The machinations of the nation's biggest "too-big-to-fail" banks would make for entertaining reading if it wasn't so serious. The most recent scaremongering centered on the forthcoming litigation arising out of the roughly $1 trillion of mortgage securities backed by residential mortgages. The banks are being hit by prosecutors and regulators, but investors seem not as worried. Bank of America's stock has risen more than 70 percent in just this year alone. Go figure.
Litigation tends to take about seven years to work its way through the courts and on to a settlement or judgment. In the meantime, the problems leading to the court battles have the time to correct themselves. But not before a fortune has been spent in legal fees.
But I digress. The white knight coming to the rescue of the banking industry could be the big money moving into the residential foreclosure market. Some of the nation's largest private equity firms are buying, renovating and renting out houses across the country by the thousands. Collectively, they have raised as much as $8 billion, which presumably is just a start. Eventually, their business plans call for selling the homes back to the renters -- which is certainly commendable.
For us small fry who want to invest in this opportunity, we may not have to wait long. A company called Silver Bay Realty Trust will be offering a real estate investment trust soon that taps into this market. Kohlberg Kravis Roberts & Co. also plans to spin out their residential real estate in an IPO. These firms have been buying properties in California, Florida and other areas where housing was hit the hardest.
As is the case with most basic commodities that experience a catastrophic downdraft in values, there is usually a "snapback" sooner or later. This flood of big money could trigger a surprise, substantial burst of value.
To date, investing in single-family foreclosed homes has been the province of individual investors. The king and queen of this sweat equity are the husband and wife from San Francisco who have bought hundreds of homes in Cleveland for just a few thousand dollars each. Folks like this, combined with new institutional money coming into the market, have contributed to the year's 6 percent rise in home values nationally. Who knows? It could accelerate to an even larger increase next year as the train is leaving the station.
Meanwhile, the banks struggling to get out from under their cloud could find that a rising tide of home values increases the value of what they have repossessed. Some people certainly have been banking on it. Fairholme Fund (FAIRX) was Morningstar's fund of the decade in 2010, and it is this year's best performing fund with a year to date return of 29 percent. About 9 percent of the fund is invested in Bank of America, whose Countrywide disaster makes it one of the biggest targets of the upcoming litigation. Never to be left out, Warren Buffett in August 2011 invested $5 billion in BofA and has enjoyed a 50 percent profit in the interim.
So, in spite of what promises to be headline-grabbing stories of the upcoming litigation aimed at banks, smart money doesn't seem to be all that concerned. It is betting on growing strength in the housing markets. Let's hope that they're right. If we're lucky, this major component of our economy may recover enough to blunt what business cycles indicate will be a mild recession in 2014.
Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0505, ext. 228, or email him at email@example.com.