Big Short redux?


Big Short Redux coming?

Columnists sees eerie similarities today to Big Short conditions.

Vote at the end of this blog on whether you think conditions are ripe for another Big Short.


By Keith DuBay

Special to Denver Real Estate Watch.

Big Short

Keith DuBay

Is Big Short.2 knocking on our door?

The Big Short, a book by Michael Lewis and the Oscar-nominated movie by the same name, chronicled the financial shenanigans that led to the Great Recession and those who profited from it because their crystal balls saw housing prices falling off the cliff.

After banks fail, the commercial, industrial and housing markets crash and credit tightens, throwing the country into an economic tailspin.

It all seems so obvious. We should have known.

But participants in a raging segment of the economy, like we have in real estate now, never know.

Most of them, anyway.

It’s easy to understand why we are blindsided by booms crashing.

It’s not only difficult to predict the end of any bull market, whether in stocks, commodities or real estate, but it contravenes the natural human instinct of optimism.

We want to enjoy good times.

It is hard to fault that desire.

Bubble Brewing

Yet, signs of a bubble, fueled by easy money policies by the Federal Reserve and high demand for real estate after years of underbuilding, are becoming more obvious every day.

Here’s what’s on my radar: a warning from Moody’s about community banks, plus an eerie Big Short-like statistic.

The Federal Deposit Insurance Corp. in its 2016 Quarterly Banking Profile, reported that while the banking industry saw a 2 percent drop in profits, community banks income rose 7.4 percent.

That’s ostensibly a good thing, but not in Moody’s eyes. The big profits are being produced by commercial real estate lending, which the rating agency sees as credit negative.


Because Moody’s knows what I learned as a longtime banking reporter.

Early in my career at the now defunct El Paso Herald-Post newspaper in El Paso, Texas, I covered dozens of bank and savings and loan failures.

Later at the Rocky Mountain News, I reported on more than 30 Colorado savings and loans that failed, were sold off for a pittance or merged into another institution.

Banks failed too.

The reason? In every case it was exposure to commercial real estate.

Moody’s take

Moody’s puts it this way: “When the CRE (commercial real estate) market deteriorates, as one of our key indicators suggests has already begun, community banks’ creditworthiness will deteriorate more than larger banks, as was the case in the last recession. Community banks grew CRE loans 11.9 percent during the past 12 months, compared to 9.4 percent for all other banks. Within CRE, 19.1 percent growth in multifamily and 16.3 percent in construction/development loans led the increase. Moreover, community banks increased their unused CRE loan commitments by a substantial 22.7 percent.”

Commercial real estate by nature is a big boy game.

It takes investors with large, diversified balance sheets, extensive knowledge and experience and the patience to weather economic storms, not to mention the courage to buy low and sell high.

In my experience, backed by Moody’s opinion, community bankers possess neither the expertise nor capital to compete in CRE.

Moody’s also published a chart that to me showed an eerie resemblance to 2007, the year that things began to fall apart, leading to the first national real estate downturn since the Great Depression of 1929.

The agency tracks loan-to-value for commercial mortgage-backed securities, or CMBS.

It’s an important indicator because it tells us how much equity these securities carry.

Loan-to-value has recently surpassed the 2007 peak. These are the type of securities that bore the same credit quality scrutiny and scorn of legendary fund manager Michael Burry. Burry was the doctor in the Big Short, played by Christian Bale in the movie, who bet against big banks as a newly minted hedge fund manager, and ultimately made a fortune, while most money managers remained mindlessly bullish.

Participants in the CMBS markets will no doubt say that credit underwriting standards are better than they were in 2007, that banks have to pass stress tests that require them to carry more cash reserves.

No Where to Hide

All of that may be true, but I’ll believe it when I see it.

In my opinion, when massive economic tidal waves hit, there’s not much refuge available.

Everybody gets wet, and everyone looks foolish when just a year ago they looked so smart.

