By: Ronald D. Struck                                                               May 1995

CAN REAL ESTATE STILL RELY ON BANKS?

Banks, real estate developers, and homebuyers must return to the basics.  Banks must provide true "value added" services, be more prudent, and stop chasing highly speculative business.  Real estate developers must build what the market needs, not build more just because they can get the money to do so.  Homebuyers must acquire homes as shelter, not primarily as speculative investments.

While the banking system has not collapsed as it did in the 1930's during the Great Depression, the world wide banking system is undergoing radical changes, which are profoundly affecting the real estate industry.  Are the banks having trouble because real estate values fell, OR is real estate having trouble because the banks are failing?  The answer is Yes.  Banks and S&Ls made money easily available to developers in the 1980s,  so developers took it and grossly overbuilt, which precipitated the real estate crash in the early 1990s.  Unrealistic optimism has the same effect on any market, the Holland tulips, oil, gold, etc., the speculative bubble eventually bursts and the market pays the price, in pain, suffering and riches, for its excesses and abuses. 

Is the banking system doing its job?  Were it not for exclusive franchises granted by the government, there is not a service provided by a bank, which could not be provided by a non-bank.  Even with the franchise, there are very few services banks provide which are not already available from non-banks.

Governments are breaking down into smaller units to better serve the needs of their citizens.  Why not banks.  Why is the net worth of a bank used to offset investments in something like Citicorp's Quotron securities quote system, bought for $630 million is 1986, and wrote down by $400 million in 1991.  Wall Street executives weren't keen on giving their business to Citicorp, a financial services rival in their eyes.  Or loans to Brazil.  Or to Trump.  Or to corporate raiders.

In the not to distant past, it was the goal of every aggressive developer to establish and maintain strong relationships with one or two banks (or S&Ls).  It was thought that such relationships could be nurtured into reliable long-term sources of capital to meet all types of development needs.  A developer who still has this view, regardless of the identity of the bank, must have their head in the sand.

Banks have become, easily, the most volatile and unpredictable participant in a developer's business.  Why - because the basic essence of the structure of the world wide financial system is undergoing a major reformation.

When you boil it all down, banks are nothing more than the artificial creation of the government.  Franchises created by pieces of paper which say how federally insured deposits can be taken in and what kind of loans can be made.  Banks provide no services that cannot be provided by non-banks, and in most if not all cases, far more efficiently than banks.  Many examples of this fact already exist.

Depositors give banks their money and the banks give them back deposit accounts insured by an agency of the government.  From an investment viewpoint, these insured deposits are nothing more than surrogate investments in government/agency obligations (or securities).  Therefore, the rates paid on deposits should be comparable to those paid on government/agency securities, and too often they are not.

Money market accounts offered by securities firms are as close as the government has let anyone get into the banks' exclusive checking account franchise.  Do checking accounts provide investors with more security?  No - many money market accounts invest exclusively in government/agency securities.  Do checking accounts provide more liquidity?  No - if the government would permit it, they could provide exactly the same level of liquidity.  Do checking accounts pay higher returns?  No - interest paid on checking accounts is substantially lower that the rates paid on money market accounts.

So, what do you get for your money at a bank?  A large expensive building.  A friendly face to talk to you.  An overhead structure that is very expensive to operate.  And, low rates.

Using a bank for deposits and money management is like using a horse and buggy.  It may occasionally be nice and quaint but, with today's high tech capabilities, it’s extremely inefficient.  Computers and automatic teller machines make the bank building and friendly teller face obsolete.  If someone prefers to continue using the horse and buggy, they can’t expect to get around as fast as someone using a car.  Likewise, if someone feels more comfortable having their bank building nearby and someone to talk too, they can't expect to be as efficient in maximizing returns on their money as someone who uses money market funds.

The government, and its agencies, have billions of dollars of securities outstanding, and are issuing billions more every year.  Much of the deposits gathered by banks are invested in these securities.  Depositors could invest in these securities directly and earn a much higher return.  Naturally, the banks retain a large portion of the return generated by the securities to cover their very large overhead and profits.  This is not much of a "value added" service.   

And, banks need to re-establish their traditional policeman role of keeping their borrowing customers on the straight and narrow.  One of their primary roles is to know wild speculation when they see it, and assure their lending activities reflect the true speculative risks involved.

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