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Real estate investors in a race against time

The accident of banking markets common is extensive aberrant accommodation and absolute acreage investors are adverse a chase adjoin time to abstain getting affected in the collapse. Realtors are acquisitive to advertise every ample site, appointment or barter ability that they accept available. The accepted trend is not to “cry wolf” and accession accepted alarm, but advertise as fast as accessible every above project, brokers accept told Bulgarian-language Standart circadian on October 2 2008.

The ambition is to accord the money as bound as possible, in cash, as it is cryptic yet which way the Bulgarian absolute acreage bazaar will swing. However, the bogey of banking adversity in US absolute acreage bazaar is authoritative bounded investors and developers afraid and impatient, and they are searching to offload their investments immediately.

Those with banknote will be able in two or three years’ time to go arcade in Bulgaria at their leisure, buy abundant backdrop cheaply as, by then, there will be a surplus of absolute acreage in the country accomplished for the taking. This trend has been empiric in the beyond anniversary resorts, the alleged PUDs or Planned Utility Developments - gated residential areas with their own recreational facilities, as explained by Luchezar Iskrenov, Head of the National Committee for Absolute Acreage told Standard.

In the accomplished few months the appeal for such projects has alone significantly. Developers in about-face are acquisitive to offload and advertise at a abundant lower amount absolute condominiums, rather than alone units at a proportionally college price. This is because developers are acquisitive for a acknowledgment on investments and, in ablaze of the approaching banking meltdown, they wish to transform those projects into aqueous banknote as anon as possible, Iskrenov added.

Sofia City Centre arcade capital is a prime indicator that the time has appear if ample projects are gagging to be sold. The capital afresh went for 101.5 actor euro to Heitman European Property Partners III. Equest Balkan Properties, the antecedent buyer and abettor of the site, bought the capital two years ago for 94 actor euro.

The accumulation – a meagre 7.5 actor euro – is not the affectionate of acknowledgment one would apprehend from such a ample site, according to the country’s banking experts. And the trend for the approaching is that such ample projects are acceptable to change easily several added times.

Globally, such malls can be resold up to 5 or six times afore they are purchased by a close which will assuredly yield ascendancy and administer them permanently. Those sorts of deals are not clashing how ancestors homes or apartments change hands. These ample deals absorb huge sums of money, and are brokered and managed by agencies who accomplish with VIP audience beneath an blind of secrecy.

Crisis will wake up the property market according to brokers

The financial turmoil has affected the Bulgarian property market positively in protecting it from saturation and even a bubble, experts and consultants have said.

The crisis has impacted both housing and business projects and driven scores of investors out of Bulgaria’s densely overbuilt mountain and seaside resorts.

The retail centre segment is also braced up for a cool-off, and only a handful of the shopping centres set to mushroom all across the country will be completed, according to property experts.

“The situation is on the whole healthy rather than alarming. This means that it is only projects with solid investor capacity, a good concept and a long-term strategy that will be realised,” Colliers International co-manager David Davidov said.

Forton International’s Sergei Koinov said the financial crisis has penetrated all property segments, including offices, where projects set to sprawl on 1.5 million sq m in the coming months and years will meet tepid demand.

“And yet I think the global financial crisis spread to Bulgaria just in time to sober up the real estate market and help it avert the property bubble we have seen in Ireland, Russia, Romania, Kazakhstan and Latvia,” Mihail Chobanov of Bulgarian Properties said.

