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Fed Holds Steady on Strategy; Cites ‘Pause’ in Growth

January 30, 2013 by Leave a Comment

WASHINGTON — The Federal Reserve, noting that economic growth had “paused” in recent months, said Wednesday that it would continue its efforts to stimulate the economy for as long as it deemed necessary.

The Fed attributed the pause in growth to the impact of Hurricane Sandy and other “transitory factors,” and it said that there were some signs of increased strength in areas including consumer spending and housing.

It affirmed the stimulus program it announced in December, saying that it would hold short-term interest rates near zero at least until the unemployment rate fell below 6.5 percent and expand its holdings of Treasury securities and mortgage-backed securities by $85 billion each month.

“The committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline,” the central bank said in a statement released after the conclusion of a two-day meeting of its policy-making committee.

The decision was supported by 11 of the 12 members of the Federal Open Market Committee. Esther George, president of the Federal Reserve Bank of Kansas City, was the only dissenter, citing concerns about economic stability and inflation.

The Fed announcement came hours after the government reported that economic growth was unexpectedly weak in the fourth quarter. The Commerce Department said that the economy contracted by 0.1 percent, the first decline since 2009.

For the year, the economy grew by 2.2 percent – a decent pace in normal times, but not fast enough to help the millions of Americans still unable to find work.

The central bank is trying to increase economic activity by holding down interest rates and reducing the availability of safe assets like Treasury bonds, pushing investors to take larger risks and reducing borrowing costs for businesses and consumers.

Officials have pointed to increased sales of cars and homes as evidence that the policy is working, but they also have sought to temper expectations, warning in particular that monetary policy cannot offset reductions in government spending.

Indeed, the unemployment rate has not declined since the Fed launched its latest round of purchases in September. The rate was 7.8 percent in December, the same as four months before. The government will report the rate for January on Friday.

Fed officials also are wrestling with the potential costs of further expanding the central bank’s vast investment portfolio.

Some critics warn that the Fed’s efforts will loosen its control over inflation, but those warnings so far have come to nothing. Inflation has actually fallen below the 2 percent annual pace that the Fed regards as healthy, leading some officials to argue the economy could use a little more inflation.

Fed officials say that they are more concerned that asset purchases will destabilize financial markets, by removing safe assets from circulation, increasing the volatility of prices, or encouraging too much speculation.

In December, the Fed said that it would purchase Treasuries at an initial pace of $45 billion a month, adding to the commitment it made in November to buy $40 billion a month in mortgage-backed securities.

Mr. Bernanke underscored at a news conference following the announcement that the Fed might adjust the volume of purchases.

“The committee intends to be flexible in varying the pace of securities purchases in response to information bearing on the outlook or on the perceived benefits and costs of the program,” Mr. Bernanke said then.

At the time, some analysts saw evidence that the Fed already was contemplating the possibility that it was doing too much. That impression was reinforced by an account of the meeting released a few weeks later that said some officials wanted to reduce the pace of purchases by the summer.

But it would be relatively easy for the Fed to do less. The more worrying possibility is that the economy might need additional help, forcing the Fed to consider whether it is able to do more – and whether it should.

Article source: http://www.nytimes.com/2013/01/31/business/economy/fed-says-growth-has-paused-holds-steady-on-rates-and-strategy.html?partner=rss&emc=rss

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Fed Returns $77 Billion in Profits to Treasury

January 11, 2012 by Leave a Comment

WASHINGTON — The Federal Reserve said on Tuesday that it contributed $76.9 billion in profits to the Treasury Department last year, slightly less than its record 2010 transfer but much more than in any other previous year.

The Fed is required by law to turn over its profits to the Treasury each year, a highly lucrative byproduct of the central bank’s continuing campaign to stimulate economic growth.

Almost 97 percent of the Fed’s income was generated by interest payments on its investment portfolio, including $2.5 trillion in Treasury securities and mortgage-backed securities, which it has amassed in an effort to decrease borrowing costs for businesses and consumers by reducing long-term interest rates.

