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Economist: Washington’s Fixes Have Become the Problem

Uncertainties over taxes and access to credit are driving U.S. businesses to hoard cash rather than lead the economy into recovery by spending and hiring, according to a prominent real estate researcher.

The private sector has squirreled away trillions of dollars that could revitalize the economy, but businesses are reluctant to part with cash they may need for operating capital in the absence of credit, and to pay higher tax bills at all levels of government, according to Dr. Mark Dotzour, chief economist at the Real Estate Center at Texas A&M University.

“We are used to thinking of the federal government as the solution to these problems for economic growth and they have rapidly become the source of the problem because of the uncertainty that they have created for business people,” says Dotzour, who was one of several presenters at a symposium hosted by the CCIM Central Texas chapter on Feb. 23 in Austin.

What uncertainty? Taxes, for one. Early proposals to raise the capital gains tax from the current 15% to 24% have been scaled back to 20%, but even that hike would reduce initial returns on investments in commercial real estate, Dotzour says. That threat of a bigger tax hit will lower initial returns on investments in commercial real estate. That would lower the price an investor can pay for commercial real estate and push down already sinking asset values.

Similar worries about higher income tax rates, increasing energy costs as a result of cap and trade legislation, and health-care reform proposals that leave members of the medical and insurance industries guessing as to what their incomes will be next year are collectively weighing on the minds of business owners and would-be entrepreneurs.

Just as tight credit and tax hikes by President Herbert Hoover's administration exacerbated a recession to create the Great Depression in the 1930s, which Dotzour dubs “the Hoover maneuver,” a lack of credit and potential tax hikes will stifle business growth as the nation struggles to climb out of the current downturn.

Washington’s response to the recession with stimulus dollars has served to prop up ailing financial institutions and state governments without doing enough to correct underlying problems that brought on the credit crunch and banking crisis, Dotzour contends.

By allowing banks to extend loans that are covering their debt service payments but that are underwater, meaning the value of the asset has fallen below the remaining loan balance, the federal government is postponing the inevitable write-downs — and bank failures — that must occur in order for surviving banks with healthy balance sheets to resume lending to small businesses.

Dotzour says redefining fair market value to reflect an owner’s asking price, rather than what a willing buyer would pay for a real estate asset, has allowed banks to avoid write-downs on loans that would otherwise be deemed underwater. He compares the practice of extending bad loans at U.S. banks to the Japanese government allowing banks to keep bad real estate loans on their books, which mired bank balance sheets and crippled that nation’s economic growth for more than a decade beginning in the 1990s.

“Now let’s try the Hoover maneuver and the Japanese thing all in one year,” Dotzour says. “This is a cocktail for disaster.”

Others at the conference took a more reserved view of the government’s approach to bad real estate loans. In a presentation on the capital markets, Phil Capron, president of Austin-based real estate investment firm Falcon Southwest agreed that the federal government is “supporting the fiction of minimal loan problems.”

By allowing banks to extend underwater loans, however, government regulators are enabling banks to write off bad debts a little each year and work through their problems without much pressure to speed up the process, Capron told the group.

An even greater source of uncertainty is the looming fiscal crisis for state and local governments that have relied on federal stimulus dollars to help balance their 2010 budgets rather than cut programs and staffing, says Dotzour. With major indexes showing commercial real estate values down by 40% or more from their peaks in 2007, tax appraisal rolls must soon realize a massive decline in the tax base that funds everything from state government to school districts.

“That is the biggest threat to a double-dip recession,” Dotzour says. “Government entities from the states on down are going to have to lay people off to balance their budgets.”

On the positive side, consumers have reined in their debt balances and discretionary spending, corporate profits and shareholder earnings are increasing and businesses have right-sized their spending, Dotzour says. “The only component of the economy that hasn’t right-sized yet is government at the state, city, county and federal level,” he says. “That’s going to have to happen.”

Dotzour’s contention that federal regulators aren’t doing enough to force banks to write down bad real estate loans and revalue commercial real estate collateral struck a chord with Tim Hendricks, senior vice president in the Austin office of Atlanta-based Cousins Properties Inc. (NYSE: CUZ). Hendricks says the creation of the Resolution Trust Corp. (RTC) in the 1980s enabled the banking sector to deal with bad real estate loans and resume lending in an environment of corrected real estate values.

“At some point there has to be a re-adjustment in the market,” says Hendricks, who was among the more than 200 real estate professionals at the Austin gathering. “The RTC dealt with flushing through those buildings and we’re going to need to do something similar to that this time around. The feds are going to have to make that happen and make the banks work through their problems.”

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