Home Truths about the Property Market

The sub-prime mortgage crisis and the credit crunch that has followed in its aftermath are taking their toll on the housing market. On August 28, the S&P Case-Shiller U.S. National Home Price Index showed that home prices fell 3.2% in the second quarter. According to the National Association of Realtors, the inventory of unsold homes is at a record high. As sales have fallen, many home builders have seen their stock prices drop by more than 60% during the past year. How serious is this situation? Is there light at the end of the tunnel? Joseph Gyourko, director of Wharton's Samuel Zell and Robert Lurie Real Estate Center, and Todd Sinai, a professor of real estate, spoke to Interviewer about these questions and more. Transcript:Interviewer: The S&P/Case-Shiller Home Price Index, whose latest figures were announced on August 28, indicated that U.S. home prices fell 3.2% in the second quarter. What impact have these slowing sales had on home builders?Sinai: The slowing sales are really a reflection of the slowing of the housing market, which is a sign that the home builders really don't have a lot of demand to build into. You can see that in their share prices; you can see that, during the boom, these companies were doing very well -- and that when we have a slump, it dries up. During the boom, you need a lot of construction. People were moving into new households, or so people believed, and the construction increased in order to meet that supposed demand. And, when that demand dries up, for whatever reason -- and at this point it seems to be drying up for credit companies -- then there is no one to build for. These are companies that have two sources of value: One is the flow of new construction delivering housing to the market, and the other is speculating on land in the future. And, in an era where there is less demand and declining values of housing and land, those two assets are going down. Interviewer: Thanks, Todd. Joe, do you have anything to add to that?Gyourko: Just one point. I think the issue for home builders, as Todd noted, may not be so much the price as it is the declining transactions volume. The number and velocity of sales are going down. They'd certainly like to sell their homes at higher prices, but home builders are really manufacturers. They're just manufacturers of a good called "housing," and they make their money on volume to a large extent. And when volume goes down, they're hurt, and that's why their share prices are down. Sinai: If I can jump in for a second, I think that there are two factors that go into that. One is the transactions that Joe just mentioned: They make their money on volume. But the other is -- if you [use] the manufacturing analogy -- they've built up inventory. They've been building up a tremendous amount of inventory -- which, I think, they've priced on the assumption that it would sell. And what they are finding themselves with, essentially, is the equivalent of warehouses full of stuff that's really not selling just yet. Now, the good news for them is that just pure population growth means that they can sell two million of their inventory per year. So an overhang of 3-4 million houses means that you're looking at a year's worth of excess inventory at normal rates of acquisition. But they've built a lot, and right now they're not going to be able to sell it until the credit markets turn around. Gyourko: One final point: The other major loss that they're having is in land value. They're having to write down the value of their land because this inventory of land that they've built up -- [if] they can't put homes on it and sell those homes -- is worth much, much less than what they bought it for. And that's the other thing that is depressing their share prices. Sinai: I think that it is also important to keep in mind that we tend to talk about home builders as these big national entities, and some of them are. But, really, the effects on their land and their inventory of houses really depend on the markets that we are talking about. Really high excess markets, like south Florida, are where home builders are basically in trouble, and I don't think that we've seen the bottom of that. I think that it's going to go down quite a bit.And then there are other markets where it historically has been tough to build. A lot of houses were not built in those markets. Those areas are not overbuilt and the land hasn't come down. So, for the country as a whole, I think we are seeing a big decline. But for various cities, it depends really very much on what city you are talking about.Gyourko: Right, if you look at the Case-Shiller Indexes, which were down in aggregate year over year and for most cities, in Seattle they were still up, year over year; and in Charlotte, they were up a decent amount. So, these markets are local -- most are down, but not all.Interviewer: As both of you have said, home builders clearly have a problem. The credit supply is tight, demand has fallen, stockpiles of unsold inventory are going up and their share prices are coming down. Did you find that there were any home builders who are adopting innovative strategies to deal with this downturn? Or, if not, what advice would you give them? What should their strategy be in this downturn?Gyourko: Well, I think that different home builders have tried different things, and we don't yet know what will work because the negative market effects are overwhelming almost anything that anyone is doing right now. Some home builders have tried to reduce inventory by cutting prices; others have decided that they're not going to cut prices and that the market will recover relatively quickly -- and that, therefore, they should just hold their inventory. I suspect that the former are more right than the latter. But this is a really pretty severe negative effect for them, and I'm not sure that there's a really great strategy out there. What I think this reminds us all of is that the land market is volatile, and you better not over-lever. I think that is going to be the lesson in this cycle, which is the same lesson from the last down housing cycle. Those who really over-levered got into serious trouble. And I think that is really going to be the case here because we have a credit crunch, not just a fall in demand for housing.Interviewer: Todd, do you have anything to add?Sinai: I think that's pretty much exactly right. As Joe noted, I think the really important point here is that we are really at the very beginning of seeing what is going on. And, what we are seeing in the credit markets is a re-pricing of risk.... Initially, investors were pricing their investments, and the kind of deals they were asking for were ones where they had a historically low premium required for the risk that they were taking. And now, the pendulum has swung much the other way because I think that people really don't understand exactly how much risk they are taking and I'm sure that they are waiting on the sidelines to see. The fortunes of the home builders, in large part, are going to depend a lot on how quickly that pendulum swings back to the middle. This is because so much of the value of the assets they held, the ability of people to buy these houses and the value of the land that they were putting these houses on, was so dependent on the credit market and the fact that credit was easily available. This also means that they were highly susceptible to a tightening of the credit markets. They get that at two ends now. One is the value of their assets and the other is the cost of their leverage and the cost of their capital that they are using. So, to Joe's point, highly over-levered companies are in trouble for two reasons: One is the cost of their capital -- their debt capital is more expensive; the other is that they can't ride out the downturn. But, this just means that they are even doubly sensitive to changes in the credit market. Interviewer: What are some of the changes that are happening, then, with the actual sub-prime lending market, that are directly impacting the homebuilding industry?Gyourko: It's radically shrinking. I think this is a longer-term phenomenon, not just the short-term phenomenon that we had seen in August, where the credit market seized up and for a couple of weeks you couldn't get jumbo loans in the prime markets. In other words, these were not credit impaired borrowers; these were regular people, with good FICO scores and the like, who, if it wasn't a conforming loan, they couldn't get a loan for a couple of weeks. That hiccup has, I think, disappeared largely.But what you are seeing is -- to Todd's point on the re-pricing of risk -- we now understand that really highly levered mortgages to people with impaired credit, or with very, very little equity down payment, possibly none, have higher default rates and they're riskier. I think the biggest change that we're seeing now is the elimination of these mortgage lending programs, particularly by non-banks. Capital One has shut down its sub-prime unit. Lehman Brothers shut down its sub-prime unit. I do believe the regular banks with stable depositor bases will step into this void, but it will take a while. If you look at the data, the fraction of non-prime mortgages issued tripled in this last up cycle -- from below 10% to about 33%. I think that it's going back to below 10%. And, by the way, that would be no