With Thanksgiving upon us and the holiday season in full swing, we here at CrunchedCredit.com would like to present our “Golden Turkeys”, noting certain special contributions to the ongoing resurrection of the Commercial Real Estate Finance industry.

The Golden Turkey for the Best Self-Inflicted Wound: FASB

Hands down, this goes to the Financial Accounting Standards Board. We don’t know whether to give top honors to FAS 166 and 167 dealing with the transfer of financial assets or the new Fair Value Accounting Rules. But in any event, in a series of changes which certainly must have made more sense to academic accounting communities and to the financial markets and investors for which these little regulatory gems were designed, for reasons which remain curious even now, they’ve imported enormous financial volatility and burdened the balance sheets of financial institutions with assets they don’t own and liabilities for which they have no contractual liability in the middle of the greatest financial correction in modern memory. At least we changed the rules of the game, we drop a giant pro-cyclical engine into the balance sheet, stir in a little FinReg, and, Viola! — chaos. We could have hoped someone with regulatory gravitas could have stood up and said, "What are you thinkin’?" And now for a second heaping of goodness, FASB is considering expanding Fair Value to all financial assets, which will produce even more volatility onto the balance sheets of financial institutions. Oh, and have we mentioned Lease Accounting? If FASB has their way, all leases will be treated as capital leases. we can’t even begin to tell you how bad that is. FASB, the winner in this category, hands down.

The Golden Turkey Award for Best Regulatory Knifefight: FDIC

This award goes to the FDIC. This late, lamented Congress began spinning the tale that the absence of skin in the game caused the capital meltdown over the past three years, and, in large measure, through sheer undisputed resolution, it has become received wisdom. (There must be a Golden Turkey for that itself, isn’t there?) So the SEC begins a regulatory initiative to impose skin in the game requirements for use of a shelf in a publicly registered transaction. Good enough, and then the Congressional locomotive comes through and skin in the game becomes a part of Dodd-Frank. Under Dodd-Frank, all the relevant banking regulatory agencies and the SEC are directed to engage in joint rulemaking on skin in the game. In the middle of all this, the FDIC publishes its new securitization Safe Harbor, which contains a completely freestanding and independent skin in the game provision. Oh, sure, the Reg which is in final form is applicable as of January 1, 2011, has an auto-conform provision that the Dodd-Frank skin in the game provisions won’t be law for two years, so we have, irrespective of the FDIC imposing its own set of conflicts rules on a certain sector of the securitization market, face a specific direction to engage in joint rulemaking. What the banking regulatory community thinks about this one can make the other members of the bank regulatory community and the Federal Reserve think about this one can only imagine. We suspect the SEC might be a bit pouty too.

The Golden Turkey Award for the Idea Which Launched a Thousand Ships: Risk Retention

Yes, we have to make mention of the 2010’s fiscal cure-all – risk retention. Risk retention has earned a place of just south of gravity and just north of evolution (with some notable exceptions) as received wisdom in this country. It is at the core of a vast amount of regulatory change which will sweep financial markets when turbo charged by FASB’s views on consolidation of securitization vehicles literally changing the fundamental rules of the securitization game in a way to diminish capital formation at a time when capital formation is critical to the recovery of our economy. A base for received wisdom? Pretty dodgy. Lehman, Bear, Merrill, AIG, et. al. didn’t fail because it laid off the risk of ownership of financial assets. It was because they retained it. The worst performing sector of the entire commercial real estate debt capital markets was the land loan and construction lending sectors. Sectors notably bereft of the ability to sell off the risk. While reasonable people might differ on the behavioral impact of retaining a 5% strip of a financial asset, the data simply do not support the religious fervor with which this notion has been embraced. Hockey stick, anyone?

The Golden Turkey Award for the Most Opaque Regulation: 17g-5

This was a highly competitive category this year – but the winner is Rule 17g-5!

Rule 17g-5 provides that rating agencies must require a party retaining a rating agency to rate an asset backed security (including CMBS), to establish and maintain a password-protected website for all other rating agencies. The website must contain all information provided to the rating agency in connection with the rating. Both written and oral information must be loaded into the website simultaneous with its delivery to the retained rating agency. While the idea behind Rule 17g-5, the simultaneous sharing of information is good – the end result has been murky at best.

Bankers legitimately concerned with liability are insisting that there be only one conduit of information from the issuer’s side to the rating agency. No one is quite sure how to deliver oral communication to all the rating agencies simultaneously through the web-based delivery system. Credit rating agencies are likely to make mistakes due to the fact that they no longer have access to as much information. Accordingly, we find the revisions to Rule 17g-5 thoroughly deserving of a Golden Turkey.

The Golden Turkey Award for the Scapegoat of the Moment: MERS

In an upset, Mortgage Electronic Systems unseats Wall Street Fats Cats, winner of this category since 2007.

Until recently, Mortgage Electronic Systems (“MERS”)  was ubiquitous but relatively unknown. MERS has two roles. First, it acts as record title holder of the mortgage (as nominee for the noteholder) and keeps track of the owner of the beneficial interests in the note. Second, in states where it is permitted, MERS will appear in court to execute the foreclosure process.

MERS was born of necessity, created to address the inability of local recorders to keep pace with the number of assignments, providing a more modern approach to tracking the ownership of mortgage loan. As we mentioned before, ubiquitous, but relatively unknown until recently. However, in early October, a judge in Oregon stopped a foreclosure of a securitized sub-prime residential mortgage loan on the grounds that the assignment of a mortgage to MERS was ineffective because MERS didn’t hold the note – leading the judge to find that MERS lacked a cognizable interest in the property. Did MERS cause foreclosures, or even contribute to the current mortgage crisis – no. Yet, we anticipate that this will be an issue we are sure to hear more about in the future.

The Golden Turkey Award for the Worst Sequel : Basel III

Basel III wins the award for worst sequel.  Basel III is the most recent effort by the Basel Committee on Banking Supervision to fix the worldwide financial system. To provide some background, Basel II was never fully implemented, certainly not in the United States. While Basel II generally resulted in a significant relaxation of capital requirements for most lending activities, it stipulated that many types of commercial real estate loans warranted uniquely higher capital changes. These loans, called High Volatility Commercial Real Estate or HVCRE, include acquisition and development loans, construction loans and loans to sectors deemed by the applicable regulators to have higher risks of default and greater loss expectancy.

Unfortunately, now everyone agrees that something must be done, and that something is to jack up capital. Additionally, politics suggest that whatever comes out of Basel III will, this time, be implemented in the United States. Some have estimated that Basel III will require banks to raise as much as a trillion dollars in equity and obtain over $5 trillion in committed facilities to meet new capital and liquidity requirements.

We’ve heard suggestions that, under Basel III, in order for commercial real estate to be a competitive asset class for the banks, the risk spread would have to increase over 200 basis points. This may simply drive commercial real estate out of the banks. That’s why we call it the worst sequel.

The Golden Turkey “Ironman Award”: Our Readers

This is our recognition of you, the commercial real estate industry and your continued, determined efforts to right the ship during the past 12 months. There can be no doubt that 2010, with properties trading, loans being made and securitizations being printed, was a significant improvement over 2009 (which, in turn, was better than its particularly ugly predecessor). Of the many lessons that may be gleaned from the credit crisis, one is that, in boom times and bust, the CRE market lies in a state of constant innovation and requires professionals with unending creativity and unceasing motivation. We stand at a critical point in the real estate cycle as you – the architects of the future of this industry – lay the foundation for CMBS 2.0.

By the Crunched Credit Team.