The Train Is Leaving The Station

Having begun my career in Wall St investment banking nearly 50 years ago, I have lived through all of the various cycles, crises, and collapses. Just as Reinhart and Rogoff demonstrate in their tome, “This Time Is Different”, the reality is, things never really change, even over the 800 years they studied. Whether it was the S&L crisis, the Russian debt crisis, Mexican peso, 21% interest rates in 1981, the bankruptcy of New York, the dot com bubble burst, or the Great Recession, I have witnessed it all, and yet the cycle goes on. It is simply the degree of severity to the downturn that changes, and the policies that claim to fix the situation, but in the end, policy makers, and capital markets players, repeat the same mistakes. The politicians pull out the populist rhetoric, and they all say they will fix things, they care about the common man, the capitalist pigs stole the money, bailouts are unfair, or we need more regulation. By the way, there have been many bailouts of various industries over the decades. The banks were not the first.

After every crisis in the capital markets we have a virtual shut off of capital flows for deals, then it comes back slowly and with very tough underwriting. Spreads are wide at first as the risk taking lenders charge very wide spreads, such as Nomura did in 1993-1994 when they were the first to reenter the real estate lending market with securitized lending. I was directly involved in a JV with them as we started to the first hotel securitized lending platform, so I know that they were often able to make a 10 point profit at the start. Since there was no other money, and very few people understood securitization, there was also a dearth of knowledge which permitted margins to be extraordinary. As with everything else, there were soon competitors like Lehman and then others, and in time, spreads came in materially, Over time it became a commodity business and lenders were working for barely more than 1%. Up front points went away, spreads came in, proceeds went up, underwriting discipline disappeared, and then came mezz lending to fill that gap between what was lower proceeds and the borrowers wanting the lender to take more of the risk. As competition heated up further, CDO’s were created, and by then, all discipline went away. By 2007, you did not even need cash flow, proforma income was good enough, phony appraisals were standard procedure to pump up alleged values to justify more proceeds, and the beat went on until the inevitable crash. The train built up so much speed that nobody could stop it, and it simply went off the cliff in a classic Thelma and Louise last act.