different than what happened in the last down cycle, in terms of really highly levered loans and loans to people without sterling credit. So, that market is going to shrink and it will just cost more to get that debt. Right now you can't get it at all, almost -- but that will pass.Sinai: I'm not quite as bearish as Joe is here. I think the sub-prime portion of this market is really a bit of a red herring here. I think it's a focal point that people are concentrating on. It really is a nice catch phrase for the kinds of excesses that were going on in the lending market. But I don't think that it was driving home values. I don't think that it was driving most of the markets that we were looking at. It's absolutely true, I think, that sub-prime lending has shut down. That's a very small sector of the market. I think it was even smaller than it looked on paper because people who could have gotten non sub-prime loans in part were shifted to sub-prime because it looked like easy money. And so, I don't think the credit markets have dried up for those people. I think that it has gotten more expensive on the whole to borrow. But, we have seen that kind of increase in the expense before.This increase in expense has really been driven by a couple things. The first is that the whole risk of the kind of securitization structure that has driven the availability of cheap capital is being re-evaluated to a degree. Keep in mind that one of the things that has happened over the last decade is that we have had a really quite impressive decline in the cost of capital, as you can see reflected in the kind of interest rates that are charged. And that, in part, has been driven by the ability to diffuse the risk across lots of investors for securitization. That process has really driven the decline in the interest rates -- to the degree that, right now, people are quite unsure about that securitization process and whether the kind of risks that they thought they were taking when they were investing in those kind of products were really what they were getting. We're going to have a period of stepping back. I think that we have stepped back too far. I think that we will step back again ... to not-so-far rather quickly. I think the last time we had a significant hiccup in these kind of credit markets, that was on the commercial side, was in 1998 with the Asian Debt Crisis. And that was about a six-month disruption. In part, I think the things that make the pendulum more prone to swinging and the things that make this market much more volatile is its integration with the capital markets. And, that is the very thing that will make it swing back relatively quickly. We have very sophisticated and pragmatic investors, who have reduced the costs of borrowing in the housing market, or the commercial mortgage market, or whatever markets that you're looking at, because they were searching for yield anywhere. And, the capital was moving to whatever was providing the best return. After they figure out what exactly the risk-adjusted return is in this housing lending market, the capital will be there again. And this will be fairly quickly, because there will be people out there who are looking to arbitrage the rest of the world's uncertainty. You can't do it right away; people have to figure out what's going on. But I think that it will come back fairly quickly. This is not an innovation that's just going to disappear. It's not what some people talk about as the disappearance of sub-prime and it's not the comeback. That's not really the issue. The question is: Is the availability of cheap capital -- because we're willing to let people borrow on houses through the world's capital markets, rather than from just savings and loans and thrifts and that's going to lead to cheaper lending -- is that innovation here to stay? And, I think that innovation is here to stay and that we will have lower real interest rates for the housing market going forward. Now that's the bullish part of the story.The bearish part, however, is that we've had phenomenally low interest rates. And by interest rates, I mean cost of credit, its high long-term values, its really aggressive terms, [and] not having to advertise the mortgage quickly or even at all. All of that rolls into what I mean when I say interest rates. You have very loose credit to the housing market, and we've had loose credit throughout the U.S. economy, in whatever sector we are talking about. And to the degree that tightens, that really has a very strong negative effect on the values of housing, as well as on a lot of other assets, but particularly housing.A lot of the rise in house prices that we've seen over the last decade and house values that we've seen over the last decade have been driven by the decline in the cost of capital. The other side of the coin is, as that capital market tightens for housing, those prices go down. For anyone who is involved with the housing market -- meaning home builders, whose fortunes depend on the continued demand for houses -- a decline in demand, especially if it is driven by tightening credit, is going to hurt them.Gyourko: Let me follow up with one point. I agree with Todd -- that the sub-prime market won't disappear. I also agree that the real causes of the decline in the sub-prime share -- let's call it the non-prime share, rather than sub-prime, because it's not just an issue of lending to people with impaired credit. The cost of that is going to go up, and I think that it is going to go up quite a bit. And, given that higher cost, I think that there is going to be a lot less demand to be a homeowner from that group of potential borrowers. I think the big reason for this is because of really, really high loan to value [ratios]. Ninety-five percent plus [ratios] are largely going to disappear, unless it is done by a government agency like the FHA. When that happens, and you have to actually put down 5-10% for a home -- a typical home will cost a quarter of million dollars; 10% percent of that is $25,000 and 5% is $12,500 -- that's going to take a typical household a couple of years at least to save for. And, it is during that transition period where the demand for those types of loans and to be a homeowner [will] shrink quite considerably.I think that's the real negative force on home prices. Even if the lending market comes back, the new standards to get those loans will be sufficiently tighter; there will be a segment of the population that heretofore has been easily transitioning from renting to owning and won't find it so easy. It will take them time to amass the savings for a down payment. Sinai: I agree. I think, however, that going from the high loan to value ratio for the young end of the spectrum to really figuring out what is going to go on in the housing market, is a fairly nuanced and complicated thing that's really hard to predict. In particular, we've seen two trends over the last 15 years, when interest rates have been falling. One is an increase in the home ownership rate on the young end of the spectrum -- families under the age of thirty. And that undoes the trend that had been there before, with people getting married later and buying houses later. I really believe, as Joe seems to believe, that that is due to the ability to borrow at higher loans to value. It doesn't take as long to amass a down payment. Now, how big an impact is that? It's really hard to tell. We have decent survey evidence that before that period, people were able to get that money for a down payment from their families. But there appears to be a correlation in the data that says that as credit has loosened, people are buying houses earlier. However, another trend is going on: People are staying in their houses longer as they get older. We are entering a period where we have a large and rapid increase in the older end of the spectrum. You have the baby-boomers getting older, and they're not moving out the way that people have previously. So, when you think about total housing demand, you need to consider the fact that over the next year, year and a half perhaps, we're going to see less demand from people who were at the "I needed help with the down payment" end of the spectrum, but more demand from people who formerly would have moved out of their houses at a younger age, but no longer are doing that. They're staying in their houses until they're ninety. And, those two offset to a degree, and it's really hard to tell which is going to win. It probably means, at least for the foreseeable future, that those seniors, since they're such a large demographic, are going to do well. But, you know what? The people who are just entering the home-buying age are also a relatively large demographic, because they're the Echo boomers. So, that is very difficult to tell -- which is going to win out on that front. Gyourko: Don't you think that it will vary by project?Sinai: I think that it is going to vary by market....Gyourko: This is why it's hard to generalize.... Some projects home builders have are targeting the demographics that Todd's talking about. For instance the rise in the home ownership rate among those over 75 was very high and was on the order of the rise of households under 45. It depends on which projects are targeted towards which demographics. They're often very, very different projects. So I think that Todd is exactly right. It's really hard to generalize. Although, I