Government Intervention
Real estate cycles are a bit like the fashion industry. Some old theme is resurrected again and again, but always with a new a new twist that sets it apart from previous versions.
- The 1980 Depository Institutions Deregulation & Money Control Act and Economic Recovery Tax Act of 1981 were primarily driven by politicians' desires to stimulate the economy during recessions. The result was a significant increase in risky lending.
- Commercial real estate markets were temporarily paralyzed as the 1981 Tax Act worked it way through Congress. In the months that Congress debated the legislation, commercial property values dropped as much as 30%. Some investors chose to sell quickly during that perio0d of uncertainty to avoid possible increases in capital gains tax.
- The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 forced healthy S&Ls to sell real estate assets to raise capital. But high quality real estate assets that had been performing well were already worth less because of the tighter lending standards imposed by federal regulators.
- The Resolution Trust Corporation (RTC), created in 1989, was hamstrung from the beginning. The pressure from Congress to liuidate properties quickly was at odds with antidumping provision that was a part of RTC’s original legislative mandate.
- The RTC attempted to remain independent of political and economic pressure. By 1992 Congress was calling the RTC irresponsible and inefficient.
- The RTC was acutely aware that if it sold distressed properties too cheap, the new owners would offer rents so low that healthy properties would be affected. As the inventory of distressed assets great, estimating the value of all commercial properties become more difficult.
- $400 billion in failed S&L assets were eventually sold through the RTC. The rapid sale of real estate demanded by Congress Significantly weakened the value of other non-distressed properties in many markets as predicted.
- Policy overreaction occurred in the early 1990s in an environment of “blame avoidance” by Congress. Politicians had no desire to appear soft on the S&Ls. Regulators restricted banks from originating even viable commercial real estate deals.
- The 1988 Basel Accord and FIRREA increased commercial real estate capital reserve requirements. The office of the Comptroller of the Currency, the regulator for federally chartered banks, issued stricter underwriting guidelines in 1990. Higher risk was assigned to commercial real estate loans, forcing even higher capital retention. Meanwhile, creditworthy borrowers wee being penalized for the dead-beat borrowers of the 1980’s.
- Government regulators were running a significant number of banks by 1992, producing suboptimal results with their risk-adverse behavior. This risk aversion prolonged illiquidity in the credit markets. Regulators dictated harsh loan-to-value and debt service coverage ratios, fearing Congressional investigations into their decisions. By avoiding all risk, lending was severely curtailed. A borrower’s past payment history was often totally ignored.
Lessons Learned
Decisions by regulators were often more politically driven than market driven. Government regulation, ownership and management of private assets did lead to long-term market stability in commercial real estate markets. However, government intervention proved too slow and cumbersome to orchestrate any viable short-term relief in crisis situations.
At the height of the commercial real estate boom, Congress had refused to pass any reforms that would have lessened the impending downturn. As a result, it was forced to offer economic incentives at the bottom of the bust to attempt a recovery.