Through those purchases, the central bank has become the largest single investor in federal debt and securities issued by the government-owned mortgage finance companies Fannie Mae and Freddie Mac. As a consequence, most of the money flowing into the Fed’s coffers comes from taxpayers.

But Fed officials note that this cycle — payments flowing from Treasury to the Fed and then back to the Treasury — still saves money for taxpayers because those interest payments otherwise would be made to other investors.

“It’s interest that the Treasury didn’t have to pay to the Chinese,” the Fed’s chairman, Ben S. Bernanke, half-jokingly told Congress last year.

The scale of the transfers grew rapidly after the financial crisis.

The Fed made an average annual contribution to the Treasury Department of $23 billion during the five years preceding the crisis. In the years since 2007, the Fed’s average contribution has more than doubled to $54 billion.

The Fed transferred $79.3 billion in 2010. Its investment portfolio grew again in 2011, approaching $3 trillion, but profits fell modestly as the Fed reduced some more lucrative holdings, like its support for the insurance company American International Group, and expanded its holdings of low-yield government debt.

Notwithstanding its conservative investment portfolio, the central bank remains highly profitable because of its unique business model. Rather than paying for funding, it simply creates the money that it needs at no cost. The return on its investments, as a result, almost all flows directly to the bottom line.

Still, the model is not foolproof. The Fed could decide to undermine its own profitability if it concluded that the pace of inflation was increasing. Fed officials have said that they would respond to inflationary pressures through a combination of selling assets and raising short-term interest rates, which would have the effect of undercutting the value of those assets just as they were being sold. The Fed also could conclude that it needed to pay higher interest rates to banks that keep reserves on deposit with the central bank, to discourage withdrawals of that money.

In addition to the money sent to the Treasury, the Fed spent $4.5 billion on its own operations, including its expanded role as a regulator of the largest financial companies. The 2010 law overhauling financial regulations also requires the Fed to provide funding for two new agencies, the Consumer Financial Protection Bureau and the Office of Financial Research. The bill totaled $282 million last year. Other federal financial regulators are financed by the industries that they oversee. Both systems are intended to shelter regulators from political pressure.

The results reported Tuesday are preliminary. The 12 regional banks that compose the Federal Reserve system will publish final financial results in a few months. If there is a change in estimated profits, the Fed will adjust the amounts that it pays to the Treasury this year. The contributions are made weekly.

Article source: http://feeds.nytimes.com/click.phdo?i=73c09c03edfafde7c8e845a656178516

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The Fed Will Publish a Forecast on Rate Moves

January 4, 2012 by Leave a Comment

The change was approved at the most recent meeting of the Fed’s policy-making committee, in December, but was kept secret until Tuesday afternoon, when the Fed released an account of the meeting after a standard three-week delay.

The inaugural forecast, set for Jan. 25, will show the range of predictions made by Fed officials about the level of short-term interest rates in the fourth quarter of 2012, 2013 and 2014, although it will not list individual predictions.

It also will summarize when they expect to start raising short-term rates, which they have held near zero since late 2008. And it will describe their plans for the Fed’s investment portfolio.

The forecast could reduce borrowing costs for businesses and consumers by convincing investors that the Fed intends to keep rates near zero for longer than expected. But the benefits most likely would be modest, as rates already are very low and already are widely expected to remain near zero into 2014.

A more significant possibility, is that the changes will set the stage for the Fed to announce an expansion of its existing economic aid campaign, for example, by once again increasing its purchases of Treasuries and mortgage-backed securities.

According to the meeting minutes, “a number of members” of the 10-person committee “indicated that current and prospective economic conditions could well warrant additional policy accommodation, but they believed that any additional actions would be more effective if accompanied by enhanced communication.”

