As the economy continues on its gradual path to recovery, signs of another major crisis are emerging – this time in the commercial real estate sector. If the problems in the sector are not dealt with quickly and ruthlessly, they have the potential to throw the recovery off track and plunge the economy back into recession.
Over the next 3-4 years, almost $1.4 trillion worth of commercial real estate loans would have to be refinanced. The problem is that about half of these loans are against properties that have seen a sharp drop in value, which means that a large percentage of these loans are set to go bad.
According to estimates of a congressional panel, the bad loans would lead to losses that could easily hit the $300 billion mark. This would be terrible news for many medium and small banks that have too much exposure to the commercial real estate market. The panel warned that the number of banks affected would be as high as 3,000. The crisis would not only threaten the existence if the banks, it would also hit the broader economy hard as these banks are instrumental in the smooth functioning of many local and state economies.
As of now, there are no measures directed at nipping this crisis in the bud. In fact, measures like TARP (Troubled Asset Relief Program), which were introduced in 2008 to save the financial system, are gradually tapering off. They would be largely ineffective by the time things really get serious in the commercial real estate market.
One of the measures that some policy makers have suggested is to stress test the banks to identify the most vulnerable ones so that targeted support can be offered to them. This plan is not considered practical by the Treasury Secretary as the number of banks under threat is too high for any detailed analysis.
Another remedy being suggested is that the regulators should allow the troubled banks to extend the loans that are about to turn bad instead of writing them down as losses. However, this might only delay the inevitable as there are no clear signs yet of a strong price recovery in commercial properties.
The last resort would be for the government to come forward and support the banks directly by either buying their toxic assets or providing them capital to stay solvent. But with all the focus right now being on reducing deficit, there is no guarantee that the Obama administration would be prepared for such a move.