think that we both agree that there's been a negative demand and shock to the housing market. And, we're both glad that we're not home builders. Sinai: Yes -- it's certainly negative relative to a year and a half ago. Interviewer: What kind of implications does the U.S. market have on the global residential market?Gyourko: I think what happens in U.S. credit markets certainly can have global effects. What happens in Europe and Asia because the Miami market is depressed -- I think that it's miniscule to nothing. I think the big spillovers are from credit market problems, because we are such a big part of that. And, it also appears that foreign investors bought a decent share of the sub-prime. It was not just American. But, I don't believe in general that what happens in a local U.S. housing market has a very big effect outside of that market. Sinai: What is happening in local U.S. housing markets is a reflection of something that is going on in the credit market. It's a symptom of something that is fundamentally going on in the U.S. economy.Gyourko: It's the re-pricing of the risk that you were talking about. Sinai: It's a re-pricing of the risk. It's a tightening of the credit. Now, those same fundamentals are going on in other countries as well. So, I agree with Joe completely that the risk re-pricing is global.None of the outcomes that we're seeing in the U.S. market -- the decline in sub-prime lending, bankruptcies of a couple companies, or falling home values -- are going to affect the European market. But the same things that are causing [these things] to happen here can happen in global markets. Gyourko: It's the capital markets that are integrated, not the housing markets, per se.Sinai: Exactly.Interviewer: I'm going to ask you both to imagine that the CEO's of the top five U.S. home builders are in the room with us right now and they have two questions for you. One is how long am I going to go through all of this pain? And, what do I do in the meanwhile? What would your advice be?Gyourko: I'm not sure I know what they should do in the meanwhile. But I think that I may be a little more pessimistic than Todd here. I think that the slump will probably last into 2009. Before the credit crunch, I thought that sometime in 2008 we would get better. I'm more worried now.I don't know enough about individual home companies, [except] the point I made earlier about less leverage is better in these markets -- but there may not be anything that you can do about that. Your capital structure was probably set before. I only have this, for the future: We all need to remember, leverage really is risky. And it's risky in cyclical businesses like homebuilding and real estate in general. Sinai: We tend to get snookered by the fact that we've had a dozen years of housing sector prosperity -- from 1995 to 2007. There was really only a decade -- from 1995 to 2005. Our memories are short; we tend to only look back to that period. I think that people who are running these homebuilding companies, their memories are not as short as the rest of ours are. They recognize that their industries historically have been highly cyclical, because the housing market is cyclical. As Joe mentioned earlier, they are in the production business, and when people need your product and you make it, you do well. And, when people don't need your product and you can't make any more, you don't do so well. This is a fact of life, and whether you want to survive the downturns, it's -- to a degree -- a matter of how much leverage you take on. This is just a choice of how much risk to take on versus how much return to take on. You can take on more leverage and take on more risk and also get a higher return and you'll see when the market turns. And so, companies can easily have different strategies about that. I think the issues going forward are really going to depend on what happens in the credit markets. Joe said that his view depended on what happened with the credit crunch for the kind of softness that we had seen in the housing market. Even before the credit crunch, I thought that some markets were very overpriced. I'm not a person who believes in housing market bubbles. But, I am a person who believes that housing markets really have fundamentally, in the last decade, been driven up in price by the availability of credit. And, in some markets it was clear that prices were unexplainable, and most of south Florida would fall into that case. Even before the credit crunch, I thought that house prices were 30% overpriced there.After the credit crunch, I think that there is no place for them to go but down --though you might not actually see them go down. You might just see nothing much sell and eventually the market will catch up. But for the rest of the country, the states that weren't quite as out of balance as places like south Florida -- what's going to happen?Well, the higher costs of capital, the tighter credit, really have a disproportionate impact on what we thought of as the "hot" markets. These are the markets that were really booming before, the San Franciscos of the world, the New Yorks, the Bostons and the Los Angeles. They'll take a disproportionate hit in overall demand, not just from sub-prime, but the fact that it's going to be more expensive across the spectrum to get capital for housing. So, depending on which market the home builder concentrates in, they're going to see a differential impact.... If the credit crunch gets worse, I think we will see an even bigger impact in the housing markets and therefore an even bigger impact on the home builders. It's going to be even more protracted.... We were talking about the two things that home builders have -- the value of the land that they hold and then the production business of building houses. The value of the land that they hold can go down quite a bit. While at some point, we're going to need to produce more houses just because we're not getting any fewer people.We've got to keep in mind that as the credit market tightens, we're still growing in population. We're still going to need houses eventually. And, that puts a cap on the home builders not producing housing. Though, Joe mentioned that one thing that happens is that the home ownership rate goes down. So, some of the housing that might get produced might not be single family detached houses that these home builders are making. They might be apartments that get produced in the future, because people can't afford to own their own home. But that is one factor that goes on. But what it means is that what happens with the Fed and what happens with the global capital markets really are going to determine this. And, in particular, because interest rates in the credit market have been so loose, just little bits of tightening, things that we wouldn't have worried about a decade ago -- 50-point basis increases in the borrowing rate or a percentage increase in the mortgage rate -- really have an enormous impact on the pricing of houses and the pricing of land. So, my big fear is that the credit market is going to tighten a little and that that is going to affect the housing markets a lot -- which means this is going to affect home builders a lot. We'll just have to wait and see if that happens. If that happens, we'll have a long way to go to get out of this. If the credit markets aggressively return to close to 2005 kind of levels, then I think that this is relatively short lived. Gyourko: Regarding your second question about what would I do if I were a home builder? Assume I had a strong enough capital structure to ride out the downturn. I would really start thinking about how I can prosper from the distress that you see out there and that is coming. There is going to be consolidation in the home building and housing market.In the last down cycle, the big home builders took market share. It would not surprise me if they did this again. I suspect they are thinking hard about those opportunities to take advantage of the distress that they actually see in their industry. Interviewer: That's exactly right. In the downturn that followed the debacle in the Thrift industry, in the late 1980s and early 1990s, there were lots of home builders who found tremendous opportunities. In fact, it was at that time that the securitization really stepped in to bring capital back to the market, and I think that we might be seeing similar opportunities today. Gyourko: Well, in the early 1990s, the home builders that had the strongest balance sheets were able to buy the land on which they made such great profits over the last decade at very, very low rates/low prices. And I think that they are going to try to do that again. And that will be the next big play -- to try to buy cheap land amidst all of the distress.Interviewer: Is there a current equivalent of the Resolution Trust Corporation [RTC], where those deals are available?Gyourko: I don't think it will come to that, because the RTC got started because a sector of the banking industry, the thrift sector, basically disappeared. I don't think that's going to happen here. As I said, what you are seeing disappearing are the sub-prime operations of pure capital market players without depositor bases. I think that this is going to be buying from one private party to another. I don't believe that you're going to see a government entity come in and reorganize the industry, as it were.