This, however, is unlikely to have any broad impact on the economy, because the Fed lacks the power to address the most important issues weighing on growth, including a lack of demand from gloomy consumers, high levels of debt throughout the economy and the depressed condition of the housing market. Stock traders took the Fed’s announcement in stride as indexes continued their rise in the first day of trading in 2012.

The Standard Poor’s 500-stock index closed up 1.6 percent. The Fed’s staff, which prepares an economic forecast noted for its unusual accuracy in an uncertain business, reduced its medium-term outlook for growth, citing the impact of events in Europe, according to the minutes.

“The Fed’s core problem right now is that the parts of the economy through which those interest rate effects would normally get traction are blocked,” said Vincent Reinhart, chief United States economist at Morgan Stanley and a former senior Fed staff official. “It is not clear how effective any of these policies will be.”

The change in communications policy is part of a broader effort by the Fed’s chairman, Ben S. Bernanke, to improve public understanding of the central bank’s goals and methodology. It formalizes a series of experiments with forecasting that the Fed has made in recent years, beginning with its statement in December 2008 that rates would remain near zero “for some time.”

Talking about future policy was a longstanding taboo among central bankers, who worried that investors would treat the predictions as promises and react badly when some predictions inevitably were off base. But the Fed now is casting its lot with the growing camp that regards shaping expectations as a primary tool for monetary policy, and is eager to seize any opportunity.

The forecast will summarize the predictions of the Fed’s five governors — two seats on the board are vacant — and the 12 presidents of its regional banks, only five of whom hold votes on the committee at a given time. It will be included in an existing forecast of economic conditions — the rates of growth, inflation and unemployment — that the Fed publishes four times a year.

In presenting those forecasts, the Fed excludes the three highest and the three lowest estimates submitted by the officials. It then reports the highest and lowest predictions among the remaining 11 forecasts, showing a range that it describes as the “central tendency.”

For example, the forecast published in November, showed the committee expected growth of 2.5 percent to 2.9 percent in 2012.

The Fed also will publish what it described as “qualitative information” regarding the committee’s expectations about the management of the Fed’s balance sheet.

The Fed’s plans for buying or selling assets are, at present, of even greater interest to most investors than the path of short-term interest rates.

Support for the changes was not unanimous, according to the minutes, which said that some “did not see providing policy projections as a useful step at this time.” But no formal vote was recorded. Instead, the minutes reflect that the participants — not just the 10 members with votes — reached a consensus.

Article source: http://feeds.nytimes.com/click.phdo?i=ef751cea62ea4695213334237bc6448a

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High & Low Finance: Deloitte’s Failings Revealed, but Only After More Than 3 Years

October 21, 2011 by Leave a Comment

They should have drilled into allowances for loan losses, and they should have been especially alert for signs that the banks were playing games when they sold loans. Auditors should have carefully reviewed how the banks were valuing their mortgage-backed securities and loans that they planned to sell.

It won’t surprise you to learn that in at least one case, the auditor seems to have done a pretty poor job.

What may be surprising is that the Public Company Accounting Oversight Board figured that out at the time, and was harshly critical of Deloitte Touche, one of the Big Four audit firms, for not doing the work to check assumptions in those areas and for being overly reliant on whatever the bank’s management said was proper.

Those comments were made after the board’s inspectors reviewed Deloitte’s audit of a bank’s 2006 results, as part of the annual inspection of the firm. The inspection of 61 Deloitte audits concluded in November 2007.

Had the auditor taken the criticism to heart, it might have gone back in and checked more thoroughly.

But it did not.

The bank was not named in the report, even in the previously confidential part released this week.

I thought it might have been Washington Mutual, a Deloitte client that collapsed in September 2008, but Deloitte says that was not the case.

Deloitte, in its response to the board, stated that at the bank, “the audit procedures performed, the conclusions reached and the related documentation were appropriate in the circumstances.”

In other words, Deloitte concluded the board simply did not understand what it was talking about.

All that became public in early 2008, when the censored version of the board’s report became public. But it was little remarked on at the time. Now we have seen the rest of the report, and it is even more critical.

