Commercial Real Estate Finance

Did you see the movie, “A Beautiful Mind” (not “War Games”)? If you didn’t, don’t bother. The film is mediocre at best, and there are better ways to spend two hours. I only bring it up because it’s about a guy named Nash who overcame personal tragedy to win a Nobel Prize in economics. His work was mostly on game theory; one scenario being a Game of Chicken (Hawk-Dove).

You are probably saying “1) Russell Crowe is sort of annoying and, 2) I don’t know what this has to do with real estate.” My response: 1) I agree about Crowe and, 2) plenty.

If you are in commercial real estate, you are living with the consequences of several games of chicken. And, your future is a function of several more.

For example: in 2008, Bear Stearns and the US Government (the “Feds”) effectively got into their respective cars, pointed at each other, and stepped on the gas (I guess if you really wanted to abuse the metaphor, you could say they got in their cars in 2003 or so). In March of 2008, they were right about to collide. Just before impact, the Feds swerved, and Bear got some help. As you may remember, the Federal Reserve provided a $30 billion credit line.

In the time between the Bear blow-up and the Lehman fiasco, red-faced politicians were struggling to explain why the Feds could help the banks, but not the auto industry (Michigan and Ohio have a combined 37 electoral votes). So, in late 2008 when Lehman and the Feds pointed their cars at each other, this time the Feds refused to swerve. For their part, the management team at Lehman was far too arrogant to swerve their car. Plus, they had the lesson from the Bear blow-up: the US government would save them. The result: financial catastrophe, with particularly ugly effects for commercial real estate.

Now how do you feel about game theory?

As you read this, the US and China and playing at least one game of chicken: monetary policy. The USD/Yuan exchange rate is in the news again. The treasury secretary, the nominal care-taker of the US dollar, has been pressuring China using a new tack; one I often use with my young son, “…see how nice the others are playing?…”

As I’ve written before, the PBOC artificially inflates the value of the USD relative to the Yuan. The reasons for the current state of affairs notwithstanding, most people agree the long term effect, with no change in policy, is not good. So, why does this ‘bad policy’ continue?

Sitting in their ‘car’, the Feds are saying, “Hey, China, you need to let the Yuan appreciate because your artificially cheap currency gives you an unfair trade advantage. My boss doesn’t want to get smoked in the mid-term elections and manufacturing states are key for us. Oh yea…. and, if you don’t change your behavior, global imbalances…blah, blah…”

The PBOC, in its car, is saying, “Listen, Secretary Geithner, you think you have problems? Trust me when I tell you that out of work laborers are a far bigger problem for China than the US. In your country people just change their vote. Around here, people get killed. i.e. I need to support my export economy at all costs. If you want to have a better trade balance, buy less and save more. And, by the way, do you really want me to stop buying so many treasuries?”

The cars continue on their collision course.

What does the collision look like? Among other things, runaway global inflation and the inevitable government response. How about gold at $3000 and oil at $200? How about the PBOC throws caution to wind and dumps treasuries on the open market? How about the Fed really deciding to fight inflation, once the toothpaste is out of the tube (Think Volker c. June 1981)? How about serious social unrest in China? What would those things do to your ability to find a commercial real estate loan?

My layman’s understanding of Nash’s work is that, in game theory, cooperation sometimes yields better outcomes than competition. Maybe Obama’s focus on cooperation and diplomacy isn’t such a bad idea?