Our nation’s ongoing economic travails may be entering a new phase, but are not ending. The stock market has recovered from lows set in March, the rate of job losses may be easing and some indicators may show credit is more available. All this is welcome news.
But the financial problems of regional affiliates of Minnesota-based developer Opus Group illustrate that challenges remain — ones that will take a long time to work out.
Since the economic debacle started to unfold with the failures of two Bear Stearns mortgage-backed securities funds two years ago, people have misunderstood two crucial distinctions. Was the crisis one of liquidity or solvency? And were the problems cyclical or structural?
Illiquidity occurs when the assets a financial firm owns are sound in the long run but the company is not able to turn them into cash quickly enough to make required short-term payments. Insolvency is when the assets really have lost some or all of their worth.
Cyclical problems are short-term, resulting from the long-established business cycle of prosperity alternating with recession. Structural problems involve deeper and longer-term causes.
In 2007, as complications of the Bear Stearns defaults echoed through short-term credit markets, the U.S. and European governments treated it as a liquidity problem, as if virtually all assets were good and only short-term fears were inhibiting lending. But many of the assets were not good. Insolvency was the far bigger problem.
Governments and the media focused almost entirely on dicey home mortgages and arcane bonds into which such mortgages were packaged. But many other assets, physical as well as financial, were also bad. The commercial property sector, while not as large as the residential, had its own dry rot, especially in the southeast and southwest, where urban growth had been most frenetic.
Opus West, based in Phoenix, says it has developed 52 million square feet of commercial and residential property in the past 30 years. But several of its most recent projects are turning sour, including a 191,000-square-foot office complex in Glendale, Ariz., that is less than 3 percent rented. Earlier, a 1.3 million-square-foot project in Austin, Texas, went bankrupt. Opus South, another regional operating company based in Atlanta, already is in Chapter 11.
Opus is not a fly-by-night developer. But it got caught up in an economic phenomenon that transcends the normal business cycle of recession and prosperity. The property bubble that opened the 21st century was a structural one.
Rather than normal ups and downs, it was based on a never-before-seen high level of household consumption, the reverse of which was unprecedented low savings. It was based on decade-long excessive growth of the money supply and on more than two decades of peacetime government borrowing, also previously unheard of. And it was based on U.S. financial relations with East Asia that suppressed normal warning signals.
Cheap imports held consumer prices down. So the excessive money growth in the economy went into real estate and stocks, driving up those prices rather than consumer inflation. Capital inflows from Asia kept high government borrowing from pushing up interest rates.
Add to that Wall Street’s introduction of myriad complicated and poorly understood financial instruments, combined with a blase regulatory climate and the die was cast for a debacle.
Opus is just one of many historically well-run firms that got carried away in a bubble caused by fundamental forces no one fully understood. Many other developers, and banks that lent to them, have troubled projects. Expect more projects to go sour, more loans to fall into default and some firms even to go bust.
Yes, some of the visible signs of a severe recession may be ebbing. But don’t expect true, sustainable recovery until we deal with the underlying structural problems.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.