The report said its inspections indicated “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.”

Deloitte responded by denying almost everything. It did not like the “second guessing” shown by the regulators. It said “we strongly take exception” to the observation about its culture, which it said was simply wrong.

In any case, the firm concluded, “there were only a limited number of instances,” not nearly enough to justify questioning Deloitte’s quality controls.

The board inspectors found problems in 27 of the 61 Deloitte audits.

The Sarbanes-Oxley law that established the board included provisions to protect the public images of audit firms. If a board inspection found problems with the quality control systems, that was to be kept confidential unless the firm did not move to fix the problems over the following year. Then the release could be delayed while the firm tried to persuade the board to keep the information private. If that effort failed, the firm could appeal to the Securities and Exchange Commission.

Only then could the report be made public. So in this case, it took 41 months from the issuance of the report — more than three years — for Deloitte’s clients to learn of the problem.

The board also has the authority to file enforcement actions against auditors, but those, too, are private until the S.E.C. rules on an appeal. It is as if charges of robbery had to be kept confidential until all appeals had been completed. There is no way to know if the accounting board has taken action against anyone. An auditor that the board deems to be in violation of rules may keep working for years while secret proceedings continue.

Firms have every incentive to stall, and then to say that whatever is being criticized happened years ago.

Deloitte’s current chief executive, Joe Echevarria, tried to sound cooperative in his response this week, and was careful to point out he was new on the job. A Deloitte spokesman said that Barry Salzberg, the chief executive when Deloitte sent the response letter in 2008, was traveling in Asia and unavailable for comment.

Mr. Echevarria emphasized in an interview that the firm was investing in training, and spoke of a desire to be the leader in audit quality.

Article source: http://feeds.nytimes.com/click.phdo?i=7bb1461d1a2e028479956719f92f9d4f

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Fed Moves to Push Down Long-Term Rates

September 21, 2011 by Leave a Comment

In extending its campaign of novel efforts to shake the economy from its torpor, the Fed said that it was responding to evidence that there was a clear need for help.

“Growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions and the unemployment rate remains elevated,” the Fed said in a statement that listed its reasons for worry about the anemic condition of the American economy. “Household spending has been increasing at only a modest pace in recent months.”

The central bank said in a statement that the program was aimed at reducing the cost of borrowing for businesses and consumers, including the cost of mortgage loans. It hopes that the lower rates will encourage companies to build new factories and hire more workers, and consumers to start spending again on homes and cars and clothes and vacations.

Specifically, the Fed said that by June 2012 it would sell $400 billion in Treasury securities with remaining maturities of less than three years and purchase roughly the same amount of securities with maturities longer than six years. It said the result would move the average maturity of the bonds it holds to about 100 months from 75 months.

In the bond market Wednesday, the yield on 10-year Treasury notes did indeed fall after the announcement, to 1.88 percent from 1.94 percent, while the 30-year bond yield dropped to 3.02 percent from 3.20 percent. Stocks on Wall Street were down about 1.7 percent in afternoon trading.

Separately, the Fed said it would resume direct efforts to help the mortgage market by reinvesting the proceeds of its existing investments in mortgage-backed securities into new mortgage-backed securities, rather than putting the money in Treasuries.

Three members of the Fed’s 10-member policy-making committee dissented from the decision: Richard Fisher, president of the Federal Reserve Bank of Dallas; Charles Plosser, president of the Federal Reserve Bank of Philadelphia; and Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. The members were the same who opposed the Fed plan announced in August to hold short-term interest rates near zero until at least 2013.

The new effort is an experiment without a direct precedent, although the Fed tried something similar in the 1960s. Essentially, by shifting its money into riskier investments, the Fed hopes to drive down rates without expanding the size of its portfolio, as it has done twice in recent years. By reducing the supply of long-term Treasuries, the Fed intends to force investors to accept lower rates of return on a wide range of riskier investments.

