Wall Street Financial Wizard Eugene Xu Invests in North Carolina Real Estate: The Current Market Environment is Far Different from before the Financial Crisis
Report by Song Danqi at the Carolina Branch of Chinese Headlines
During the Lantern Festival on February 15, 2022, the US-China Economic and Cultural Association (CAECA) specially invited Eugene Xu, a mathematical genius and banker in the American financial world who has been on Wall Street for 30 years, to come to the North Carolina Research Triangle to share his assessment of the current financial situation.
The topic of the speech was: the impact of Federal interest rate hikes on U.S. investment.
Mr. Li Meng, president of the US-China Scripture Association, introduced that Mr. Xu, who grew up in Shanghai, won second place in the National Mathematics Competition. In 1978, he joined the “Best Mathematics Class in Fudan”. This class also included Li Yuanchao, Li Jun, and many other young talents. The famous mathematician Professor Su Buqing, the president of Fudan University at that time, was their teacher. After completing his master’s study at Fudan University, Mr. Xu crossed the Pacific to the United States. He obtained his Ph.D. from UCLA in 1991 and came to Wall Street, the world’s financial heart, in 1993.
Dr. Xu rose to fame with his prediction of the American subprime mortgage crisis three years in advance. He’s also widely known for his role in the movie “The Big Short” where he was depicted predicting the inevitable occurrence of the subprime mortgage crisis through careful, allowing his employer, Deutsche Bank, to make a fortune by shorting the market.
In 2010, Dr. Xu and his colleagues founded the hedge fund LibreMax, which manages $6 billion in funds. In 2020, he left LibreMax to form GardenStar Group with several partners.
GardenStar Group is a real estate investment and technology company that is currently developing in a real estate project in the Research Triangle. Because of this, he has been frequently visiting North Carolina, paving the way for his lecture on the 15th of the first month of the Year of the Tiger.
“Everyone knew that I was experienced from 2008, that I foresaw the situation early on. Now that housing prices are rising so much, and the Fed is about raise interest rates again, do you see any similarities? Has an opportunity to short come?”
Mr. Xu briefly explained his personal experience in 2008. He entered Wall Street in the early 1990s, during which he experienced many bull and bear markets, but during that time in 2008 “really all the risks that could have compounded and exploded together.”
The financial crisis was not just a simple matter of rising house prices. From the perspective of real estate itself, we know that the price trend of any market depends on where its engine is. The engine is currently marginal buyers, and there are about 10% more people in this group than the number of ordinary buyers. The engines in the real estate market before the financial crisis were subprime borrowers.
The number of people who owned a home in the United States was very stable before 2000, a little more than 60%. By 2006, it had become 69%; almost 10% more people could suddenly buy a house. They were able to buy a house because of subprime mortgages. Those with bad credit or issues with repayment ability were essentially blocked from taking out a mortgage before 2000. But after 2004, it suddenly became possible to borrow for a number of reasons, one of which was the repeatedly Federal Reserve cutting interest rates leading up to that time.
Why were lenders willing to loan out subprime mortgages?
Originally, no one wanted to lend money to people with bad credit. But then a financial product appeared, called “asset securitization”. The loans were packed into asset packages, and bonds were issued on those packages. These credit bonds came with a rating of AAA. Many investment institutions around the world, including sovereign funds and banks, would then purchase them. Everyone suddenly felt that it was an incredible way to make money, so they all bought it, lowering the interest. Lenders with bad credit (subprime loans) did not need to pay the original 10% interest, but only 2% to 3% interest in the first two or three years with increase to 6% to 7% in the following years. Borrowers were undaunted by higher interest rates in the long-term. Because they thought that their houses would appreciate, they thought they could borrow new mortgages and repay the existing ones.
The Wishful Thinking of the Loan Company
Maybe you’d ask: Is the loan company stupid? What if the loan isn’t repaid? They weren’t stupid. Their solution was to make you repay the loan according to this model: in the first few years of your loan, you only need to pay about 2% to 3% interest on the loan value per year, but after a few years, your loan interest rates will quickly rise to a high level to make up for the low rates in the previous years. If the lender defaults due to high interest rates in a few years, the loan company repossesses the house as collateral, and then sells it to cover the loss, even gaining a profit.
