Real estate HF manager David Michelson on the FDIC...

Hedge Fund News London: David Michelson, a hedge fund manager and general partner for real estate distressed fund Three Arch Investors, shares some insights on the bailout and the real estate market with Opalesque, from IGS Group’s offices in London.

On FDIC’s higher limit: meant solely to give confidence
The bill which was passed by the US Senate on Wednesday night includes the provision of $700m to the Treasury for the financial system bail-out plan, but it also includes other provisions, such as an increase of the FDIC’s limit, tax breaks and other details. The bill proposes to raise the Federal Deposit Insurance Commission (FDIC) limits from $100,000 per account to $250,000 account until the end of 2009. Supporters of the measure say it will prove especially comforting to small business bank customers.

The FDIC is a US government corporation created in 1933, that provides deposit insurance which guarantees the safety of checking and savings deposits in member banks. The vast number of bank failures in the Great Depression spurred the United States Congress to create an institution to guarantee deposits held by commercial banks.

“The increase in the insurance level is meant solely to give confidence for savers to go into their banks, to get the cheaper form of capital into the banks and it’s important that confidence be built up in the market,” said David Michelson. “The problem the banking system has is that, in the bailout context, when the transfer of the assets goes to the government, just after the sale of Merrill Lynch to Lone Star at 22 cents on the dollar, you’re going to have a significant decline in core capital.”

On July 28, 2008, Merrill Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds for a purchase price of $6.7 billion. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion, and in connection with this sale Merrill Lynch was to record a write-down of $4.4 billion pretax in the third quarter of 2008.

Big banks, small banks
Going back to the bailout bill issue, the major banks will, with newly clean balance sheets, be able to attract new capital from international sources. But the smaller banks and the regional banks are primarily going to have a problem because they may rate down the value of the assets as the government is going to attempt to. That is going to cause a significant decline in that core capital and these smaller banks will just not be able to attract the international investor, Michelson said.

“So we are looking at a significant inventory of distressed assets that will come both at the regional and the local level - and even from the government bailout program - because if physical assets (real estate, not paper) are not income-producing, there would not be any reason for government to hold on to those assets.” The bailout program, together with the $100bln of additional tax cuts, are designed to create some form of floor to contain the collapse.

“If you look at the finest financial minds out there and see what they’re doing instead of what they’re saying,” Michelson continued. “They’re buying the absolute best assets they can because values have gone from irrational exuberance to irrational fear. Which is a common pattern; the pendulum swings too far on the greed side and now it’s going too far on the fear side.....

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Real estate HF manager David Michelson on the FDIC...