Congress Seeking To Stop CRE ‘Infection’

Written by Jessica Lillian
on February 11, 2010 No Comments
Categories : From The Orb

Once again, commercial real estate's continued woes have prompted intense concern and investigation in the U.S. Congress. As other sectors of the economy edge toward recovery, underwater commercial mortgages, weakness in property fundamentals and other marks of the CRE crisis are spurring additional calls for regulatory action.

Last week, Reps. Paul E. Kanjorski, D-Pa. (and chairman of the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises) and Ken Calvert, R-Calif., mailed an urgent letter to Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke.

The letter, which was co-signed by 77 other members of the House of Representatives, focused on the effects of the commercial mortgage liquidity crisis on business owners and, by extension, overall job-creation and job-retention trends nationwide.

‘In order to safeguard the businesses operating on Main Street and protect the millions of jobs depending on commercial real estate, the Treasury and the Federal Reserve now must take needed and urgent action to stave off a potentially devastating wave of commercial real estate foreclosures and bank losses,’ Kanjorski and his colleagues wrote.

The authors recommended three specific regulatory actions. First, with loan modifications often complicated to the point of impossibility by layers of securitization and other complex structures, regulators were instructed to implement ‘a clear method for measuring and evaluating the effectiveness’ of modifications performed in accordance with guidance issued by the Federal Deposit Insurance Corp. in October 2009.

Kanjorski and his colleagues also called for the establishment of metrics to help lending institutions accurately differentiate between performing and nonperforming loans, and instructed Geithner and Bernanke to ‘make clear public statements’ encouraging lenders to extend credit for performing assets. Doing so, they explained, would help inspire confidence in CRE and restore long-term value in the market.

The lawmakers stressed the need to take action on CRE ‘before it becomes a full-fledged crisis, forestalls our economic recovery and possibly requires additional taxpayer-funded capital injections.’ However, by many accounts, at least a portion of that feared situation has already become reality.

Today, a ‘deeply concerned’ Congressional Oversight Panel (COP) released a report titled ‘Commercial Real Estate Losses and the Risk to Financial Stability.’

Perhaps most dramatically, the panel members concluded that a ‘significant wave’ of commercial mortgage defaults over the next four years would ‘trigger economic damage that could touch the lives of nearly every American.’

The 189-page report, which traces the roots of the current crisis back to over five years ago – when some banking supervisors first began to note concerns about an ‘overconcentration’ in CRE lending – describes the multi-pronged effects of the troubled loans today.

Due to the nature of CRE lending and the once-dominant commercial mortgage-backed securities (CMBS) market, small banks, medium-sized banks and large banks alike now face steep losses, according to the COP.

‘The CMBS market was able to siphon off the highest-quality commercial properties through lower interest rates and more allowable leverage,’ the report notes. ‘Banks, particularly mid-size and small banks, were left lending to transitional properties or construction projects with more uncertain cashflows or to less-sought-after properties in secondary or tertiary markets.’

For small banks with high exposure to CRE loans, the problem is compounded, and the effects spread far beyond each local bank initially affected.

‘The withdrawal of small-business loans because of a disproportionate exposure to commercial real estate capital creates a negative feedback loop that suppresses economic recovery: Fewer loans to small businesses hamper employment growth, which could prolong commercial real estate problems by contributing to higher vacancy rates and lower cashflows,’ the COP wrote.

Although the report does not specifically endorse any particular intervention proposals, such as the measures suggested in Kanjorski's letter, the authors include a general call to action addressed to the federal government.

Should that intervention take the form of continued support through stability-inducing government programs such as the Troubled Asset Relief Program (TARP) and the Term Asset-Backed Securities Loan Facility (TALF)? The COP's analysis shows these programs have had only a possible – and limited – effect on the CRE market.

‘Until now, to the extent that the TARP has had any impact on the commercial real estate sector, that impact has been centered around the CMBS market; the TALF focuses on securitizations, and the [Public-Private Investment Program] is designed to buy legacy securities – that is, already-issued mortgage-backed instruments,’ the report explains.

‘In light of the fact that large banks tend to have more exposure to securitized commercial real estate loans than smaller banks do, and smaller banks tend to have more relative exposure to whole loans, the TARP's assistance in the commercial real estate market has been confined mostly to the large financial institutions,’ the report continues.

Moreover, COP members Paul S. Atkins (former Securities and Exchange Commissioner) and J. Mark McWatters concurred with the overall conclusions in the report but cautioned against additional use of TARP and the like as a means of preventing CRE disaster, arguing that ‘propping up’ struggling institutions constitutes a moral hazard.

‘Although some financial institutions may struggle or even fail as a result of their ill-advised underwriting decisions and the resulting overdevelopment of the CRE market, any taxpayer-funded bailouts of these institutions will inject unwarranted moral hazard risk into the market and all but establish the United States government as the implicit guarantor of any future losses arising from distressed CRE loans,’ Atkins and McWatters wrote.

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