Controlling Class Smack Down For Mortgage REITs?

I went for a ride on my mountain bike last week. Is it any wonder that all I could think of during the long, steep, uphill grades was REITs? The analogy is apt, as making money in this sector is almost as strenuous. This afternoon, however, after I wiped the vomit from my shirt luckily I can’t afford to eat much that day seemed like a decade ago. Earlier in the day today, General Growth Properties (GGP), an equity REIT that owns and operates shopping centers announced that it may be unable to refinance its debt. Even pedestrian REITs like AIMCO (AIV), an owner of apartments will you take food stamps? took it in the shorts to the tune of 30% as confidence completely evaporated from anything related to real estate and mortgages.

But didn’t our lame, ignorant congress finally get a clue as to the damage a full-fledged banking crisis would cause? For those libertarians that are still ambivalent about the whole thing, if those gerrymandered economic neanderthals hadn’t finally passed the TARP bill, the United States would probably be facing the same fate as Iceland: imagine logging into your online brokerage account and being unable to trade or transfer cash. Such is the state of affairs legally blonde in Reykjavik at the moment.

But we do finally have TARP and the treasury had better get at it – and soon. The GGP debt is precisely the kind of stuff the TARP plan was meant to address. Nobody wants it, and nobody needs it. But what if the Treasury does purchase, for example, GGP debt. What will they do, if anything, for the equity?

If Bear Stearns, Indy Mac, Fannie Mae, Freddie Mac, Washington Mutual, Lehman, Wachovia and others are any clue, the answer is plainly nothing. I’m not sure if this matters for largely match-funded REITs like NCT, RSO and crazily enough, even loss crippled CRZ. Especially when the government socialization of private mortgage losses (purchasing broken CMBS debt) at above-market prices and suspending mark to market accounting allows everyone to believe in fantasies giselle bundschen cooks me breakfast whilst naked namely, that there is a market for this stuff in the first place, which there ain’t.

But there is no market and it pays to remember that with all this “rescue” talk the Fed has not been kind to equity holders, even PREFERRED EQUITY holders. So for those of you who are marveling at the deals to be had in the REIT preferred space, given the perceived “safety” relative to the common, think again. The preferred holders in Fannie Mae and Freddie Mac were wiped out just like the common, and the TARP bill contained a special provision just to bail out the regional banks that held this junk. But there was no such luck for the individual tax payers who were stuck holding this now worthless scrip, even though they will help pay the Treasury’s tab for bailing out the hapless banks.

So how will the TARP program treat those REITs that are investors in Controlling Class CMBS, which is pretty darn close to equity? This was the question on my mind as I pedaled my way up the hill, after spending the morning watching the likes of Anthracite (AHR) and JER (JRT) get knocked back to the Stone Ages. Last week, after these two REITs get disproportionately sold, it seemed that the market was counting on the treasury to penalize those who knowingly invested in the lowest rung of the CMBS food chain.

But today, after listening to Bernanke address the National Association for Business Economics about the need to restart the CMBS and securitization markets, I was less convinced. Controlling class CMBS is an essential cog in the CMBS wheel, and without it there will be no market. Unfortunately, as in Iceland at the moment, there is simply is no market for anything and cash truly is king. But these juicy REIT dividends are no compensation for margin calls and 50-75% losses of principal. I had no idea how big the mother of all bailouts would be when I wrote wrote this post, and it’s safe to say neither did Helicopter Ben. All that ivy must have obscured his view.

More information on how REITs work can be found in the post REIT Definition.