Economists project that the effort could reduce interest rates by a few tenths of a percentage point, a significant increment when multiplied by the vast extent of borrowing. The forecasting firm Macroeconomic Advisers estimated in advance of the Fed’s announcement — based on its best guess about the details of such a program — that the Fed’s efforts could add about 0.4 percentage points to economic output and create about 350,000 jobs.

The Fed already is engaged in an enormous effort to stimulate growth. The central bank has held short-term interest rates near zero since December 2008. To further reduce long-term rates, it has amassed more than $2 trillion in government debt and mortgage-backed securities. And the Fed announced after the most recent meeting of its policy-making committee in August that it intended to hold short-term interest rates near zero until at least the middle of 2013.

The Fed had previously said only that it would maintain rates near zero for an “extended period,” and a new study by the Federal Reserve Bank of Cleveland found that the change in language had a significant impact. Specifically, by convincing investors that short-term rates would remain low, the Fed succeeded in lowering long-term rates — which are based in large part on expectations about the level of short-term rates throughout the longer period. Rates on the benchmark 10-year Treasury note, for example, declined by about 0.20 percentage points, the study found.

Article source: http://www.nytimes.com/2011/09/22/business/fed-to-shift-400-billion-in-holdings-to-spur-growth.html?partner=rss&emc=rss

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Stocks & Bonds: Stocks Trim the Day’s Deepest Losses

September 7, 2011 by Leave a Comment

Analysts said that Wall Street’s drop was also a carryover from last week’s disappointing report on United States unemployment and from news that major American banks were facing a federal lawsuit related to their handling of mortgage securities.

While stocks slumped in early trading by about 3 percent, they curbed losses toward the end of the day. The Dow Jones industrial average of 30 stocks was down 0.9 percent, or 100.96 points, to 11,139.30. The Standard Poor’s 500-stock index lost 0.7 percent, or 8.73 points, to 1,165.24, The Nasdaq composite fell 0.3 percent, or 6.50 points, to 2,473.83.

Investors stayed with the security of fixed-income instruments. The Treasury’s benchmark 10-year note rose 3/32, to 101 9/32. The yield fell to 1.98 percent from 1.99 percent late Friday.

“The whole market is under pressure because of what is going on in Europe,” said Jason Arnold, a financial analyst with RBC Capital Markets.

The equity losses were reminiscent of those on Friday, when the Labor Department reported zero job growth in the United States economy in August. In addition, the market reacted to reports of impending legal action by federal regulators against 17 financial institutions that sold Fannie Mae and Freddie Mac nearly $200 billion in mortgage-backed securities that later soured. Investors fled financial shares, and on Tuesday the sector continued to be hit hard, closing 1.7 percent lower.

Bank of America and JPMorgan Chase each declined more than 3 percent. Bank of America fell to $6.99 and Chase to $33.44. Citigroup fell 2.5 percent to $27.70. Morgan Stanley was down nearly 4 percent at $15.33

Bank stocks, which are particularly sensitive to prospects for lending and housing, are seen as being at additional risk because of regulatory and legal issues after the lawsuits were filed on Friday. “There really has not been particularly good news in the financial space for a while,” Mr. Arnold said. “It is just waning optimism for financials.”

But most of the focus in the markets has been on the lack of progress in solving persistent euro zone debt problems, which “is creating a pocket of selling with no buyers,” said Alan B. Lancz, the president of Alan B. Lancz Associates. In addition, investors are concerned about the impact on global growth of weak economic data.

The market turmoil of recent weeks showed no signs of letting up. On Tuesday, gold rose to another nominal high, and Swiss authorities took action to weaken the franc, which has soared because of its role as a haven.

In the United States, economic data was scrutinized for any sign of strength in the country’s recovery. The Institute for Supply Management said Tuesday that the services sector of the economy expanded in August, the 21st consecutive month it has done so, as reflected in the 53.3 reading of the I.S.M. nonmanufacturing index, although expansion in some sectors, like business activity, was slowing down.

