Amid national headlines bellowing the losses on Wall Street, panicked pleas on Capitol Hill, and political wrangling over government bailouts, one might almost hear the echo of eighteenth century Scottish novelist Sir Walter Scott’s famous quote: “Oh what a tangled web we weave when first we practice to deceive.”
At least that’s what some experts in Utah’s financial industry say; on the whole, the credit crisis can be summed up in a few words: unrealistic expectations, combined with greed and possible dishonesty.
But do the recent events in the global and national financial markets spell doomsday for Utah? The answer according to many: No. While the state is certainly not immune to the financial infection spreading from coast to coast, the long-term prognosis for Utah is good. However, there is no doubt that segments of our economy are in recession and it will take a while to emerge from it, some experts say.
“We’ve had shocks to the U.S. and global financial system that were as serious as any since the great depression,” says Jeff Thredgold, economist for Zion’s Bank. “Utah is obviously affected by what has happened. Utah has been taken down to a no-growth basis at this point. We’ve lost 15,000 jobs.”
According to Thredgold, Utah was running at a 2 percent job growth rate just two months ago, but now it’s close to zero, and new home construction is weaker than it has been in 17 years. “If you have weakness in home construction, it affects other sectors,” he says.
The Beginning of the End
In Utah, as with the rest of nation, the credit debacle circled back to strike its heaviest blow on the market from which it started: real estate.
“In the broader picture, the main issue that drove this current situation is the real estate market,” says Howard Headlee, president of the Utah Bankers Association. While Headlee says there is some dispute as to whether there was blatant dishonesty on the part of those selling the securities or those buying the properties, it is clear that, “underwriting standards were relaxed and mortgages were being funded that shouldn’t have been.” This is what the term “subprime” refers to: risky loans made to individuals who were not able to meet certain credit standards to qualify for prime rates.
But because of the real estate boom taking place in the nation at the time, and rising confidence that the situation would only improve, many of these mortgages were extended and, “People could afford to buy more house,” says Headlee. “You had this run-up and obviously now, what popped that balloon was the fact that the people who shouldn’t have gotten loans stopped paying on those loans . . . and when you take that demand away, you can’t support the prices out there.”
Thredgold describes it this way: “The premise in the old days, seven or eight years ago, [was that when] lending institutions made loans, the focus was on the quality of loans.” But when new lenders designed ‘exotic’ loans, and myriad payment and interest options to fit every need, lenders were paid on quantity. This shift, he says “is really the bottom line of subprime loans.”
As the bubble burst across the nation due to loan defaults and the ensuing increase in foreclosures and bankruptcies, the ripple effect was felt throughout the financial world, cumulating in panicked depositors withdrawing funds from their banks. This made the situation worse, illustrated by the run on IndyMac Bank in California which forced its closure. But even those banks which avoided this panic mentality, including all Utah institutions, have been affected.
“Everybody who defaults on a loan impacts banks’ capital,” says Headlee. “Every time a bank takes a hit, we all take a hit. There’s no free lunch.” Look at it like a mathematical equation: Assets (or loans) equals liabilities (or deposits) plus equity.
“If you decrease your equity or capital, in order for that equation to balance, you have to reduce your assets,” says Headlee. This translates into fewer dollars available for consumer and business loans. And that hits home everywhere.
Certified financial planner Bob Aamodt has seen that ripple effect in his clients’ portfolios. “You have a direct impact on certain types of bond investors, particularly those that are called bank loan funds, or floating rate funds,” he says. “In July 2007, as the credit crisis escalated, we saw a decline in more than 10 percent of the value [of those funds]. People that were using those as surrogate cash reserves were impacted.”
In March, when the federal government stepped in to orchestrate the bailout of the investment and brokerage firm, Bear Stearns, Aamodt was one of many people who felt that “we were over the hump because the federal government had displayed what was considered to be an aggressive stance in orchestrating the purchase of Bear Stearns,” he says, adding that the action created positive sentiment in the market. But, he says, even though the government showed a penchant for fixing Wall Street’s mistakes, the underlying problems still existed. “The latest round of buyouts, bankruptcy and bailouts was the final straw for the government to throw out the usual playbook and try to solve the problem.”