Global Hotspots in the Property Business

Emerging real estate markets in India and China, along with recovering property industries in Germany and Japan, are among the top destinations for global real estate investors, according to panelists at the Samuel Zell and Robert Lurie Real Estate Center's fall meeting.During a session titled, "Global Hot Spots -- How to Think about Hot Foreign Markets," Wharton real estate professor Peter Linneman called on each panelist to describe the markets they find most intriguing. "How much is hype? How much is reality?" he asked.Stuart Rothenberg, managing director at Goldman Sachs and head of its real estate principal investment area, said his company is most interested in Germany. The country has property available that generates strong yields, a recovering economy and efficient financing. In addition, German banks are liquidating large portfolios of non-performing loans, creating opportunities to buy residential property with yields of 4.75% to 5.25% and commercial property yielding just above 5%.Rothenberg is optimistic about the German market because new supply has been limited by a sluggish economy, until now. Recently, multinational corporations have expressed interest in establishing German headquarters, which will drive down vacancy rates. Governments, he added, are taking steps to speed the pace of privatization. Goldman Sachs' first German acquisition was a state-owned residential portfolio in Berlin. "The only bad news about Germany is you are competing against a lot of German funds," he said.China is the top pick for Keith Barket, senior managing director at Angelo, Gordon, an alternative money management firm with $10 billion under investment. Barket said his firm does not take on large portfolios, but makes single asset acquisitions in a targeted, "rifle-shot" approach. The firm began to look beyond U.S. holdings more than six years ago and was drawn to China by its rapid economic growth -- projected to hit a continued 9% a year.Angelo, Gordon uses a partnership model for its real estate investments, which Barket said works well in the United States but has been harder to duplicate in China where there are fewer equity partners available. However, he added, this is not a huge problem because he often runs into similar differences in managing local partnerships within the United States. Partners in New York, for example, are radically different than those in the Middle West, he said.Angelo, Gordon searches for partners in China, much the way it does in the United States -- getting to know the handful of real estate experts in any one location. In Shanghai, for example, there are less than a dozen brokers, lenders and developers to know. "The real estate world is a small world," Barket said.Michael Pralle, president and chief executive officer of GE Real Estate, with a $48 billion portfolio, said his firm is most interested in Japan. Yields are good and interest rates remain extremely low. Meanwhile, the economy is finally in recovery, but real estate prices remain near 25-year lows. Pralle said GE did its first transaction in India only a year ago. "Other people were in India earlier. We are pretty cautious."He said GE usually enters a new market with a local partner that has a specialty in the property type GE wants to acquire. For example, GE has a multifamily partner in France and has decided to focus on partners with IT parks and residential projects in India.The firm's parent company helps forge relationships with desirable partners in emerging markets where GE is already doing business, he added. "We have a modest edge because of our parent company, which has big investments in India and China. When we come in to do real estate, we have some confidence we will be treated relatively fairly."Opportunities in IndiaLinneman described panelist Surendra Hiranandani, managing director and founder of the Hiranandani Group in Mumbai, as extremely popular these days with the hordes of real estate investors trekking to India to investigate its hot property market. "There's an image that, in India, the streets are paved with gold. What's the reality?" Linneman asked.According to Hiranandani, the Indian economy only began to open up in 1991 compared to China, where free-market reforms began to take hold in 1979. The effects of those changes are just now beginning to become evident in India. He also noted that the capital coming into India is generating greater transparency in business. "When capital is scarce, people find nefarious ways of raising it. The availability of capital automatically makes it more transparent."Meanwhile, Hiranandani said, a new generation in India is open to free-market reforms. He pointed out that Bill Gates displaced Mahatma Gandhi as the most respected person among Indians in a recent poll. In addition, India is a young country, with an average age of just 24 and vast potential to grow. "There is a huge supply gap. It's definitely an underexploited market." He said the best opportunities are in residential and hospitality development. Large Singapore-based firms have been building office developments, which means that sector may be overbuilt.Construction costs are low in India, making it easy to generate new value. Hiranandani also pointed out that developers have an opportunity to lead residential buyers to trade up to better homes. "People have the money. They don't know what it is to upgrade -- you have to show it to them. You're going to see a lot of activity in housing."According to Rothenberg, real estate investors outside India worry about going into the market. "There's so much excitement about India, but people are worried about being a sucker -- the foreigners who don't know what they don't know." To get around the problem, he said, Goldman Sachs tries to focus on assets in a portfolio of non-performing loans that may be strong properties with better management. The firm sticks to existing assets in a new market and will only consider new development once it has a good handle on the potential upside and puts its own staff on the ground.There are attractive deals in China, he adds, but they take a lot of time and energy to complete. His firm has only bought a few buildings in China's major cities. "And that's with a lot of trying over the last five years."Hiranandani points to a shortage of properties to buy in India, but that's only because there has been so little development for decades. He said foreign developers should not be afraid of becoming suckers if they are willing to be fair to their Indian partners when structuring a deal. "You will probably have fewer problems with the government than I would as a local," he added. "The government is scared of institutions and will [get involved] more with private individuals."He suggested that multinationals may have trouble working in India because they are large and bureaucratic, slow to make decisions and unwilling to put the effort into smaller transactions. Meanwhile, locals want to have a personal relationship with their foreign partner, particularly when dealing with private equity investors that do not have the transparency of a publicly-traded firm.Hiranandani went on to say that there is little chauvinism or anti-American feeling in India and that the government is open to foreign capital. Communication is easy because English is spoken as a first language in most regions.Growing Urban PopulationsForeign real estate companies must be pragmatic about the investment timeframe in India and China, suggested Pralle. While the markets are growing fast and will be important in the long term, they will yield relatively small returns over the next three to five years. "You work months and month to get these deals closed because they are more complicated. They are potentially more volatile and the government can change on a dime." There are some existing assets worth buying in China, but most of the opportunity is in new development, Barket added. Millions of people continue to migrate from rural areas to urban centers where they need housing and other types of development. There is a huge need for equity capital. His firm is developing residential real estate at profit margins of 20% to 40% compared to 15% in the United States.Land prices, Hiranandani notes, are rising in India but not enough to cut deeply into profitability. He, too, said millions of migrants are flowing into Indian cities and are willing to pay more than locals think. "In the last three years, whatever I thought was expensive turned out to be cheap," he said. Migrants moving into a new area are not aware of what prices were paid in the past. "So many migrants are coming in and so much is happening. People value the prime locations. They want to be a part of the action. They want to be part of the big story."Linneman asked about the South Korean government's prosecution of the head of a U.S. private equity group, Lone Star Funds, for stock manipulation. Rothenberg said his firm passed on a South Korean portfolio because it was concerned about the government. "The feeling on the government was that it changes its mind whenever it wants. It's all about money. If you were making too much money, the government wanted it." A tax structure for a project could be agreed upon, but suddenly opened up for new audits. "They use audits to say, 'Pay up' and people like Goldman Sachs pay up because our reputation is more important to us and we don't want negative press. Lone Star said 'No.' When they didn't pay up, the Korean government saw them making too much money -- this is my view -- and it went after them because it wanted a piece."Pralle has not seen too much of that problem in real estate, but his parent company has had similar problems with power plants in India. "If you're involved in a highly visible project and are making profits that seem extraordinary, the government gets irritated and they change the rules midstream."Linneman asked the panelists what concerns them most about the investments they are making in today's hot spots. Barket said he worries about training his relatively inexperienced team in China and making sure it aligns itself with good local partners. He is also concerned about the stability of China's government. "In the longer run the risk I see in China is a dramatic change from what they are doing today. If they move to a democracy too quickly, that actually would be a problem, which is a little counterintuitive."Rothenberg is confident Goldman Sachs has made the right investments in Germany; now he is concerned about operations. "We worry that what could go wrong is not a bad investment or a problem in the economy, but operationally having a malfunction -- people stealing or hiring the wrong people -- that will mess us up."Linneman asked about capitalization rates, or the ratio of operating income to the price of a property. He said he was surprised to learn the rates were not dramatically higher in new markets compared to the United States, which would seem to be considerably less risky. The panelists said a shopping center in the United States might have a cap rate of 5%. In Turkey, it would be 6.5%, in India 8% to 12% and in China 10% to 12%. "If you believe the investment community," said Pralle. "There's very little risk in the world today."Linneman stressed that the rise of global real estate hot spots is important to investors who may never venture outside the United States. "If you understand what is, or is not, happening in these markets, you understand the alternatives for capital that are increasingly global," he said, "and you can see how you look in comparison."

Credit Crisis Interviw

Credit Crisis Interview: Susan Wachter on Securitizations and

Deregulation

The drive to securitize mortgages combined with deregulation were key triggers of the credit crisis, says Wharton finance professor Susan Watcher. She is one of seven Wharton professors interviewed by Interviewer for this special report on the credit crisis. An edited transcript of the conversation follows. Interviewer: The blame for this crisis has been put on all sorts of factors from the rise of securitization to low interest rate policies of the Federal Reserve, homeowners' greed, short-term mentality on Wall Street, federal regulators with their heads in the sand, and all sorts of things. What do you think were the major factors of the last 10 or 15 years have contributed to the sub-prime crisis?Wachter: Well, guilty as charged, all of the above were part. They all contributed. It would not have happened but for securitization. It would not have happened but for deregulation, and deregulation securitization came together. I don't know about the greed. There certainly are investors out there who are speculating.