The survey exceeded forecasts assembled by Bloomberg News that pointed to a reading of 51. A reading of 50 is meant to be the dividing line between an expanding economy and a contracting one.

Debt concerns related to the euro zone, particularly over Greece and Italy; the bank lawsuits in the United States; and worries about economic growth were the biggest factors damping prices, Michael A. Mullaney, vice president of the Fiduciary Trust Company, and other analysts said.

“Friday set the tone with the employment report,” Mr. Mullaney said. “We are basically hard struck to find out where the growth engines are going to come from.”

The conditions were worryingly similar to those of the sell-off that followed the collapse of Lehman Brothers in 2008, Deutsche Bank’s chief executive, Josef Ackermann, said Monday.

In Zurich, the Swiss National Bank said it was setting a minimum value of 1.20 francs per euro and was prepared to spend an “unlimited” amount to defend it. The central bank was acting to help the country’s exporters, who fear being priced out of foreign markets by the strong franc.

Asian and European markets were lower. Gold futures eased slightly to $1,869.90 an ounce after rising more than 1 percent to more than $1,900 an ounce in Comex trading.

David Jolly and Bettina Wassener contributed reporting.

Article source: http://feeds.nytimes.com/click.phdo?i=82e4a9919b53ccca2189c8a252e672fd

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Credit Agency Tells Congress a Default Is Unlikely

July 28, 2011 by Leave a Comment

The official, Deven Sharma, president of Standard Poor’s, added that deficit-reduction plans currently being considered in Congress could be enough to allow the United States to keep its triple-A credit rating.

But Mr. Sharma declined to specify what level of cuts would be needed to maintain the top-level credit rating.

He said news articles last week “misquoted” a July 14 S. P. report as saying that Congress would need to achieve at least $4 trillion in spending cuts over 10 years to maintain the country’s triple-A rating.

A cut of $4 trillion, a number that is cited in the S. P. report and that has been the focus of concern on Wall Street over the last two weeks, was “within the threshold” of what S. P. thinks is necessary, Mr. Sharma said. But he declined to draw a bright line, saying only that “some of the plans” currently being considered on Capitol Hill “could bring the U.S. debt burden and the deficit level in the range of a threshold for a triple-A rating.”

The remarks came at a hearing by the Oversight and Investigations Subcommittee of the House Financial Services Committee. The hearing was scheduled to examine the performance of the major credit ratings agencies since changes in policies affecting the companies were instituted as part of the Dodd-Frank Act.

The credit ratings agencies were sharply criticized after the financial crisis for offering top-level ratings on billions of dollars of mortgage-backed securities that later lost substantial value when the housing market collapsed.

But the hearing quickly turned to the issue of what would happen if the nation were unable to meet its obligations because Congress did not raise the federal debt ceiling.

Pressed by Representative Scott Garrett, a New Jersey Republican, on whether the deficit-reduction plans put forth by the Obama administration or Senate Democrats would be sufficient to maintain the country’s credit rating, both Mr. Sharma and Michael Rowan, global managing director in the commercial group of Moody’s Investors Service, declined to comment.

Banking regulators who testified at the hearing were less hesitant to give their views about how a downgrade of the country’s credit rating would affect the financial markets and banks.

David K. Wilson, senior deputy comptroller and chief national bank examiner in the Office of the Comptroller of the Currency, said that members of Congress were “right to worry” about the possible unknown effects of a downgrade.

At the least, he said, borrowers would have to increase the amount of Treasury securities they offered as margin, or collateral for loans. A downgrade of the country’s credit rating would probably also be followed by lower ratings on state and local government debt, he said.

Any difficulties would be “manageable in the short term” because even a downgrade to AA from the current AAA rating would still mean that Treasuries were “very high-quality securities,” Mr. Wilson said. The long-term effects of a ratings downgrade, he added, were unknown.

