Sub-prime Redux: The Rental Housing Market

Blackstone Is Beautiful

My neighbor Warren doesn’t understand high finance. He’s a physician, and they’re usually pretty savvy market-wise, but he’s an exception. Yesterday over the back fence he was expressing alarm over what he thought was a dangerous development in the banking sector.

“It seems that the next big thing on Wall Street,” said Warren, “is banks and other players bundling rental housing into a new product, that is a rent-backed security, similar to the mortgage-backed securities (MBS) that were at the root of the big crisis in ’09.”

“I hadn’t heard about that,” I said. “But it sounds like an exciting innovation. But you’re panicking needlessly, Warren. Mortgage-backed securities didn’t cause the crisis on Wall Street. It was Obama’s inept handling of the situation.”

“Exciting innovation? Are you nuts?” Warren in his naivety was getting upset. And because he’s such a financial neophyte, I was forced to sketch in the background of what happened back during the sensible Bush Administration.

“You’ve probably forgotten, Warren,” I reminded him. “That the investment banks, brokers and traders, led by Street heavies like Goldman and Deutsche Bank, opened up a new vista financially when they assembled thousands of mortgages, (some taken out by the 99% who might never have been able to get financing otherwise). Then they sold this MBS product to institutions and more astute individuals. The credit rating agencies loved it because it was so progressively democratic — true compassionate conservatism.”

“But I thought that those sub-prime mortgages were the whole problem,” Warren said. “Moody’s and Standard and Poor rated them Triple A, when many of the mortgages were garbage.”

“You read that in the liberal media,” I corrected him. “Actually, the banks followed up by inventing a new form of insurance called ‘credit default swaps,’ which amounted to a hedge against the sub-primes declining in value.”

“Then what caused the Crisis?” Warren is so infantile when it comes to the complexity of the financial world.

“The incoming lefty Administration, mostly. They didn’t move when they should have to bail out Bear Sterns, the way Paulson showed such dispatch in rescuing Lehman Brothers. And once Paulson and Bush had put TARP in place, the Street responded by correcting all the imbalances. Despite the Democrats’ further efforts, like the Dodd-Frank Bill, to impose regulations that throttle the free enterprise that we hold dear.”

“Gee,” Warren admitted, “I never saw it in that light.”

“So what’s this you’re saying about residential rental mortgages?

“Well, it seems that housing prices are rising, so you’d think that it should indicate that the economy is really picking up. But at the same time, home ownership is continuing to decline, particularly in low-income areas, such as black neighborhoods and communities.”

“Not surprising,” I said. “Those people have a tradition of getting by with rent parties and poor attitudes toward home ownership.”

“But it’s a national trend in rental properties,” Warren said. “And that’s largely because private equity firms such as the Blackstone Group, have been buying up rental housing like it’s going out of style. In L.A., Atlanta, Chicago and even New York. Wall Street banks as well as private equity funds have bought up perhaps a quarter of a million cheap housing units, mostly foreclosed. But instead of flipping them, they’ve used them as collateral for a new financial instrument — you could call it a rental-backed security (RBS).”

“Well, I for one think that’s marvelous,” I said. “That’s true Reaganomics — a trickle down model if ever there was one.”

“Nobody seems to be sure about the outcome,” Warren said. Namby-pamby as usual. “”What is clear is that people like Blackstone — backed by banks such as Deutschebank — are capable of outbidding retail buyers in the rental home market, which of course drives prices up and has the effect of sucking wealth accumulation out of sub-grade communities.”

“But that’s the whole point of Reaganomics,” I straightened him out. “Those people can’t do things for themselves, so it’s right and proper for the job creators to open up this market. Trickle down.”

“I’m not sure,” Warren persisted. “JPMorgan Chase was just fined $13 billion for defrauding mortgage investors.”

“You just don’t understand, Warren,” I cautioned him. “When you’re moving in those numbers, mistakes are made, but it doesn’t change the principle that if the banks do well, everybody prospers.”

“You may be right,” Warren acknowledged. “But I understand that some Street analysts are uneasy about the idea of securitized mortgage debt based on a universe of rent checks issued by a wide range of poor people.”

“Well, if Moody’s likes the concept who are we to question it? Like I say, those people have been throwing rent parties with jazz bands sitting in since they boarded up Storyville. It’s the American way.”

As everybody knows, The Blackstone Group is a private equity firm, but with total assets under management a small fraction of those of its kissin’ cousin BlackRock, a money management giant with assets under administration in the trillions. But Blackstone’s profitability is almost equal that of BlackRock, which suggests that the latter might also be eying the private equity caper.

BlackRock, run by world-beater Larry Fink, began as a joint venture with Blackstone when Fink came aboard. Asset-wise, 25 years later, Fink’s tail has been wagging Blackstone’s dog, so that Mr. Fink severed the tail. But the nagging truth is that private equity is a better game than asset management. with Blackstone scoring big in private equity deals, hedge fund operations and — admit it — real estate.

BlackRock, as the world’s largest asset manager, may be too big to flail around in the private equity game, but it may be contemplating following Blackstone’s success so far in the new rental housing dodge. Fink could do it easily with — for him — a minor acquisition in the private equity sector.

But Warren is still skeptical.

“With all these mortgages being securitized and sold to investors,” Warren pointed out, “there’s apparently a huge pressure for full occupancy, at the same time that there are higher rents being applied and more aggressive collections going on — again, especially in poor areas, where most of these rental mortgages occur. One analyst believes that the whole rental-backed experiment could fail not because of delinquent renters but because of delinquent landlords. Bottom line — we could have 2009 all over again.”

“Right there, you just lost the argument, Warren.” I mean, he’s just such a worry-wart. “Didn’t the banks land on their feet the last time?”

“I guess you’re right,” Warren admitted.

“You’ve got to trust the banks,” I concluded. “Don’t they always come out all right?”

Bill Annett writes four newsletters: The Canadian Shield, American Logo, Beating the Street, and The Oyster World. He can be reached at: Read other articles by Bill.