Bailout announcements last month also temporarily bolstered the market, but skepticism over their ability to cure the problem created a volatile rise-and-fall market, intimidating conditions for any investor. But according to Thredgold, the media has fed the fears. “There are obviously serious issues being addressed right now, but the incredible negativity from the media only makes things worse.” So, while some hand wringers may see the nation’s current financial situation as overwhelming and unstoppable, local advisors say the solution to getting out of this mess is not as complicated as it may seem.
The positive news is that the increasing diversity of Utah’s economy is really paying dividends, Headlee says. The GDP (Gross Domestic Product) continues to rise primarily due to the strength of exports and the increasing positive influence of the global economy on the American economy. “The Governor’s efforts to bring global focus to Utah’s economy has been critically important to our ongoing economic resiliency,” he says. The other element critical to Utah’s economic resiliency: bringing your deposits home to Utah banks.
“Consider it an investment in our future, our schools and your business,” Headlee says. “Do your part and spread the word. Every dollar counts. Save more, deposit more, bring it home and grow our economy.”
Headlee also says it’s important to understand that FDIC insured banks are highly regulated and did not make the loans that are the root of the credit crisis. These “exotic” loans originated by unregulated entities who sold them directly into the secondary market. “Our bank regulators are forcing banks to pull back in response to the slowing economy, especially in the area of residential development, but the toxic loans are not on our balance sheets; therefore, we are confident in our ability to endure this slow down,” he says.
Even though loan application standards have tightened during the past few years, an increase in liabilities or deposits means that banks are able to increase their assets, or the amount of money they are able to loan out. More loans mean more growth, generating an ongoing cycle of success.
Both Headlee and Dave Mansell, president of the Utah Association of Realtors, say the overall remedy to the credit debacle depends on people being financially responsible, getting out of debt and living within their means.
“We’ll have to make sacrifices, but I think they are manageable sacrifices,” Mansell says. “The challenge that we’re going to have in the short term is that getting a mortgage is more difficult than it has been, but there should be liquidity coming back into the market around six months from now.”
Headlee contends that most people’s inclination is to rely on banks for help in times of financial crisis. Instead, he suggests people “should look in the mirror, and make every effort to pay their bills and pay them on time. They signed the contract; they need to honor those contracts. We need people to honor their commitments and to consume less energy. Everybody needs to do their part.”
Mansell and Aamodt say for those that have maintained liquid assets, the time to buy is very real.
“The stock market is the only market in the world [that] when things go on sale, as they have for financials, everyone runs out of the stores,” Aamodt says. “That doesn’t mean that all products on the shelf are good products. You have to be picky, but there are bargains to be found. Any time there are problems, there are opportunities. But you have to be positioned to take opportunities.”
Aamodt says he often finds clients with financial profiles that are diversified, but include no available cash. Without liquid assets, he says, even the most financially savvy individual may not be able to act quickly in down times.
“Any time you go through shaky economic times, it drives home the [point] to be prepared to take advantage of the opportunities,” says Aamodt. “If you don’t have a well thought out plan, you’re going to be scared. [We tell people to] get good advice and consult with a good professional. [Investors] are cautious right now. But it’s also an opportunity.”
As Mansell considers the future, he looks to the real estate markets in California, Arizona and Nevada. “The number of sales [in those states] were up in the last quarter. If that happens again over the next quarter, then I would say we’re on our way back to a good market,” he says. “Historically, in our trending, we follow them. If they go up, we’ll go up.”
Howard Headlee says due to the fact that the secondary markets are no longer providing significant credit to our market place, borrowers have returned to the banks for credit, where not only are the underwriting standards higher, but the supply of credit is more limited and will go first to the highest quality loans, which is precisely why it is more important than ever to increase deposits in Utah banks, he says. This enables the banks to be able to make loans to more local businesses and keep the economy moving forward. And while he says we will move forward at a slower pace than the last several years, thanks to Utah banks’ capital reserves, we will survive.
“What I will predict is that when we do rebound, we will rebound faster than the rest of the country and Utah banks will be a significant part of that rebound,” he says. “We’re going to come out of this, and we’re going to come out of this strong. We’re smart, we’re well educated, we’re an optimistic state. We’ll work our way through it.”