Asked by Representative Brad Miller, a Democrat from North Carolina, if he were “right to worry that this could be real bad if our debt were downgraded,” Mr. Wilson replied, “You know, it’s hard to measure, but I think you’re right to worry. I mean, it could happen. It could be a big thing.”

Representatives from the Federal Reserve, the Securities and Exchange Commission and the comptroller’s office all said they believed that the credit rating agencies were doing a better job of accurately assessing risks in their credit ratings now than they were before the financial crisis.

However, Mark E. Van Der Weide, senior associate director in the division of banking supervision and regulation at the Federal Reserve, said “the crucial thing is that no matter how good we think they’re doing, we not over-rely on them — not the government, not the private sector.”

Republican members of the panel also asked Mr. Sharma whether Treasury Department officials had pressured the company not to downgrade the United States credit rating.

In an April 27 letter to the Treasury secretary, Timothy F. Geithner, Representative Randy Neugebauer, a Texas Republican who is chairman of the oversight subcommittee, questioned the appropriateness of the government protesting ratings changes “given its regulatory and oversight role over the agencies.”

In a June 13 response, Mr. Geithner said the department had “entirely appropriate” contacts during the ratings review process with Standard Poor’s, which, he noted, “we do not regulate or oversee.”

Mr. Sharma told the committee that its contacts with Treasury, which included the sharing with the department a draft news release about S. P.’s decision to put the United States’ credit ratings under review for a possible downgrade before the move was announced to the public, were “standard operating process.”

This article has been revised to reflect the following correction:

Correction: July 27, 2011

An earlier version of this article incorrectly said that officials from two credit rating agencies said the United States was unlikely to default.

Article source: http://feeds.nytimes.com/click.phdo?i=686b7e4bcf3cbd5f30e2f07161f46ee4

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Square Feet: Commercial Lenders Take Step Into Riskier Deals

June 29, 2011 by Leave a Comment

An increasing number of financial institutions are vying to make loans on commercial real estate now. But many buildings are still drowning under heavy debt loads, leaving few properties that can support new borrowing. This means that banks, insurance companies, hedge funds and others are competing fiercely to underwrite the few viable loans that are available. Because of the competition, some lenders have begun to compromise their underwriting standards, say ratings agencies and market professionals.

“We are deeply concerned,” said Tad Philipp, the director of commercial real estate research for Moody’s Investors Service. “Underwriting standards have gone from very good in 2010, to just O.K. this year, and we want to make sure they don’t drift into risky territory.”

Commercial loans are big business. At the peak of the market, in 2007, commercial mortgage-backed securities, which are bonds backed by pools of commercial real estate loans, were a $243 billion market, according to the research company Trepp. The market then stalled and reached a nadir in 2009 with only $2.4 billion in issuance. The market began to thaw last year and 12 deals totaling $12.6 billion were completed. Most of the loans underwritten last year consisted of top properties in prime markets, where there was very little risk of default.

This year, the deals have picked up significantly. So far, there have been 16 deals for $16.8 billion, Trepp said. Some of these deals include properties in Oklahoma and Kansas, and even hard-hit markets like Florida and California. Some of the assets are also less stable, with lenders underwriting deals for mobile home parks and self-storage units.

At the same time, metrics used to judge possible defaults are indicating more risk. Increasingly, appraisers are taking into consideration higher future rents and occupancy rates, rather than using only current figures. Inflated appraisals were common during the market peak but disappeared after the crash. There are also more interest-only loans, where the borrower pays interest on the loan but does not pay down the principal, with a large balloon payment due at the end of the term.

Appraisers say their figures are not inflated, but rather reflect the improving market in some areas of the country. “It is important to point out that commercial real estate is a two-tier market: there are distressed properties and markets and premier properties and markets,” said Leslie Sellers, the 2010 president of the Appraisal Institute, an industry group that has more than 24,000 members. Appraisers are accounting for a rosier future in only those top-tier markets, he said. “If we didn’t do that, we would be remiss.”

