The Urban Land Institute needs to be a fixed point where one can look for aid in avoiding the incrementalism of bad practice and misaligned values. The goal needs to be one of honoring not just the land, but also one another as professionals.
An allegory for the financial industry’s present condition might be that of a red-tailed hawk soaring above the Manhattan skyline, flying at full speed toward the sheer wall of a glass-enclosed skyscraper—and relying on the transparency of the glass for protection from undue risk. The crisis occurs, and the bird falls fluttering to the ground with a broken wing.
Is this the bird’s fault? Is it a law of nature? Should the glass have etching or cross ribs to alert the bird to the danger? Can the bird recover? Can it recover by itself, without outside help? Will it ever soar again? Will it ever fly again with uninhibited grace? What resources should be applied to its recovery? Is it too rare a bird to fail?
A number of proposals have been suggested to alleviate the current financial crisis in order that we all may soar once again. Several are suggested in a new book, Ending Government Bailouts, by George P. Shultz, a former U.S. treasury secretary, and John Taylor, a former undersecretary of the treasury. The proposals are aimed at making failure tolerable. We still need a better diagnosis of exactly what imperfections are in our system that we are attempting to ameliorate.
We need better systems to define and measure systemic risk. We need preexisting processes to deal with failure, rather than bailouts, including a better bankruptcy process for resolving failed institutions. We need agreed-upon procedures that keep government intervention from making the crisis worse, such as the Lehman Brothers intervention. We need to define better which institutions have access to the U.S. Federal Reserve for loans and guarantees. We need to avoid overregulation and complexity. Finally, we need to continue to rely on the underlying market system. Others have suggested requiring issuers of securities to retain an ownership slice, thus keeping some “skin in the game,” as well as a slowing down of the offering process for new securities to provide for greater due diligence.
We appear to be living in a period of post-crisis anarchy. Imagine you are charged with strategic planning for a major financial institution. In order to come up with a three-year business plan, you need to have answers to the following questions:
- What is my capital structure?
- What is my financial leverage?
- What is my target return on equity?
- What lines of business will I be in?
- Will I be allowed to do proprietary trading?
- What reserves will I need to set aside for certain classes of assets?
- How do I measure systemic risk in my business?
- How do I derive compensation structures to attract and retain talented professionals?
- What level of corporate taxes will I pay?
- Will there be an estate tax?
- What are taxes on unearned income?
- What are my health care costs?
- Who will regulate me?
- What will the rules be?
- Should I remain a bank holding company?
- Will I be forced to use mark-to-market accounting?
- Am I too big to fail?
- What should my dividend policy be?
- How should I position my common stock as an investment?
- Are my earnings fee-driven and stable or are they trading-driven and volatile—or some combination of the two?
- How can one plan in such an uncertain environment?
At present, banks are benefiting from the interest spread between low-cost customer deposits and federal funds and the risk-free return on medium-term Treasuries. Banks are not being forced to mark to market distressed loans that are not impaired and are stated to be held to maturity. Even under such benevolent conditions, some 500 banks are predicted to be soon taken over by the Federal Deposit Insurance Corporation. There remains about $300 billion of maturing commercial real estate debt over each of the next five years, with virtually no way, at present, to refinance.
How did we come to such a state? As long as four years ago at a ULI finance seminar, warnings were given as to the relaxation of loan-to-value requirements, “no document” single-family home mortgages, and numerous other signs of excess in the system. At the advent of linkages of real estate credit to the capital market system 30 years ago, there were no rating agency reviews of real estate debt. Major institutional buyers of such debt performed their own detailed analysis of each mortgage and formed their own view as to creditworthiness. As financial institutions were caught up in the bubble, emphasis was placed on speed over care, and overwhelmed rating agencies were used as a shortcut and a crutch.
In the absence of leadership and firm conviction, sloppy behavior (failure to perform due diligence) became bad practice (no-document loans), leading to violations of civil law and regulations (breakdown of the Chinese wall” and trading short, newly issued securities that a firm was sponsoring), and ultimately to criminal behavior (fraud in mortgage applications).
With no fixed reference point, the real estate finance industry went careening down the road to ruin. Billion-dollar portfolios were flipped overnight at valuations that any professional knew were excessive. Customers were no longer viewed as the basis of a service business franchise, but rather as targets of opportunity to be traded against. The core values of the business were heedlessly discarded. To be a profession, a line of business must have an underlying ethic. It must provide enhanced value to its customers, and the primary goal should not become self-aggrandizement. As J.P. Morgan testified to the Pecora Congressional Commission in 1932: “We do only first-class business—and that in a first-class way.”
ULI has a solid underlying ethic of responsible land use. For many years, the Institute has attempted, through the same finance seminar and through other means, to sound an early warning of market excesses. The warning was given this time around, but everyone was so caught up in the game that no one seemed to be listening. Perhaps the Institute should become more active in promulgating findings that come about through such seminars, meetings, and research.
As a leading real estate professional organization, as well as a convener of real estate talent, ULI should be a place where we encourage and reinforce values and help repair broken wings. We should attempt to avoid the cynicism of “the deal” at any cost and encourage respect for one another, our clients, and the process itself. We should honor those who participate in the process of improving the built environment in a manner that adds to the character and trust of our profession. There are members of ULI who have been trusted friends for 35, even 50 years. We need to validate those trust relationships. If we model excellence and integrity, the financial rewards are sure to follow. The Institute needs to be a fixed point where one can look for aid in avoiding the incrementalism of bad practice and misaligned values. We need to honor not just the land, but also one another as professionals.
Meanwhile, this high-flying, rare bird must be saved to soar again another day. The key to understanding real estate is to understand the cycles. There is a series of discontinuous cycles—the public market pricing cycle, the private market pricing cycle, the interest rate cycle, and the localized real estate supply-and demand cycles. General economic cycles overlay the specifically real estate cycles. A way to understand real estate—and make a fair amount of money from it—is to keep an eye on all these cycles as they play out in relation to one another, creating pricing and value anomalies as well as opportunities for profit.
So, enjoy the cycles and try to think a half cycle ahead at all times. Most important, be sure to bring your moral compass along with you.