There is also a very technical reason for this. As the asset package grows bigger and bigger, someone needs to maintain it, and they will be given 0.5% every year as a reward for collection. Imagine maintaining $1 billion in assets; 0.5% is a lot of money, especially since it does not require capital. Everyone comes to compete. Some people propose that if someone cannot pay, they will advance the arrears for free. That is to say, advance the debts that are in default for free, and then recover the money after they get the house from foreclosure.Later, housing prices stopped rising, and these people had to pay their mortgages. The biggest problem was the company that made the advance payment. It was expected that only 1% to 2% of borrowers would default each year. If too many breach the contract, it would be very difficult for him to make advance payments. They also expected that there would not be many foreclosure cases in court, and the foreclosure process would be completed quickly. However, with so many houses foreclosing, the courts were overwhelmed, and the foreclosure process would take years. If something originally only had to be advanced for 6 months, it could now have to be advanced for up to 3 years. These institutions would have no choice but to collapse. The only thing to do was squeeze out before others, so a house of $100,000 would be sold for $30,000.
This is what happened in 2008. The default of these subprime mortgages caused a series of compounding problems.
The Crisis won’t Happen Today, but the Market will Undoubtedly Cool Down
Reflecting on the financial crisis more than a decade ago, Mr. Xu speaks with confidence that the future market will not have a major crash like the one in 2008.
“The average credit score of borrowers is currently about 700. In 2005, it was only about 680. There are more people buying houses with full cash now than before 2008. In 2005, no one believed there was any inflation, and many people bought houses for speculation. Today, many people buy because of inflation since the annual loss of cash in the bank is 5%. In the last two months, it was up to 7-7.5%.”
Mr. Xu then changed the topic and said, “but then again, every time the Fed raises interest rates, it will cool the real estate market. This is inevitable. Because the cost of borrowing will be higher after the interest rate hike, inflation will decrease, so there is no need to worry so much keeping money in the bank.
“There is one more thing I want to share with you all: the total deposit in the U.S. bank is currently $18 trillion. In 2005, it was less than $7 trillion, about $6.5 trillion. Once the housing market cools down, part of this money will still be needed.”
There is another factor. Asset securitization is still packaged, but if the mortgage is placed in the asset package, no company in charge of collecting money is willing to advance compensation anymore. “So I don’t expect subprime real estate to fall as sharply as it did in 2008.”
As long as the price of something increases, production will increase as well, but because of the pandemic, this law does not hold. Housing prices have gone up, but production has not. Of course, the reason for this phenomenon is likely temporary. As the pandemic eases, the supply shortage will also ease. “The real estate market will cool down, but it will cause a sharp decline.”
Where is the best place to put your money right now?
A participant asked where it would be best to invest money now. Mr. Xu believes it is not appropriate to invest too much in the bond market right now, as the Fed is about to raise interest rates. He also believes that problems such as the high leverage ratio of companies caused by the low interest rate environment up until now will be reflected with a drop in the stock market, but it is hard to say when the turning point will be. He believes that inflationary pressures will still exist in the next one or two years, and the rapid growth of labor costs will be maintained for a period of time. Real estate investment, as a relatively effective investment to resist inflation, should still be optimistic. The key is to grasp the timing of the decline in demand for building and purchasing houses caused by the Fed raising interest rates.
He quoted an adage “Time in the market is more important than timing the market.” He suggested taking into account the risks of investment and holding currency while using active investments to diversify capital gain asset appreciation.
North Carolina is a Rare Investment Opportunity Area in the United States
Dr. Xu affirmed and praised North Carolina’s investment environment, “In the United States, there are not many places like the North Carolina Research Triangle.”
He believes that North Carolina has the advantages of both southern and northern states in many aspects. For example, it has a good local business environment with many business-friendly laws and policies. It also has a good educational and scientific research resources with the large-scale presence of companies such as Apple, Google, and Toyota. Digital technology, biotech, finance, automotive, aviation, and other industries have developed rapidly, attracting people from all backgrounds across the country to migrate to North Carolina. The new population will increase the demand for auxiliary industries such as clothing, food, housing and transportation, thereby creating more business opportunities. A larger population and a larger economy will increase the tax base of the local government, thereby enabling the government to provide better public services, forming a positive cycle.
Eden Cai, chairwoman of GardenStar, spoke in agreement.
Nearly 40 guests attended the meeting including:
- Lin Xinwei and his wife, entrepreneurs from North and South Carolina and Georgia.
- Yang Jianping, chairman of the North Carolina Chinese Federation.
- Li Bin, Yao Guoxun, Guan Shihui, directors of the American Chinese Scripture Association.
- Secretary-General Ou Hong.
- Guangya Liu, Cary Town Councilwoman
- Hongbin Gu, Former Chapel Hill Town Councilwoman
- Tony Xie, entrepreneur of the North Carolina Chinese Loan Company.
- Cheng Candong, Secretary General of the Board of Directors of the North Carolina Chinese Enterprise Association.
- Liu Yang, Vice President of the North Carolina Chinese Scholars China-US Exchange Association.
- Hai Ying, David Wu, TransGlobal Holding Company