The Wizard of OZK
By Scott Sumner
This past July, Bloomberg had an interesting story on the Bank of the Ozarks, soon to be rebranded “OZK Bank.” The bank has been very aggressive in making loans to property developers all over the country:
If there’s a marquee project in America—the tallest residential building in Nashville, condominiums in Miami’s Brickell financial district, a 450-unit apartment tower in the midst of Seattle’s booming Amazon campus—chances are “the Little Rock bank that could,” as the Kushner publication called it, is involved. . . .
Ozarks didn’t have a New York office until 2013; this year, industry watcher the Real Deal named it the city’s third-biggest construction lender. It’s committed more than $6 billion there, including loans for the Kushners’ purchase of a parking lot in the Dumbo area of Brooklyn, a $700 million Long Island City office tower anchored by Bloomingdale’s and WeWork Cos., and a 73-story residential tower that will be the tallest ever in Brooklyn. Gleason’s bank is the largest construction lender in Los Angeles, the largest in Miami, and one of the largest in Chicago, Denver, and Seattle. . . .
Eighty percent of Ozarks’ portfolio is in real estate, and half of that is in construction and land development, which is historically the riskiest sector and has led to a disproportionate share of bank failures. The share of these loans at a typical midsize bank such as Ozarks is eight times smaller, on average. Also, unlike many of his rivals, Gleason doesn’t work with other banks to spread risk or sell off loans as securities; he’s so confident of his judgments that he loads them onto Ozarks’ own balance sheet. Since 2014 profit has jumped almost fourfold, and the return on assets is double the industry average.
(Yes, that Kushner.) So why is this a concern? Isn’t this just capitalism in action?
If only that were so. The bank relies on funds from depositors, which ultimately means taxpayers:
As rates rise, Vandervliet predicted, the spread between what Ozarks pays out to depositors and collects in interest will shrink.
But didn’t Dodd-Frank limit the ability of banks to make risky bets with taxpayer-insured funds?
Regulators will have less authority to put the brakes on that pattern after Trump signed the law easing some of the oversight measures enacted in the wake of the financial crisis—“the crippling Dodd-Frank regulations that are crushing small banks,” as he put it. Congress did away with mandatory stress-testing that forced banks with $10 billion to $100 billion in assets to evaluate how, for instance, a 40 percent drop in commercial real estate prices might affect their balance sheets.
But there’s no reason to worry, as the economy is doing great, isn’t it? Here’s the Financial Times, from 2 months after the Bloomberg article:
Even as developers have been reshaping Manhattan’s skyline with soaring residential towers, the local new-build market has been dropping like a stone.
The number of new homes sold in Manhattan in the year to September is down 39 per cent on the same period in 2017, according to new data from real estate firm Douglas Elliman. Median sale prices fell 9 per cent over the period.
“We’re in the middle of a US housing slowdown, with Manhattan’s prime market the first and most sensitive to react,” says Jonathan Miller of Miller Samuel, a local property appraiser.
The slowdown has been most pronounced among the priciest homes, many of which are to be found in the slew of new super-slim residential skyscrapers that have sprung up along Billionaires’ Row — the area to the south of Central Park, centred around West 57th Street — and in parts of Lower Manhattan. . . .
Things could yet become worse. In the past three years, nine new residential skyscrapers (many include commercial tenants, too) taller than 200m were built in Manhattan, according to the Council on Tall Buildings and Urban Habitat. Between the beginning of this year and the end of 2020, 22 more are set to join them
This slowdown is partly driven by policy changes:
At precisely the time that buyers for these new homes are most needed, growing ownership costs of new homes will discourage buyers. The new Republican tax bill, in force since January, caps at $10,000 the state and local taxes that many Americans can offset against their federal tax bill (so-called “itemised” deductions). . . .
This is particularly galling to buyers in New York where state and local taxes are among the highest in the country, says Miller. He estimates the property tax on a new $3m Manhattan home is currently $44,000 per a year
But won’t foreign buyers come to the rescue? More policy changes . . .
