The Costs of “Extend and Pretend”

For months now, Calculated Risk has been criticizing the policy of “extend and pretend”–the practice of pretending that real estate loans are still worth their full value, making modifications so that borrowers can avoid going into default, so that banks don’t have to recognize losses on their assets. Here’s one story about “zombie buildings”–office buildings, in this case.

Alyssa Katz has a great article in The American Prospect about extend and pretend when it comes to multi-unit residential buildings, focusing on New York City. Expensive condo towers are now “see-through” buildings (so named because you see through the glass walls right through the empty floors–a phenomenon I first saw in 2001, after the Internet bust, along Highway 101 on the San Francisco Peninsula). Another problem is apartment complexes that were bought by private equity firms and flipped to developers during the boom with plans to evict the low-rent tenants and replace them with high-rent tenants; the high-rent tenants never arrived, the developers can’t make their loan payments, and no one is maintaining the buildings for the remaining tenants. (And no one is saying that property developers have a moral obligation to pay their debts rather than turn their properties over the bank.)

One of the underlying problems is that developers (or the banks that inherited their properties) have an incentive to hang on and hope for a return to prosperity that will deliver the promised condo buyers or high-rent tenants–in other words, betting on another boom. The alternative is selling the properties to someone who will convert or restore them to the type of housing that there is actually demand for–affordable rental units–but that means that someone has to take a loss, because an affordable building is simply worth less than one stuffed with investment bankers. Unfortunately, as Katz says, “With so many lenders at the brink of insolvency, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) appear to be in no rush to cause them further pain.” The lack of urgency was unwittingly confirmed by a Treasury spokesperson, who said, “The commercial real-estate market is something we’re watching closely, but it’s premature to discuss solutions.”

By James Kwak

13 thoughts on “The Costs of “Extend and Pretend”

  1. An increase in interest rate would make the opportunity cost of keeping the building empty much higher. This is the kind of thing interest rate is supposed to be used for.

  2. Honest John ran a used car lot beside a major highway outside Boston. In back, behind the sales office stood a 1974 Cadillac up on blocks, paint faded with a family of cats living in the trunk.

    John’s buddy Frank asked about the old Cadillac one day. “I bought that car in 1979 for $3,500 dollars and I’m afraid I paid too much.” John said.

    “Why don’t you sell it to the junk yard?” Frank asked. “I’m sure they’ll give you a couple of hundred for it.”

    “‘Cause if I don’t sell it I won’t lose any money.” said John.

    John should have been a banker.

  3. Let’s be clear on what affordable would mean for those units. (I’m in Brooklyn and almost bought at Forte before going to another condo development that is fully sold). After going back the bank, they came back on the market at a slashed price of $495/psf and it appears 30 units went to contract in a month.

    I think it’s the right move and it’s a price level the market should be able to sort out on its own. But it is not for the working class.

  4. Thank congress for getting rid of ‘Mark-to-Market’. Their gift to the banks had the dramatic effect of delaying writedowns a whole six to twelve months. The CRE market will not recover until 12-18 months after banks truely face the music on these assets. Expecting the market to come back before these distressed situations are resolved is insanity.

  5. I could be wrong, if I am, please somebody correct me. Katz sounds like a Hebrew name and she lives in Brooklyn. I say Hebrew because I’m not allowed to use the “naughty” J word here. It’s only worth noting because Hebrew people tend to be very sharp intellectually, and Miss Katz seems to be a very excellent journalist. I’ll take 1 Alyssa Katz over about 1,000 Diane Sawyers. Katz is one of those women who gives you hope in the professions of journalism and writing.

  6. James-

    For the record, I think the term “see-throughs” originated in Texas(Houston?Dallas)/ in the 1980’s. I distinctly recall a trip buying a portfolio of mortgages to back a re-insurance transaction when I first heard the term.

    Keep up the good work.

    Sam Taylor

  7. These are the kinds of games to keep toxic assets (the derivatives based on these now failing mortgages) from going bad. So long as the bank finds a way not to book the loss, the TA stays where it is, quietly overstated on its balance sheet. I believe that’s why so many banks have decided not to pursue foreclosure in default, but rather to convert the property and accept rent. The beat goes on, at least a little longer.

  8. “criticizing the policy of “extend and pretend”–the practice of pretending that real estate loans are still worth their full value, making modifications so that borrowers can avoid going into default, so that banks don’t have to recognize losses on their assets.”

    You say that as if it were a bad thing. The problem is that we haven’t taken it far enough. We can start with pretending that the unemployable have jobs, and pay them with pretend dollars (well, that is a flaw, as we already all use pretend dollars – I’ll have to work on that part of the scheme). They will buy pretend houses (abandoned houses in Detroit), eat pretend steak (spam), and watch pretend cable TV on pretend 60 inch high def TV’s (i.e., crayon drawing on wrapping paper). There, pretending to be well off is almost as good as being well off. And we finish by pretending to be happy.

  9. In Germany they do “Extend and Pretend” to save jobs, it seems to work for some. At least the shock of loosing job is reduced.,1518,druck-669502,00.html
    Germany’s short-time working program has helped prevent massive unemployment during the current recession. Although the model has been admired internationally, its biggest test is still ahead. The hugely expensive scheme is a risky bet that the economy will turn around in 2010.

  10. Welcome to the lost decade(s) or maybe a century.

    Japan is still extending and pretending.

    Hey! CONgress, Banksters, FASB, Wall Street!

    Listen carefully – The Credit Bubble, Housing Bubble, Mortgage Finance Bubble have been blown up. Its over. Those prices and valuations are not coming back.

    You must come to grips with reality. The bookkeeping and accounting fantasy you refuse to acknowledge is keeping the Real Economy from recovering.

    Bite the bullet and lets move on. You are bankrupt.
    Like a drowning person at sea, you will drag down your rescuer. Shouldn’t you develop some honor in the end, and just quietly slip beneath the waves?

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