BFP Management Blog

Archive: March 2010

How a Modern Greek Tragedy Could Affect You

Back in my college days, I enjoyed reading great works by Greek Philosophers Plato, Socrates and Aristotle. Their writings provided inspiration to my learning as I compared The Republic of Ancient Greece to our society some 2300 years later. Today however I want to look at modern Greece and discuss their problems which will give us a view of what we may soon face.

Greece is running a deficit of 12.5% of GDP and are being pressured by its European Union partners to lower that to 10%. The country is in crisis since it needs to raise money but investors are looking at Greek Sovereign Debt as risky. In other words, there is a lack of confidence in Greece’s ability to pay back this new debt and investors want a higher return on their investment. In Chart 1 we see that the spread has only recently widened between German and Greek bonds.


 Blog 0310 #1

In digging deeper into this problem, we must note that the Greek economy depends on government spending which is about to be cut. Let’s also remember that the more interest Greece has to pay investors for the money borrowed, the less the government has to run its own daily business. The suggested cut from 12.5% to 10% makes a significant recession highly likely and already government unions are planning strikes. The Greeks are now dealing with the fact that a country (or state or household) can not defy basic economics and live beyond its means forever.

How would significant cuts in government expenditures affect our industry? Today, a Greek Apartment owner is faced with higher interest rates, unemployment and likely higher taxes.

In 2009 the deficit in the United States was 12% of GDP ($1.5 Trillion) and while many fellow economists and investors argued vehemently that the bailouts and increased deficits saved the economy from a collapse, my question is, to avoid the collapse, hasn’t the government simply kicked the can down the road? It is likely that the problem will be even bigger and like the Greeks, we will have some very difficult decisions ahead.

As Bill Gross, CEO of PIMCO (the world’s largest market maker of US Securities) said in January, “the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.” In Chart 2, we see the US Fed couldn’t sell off its massive amount of debt (See August 2009 Apartment Reporter regarding “Quantitative Easing”), so it bought it itself (printed money) and expanded its balance sheet and guaranteed bonds to levels not seen since the 1930’s (nearly 20% of GDP).


 Blog 0310 #2

To continue running these massive deficits, the government can get funding from 3 places:

   • Higher taxes

   • More government borrowing

   • More freshly printed dollars (monetized borrowing from the Fed)

While there will be some of each, the majority will have to come from adding to the Fed’s balance sheet. Like the Greeks today, we will only be able to continue to do this until confidence in our ability to repay our sovereign debt and maintain the value of those many printed dollars wanes.

I’m very often asked when will my prognostications occur? Much like the housing bubble prediction, prices went up until confidence fell. It will be the same with our government borrowing.

Commercial real estate values should continue to fall (although there may be stagnation due to lack of transactions) as the cleansing of the market through deleveraging is simply being delayed. Government borrowing will eventually lead to higher interest rates which will decrease the values of properties.

This is a critical time to focus on managing your units, lock in long term fixed rate debt while it’s available at the lowest rates in many years and patiently look for distressed properties that can be repositioned. Patience is the key word when considering investing more of your money into the market.

Kyle Kazan

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