But a large part of it is the prices rising -- the affordability crisis -- and pushing on the part of both borrowers and lenders for more affordable products which also ... let more people into home ownership [and] let more people refinance, but the standards eroded over time.Interviewer: Now why was that? This is what we call partly the underwriting question -- that the lenders were simply willing to lend to people that they had less likelihood of getting paid from than they were before. What led them to do that?Wachter: Well, I want to be clear too. There are two ways that standards erode over time. One, the underwriting standards literally started to come into play in 2006, where people could basically say what their income was on many of these loans. And that's underwriting eroding over time.

But also the standards [themselves] -- the LTVs (consolidated loan to values) -- went up with piggyback loans. So the lending standards that existed became more liberally offered. So as a consequence, supply function shifted. There was more supply. Now, you ask me why.Interviewer: Yes, why?Wachter: Well, it is an interesting question. That is going to be a question for economic historians to ask and answer. But in models that my colleague Andrey Pavlov and I work [with], it is the natural competitive. Moving for market share, you compete not just on price, but you compete on market. You compete for market share by competing with your fellow lenders by undercutting them. And you can undercut them on rate [and] you can undercut them on standards to increase market share, especially so if the ones who originated making the loans don't have any exposure to the risk on the other side.Interviewer: Now there also is a change in the kinds of institutions that were making mortgage loans. And back in the days when we think of it all as being Freddie Mac and Fannie Mae, there were certain standards that some of these newer firms didn't have to abide by. Is that correct?Wachter: Absolutely correct. And the firms who were gaining in market share were not as exposed to risk, so that is part of the story of how this happened. Fannie and Freddie's market share, FHA's market share [in] particular -- the Federal Housing Administration government insured -- dramatically declined as sub-prime increased. We saw that starting in 2002 through the end of 2006.Interviewer: So Fannie and Freddie were simply not able to make the kinds of loans that some of these other firms started to make?Wachter: Fannie and Freddie, and I want to also include FHA because there is really a one-for-one. Fannie and Freddie and FHA were not able to make these loans because they by law [they] needed to invest in "investment grade," which excluded sub-prime.Interviewer: Now, why were these other types of firms able to get into the market at this point rather than 15 or 30 years ago or some other time?Wachter: This is a private label securitization which did not exist 15 or 20 years ago. What existed was securitization, which was Fannie and Freddie and jumbo securitization. Jumbo securitizations are loans that are investment grade prime, but over the conforming loan limit of $417,000 until recently.

So those were the markets. That was it. And that's all that there could be because there was really no way of evaluating risk, charging VARs for different risks. So with risk-based pricing came the incentive to lend to riskier borrowers and to charge them perhaps more for the loan.Interviewer: And was this a technical advance or research on what risks are and that sort of thing? What were the elements that went into that?Wachter: This is technical. Automated underwriting was first developed by Freddie Mac in the mid-1990s.Interviewer: That means computerized, basically, right?Wachter: Correct, for the risk of the borrower using credit card FICO score type of information that used to be used in consumer credit that migrated over to [the] mortgage market.Interviewer: And the purpose of the automated underwriting is to give the lender an idea of the prospects that a particular borrower is likely to default on the loan based on past history, patterns of other people in that category?Wachter: Based on past history and their characteristics.Interviewer: And I take it that one of the problems in the sub-prime situation is that now you are dealing with a group of borrowers and a group of products for which the track record is not as extensive, is that right?Wachter: That's simplified, that's really too simplified.Interviewer: Well let's hear the complicated version.Wachter: OK. The automated underwriting is quite successful at predicting based on the risk of the borrower. There's another component, which is the value of the home. So any incentive to default on a mortgage or eventually foreclosing their losses, that series of events happens because of the borrower risk, their willingness to pay, etc., which is predicted by credit score. But in addition, ... the most key factor for foreclosure prediction is loan to value.

So if values deteriorate and if loans exceed values, then it is very difficult to sell the home, therefore foreclosure is almost inevitable. That is where we are today. And the models -- the automated underwriting -- were really not developed to predict what values would be under extreme circumstances.Interviewer: Let's look at that how extreme they really were. When you look back at the period when many of these loans were being written -- earlier to middle part of this decade -- interest rates were extraordinarily low, unusually low at that time. And what happened afterward that seemed to have been the trigger event for many of these defaults and then foreclosures appears to be that interest rates simply rose to normal levels. The Fed Funds rate went from 1.0% to, I think, 5.25%, something like that. Was that really so unpredictable that rates would go back to the normal range from an abnormally low range?Wachter: Yes. First, we can't predict rates, but certainly the rates as they were in 2006 were not historically high. In fact, they are historically in a moderate range. So it is not as simple, again, [as] say[ing] it was the rate rise that occurred in 2006, nor is it [as] simple [as] say[ing] that [it] was the rate decline in 2001 to 2003 which set us up. Those, I think, were contributory factors, but they were insufficient to explain the sharp debacle that we are in now.Interviewer: Because rates certainly haven't gone back to levels we saw 20 or 30 years ago when there were double digit rates for many mortgages, is that correct?Wachter: Exactly. And at that point, obviously, we didn't have anything like we have today. We did not have this kind of crisis.Interviewer: Now the second element of this was the falling of home prices, which as you said, left lots of people under water. They can't sell or they may feel inclined just to walk away, as people say. Many people tend to think of their homes as the perfect investment that always raises in value, but there have been periods when they have retrenched. And it doesn't seem, again from the professional's point of view, all that surprising that home prices would level off and perhaps drop after the extraordinary gains from the '90s into the early part of this decade.Wachter: This is the first time in U.S. history since the Great Depression that we have had a national decline in home prices. So it is exceptional. And part of the story of the extraordinary collapse of 2007 -- and current 2008 continuing -- is the 2006 explosion of credit. So that, on one hand, we did have rates go up in 2006. On the other hand, standards eroded dramatically in 2006. And it's the 2006 book of business that is under most stress. That's where the foreclosures are coming from as of now.Interviewer: So why are we seeing this sort of unprecedented nationwide decline in housing prices?Wachter: So it is not local markets. It is not unemployment. It is not simply expectations reversing. It should be something...Interviewer: It is not the local factory shutting down or something like that.Wachter: And that indeed has been what previous housing price recessions have been attributed to. There is a critical factor that all of this misses, and it is not interest rates either. ... It is that the standards [are] eroding, especially in 2006 when there [was] a dramatic decline in standards, [which] was unsustainable and that retrenched.

We had a sharp reversal, starting in 2006, of these unsustainable standards which were artificially inflating housing prices. So over this period standards eroded, artificially inflating house prices. Housing price increases and even levels could only be sustained with this unsustainable, overly liberalized credit being manufactured, which directly caused the price rise of 2006.Interviewer: And basically, that boils down to making money so easily available that people have more to spend, and they bid up prices. Is that the mechanism?Wachter: Absolutely. It's a credit induced bubble. People are able and willing to pay more when you have zero down payment, negatively amortized. They can get into the home and the bet is not on them. The bet is on someone else [as to] what's going to happen in the future.

