The Night Comes On...

London Visitors Diary - March 2008

Denial! The People haven’t yet grasped what it precisely means that credit is no longer ubiquitious, nor do they comprehend the dominoes that will inevitably follow in the aftermath of its withdrawal. When did Paul Reichmann realize that his vision of Golcanda-on-Thames was, despite its audacious brilliance, doomed to change hands several times hence, sadly without him (O&Y) as seller, but his creditors. The magnificent Empire State Building, icon of all that bedazzles the visitor to Manhattan was a white-elephant, meaningfully vacant for a decade-and-a-half after it pierced the upper boundaries theretofore seen for skyscrapers. And few Canadian bankers, no matter how hard they might try, will forget the early 1990s purging of just-minted vacant buildings at thirty cents on the dollar of prevailing cost of new construction. Vision is simply not enough. Nor is skill. Not where leverage is involved. Timing, it would seem, is very nearly everything.

And so I look out the window of a friend’s office high-above the London skyline and – suspending judgment upon the “success” of vision and risk-taking as might be proffered two decades hence – see frames of rising towers that will ultimately stand empty, destined to pass, as if on a carousel, from old-owner, to bank, to vulture, and then, eventually, back to public ownership in the form of a purchase by a pension fund, REIT, dedicated property investor, or if it be prime, by hoard of still-to-be recycled petrodollars. Both in London proper, and from the train escaping the city’s grip, sky-cranes are everywhere. And as I drive past sites – from the craters to the half-completed - marginal of projects (and they exist in numbers that are astounding, built upon poor locations and cashflow models that redefine the meaning of the word “optimism”), I cannot help but wonder what precisely their principals might be thinking at this very moment, or what spin they are preparing for their bankers upon next chance encounter. Were jingle-mail an option, would they be addressing the envelope as you read this?

Between the impending mass of layoffs from hedge-funds now-gone or soon-to-be put out of their misery, private equity firms, commercial and city banks reeling from that Jones-ing feeling, the impending exodus of non-doms, the looming wealth-effect spirals from continued home price implosion a-la-USA, erosion in the values of other core investment assets, Financial ZIRB (zero incentive reward bonuses), the biting of higher energy and food prices, the inevitable trough in visitors due to ridiculously over-valued pound sterling and recession or sclerotic growth elsewhere, and the negative cascades that ripple through the chain of dependencies supporting the formerly lavish business and personal spending that will wither by comparison to its former robust levels. This is a tale of woe, and I believe rather deterministic in its arrival despite government protestations to the contrary that suggest (or rather hope and pray) Britain will escape recession. No manner of bolstering the UK governments financial team (or policy for that matter) will have any appreciable impact upon its impending arrival.

Lore according to Knight-Frank has it that very near forty percent (40%) of central London residential purchases >GBP1mm were made by non-residents, primarily for “investment purposes”. Much is made about them being “cash” buyers, and so (the reasoning goes) unaffected by vicissitudes of leverage, and unbowed by price destruction. But, this one asset purchase says nothing about their total leverage, or their beta to credit generally. They may have leverage on their domestic abode to benefit from interest deductions. Their business may be leveraged. Euro-based investors will have already seen 15% decline in values via currency alone. Most stock-market investment is, in fact, “fully-paid”, but that doesn’t prevent investors from selling in reaction to, or after things have already gone down. So when it becomes apparent that their investment is “dead money”, one shouldn’t be surprised to find many sellers, putting further pressure on prices. I am sympathetic to the optimists seductive extrapolation of the recent past towards the future, for property prices have indeed provided robust returns. But they would do well to consider alternative realities, such that I chanced upon today in “Country Life” (no, I’m not a regular reader), which detailed the history of a Torquay “cottage”, sold for GBP2400 in 1868 to change hands in 1902 for a mere GBP1,000, before being sold in 1987 for GBP110,000 and now, in 2008 “offered” in the region of GBP1,750,000. Japanese and Germans can attest to the lingering after-effects of commercial and residential bubbles, however, even those bubbles are unlikely to see terminal values more than thirty years hence at 30p on the proverbial pound.

A bubble is a bubble is a bubble. The unwinding of which is typically rather unpleasant. London, and by extension, the UK, is in the early stages of being broadsided by the concurrent popping of three bubbles – one in property, one in HFs and PE Funds, and the other in credit and leverage itself. If you be long and leveraged into one, two, or all three, you should now be worried…very worried indeed…