Time to Take a BIG Bite (Part One) As a rookie broker, I had a sales manager who gave me one of the best nuggets of wisdom I’ve ever received: “If you have to eat a sh** sandwich, don’t nibble.” It really doesn’t need a lot of explanation and these days, it’s not just great advice, it’s probably the solution to most of the developed world’s economic and political problems.
I spent last week on a Gulf Coast beach and nowhere are banks and investors in greater need of taking that decisive big bite. During the boom, the investors leveraged themselves, enabled by the banks naturally, to the eyeballs in order to buy overbuilt, beachfront condos that were stacked on top of each other like a Jenga tower. Then the bubble burst. The value of the Jenga condos gets cut 20, 30, 50 per cent. The loans on the condos stop performing. Owners walk away. Foreclosures happen. Banks are stuck with non-performing assets.
I was waiting with my family for the little restaurant buzzer to tell me that our table at an overpriced, subpar restaurant was ready. We sat at a table on patio surrounded by struggling little beachy boutiques. At the end of the row was a real estate offices with a “distressed property” flyer posted in the window. The property was a large, custom built, waterfront house. The listed price was around $700,000. My guess is that’s around 50 cents on the dollar of the original price and, honestly, it’s still probably overpriced. It’s the unwillingness of both parties to take the unavoidable, big bite. If the owner is still hanging on (doubtful…but maybe it’s a short sale…the flyer didn’t mention foreclosure) he feels that 50 cents on the dollar is fair and obviously the bank agrees. However, the market may not feel that way and both sides are still deadlocked in a Mexican standoff waiting for unreality to come along. The owner’s financial statement continues to deteriorate and the bank hangs on to a crappy asset that pays them nothing. 30 or 40 per cent of something is better than one hundred per cent of nothing.
Seriously, the banks truly need to take the big bite. Granted, they’ve done an OK job of cleaning up their portfolios since the financial crisis of 2008 but there’s still a lot of junk in the basement. And why shouldn’t the banks dig in to their proverbial sh** sandwich? Their customers have. Small businesses have cut themselves to the bone due to a tough environment and lack of credit. Many have folded altogether, the owners filing personal bankruptcy, the space they rented, now dark, burdening the landlords and, in many cases, creating yet another non-performing asset. What would happen if the banks actually did take their big bite? They’d book hundreds of billions of dollars, maybe trillions of dollars, collectively, in losses. Their shaky “earnings” would shrivel up. Their stock prices would get hammered into the low single digits. But I truly don’t think it would affect liquidity. The Fed has flooded the money supply like the Germans flooded the south of France prior to D-Day. Hell, their capital positions would probably improve as they cleared the decks. When this happens, things will really move. But as unsavory as it seems, and it is, the first step is…gulp…opening wide.