Trouble in real estate paradise hits home.

Denver is a prime example of rising commercial and residential real estate prices.

There has never been a time in Denver before now when homes have appreciated so much more than the inflation rate.

Housing prices have risen every month since 2012.

Last year, while the economy appreciated 2 percent, Denver housing prices rose 12 percent.

Every month Denver area residential home prices set a new record, while inventory remains low.

All of the seller market stories run rampant, from frothy bidding wars in which a house sells $100,000 over the asking price to aggressive sellers’ demands during the negotiation process.

And it’s not just houses.

Unaffordable Rents

Luxury apartments are being built right now that require incomes of $75,000 to $100,000. That’s right. In some cases you need a six-figure salary so landlords can take your rent.

How many millennials have that kind of income?

Add student debt to that burden and rents can quickly consume 30 percent or more of your income.

How is this market different from all of the others?

It’s unchartered territory. But it can’t go up forever.

Low interest rates have artificially pushed home prices up.

Yet at the same time bank underwriting is not as lax as it was. Some say they are too tight, which could lead to looser borrowing standards, allowing unqualified buyers to again sign on the dotted line, a major reason that led to the crisis illustrated by the Big Short.

Signs of a softer market are present.

Home sales in the Denver area were down 17.6 percent in July compared with July 2015, according to a report by the Denver Metro Association of Realtors.

Slowing Home Sales

The number of new listings entering the market last month fell by 9 percent from July 2015.

And fewer new homes are entering the market, partly because it’s difficult for builders to make money on cheaper homes, which are in the highest demand.

Meanwhile, institutional investors seeking higher yields than the bond market provides have poured truckloads of money into rental communities.

You can’t swing a dead cat in the metro area without hitting an apartment building under construction.

A lot of smart people, apartment developers included, think a crash is coming sooner than later.

But the truth is as long as developers can obtain non-recourse financing, that is, they aren’t personally responsible if the apartment loan doesn’t perform, they will continue to take the money and build.

Arsenault Warns of Recession

Marcel Arsenault, CEO of Real Capital Solutions in Louisville,  made his name and not to mention millions of dollars, who like the protagonists in the Big Short, saw the crash coming.

Arsenault sold his office portfolio before the crash and shorted, that is bet against, a number of publicly traded home builder stocks when they were flying high.

Earlier this year, Arsenault spoke on a panel at a conference sponsored by the Colorado Real Estate Journal.

Arsenault had a rather grim outlook for the real estate market.

His disaster scenario is as follows:

  1. Multiyear overbuilding above population demand.
  2. Millennials finally convert from renters to homeowners.
  3. A recession, around 2019.

Dire predictions by someone as smart as Arsenault, the Moody’s report and my own experience covering real estate are enough of a warning for me.

While it’s true that Colorado is seeing the second-best population growth in the nation and that residential building activity is below historic norms, it’s also true that no one ever repealed the laws of supply and demand.

As soon as the jobs disappear, all those people could easily move somewhere else.

Under that scenario, how does your demand look?

It’s a good time to contemplate of all these warning signs.

After all, we don’t want to give Michael Lewis fodder for a sequel to The Big Short.

Is another Big Short scenario, where housing prices fall off the cliff, imminent?

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Keith DuBay is managing partner of the Blue Coast Media Group.

Have a story idea or real estate tip? Contact John Rebchook at is sponsored by 8z Real Estate. To read more articles by John Rebchook, subscribe to the Colorado Real Estate Journal.








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John Rebchook

John Rebchook has more than 30 years of experience in writing and communications. As the Real Estate Editor for the Rocky Mountain News, he wrote about residential and commercial real estate for 26 years. He has won numerous awards for business stories and columns that he wrote, both as an individual and part of teams. In addition to real estate, he also covered economic development, banking and financing, the airlines, and cable TV for the Rocky. In addition, he was one of the original freelance writers for, covering commercial real estate for the Internet publication.

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