Does Kicking the Can Work?

Kicking the can down the road has become a trend in residential and commercial real estate but the trend may be hurting more than it's helping.  It seems that many have been slow to acknowledge the full extent of the long-term consequences of the unrestrained lending practices which occurred from 2001 to 2006.  Now, it seems that many believe that burying their heads in the sand until the mess blows over is a reasonable strategy.  The sad truth is there is not much relief in sight for the US economy and many of the banks are still overburdened with non-performing real estate loans.  The picture is not much brighter on the residential side either.  Many more residential properties purchased with ARMs are due to reset in 2011 and 2012.  Is there any benefit to kicking the can further down the road?  In a recent Tierra Grande article, Dr. Dotzour, an economist with the Texas Real Estate Center at Texas A&M, explains why there is not much benefit at all.  Here is what Dr. Dotzour has to say with regard to "kicking the can" aka as "extend and pretend":

Clearly, these are not normal times. Many maturing loans

are being extended rather than foreclosed on. This postpones the day of

reckoning when the owner loses the property and the lender incurs the loan loss.

This phenomenon is called “extend and pretend.”  

The lender extends the loan and pretends it is still performing.

Banks are weighed down with loans like this. Wall Street

has sold billions of dollars of these loans to investors all over

the world. Why don’t the banks and other lenders foreclose on

these properties and let the market clear? Why don’t they sell

them to new owners that can fix up the properties and find

tenants for them? The answer is that after the massive losses incurred by banks

from failed residential mortgages, they are not sufficiently

capitalized to immediately recognize the additional losses they

have in their commercial real estate loans. After closing more

than 315 banks in the past three years, the FDIC Deposit

Insurance Fund (DIF) is $8 billion in the red. The

FDIC indicates it could take 17 years to rebuild

the DIF to desired levels.  Federal policies initiated in the past two

years suggest extend and pretend could be in place for many years to come.

Rather than take the losses immediately, policy makers have decided to

amortize these losses over a number of years.

Wow -- enough said.  It seems that waiting, hoping, and praying for happier days is fine as long as you're not looking for them through rose colored glasses.  Although there have been small signs the economy is truly improving, there are many, if not more, signs which suggest the economic recovery is sputtering.  For instance, lagging home sales have continued to weigh down home builder profits.  According to WSJ, Lennar, one of the nation's largest builders, reported that fiscal second quarter profit fell 65%.  In addition, Fed chairman Bernanke publicly stated this week that he is at a loss as to how to explain the sagging economy's lackluster performance.  Could it be partly because "extend and pretend" or "kicking the can" is not a viable solution and that without a housing recovery the broader economy will merely continue to limp along?  The straightforward answer is yes and with unemployment lingering around 9% and commodity prices on the rise, it is hard to see how kicking the can further down the road is going to accomplish much.  Yes, things are better in Texas but plenty of can kicking has taken place here just like in other parts of the country.  Maybe it's time to get real about the economic state of affairs which starts by stopping the pretense that things are better than they are.  Here are a few suggestions:

• lock in the capital gains tax rate for a defined period of time
• release trapped real estate assets into the marketplace
• create tax incentives for investors who purchase distressed assets
• discontinue governmental policies that encourage moral hazard
• resist the temptation to over-regulate the lending industry
• US government should become a lender of last resort for small business
• discontinue the practice of bailing out businesses that are deemed to big too fail

We must find strategic ways of promoting a healthy real estate market whereby banks can foreclose on properties, sell them at a discount, and take the loss, allowing new investor/owners to then lease the space at lower market rates.  A similar clearing process needs to take place in the residential sector as well.  Until we stop acting like ostriches in America, we'll never run like gazelles.  Addressing these very real and core problems will allow us to move further down the road without kicking the can!