So it's affordability, and it also is simply that these are loans without money going into them in some cases. That's the investor side of the story.Interviewer: Now, there was during this period an increase in the use of adjustable rate mortgages. This has been one of the problems for borrowers who now are facing resets. The interests rates have gone up, and that's causing their monthly payments to rise to points where they can't pay it or don't want to pay it.

First, is it correct that the use of adjustable rate mortgages increased? And what caused that?Wachter: Not just adjustable rate mortgages. More to the point: teaser rate adjustable rate mortgages and option ARMs. All of these latter are negatively amortizing instruments. That is, you get into the loan and then you borrow more money over time.

That drives the loan-to-value ratio up, which again is going to be the key to the next part of the story which is: Now what do we do? Our loan is worth more than the home. Maybe we walk.Interviewer: And there's lots of research that people who don't have "skin in the game," as they say -- that is, equity in the house -- are more likely to walk away from it than people who do.Wachter: Absolutely. That is a key constant in all of our research. Foreclosure loan is driven by high loan to value, upside-down LTVs greater than 1.Interviewer: And one of the factors here is that lenders stop requiring the kind of down payments that many people were accustomed to years ago: 10% or 20% of the sales price. Why did they stop demanding those?Wachter: Well, in part it was the ability to expand the market, this natural competition. If one guy's doing it, the other guy's doing it. That's how you get market share.

And it's not simply the LTV of one lender. These are consolidated loan to value ratios. So they were allowing piggybacks to come on, which were very popular to allow people to afford their home. Good business, good fees.Interviewer: Now, there's lots of debate about what to do now that this has happened. It seems to me there are two broad areas: What to do about the people, the borrowers and lenders who are in trouble right now, and then what to do to prevent a recurrence of this kind of thing in the future.

Let's break it down. What do you think should be done for the borrowers who are finding themselves underwater today? This has been a big issue in Washington recently.Wachter: Yes. On the one hand there's moral hazard involved. There's the story [that] rescuing people who make bad decisions only supports bad decisions going forward. And there were bad decisions not only by borrowers, but by the underwriting agencies ... and by investors. So let's let everyone take their medicine, [become] educate[d] and go forward. Learn by doing.

There's an argument for that, unless it actually leads to a serious recession which is a destabilizing one where in fact we have a free fall in prices which feeds back to the overall economy. We don't know that that's going to happen, but we don't know that it's not going to happen.Interviewer: So, it's one thing to say that this is a homeowner who took a chance and it didn't work out. That's their tough luck. It's another thing to say to that person's next door neighbors that it's too bad that your home prices are falling because there's a glut of houses on the market in your neighborhood due to this. That's really what we're concerned about -- the collateral damage and the rest of us suffering in some way. Is that one of the issues?Wachter: And the overall economy. And what's the medicine? What's the response to that? The Fed is out of quivers at that point. So preventing that kind of free fall in housing prices has to be out there.

We have to have some tool to do that even if we don't implement it immediately. Because, in fact, the need for it depends on the severity of the slowdown or recession that we may be in.Interviewer: And what do you think is the tool for dealing with that?Wachter: Well, the concept has been supported by the Fed Chair Bernanke. There's a bipartisan legislation on [Capitol] Hill that has the FHA coming in and putting a floor on the market.

There's something to be said for that kind of response where the lenders take a haircut and the investors take a haircut. But they do it, and then in return for it the federal government then takes the risk of further price declines, which hopefully then will be slowed down.Interviewer: So you make both parties suffer enough that they wouldn't want to do it again, and at the same time limit their losses to the point where their disaster doesn't spill over and affect everyone else.Wachter: Exactly. A floor for security for all of us.Interviewer: How do we distinguish between the borrower who is just an ordinary homeowner with a primary residence who either made a mistake or was duped into a mortgage that wasn't a good idea, and somebody who is a speculator or somebody who was buying more house than they really could afford?Wachter: Well, that's a simple one. There are owner-occupants versus investors. You have to go down that line.Interviewer: Again talking about the institutions, the ones that lent money, how big a haircut do they need to take to discourage this kind of thing in the future?Wachter: Well that of course is going to be questioned. But there are already firms out there that are pricing. There is some sign, and it looks like right now there are some trades at about a 20% to 30% haircut.Interviewer: Now, this is dealing with the current crisis. Looking down the road, I think most people would like to not see this kind of volatility in these markets in the future. Are there things that can be done to tweak the way the mortgage markets and the securities markets work to prevent the kind of excesses that led to this?Wachter: "Tweaks" is a small word. There are going to have to be major changes to the way securitization works.

This exposes the Achilles' heel of securitization, which is that it leads to a pro-cyclical impact of housing on the overall economy. Housing brings down the overall economy, and then the overall economy interfaces with housing. Then we're in a free fall.

We need to have a response. I think it's early in the game, certainly early in the game to put on major changes in regulatory responses because right now we have to be very concerned about liquidity. That's the number one issue. In the sub-prime market, we have to be very concerned about liquidity in the overall mortgage market. It's major.

Looking down the line, we are going to have to question the underlying basis for where we are here today, which is risk-based price securitization. That's what's new this time.Interviewer: And can you explain that?Wachter: What's new this time is that unlike the securitization of the past, the securitization is tranching of risk in very complicated CDO's, CLO's, SIV's -- instruments which do not trade.

So we do not have market discipline. Although the price of the loan may be varied by risk, ... the price of the mortgage instrument and the securitization of the mortgage instrument, these securities did not trade. Therefore, there wasn't a market discipline to price the risk and give the signal that these were extraordinarily risky instruments.

They were marked to model, not to market. There were lots of fees up front across the board. But the ultimate risk was unknown, because in fact they weren't priced to the risk.

In some sense, it's a disaster when we have potentially the foreclosure rate that we have of 2-3%. It could bring down the economy with it if there's a recession that's serious. But on the other hand, if this is priced and if the rate of return on the instruments that Wall Street pays is high, at least we're sending the right signal. That did not happen.

In our research, what we've seen is that the standards eroded, but the rate did not go up. So this is a failure of pricing. It's not surprising because these instruments did not trade.Interviewer: Well, if they don't trade and you don't have examples of recent sales to look at to set values, how will you set values? They tried to use models and that clearly doesn't work. These are theoretical bases for setting value.Wachter: Clearly.Interviewer: What's the alternative?Wachter: If we are going to have securitization, it's going to have to be securitization with trading, or with some indicator that these are extraordinarily risky securities because they don't trade -- some kind of red flag. ... There is discussion [and] the SEC is moving along these lines. That is one answer.