Fewer international buyers are purchasing homes in the United States, a turnaround from a surge in 2017 that could affect home sellers, real estate agents, mortgage lenders and others who deal with the housing market.
The drop is attributed to a number of economic factors and to noneconomic ones such as U.S. policy toward immigrants.
Remember the last time we cracked down on immigration, in 2006?
As long as lenders are aware of the slowdown, and don’t start new projects, the current loan portfolios should be manageable. But will they stop? Surely they won’t make additional bets in a Manhattan market that is already quite shaky. This is from last weekend’s New York Post:
Powerful developers just took control of properties they needed to build long-in-coming mega-projects on two different blocks between Fifth and Sixth avenues.
Gary Barnett’s Extell Development Company bought 4-story 32 W. 48th St., former home to the Plaza Arcade diamond mini-mall, for $40 million, and at the same time closed on title to several adjacent buildings an air rights to another. The deals popped up in city records Friday night.
“We now have everything we need to build,” Barnett said on Sunday. Tentative plans call for a hotel with a “few hundred keys” and stores, he said.
The purchases totaled $85 million. Extell also signed a $63.8 million mortgage spreader agreement with Bank of the Ozarks for the six adjacent properties — 30, 32, 36 and 38 W. 48th St. and 25 and 27 W. 47th St. The new project will connect West 48th Street with the 47th Street diamond block.
Once NYC developers put up their luxury condos, the property taxes are surprisingly low. Again the New York Post:
New York City’s method of assessing property values is so out of whack that the buyer of the most expensive apartment ever sold — a $100 million duplex overlooking Central Park — pays taxes as if the place were worth just $6.5 million.
With controversial tax breaks granted to the One57 condo tower, the total property tax bill for the spectacular penthouse is just $17,268, an effective rate of 0.017 percent of its sale price.
Here’s my theory of modern American capitalism. During the 20th century, the government began intervening in the economy in a major way, often with good intentions. At some point, the rich learned how to “hack” the system and loot the public. I once spoke to a business executive in the education area (I can’t be more specific) whose basic business model is to engage in what’s politely called “regulatory arbitrage”. The programs he was taking advantage of would sound very “progressive” to the average person. And indeed those property tax breaks for NYC billionaires are defended by the very left wing de Blasio administration:
“This is a serious problem that [Mayor Bill] de Blasio needs to figure out,” he added. . . .
In a prepared statement, de Blasio spokesman Wiley Norvell said: “These inequities have been built into the tax system over decades, and they won’t be solved easily or quickly.”
“Any solution would require tax-law changes in Albany, and the impact of those changes on the lives of New Yorkers would have to be taken into account,” Norvell added.
Then we have a medical industrial complex absorbing 17% of GDP, mostly government dollars (directly, or via tax deductions.) Many surgeons, drug companies, and medical equipment companies become quite rich off the system. Ditto for firms that supply equipment to the military. Or property developers who make vast fortunes with taxpayer money funneled through the banking system. Or Disney, with its ability to get politicians to endlessly renew copyright protections—long after they are no longer needed to spur creativity. Or sugar growers protected from imports.
I could go on and on, but you get the point. The left correctly senses that there is something seriously wrong with the modern American economy. But they misdiagnose the problem as “laissez faire capitalism.” Actually, laissez faire capitalism is the solution; the problem is state capitalism, or if you prefer, crony capitalism.
PS. Disclaimer: As before, let me emphasize that I don’t predict recessions, and have no idea how the current slowdown in NYC property will play out. Nor do I have any views on the soundness of Bank of the Ozarks, other than that it seems emblematic of a flawed policy regime. A seemingly endless supply of credit from a formerly obscure Arkansas bank to the biggest and most influential developers in New York and Miami? What could go wrong?
Commercial property booms always end at some point, and I worry that taxpayers will be left holding the bag, just as in the 1980s and 2008-12.