As readers of the Insider know, I am a voracious reader of the news. Recently a series of news items struck me as a pattern, and I decided to dig into the similarities between the setup to the Great Recession and now. I think you may find this as unsettling as I did.
The similarities I found myself by digging a bit into recent news articles (included for your reference below).
Subprime Mortgage Crisis, Its Timeline and Effect
THEN
June 2004-June 2006
Fed Raised Interest Rates
NOW
March 2022-Sep 2022
Fed Raised Interest Rates
Raising interest rates puts brakes on the economy and so often precedes economic slowdowns and turmoil.
August 25-27, 2005
IMF Economist Warns the World’s Central Bankers
July 2022
The I.M.F. warns that a global recession could soon be at hand
The IMF has a global perspective and gives a balanced and fair view of the global economic situation. Their economics bench is deep and when they issue warnings of this sort, it pays to heed them.
December 22, 2005
Yield Curve Inverts
August 2022
Yield Curve Reaches Most Inverted Level This Century
A normal yield curve is one in which short term rates are lower than long term rates. When the yield curve “inverts” (which it does only rarely), it means that the financial markets are thinking short term risks are high compared to long term risks. This often precedes a recession.
September 25 2006
Home Prices Fall for the First Time in 11 Years
October 2022
US home prices drop at fastest pace since 2009
Considering the vast amount of wealth stored in real estate, when prices drop across the nation, there is widespread pain. Caveat this time: most homeowners have a lot of equity in their homes, which wasn’t true heading into the Great Recession.
November 2006
New Home Permits Fall 28%
August 2022
Single family starts drop 10%
New home permits dropping and single family starts dropping both signal distress in the housing market.
2007
The Fed Doesn’t reduce rates enough to calm markets
September 2022
Fed hikes interest rates by a sharp 0.75 points despite recession fears
In the last cycle, the Federal Reserve (as became clear in hindsight) wasn’t aggressive enough in dropping interest rates. This unnerved the markets and the following volatility proved to be destabilizing. This time it’s a little different, but similarities exist. Now, the Federal Reserve is continuing aggressive interest rate hikes in the face of signs of an impending recession.
September 10, 2008
2008 Lehman Brothers credit default swap costs soar as markets bet against the bank
October 2022
Credit Suisse Credit Default Swaps hit record high as shares tumble
Don’t worry too much about the technical details of what a Credit Default Swap (CDS) is. Just think of it as a kind of insurance for (in this case) bond holders. It ensures that if you held Lehman Brothers bonds and those bonds were defaulted on then you would still get your principal and interest. If the cost of the CDSs are soaring, it means that people were betting against the viability of Lehman as a going concern. Of course, Lehman went on to be a spectacular bankruptcy. Currently there are two banks that are under extreme pressure, as measured by the cost of their CDSs. One is Credit Suisse and the other is Deutsche Bank. The parallels to the Lehman situation are eerie.
September 2008
Stock Market Crash
YTD 2022
Worst YTD S&P 500 performance in 20 years (and that includes 2008!)
The stock market crashed in ‘08, but the stock market has been even worse so far this year. Yup.
September 16th 2008
Lehman Brothers bankruptcy; beginning of Great Recession
?
???
In 2008 the tipping point was Lehman’s bankruptcy. Will it be Credit Suisse or Deutche Bank this time?
The timeline from the lead up to the great recession comes largely from this article from The Balance:
Let’s be clear about my message here. I am most definitely saying that there are uncanny parallels between the Great Recession and this period we’re heading into. I am NOT saying this is going to be the same case. Why? Because this time around lending standards are still tight, and there’s an enormous amount of equity in people’s homes. Last time around credit standards were loose and many people tipped into negative equity territory as soon as the market shifted.
Also, the world saw what happened when Lehman was allowed to fail the way it did last time. I do not believe that European regulators have the stomach for that particular flavor of turmoil with the war in Ukraine on their doorstep – not to mention the dire fuel shortages they will be facing this winter looking to be a certainty. In my view they will step in to bail out either or both banks if necessary.
Why does all of this matter to real estate in New York?
The first point is for buyers, and pertains to a clause in the contract called the funding contingency. If you are buying with a mortgage, it would be a very good idea to request a funding contingency in this parlous financial environment. The funding contingency allows the buyer to get their deposit back in the case that the loan commitment letter is issued, but the bank subsequently does not fund the loan. Typically sellers see this as highly unlikely and will allow buyers to have this clause without too much trouble. Here’s why it matters. When Lehman Brothers went down in 2008, the following day there was not one mortgage closed in the US. And no mortgages were written for quite some time. That’s because banks were circling the wagons around their balance sheets and fighting to survive. So rather than lending money they were keeping it to service their current liabilities.
If you were a buyer and the bank issued a loan commitment letter then Lehman failed, you were stuck. Without a funding contingency or a renegotiation of the contract, buyers could (and did) lose their contract deposits because they couldn’t afford to close on the property.
For sellers, we have no idea if there is going to be a Lehman event heading our way. What we can clearly see is that the risk is higher that it will happen. So if you think you want to sell, my advice is this: sell now, and sell quickly. Else be prepared to rent your property or stay in it until the next cycle upswing.
Have a great weekend, everyone!
