The world of real estate capital has changed greatly over
the past decades, and our class was lucky enough to have these times
illustrated by Jerry Holhouser, CFO of Silver Companies. Mr. Holhouser brought
40 years of experience in the industry to show us the cycles and highs and lows
that have brought us to today’s state of affairs. Along with these insights, he
reminded us of George Santayana’s famous quote, “Those who cannot learn from
history are doomed to repeat it,” and it was interesting to see how applicable
that was in the financial history of the country.
Mr. Holhouser began his career in the 1970s, having
discovered that engineering was not his calling. At the time, the banking
industry was an easy and comfortable job, and so he entered into the world of
savings and loans. Though new to the industry, Mr. Holhouser felt that he
learned a lot from that first job, and he told us that this concept is key:
Don’t worry about the money, it will come; find a job where they are “crazy
enough to teach you.” I felt this was excellent advice, as our education does
not end in the classroom, it continues in the positions we will apply ourselves
to as we grow.
Prior to the 70s, the loan industry was not handled by
banks, but by savings and loan institutions. They did not have adjustable
rates, they were fixed by the government. However, in 1970, Regulation Q was
passed and would have dramatic effect on the industry. The regulation fixed the
rates that S&Ls could pay borrowers, with no flexibility. Banks were
prevented from paying interest on checking accounts, and companies found that
they could no longer compete on prices with each other. The companies tried
several methods to attract customers, including opening numerous branches in as
many places as they could, trying to offer better services, and even giving
away gifts of jewelry and toaster ovens. While I would not mind my bank giving me some
jewelry, I prefer the modern method of selecting the institution that offers
the best rates and returns.
When an industry is in trouble, innovation is the key to
staying afloat. In order to try to generate fees, S&Ls began to open
subsidiary companies, getting involved in multiple businesses. Through the
private equity company I work for, I have seen the evolution of this concept,
and institutions maintain a presence in many other industries to this day. This
applies the investment sensibility of diversification; attempting an incursion
into new revenue possibilities when one’s main industry is struggling.
The government at the time realized that there would be an
astronomical cost to fixing the Savings & Loans industry, and decided to
try to “kick the can” further down the line. At this time, banks were insured
by a thrift insurance fund, much the same way they are currently covered by the
FDIC. However, the government was delaying paying into this fund, and instead
deregulated the interest rates on deposits. With lending rates still being
regulated at 6%, this was a disaster waiting to happen. Again, this shows that
old lessons have not been learned: on everything from social security to
medical insurance, it seems that the government is more interested in having
the massive expense of fixing problems be someone else’s task, while they just
apply a temporary “band-aid” to the issue.
The solution would not come until the government intervened
in 1986, returning payments to the thrift fund. The FDIC took over the
regulation and insurance of banks. The government took over all the bad loans
from S&Ls and created a Resolution Trust Corporation to manage them. The
next few years of financial innovation would revolutionize the mortgage industry.
Fannie Mae-Freddy Mac would buy loan packages and sell them to investors on
Wall Street, and the thrift fund crisis would come to an end. While this led to
a decade of improved economy, these “improvements” would eventually show their
vulnerability, as the combination of financial institutions’ expansion of
business, lax regulation, and politicking led us into our most recent crash. I
know they say the economy moves in cycles, but one must wonder, are the cycles
just us refusing to learn from our past mistakes?
After seeing two crises and recoveries, Mr. Holhouser could
not have been surprised when the crash of the 2000s occurred. As he cautioned,
those who do not learn will make the same mistakes. Sub-prime mortgage lending
combined with the housing real estate bubble created a perfect storm of
economic woes. It was interesting to see how even after previous lessons, the
same mistakes were made and history, as Santayana and Mr. Holhouser cautioned
us, repeated itself. Only time will tell how new regulations will bear out, and
if the industry has truly learned its lesson.
While the sub-prime mortgage crash of the 2000s cost many
people a lot of money, as always, a few who had foresight profited greatly from
the situation. In a 2009 article,
the Wall Street Journal discussed the methods that netted John Paulson $4
billion in a year in, what some consider, the “greatest trade ever.” Paulson
realized that the prices of homes were drastically over-inflated, and realized
that an inevitable drop was coming. He approached other institutions, such as
Goldman Sachs and Bear Sterns, proposing that they create securities of
sub-prime mortgages. Meanwhile, he was betting against these securities in the
form of CDOs, insurance on debt. Many investors were skeptical of his
prediction, including Goldman writing him off as “a nut.” However, when a
record 10% of homeowners defaulted on their mortgages, he began to make money
hand over fist. Mr. Paulson and his analyst, Mr. Pelligrini, had learned
Santayana’s lesson of learning from history, utilizing research on housing
prices since the 1970s. His bet against the housing market paid off, showing
that foresight and risk-taking can turn a crisis into a cash-cow.
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