A sharp increase in the number of commercial real estate lenders is mostly driving the surge in mortgage-backed securities. Large banks like Bank of America, Citigroup and Goldman Sachs have resurrected their commercial mortgage-backed securities, also known as C.M.B.S., lending again after the downturn, while new players have also entered the market, like Cantor Fitzgerald and the hedge fund giant Citadel.

“Banks need to generate earnings, but they aren’t underwriting many new mortgages or other loans, so securitization is a very attractive option,” said K. C. Conway, the executive managing director of real estate analytics at Colliers International.

Insurance companies and foreign investors are also lending as they look to rotate into hard assets and out of cash and other investments that are vulnerable to inflation, Mr. Conway said. In the search for hard assets, the commercial real estate market is attractive because it is widely perceived to have bottomed out.

Yet there are only a relatively small number of properties that are not highly leveraged and in a position to borrow funds. According to Trepp, over one trillion dollars’ worth of commercial real estate loans due in the next five years are still underwater, meaning the market value of the properties is less than their debt.

“It is the classic scenario of too many dollars chasing too few deals,” said Peter J. Mignone, a partner at the New York office of the law firm SNR Denton.

With so few opportunities, lenders are facing multiple pressures. To create bonds, they must pool together several commercial loans, but with so few strong borrowers, “their only choice is to leave the primary markets and look to the secondary and even tertiary markets to fill up these loan pools,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University.

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Economix: Should You Worry About a U.S. Default?

April 20, 2011 by Leave a Comment

Carmen M. Reinhart says ratings agencies have a poor track record in predicting financial crises.Mary F. Calvert for The New York Times Carmen M. Reinhart says ratings agencies have a poor track record in predicting financial crises.

Standard Poor’s, the ratings agency, lowered its outlook for the United States to “negative” on Monday, a warning that the country’s top-notch, triple-A credit rating may be lowered. Credit ratings are supposed to give crucial insight into a debtor’s likelihood of default, so a lot of investors and pundits made a big deal about this announcement.

Given the lackluster job that S.P. and other agencies did in rating mortgage-backed securities before the financial crisis, some critics have questioned the relevance of the agency’s latest pronouncement. But the toxic-assets track record aside, there are other reasons to discount this latest S.P. call.

In a recent interview, the financial crisis historian Carmen M. Reinhart said that ratings agencies had historically done a poor job at predicting sovereign debt defaults, currency collapses and other financial crises.

That is because, as she wrote in her paper, “Default, Currency Crises, and Sovereign Credit Ratings,” ratings agencies — like so many other professional forecasters — tend to focus on the wrong variables in calculating their ratings. In other words, S.P.’s announcement may not actually tell us very much.

Whatever the historical record of ratings agencies, markets nonetheless reacted strongly. And today the Obama administration has come out in full force to reassure investors.

As my colleague Christine Hauser wrote, Treasury Secretary Timothy F. Geithner tried to soothe foreign investors who might be concerned about the security of United States debt.

Mr. Geithner offered the following words of comfort: “Look at the price at which we borrow.” In other words, don’t worry, because interest rates are still joyously low.

But run this observation by economic historians, and you will find that it also provides little assurance.

In other research Professor Reinhart has found that that interest rates are surprisingly bad at predicting debt crises in the near future. The painful rise in the cost of borrowing that is typical in a sovereign debt crisis often comes on extremely suddenly, Professor Reinhart says. (After all, the assumption that just because things have been trending a certain way for a long while means they will stay that way forever is exactly the kind of logic that led to the housing bubble.)

In other words, there are a lot of things to pay attention to when you are trying to predict whether the United States is likely to default. Unfortunately, despite what you may have read lately and seen in the markets, sovereign credit ratings and current interest rates may not actually lend you that much insight.

Article source: http://feeds.nytimes.com/click.phdo?i=18d107a88d1f7e29f1d4bd3f85acb0a0

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