The press has recently made a big deal about the Bear Stearns Hedge Fund debacle. In short, the portfolio managers had unexpected losses in AAA securities. The way that CDO’s work is that they use highly leveraged money and dice up the cash flows from these bonds to creat synthetic bonds and sell off new cash flows to investors. They are predicated on LEVERAGED MONEY. Keep in mind that AAA corporate bonds are the same rating as US Treasuries… the same rating as risk free government guaranteed debt. I know the manager of this fund and can assure you that he is no dummy.
Who cares about Wall Street and what one fund manager screwed up? First, if one fund blew up, there is likely more as this particular fund invested in relatively high quality assets. There is a ton more that do the same thing with high yield and distressed assets… if one AAA fund can blow up, believe me, a lower quality one can just easily. Since this blowup, lending to hedge funds has tightened. Despite whats going on in equities, corporate bonds are getting annihilated right now. It’s only a matter of time before the equity markets go south.
What the hell does this have to do with real estate? When I first got onto this board, many people touted that real estate was a great investment, and better than equities, because of the ability to highly leverage your investment. I maintained that leverage is not always a good thing-- it’s only good in a bull market. As I have said this many time before, leverage is a two way street. If bonds, and eventually stocks tank, it WILL have an effect on real estate. I dont think we have seen the beginning of this. On bloomberg, there is a story about the Miami RE market. Currently, there are 20k condo units for sale. Because of the # of projects that were in the pipeline, an additional 23k units are expected to be in the market in the next few months. Thats close to 50k units on the market! Keep in mind that lending standards WILL get more difficult, taking a lot of potential buyers out of the market. Now, throw in all the funky mortgages having resets in the next couple years and there is more downward pressure. I think whats going on in miami WILL spread to other areas. Once we start seeing unwinding of leveraged money, the market will move remarkably lower.
Be careful folks.