm curious. So, you know, thinking back in two thousand
Speaker 1: two nine, that was truly a national crisis, and it
Speaker 1: basically hit everywhere at the same time and arguably to
Speaker 1: the same severity this time. I mean, you know, I'm
Speaker 1: in New York and obviously, uh, people think it's going
Speaker 1: to be pretty bleak here for a while. But I
Speaker 1: was just in Austin, Texas for a while and people
Speaker 1: this is booming and a lot of people are moving there.
Speaker 1: And so I'm curious how you see the sort of
Speaker 1: bifurcation of the economy where it's not just not necessarily
Speaker 1: a national recession nder a national depression, but as simultaneous
Speaker 1: boom in one place, boom in some real estate market,
Speaker 1: boom in some office markets, and crash and others think
Speaker 1: that that is a very accurate assessment of the way
Speaker 1: things are right now, which makes it very interesting in
Speaker 1: the sense that there are definitely going to be winners
Speaker 1: and losers, right and and that's you know, it's not
Speaker 1: fun for the losers, but it's fun for the people
Speaker 1: who like to play the game and think they're capable
Speaker 1: of winning. So, you know, when you talk about real estate,
Speaker 1: when you talk about anything related to the economy, and
Speaker 1: when you talk even about societal constructs, there's a massive
Speaker 1: competition going on right now for all those things. You
Speaker 1: just described it very well, and it's going to be
Speaker 1: it's going to be something to behold to. Just sort
Speaker 1: of describe the challenge. I mean, a, we've had this
Speaker 1: extraordinary government response so far. We'll see what further is
Speaker 1: going to come. But you also sort of describe the
Speaker 1: sort of sense of anarchy. Does that exacerbated the fact
Speaker 1: that different parts of the country are experiencing this moment
Speaker 1: so differently. I think that what's likely to occur it's rational.
Speaker 1: The rational things will occur, meaning investors, companies will go
Speaker 1: to places that they feel it can deliver things that
Speaker 1: benefit companies and the and their constituents, primarily their employees. Right,
Speaker 1: So companies will move from places where perhaps physical safety
Speaker 1: is not as not as certain, or fiscal imbalances create
Speaker 1: a need for higher taxation, and they're going to move
Speaker 1: to places where physical safety is perceived to be better
Speaker 1: and taxation lighter. And uh, that's true for employers, and
Speaker 1: it's true for the wealthiest of the communities who pay
Speaker 1: a lot of the taxes. As you know, New York
Speaker 1: of its budgets paid for by one percent of the
Speaker 1: tax payer. So that creates his downward spiral. It's very
Speaker 1: very hard to undo. And uh, and then a very
Speaker 1: bullish spiral for the kind of recipients of these movers
Speaker 1: and the states that people are coming to. So that's
Speaker 1: how that ultimately plays out. Because if you play it
Speaker 1: out to its logical conclusion, you're going to have dystopian
Speaker 1: cities around this country and it's going to be really,
Speaker 1: really weird, and the federal government have to make a decision.
Speaker 1: I think about what is the United States? Right? I mean,
Speaker 1: there's there's some really big questions that really have never
Speaker 1: been asked for a couple hundred years in this country
Speaker 1: that will need to be asked if this plays out
Speaker 1: the way I think we'll play. Okay, well, Ethan, we'll
Speaker 1: have to have you back on I guess in a
Speaker 1: few years time to see how this all shakes out
Speaker 1: and talk about it some more. But Ethan Penner, thank
Speaker 1: you so much for being on all bots. Really appreciate it. Yeah,
Speaker 1: that was great pleasure. Thank you. So Joe. Are you
Speaker 1: looking forward to your dystopian city future in New York?
Speaker 1: I am. You know what. I took a lock yesterday,
Speaker 1: uh sort of my first day sort of really exploring
Speaker 1: because I was doing my required two weeks quarantine and
Speaker 1: I don't know, it didn't feel I don't know. I
Speaker 1: was not as alarmed as as other people were by
Speaker 1: the state of the by the state of the city.
Speaker 1: There weren't like people driving around in weird trucks and
Speaker 1: wearing like masks and stuff like Matt Max and flamethrowers,
Speaker 1: like people all the news and blogs like talking about
Speaker 1: what a dystopian anarchy is New York. Mostly, it just
Speaker 1: sort of seemed kind of quiet. Okay, yeah, that's not
Speaker 1: quite anarchy, is it. Um? All right, Well, I really
Speaker 1: enjoyed that conversation with Ethan um. It's great to talk
Speaker 1: to someone who invented uh CMBs, obviously, but beyond that,
Speaker 1: one thing that I always find fascinating in all these
Speaker 1: conversations about real estate is the mind, the mechanics of
Speaker 1: it and the different incentives of all the players involved,
Speaker 1: and I thought he laid those out really well when
Speaker 1: it came to uh C MBS, the difference between traditional
Speaker 1: lending versus having a group of private bond holders, and
Speaker 1: also the interests of the special services. That's great. That
Speaker 1: was really interesting and I haven't thought about that at all,
Speaker 1: and it's it also seems it's extremely important to sort
Speaker 1: of have a feel for all these different incentives right
Speaker 1: now because of this sort of requirement at least in
Speaker 1: the short and medium term, that um, you know, the tenants,
Speaker 1: the underlying tenants be given some sort of break, right
Speaker 1: because if a bunch of stores were to just completely
Speaker 1: board up and go out of business, then that could,
Speaker 1: you know, crush a neighborhood for a long time. Whereas
Speaker 1: if they're allowed to hang on for four months or
Speaker 1: six months or maybe even a year as we get
Speaker 1: a vaccine and life returns to something resembling normal, that
Speaker 1: maybe they can but up and some sort of normalcy
Speaker 1: can exist. But everyone in that chain has some sort
Speaker 1: of incentive. And do landlords hold out for maximum rents
Speaker 1: and can the landlords renegotiate with the lenders so that
Speaker 1: they have time to give their tenants to break just
Speaker 1: sort of all kinds of complications just to get through
Speaker 1: what it's going to be an extremely complicated time. Absolutely,
Speaker 1: and again it kind of makes you, well, you asked
Speaker 1: about price discovery in this market, and it really makes
Speaker 1: you think about how much of that is going on,
Speaker 1: given the timeline is involved, and given the fact that
Speaker 1: a lot of transactions just aren't happening at the moment.
Speaker 1: Shall we leave it there, Let's leave it there, all right.
Speaker 1: This has been another episode of the ad Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway and I'm Joe wisn' though. You can follow
Speaker 1: me at The Stalwart and follow our producer Laura Carlson
Speaker 1: at Laura M. Carlson. Follow the Bloomberg Head of Podcasts,
Speaker 1: Francesca Levi at Francisco Today, and check out all of
Speaker 1: our podcasts at Bloomberg under the handle at podcasts. Thanks
Speaker 1: for listening.