The other answer is -- and these are not either/or -- ... [that] we have been in an extreme deregulated environment where basically anything goes. And in that environment, even the competitors can race to the bottom. So there maybe [is] some need for the return of prudential regulation, especially if it is the banks themselves who are engaging in this race to the bottom competition, because then all of us are exposed to demand deposit insurance.Interviewer: Now in order to encourage trading, would you have to have some form of standardization so that people would have a fairly good understanding of what this instrument is? I gather that in this recent event, many were sort of custom-made and each one was, in some respects, unique to all the others.Wachter: Which of course means you can't trade the liquidity, etc.Interviewer: So would you standardize them?Wachter: Without standardization, there is no trading. So that's an open question. There are ways, and we are just beginning to think about how that would actually come about. It could be totally market-based incentives for standardization, [and the] SEC might have to have a role, but as you say, without standardization, there is no liquidity, there is no trading.Interviewer: Another proposal that has been floating around is to make sure that the participants in these markets all keep skin in the game, as they say. That is that instead of packaging up or bundling up one of these securities and then sending it on its way into the market and forgetting about it, the creators would have to maintain some sort of position or some sort of guarantee so that if things went wrong, they would pay a price. And that would give them an incentive to produce things of a higher quality. Does something along those lines make sense?Wachter: It does. The basic research that my colleague Andrey Pavlov and I have done, which in fact helped explain the Asian banking crisis, points to the incentive to produce ... short-run fees. And if there is nothing on the other side about what the consequence is of these fee-driven returns, then you are going to have a race to the bottom. It is under certain circumstances inevitable.

So this is not the first time that we have had a real estate and banking crisis that occurs together. In fact throughout history -- we just look at ... at Japan over the last 20 years. So yes, [having] skin in the game so that decisions are not just short-term [and] fee-driven is absolutely critical in every step of the way.Interviewer: Looking at the other part of the equation, which is the home buyer who will continue to want to get mortgages. You get the impression that many people are still going to want to use adjustable rate mortgages. For some types of borrowers, they may be a better choice than the classic 30-year fixed rate mortgage. Do you agree that they should still be part of the market?Wachter: Absolutely. There is nothing wrong with adjustable rate mortgages. We have had adjustable rate mortgages for tens of years, and in the rest of the world they are the most common, they are the standard mortgage. It is not adjustable rate mortgages that are problems, the problems are negatively amortizing teaser rate option ARMs, which are predictably subjecting borrowers to payment shock at the same time that they are predictably artificially boosting the market, so that at the other side the market prices will fall. A recipe for exactly where we are.Interviewer: Now, when people take out adjustable rate mortgages, one of the appeals is that with the teaser rate, you qualify for the loan based on the low rate with a smaller payment that will fit a more modest income. But there has been some talk of having to look more deeply into the borrower's future or estimate what it is going to be and see what will be the borrower's ability to pay a higher payment if interest rates cause a reset that is much higher. Is there some way to do that?Wachter: Well certainly, very recent votes in the Fed proposed rules that indeed you underwrite to the rate that that teaser rate adjusts to, which of course would have avoided a lot of the damage that we have. The other issue of adjustable rate mortgages [is that] you can't have an adjustable rate mortgage which underwrites to any interest rate. But adjustable rate mortgages, as I said before, are not the cause of the problem that would occur in the end. They are a well wedded instrument. We can have them.

We can have adjustable rate mortgages. We can have fixed rate mortgages. What we can't have is an explosion of credit that induces price rises artificially and then induces the pullback.[There are] two things which you didn't ask me about, but that I want to quickly address. One [is that], early on, you said, "What caused this?" One of the causes was [that] default rates did not rise immediately, and of course they don't rise as long as the values are driven up. But as long as credit standards erode, and so as more credit is pushed out there, that is unsustainable [and] prices will increase. So the signal to pull back is not in the defaults. If you're looking there, you are not going to find it. So you need to have market discipline, which is looking to the long-term and being able to identify this artificial credit induced bubble and price it. That's one way out.

The other way out is a prudential way out, which is if the banking sector is part of this ... artificial boom. By the way, it was tangential this time around in the U.S., but it isn't in the rest of the world. We have seen these kinds of booms and busts brought down [in] Japan for 20 years, which came from the banking sector.

So in this case, there has to be prudential supervision of the banks themselves because banks too can engage in [a] fee-driven race to the bottom. Even if they have skin in the game, it happens and there is no reason why it wouldn't happen.Interviewer: I want to make sure we understand what prudential means in this context. Can you explain that a little further?Wachter: Thinking further... Further down for the long run.Interviewer: Further down the road.Wachter: And that, of course, is what the regulators must do if, on the one hand, they are also giving out demand deposit insurance, which basically takes out a big part of the providers of the funds to the banks from making these decisions. Someone has to have the long-run concern. Demand depositors are neither in place nor do they have the incentive for their insurance to do so.Interviewer: Finally, what is your general assessment of the way the Federal Reserve has handled this so far?Wachter: Bernanke has really pulled this off. It is really incredible. Nonetheless, even he is quite concerned with going forward. There may need to be more that happens and it's out of his hands at this point.Interviewer: And looking at the things they've done, it's a whole range of things from opening the discount window to lending out treasuries and taking mortgage securities as collateral to helping out with the Bear Stearns situation. Which of these do you think have been the most useful?Wachter: Well, we have been so exposed -- not just in the U.S. but worldwide to a potentially worldwide crash -- that there are two of these that are absolutely critical. One was the decline in short-term rates, the increased liquidity -- which is not just the Fed but worldwide -- which keeps ARMs lowered short-term rates, which allow these teaser rates to adjust to a lower rate than they otherwise would adjust to.

Secondly, [and] equally important, is the historic Bear Stearns intervention, which is going to be very controversial historically and brings on its own questions going forward now [that] we have a whole other part of the financial system that is going to be rescued to some degree. Therefore, there is a very increased moral hazard there as well. [It's] a very controversial decision.Interviewer: And have you got a conclusion of your own about that?Wachter: Well, at the time, I think without that we would have had a bank run in the non-financial sector, no doubt about it.Interviewer: And it does seem that although people have called it a bailout or a rescue, there certainly was a lot of suffering on the part of Bear Stearns' employees and shareholders and executives.Wachter: The shareholders were indeed disciplined and I am sure that was part of the planning of the event.Interviewer: Let me just finish by asking, do you think we are closer to the end of this whole process or still in the beginning?Wachter: We are not in the beginning. We are not at the end. It is really this critical middle piece of how does the overall economy perform? And how does that subvert the potential recovery in the housing market or, in fact, cause the housing market to further unravel? There is no answer. We don't know. That's uncertainty that's simply going to play out in the next three to six months.Interviewer: So this really is very much not just a routine crisis or cycle, but a kind of uncharted territory.Wachter: For the next six months, we are in uncharted territory. We simply don't know how far the economy is going to fall, if it's going to fall, and how it's going to interact with falling home prices.