Like Elon Musk, Frank Rolfe skates close to madness. He is brilliant at what he does. He has popularized the industry and catalyzed many of the changes that happened over the past decade and a half. Many of us owe our business success to him. I chatted with him once in an elevator and enjoyed the experience. He takes the heat for the rest of us when he gets bashed in the press. But – he does have some crazy ideas.
Q: Frank – Do you really think the Wall Street Journal is a woke rag?
A: Yep.
Q: Do you support Donald Trump?
A: Yes.
Q: What are your views on Pizzagate and Jewish space lasers?
A: I’m just sayin…
He straddles the razor’s edge between madness and genius. Maybe we will soon have two Frank Rolfes.
As I was trying to write some serious stuff this afternoon, my phone farted and emitted this, from Frank. The ratio of noise to information is high, but as far as I can tell, here is what it says:
- There have been some high-profile bank failures recently. These may lead to a general run on banks;
- Deposits up to the FDIC-insured minimum are safe;
- Seller financing will not be affected by bank insolvencies;
- Conduit financing will not be affected by bank insolvencies;
- Frank lived through the S&L crisis of the late 80s and has some stories to tell;
- Bank insolvencies could cause banks to call mortgages. Park owners with conventional bank financing should take steps to avoid this.
The first five of those statements are both true and non-controversial (admittedly, I do not know what Frank was doing during the late 80s). I do not believe that the sixth statement is true. If a bank goes bellyup after it lends you money, that is not an event of default on the loan. Under any lending documentation that I have seen, events of default only include actions of the borrower or events that affect the borrower’s ability to pay. An event that affects the lender’s economic stability is not, and should not, be an event of default. Absent an event of default, a loan cannot be called.
(As I understand it, Silicon Valley Bank did not fail because it engaged in risky behavior. Instead, it was a victim of the yield curve. Yields on longer-term bonds are usually higher than yields on short-term bonds. This is because the longer investors’ money is tied up, the higher the fee they demand for the use of it. That is what smart-alecks mean when they refer to the ‘yield curve’ – it is the line that curves up and to the right when you plot yields on government debt, with longer-dated debt listed to the right of shorter-dated debt. In exceptional times, the yield curve is ‘inverted’, i.e. it slopes down toward the right. An inverted yield curve often heralds an imminent economic downturn. We have an inverted yield curve now.
Bond prices have an inverse relation to interest rates. As interest rates go up, bond yields go up and bond prices go down. The prices of longer-term bonds are more sensitive to interest rate fluctuations than prices of shorter-term bonds.
Banks are in the arbitrage business. They make money from the difference between short-term loans and long-term loans. They borrow money from their depositors on a demand basis and they lend it on a long-term basis. For a long time, the model was 3-6-3. A banker borrowed money from his depositors at three percent interest, lent it to mortgagors at six percent interest, and was on the golf course by three P.M. each day. Things have changed a bit. Rates have changed. Women are now in the industry and banks have other lines of business – but the arbitrage model is still the core money-maker.
Since banks lend out depositors’ money on a long-term basis, they do not have enough cash sitting in a box to pay out all of their depositors at once. A run on the bank happens when too many depositors demand their money simultaneously. In order to lessen the risk of a run on the bank, banks are required to buy deposit insurance from the FDIC and to keep a certain amount of money in safe assets as reserves. The safest asset – so long as Congress doesn’t screw up too badly – is U.S. government debt.
That is where the yield curve comes in.
SVB did not invest its reserves in risky assets like crypto. Instead, it used them to buy long-term government debt. Shortly after it did that, the Fed started raising interest rates. When that happened, the price of long-term government debt got whacked. When that happened, the value of the reserves that SVB had to pay off depositors decreased.
Another effect of the increase in interest rates was a downturn in the tech sector. Growth industries like tech are sensitive to interest rates because the value of tech companies is based on future earnings. Like a payoff on a long-dated government bond, the present value of future revenue from, say, Amazon or Google decreases when interest rates increase. So, when interest rates went up, the tech sector got whacked.
SVB did not invest in tech companies. However, its depositor base was made up of individuals involved in the tech industry. When the depositors’ net worth took a hit, they started to withdraw money from their bank accounts. SVB could not meet these demands because the value of their reserves had cratered. The rest is, for now, shitty blog posts and journalism. The second draft will be history.)
If a bank that lends you money goes bellyup, you still have to pay. The terms of the loan don’t change. You just pay what you would ordinarily pay to your bank to the successor entity. If that is the FDIC, you pay to the FDIC. If another bank buys your bank, you pay to the successor bank. From the borrower’s perspective, the lender’s bankruptcy is a non-event. You just need to make sure that your checks go to the right payee.[1]
When I bought my second park, I also bought a few notes that the seller had taken back on some homes in the park. One of the notes was secured by a home owned by a guy named Junior. Junior was a nondescript-looking young guy whose only significant feature was his teeth, which were pointed and arranged like the teeth on a crosscut saw. You only saw them when he shouted – but he shouted often. The day after the closing, I knocked on his door and said, ‘Hi – I have bought the park. You will keep making the same payments on your note as before. The only difference is that you will make the checks out to me, instead of to the previous owner. He took a beat, wound up and shouted loud enough for the whole park to hear, ‘You can’t do that! That’s Illegal!’
That’s when I noticed his teeth.
I tried to explain to Junior that it was legal. During the last banking crisis, I had written articles about tax accounting for payments on distressed debt. When distressed debt changes hands, it does so at a significant discount to its principal amount. The tax law was drafted with healthy debt in mind, so it is unclear how income or gain from this market discount should be treated for federal income tax purposes. So, of course it is legal to transfer debt obligations. If it weren’t legal, I would not have been able to write those articles. But Junior would have none of this. He insisted that it was illegal for me to own his debt obligation, that he was going to talk to his lawyer, and that he was going to sue me. Instead of running with the land, he thought that the obligation ran with the flesh.
Junior moved out shortly after that. He was shouting and flashing his teeth as his truck pulled out of the park, packed with his wife, his two toddlers and their possessions. He was crazy. Frank is brilliant. I hope that he does not end up like Junior.
[1] The failure of SVB and Signature banks, and the recent troubles at Credit Suisse, might actually be a good thing for park owners, because they might cause the Fed to pause or halt rate increases. I am exposed to interest rate risk because both of my banks are financed with conventional mortgages that reset every five years. One resets in May. With luck, rates will stabilize and I will be squeezed a bit less hard than I expected because of this.